American Shipbuilding Association

Senator Robb introduces S. 2897
The Completed Ship Delivery Method of Accounting

On Thursday July 20, 2000, Senator Charles Robb (D-VA) introduced S. 2897, a bill to amend the Tax Code to permit a modified use of the “Completed Contract Method” of accounting for long-term naval ship construction contracts.  Original cosponsors of S.2897 are Senator John Breaux (D-LA), Senator Mary Landrieu (D-LA), Senator Olympia Snowe (R-ME), and Senator John Warner (R-VA).  S.2897 specifically provides that a builder of naval vessels shall pay income tax upon delivery of the ship, provided that ship takes two or more years to construct.

In explaining the need for this legislation, Senator Robb stated, “It is imperative for our national defense that we rebuild and maintain a minimum naval fleet of 300-ships.  In order to get to this level, we must consider all aspects of shipbuilding.  In particular, I believe that it is time we take the shipbuilders out of the penalty box and allow them to use the completed contract method of accounting instead of paying taxes on progress payments. The current tax treatment causes our shipbuilders a cash flow problem because they have to estimate what their profit may or may not be three to seven years before the construction of a naval ship is ever competed, and divert a percentage of progress payments to pay taxes on that estimated income.  Progress payments are not revenue, but rather the means of financing a ships construction.  The Tax Code needs to be amended so that progress payments may appropriately be used to finance and invest in the construction of the ship to ensure its highest quality at the lowest possible cost.”

Shipbuilding is unique because it takes three to seven years to build a technologically sophisticated naval ship, which is the equivalent of a floating city.  However, the current Tax Code disregards this fact and places a financial burden upon naval shipbuilders by expecting them to know their profit margin on these complex systems three to seven years into the future.  However, when these same companies build a commercial ship, the Tax Code provides that they pay their income taxes upon completion of the contract.

Currently, the Tax Code requires naval shipbuilders to use the Percent of Completion Method (PCM) of accounting.  This method requires a company to estimate the profit they may or may not realize upon completion of a ship and pay taxes annually on progress payments during construction.  These progress payments are not revenue, but a source of construction financing.  The PCM imposes a severe cash flow penalty on naval shipbuilders during the construction phase by eliminating the resources that could be used to invest in facilities and processes, which would reduce the cost of naval ships to the taxpayer.  Neither the Office of Management and Budget nor the Congressional Research Service are expected to estimate with accuracy the revenue the U.S. Treasury will receive years into the future, but the current Tax Code expects builders of naval ships to know their revenue years into the future.  Compounding this unfair tax burden is the fact that these companies are not fully paid for the ship until 12 months after it is delivered to the U.S. Navy. 

Passage of S. 2897 will remove an onerous financial restriction placed upon American shipbuilders and help lower the cost of naval ships.  As Senator Robb stated: “This is just one step in rebuilding our naval forces and in strengthening the industry upon which the Navy depends.”

Defense Appropriations Conference Committee Cuts
Shipbuilding Below President’s Request

The President's budget request for FY 2001 included only 8-ships, an increase of two ships over the previous year and two ships below the steady build rate of 10-ships per year necessary to maintain a minimum fleet of 300-ships.  Unfortunately, the Conference report on the FY ’01 Defense Appropriations Bill (H.R. 4576) reduced this request and returned the naval build rate to only 6-ships per year.

Specifically, the conferees reduced the president’s SCN budget request from $12.3 billion to $11.6 billion.  Roughly $1 billion was cut from the LPD-17 amphibious ship program leaving the Navy and Marine Corps with only $560 million in advance procurement rather than two ships.  The conference report did, however provide advance construction authority, which the Navy could use to enter into a contract for the 2 ships (LPD-21 and LPD-22) if the Navy determines sufficient funds are available.

The bill also zeroed out $263 million requested by the Navy for prior year shipbuilding cost growth, and instead directed the Navy to find the money necessary within its budget.  On the positive front the Conferees granted multi-year procurement authority for DDG-51 destroyer program, but only provided $100 million above the budget request in advance procurement.   Adequate advance procurement funding is necessary to stabilize the DDG-51 program at three ships per year.  A .07 percent across-the-board cut was also directed against R&D and procurement programs. This equates to an additional cut of 8.1 million against the Navy SCN account.

The LHD-8 program was the one winner with a $460 million increased appropriation and direction to the Navy that the ship shall be funded on an incremental basis.

The following chart shows the conference committee action on each shipbuilding program, in millions.

30-Year Shipbuilding Plan Will Drop Naval Fleet Below 300-Ships

On June 26th, Secretary of Defense William Cohen released the 5-month overdue shipbuilding study mandated by Public Law 106-65.  The study which looked at shipbuilding needs for the next 30-years did not address the past decade of neglect nor did it endorse the 360-ship fleet that the regional Commanders-in-Chief’s have repeatedly called for, saying it was only “ one possible option” to be considered in next year’s Quadrennial Defense Review. 

Senator Olympia Snow (R-ME), who chairs the Senate Seapower subcommittee, stressed that the report pointed to the need for greatly stepping up the pace of ship construction, “I will continue to question the disturbing gap between the shipbuilding requirement needed to meet our national security strategy and the Administration’s budget request.”  Senator Charles Robb (D-VA), the sponsor of the study, criticized the report for sidestepping what needs to be done to increase shipbuilding rates in the short run, “In effect, this study says this is what we need – we’ll leave it to somebody else to make the tough decisions on their watch to get the job done, but we can’t give you a plan.”  

Cynthia L. Brown, President of the American Shipbuilding Association, expressed dismay with the plan, "this report is based on flawed assumptions and unrealistic numbers in an effort to justify the Administration's budget for shipbuilding as adequate in maintaining a naval fleet of 306 ships -- the minimum acceptable risk constrained level according to the Department of Defense.”

According to an analysis conducted by the American Shipbuilding Association, this plan will not maintain a 300-ship Navy unless the Department of Defense is prepared to make huge investments to keep old ships operating well beyond their intended economical service life.  Such an approach could in fact place America's Sailors and Marines at greater risks by retaining technologically obsolete and maintenance intensive ships in the fleet longer than intended.

DOD’s long-range plan recommends an annual average build rate of only seven (7) ships per year between now and through 2013. A major deficiency in the report is that DOD does not acknowledge the annual build rate of the past eight years – which has averaged only six ships.  This means that if the required average build rate is 9 ships per year based o a 35-year life expectancy, the Navy will have to recoup the ship shortfall created by procuring less than 9 ships per year in prior years.  Using DOD numbers, the Navy enters FY ’01 with a deficit ship procurement rate of 24 ships in sustaining the 300-ship fleet.

If the actual 30-year life expectancy was used, the annual average build rate would have to be 10 ships per year.  Given the average rate of only six ships per year for the past eight years, the Navy enters FY’01 with a 32-ship shortfall in maintaining a 300-ship fleet.  This means the annual average build rate would have to exceed 10 ships per year beginning immediately just to overcome the deficit of prior years.

Copies of the ASA analysis are available at www.americanshipbuilding.com, under the news section.

Senate Appropriations Committee Marks Up Commerce, State, Justice and the Judiciary Appropriations Bill

On July 18th, the Senate Appropriations Committee marked up of the FY2001 Commerce, Justice, State and Judiciary Appropriations Bill, and increased funding for the Title XI program by 18.3 million, from $2 million requested to $20.3 million.  The Committee also included legislative language to remove the $1 billion cap on the annual amount of loans to be guaranteed under the program.  The removal of this cap is intended to free up an additional $7 million of prior year funds that otherwise could not have been expended to guarantee loans because of the cap. This means that the Committee bill provides $27.3 million for new loans.  The Committee has not reported the bill and there is some indication that the Committee may further improve Title XI funding if additional funds are made available.

To this end, on July 26, 2000, a bipartisan group of Representatives sent a letter, sponsored by Congressman Robert Andrews (D-NJ), to the Commerce, State, Justice, and the Judiciary Appropriations Conferees reiterating their support for appropriating $50 million for the Maritime Administration’s Title XI Ship Loan Guarantee Program in fiscal year 2001. The American Shipbuilding Association is appreciative of the continued effort to support this critical national security support program.  Co-sponsors of the bipartisan letter include Representatives: Neil Abercrombie (D-HI), Herb Bateman (R-VA), Robert Brady (D-PA), Sonny Callahan (R-AL), Randy “Duke” Cunningham (R-CA), Peter DeFazio (D-OR), William Delahunt (D-MA), Michael Forbes (D-NY), Rodney Frelinghuysen (R-NJ), Wayne Gilchrest (R-MD), William Jefferson (D-LA), Walter Jones (R-NC), Steven Kuykendall (R-CA), James Maloney (D-CT), Jack Metcalf (R-WA), James Oberstar (D-MN), Ronnie Shows (D-MS), Gene Talyor (D-MS), Karen Thurman (D-FL), David Vitter (D-LA), Robert Weygand (D-RI), and Don Young (R-AK).

Industry News

Construction Begins on the Largest U.S.-Built Cruise Ship

Ingalls Shipbuilding began steel fabrication on a 1,900-passenger cruise ship in Pascagoula, Mississippi at a patriotic Independence Day celebration.  Representative Neil Abercrombie (D-HI) in a speech on the House floor heralded the event: “The construction of the two cruise ships for American Classic Voyages at Ingalls Shipbuilding demonstrates that America can build ships competitively on the world market.”

When the new United States Lines ship is completed in early 2003, it will sail exclusively in the Hawaiian Islands, and be joined by a twin vessel in 2004. Each ship will feature spacious open decks to view the beauty and scenery of Hawaii, a 7-deck high atrium, a signature Destination Learning Center, and a uniquely Hawaiian outdoor performance stage.