The director of the White House’s Office of Management and Budget has surprised senior Defense Department officials by proposing a series of caps on annual military pay raises, starting in January 2004.

With U.S. troops battling terrorism and amassing in the Persian Gulf for possible war with Iraq, Mitchell E. Daniels Jr., director of OMB, has asked Defense officials to expect to cap the 2004 military pay raise at 2 percent, versus the 3.7 percent planned, government sources said.

Moreover, Daniels wants future military raises tied to inflation — the annual rise in cost of living — rather than to wage growth in the private sector. That could reduce the competitiveness of service pay, but it also would save the government billions of dollars over the next decade, sources said.

The proposed pay cap for 2004 alone would save $1 billion in its first full year. A 2 percent military raise also would match the raise penciled into the administration[’s budget for federal civilian employees.

A senior military officer said confidently that he didn’t expect the OMB plan to survive final scrutiny within the administration. If, as expected, the Department of Defense opposes the pay raise guidance, President Bush himself could be asked to decide the issue.

Daniels’ pay raise plan is aimed at easing a federal budget deficit that is beginning to soar, the result of an economic recession, sharp stock market declines that cut taxable gains for businesses and investors, and higher spending on defense and homeland security.

The federal deficit for fiscal 2002 hit $159 billion. Only a year earlier, the government reported a surplus of $127 billion.

“It’s now clear that the unexpected surge in revenues toward the end of the last decade was temporary, and that revenues are returning to historic levels,” said Daniels in announcing the deficit Oct. 25. Given that, and new spending to address terrorism, “it is absolutely essential that we set aside business as usual and keep tight control over all other spending.”

Business as usual for military pay in recent years has been above-average raises to make up for earlier caps. Until the OMB guidance, DOD assumed a 3.7 percent military raise in 2004, based on a 1999 law that set pay adjustments a half percentage point above annual wage growth in the private sector as measured by the Bureau of Labor Statistics’ Employment Cost Index. ECI-plus-a-half was to run through 2006 to narrow a vaguely defined “gap” between military pay and private sector wages.

With Congress adhering to this formula for a fourth year, servicemembers next month will get a minimum pay hike of 4.1 percent — one half of a percentage point above wage growth measured by last year’s ECI.

Members in select ranks and grades, for a second year in a row, will receive even higher raises. The “targeting” this year is aimed at making the pay of senior enlisted and midgrade officers more competitive with private sector peers based on educational background.

Daniels wants to shelve not only the ECI-plus-a-half but any link to private sector wage growth, a source said. Instead, he wants raises linked to the Consumer Price Index which tracks the cost of goods and services. OMB projections show raises tied to inflation, rather than wage growth, will save a lot of money over the decade.

Recent history illustrates the impact. Federal retirees, Social Security recipients and veterans drawing VA compensation will receive a cost-of-living adjustment of 1.4 percent this month, based on the CPI. Yet the ECI used to set next month’s military raise came in at 3.6 percent.

Congress adopted the ECI-plus formula in 1999 when the services faced serious recruiting and retention challenges. It was to close a perceived pay gap gradually. The manpower challenges have eased for active forces, but the war on terror, and homeland security demands, resulted in 130,000 reserve and National Guard forces being called up in the past year. Thousands of troops are deployed to the Persian Gulf, readying for war should Bush give the order.

That’s why Defense officials are said to be shaking their heads at the timing of the OMB’s call to cap military raises in 2004 and beyond.

But besides above-average pay raises, which began in January 2000, manyservice members have received bigger re-enlistment bonuses. Roughly 750,000 members living off base in the United States are seeing housing allowances rise faster than rental costs, through 2005, under another initiative to eliminate out-of-pocket rental costs. Pay, overall, has improved.

No OMB or Defense official would comment on the record about pay raise plans for 2004. One source called the issue “extremely sensitive.” In a Washington Post story about federal agencies being told to plan for a two percent raise for civilian employees in 2004, OMB spokeswomen Amy Call said the guidance was not set. “This is definitely one the president will make a decision on,” she said.

That’s all the more likely if the Joint Chiefs argue wartime morale could be at stake.

A final administration decision on pay raises likely will be unveiled in February when the president sends his proposed budget to Congress. If it calls for a military raise of 2 percent in 2004, Congress still could reject it in favor of the 3.7 percent raise backed by law. Or lawmakers could make a small concession to deficit woes. With a 3.2 percent raise, military pay at least wouldn’t lose ground again to private sector wages.

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