Contracting-out services across the economy have grown dramatically in the last decade. While the focus here is on contracting with government, the outsourcing movement – the “Uberfication” of the economy – affects all dimensions of the hiring process. So contracting out deserves a broad look initially. The impact of Uber reflects a shift in jobs in the service economy from employee to independent contractor status. While a few states like California have challenged the status of Uber drivers and won concessions,Footnote 1 Uber, Lyft, and related companies, in transportation and beyond, are redefining the relationship between workers and private employers. The government is not an employer of this nature, and its contractors are subject to articulated agreements, but what is going on in the economy at large will ultimately affect how government employs its workers. That may be a good thing as flexibility in employment can help government compete with the private sector.Footnote 2
A. The Big Picture: Contractors in the Labor Force
Contractors are growing as a share of the national workforce as well as in government at all levels. Nationally, Lawrence Katz and Alan Krueger show that alternative work arrangements grew from 10.1 percent of the US workforce in 2005 to 15.8 percent in 2015. This growth constitutes all net employment growth during that period.Footnote 3 Contracting out is the largest category of alternative work arrangements and it occurs predominantly with higher-wage jobs. As David Weil has explained, large employers are shedding direct employment and reducing costs by turning to contractors outside the organization.Footnote 4 By redefining work in the service economy to make greater use of contractors, workers in traditional jobs are disadvantaged. President Obama has observed that some jobs “aren't coming back” because of lower costs and higher scalability, flexibility, industrial skills, and diligence of foreign contractors.Footnote 5
Part of the reason for the growth in contractors is the use of technology. New technologies allow for jobs to be standardized and easily monitored. Uber and Airbnb come immediately to mind. As Neil Irwin writes, “when people working as a team need extensive experience working together, it can be tricky to contract out work. But when there are clear simple measures of how successful each person is, and a company can monitor it, the employer now has flexibility.”Footnote 6 This states the parameters well: technology reduces the transaction costs to employers for finding workers under circumstances where measurement and monitoring is possible.Footnote 7 Interestingly this analysis also applies to telework, where measured and monitored performance is necessary as well, as will be discussed in Chapter 8.
None of this should come as a surprise to governments. Regressions from the Katz/Krueger study show that the use of contractors in the federal, state, and local governments rose from 6.2 percent in 2005 to 11.9 percent in 2015,Footnote 8 almost exceeding the percentage growth in alternative workers generally. The largest category of alternative workers are employed by contracting-out entities and many of those are primarily or even exclusively working for governments. While it is difficult to collect contracting-out data from state governments, which do not generally keep public records of their short-term contractors,Footnote 9 the trends show movement in the direction of contractors. Since the number of state personnel shrunk significantly in the last decade,Footnote 10 it is likely that part-time contractors as well as shrinking state budgets were causal factors.
B. Contracting in the Federal Government
Much more is known about contracting out at the federal level, which is the leading edge of government contractor utilization. Over many years, contractors have provided services to federal agencies in numbers that may exceed their presence in the general labor market. The current federal services contractor budget is around $250 billion. To put that number in perspective, it approximates the cost of the entire civil service.Footnote 11 Overall, therefore, contractor expenditures are about 50 percent of the total agency expenditures for personnel, but in some agencies, such as DOD, DOE, the US Agency for International Development (USAID), and NASA, the contractor costs are even higher. While the total amount spent on government contracting is leveling out, due to sequestration and budgetary uncertainty,Footnote 12 the total spent on services contracts will probably remain high into the future. A continual difficulty is translating the amount of federal spending on human capital into numbers of contractors. We know how many federal employees there are and also how much we are spending on contractors. But the number of contractors those dollars support is hard to pin down. So let's start with what we know – the size of the federal establishment. Consider this chart from John DiIulio's recent book.Footnote 13
Cover image, John DiIulio, Bring Back the Bureaucrats, Templeton Press, 2014.
This chart is saying that the number of civilian government employees has remained steady (at about 2 million) since the Kennedy Administration, over 50 years ago. In reality, government employment at the federal level has been shrinking. These facts do not fit the public perception of the size of the federal government. Many would assume that as government spends more, the bureaucracy gets bigger, but the evidence is the opposite. As DiIulio shows, gross domestic product (GDP) has increased five-fold since 1960, and, assuming a correlation between the size of the economy and the need for officials to serve it, the bureaucracy remains the same size. Now think about the number of new agencies and programs created since the 1960s (start with the EPA and the Department of Homeland Security (DHS)) or other size indicators like the growth in the number of pages in the federal register.Footnote 14 If the GDP has increased five-fold and the number of federal register pages has increased seven-fold then who is doing all the work if the number of federal workers remains the same? The answer, of course, is contractors are expanding exponentially.
The number of government workers has not been keeping up with the growth in the economy either at the federal, the state, or the local level. In effect, the data show the Era of Big Government is over.Footnote 15 From a peak of around 7.5 percent in the Second World War, the percentage of regular payroll employment represented by the federal government dipped below 4 percent in the 1970s, and today hovers around 2 percent.Footnote 16
One way to understand the growth in contractors is to view the triangle created by DiIulio's chart as representing an employment gap. If it is not filled by bureaucrats, the workers can come from only one source: contractors in all sizes, shapes, and forms. Unlike federal employees, who are carefully identified by headcounts (“full-time employees,” or FTEs), the number of federal contractors is difficult to discern. Paul Light has made several estimates of the number of contractors that vary between 7.6 million and 12 million.Footnote 17 Since the budgets for the federal workforce and service contractors are now about equal, that could mean there are many more contractors than federal workers, given temporary and part-time personnel in the contractor workforce, or that because of cost, the contractors are far fewer in number than suggested by Light's estimates. Stan Soloway, former head of the Professional Services Council which represents contractors, takes this position and contends that given overhead and profit charges the total dollars spent per contractor actually represent far fewer of them than the 2 million federal employees.Footnote 18
But whatever the number, it is a large one. John DiIulio calls this situation “leviathan by proxy” and includes in the “contractor” calculation state and local workers as well as for- and not-for-profit employees. Since Barack Obama's government could not be run with the numbers John Kennedy had at his disposal, service contractors, who were unknown in Kennedy's day, are now a large part of Obama and Trump's workforce.
The growth in contractors is not just a numbers game, however. DiIulio's assertion is that contractors not only serve government but create ongoing needs for their services. In effect, they help perpetuate big government (Leviathan) not only by supplying services, but by demanding them. For-profit, not-for-profit, and state and local governments form powerful interest groups that seek to protect and expand their programs. This phenomenon, well known to public choice scholars as “rent seeking,” is discussed in Chapter 5 under the heading of “regulatory capture.”
DiIulio's prescription is to hire 1 million bureaucrats to replace the contractors, thereby reducing the incentive to increase the size of government, while managing it more effectively. He delivers this message knowing that it is unlikely to meet with approval. But in truth, if there were 2 million federal employees 50 years ago and the economy has grown five-fold, the number is quite conservative. And it is certainly below the number of contractors currently employed, however we count them. At the policy levels, growth in federal managers would have a positive impact on the federal budget, since government officials do not have the same rent-seeking incentives as contractors (although they want to protect their jobs). The contractor lobby is also more important to Congress for campaign funding reasons than are government employees, so programs might actually be slimmed down as a result. And, of course, the degree of professionalism might also grow and with it the quality of services the public expects. Conceivably, the dismal numbers on trust in government might also move in the right direction.Footnote 19
Selling this idea before today's Congress may be a quixotic venture, but it is a thought experiment worth engaging in. Moreover, when many countries in the world are trying to build merit-based civil service systems,Footnote 20 strengthening ours raises the bar internationally as well. That point ought not to be lost. The civil service system, which surely needs to be modernized to account for the encrusted nature of the hire/fire process as well as the growth of alternative work arrangements, noted at the outset of this chapter, is still the best way we have to run government. Contractors can still be effective as adjuncts in this regime, but they need leadership and oversight from professional managers.
Given that the government's budget for contractors approximates that of the entire civil service, it is not surprising that some agencies have as many contractors as employees. At DOD, for example, there are 700,000 full-time contractors for its 800,000 civilian employees.Footnote 21 And there are many other agencies where the contractor-to-employee ratio approaches 50/50, if their numbers are known. Often the only way for an agency to affect contractor numbers is to translate numbers into dollars, as Robert Gates suggested when he was Secretary of Defense.Footnote 22 Despite data collection obstacles, the Government Accountability Office (GAO) lists some agencies with contractor/employee ratios even greater than the 50/50 level.
C. The Correlation between Contractor-Driven Agencies and High-Risk Ones
NASA, DOE, and USAID have two things in common: they have contractor/employee ratios far exceeding 50/50, and they are longtime members of GAO's high risk list for mismanagement, fraud, waste, and abuse. The Comptroller General, Eugene Dodaro, has stated that GAO has never taken a contractor-dominated agency off its high risk list,Footnote 23 even though one-third of other agencies have been removed from the list over time.Footnote 24 The Comptroller stated that the reason these agencies have never left the list is largely due to inadequate contractor management.Footnote 25 This oversight deficiency is caused by lack of contracting officers and outmoded technology. When agencies become overwhelmed by contractor services, we have a failure of professional government. If permanent membership on the high risk list has become an indicia of contractor-driven government, Congress should pay close attention. And all who care about effective government should be alarmed.
D. Contractor-Driven Agencies: Department of Energy and USAID
Has this agency contracted out its brain?Footnote 26
Three major agencies have about a 90/10 contractor–employee ratio. One of them is NASA, whose well-known contractor-guided mission makes it more like a government corporation than a federal agency. The other two, DOE and USAID, will be more closely analyzed to understand how the high contractor ratios might affect their missions and operations. I was able to secure interviews with present or former key personnel of these agencies who were of great assistance in explaining how they deal with high contractor ratios and the effect they have on operations.
1 Department of Energy
DOE pretty much owns the Nobel Prize for PhysicsFootnote 27
There are over 100,000 contractors at DOE and 13,000 government employees.Footnote 28 On its face, that imbalance would seem to produce management and oversight problems of major proportions. And there are stresses in the contract-awarding and -renewal process at DOE that help explain its long placement on GAO's high risk list. But any analysis of management control problems must take into account the nature and duties of the contract employees. Roughly 80,000 of the contractors are in the national research laboratories like Scandia and Lawrence Livermore.Footnote 29 While these labs are under DOE control, they are populated by physicists, engineers, and other scientists who have long-term relationships with the government, who produce high-level research. Indeed, agency officials say that these “contractors” consider themselves government employees and are sometimes paid directly by the government through long-standing arrangements.
Secretary Ernest Moniz says “the Energy Department's staff and contractors are at the heart of everything we do.”Footnote 30 This is an obvious effort to integrate the two workforces. Indeed, as a professor of nuclear physics at MIT, the Secretary was a contractor before going inside government, where he has been an invaluable asset both as Secretary and as a negotiator with State Department Secretary John Kerry of the Iran Nuclear Agreement.
There are contract oversight vulnerabilities, however. They appear to involve the selection of managers for the laboratories, who do change, rather than the operating arms where most of the contractors remain in place and produce, as Croley indicated, notable awards in physics. Attorneys in the DOE General Counsel's Office who were also interviewed maintain that the continuity of the scientific community makes the oversight burden manageable.
The other large group of DOE contractors (in the 20,000 range) work in nuclear waste management, where the functions and turnover are more frequent and contracting oversight is more challenging.Footnote 31 Overall, then, overseeing contractors with DOE employees seems a more manageable proposition than the 90/10 ratio initially suggests. The burdens on contracting officers, DOE officials admit, are substantial, but the conclusion that the high ratio of contractors alone does not accurately reflect the degree of risk they pose to the agency's operations seems reasonable.
2 US Agency for International Development
At USAID, contractors also represent around 90 percent of the total workforce and the management problems are more complicated. For one thing, there are no equivalents to DOE's scientific laboratories where contractors have long-established and set relationships. USAID's relief missions involve work with private partners to end extreme poverty and promote democratic societies.Footnote 32 Priorities are constantly being rethought and readjusted under the influence of events (natural disasters, political upheavals, etc.), the White House, executive agencies like the Department of State, as well as Congress itself.
USAID's government workforce is often shorthanded and contractors are forced to play a central role in planning and execution. A recent agency head explained that some of his key advisors in top management decisions are contractors whose special expertise is highly valued. While he was sensitive to the need to add government employees at the professional level (and did add 4,600 to those ranks over his term)Footnote 33 the obstacles to civil service hiring (including the veterans’ preference) often pushed him in the direction of contractors who could come on quickly with appropriate credentials.
The contractors in the field, however, created other problems. When the agency sought to change direction, some contractors whose programs were affected would go to Congress to object, creating pressures on USAID's professional managers.Footnote 34 Contractor influence on Congress is a well-known phenomenon (consider military contractors whose weapons are strategically produced in numerous congressional districtsFootnote 35). For USAID leadership this meant lengthy meetings on the Hill that assume valuable management time. This situation starkly presents the problem of contractor “rent seeking,” which is the subject of detailed analysis in Chapter 4.
Heavily populated contractor agencies like DOE and USAID face special challenges in managing the mixed workforce. Overworked civil servants are particularly at risk in the contracting and contracting-oversight process. Agency personnel in these situations may overlook opportunities for competitive bidding and resort to pro forma renewals.Footnote 36 While, as the situation at DOE indicates, the ratio of contractors to civil servants does not by itself prove professional management inadequate, at USAID, on the other hand, the ratio is more problematic. Contractor/employee ratios are a useful starting point in trying to determine whether public management is performing well.
E. Professionally Starved Agencies: CMS and IRS
There are many agencies who have higher than 50 percent contractor ratios, but two stand out because of the importance of their missions and the public nature of their failures: the Center for Medicaid Services and the Internal Revenue Service.
1 Center for Medicaid Services
Some agencies founder because of a shortage of professional employees to do the job, a gap contractors are forced to fill. The situation at the Center for Medicaid Services (CMS), part of the Department of Health and Human Services, is remarkable from a personnel perspective. CMS has about a 3/1 contractor to employee ratio, far below the 9/1 ratio at DOE and USAID. But that hardly tells the story. There are 5,600 employees at CMSFootnote 37 and at least 14,000 contractors.Footnote 38 Incredibly, CMS got little new staff to implement the Affordable Care Act (ACA). The agency was short on professionals who knew how to set up a website, the crucial breakdown that doomed the ACA rollout.Footnote 39 The website was Healthcare.gov which provided access to the federally facilitated marketplace (FFM) that allowed the public to compare and select insurance plans. As GAO reported, CMS employees issued task orders to the contractors developing the FFM “when key technical requirements were unknown, including the number and composition of states to be supported and, importantly, the number of potential enrollees.”Footnote 40 This lack of preparation or experience was glaring for an agency with an extraordinarily complicated new mandate. CMS officials used cost-reimbursement contracts “which created additional risk because CMS is required to pay the contractors allowable costs regardless of whether the system is completed.”Footnote 41 The use of cost-plus contracting by CMS was almost an admission that they were in the dark about the requirements needed successfully to complete the contract. Lack of professional personnel at CMS undermined the competency of government. The problem is not just the number of contractors overseen but whether the talent is available in-house to evaluate the efforts of contractors to do quality work.
2 Internal Revenue Service
The situation at the Internal Revenue Service (IRS) is even more challenging than CMS from an inadequate management perspective. IRS is one of the few agencies that can put a price tag on the value of their employees. IRS employees return many dollars to the Treasury for every dollar spent on their salary and benefits.Footnote 42 Do these “missing” employees have work to do? You bet. The amount of taxes owed to government that have not been collected is known. It is called the “tax gap.” It currently stands at over $400 billion.Footnote 43 Remember, these are the moneys taxpayers owe, but do not pay, for a variety of reasons: some can't pay and some won't pay. It is the latter category the IRS should focus on. If it is assumed that 25 percent of that amount is collectible (say $100 billion) and that new employees return twenty times their cost in recoveries,Footnote 44 this could easily justify 10,000 new IRS agents. The tax gap can be viewed as a measurement of government failure that can be reduced by responsible appointments. On both a financial and management perspective, this seems like low-hanging fruit.
Lack of professional management also leads to other failures. Consider GAO's report that IRS paid $3.1 billion in identity theft refunds in 2014.Footnote 45 GAO criticized IRS for not developing a comprehensive strategy on identity theft and put the agency on its 2015 high risk list. So the case for more agents and professionals is overwhelming. From a trust-in-government perspective, how demoralizing is it for the vast majority of taxpayers to pay their share on a largely voluntary basis and see a minority ignore their obligations. This jeopardizes the tradition of voluntary compliance itself and further reduces the public perception of government competency.Footnote 46
In what rational system could this happen? The answer is in our political system.Footnote 47 The Republican Party attacks the IRS because of allegations that it discriminated against conservative groups in its “501(c)(4)” registration of not-for-profits.Footnote 48 This has made them do strange things like prefer to fund private collection agencies (PCAs) – bounty hunters, really – rather than add qualified agents.Footnote 49 Who could rationally prefer contracting for harassing debt collectors rather than using professional personnel for collecting taxes? Congress experimented with PCAs on two prior occasions and as Nina Olson, the National Taxpayer Advocate, reports, the IRS lost money each time.Footnote 50 Moreover, Olson criticizes the PCA program for targeting low-income taxpayers and diverting IRS personnel from other assignments. She concludes the prior PCA programs “undermined effective tax administration, jeopardized taxpayer rights protections and did not accomplish its intended objective of raising revenue.”Footnote 51 It is hard to think of a bigger outsourcing failure than the PCA program, yet Congress wants to try it again rather than add professionals with a proven record of accomplishment.
The House Oversight and Government Reform Committee decided to censure the IRS commissioner, John A. Koskinen (as a prelude to impeachment no less),Footnote 52 because he mishandled production of emails sought in the earlier 501(c)(4) investigation.Footnote 53 Mr. Koskinen, who has served in high-level roles for Republican and Democratic administrations, is the kind of professional government needs: someone who believes in government and takes on tough assignments.Footnote 54 His treatment could surely discourage others from taking on similar assignments that government needs to fill in the future. Moreover, think how hard it has been for him to effectively manage the beleaguered IRS while he prepared for impeachment hearings.
F. Contractor Ratios and Rational Government
The growth in contractors in the economy as a whole over the last decade reflects a transformation in the employer–employee relationship. But in government, contractors now represent not only numbers, but brains – brains that have been outsourced. Booz Allen Hamilton, owned by the Carlyle Group, earns about $5.48 billion per year from agencies who employ their 22,600 employees.Footnote 55 These are a cadre of highly competent talent, many of whom have prior government service, and one-half of whom have security clearances.Footnote 56 Since obtaining top-secret and above clearances can take up to a year, this is yet another reason why it is easier to hire contractors than civil servants. But having employees with security clearances does not mean they will be properly used. Two Booz Allen contractors, Edward Snowden and Howard T. Martin, have been charged with theft of government documents.Footnote 57 The size of Booz Allen's Washington contractor force recalls the question posed by Jack Donahue in his “warping” of government work discussed in Chapter 2.Footnote 58 Talent at the top end, rather than the middle or lower end – those who do Donahue's “custom” rather than “commodity” tasks – are the real growth area, because they yield higher salaries. Contractors, like everyone else, follow the money.
The examples given in this chapter show that it is not just the number of contractors versus government employees that matters most, but the extent to which they invade the executive level of decisionmaking. CMS and IRS need more professionals to do their missions competently. Glaring inadequacies in oversight of the contractor regime can only be overcome by infusing more talent in government itself. Rational government is not contractor government, it is professional government managing contractor services.
