March 13, 1986

March 13, 1986 | Backgrounder on Federal Budget

"How ,to Privatize Federal Services by ""Contracting Out"""

(Archived document, may contain errors)

494 March 13, 1986 HOW TO PRIVATIZE FEDERAL SERVICES BY "CONTRACTING OW INTRODUCTION Privatization has come of age. The Reagan Administration's FY 1987 budget argues that considerable budget savings can be achie ved without cutting services but by transferring government functions to the private sector-in short by privatization. A major privatization device is "contracting out," an inelegant term to describe what happens when the government hires private firms to provide government services under contract services for some time have been provided by private contractors.

Notable examples include delivery qf sophisticated communications satellites and military weapons procurement potential for budget savings would c ome from the federal government turning to private firms to supply such routine services as data processing, janitorial services, and maintenance work. These are A number of highly specialized goods and But the greatest generally-kn&n as "commercial that a re routinely provided in f inus The Reagan Administration services" because they are activities the private sector by commercial has been committed to contracting out commercial services since 1981, but its efforts have been undermined repeatedly directiv e s, while Congress has erected more than a dozen legislative impediments to contracting out federal services. The result: rather than reducing the size of the federal work force engaged in commercial activities 120,000 additional workers have been added to the federal payrolls since January 19

81. And despite the 1983 recommendation of the Grace Commission that 500,000 government positions be contracted to more efficient private firms, the Administration in 1985 reviewed just 2,381 civilian agency positions as candidates for privatization Federal agencies have been ignoring White House At the current rate, it would take 1001years to conduct cost estimates for every federal commercial activity.

If he truly intends to reduce federal spending, Ronald Reagan mu st make contracting out a top administrative priority seek institutional changes in the contracting out procedure have documented that 20 to 35 percent savings from contracting out are typical. Because contracting out does not reduce service levelsi it pr ovides a painless way to slash the deficit.

In recent months, the Administration has been sending mjxed signals on contracting.

Manaaement ReDort, accompanying the FY 1987 Budget, makes very useful recommendations for facilitating contracting out--most no tably allowing targeted commercial functions to be automatically contracted to private firms withoutzrequiring time-consuming cost comparisons with in-house provision. Yet the Administration seems to be giving these initiatives secondary priority. Greater emphasis seems to be placed on the noble wish, invoked by heads of government from Washington to Moscow, that government productivity be improved.

Rather than concerning itself with making government computer operators more efficient, for example, the White House should be asking why the government hires computer operators at all when private firms could provide them at low, competitive prices.

To accelerate contracting out, the Administration should change the procedure for awarding contracts so that the bias against private firms is removed. In aadition, Congress should overhaul drastically the impediments that it has'erected to contracting out. By working together to improve the process, significant reductions in spending could be achieved without redu c ing services to the American people And he must Studies For instance, the Administration's I HOW CONTRACTING REDUCES FEDERAL SPENDING When the federal goverr.ment contracts out an activity which is commercial in nature, it retains its funding responsibili ty, but relies on private sector competition to assure that the good or service is delivered at the lowest possible cost and at high quality.

The federal government currently employs nearly one million workers who perform 11,000 separate commercial activit ies. This workforce 1. W. Jackson Coleman, "Implementation of O.M.B. Circular A-76 Hearings, Subcommittee on Human Resources, House Committee on Post Office and Civil Service, October 30, 1985 2. For more complete details, see: "Status Report on Federal P rocurement in Office of Management and Budget, Manaaement of the United States Government, Fiscal Year 1987 pp. 92-103 2includes electricians, dentists, janitors, pluqers, caterers laboratory technicians, and even veterinarians.

Since 1931 at least a dozen studies have investigated the potential savings from contracting with private vendors for such services and is being carried out on a limited basis on the federal level. The findings of eight representative studies. are.shown in-Tzrble 1 Such contracting out now is routine in thousands of cities Private contractors tend to be more efficient than their public sector counterparts--not because federal employees are less able, but because they face different incentives. Since private firms operate under compe titive conditions, they have a powerful incentive to seek innovative approaches to reduce the cost of providing their service.

If they do not keep cost down and quality up,.they soon will lose contracts to their rivals No such incentive exists in the public sector. The lack of competition removes the pressure to be more productive. In fact, there are perverse incentives, for if a public sector agency becomes more efficient at providing a service, then that agency is likely to see its budget cut-to reflect the savings-for the next year.

Injecting competition into the procurement process even generates greater efficiency within the bureaucracy. Example: an analysis of cost comparisons in the Department of Defense reveals that the cost of services provided by federal employees fell by 17 percent when they were forced to compete with private firm?.

Department oiler 100 million since 1 982 This'alone has saved the If cont:cacting out were expanded on the federal level, the The Office of Managemeat and Budget's latest Congressional Budget Office envisions a 1.2 billion reduction in government costs projection puts the figure at $3 billio n.

Improveci Service Qualitv The most outspoken opponent of contrncting out predictably has been the American Federation. of. State, County and.Municipa1 Employees 3. Office of Management and Budget Circular No. A-76 (revised August 4, 1983 4. Office of Ma nagement and Budget, "Enhancing Governmental Productivity Through Competition: A Program Report on OMB Circular No. A-76," 1984, p. 7 5. Congressional Budget Office Contracting Out for Federal Support Services: The Potential Savings and Budgetary Impacts, " 1982 6. Office of .Management and Budget, "Enhancing Governmental Productivity Through Competition 1984, p. 10 3Source of TABLE 1 COST SAVINGS ESTIMATES FROM CONTRACTING OUT STUD'fES CONDUCTED SINCE 1981 Study Type of Service Percentage Savings From Cont r acting Out Ecodata,7under contract with HUD II II II II II II American Pu$lic Works Association Department of Defense Department of Def ensel U.S. Air Force Municipal janitorial services 73 Municipal refuse collection 42 Municipal overlay construction 96 H ighway and street maintenance 16 Department services contracted between 1980 and 1982 22 Revised 1985 estimate, all DOD contracted services 29 Review of 132 contracted functions 33 7. Barbara J: Stevens, ed ComDaratiire Studv of MuniciDal Service Delivery (New York Ecodata, 1984 8. John L. Whelman Contracting and Street Maintenance Paper prepared for the American Public Works Association, 1983 9. U.S. Department of Defense, ReDort to Congress on the Commercial Activities Program March 12, 1984, p. 5 10. La w rence Korb, Assistant Secretary, Department of Defense, Testimony before the House Armed Services Committee, April 1985 11. Air Force Times, June 17, 1985 4- Institute of Transportation Studies, Universitg of California, Irvine Municipal contracting of ur b an mass transit 25-50 U.S. Gsneral Accounting Off ice Federal cl.eaning costs I 50 Office of nanagement and Budget 60,000 positions contracted 24 Agencywide review of Includes savings from activities which remained in-house due to the agency reducing its initial cost estimate.

The union charges that while contractors may indeed provide services at lower cost, they Ilfrequently cut corners by hiring inexperienced transient personnel at low wages, by ignoring contract requirements or by providing inadequate supervision. This complaint is refuted by performance evaluations of contracted activities which reveal that if anything, service quality is enhanced by hiring private firms A 1984 study of cmtracted municipal services by Ecodata, Inc found no dimunition i n service quality Ifor many of the services, the individual cities with the lowest costs of service delivery also achieved among the highest levels of quality 111 the California Tax Foundation 1981 survey of 81 local governments. By a margin of two ta one , cities indicated that service had imprBved from contracting over those that complained of poorer service In fact, it concluded that Further corroboration of service quality is found in 12. Roger F. Teal, Institute of Transportation Studie.3, University o f California, Irvine Transit Service Contracting: Experience and Issues Paper presented at the Annual Meeting of the Transportation Research Board, Washington, D.C., January 1985 13. General Accounting affice GSA'S Cleaning Costs Are Needlessly Higher Than in the Private Sector 198 1 14. Office of Management and Budget, Manaeement of the United States Government, Fiscal I Year 1987 15. Gerald W. Maentee The Case Against Privatization The Privatization Review, Fall 1985, p. 7 16. Stevens, OD. cit p. iv 17. C alifornia Tax Foundation, "Contracting Out Local Government Services in California,"

May 1981, p. 9 5These findings were to be expected. Private coiltractors typically are forced to meet rigid performance speciications, and the quality of services they pro vide is closely scrutinized. With public delivery, by contrast, such accountability is low 0 nonexistent.

More Efficient Use of Resources A 1983 Joint Economic Committee of Congress (JEC) study of federal. procurement finds that offering federal contrbcts to the private sector greatly stimulates business expansion. Equipment and other capital purchased by a private firm to fulfill the terms of a federal contract are likely to be later adopted for other commercial ventures By contrast, the government, beca use of its limited flexibility, often has capital sitting idle upon project completion.

Technological spin-offs to other commercial markets from government funded research and development were particularly important, the .study notes.

Contracting out also permits the federal government to marshal1 the specialized talents of private companies on a temporary basis rather.than keeping such expertise permanently within the government.

Agencies acknowledge that. this option offers the gcvernment greater flexib ility in responding to changing priorities WHY FEDERAL CONTRACTING REMAINS THE EXCEPTION AND NOT THE RULE The first presidential directive on federal ccntracting was issued by Dwight Eisenhower in 19

55. It specified thgt "the federal government will not start or carry on any commercial activity to provide a service or product for its own use if such product or service can be procured from private enterprise.I directive has been thwarted .repeatedly for three deaades reasons The intent of this The The Cos t Conmarison Process Prevents Contractinq Out The original Eisenhower policy statement was stripped of much of its force in 1966, when it was replaced by Office of Management and Budget Circular A-76, which forms the basis of current policy. This new direc t ive requires the.federa1 agencies only to conduct detailed cost comparisons between Ilin-house government suppliers1# and private vendors, and to choose the less expensive alternative. Despite the 18. Robert Premus, David Karns, and Anthony Robinson Socio economic Regulations and the Federal Procurement Market," Joint Committee Committee, December 1984 6apparent reasonableness of this approach, the rules which govern the cost comp$risons are heavily skewed against private contractors.

Examples 0 Unless the private contractor's bid beats the in-house estimate by at least ten percent, to cover government %ransition costs," the function automatically remains in house despite the potential savings from contracting out a fixed price, whereas the agency is only r e quired to submit a cost estimate. This places the private bidder at a significant disadvantage: if he underestimates his costs he will have to swallow the loss. The agency, on the hand, is not penalized by submitting low cost estimates no penalty nor does it lose the contract agency funds o'The commercial- firmls bid must include an allowance for indirect costs, such as corporate salaries and other administrative expenses: the agency's need not. The U.S. Chamber of Commerce estimates that this alone consti t utes a 20 to 30 percent handicap to the private bidder o Costs are added to the bid submitted by private providers to pay for government monitoring of contract performance: no cost for checking quality is added to the agency cost estimate o Very low bids m ay be rejected as being Iloutside the competitive range This discourages breakthrough innovation and means that in many cases the selected proposal from private biaders is not always the lowest bid. It also leads to more decisions in favor of the agency p r ovider o The private bidder must submit a Ilfirm contract1I proposal with If its estimates prove to have been too low, it pays It simply draws additional This biased'cost comparison process has placed private bidders at an estimated.35 percent cost handic ap.

Congressional Budget Office, eliminating the 10 percent rule alone uould ingrease contracts awarded to commercial sources by.14 percent According to the 19. A comprehensive analysis of the cost comparison process and its flaws is examined in William D. Russell, Testimony before the Subcommittee on Human Resources, House Post Office and Civil Service Committee, October 20, 1985 20. Tbid p. 4 21. Congressional Budget Office, p. 22 7The Canmaisn in Conaress to. Prevent Contractins Out The unfair cost comp arison process tilts decisions against private vendors. An even greater problem is that restrictions imposed by Congress ensure that only a small share of federal cpmmercial activities are even subject to competitive bidding.

In recent years, Congress has passed over 20 separate prohibitions on contracting out impediments to contracting of Pentagon commercial activities, for example, by claiming that contracting out would jeopardize Ilnational security" interests. But is is ce r tainly in the interest of U.S national security for the Pentagon to get maximum value from its defense dollars. Every dollar saved by contracting out routine Department of Defense commercial activities is an additional dollar to protect national security i n other areas. And it is important to stress that if congressional restrictions from contracting such activities as firefighting and security guard functions on military bases were lifted, the Secretary of Defense would still have the authority to prevent contracting where legitimate security considerations arise Congress usually justifies the In fact, mounting evidence suggests that Congress merely uses the Inational securityii motivation as a guise to conceal more parochial concerns. Congressmen Bill Nic h ols (D-AL who has played a lead role in restricting contracting out by the Department of Defense acknowledges that one of his goals has been "to protect [military civilian] jobs Congressionally imposed restrictions on civilian agencies are equally insidio us. The General Services Administration, for instance is prohibited from contracting out guard, elevator operator messenger, and custodian ser~ice These exemptions cost federal taxpayers $32 million each year.

The Veterans Administration (VA) is expressly prohibited from contracting its medical care activities, whatever the savings, unless in-house facilities can not fully handle the patient load. Ths Grace Commission found that when VA nursing home care was contracted out the average cost per day was more than cut in half 45 per day versus the $109 per day the VA charges motivate the VA restriction are dubious as well: the Air Force often contracts out for similar hospital care without degrading service n Quality of care concerns which 22. As quoted in "Co n tracting Out: Win Some, Lose Some, Some Rained Out," Governmerlt Executive, 1985, p. 41 23. OMB, ManaPement of the United States Government, p. 72 aquality million annually according to the Grace Commission is considerable. Thanks to the restrictions, onl y an estimated 30 percent of the government's $20 to $30 billion tab for commercial services is even eligible for the savings that contracting out offers The VA restriction costs the federal taxppiers at least $100 The cost impact of these congressional ob s tacles to contracting Omosition to Contractina Out Within the Asencies The Administration must share the blame for the unsatisfactory progress on fully implementing the A-76 directives. 'Congressional restrictions do not explain why less than 2,000 cost r eviews were conducted in civilian agencies in 1984, and only 2,300 in 19

85. The Executive Branch employs over 20,000 "program analysts" who should be undertaking comparisons, yet the number actually conducted is very small. The problem evidently begins wi th the heads of such Administration agencies as the National Oceanic and Atmospheric Administration, NASA, and the General Services Administration. Charges the General Accounting Office, "The commitment of agency heads to the reform effort has not been de m onstrated and agency officials interviewed by GAO believe they do not have to follow the [Circular A-761 policy guidance.tt25 Even when the cost comparisons are reluctantly performed by an agency, the bureaucracy can skew the process so unfairly against t h e private bidder or delay the proceedings for so long, that few contracts ever get out the door Typical of such footdxagging is at the General Services Administration. The GSA spends $250 million more to clean offices with its own custodians than it would cost to contract out this service.

According to the GAO this waste of taxpayer money occurs "despite GSA's knowledge that it costs more to clean with its in-house custodial staff...Instead of actively pursuing the sgirit of A- 76 GSA is only slowly conver t!.ng to contract cleaning If the agency proceeds at its current pace, it could take fifteen years for janitorial services to be privatized. The message is clear: without a 24. William R. Kennedy, Jr. and Robert W. Lee, A Taxuaver Survev of the Grace Comm i ssion Reuort (Ottawa, Illinois: Green Hill Publishers, 1984 p. 2 25. General Accounting Office Progress of Federal Procurement ReKorm Under Executive Order 12352," 1983, p. ii 26. General Accounting Office GSA's Cleaning Costs Are Needlessly Higher Than i n the Private Sector," 1981, p. ii 9forcing mechanism attached to the A-76 program, agencies will not even try to obtzdn the saving achievable through contracting out.

FIVE STEPS BY WHICH THE WHITE HOUSE WOULD IMPROVE AND EXPAND CONTRACTING OUT 1) Jssue an Executive Order to reconfirm the Reaaan commitment to contractina out.

The Office of Management and Budget's contracting out initiatives are doomed to failure without Ronald Reagan's explicit and wholehearted support. Through an executive order, he shoul d require federal agencies to classify all of their functions as either I' inherently governmental1' or "nongovernmental, I' with the second category eligible for contracting out. Once these designations have been made they should be reviewed for consiste n cy by OMB, and made subject to appeal by private contractors would elhinate time-consuming disputes and inconsistency. The President should also direct all agencies to conduct cost studies for a fixed niimber of civil service jobs each year that are subje ct to contracting 2) aliminate the cost comnarison process when nrivate sector deliverv is clearly less .emensive.

Certain inherently commercial activities, such as janitorial services, automatically should be contracted out to private firms.

This would f ree up agency personnel to conduct reviews on more complicated cases recommended this reform the cost comparison process for certain activities This general classification In early 1986, the Office of Management and Budget The proposal would pennit agenci e s to bypass 3) mjld aaencv heads and lower level appointees accountable for any failure to execute A-76 A chain of responsibility in each agency should be established to assure that cost comparisons are made and conducted in a fair and speedy manner shoul d be required and carefully reviewed fail to make progress in executing A-76 should be removed and replaced with those who will publish information on the positive results of A-76, to counter public employee union lobbying Progress reports from all program administrators Political appointees who Political appointees should also be required to 4) Replace method specifications with performance snecifications on most federal contracts.

Bids by private contractors have to cover the cost of rigid, and in many ca ses unnecessary, agency specifications. Contract 10 - solicitations routinely exceed 100 pages. A 1983 Joint Economic Committee investigation found that for 67 percent of businesses that had voluntarily reduced their participation in federal procurement l l complexi&y of contract requirementstt was a major factor in this decision. If requirexents were simplified and related more to contract performance and progress rather than to the method the contractor employs to fulfill the terms of the contract, competi tion would be enhanced, costs would be reduced and. contrasts .would-be awarded faster 5 Contract out the contractina out Drocess itself.

As long as the authority to determine whether or not an activity will be contr6cted out rests on the shoulders of the agency itself contracting out will remain the exception rather than the rule.

The contracting out decision must be removed from the hands of the agency bureaucrats. A number of municipalities already use independent auditors. Example: Phoenix created a se parate auditing department that not only evaluates outside bids, but verifies the accuracy of the in-house estimate of overhead and whatevm indirect costs could be eliminated by contracting out. The auditor awards the contract and monitors its performince , whsther ii: is being delivered by private firms or by public workers It computes the proper allocation The federal government should experiment with such an approach.

An auditing office, for instance, could be added to OMB or GAO.

Failure by a cabinet detpartment to provide information quickly to the auditors could result :in functions being contracted out by default.

Reporting to such an independent auditing department would mean that performance standards would apply equally to contractors and the agencies, since in-house performance would be monitored.

There is no reason why this independent agency need be a government department. In fa ct, the federal government should consider contracting out the contracting out process. The President could nominate a panel of private auditing firms, subject to Senate confirmation, to undertake the cost comparisons. The private auditors would be respon s ible for making cost estimates, awarding contracts and monitoring performance problems receive payment based upon savings to the government and satisfactory performance of the contracts they awarded and managed Perhaps the auditors could 27. Joint Eccmomi c Committee, p. 39 28. Innovating approaches to contracting out employed in Phoenix and other cities are described in Robert W. Poole, Jr., Departments vs. Contractors, Fiscal Watchdog February 1934 11 FOUR STEPS FOR CONGRESS TO PROMOTE CiJNTRACTING OUT 1) Remove leaislative restrictions. on contractina out.

With few exceptions,.congressional restrictions.on' contracting out.have ill served the public. Where national security questions arise, the appropriateness of utilizing contracts should be determined b y the Secretary of Defense. Where quality of care objections have prompted restrictions, as with veterans1 health care, independent auditors, free of constituency pressure, should ensure that contractors live up to quality commitments 2) Modify competitiv e biddina realations to eliminate biases The competitive bidding process imposes a 35 percent handicap on aaainst contractina out the contractor government when taxpayer savings would be realized by contracting out.

Representatives Robert Smith (R-OR) and Charles Stenholm (D-TX) have introduced the Cont?zct Savings Act, which tackles the problem of congressional red tape The rules tend to keep contracts inside the Legislation is needed to remove unreasonable restrictions 3) Review the Service Contract Act and the Davis Bacon Act.

The objective of government procurement should be to assute that taxpayers' money is being spent wisely. In 1972 the Commission on Federal Procurement warned that Itthe cumulative effect of realations already imposed on the procure ment process and the addition of those contemplated could overburden it to the point of breakdown. Nearly 15 years later, federal procurement is more burdened than ever, with only the most skillful and experienced contractors able to wiggle through stacks of paperwork requirements and red tape law, covering 64,000 pages, affect procurement and contracting that are concerned with social policy, while placing a moratorium on new ones. This reassessment should look first at the labor requirements affecting A-

76. The Davis Bacon Act requires that workers on federally contracted construction projects receive the prevailing wage in the area where the work is performed. The Service Contract Act is the counterpart of the Davis Bacon Act, applying to service contra ct workers On the federa3 level alone, 4,000 provisions of federal Congress should reevaluate those existing contract regulations Surveys of contractors have found that Davis-Bacon 29. United States Commission on Government Procurement, Vol. 1, 1972, p. 1 1 4 12 is considered the single most burdensome regulation affecting federal contracts. The Service Contract Act is only sligt.tly less inhibiting. These two regulations cost the taxpayer $1.3 billion rules 4) Reform the small business and minoritv bvsiness set-aside These set-aside programs restrict eligibility. on .specif$ed government contracts by mandating that they be awarded to small and minority-owned businesses. Aside from the questionable effectiveness of this method of promoting the growth of targe t ed businesses, there is strong evidence that the biggest winner from set-asides. is the bureaucracy. The reason is that if no small or minority business is the bidding is not then opened up to large contractors. Rather, the activity remains in-house. If C o ngress genuinely wants to assist small businesses through federal contracts, it should do so by reducing regulations rather than eliminating competition able to match the agency in-house bid, which is frequently the case I I I CONCLUSION The goal of gover n ment procciement, set down by the 1972 of the needed quantity at the l6west reasonable price available.I1 the I' civil disobedience" characterizing bureaucratic responses to contracting initiatives, the taxpayer has been denied the full benefits of contra cting out under Ronald Reagan. In 1986 there are more federal workers performing commercial activities than ever before, and the competitive procurement process is more regulated and restricted than it has ever been.

Most of the privatization initiatives p roposed by Reagan's 'FY 1987 budget must travel the treacherous route of winning congressional approval. By contrast, a more aggressive contracting out campaign can be undertaken immediately by the Administration, independent of Congress Commission on Fed e ral Procurement, is to obtain ''products and services thanks to congressionally imposed restrictions on contracting out, and I I But I The Gram-Rudman-Hollings timetable for federal deficit reduction means that Congress and the White House must seize ever y opportunity to cut unnecessary spending. Since contracting out cuts spending while preserving the level of services to beneficiaries--and in many cases improves the quality of service delivery--there is every reason why lawmakers should step up the pcce of contracting out. Failure to do so will indicate that Washington is still not serious about cutting the deficit with the minimum of semice disruption.

Stephen Moore Policy Analyst 13

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