Government Assistance and Private Economic

• Author: First Lieutenant Alvin K. Helieratein and Organization for Defense First Lieutenant Richard E. Speidel
• Pages: 03

1. INTRODUCTIOS

   The voluminous defense requirements of the Vnited States,' while beneficial la ihe economy a8 a whole, severely strain the capacity and ingenuity of private producers who undertake to satisfy them. The complexity of military technology and its dependence upon specialized property, know-how and continuing research and development necessarily reduce the number of producers who are able to perform. Further, the unusual buainess riaks vhich inhere in the inconstancy of defenae procurement make othervise capable producers unwilling ta perform Government contracts unless these risk8 can be reduced and a fair profit assured. This is paradoxical since an underking procurement goal is maximum competition snd a broad distribution of Government work.? To the extent that private producers are unable or unwilling to perform defenae contracts the benefits in price and Quality which the Government obtains from maximum competition are decreased. The net effect of this may be a few contractors performing a large percentage of defense conzracts wi:h a minimum distribution of

   '

   Formerly member of F8cu.r) of Ihe Judre Advocate Geceral'n School, U.S. Army, Charlartesville, Ylrplma, member of the Nerr Tork Bar; graduate of Columbia Lhwemtv Lnn School.

   appraxlmstely 107 Of the gro

   DEFESSE, PROCUREMENT PSL'BCOIIXITTEE OF THECSITED STATE8 SEX\TATE 1-2

   C.S.C. &631(a) (19663' "The essence of :he of pni-ste enterprise IS free eompetiti~n , , , T

   security of this Nation . , . ./'

   A00 1SO'OB

   on and expansion

   work to small business.3 But of equal importance, the capacity of industry to develop, manufacture and deliver superior weapons in the event of World War Ill may be jeopardized.' A basic purpose of Government assistance, therefore, is to facilitate defense production by increasing the number of prime contractors and subcon. tractors who are willing and able to satisfy the Government's needs. The nature and effectiveness of this assistance is the subject of this article.

   11. TYPE OP COSTRACT: PROFIT AND RISKStandardized or \%-ell defined products with predictable costs are procured by the Government through formal advertising. Competition among qualified bidders insures realistic pricing and the nature of the item purchased minimizes business risks.8 Since no special incentives are needed to attract bidders, the Govern. ment is more concerned i%-ith whether the successful contractor receives an excessive profit than vjith whether the profit margin is fair.@ In much defense procurement, however, changing requirements mitigate against standardization and cost certainty. The Government is actually buying services and teehnisues rather than well defined products. These needs both limit the pool of

   GOV'T. ASSISTANCE AKD PRIVATE ECOXOYIC ORG.

   available contractors and increase the business risks of those to whom contracts are awarded. Consequently, the Government must maintain the attractiveness of defense prwurement by insuring a fair profit to contractors. This can be accomplished by minidizins or eliminating certain business risks through the use of a proper type of contract7 or appropriate contract clauses.

   A few illustrations are appropriate. If a negotiated fixed-price contract is used where production costa are uncertain, price flexibility is maintained by price redetennination provisions.8 By this technique, the contractor's profit margin is protected from a cost overrun. If the contractor is required to develop a new product, a termination for default in the event that a definite delivery date is not met is unrealistic.' Accordingly, the contractor may be awarded a special incentive contract which rewards success by higher profits but does not unduly penalize failurelo or may be required to use "best efforts'' rather than deliver within a Spd-fied time." Finally, the Government will, in certain eases,

   7 Type of eontiact in this eontext refers to the method by which the con- tractor is compensated rather than the contract form OY end purpose. The head of a prwuiement agency may award any type of negotiated contract "that he considers will promote the best interests of the United States." 10 US.C. $2306(a) (1858). While the Government's intemd is proteeted by flexible and realistic pricing, the contractor also benefits when the tme af contract used redueen pricing risks which affect profit. Ct. COHEN, LAWAND THE SOCIAL ORDER 110-111 (1835) (primary purpose of contractu and eontraet iaw is to distribute risks in eomalieated tranraetiom).

   UASPR b403.3 (4 Apr 1855); ASPR 7.109 (20 Apr 1958). Where a new

   product is rewired and pmduetion emti are uncertain. the parties will negotiate an initial fired priw bnsed upon estimates of Cost. This will be avbiwt ta redetermination at a future date in light of actual production costs.

   Q

   For an illustration of the problems whieh might arise when rraeareh and development work is done under a fixed.priee emtract mquiring deiivem of an acceptable product within B specified priod of time, see Aeioaanio lmtnc man! COT., ASBCA No. 4128, 12 March 1868, DA Pam 715-6045, pap. 6. See also. 37 Comp. Gen. 239 (19571. If B termination far defavit is pioper, the contraetar receives neither profit nor costs far vdnished work and may be liable for the excess mats of B repurchase.

   10The Gwernmmt awards both performance and cost typo incentive con- tracts. In the former. the contractor earns more profit if standard8 of performance exceed minimum eontract requirements, ASPR 3-408 (20 Apr 18591, and in the latter a higher profit ii Paid if produetion cost8 are kept below estimates, ASPR 3-403.3 (iii) (b) (14 Hay 1958). In both imtaneps, P failure to meet desired Cost or performanee atandords results only in B profit redudion. See DEPARTMENT OF DEFENSE, PROCUREMENT PRE-SENTATION, o n oi!. auva note 1, at 28 (discussion of special performanee ineentiva).

   *GO 10041B 101

   LLASPR7402,2(a) (30Jun1858); ASPRT-402.4 (1 Oet1858).

   indemnify contractors against extra-hazardous risks.'Q Thus, flexible pricing, realistic standards of work and indemnification, particularly in negotiated fixed-price contracts, protect the contractor'8 profit margin and reduce the chance of sustaining a loss.

   The coat-plus-fixed-fee type contract, which is used primarily far research and development, provides maximum insulation against busineaa riski.13 Consequently, profit has been arbitrarily limited to fixed percentages of estimated c03t.5 at the time of contracting.l4 It has been suggested that higher fees would attract better research and development and encourage more amail busi-ness participation:j Further, since the fee is based upon esti-mated cost3 at the time of contracting and does not accelerate in the even: of an overrun, it may be unrealistic. Yet in evaluating the adequacy of the cost-phs-fixed-fee profit allowance, it is important to recognize that profit incentive in research and development varies with the type of project and the contractor involved. Non-

   GOY'T. ASSISTANCE AND PRIVATE ECONOMIC ORG. profit institutions, for example, receive no fee. On the other hand, profit making firma may not demand a large fee if the project involves basic research which must be done to maintain business standing or will afford valuable experience in future Government supply eantracts.16 Finally, the Secretary of Defense has power to approve fixed fees up to 15% of estimated costs." This provides fiexibility where extra incentive is required in particular eases.

   The risk of doing business with the Government cannot be eompleteiy eliminated by the type of contract or contract clause used.18 Yet a steady flow of qualified producer8 can be maintained by a choice of contract which minimizes risks and insures a fair profit. While this is a form of assistance to the contractor, it also contributes to realistic pricing and is in the Government's beat interest.

   111. ORGANIZING A PRODUCTION BASE

   A contractor must possess specialized and expensive capital equipment and maintain a continuous program of expansion and replacement to perform defense contracts. This section will examine the methods whereby the Government assists business in attaining the necessary capacity for defense production: tax assistance, small business loans and investment, loans under the Defense Production Act of 1950 and Government furnished property.

   1. Asriztanee LTnder the Tas Laws

      Under section 167 of the Internal Revenue Code of 1954, any business map deduct from gross income a reasonable allowance for the exhaustion, wear and tear and obsolescence of property used in a trade or business or held for the production of income.10 These yearly depreciation deductions reduce both taxable income

      18 It has been asserted that the primary inducement for firms to undertake research and development NOT.' in the increased ability ta obtain more profitable production contracts erawmg. aot af the research. Jlrmo lo? the Amistent Seoratary o i Defense (Supply and Logiiticsl, AFXPP-PR (30 Jun1858). This increased abiiiry constitutes adequate conaideration to support B

      Government contract, Penn8yLon;o Breharge Bank V. Cnited States. 110 F. Supp. 629 (Ct. Ci. 1968), but I? madequa!e to make the contractor subject to state po~~es80ryinterest taxes. lh-nitrd States Y. Livingston, 179 F. Supp. 9 (E.D.S.C. 19591.

      17 see nvpra, note 11.18 See Noviek & Springer, Eeoriomios of Defense Pracvrrmeni and SmaU Buaeness. 24 LAV. & COKTEXIP. PROB. 118 (19691. 1) IKT. REV.

      CODE of 1964, 8 167 (8).

      *@a LP04IB 103

      NILITARY LAW REVIEW

      and the price of the capital acquisition.20 Despite language which permits a deduction for obsolesenee, depreciation procedures under section 167 foeus on durability rather than useful life. In a period of rapid technological advance and increased business efficiency, machine twls are being written off for tax purposes in 15 to 20 years when the useful life in terms of technical obsolesence is between 6 and 10 years.21 Further, depreciation allowances are...