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In 1997, the Department of Defense proposed, and the Congress enacted, a new set of procedures for calculating the locality-specific housing allowance that the Department of Defense (DoD) pays to service members stationed in the United States who are not housed in government quarters. The old system, which based allowances on what service members reported spending on housing in each locale, had been justly criticized for paying too little in areas where housing was expensive and too much where housing was inexpensive. The new system bases allowances on the prices that must be paid in each locale to rent certain standard units of housing--a two-bedroom apartment, for example--that DoD will select.

This paper discusses the rationale for the new housing allowance system and the problems that may be encountered in its implementation. The paper is the second of three reports examining various aspects of the military pay system that the Congressional Budget Office (CBO) has prepared at the request of the Chairman and Ranking Minority Member of the Subcommittee on Personnel of the Senate Committee on Armed Services. An earlier CBO paper, Military Pay and the Rewards for Performance (December 1995), examined proposals for restructuring the table of military basic pay. The final paper will explore the controversy surrounding the reported "pay gap" between people in the military and their counterparts in the civilian sector.

Richard L. Fernandez of CBO's National Security Division prepared this paper under the general supervision of Deborah Clay-Mendez and Christopher Jehn. The author gratefully acknowledges the valuable comments that Kristen McCue, formerly of CBO, and John Warner of Clemson University provided on an earlier draft. Neil M. Singer and Cindy Williams, also formerly of CBO, oversaw much of the analysis.

Leah Mazade edited the manuscript, and Liz Williams proofread it. Judith Cromwell prepared the paper for publication. Laurie Brown prepared the electronic versions for CBO's World Wide Web site (www.cbo.gov).

June E. O'Neill
Director
October 1998
 
 

SUMMARY

I - INTRODUCTION

• Why Does DoD Need a Locality-Specific Allowance?
• What Would Happen If There Were No Housing Allowance?

II - EXPENDITURE-BASED AND PRICE-BASED ALLOWANCES AND THE DEMAND FOR HOUSING

• Steps in Setting Locality-Specific Housing Allowances
• Housing Prices, Housing Choices, and Housing Expenditures

III - IS A PRICE-BASED SYSTEM BETTER THAN AN EXPENDITURE-BASED SYSTEM?

• Why Not Use an Ideal System?
• Expenditure-Based and Price-Based Allowances Compared with the Ideal
• DoD's Choice of the Standard Unit Can Affect the Performance of a Price-Based System

IV - IMPLEMENTING A PRICE-BASED APPROACH: THE PROBLEM OF ESTIMATING PRICES

• Deriving Housing Prices from Military Data
• How Well Do Existing Price Indexes Fit the Military?

V - CONCLUSIONS

APPENDIXES

A - Calculating Welfare-Based Allowances
B - Estimating Price Elasticities of Demand from Military Data
 

TABLES
1.	Portion of Military Income Spent on Housing, by Pay Grade and Dependency Status, 1996
2.	Illustrative Housing Allowances and Consumption Choices for a Junior Enlisted Service Member
3.	Comparing Ideal Housing Allowances and Allowances Under Other Approaches, by Pay Grade and Housing Price
B-1.	Observed Elasticities of Demand, Fraction of Income Spent on Housing, and Implied Income-Compensated Elasticities, by Pay Grade
FIGURES
1.	Distribution of Military Personnel by the Price of Housing in the Area to Which They Are Assigned
2.	Illustrative Demand for Housing When There Is No Variable Housing Allowance
3.	Demand for Housing and the Calculation of a Variable Housing Allowance Under Expenditure-Based and Price-Based Systems
4.	Relationship Between Housing Allowances and Housing Prices Under Alternative Approaches to Calculating Allowances
5.	Alternative Measures of Prices for a Sample of Military Housing Areas with Large Military Populations
6.	Comparison of Housing Expenditures for Service Members in Pay Grades 0-3 and E-4, for Selected Military Housing Areas
A-1.	Differences Between Ideal Housing Allowances and the Allowances Under Alternative Approaches for a Locality Where Housing Prices Are High
A-2.	Differences Between Ideal Housing Allowances and the Allowances Under Alternative Approaches for a Locality Where Housing Prices Are Low
BOXES
1.	Variation in Housing Prices by Pay Grade
2.	Feedback in an Expenditure-Based Allowance and the "Downward Spiral"
3.	Amenities, the Price of Housing, and Well-Being
4.	Sensitivity of CBO's Results to Assumed Price Elasticities

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