With almost 700,000 civilian employees on its payroll, DOD is the second largest federal employer of civilians in the nation, after the Postal Service. Defense civilian personnel, among other things, develop policy, provide intelligence, manage finances, and acquire and maintain weapon systems. Given the current global war on terrorism, the role of DOD’s civilian workforce is expanding, such as participation in combat support functions that free military personnel to focus on warfighting duties for which they are uniquely qualified. Civilian personnel are also key to maintaining DOD’s institutional knowledge because of frequent rotations of military personnel. However, since the end of the Cold War, the civilian workforce has undergone substantial change, due primarily to downsizing, base realignments and closures, competitive sourcing initiatives, and DOD’s changing missions. For example, between fiscal years 1989 and 2002, DOD reduced its civilian workforce by about 38 percent, with an additional reduction of about 55,000 personnel proposed through fiscal year 2007. Some DOD officials have expressed concern about a possible shortfall of critical skills because downsizing has resulted in a significant imbalance in the shape, skills, and experience of its civilian workforce while more than 50 percent of the civilian workforce will become eligible to retire in the next 5 years. As a result, the orderly transfer of DOD’s institutional knowledge is at risk. These factors, coupled with the Secretary of Defense’s significant transformation initiatives, make it imperative for DOD to strategically manage its civilian workforce based on a total force perspective which includes civilian personnel as well as active duty and reserve military personnel and contractor personnel. This strategic management approach will enable DOD to accomplish its mission by putting the right people in the right place at the right time and at a reasonable cost. NSPS is intended to be a major component of DOD’s efforts to more strategically manage its workforce and respond to current and emerging challenges. This morning I will highlight several of the key provisions of NSPS that in our view are most in need of close scrutiny as Congress considers the DOD proposal. The DOD proposal would allow the Secretary of Defense to jointly prescribe regulations with the Director of the Office of Personnel Management (OPM) to establish a flexible and contemporary human resources management system for DOD—NSPS. The joint issuance of regulations is similar to that set forth in the Homeland Security Act of 2002 between the Secretary of Homeland Security and the Director of OPM for the development of the Department of Homeland Security (DHS) human resources management system. However, unlike the legislation creating DHS, the Defense Transformation for the 21st Century Act would allow the Secretary of Defense to waive the requirement for joint issuance of regulations if, in his or her judgment, it is “essential to the national security”—which is not defined in the act. While the act specifies a number of key provisions of Title 5 that shall not be altered or waived, including those concerning veterans’ preference, merit protections, and safeguards against discrimination and prohibited personnel practices, the act nonetheless would, in substance, provide the Secretary of Defense with significant independent authority to develop a separate and largely autonomous human capital system for DOD. The DOD proposal also has significant potential implications for governmentwide human capital policies and procedures and for OPM as the President’s agent and advisor for human capital matters and overseer of federal human capital management activities. In essence, the act would allow for the development of a personnel system for the second largest segment of the federal workforce that is not necessarily within the control or even direct influence of OPM. To strike a better balance between reasonable management flexibility and the need for a reasonable degree of consistency and adequate safeguards to prevent abuse throughout the government, Congress should consider making these provisions of the Defense Transformation for the 21st Century Act consistent with the Homeland Security Act of 2002, or at a minimum, providing some statutory guidance on what would constitute a situation “essential to the national security” that would warrant the Secretary of Defense to act independently of the Director of OPM. DOD states that it needs a human capital management system that provides new and increased flexibility in the way it assesses and compensates its employees, and toward that end, we understand that in implementing NSPS DOD plans to strengthen its performance appraisal systems and implement pay banding approaches as core components of any new DOD human capital system. We have a long and successful experience in using pay banding with our analyst staff as a result of the GAO Personnel Act of 1980. Certain DOD components have had a number of years of experience with pay banding through OPM’s personnel demonstration projects, authorized by the Civil Service Reform Act of 1978, to test and introduce beneficial change in governmentwide human resources management systems. For example, in 1980, the Navy personnel demonstration project, commonly referred to as the China Lake demonstration project, implemented a number of reforms including pay banding and a pay for performance system. More recently, the Civilian Acquisition Workforce personnel demonstration project (AcqDemo) was implemented in 1999 and created a pay banding system that covers part of its civilian acquisition, technology, and logistics workforce. The expected results of AcqDemo’s pay banding system include increased flexibility to assign employees as well as increased pay potential and satisfaction with advancement for employees. According to agency officials, an evaluation to OPM on AcqDemo’s progress is scheduled to be available this June. Lastly, DOD’s science and technology reinvention laboratory demonstration projects all implemented some form of pay banding and pay for performance. OPM reports that these reinvention laboratory demonstration projects have been able to offer more competitive starting salaries. Additionally some labs’ turnover experience was significantly lower among highly-rated employees and higher among employees with lower ratings. DOD’s demonstration projects clearly provide helpful insights and valuable lessons learned in connection with broad banding and pay for performance efforts. At the same time these projects and related DOD efforts involve less than 10 percent of DOD’s civilian workforce and expanding these concepts to the entire department will require significant effort and likely need to be implemented in phases over several years. As you know, there is growing agreement on the need to better link individual pay to performance. Establishing such linkages is essential if we expect to maximize the performance and assure the accountability of the federal government for the benefit of the American people. As a result, from a conceptual standpoint, we strongly support the need to expand broad banding approaches and pay for performance-based systems in the federal government. However, moving too quickly or prematurely at DOD or elsewhere can significantly raise the risk of doing it wrong. This could also serve to severely set back the legitimate need to move to a more performance and results-based system for the federal government as a whole. Thus, while it is imperative that we take steps to better link employee pay to performance across the federal government, how it is done, when it is done, and the basis on which it is done can make all the difference in whether or not such efforts are successful. In our view, one key need is to modernize performance management systems in executive agencies so that they are capable of adequately supporting more performance-based pay and other personnel decisions. Unfortunately, based on GAO’s past work, most existing federal performance appraisal systems, including a vast majority of DOD’s systems, are not designed to support a meaningful performance-based pay system. The bottom line is that in order to receive any additional performance- based pay flexibility for broad based employee groups, agencies should have to demonstrate that they have modern, effective, credible, and, as appropriate, validated performance management systems in place with adequate safeguards, including reasonable transparency and appropriate accountability mechanisms, to ensure fairness and prevent politicalization and abuse. At your request Madam Chairwoman, and that of Senator Voinovich, we identified key practices leading public sector organizations both here in the United States and abroad have used in their performance management systems to link organizational goals to individual performance and create a “line of sight” between an individual’s activities and organizational results. These practices can help agencies develop and implement performance management systems with the attributes necessary to effectively support pay for performance. More specifically, Congress should consider establishing statutory standards that an agency must have in place before it can implement broad banding or a more performanced-based pay program. As the request of Congressman Danny Davis, we developed an initial list of possible safeguards to help ensure that any additional flexibility Congress may grant for expanding pay for performance management systems in the government are fair, effective, and credible. We provided an initial list to Congressman Davis late last week. This initial list of safeguards was developed based on our extensive body of work looking at the performance management practices used by leading public sector organizations both in the United States and in other countries as well as our own experiences at GAO in implementing a modern performance management system for our own staff. We believe that the following could provide a starting point for developing a set of statutory safeguards in connection with any additional efforts to expand pay for performance systems. Assure that the agency’s performance management systems (1) link to the agency’s strategic plan, related goals, and desired outcomes, and (2) result in meaningful distinctions in individual employee performance. This should include consideration of critical competencies and achievement of concrete results. Involve employees, their representatives, and other stakeholders in the design of the system, including having employees directly involved in validating any related competencies, as appropriate.