allow ships to be built in a manner approaching assembly line fashion. The immediate payoff is shorter construction times and reduced construction costs.

In addition to the shipbuilding industry transition, the suppliers of steel, pumps, engines, pipe, etc., are going through similar lean periods. Manufacturing lead times have decreased significantly over the past 12 months, thus helping to reduce construction times and costs. Since a large percentage of a ship's cost is actually for material from suppliers, the supplier base adjustment also contributes to lower overall ship costs.

Recent award experience indicates that actual awards have, in general, been lower than the funds available for those awards. While some of the savings can be attributed to lower than anticipated inflation rates (4.4 percent) actually experienced during fiscal year 1982 compared to 9.6 percent forecast in January of 1982), bid prices also have been lower than experienced in the past, particularly where there has been competition.

Current experience of favorable contract awards for prime shipbuilding programs, a changing shipbuilding industry characterized by intense competion for and dependence on Navy work, and a Navy shipbuilding program that over the next 5 years will emphasize proportionately higher numbers of less complex auxiliary ships-taken together give high confidence that our acquisition policy improvements are valid and that we will be able to execute our shipbuilding programs, in total, within current Navy estimates. Consequently, the Navy maintains that there is absolutely no validity to suggestions that the current budget is underfunded by $5 billion for 1984-1988, or that overruns can be expected.

Senator LEVIN. What are the remedies you mentioned as available to the government to recoup from contractors overrun costs caused by poor contractor performance? In the past 5 years, how many times has the Navy resorted to these remedies and how much was recovered?

Mr. SAWYER. The "remedies" available to the Government lie within the terms of the contract. In the case of fixed price incentive contracts, which are the most prevalent type for ship construction, the incentive feature provides the remedy. If the contractors' actual cost of performance is less than the target cost, the Government benefits from the reduced cost and the contractor earns additional profit. If the actual cost exceeds target cost, the Government pays a portion of the additonal cost, but the contractors profit is reduced. Therefore, any recoupment is in the form of the contractor sharing in the "overrun" of the target cost. We do not view this natural effect of an incentive feature as truly being a remedy nor the final sharing of above or below target costs as "recovered" costs. Our contracts also provide the additional remedies concerning default and termination provided for in our standard clauses.

SHIPBUILDING CONTRACTS

Senator LEVIN. What type of contracts does the Navy have for each of its major shipbuilding programs? In each case, provide the sharing arrangements between the contractor and the government for cost underruns (savings) or overruns, both above and below the target and ceiling prices.

Mr. SAWYER. The Navy uses the following types of contracts for its major shipbuilding programs:

Cost Plus Fixed Fee (CPFF).

Cost Plus Award Fee (CPAF).
Cost Plus Incentive Fee (CPIF).

Fixed Price Incentive (FPI).

Firm Fixed Price (FFP).

Each of the following programs have the type of contract identified. Types of contracts and their sharing arrangements may vary from program to program or may vary between contracts within a program. When the sharing arrangement is identified, i.e. 70/30, the 70 means that the Government's share of the underrun or overrun of target cost is 70 percent and the contractor's share is 30 percent. When the incurred costs reach the ceiling price, the contractor absorbs all costs. Therefore, there is no sharing of overruns above ceiling price. As CPAF and FFP contracts do not have a sharing arrangement, where such type of contract is identified, no sharing arrangement is shown. Contracts identified within a Program as a "Flite" or "Group" means that, as the program is funded by the Congress, the quantities are combined into a Group or Flite for ease of identification. The First Flite or Group is the earliest funding of that program and the latest Flite or Group is the most recent funding.

[See contract type table submitted to question asked by Senator Cohen.]

SHIPYARD ADVERTISING

Senator LEVIN. Who pays for the advertising about Navy programs by shipyards producing Navy ships-the Navy or the shipyards? How does the Navy determine that it is not being billed—directly or indirectly for these advertising costs? Do the contractors identify their advertising costs in documents submitted to the Navy?

Mr. SAWYER. The Defense Acquisition Regulation (DAR) restricts the payment of advertising costs received in the performance of DOD Contracts to (1) recruitment of personnel required for the performance of the contract; (2) procurement of scarce items for the performance of the contract; (3) disposal of scrap or surplus material acquired in the performance of the contract. DAR specifically disallows advertising costs related to sales promotion. The Navy ensures that it is not being billed, either directly or indirectly, by periodic audits performed by the Defense Contract Audit Agency which applies the DAR criteria for allowability and allocability of costs chargeable to DOD contracts. Cost Accounting Standard 405 requires contractors to identify and exclude from any billing, unallowable costs.

UNUSUAL CLAUSES IN THE LEASE AGREEMENT

Senator LEVIN. There has been talk in the Congress of amending the provisions in the tax code to remove the incentive for long-term leasing of this type of equipment to the federal government. If such changes were made, what would be the status of these contracts?

Is it true that the Navy has indemnified the Shipbuilders against changes in tax code?

Mr. SAWYER. The Navy has not indemnified the Shipbuilders for anything. The TAKX contracts provide that capital hire payments will be adjusted in the event there is a change in tax law between the date of the best and final offer (August 17, 1982) and the delivery of each ship. Since the charter hire pricing was based on the then current tax law, this provision protects both the shipowners and the Navy since neither is able to predict the impact of possible changes in tax law during the next two or three years.

Senator LEVIN. What about adverse rulings by the Commissioner of the IRS on the designation of the contract between the operator and the Navy as a service contract?

Is it true that the Navy has indemnified the shipowner against adverse rulings by the Commissioner of the IRS?

Mr. SAWYER. The charter hire rates in the contract are based on the assumption that the time charter is a service contract and the shipowner is entitled to claim the Investment Tax Credit. The contracts provide that in the event the IRS rules that the time charters are not service contracts and Investment Tax Credit is not available, then the charter hire will be adjusted accordingly. This would increase charter hire approximately $2.8 million per year per ship. It's noted that without such a provision, the shipowners would have originally priced the charter hire on the assumption that the Investment Tax Credit was not available and thereby reaped a windfall if it was later determined to be available.

Senator LEVIN. Is it also true that the Navy has promised the shipowner the cost of legal counsel for any ruling the Navy agrees to challenge?

Mr. SAWYER. The Navy is only obligated to indemnify the shipowner for legal expenses incurred in contest actions with the IRS in the event the Navy requests such action. It's inconceivable that the Navy would make such a request unless it's necessary to seek a clarification of the extent and cause of a disallowance.

Senator LEVIN. Since when does one branch of the government offer to pay a contractor's legal costs to challenge another branch of the government?

Is this type of clause ever included in other Navy contracts?

If so will you please provide examples for the record?

Mr. SAWYER. The payment to be made by the Navy is in the nature of an equitable adjustment. A contractor's legal expenses incurred in preparing and documenting a request for an equitable adjustment are allowable costs under Defense Acquisition Regulations. The contest action with the IRS which is contemplated by this provision is in the nature of an administrative proceeding to seek additional clarification and explanation from the IRS so that the exact extent of the equitable adjustment due from the Navy may be determined. It must be kept in mind that the Navy has not provided a blanket indemnity for all loss of tax benefits for any reason. Rather, the Navy's indemnity obligations only cover a few very narrow events and only a portion of the shipowner's tax benefits. Thus, a disallowance action by the IRS could cover a number of events that are not covered by the Navy's indemnity obligation as well as

those that are. Therefore, it may well be necessary to compel further administrative action by the IRS to delineate the exact causes and amounts of disallowance for which the Navy might be responsible.

HIDDEN COSTS ISSUE

Senator LEVIN. To what extent does the choice to lease ships reflect the Navy's belief that it doesn't have the money to buy the shipbuilding program it believes it needs and is attempting to let reduced tax revenues foot part of the bill?

Mr. SAWYER. The decision to charter the TAKX ships was not made because the Navy believed that Congress would not appropriate money to purchase these vital ships. Rather, the decision was made because chartering is in compliance with policy of Congress, as expressed in the Merchant Marine Act, 1936 as amended, and the Navy to rely on the U.S. Merchant Marine to meet defense ocean transportation needs to the extent practicable. In addition, the Navy believes that chartering is a more cost effective and expeditious method of procuring this transportation service than purchasing the ships.

Senator LEVIN. To what extent is this idea an attempt to move these ships out of the highly visible procurement accounts of the budget and into the less scrutinized O&M accounts?

Mr. SAWYER. The decision to charter the TAKX ships was not in any manner an attempt to reduce the visibility of the program. A complete report and numerous briefings on the program were given to the House and Senate Armed Services and Appropriations Committees and their staffs. In addition, hearings were held by the Readiness Subcommittee of the House Armed Services Committee in September 1982 prior to the finalization of contract awards.

Senator LEVIN. How can we be certain that Navy still retains the incentive to select the least costly method of procurement when the agency is not accountable to the Congress, or anybody in the government for the full purchase price of the items it buys?

Mr. SAWYER. The Navy has and will continue to exercise prudent management and business judgment in all its procurement decisions regardless of the degree of visibility or procedural accountability. It is also anticipated that OMB will provide more definitive guidelines and procedures for future chartering or lease vs. purchase decisions.

Senator LEVIN. What would be the costs involved in extricating ourselves from these contracts?

Would those costs be greater than the $270 million extra being paid for these ships over the life of the contract?

Mr. SAWYER. The Navy believes that chartering the TAKX ships is less expensive for the Navy and total Government than a purchase. The alleged $270 million of extra costs comes from a February 25, 1983 report prepared by the Staff of the Joint Committee on Taxation (JCT). The methodology and assumptions utilized by the Staff of the JCT were very different from the methodology and assumptions utilized in the four prior analyses prepared by experts inside and Government. The conclusions reached in all four prior analyses was that chartering the TAKX ships was substnatially less expensive than purchase. Bascially, the Staff of the JCT used a pre-tax methodology which counted all tax outflows but only a portion of the tax outflows in the transaction and also assumed that a Government purchase would have been 100 percent financed by the issuance of a Treasury debt. The other studies used an after-tax methodology and assumed a Government purchase for cash. If, upon completion of its review of the program, Congress is still convinced that chartering is in fact more expensive than purchasing, the Government has the contractual option of purchasing the ships upon completion rather than going forward with the charters. The Navy could also terminate the contracts for convenience but that would cost at least several hundred million dollars and substantially delay the availability of the sealift capability vital to the Rapid Deployment Force.

QUESTIONS SUBMITTED BY SENATOR HENRY M. JACKSON

SHIPYARD SECURITY

Senator JACKSON. Mr. Sawyer, what actions are contemplated in the next fiscal year to address the problem of shipyard security?

Mr. SAWYER. Action has been taken at Newport News Shipbuilding and Electric Boat, as well as at the Naval Shipyards. Currently, Electric Boat Division and Newport News Shipbuilding and Drydock Corp. have submitted proposals for

upgrading physical security, in response to a Navy Request for Proposal. These proposals are currrently being evaluated. Additionally, the Naval Sea Systems Command is planning to evaluate the effectiveness of a variety of security systems which can be applied in shipyards. An array of intrusion detection systems and surveillance systems will be tested. Further, naval shipyards are reviewing and upgrading security procedures including: personnel access controls (badging), surveillance systems, security training for all personnel, formal support agreements with local, federal, military, state, city/county law enforcement agencies, and ship forces.

Senator JACKSON. Mr. Sawyer, if corrective measures are planned, what is the estimated cost to the Navy for this effort? Does the Navy have funds available or already earmarked for this purpose?

Mr. SAWYER. While the Navy has identified the general type of security/control required, the specific equipment needs have not been identified. Therefore final cost estimates are not yet available. Preliminary estimates of one-time costs for installing effective physical security systems range from $2 to $4 million per shipyard. An additional $2 to $3 million per shipyard is estimated to be required annually to accomplish security system training, maintenance, and personnel upgrade. Initial requirements will be funded by reallocation of current Navy resources. Outyear requirements will be programmed and budgeted in accordance with normal Navy and DoD procedures.

Senator JACKSON. Mr. Sawyer, in response to a breakdown in security at Electric Boat, the Armed Servies Committee held a hearing last August on general security conditions at civilian and military shipyards. Since that time, what has the Navy done to improve security at these shipyard?

Mr. SAWYER. The Navy established a Shipyard Security Review Group that studied the problem and made recommendations on how to improve shipyard physical security. These recommendations are being implemented by the Naval Sea Systems Command's Shipyard Physical Security office. Electric Boat and Newport News have responded to a Navy Request for Proposal to improve security. These responses are currently being evaluated. Navy shipyards were directed to make certain immediate improvements within available resources and to provide plans for long-term improvements to the Naval Sea Systems Command for a coordinated review.

Senator JACKSON. Mr. Sawyer, in addition to potential damage to Navy vessels and shipyards, and the possible loss of classified data and technology, does the security problem at our shipyards also include the theft of Navy material?

Mr. SAWYER. Theft in shipyards is a potential problem as it is any industrial activity with large numbers of employees and substantial amounts of pilferable material. The Navy has an on-going program to reduce theft losses. Some of the improvements undertaken to improve physical security will also help to reduce the potential theft opportunities.

Senator QUAYLE. Thank you, gentlemen, for your cooperation. The committee is adjourned.

[Whereupon, at 12:30 p.m., the subcommittee proceeded to other business.]

DEPARTMENT OF DEFENSE AUTHORIZATION FOR APPROPRIATIONS FOR FISCAL YEAR 1984

WEDNESDAY, MARCH 23, 1983

U.S. SENATE,

SUBCOMMITTEE ON SEA POWER AND FORCE PROJECTION,

COMMITTEE ON ARMED SERVICES,

Washington, D.C.

U.S. CENTRAL COMMAND AND U.S. READINESS COMMAND The subcommittee met in open session at 2:05 p.m., in room SR232A, Russell Senate Office Building, Senator William S. Cohen (chairman) presiding.

Member present: Senator Cohen.

Staff present: L. Wayne Arny III and James R. Locher III, professional staff members; Drew A. Harker, Mark B. Robinson, Judith A. Freedman, research assistants; and Kathleen L. McGuire, staff assistant.

Also present: Jim Dykstra, assistant to Senator Cohen; Arnold Punaro, assistant to Senator Nunn; Bill Lind, assistant to Senator Hart; and Peter D. Lennon, assistant to Senator Levin.

OPENING STATEMENT BY SENATOR WILLIAM S. COHEN,
CHAIRMAN

Senator COHEN. The subcommittee will come to order. This afternoon's session concerning the U.S. Central Command and the U.S. Readiness Command is the subcommittee's first hearing this year on force projection issues. These two unified commands are at the forefront of U.S. force projection planning and execution.

The U.S. Central Command has geographic responsibility for the Persian Gulf/Southwest Asia region which has been the main focus on U.S. rapid deployment plans and programs. The U.S. Readiness Command has responsibility for U.S.-based strategic reserve forces which would be reinforcing units in times of crisis.

The principal purpose of this initial force projection hearing is to provide an understanding of force projection organizations and relationships, their mission responsibilities, and the resource growth allocated to the various headquarters.

Not only are these topics within the oversight responsibilities of the subcommittee, but in addition, this understanding will be useful as the subcommittee addresses force projection programmatic issues in subsequent hearings.