Defense contractors' profits have substantially outpaced those of other manufacturers during President Reagan's rearmament program but have not been "unreasonable," according to a Pentagon report released yesterday.
The report, based on an 18-month Defense Department study, used a special economic model to show that weapons contractors averaged annual profits of 4.7 percent from 1980 to 1983, while makers of durable goods averaged losses of 3.65 percent.
In absolute terms, defense profits were lower in the recessionary years 1980-83 on average than in the 1970s, but compared to those of non-defense manufacturers they were consistently higher.
Pentagon analysts, in the first comprehensive review of defense industry profits and accounting practices in a decade, said the contractor profits, which rose from an average of 2 percent in 1980 to 9 percent in 1983, represent "an equitable return," reflecting Reagan's military buildup and the decline in inflation rates.
Despite its endorsement of defense industry profits, the report is expected to fuel congressional critics' arguments that profligate and inefficient contractors are fattening themselves on government business.
The report, titled "Defense Financial and Investment Review (DFAIR)," has been long awaited as the controversy over defense industry practices intensified. Some congressional officials have criticized the study's methodology because the 76 contractors that provided financial data did so confidentially, insisting that it be collated by a private accounting firm before being turned over to the Pentagon.
"In general, the DFAIR analysis concludes that current pricing, financing and markup policies are balanced economically, are protecting the interests of the taxpayer and are enabling U.S. industry to achieve an equitable return for its involvement in defense business," the report said.
The 180-page study also concluded that:
*Monthly progress payments, which provide major contractors with working capital, should be increased from 80 to 85 percent of expenses to help defray defense firms' borrowing costs. Defense Secretary Caspar W. Weinberger lowered the rate earlier this year, saying the contractors had more government money than they needed.
*"Markup" guidelines used to determine contractor profits are weighted too heavily to reflect costs and should be geared to encourage capital investment.
*Contractors earn "consistently lower" profits than Pentagon officials allow them in negotiations.
In their profit comparisons of contractors and other manufacturers, the analysts adopted a special economic standard because of the peculiarities of the defense business. Traditional measures, such as return on capital and return on equity, show defense contractors' profits exceeding 20 percent from 1980 to 1983, but these measures were discarded as "inappropriate."
Measuring "economic profit" derived from investment of assets, the report shows defense contractors earning an average of 6.5 percent from 1970 to 1979. In the same period, durable-goods manufacturers averaged 5.8 percent, the report said.
Durable goods registered losses from 1980 to 1983, in "the most severe recession in 50 years," according to the report, but the Reagan defense buildup continued to make weapons production profitable.
"Demand in the defense industry depends primarily on the perceived defense needs of the nation," the report said. "As the volume of defense business increases, so will profits. Profitability of defense contractors has not been unreasonable."
Analysts broke down the defense industry by product and found that the makers of airplanes and aircraft engines had the highest average profit rate, 11.8 percent from 1977 to 1983. Contracts for weapons, vehicles and ammunition averaged profits of 9.1 percent; electronics, 9.1 percent, and missiles and space systems, 8.4 percent.
Air Force Col. Ronald Finkbiner, who supervised the study and released copies at a Pentagon briefing, said that procurement policies are "basically economically sound. Nothing is showing up in terms of an extraordinary degree of profitability."
Defense firms profited at a time when other manufacturers suffered, he said, because weapons builders "were not faced with the same sort of falloff in demand that was existing in the commercial sector" starting in 1981.
Finkbiner said his task force stuck to financial analysis of the defense companies without looking at the pattern of fraud, waste and abuse that has been attributed to the industry in recent months, raising questions about contractor profits.
One of the report's recommendations touched on the controversial practice of contractor billings for overhead costs. Defense firms have been accused of padding their bills with unallowable claims for lobbying expenses, entertaining, promotional gifts, private travel and, in one case, kennel fees for a company official's dog.
Analysts suggested that the Pentagon eliminate overhead costs in calculating profit rates for contractors so as to "remove any incentive . . . for contractors to increase these costs just to obtain higher markups."
Eliminating overhead costs and related items could cut the profit margins by up to 1 percent, according to the report.