USA Inc.

USA Inc. February 201 EFTA01123234 About USA Inc. Created and Compiled by Mary Meeker February 2011 This report looks at the federal government as if it were a business, with the goal of informing the debate about our nation's financial situation and outlook. In it, we examine USA Inc.'s income statement and balance sheet. We aim to interpret the underlying data and facts and illustrate patterns and trends in easy-to-understand ways. We analyze the drivers of federal revenue and the history of expense growth, and we examine basic scenarios for how America might move toward positive cash flow. Thanks go out to Liang Wu and Fred Miller and former Morgan Stanley colleagues whose contributions to this report were invaluable. In addition, Richard Ravitch, Emil Henry, Laura Tyson, Al Gore, Meg Whitman, John Cogan, Peter Orszag and Chris Liddell provided inspiration and insights as the report developed. It includes a 2-page foreword; a 12-page text summary; and 460 PowerPoint slides containing data-rich observations. There's a lot of material — think of it as a book that happens to be a slide presentation. We hope the slides in particular provide relevant context for the debate about America's financials. To kick-start the dialogue, we are making the entire slide portion of the report available as a single work for non-commercial distribution (but not for excerpting, or modifying or creating derivatives) under the Creative Commons license. The spirit of connectivity and sharing has become the essence of the Internet, and we encourage interested parties to use the slides to advance the discussion of America's financial present and future. If you would like to add your own data-driven observations, contribute your insights, improve or clarify ours, please contact us to request permission and provide your suggestions. This document is only a starting point for discussion; the information in it will benefit greatly from your thoughtful input. This report is available online and on iPad at In addition, print copies are available at USA Inc. EFTA01123235 Foreword George P. Shultz, Paul Volcker, Michael Bloomberg, Richard Ravitch and John Doerr February 2011 Our country is in deep financial trouble. Federal, state and local governments are deep in debt yet continue to spend beyond their means, seemingly unable to stop. Our current path is simply unsustainable. What to do? A lot of people have offered suggestions and proposed solutions. Few follow the four key guideposts to success that we see for setting our country back on the right path: 1) create a deep and widely held perception of the reality of the problem and the stakes involved; 2) reassure citizens that there are practical solutions; 3) develop support in key constituencies; and 4) determine the right timing to deliver the solutions. USA Inc. uses each of these guideposts, and more; it is full of ideas that can help us build a better future for our children and our country. First, Mary Meeker and her co-contributors describe America's problems in an imaginative way that should allow anyone to grasp them both intellectually and emotionally. By imagining the federal government as a company, they provide a simple framework for understanding our current situation. They show how deficits are piling up on our income statement as spending outstrips income and how our liabilities far exceed nominal assets on our balance sheet. USA Inc. also considers additional assets — hard to value physical assets and our intangible wealth — our creativity and energy and our tradition of an open, competitive society. Additionally, the report considers important trends, pointing specifically to an intolerable failure to educate many in the K-12 grades, despite our knowledge of how to do so. And all these important emotional arguments help drive a gut reaction to add to data provided to reinforce the intellectual reasons we already have. Second, USA Inc. provides a productive way to think about solving our challenges. Once we have created an emotional and intellectual connection to the problem, we want people to act and drive the solution, not to throw up their hands in frustration. The authors' ingenious indirect approach is to ask what a turnaround expert would do and what questions he or she would ask. The report describes how we first stumbled into this mess, by failing to predict the magnitude of program costs, by creating perverse incentives for excessive behavior, and by missing important trends. By pointing to the impact of individual responsibility, USA Inc. gives us reason to believe that a practical solution exists and can be realized. Ml USA Inc EFTA01123236 Third, the report highlights how powerful bipartisan constituencies have emerged in the past to tackle great issues for the betterment of our nation, including tax reform, civil liberties, healthcare, education and national defense. Just as presidents of both parties rose to the occasion to preside over the difficult process of containment during the half-century cold war, we know we can still find leaders who are willing to step up and overcome political or philosophical differences for a good cause, even in these difficult times. Finally, the report makes an important contribution to the question of timing. Momentum will follow once the process begins to gain support, and USA Inc. should help by stimulating broad recognition and understanding of the challenges, by providing ways to think about solutions, and by helping constituencies of action to emerge. As the old saying goes, "If not now, when? If not us, who?" With this pioneering report, we have a refreshing, business-minded approach to understanding and addressing our nation's future. Read on...you may be surprised by how much you learn. We hope you will be motivated to help solve the problem! Ml USA Inc. iv EFTA01123237 Table of Contents About USA Inc Foreword Summary vii Introduction 5 II iii High-Level Thoughts on Income Statement/Balance Sheet 25 Income Statement Drilldown 53 Entitlement Spending 72 Medicaid 94 Medicare 100 Unemployment Benefits 121 Social Security 129 Rising Debt Level and Interest Payments 142 Debt Level 145 Effective Interest Rates 161 Debt Composition 168 Periodic Large One-Time Charges 177 TARP 188 Fannie Mae / Freddie Mac 193 ARRA 200 Balance Sheet Drilldown 209 USA Inc. v EFTA01123238 What Might a Turnaround Expert Consider? 221 High-Level Thoughts on How to Turn Around USA Inc.'s Financial Outlook 237 Focus on Expenses 253 Reform Entitlement Programs 255 Restructure Social Security 256 Restructure Medicare & Medicaid 268 Focus on Operating Efficiency 329 Review Wages & Benefits 335 Review Government Pension Plans 338 Review Role of Unions 342 Review Cost Structure & Headcount 345 Review Non-Core 'Business' for Out-Sourcing 349 Focus on Revenues 355 Drive Sustainable Economic Growth 356 Invest in Technology / Infrastructure / Education 366 Increase/ Improve Employment 383 Improve Competitiveness 389 Consider Changing Tax Policies 395 Review Tax Rates 396 Reduce Subsidies I Tax Expenditures / Broaden Tax Base 400 Consequences of Inaction 413 Short-Term, Long-Term 415 Public Debt, Net Worth vs. Peers 416 Lessons Learned From Historical Debt Crisis 422 General Motors 431 Summary 437 Appendix 453 Glossary xix Index xxvii USA Inc. vi EFTA01123239 Summary Imagine for a moment that the United States government is a public corporation. Imagine that its management structure, fiscal performance, and budget are all up for review. Now imagine that you're a shareholder in USA Inc. How do you feel about your investment? Because 45% of us own shares in publicly traded companies, nearly half the country expects quarterly updates on our investments. But although 100% of us are stakeholders in the United States, very few of us look closely at Washington's financials. If we were long-term investors, how would we evaluate the federal governments business model, strategic plans, and operating efficiency? How would we react to its earnings reports? Nearly two-thirds of all American households pay federal income taxes, but very few of us take the time to dig into the numbers of the entity that, on average, collects 13% of our annual gross income (not counting another 15- 30% for payroll and various state and local taxes). We believe it's especially important to pay closer attention to one of our most important investments. As American citizens and taxpayers, we care about the future of our country. As investors, we're in an on-going search for data and insights that will help us make more informed investment decisions. It's easier to predict the future if one has a keen understanding of the past, but we found ourselves struggling to find good information about America's financials. So we decided to assemble — in one place and in a user-friendly format — some of the best data about the world's biggest "business." We also provide some historical context for how USA Inc.'s financial model has evolved over decades. And, as investors, we look at trend lines which help us understand the patterns (and often future directions) of key financial drivers like revenue and expenses. The complexity of USA Inc.'s challenges is well known, and our presentation is just a starting point; it's far from perfect or complete. But we are convinced that citizens — and investors — should understand the business of their government. Thomas Jefferson and Alexis de Tocqueville knew that — armed with the right information — the enlightened citizenry of America would make the right decisions. It is our humble hope that a transparent financial framework can help inform future debates. In the conviction that every citizen should understand the finances of USA Inc. and the plans of its "management team," we examine USA Inc.'s income statement and balance sheet and present them in a basic, easy-to-use format. We summarize our thoughts in PowerPoint form and in this brief text summary at We encourage people to take our data and thoughts and study them, critique them, augment them, share them, and make them better. There's a lot of material — think of it as a book that happens to be a slide presentation. Ml USA Inc. vii EFTA01123240 There are two caveats. First, we do not make policy recommendations. We try to help clarify some of the issues in a straightforward, analytical way. We aim to present data, trends, and facts about USA Inc.'s key revenue and expense drivers to provide context for how its financials have reached their present state. Our observations come from publicly available information, and we use the tools of basic financial analysis to interpret it. Forecasts generally come from 3rd-party agencies like the Congressional Budget Office (CBO), the nonpartisan federal agency charged with reviewing the financial impact of legislation. Second, the 'devil is in the details.' For US policy makers, the timing of material changes will be especially difficult, given the current economic environment. By the standards of any public corporation, USA Inc.'s financials are discouraging. True, USA Inc. has many fundamental strengths. On an operating basis (excluding Medicare and Medicaid spending and one-time charges), the federal government's profit & loss statement is solid, with a 4% median net margin over the last 15 years. But cash flow is deep in the red (by almost $1.3 trillion last year, or -$11,000 per household), and USA Inc.'s net worth is negative and deteriorating. That net worth figure includes the present value of unfunded entitlement liabilities but not hard-to-value assets such as natural resources, the power to tax or mint currency, or what Treasury calls "heritage" or "stewardship assets" like national parks. Nevertheless, the trends are clear, and critical warning signs are evident in nearly every data point we examine. F2010 Cash Flow = -$1.3 Trillion; Net Worth = -$44 Trillion With a Negative Trend Line Over Past 15 Years USA Inc. Annual Cash Flow & Year-End Net Worth. F1996 - F2010 a I 3400 4600 la ntruni at One.Time Expenses' 41,200 Cah Flow (eltaxls) 1 445,000 315.000 " I 4'5.000 j -530.000 -0-NM Worth (right axis) 41.600 460.000 F1096 F19911 F2000 F2002 F2006 F2006 F2000 F2010 Malt Le4 Yaw/ (mai parrs.* ri Svf wt., C,,', . Amnar - latitai-wenwt• no. Gear. roe rem% natillu utaNid AAA n.atiairs "am SC04.50.1.174/41,4•Otarnin.ifiinv.a.i. Cove Me Me 75 "WO '0%. Arne enitiVOS F2AVIVIXIt su GOIMra CO PO* 0300, ryjas t2ne m2 IMP p.wAs R179c4nwl CC ct,nt Mie 6 POO.* ida,"/S419 sone,1 towaycnceoarowyrootP2010E Ipµ.S INS nil rAfe maim.. MPS ai•nutv pansw am, $428 (via's/Vat !.as. Mac P20/0 nal spennirprondelmmluly weep b Ann) MAINS reirals• kr Umbra wcwave nut., &on Pmtl.a.st, twer mhttrOstAatoi ice maw Oserilien• nwl6Ya kens. cam *mph? Ithis Mu. Cani cati,va••na..1 ay/ &Ant. rwr n`u, Avg ct /wart '10: 0 Awn.. f War atm ft Cianntriire USA h.: I Sunni°. K P C USA Inc. viii EFTA01123241 Underfunded entitlements are among the most severe financial burdens USA Inc. faces. And because some of the most underfunded programs are intended to help the nation's poorest. the electorate must understand the full dimensions of the challenges. F2010 USA Inc. Revenues + Expenses At A Glance FWIC. Arnow, - $2.2T r7OTJUSA Ue.~.4bwarina .oa.nrr"w, isinuismtimi.m••••••~nwaisaneenno.seastasam. Unfunded Entitlement (Metare . Social Secumy) • Undertended Entitlement Expenditures (Medicaid) - Among Largest Long-Term Liabilities on LISA Inc.'s Balance Sheet MI OA Bits, Cmip nVIO Unfunded Medicare Medicaid' $35.37 r..r~.r.......n..a... nanadisashaatsOetesenfronescssejeciman= Some consider defense outlays — which have nearly doubled in the last decade, to 5% of GDP — a principal cause of USA Inc.'s financial dilemma. But defense spending is still below its 7% share of GDP from 1948 to 2000; it accounted for 20% of the budget in 2010, compared with 41% of all government spending between 1789 and 1930. The principal challenges lie elsewhere. Since the Great Depression, USA Inc. has steadily added "business lines" and, with the best of intentions, created various entitlement programs. They serve many of the nation's poorest, whose struggles have been made worse by the recent financial crisis. Apart from Social Security and unemployment insurance, however, funding for these programs has been woefully inadequate — and getting worse. Entitlement expenses amount to $16,000 per household per year, and entitlement spending far outstrips funding, by more than $1 trillion (or $9,000 per household) in 2010. More than 35% of the US population receives entitlement dollars or is on the government payroll, up from -20% in 1966. Given the high correlation of rising entitlement income with declining savings, do Americans feel less compelled to save if they depend on the govemment for their future savings? It is interesting to note that in China the household savings rate is -36%, per our estimates based on CEIC data, in part due to a higher degree of self-reliance — and far fewer established pension plans. In the USA, the personal savings rate (defined as savings as percent of disposable income) was 6% in 2010 and only 3% from 2000 to 2008. K P CB USA Inc. ix EFTA01123242 Millions of Americans have come to rely on Medicare and Medicaid — and spending has skyrocketed, to 21% of USA Inc.'s total expenses (or $724B) in F2010, up from 5% forty years ago. Together, Medicaid and Medicare — the programs providing health insurance to low-income households and the elderly, respectively — now account for 35% of total healthcare spending in the USA. Since their creation in 1965, both programs have expanded markedly. Medicaid now serves 16% of all Americans, compared with 2% at its inception; Medicare now serves 15% of the population, up from 10% in 1966. As more Americans receive benefits and as healthcare costs continue to outstrip GDP growth, total spending for the two entitlement programs is accelerating. Over the last decade alone, Medicaid spending has doubled in real terms, with total program costs running at $273 billion in F2010. Over the last 43 years, real Medicare spending per beneficiary has risen 25 times, driving program costs well (10x) above original projections. In fact, Medicare spending exceeded related revenues by $272 billion last year. Amid the rancor about government's role in healthcare spending, one fact is undeniable: government spending on healthcare now consumes 8.2% of GDP, compared with just 1.3% fifty years ago. Total Government' Healthcare Spending Increases are Staggering — Up 7x as % of GDP Over Five Decades vs. Education Spending Only Up 0.6x USA Total Government Healthcare vs. Education Spending as % of GDP. 1960 - 2009 8% 6% S 4% L —Total Government (Falafel . Stale • Local) Spending on Educes= 8.2% —Total Government (Falafel . Stale • Local) Spending on Heolihcare 0% 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 Nrs 'nye el setewit ternee Miura Mthaeme s.ta WOO.. in , a. , "ni.e.agt...W. ,...inire min*" .se nSaf ad rann tr.at oArwv Sn•to Out o6ntain , Ow OMAN, Mon, SAw e; The overall healthcare funding mix in the US is skewed toward private health insurance due to the predominance of employer-sponsored funding (which covers 157MM working Americans and their families, or 58% of the total population in 2008 vs. 64% in 1999). This mixed private-public funding scheme has resulted in implicit cross-subsidies, whereby healthcare providers push USA Inc. x EFTA01123243 costs onto the private market to help subsidize lower payments from public programs. This tends to help drive a cycle of higher private market costs causing higher insurance premiums, leading to the slow erosion of private market coverage and a greater enrollment burden for government programs. The Patient Protection and Affordable Care Act, enacted in early 2010, includes the biggest changes to healthcare since 1965 and will eventually expand health insurance coverage by -10%, to 32 million new lives. Increased access likely means higher spending if healthcare costs continue to grow 2 percentage points faster than per capita income (as they have over the past 40 years). The CBO sees a potential $143B reduction in the deficit over the next 10 years, but this assumes that growth in Medicare costs will slow — an assumption the CBO admits is highly uncertain. Unemployment Insurance and Social Security are adequately funded...for now. Their future, unfortunately, isn't so clear. Unemployment Insurance is cyclical and, apart from the 2007-09 recession, generally operates with a surplus. Payroll taxes kept Social Security mainly at break-even until 1975-81 when expenses began to exceed revenue. Reforms that cut average benefits by 5%, raised tax rates by 2.3%, and increased the full retirement age by 3% (to 67) restored the system's stability for the next 25 years, but the demographic outlook is poor for its pay-as-you-go funding structure. In 1950, 100 workers supported six beneficiaries; today, 100 workers support 33 beneficiaries. Since Social Security began in 1935, American life expectancy has risen 26% (to 78), but the "retirement age" for full benefits has increased only 3%. Regardless of the emotional debate about entitlements, fiscal reality can't be ignored — if these programs aren't reformed, one way or another, USA Inc.'s balance sheet will go from bad to worse. Federal Government Spending Had Risen to 24% of GDP in 2010, Up From an Average of 3% From 1790 to 1930 Federal Government Spending as % of GDP. 1790 - 2010 40% 35% r • 25% 20% 3% Trefx1IMe Average 15% 1790-1930 10% 5.4 1790 1810 1830 1850 1870 1890 1910 1930 19W 1970 1990 2010 24% In 2010 kr" $t nun,' iv Ayr :lasa• Y AI /.4413 n "twee Mantra' sucwws Mega CalWel Ina ,VAI YNXNpv Mai° OW G&r . V WInv Inn anenn Sinus vmsnw 1.1W W. the VS 450 Mn" WwW1144.04h 40.0161144WW 14We ht..4e 04/ 44 Winn 'LS, I fan,' ri.V ar Ara 10 SO At MAO)* uMox 5...nn KP CB USA Inc. xi EFTA01123244 Entitlement Spending Increased 11x While Real GDP Grew 3x Over Past 45 Years USA Real Federal Expenses. Enthlernent Spending. Real GDP % Change. 1965 - 2010 % Change From 1965 1200% 1000% 800% 600% 100% 200% — Total Expenses — Entitlement Prog'ama — -Real GOP • , , 1965 1969 1973 1977 1961 1965 1989 1993 1997 2031 2005 2009 Entitlement Expenses +10.6x Total Expenses +3.3x Real GOP +2.7x wro on..xs.(noonmwe, surreal." Kw.> alro celAsapotant aV/AAVcr LISA PC I Sitrwe Take a step back, and imagine what the founding fathers would think if they saw how our country's finances have changed. From 1790 to 1930, government spending on average accounted for just 3% of American GDP. Today, government spending absorbs closer to 24% of GDP. It's likely that they would be even more surprised by the debt we have taken on to pay for this expansion. As a percentage of GDP, the federal government's public debt has doubled over the last 30 years, to 53% of GDP. This figure does not include claims on future resources from underfunded entitlements and potential liabilities from Fannie Mae and Freddie Mac, the Government Sponsored Enterprises (GSEs). If it did include these claims, gross federal debt accounted for 94% of GDP in 2010. The public debt to GDP ratio is likely to triple to 146% over the next 20 years, per CBO. The main reason is entitlement expense. Since 1970, these costs have grown 5.5 times faster than GDP, while revenues have lagged, especially corporate tax revenues. By 2037, cumulative deficits from Social Security could add another $11.6 trillion to the public debt. The problem gets worse. Even as USA Inc.'s debt has been rising for decades, plunging interest rates have kept the cost of supporting it relatively steady. Last year's interest bill would have been 155% (or $290 billion) higher if rates had been at their 30-year average of 6% (vs. 2% in 2010). As debt levels rise and interest rates normalize, net interest payments could grow 20% or more annually. Below-average debt maturities in recent years have also kept the Treasury's borrowing costs down, but this trend, too, will drive up interest payments once interest rates rise. K P CB USA Inc. xii EFTA01123245 Can we afford to wait until the turning point comes? By 2025, entitlements plus net interest payments will absorb all — yes, all — of USA Inc.'s revenue, per CBO. Entitlement Spending + Interest Payments Alone Should Exceed USA Inc. Total Revenue by 2025E. per CBO Entitlement Spending + Interest Payments vs. Revenue as % of GDP. 1980 - 2050E 40% 7s I a . • SO% 20 ; — ae 20% .5 s • £ t if' . lox 3 0 0% —Revenue — —Entitlement Spending • Net Interest Payments IMO 1020 2000 9010E 2010E 2030E 2040E 2050E Se...ee an".40...9M , 0(00p,..C.90,1.40 To, eurnt aeOM plielfci ?IOW ft enlbean :On , ' .0AM .0,0 ST , .... ,cr 0 4 4,0 11 , 05 C. SCOW SKIM livdenAld lapctact 0.0.4 ri a.. cing a Caw m MO I alw,...• liit rarvra'...mots1 town sour. • e.4.01.Stail~ LitI•41, AorApOry M1 zna. CtI2 .en, awn's,. At sea...02.701.• ntiws satt..riarisetva) ...0 cvn*V.1rre 1"..-• •Innae• Art , stnixe 4010- V.I. CtI2 • twain. twaw• • ttaronen sIn• pin :Nur, ent. sow ntia1 u4n10.0 KT am, oat... •Lea, 00,) I hi. Xea ANIYInext.ear•ronnaMv auen ilms, av . , •Cuiid !yarn. *•• at-0 Atuonv plyn -m Mi.n. • abt0 to n In rah Var IAL.trri roAnrK nfr. ••••. , 14,0 tow rrnaMaltatai.rd Ell 1, 403.lom.••••,"••••••4 ,1 ...roteer s, r• Hat Less than 15 years from now, in other words, USA Inc. — based on current forecasts for revenue and expenses - would have nothing left over to spend on defense, education, infrastructure, and M, which today account for only 32% of USA Inc. spending, down from 69% forty years ago. This critical juncture is getting ever closer. Just ten years ago, the CBO thought federal revenue would support entitlement spending and interest payments until 2060 - 35 years beyond its current projection. This dramatic forecast change over the past ten years helps illustrate, in our view, how important it is to focus on the here-and-now trend lines and take actions based on those trends. How would a turnaround expert determine 'normal' revenue and expenses? The first step would be to examine the main drivers of revenue and expenses. It's not a pretty picture. While revenue — mainly taxes on individual and corporate income — is highly correlated (83%) with GDP growth, expenses — mostly entitlement spending — are less correlated (73%) with GDP. With that as backdrop, our turnaround expert might try to help management and shareholders (citizens) achieve a long-term balance by determining "normal" levels of revenue and expenses: USA Inc. xiir EFTA01123246 • From 1965 to 2005 (a period chosen to exclude abnormal trends related to the recent recession), annual revenue growth (3%) has been roughly in line with GDP growth, but corporate income taxes have grown 2% a year. Social insurance taxes grew 5% annually and represented 37% of USA Inc. revenue, compared with 19% in 1965. An expert might ask: o What level of social insurance or entitlement taxes can USA Inc. support without reducing job creation? o Are low corporate income taxes important to global competitive advantage and stimulating growth? • Entitlement spending has risen 5% a year on average since 1965, well above average annual GDP growth of 3%, and now absorbs 51% of all expenses, more than twice its share in 1965. Defense and non-defense discretionary spending (including infrastructure, education, and law enforcement) is up just 1-2% annually over that period. Questions for shareholders: o Do USA Inc.'s operations run at maximum efficiency? Where are the opportunities for cost savings? o Should all expense categories be benchmarked against GDP growth? Should some grow faster or slower than GDP? If so, what are the key determinants? o Would greater investment in infrastructure, education, and global competitiveness yield more long-term security for the elderly and disadvantaged? With expenses outstripping revenues by a large (and growing) margin, a turnaround expert would develop an analytical framework for readjusting USA Inc.'s business model and strategic plans. Prudence would dictate that our expert assume below-trend GDP growth and above-trend unemployment, plus rising interest rates — all of which would make the base case operating scenario fairly gloomy. This analysis can't ignore our dependence on entitlements. Almost one-third of all Americans have grown up in an environment of lean savings and heavy reliance on government healthcare subsidies. It's not just a question of numbers — it's a question of our responsibilities as citizens...and what kind of society we want to be. Some 90 million Americans (out of a total population of 307 million) have grown accustomed to support from entitlement programs; so, too, have 14 million workers in the healthcare industry who, directly or indirectly, benefit from government subsidies via Medicare and Medicaid. Low personal savings and high unemployment make radical change difficult. Political will can be difficult to summon, especially during election campaigns. USA Inc. xry EFTA01123247 At the same time, however, these numbers don't lie. With our demographics and our debts, we're on a collision course with the future. The good news: Although time is growing short, we still have the capacity to create positive outcomes. Even though USA Inc. can print money and raise taxes, USA Inc. cannot sustain its financial imbalance indefinitely — especially as the Baby Boomer generation nears retirement age. Net debt levels are approaching warning levels, and some polls suggest that Americans consider reducing debt a national priority. Change is legally possible. Unlike underfunded pension liabilities that can bankrupt companies, USA Inc.'s underfunded liabilities are not legal contracts. Congress has the authority to change the level and conditions for Social Security and Medicare benefits; the federal government, together with the states, can also alter eligibility and benefit levels for Medicaid. Options for entitlement reform, operating efficiency, and stronger long-term GDP growth. As analysts, not public policy experts, we can offer mathematical illustrations as a framework for discussion (not necessarily as actual solutions). We also present policy options from third-party organizations such as the CBO. Reforming entitlement programs - Social Security. The underfunding could be addressed through some or all of the following mechanical changes: increasing the full retirement age to as high as 73 (from the current level of 67); and/or reducing average annual social security benefits by up to 12% (from $13,010 to $11,489); and/or increasing the social security tax rate from 12.4% to 14.2%. Options proposed by the CBO include similar measures, as well as adjustments to initial benefits and index levels. Of course, the low personal savings rates of average Americans — 3% of disposable income, compared with a 10% average from 1965 to 1985 — limit flexibility, at least in the early years of any reform. Reforming entitlement programs — Medicare and Medicaid. Mathematical illustrations for these programs, the most underfunded, seem draconian: Reducing average Medicare benefits by 53%, to $5,588 per year, or increasing the Medicare tax rate by 3.9 percentage points, to 6.8%, or some combination of these changes would address the underfunding of Medicare. As for Medicaid, the lack of a dedicated funding stream (i.e., a tax similar to the Medicare payroll tax) makes the math even more difficult. But by one measure from the Kaiser Family Foundation, 60% of the Medicaid budget in 2001 was spent on so-called optional recipients (such as mid- to low-income population above poverty level) or on optional services (such as dental services and prescription drug benefits). Reducing or controlling these benefits could help control Medicaid spending — but increase the burden on some poor and disabled groups. Ultimately, the primary issue facing the US healthcare system is ever-rising costs, historically driven by increases in price and utilization. Beneath sustained medical cost inflation is an entitlement mentality bolted onto a volume-based reimbursement scheme. All else being equal, the outcome is an incentive to spend: Underlying societal, financial, and liability factors combine to fuel an inefficient, expensive healthcare system. Ml USA Inc. xv EFTA01123248 Improving operating efficiency. With nearly one government civilian worker (federal, state and local) for every six households, efficiency gains seem possible. A 20-year trend line of declining federal civilian headcount was reversed in the late 1990s. Resuming that trend would imply a 15% potential headcount reduction over five years and save nearly $300 billion over the next ten years. USA Inc. could also focus intensively on local private company outsourcing, where state and local governments are finding real productivity gains. Improving long-term GDP growth — productivity and employment. Fundamentally, federal revenues depend on GDP growth and related tax levies on consumers and businesses. Higher GDP growth won't be easy to achieve as households rebuild savings in the aftermath of a recession. To break even without changing expense levels or tax policies, USA Inc. would need real GDP growth of 6-7% in F2012-14 and 4-5% in F2015-20, according to our estimates based on CBO data — highly unlikely, given 40-year average GDP growth of 3%. While USA Inc. could temporarily increase government spending and investment to make up for lower private demand in the near term, the country needs policies that foster productivity and employment gains for sustainable long-term economic growth. How Much Would Real GDP Need to Grow to Drive USA Inc. to Break-Even Without Policy Changes? 6-7% in F2012E-F2014E & 4-5% in F2015- F2020E...Well Above 40-Year Average of 3% CBO's Baseline Real GDP Growth vs. Requited Real GDP Growth roc a Balanced Budget Between F2011E and F2020E AK sK 2011E 2013E 201$8 2017E 2010E —Reel GOP Annual Growth (GOO semen* Femora) —Real GOP AnnualGrowth Rented to awn* Fled Derma — - 1970-2009 Average Real GOP Growth Productivity gains and increased employment each contributed roughly half of the long-term GDP growth between 1970 and 2009, per the National Bureau of Economic Research. Since the 1960s, as more resources have gone to entitlements and interest payments, USA Inc. has scaled back its investment in technology and infrastructure as percentages of GDP. Competitors are making these investments. India plans to double infrastructure spending as a percent of GDP by 2013, and its tertiary (college) educated population will double over the next ten years, according to Morgan Stanley analysts, enabling its GDP growth to accelerate to 9- 10% annually by 2015 (China's annual GDP growth is forecast to remain near 8% by 2015). USA Inc. can't match India's demographic advantage, but technology can help. Ml USA Inc. xvr EFTA01123249 For employment gains, USA Inc. should minimize tax and re uncertainties and encourage businesses to add workers. While hiring and Mrelated tax credits may add to near-term deficits, over time, they should drive job and GDP growth. Immigration reform could also help: A Federal Reserve study in 2010 shows that immigration does not take jobs from U.S.-born workers but boosts productivity and income per worker. Changing tax policies. Using another simple mechanical illustration, covering the 2010 budget deficit (excluding one- time charges) by taxes alone would mean doubling individual income tax rates across the board, to roughly 26-30% of gross income, we estimate. Such major tax increases would ultimately be self-defeating if they reduce private income and consumption. However, reducing tax expenditures and subsidies such as mortgage interest deductions would broaden the tax base and net up to $1.7 trillion in additional revenue over the next decade, per CBO. A tax based on consumption - like a value added tax (VAT) - could also redirect the economy toward savings and investment, though there would be drawbacks. These issues are undoubtedly complex, and difficult decisions must be made. But inaction may be the greatest risk of all. The time to act is now, and our first responsibility as investors in USA Inc. is to understand the task at hand. Our review finds serious challenges in USA Inc.'s financials. The 'management team' has created incentives to spend on healthcare, housing, and current consumption. At the margin, investing in productive capital, education, and technology — the very tools needed to compete in the global marketplace — has stagnated. America's Resources Allocated to Housing + Healthcare Nearly Doubled as a Percent of GDP Since 1965. While Household and Government Savings Fell Dramatically Healthcare + Housing Spending vs. Net Household + Government Savings as % of GDP. 1965-2009 29% 20% 15% —Housing • Heathen Spen019 se % of SDP — —Nel Household • Govommenl Savings as% off OOP 1 1 % °" 10% z 5% 0% 4% -10% 1994 1970 1970 1900 ISIS 1990 1995 2000 20% MN* 14970 edam uaratte a toning now 'woman Comm., raw. , ca. wa. 0,..nne• ,11. • arIM., sasor MA. S pa /the Aaitf USA In t *mins, KP CB USA Inc. xvii EFTA01123250 With these trends, USA Inc. will not be immune to the sudden crises that have afflicted others with similar unfunded liabilities, leverage, and productivity trends. The sovereign credit issues in Europe suggest what might lie ahead for USA Inc. shareholders — and our children. In effect, USA Inc. is maxing out its credit card. It has fallen into a pattern of spending more than it earns and is issuing debt at nearly every turn. Common principles for overcoming this kind of burden include the following: 1) Acknowledge the problem- some 80% of Americans believe 'dealing with our growing budget deficit and national debt' is a national priority, according to a Peter G. Peterson Foundation survey in 11/09; 2) Examine past errors— People need clear descriptions and analysis to understand how the US arrived at its current financial condition — a 'turnaround CEO' would certainly initiate a 'no holds barred' analysis of the purpose, success and operating efficiency of all of USA Inc.'s spending; 3) Make amends for past errors— Most Americans today at least acknowledge the problems at personal levels and say they rarely or never spend more than what they can afford (63% according to a 2007 Pew Research study). The average American knows the importance of managing a budget. Perhaps more would be willing to sacrifice for the greater good with an understandable plan to serve the country's long-term best interests; 4) Develop a new code of behavior— Policymakers, businesses (including investment firms), and citizens need to share responsibility for past failures and develop a plan for future successes. Past generations of Americans have responded to major challenges with collective sacrifice and hard work. Will ours also rise to the occasion? USA Inc. xvic EFTA01123251 USA Inc. February 2011 USA Inc. — Outline 1 Introduction 2 High-Level Thoughts on Income Statement/Balance Sheet 3 Income Statement Drilldown 4 Balance Sheet Drilldown 5 What Might a Turnaround Expert — Empowered to Improve USA Incas Financials — Consider? 6 Consequences of Inaction 7 Summary 8 Appendix F a EFTA01123252 This work's licensed Ice noncommercial distribution (bul NOT for excerpling or modlyki or creating derivatives) under the Creative Commorts Altributico-NonCommercial-NoDetin 3.0 Unposed CC BY-NC-ND license. You can lind !Ns license al htlpittealiirecomrnons.orplbensesitypnc- nd13.0.1tgakode or send a letter lo Creative Commons. 171 Second Street. Suite 300. San Francisco. CA. 94105. USA. This page is intentionally left blank. 4 EFTA01123253 Introduction USA Inc.' Irireduelen S About This Report USA 1..1 Inlreduttlen 5 EFTA01123254 Presentation Premise For America to remain the great country it has been for the past 235 years, it must determine the best ways to honor the government's fundamental mission derived from the Constitution: ...to form a more perfect union, establish justice, insure domestic tranquility, provide for the common defense, promote the general welfare and secure the blessings of liberty to ourselves and our posterity. To this end, government should aim to help create a vibrant environment for economic growth and productive employment. It should manage its operations and programs as effectively and efficiently as possible, improve its financial position by driving the federal government's income statement to long-term break-even, and reduce the unsustainable level of debt on its balance sheet. USA !rc acdi.ctios 7 USA Inc. Concept Healthy financials and compelling growth prospects are key to success for businesses (and countries). So if the US federal government — which we call USA Inc. — were a business, how would public shareholders view it? How would long-term investors evaluate the federal government's business model, strategic plans, and operating efficiency? How would analysts react to its earnings reports? Although some 45%' of American households own shares in publicly traded companies and receive related quarterly financial statements, not many "stakeholders" look closely at Washington's financials. Nearly two-thirds of all American households2 pay federal income taxes, but very few take the time to dig into the numbers of the entity that, on average, collects 13V of all Americans' annual gross income (not counting another 15-30% for payroll and various state and local taxes). We drill down on USA Inc.'s past, present, and (in some cases) future financial dynamics and focus on the country's income statement and balance sheet and related trends. We isolate and review key expense and revenue drivers. On the expense side, we examine the major entitlement programs (Medicare, Medicaid and Social Security) as well as defense and other major discretionary programs. On the revenue side, we focus on GDP growth (driven by labor productivity and employment in the long run) and tax policies. We present basic numbers-driven scenarios for addressing USA Inc.'s financial challenges. In addition, we lay out the type of basic checklists that corporate turnaround experts might use as starting points when looking at some of USA Inc.'s business model challenges. Source. I) 2008 ICI (Invesimenl Company Institute) / SIFSCA (Semmes Industry and Financial kisrkets Associabon)Equily and Bond Owners Survey: 2) Nwriber of gay mums with positive tax listuIrly (9IAM.pcasndedby total number or reloniS Med (1421.0.4). per Tax Fours:Won calculi/rens based on IRS data: 3) Taal federal income taxes (ex. payroll taxes) pad °(viled by lots' ao)usled gross income. per IRS 2007 data. USA Inc.I Inucauclion 8 EFTA01123255 Why We Wrote This Report As American citizens / tax payers, we care about the future of our country. As investors, we search for data and insights to help us make better investment decisions. (It's easier to predict the future with a keen understanding of the past.) We found ourselves searching for better information about the state of America's financials, and we decided to assemble — in one place and in a user-friendly format — some of the best data about the world's biggest "business." In addition, we have attempted to provide some historical context for how USA Inc.'s financial model has evolved over decades. The complexity of USA Inc.'s challenges is well known, and our presentation is just a starting point; it's far from perfect or complete. But we are convinced that citizens — and investors - should understand the business of their government. Thomas Jefferson and Alexis de Tocqueville knew that — armed with the right information — the enlightened citizenry of America would make the right decisions. It is our humble hope that a transparent financial framework can help inform future debates. USA lit I Ihn.txtLY.:1JOi. 9 What You'll Find Here... In the conviction that every citizen should understand the finances of USA Inc. and the plans of its "management team," we examine USA Inc.'s income statement and balance sheet and present them in a basic, easy-to- use format. In this document, a broad group of people helped us drill into our federal government's basic financial metrics. We summarize our thoughts in PowerPoint form here and also have provided a brief text summary at We encourage people to take our data and thoughts and study them, critique them, augment them, share them, and make them better. There's a lot of material — think of it as a book that happens to be a slide presentation. USA lit I Ittcduction 10 EFTA01123256 ...And What You Won't We do not make policy recommendations. We try to help clarify some of the issues in a simple, analytically-based way. We aim to present data, trends, and facts about USA Inc.'s key revenue and expense drivers to provide context for how its financials have reached their present state. We did not base this analysis on proprietary data. Our observations come from publicly available information, and we use the tools of basic financial analysis to interpret it. Forecasts generally come from 3rd-party agencies like the Congressional Budget Office (CBO). For US policy makers, the timing of material changes will be especially difficult, given the current economic environment. No doubt, there will be compliments and criticism of things in the presentation (or missing from it). We hope that this report helps advance the discussion and we welcome others to opine with views (backed up by data). USA Ire l It ,!re<ILntior We Focus on Federal, Not State & Local Government Data • Federal / State & Local Governments Share Different Responsibilities Federal government is financially responsible for all or the majority of Defense, Social Security, Medicare and Interest Payments on federal debt and coordinates / shares funding for public investment in education / infrastructure. State & local governments are financially responsible for all or the majority of Education, Transportation (Road Construction & Maintenance), Public Safety (Police / Fire Protection / Law Courts / Prisons) and Environment & Housing (Parks & Recreation / Community Development / Sewerage & Waste Management). Federal / state & local governments share financial responsibility in Medicaid and Unemployment Insurance. • We Focus on the Federal Government State and local governments face many similar long-term financial challenges and may ultimately require federal assistance. To be sure, the size of state & local government budget deficits ($70 billion, in aggregate in F2009) and debt-to-GDP ratio (7%2 on average in F2008) pales by comparison to the federal government's ($1.3 trillion budget deficit, 62% debt-to-GDP ratio in F2010). But these metrics may understate state & local governments' financial challenges by 50% or more3 because they exclude the long-term cost of public pension and other post employment benefit (OPEB) liabilities. Note: I) Per National Conference of Stale Legislatures. State fiscal years ends in June. 5708 aggregate extrees deficits from Puerto Rio ($W deficits in F2009). 2) Debblo-GOP !alio per Census Bureau Slate & Local Gore/Arne& Parente: 3) Calculabon based on due claim that SIT of cotter. short ft in Stale B kcal government pension and OPEB kndng trek f be .$2.51' using corporate accounting rules. per Orin S. Kramer. 'How to Cheat a Retirement Fund- 9'10. USA Inc. I Inlicduclion 12 EFTA01123257 Summary [Al LISA Irc I It'r Highlights from F2010 USA Inc. Financials • Summary — USA Inc. has challenges. • Cash Flow — While recession depressed F2008-F2010 results, cash flow has been negative for 9 consecutive years ($4.8 trillion, cumulative), with no end to losses in sight. Negative cash flow implies that USA Inc. can't afford the services it is providing to 'customers,' many of whom are people with few alternatives. • Balance Sheet — Net worth is negative and deteriorating. • Off-Balance Sheet Liabilities - Off-balance sheet liabilities of at least $31 trillion (primarily unfunded Medicare and Social Security obligations) amount to nearly $3 for every $1 of debt on the books. Just as unfunded corporate pensions and other post-employment benefits (OPEB) weigh on public corporations, unfunded entitlements, over time, may increase USA Inc.'s cost of capital. And today's off-balance sheet liabilities will be tomorrow's on-balance sheet debt. • Conclusion — Publicly traded companies with similar financial trends would be pressed by shareholders to pursue a turnaround. The good news: USA Inc.'s underlying asset base and entrepreneurial culture are strong. The financial trends can shift toward a positive direction, but both 'management' and 'shareholders' will need collective focus, willpower, commitment, and sacrifice. Ml Able: USA federal fiscal year ends in Sepfernbee: Cash bow- total revenue - Iola! spencEng on a cash basis; net Werth includes unfunded futureMabee:es from Soda, Secunry and ArecCcare on an accrual basis over the next 75 years. Source: C3SI) flow per White House Office of Managemera and Budget: net worts per Dept of Treasury. 1010 Financial Report or the U.S. Government? aryusled fo Inaba unhurded liabhfies of Sods) Seafly and Atedr-ree. USA Inc. I Inuoduction la EFTA01123258 Drilldown on USA Inc. Financials... • To analysts looking at USA Inc. as a public corporation, the financials are challenged - Excluding Medicare / Medicaid spending and one-time charges, USA Inc. has supported a 4% average net margin' over 15 years, but cash flow is deep in the red by negative $1.3 trillion last year (or -$11,000 per household), and net worth2 is negative $44 trillion (or -$371,000 per household). • The main culprits: entitlement programs, mounting debt, and one-time charges - Since the Great Depression, USA Inc. has steadily added 'business lines' and, with the best of intentions, created various entitlement programs. Some of these serve the nation's poorest, whose struggles have been made worse by the financial crisis. Apart from Social Security and unemployment insurance, however, funding for these programs has been woefully inadequate — and getting worse. - Entitlement expenses (adjusted for inflation) rose 70% over the last 15 years, and USA Inc. entitlement spending now equals $16,600 per household per year; annual spending exceeds dedicated funding by more than $1 trillion (and rising). Net debt levels are approaching warning levels, and one-time charges only compound the problem. - Some consider defense spending a major cause of USA Inc.'s financial dilemma. Re-setting priorities and streamlining could yield savings — $788 billion by 2018, according to one recent study3 — perhaps without damaging security. But entitlement spending has a bigger impact on USA Inc. financials. Although defense nearly doubled in the last decade, to 5% of GDP, it is still below its 7% share of GDP from 1948 to 2000. It accounted for 20% of the budget in 2010, but 41% of all government spending between 1789 and 1930. Kf ( Nee: Net marcfn defined as net income divided by Mad revenue; 2) net meth defined as assets (ex. sfewardshM assets Me national parks and hef age assets Me Me Washington Monument) minus Natiedes minus Me net plasma wane of unfunded entitlements (such as Social Seventy and Medicare). data per imagery Oep es -2010 Annual Repast on the U.S. Cosmorama: 3)Gotdon Adams and Matthew Le301.1711211..ALeaner and Meaner National Defense.-Foreign Affairs. Janceb 201 5) USA Inc. I Inualuclion 15 ...Drilldown on USA Inc. Financials.. • Medicare and Medicaid, largely underfunded (based on `dedicated' revenue) and growing rapidly, accounted for 21% (or $724B) of USA Inc.'s total expenses in F2010, up from 5% forty years ago - Together. these two programs represent 35% of all (annual) US healthcare spending; Federal Medicaid spending has doubled in real terms over the last decade, to $273 billion annually. • Total government healthcare spending consumes 8.2% of GDP compared with just 1.3% fifty years ago; the new health reform law could increase USA Inc.'s budget deficit - As government healthcare spending expands, USA Inc.'s red ink will get much worse if healthcare costs continue growing 2 percentage points faster than per capita income (as they have for 40 years). • Unemployment Insurance and Social Security are adequately funded...for now. The future, not so bright - Demographic trends have exacerbated the funding problems for Medicare and Social Security — of the 102 million increased enrollment between 1965 and 2009, 42 million (or 41%) is due to an aging population. With a 26% longer life expectancy but a 3% increase in retirement age (since Social Security was created in 1935), deficits from Social Security could add $11.6 trillion (or 140%) to the public debt by 2037E, per Congressional Budget Office (CBO). KP ( USA Inc. I Inueduchon 16 EFTA01123259 ...Drilldown on USA Inc. Financials • If entitlement programs are not reformed, USA Inc.'s balance sheet will go from bad to worse Public debt has doubled over the last 30 years. to 62% of GDP. This ratio is expected to surpass the 90% threshold' — above which real GDP growth could slow considerably — in 10 years and could near 150% of GDP in 20 years if entitlement expenses continue to soar, per CBO. As government healthcare spending expands, USA Inc.'s red ink will get much worse if healthcare costs continue growing 2 percentage points faster than per capita income (as they have for 40 years). • The turning point: Within 15 years (by 2025), entitlements plus net interest expenses will absorb all — yes, all — of USA Inc.'s annual revenue, per CBO That would require USA Inc. to borrow funds for defense, education, infrastructure, and spending. which today account for 32% of USA Inc. spending (excluding one-time items), down dramatically from 69% forty years ago. It's notable that CBO's projection from 10 years ago (in 1999) showed Federal revenue sufficient to support entitlement spending + interest payments until 2060E - 35 years later than current projection. KP CB Note. 'Carmen Reinhart and Kenneth Robed observed from 2700 histodcal annual data points from 44 countries that the relationshipbetween government debt and real GOP growth is weak for deb&GOP ratios beSsw a threshold of 90 percerf of GOP. Above 90 percent. median growth sales lab by one percent. and averagegrowth tabs considerably mote. We note that white Reinhart and Rogolts observairons are based an 'gross debt data. in the U.S.. debt held by the public is dose, to the European countries' definition of government gross debt. For MOM information. see Reinhart and Ropoff. Growth the Terre of Debt.-1/10. USA Inc. l Inueduclion 17 How Might One Think About Turning Around USA Inc.?... • Key focus areas would likely be reducing USA Inc.'s budget deficit and improving / restructuring the `business model'... One would likely drill down on USA Inc.'s key revenue and expense drivers, then develop a basic analytical framework for 'normal' revenue / expenses, then compare options. Looking at history... Annual growth in revenue of 3% has been roughly in line with GDP for 40 years' while corporate income taxes grew at 2%. Social insurance taxes (for Social Security / Medicare) grew 5% annually and now represent 37% of USA Inc. revenue, compared with 19% in 1965. Annual growth in expenses of 3% has been roughly in line with revenue, but entitlements are up 5% per annum - and now absorb 51% of all USA Inc.'s expense - more than twice their share in 1965; defense and other discretionary spending growth has been just 1-2%. One might ask... Should expense and revenue levels be re-thought and re-set so USA Inc. operates near break-even and expense growth (with needed puts and takes) matches GDP growth, thus adopting a 'don't spend more than you earn' approach to managing USA Inc.'s financials? Aisle: We chose a 40-year period from 1965 to 200510 examine rwrnal'levefs ofteyenue and expenses. We did not choose the most recent 40Insrpenod (196910 2009) as USA was in deep recession in 2008/2009 and underwent signitcant 13X poky frodkrafions in 1969/1969. so many metrics (Ake indiviabat Moon* and corporate prohl)yarted sista:candy from honnar USA Inc. I Inueduclion 18 EFTA01123260 . How Might One Think About Turning Around USA Inc.? One might consider... • Options for reducing expenses by focusing on entitlement reform and operating efficiency Formula changes could help Social Security's underfunding. but look too draconian for Medicare/Medicaid; the underlying healthcare cost dilemma requires business process restructuring and realigned incentives. Resuming the 20-year trend line for lower Federal civilian employment, plus more flexible compensation systems and selective local outsourcing, could help streamline USA Inc.'s operations. • Options for increasing revenue by focusing on driving long-term GDP growth and changing tax policies USA Inc. should examine ways to invest in growth that provides a high return (ROI) via new investment in technology, education, and infrastructure and could stimulate productivity gains and employment growth. Reducing tax subsidies (like exemptions on mortgage interest payments or healthcare benefits) and changing the tax system in other ways could increase USA Inc.'s revenue without raising income taxes to punitive — and self-defeating — levels. Such tax policy changes could help re-balance USA's economy between consumption and savings and re-orient business lines towards investment-led growth, though there are potential risks and drawbacks. • History suggests the long-term consequences of inaction could be severe - USA Inc. has many assets, but it must start addressing its spending/debt challenges now. USA Ire I Inlettluczion 19 Sizing Costs Related to USA Inc.'s Key Financial Challenges & Potential AND / OR Solutions • To create frameworks for discussion, the next slide summarizes USA Inc.'s various financial challenges and the projected future cost of each main expense driver. The estimated future cost is calculated as the net present value of expected 'dedicated' future income (such as payroll taxes) minus expected future expenses (such as benefits paid) over the next 75 years. • Then we ask the question: `What can we do to solve these financial challenges?' The potential solutions include a range of simple mathematical illustrations (such as changing program characteristics or increasing tax rates) and/or program-specific policy solutions proposed or considered by lawmakers and agencies like the CBO (such as indexing Social Security initial benefits to growth in cost of living). • These mathematical illustrations are only a mechanical answer to key financial challenges and not realistic solutions. In reality, a combination of detailed policy changes will likely be required to bridge the future funding gap. i!rcd,ztion 20 EFTA01123261 KP CB Overview of USA Inc.'s Key Financial Challenges & Potential and/or Solutions Rank Financial Challenge Net Present Cost ($1' % of 2010 GDP) Mathematical Illustrations and/or Potential Policy Solutions2 • Isolate and address the drivers of medical cost inflation 1 Medicaid $35 Trillions / 239% • Improve efficiency / productivity of healthcare system • Reduce coverage for optional benefits & optional enrollees • Reduce benefits 2 Medicare $23 Trillion / 156% • Increase Medicare tax rate • Isolate and address the drivers of medical cost inflation • Improve efficiency / productivity of healthcare system • Raise retirement age • Reduce benefits 3 Social Security $8 Trillion / 54% • Increase Social Security tax rate • Reduce future initial benefits by indexing to cost of living growth rather than wage growth • Subject benefits to means test to determine eligibility 4 Slow GDP / USA • Invest in technology / infrastructure / education • Remove tax & regulatory uncertainties to stimulate employment growth Revenue Growth • Reduce subsidies and tax expenditures & broaden tax base • Resume the 20-year trend line for lower Federal civilian employment 5 Government Inefficiencies • Implement more flexible compensation systems • Consolidate / selectively local outsource certain functions Note: 0 Net Ptesenl Cosris calculated as the present vete of expeded future net Nateties (expected revenue minus expected costs) for each program /issue over the next 75 years. Medicate emanate per Dept. at Treasury. 20 IO Financial Report of the U.S. Govermnenr Socia1Secutily estimate per Social Sec wily Trustees' Repast (&l0). 2) For mote deals on patinas) solutions. see sides 252-010or lull USA Inc. presentation. 3)6tedcaid does no! have dedicated tevenue source n005357 net present cast excludes funding from gentlel lax revenue. NPV anaysis based on 3% discount rare 'defied to C50's plopichon lot annual inflationedpeted expenses. USA Inc. I Intecduclion 21 The Essence of America's Financial Conundrum & Math Problem? While a hefty 80% of Americans indicate balancing the budget should be one of the country's top priorities, per a Peter G. Peterson Foundation survey in 11/09... ...only 12% of Americans support cutting spending on Medicare or Social Security, per a Pew Research Center survey, 2/11. Some might call this 'having your cake and eating it too...' USA VC In.rc<IL.ctiof EFTA01123262 The Challenge Before Us Policymakers, businesses and citizens need to share responsibility for past failures and develop a plan for future successes. Past generations of Americans have responded to major challenges with collective sacrifice and hard work. Will ours also rise to the occasion? USA Inc. I !ma:Joann 23 This page is intentionally left blank. 24 EFTA01123263 High-Level Thoughts on Income Statement/Balance Sheet USA Inc. I High Level Thoupts 25 How Would You Feel if... ...your Cash Flow was NEGATIVE for each of the past 9 years... ...your Net Worth* has been NEGATIVE for as long as you can remember... ... it would take 20 years of your income at the current level to pay off your existing debt — assuming you don't take on any more debt. KP ( No. 'See stele 30 la net worth quail. USA Inn. F 16gh Lend Troppls 26 EFTA01123264 Welcome to the Financial Reality (& Negative Trend) of USA Inc. F2010 Cash Flow = -$1.3 Trillion: Net Worth = -$44 Trillion USA Inc. Annual Cash Flow & Year-End Net Worth. F1996 - F2010 S400 $0 I O CO -$400 O LL 3 -5800 C C K I P -$1.200 a One-Time Expenses' Cash Flow (left axis) Net Worth (right axis) -$1.600 -$60.000 F1996 F1998 F2000 F2002 F2004 F2006 F2008 F2010 $15,000 SO -$15.000 -$30.000 -$45.000 Year-End Net Worth (SBillion) Note: USA federal &Jail year ends in September: Gash flow - total revenue-total spending on a cash basis: net worth intrudes unfunded future fiatolties from Soda! Security and Medicate on an accrual basis over the next 75 years. 'One-fine expenses in F2008 include $148 payments to Freddie Mac: F2009 includes $2798 net TARP payouts. 5978 payment to Fannie Mae 8 Freddie Mac and 5408 sormArs spending on dscregontry items: F20f 0 includes $268 net TARP income. $1376 stimulus spending and 5418 payment to Fannie Mae 8 Fredde Mac. F2010 net worth improved Wamakally owing to revised act uariat estimates foe Medcare program resutted from the Healthcare Wenn legislation. For more dermoltions. see next slide. Source: cash flow pee Who're House atoce or Management and Budget net worth per Dept. of Treasury. '2010 Financial Report of the U.S Government- USA Inc.] Hgh Level moughls 27 Think About That... The previous chart is in TRILLIONS of dollars. Just because million, billion and trillion rhyme, doesn't mean that they are even close to the same quantity. USA Inc.] Hgh Level moughls 28 EFTA01123265 Only Politicians Work in Trillions of Dollars— Here's How Much That Is O r 1 Pallet $1 Million (MM) $1 Billion (B) 217 Football Fields • satt es searearess aredrearess adreareas adreareare ardrearease arearearedre areareare Areserearadre asseares adresaire - d rea e- a rasa airdwarearen treetestatatesses $ 1 Trillion ( T) asserearears areareares USA Inc. ] Hqn LexV Tholepin 29 Net Worth Qualifier The balance sheet / net worth calculation does not include the power to tax — the net present value of the sovereign power to tax and the ability to print the world's reserve currency would clearly bolster USA Inc.'s assets - if they could be accurately calculated. • Plant, Property & Equipment (PP&E) on USA Inc.'s balance sheet is valued at $829B1 (or 29% of USA Inc.'s total stated assets) — this includes tangible assets such as buildings, internal use software and civilian and military equipment. • The PP&E calculation DOES NOT include the value of USA Inc.'s holdings in the likes of public land (estimated to be worth $408B per OMB)1, highways, natural gas, oil reserves, mineral rights (estimated to be worth $345B per OMB), forest, air space, radio frequency spectrum, national parks and other heritage and stewardship assets which USA Inc. does not anticipate to use for general government operations. The good news for USA Inc. is that the aggregate value of these heritage and stewardship assets could be significant. Atte. 1) USA Mo.'s hokfing offend is measured in non. financial units such as acres of land and takes. and matey of National Paths and National Mann. Sancluanet Land under USA Inc.'s stewardship accounts for 28% of the total U.S. landmass as or g'10. Dept. of !Meteor repotted S5.2 national utile reluces. 378 park units. 134 geographic management meas. 67 fish hatcheries undm their management as of 9'10. Dept of Defense repotted 203.000 acres of pubic land and 16.140.000 acres mihdrawn pubdc land. One USDA's Forest Semke managed an estimated ?SS national/mese:, while the Dept. or Commerce had 13 National Di 'Amine Sway...tries. which included near-shore coral reefs and open ocean. as or 910. Dept of Treasury. '2010 Financial Fleptv1 of Me U.S. Government • USA Inc. I Itch Level Tholepin 30 EFTA01123266 A Word of Warning About Comparing Corporate & Government Accounting... • Government accounting standards do not report the present value of future entitlement payments (such as Social Security or Medicare) as liabilities. Instead, entitlement payments are recognized only when they are paid. • Our analysis takes a different view: governments create liabilities when they enact entitlements and do not provide for revenues adequate to fund them. • We measure the entitlement liability as the present value of estimated entitlement payments in excess of expected revenues for citizens of working age based on Social Security and Medicare Trust Funds' actuarial analysis. • Government accounting standards also do not recognize the value of internally- generated intangible assets (such as the sovereign power to tax). We do not recognize those assets either, as we have no basis to measure them. But the US government has substantial intangible assets that should provide future economic benefits. Note: For more dscussion on itednades to corporate and official government accounting methods, see Laurence J. Kotlikoll. Alan J. Auerbach. and Jagadeesh Gokhale. "Generakonal Accounling: A Meaningful Way to Assess Gendabonal Policy? puldshed on 12)94 in The Journal of Economic Perspectives. Soused Greg Jonas. Morgan Stanley Research. USA Inc. F high Le...171100O1s 31 ...and About Government Budgeting • Federal government budgeting follows arcane practices that are very different from corporate budgeting — and can neglect solutions to structural problems in favor of short-term expediency. • Federal government does not distinguish capital budget (for long-term investment) from operating budget (for day-to-day operations). As a result, when funding is limited, government may choose to reduce investments for the future to preserve resources for day-to-day operations. • Budget "scoring" rules give Congress incentives to hide the true costs...and help Congressional committees defend their turf.* Note: The more detail. meter to side 7 t6 on congressional budget sewing rules related to recent Healthcare reform. USA Inc. ] Hgh Level Thoughts 32 EFTA01123267 Metric Definitions & Qualifiers • Cash Flow = 'Cash In' Minus 'Cash Out' - Calculated on a cash basis (which excludes changes in non-cash accrual of future liabilities) for simplicity. • One-Time Expenses = 'Spending Minus Repayments' for Non-Recurring Programs - Net costs of programs such as TARP, ARRA, and GSE bailouts. • Net Worth = Assets Minus Liabilities Minus Unfunded Entitlement Liabilities - Assets include cash & investments, taxes receivable, property, plant & equipment (as defined by Department of Treasury). - Liabilities include accounts payable, accrued payroll & benefits, federal debt, federal employee & veteran benefits payable... - Unfunded Entitlement Liabilities include the present value of future expenditures in excess of dedicated future revenues in Medicare and Social Security over the next 75 years. Note: LISA Inc. accounts do not tabby the same GAAP as corporations. USA Inc. I Hgh Level Thoughts 33 Common Financial Metrics Applied to USA Inc. in F2010 • Cash Flow Per Share = -$4,171 - USA Inc.'s F2010 cash flow -$1.3 trillion, divided by population of -310 million (assuming each citizen holds one share of USA Inc.). • Net Debt to EBITDA Ratio = -8x - USA Inc. net debt held by public ($9.1 trillion) divided by USA Inc. F2010 EBITDA (-$1.1 trillion). It's notable that the ratio compares with S&P500 average of 1.4x in 2010. Note. USA Inc. accounts do not follow Me same OUP as corpoiabons. Refer to safe at los a wort; of waning about panwaring corporate and government amounting. EBROA is Earnings Galore tnieresL Tax. Depreciation B Amortizeisan. Source: Dept ot Treasury. While House Office of Management and Budget Congressional Budget Office. Bak BLS. USA Inc. ] Hgh Level Thoughts 34 EFTA01123268 Even Adjusting For Cyclical Impact of Recessions, USA Inc.'s 2010 Structural Operating Loss = -$817 Billion vs. -$78 Billion 15 Years Ago C O CT3 • w O 40 Ta. -$400 to C • E E -$800 O -$1,200 To `c • -$1,600 USA Inc. Annual Operating Surplus Deficit, Structural vs. Cyclical', F1996 — F2010 $400 la Structural Cyclical F1996 F1998 F2000 F2002 F2004 F2006 F2008 F2010 Note. I )Congressional Budget Ofbce defines a sr/actual surplus or deli& as the budget surplus or deficit that womb' occur under current lewd the influences of the business cycle on the budget - the automatic stabilizers- were removed. and cyclical surplus or ciao/ as the automatic net changes in revenues and outlays that are attributable to cyclical movements hi real inflationbOuslenoutput and unemployment. COO carolled this data from Dept. of Commemes Bureau of Economic Analysis (SEA). which maintains the national income aid poduct amounts (NIPA). An important difference betWeen the official budget debt( and Ihe NIPA measure of net federal government saving is that the latter excludes such purely ffemncira transactions as the sale of government assets. and most transactions under the Troubkd Asset Rebel Program. because those transactions do not he@ to measure anent productionand income. In addraon. historical 114 IPA data ate subject to significant revision: historical budget data. by contrast. ate rarely teased signikcantly. Source: 1996-2006 data per CHO. The Effects of Automatic Stabilizers on the Federal Budget.' 5'W. 2007-2010data per White House OMB P20t2 Budge! Analytical Perspectne. USA Inc. [ I1gh Level Tnotopls 35 Understanding Differences Between Economist Language vs. Equity Investor Translation Economist Language • Budget Deficit — The amount by which a government's expenditures exceed its receipts over a particular period of time. • Structural Deficit — The portion of the budget deficit that results from a fundamental imbalance in government receipts and expenditures, as opposed to one based on the business cycle or one- time factors. • Cyclical Deficit — The portion of the budget deficit that results from cyclical factors such as economic recessions rather than from underlying fiscal policy. • Federal Debt Held By the Public — The accumulation of all previous fiscal years' Equity Investor Approximate Translation* • Cash Flow — 'Cash in' minus 'cash out.' • Cash Flow (ex. One-Time Items)* — 'Cash in' minus 'cash out' excluding expenditures that are one-time in nature (such as economic stimulus spending). • One-Time Expenses* — TARP / GSE I stimulus spending related to economic recession. • Debt — Cumulative negative cash flow financed by borrowing. deficits. Note: 'We achnuatedge that aisle Inc concept of 'cash Cower. onetime items' and cneqime expenses' is similar to 'structural deficrrand 'cyclical respectarely. these terms are not interchangeable and have afferent definitions. Congressional Budget Office delves a structural surplusor debar as the budget surplus or debar that would occur under current law if the influences of the business cycle on the budget- the automatic stabilizers - were removed. and cyclical surplus or defeat as the automatic net changes in /avenues and outlays that are attribute)* to cyclical movements in teal Onfrationuto)UstedJoulput and unenytioymera. USA Inc. F Itgh Level Tnotopls 36 EFTA01123269 How Did USA Inc.'s Financial Reality Get to this Difficult Point? USA Inc. Has Not Adequately Funded Its Entitlement Programs Recessions come and go (and affect USA's revenue), but future claims (related to entitlement program commitments) on USA Inc. now meaningfully exceed its projected cash flows. For the last 40 years, management (the government) has committed more long-term benefits through 'entitlement' programs like Medicaid / Medicare / Social Security...without developing a sound plan to pay for them. Many of these programs provide important services to low-income, unemployed, and disabled Americans in great need for help. But without proper financing, support may dwindle. USA Inc. I Hgh Level Thoughts 37 USA Inc. Has Substantially Expanded Its "Business Lines" Over Past 80 Years From 1789 to 1930, 41%1 of USA Inc.'s cumulative budget was dedicated to defense spending (compared with 20%1 in F2010), per the Census Bureau. This began to change in the 1930s, when the federal government substantially expanded its role (in effect, expanded its "business lines") in response to the Great Depression. Now 1)4196d VW curnutanve defense spending feat/ding Means beads and serviced as % of sunastne ael Ceders! spending nom 1789 a 1930. Indain9 seidans'beneets and services. Odense spending week has e Satyr 49.4.01 sumdative annual:fudge( fan 1789a 1930 and ova have Caen22%U, P2009. Source: Census Bureau. lean.) Steads of she anted &des. Caved Times a 1970.'OMa saes 9457465. USA Inc. I Ugh Level Thoughts 38 EFTA01123270 USA Inc. "Business Lines" Have Expanded From Defense to Insurance & Other Areas USA Inc. Major 'Business Line' Spending as % of GDP, F1800 vs. F1900 vs. F2000 F1800 Other KP C 2.2% F1900 2.5% nterest Payment 0.2% F2000 18.2% Other 5.1% Defense 3.0% Interest Payment 2.3% Health Retirement + Insurance' Disability 3.6% Insurance' 4.2% Note: Fiscal year 1800/1900 ended M June. Fiscal year 2000 ended in September. 'Health insurance Mtdes Metare. Metaid (federal portion) and other fetal health programs. retirement and disability insurance is Social Security. Other spending induct put& seder enw.loyee and veteran pension 8 benefits cost and spencfing on community devekopment. Lew enlacement / education / public infrastructure/ energy. etc. Source: 1800/ 1900 data per Census Bureau. 2000 per While House OMB. USA Inc. I High Level Thoughts 39 USA Inc. First 155 Years (1776-1930) = Era of Defense Dept. of Army + Navy = 41%1 of Cumulative Spending From 1789-1930 USA Inc.'s Budget Outlays For the First 155 Years (1776-1930)2 1789-1791 ... 1800 ... 1850 ... 1900 ... 1930 1789.1930 Cumulative Total Federal Government Outlays ($MM $4 S11 $40 $521 $3,320 $98,747 Defense $1 $6 $17 $191 $839 $40,332 % of Total Outlays 15% 56% 44% 37% 25% 41% Dept. of the Army $1 $3 $9 $135 $465 $28,831 % of Total Outlays 15% 24% 24% 26% 14% 29% Dept. of the Navy $0 $3 $8 $56 $374 $17.500 % of Total Outlays 32% 20% 11% 17% 12% Interest on the Public Debt $2 $3 $4 $40 $659 $13,790 % of Total Outlays 55% 31% 10% 8% 20% 14% Other' $1 $18 $290 $1,822 $44,626 % of Total Outlays 30% 13% 47% 56% 55% 45% Veteran Compensation and Pensions $0 $0 $2 $141 $221 $8,273 % of Total Outlays 4% 1% 5% 27% 7% 8% Note: Data is rounded and not meted for inflation. 1)01% is the curnutaiive defense spending Mitten° velteans*Dentias and aerates) as %of tuns/take total feckval spend.* Pool 1789 to 1930. Including veterans' tenet and services. defense spending would have been 49% of cumulative ennuis! budget from 1789 to 1930. 2)Data not available from 1776 to 1789. ' Other includes various spends* on adaanistralion. legislation and veteran compensation and pensions. Source: Census BIONIU. .Hislorkal statistics of the United States. Colonial Times M1970.'0414 sets V' [57.468 USA Inc.l Koh Level Thoughts 40 EFTA01123271 USA Inc. Next 80 Years (1931-2010) = Era of Expansion Defense Down to 20% of Spending; Social Security + Healthcare Up to 44% in F2010 USA Inc.'s Budget Outlays For the Next 78 Years (1931-2010)2 1931 ,,, 1940 .„ 1950 ... 1960 ... 1970 ... 1980 ,,, 1990 _2000 ,,, 2010 Total Federal Government Outlays (SB $4 $9 $43 $92 $196 $591 $1,253 $1,789 $3,456 Defense $1 $2 $14 $48 $82 $134 $299 $294 $694 % of Total Outlays 23% 20% 32% 52% 42% 23% 24% 16% 20% Interest on the Public Debt $1 $1 $5 $7 $14 $53 $184 $223 $196 % of Total Outlays 17% 11% 11% 8% 7% 9% 15% 12% 6% Retirement & Disability Insurance $0 SO $1 $12 $30 $119 $249 $409 $707 % of Total Outlays 0% 0% 2% 13% 15% 20% 20% 23% 20% Healthcare $0 $0 $0 $1 $12 $55 $156 $352 $821 % of Total Outlays 0% 1% 1% 1% 6% 9% 12% 20% 24% Physical Resources (Energy / Housing...) $0 $2 $4 $8 $16 $66 $126 $85 $89 % of Total Outlays 5% 26% 9% 9% 8% 11% 10% 5% 3% Other $2 $4 $19 $17 $42 $165 $239 5426 $950 % of Total Outlays 55% 42% 45% 18% 21% 28% 19% 24% 27% Note: Data is mart and nor adjusted for inflation. Physical resources include energy. natural resources. commerce a housing creek transportation inbaskudure. community and regional development. Mei includes imernalional Main. agricukure. administration of justice. general government Mutation and veterans' benefits and services Source: 193! -1939data per Census Bureau. 'Thstorica1 Statistics of the United Stales Colonial rams So 1970:1940- K P 2010 data per White House OMB. ( I USA Inc. I Ugh Level Thoughts 41 USA Inc. "Business Line" Extensions: 1930 - 2010 L' 1970's 1960's 1950's 1930's "Business Line" F2010 Extensions Expense (SE) Agencies I Programs Created (Year) Goals Energy Policy $12 Community Development Department of Energy (1977) Community 13 Development Block Grant' (1974) Healthcare 724 Education Medicare / Medicaid (1965) Establish the Strategic Petroleum Reserve / mandate automobile fuel efficiency standards & temporary oil price control Provide federal grants to local governments for projects like parking lots / museums / street repairs Provide medical insurance program for the elderly (Medicare) and welfare program for low-income population (Medicaid) Federal Subsidies for 97 K-12 & Higher Education (1965) Provide federal subsidies for student loans / school libraries / teacher training / research / textbooks and other items. Housing Federal Housing 36 Administration (1937) / Fannie Mae (1938) Welfare 28 Retirement Reduce cost of mortgages and spur home building / purchasing by offering federal mortgage insurance and create secondary market for mortgage loans. Aid to Dependent Children (1935) Social Security (1935) Provide cash assistance to low-income families with children. Replaced by Temporary Assistance for Needy Families program in 1996 Provide retirement income to the elderly TOTAL $1.5 Trillion Or 10% of F2010 GDP / 69% of USA Inc.'s Revenue / 43 of Expense Note. 'Community Deyektpment Block Gant was an &fort to consoadate various pea-existing cafegoficaf ccurununity development programs that slatted with 'urban renewal* in the 19506. "Social Security's F2010 expense excludes --$123B payments fo disabled workers via Disability insurance program (created in 1956). Source: CATO InSlifute. I4%te House OM& USA Inc. I High Level 'Roughly 42 EFTA01123272 Entitlement Programs Are the Largest & Growing Expense Items on USA Inc.'s Income Statement in Peace Time USA Inc. Spending as % of GDP, 1795 - 2010 Federal Spending As %of GDP 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% • All Other Spending Social Security War of 1812 Medicare + Medicaid World War II H Great Depression World War I 1795 1820 1845 1870 1895 1920 1945 1970 1995 Note. 3&•00446,,,,g 0/1.5 ,.'aft, federa, not awe )portion 01 spending. Souece: John Cogan. Sianford LW. ..My. USA Inc. I li,ott Level thoughts 43 Perspective — USA Entitlement Spending = India's GDP • With a population of 1.2 billion (vs. USA's 310 million) and 2010 GDP growth of 10% (vs. USA's 3%), India is a well- recognized emerging country on the global stage. • It's notable that India's 2010 nominal GDP* of $1.43 trillion was equal to USA's $1.43 trillion in federal government spending on Social Security, Medicare, and Medicaid. Nofe. 'Nominal GDP is nor al:tasted foe purchasing pore& palltyIPPFry. PopulaZiOn and GDP data pee IMP. USA Inc.] Hgh Level Thoughts 44 EFTA01123273 The Original Estimates of Medicare's Costs Were Vastly Underestimated • In 1965, the official estimate of Medicare's costs was $500 million per year, roughly $3 billion in 2005 dollars.* • The actual cost of Medicare has turned out to be 10x that estimate. Medicare's actual net loss (tax receipts + trust fund interest — expenditures) has exceeded $3 billion (adjusted for inflation) every year since 1976 and was $146 billion in 2008 alone. In other words, had the original estimate been accurate, the cumulative 43-year cost since Medicare was created would have been $129 billion, adjusted for inflation. In fact, the actual cumulative spending has been $1.4 trillion" (adjusted for inflation)...in effect, 10x over budget. While calculations have been flawed from the beginning for some of USA Inc.'s entitlement programs, little has been done to correct the problems. An accurate economic forecast might have sunk Medicare. David Blumenthal and James Morone "The Lessons of Success — Revisiting the Medicare Story", November 2008 NSI Sources. ' Lyndon S. Johnson Library& Museum. Medicare spending data per While House OMB. "Dept o✓ Health Human Services. CMS. data acbusled for inflisbon based on Sega GDP pnce index. USA Inc. I Ugh Loc.! Thoughts 45 Many Leaders Have Voiced Concerns About Entitlement Program Math / Spending The entitlement programs are not self-funded... they are unfunded liabilities. They are the single biggest component of spending going forward. -- Ben Bernanke, Chairman of the Federal Reserve Testimony before House Budget Committee, June 9, 2010 The time we have is growing short... there are serious questions, most immediately about the sustainability of our commitment to growing entitlement programs. -- Paul Volcker, Former Chairman of the Federal Reserve Chairman of President Obama's Economic Recovery Advisory Board Speech at Stanford University, May 18, 2010 USA Inc. I Ugh Level Thoughts 46 EFTA01123274 40-Year USA Inc. Data Points and Trends 1965 2005 '65-'05 Change National, Healthcare Spending as % of GDP 6% 4 16% 167°7,, FederaP Healthcare Spending as % of GDP 1 4 5 Out-of-Pocket Healthcare Spending as % of GDP 3 4 2 9.6 of Adult Population Considered Obese 13 4 32 146 c/o of Americans Receiving Govt. Subsidy' 20 4 35 75 % of Americans that Pay No Federal Income Tax 20 4 33 65 National, Education Spending as % of GDP 5 4 7 48 Federal Education Spending as % of GDP 0 4 1 Gross Debt as % of GDP 47 4 64 36 Interest Payments as % of GDP 1.2 4 1.5 25 Gini Index of Income Inequality' 0.34' 4 0.41 20 Net Debts as % of GDP 38 4 37 -3 People Below Poverty Level as % of Population 17 4 13 -26 Defense Spending as % of GDP 7 4 4 -33 % of Americans that Pay 50% of All Income Tax 106 4 4 -60 Federal Budget Surplus / Deficit as % of GDP -0.2 4 -3 KP CB Note 77 &fades aV yoronvnent and prwam spandrag. 2)Ixtudes Cabral sponang on Uctare. Uockaid and other t yawn, programs. oucludas state spcodog on Ideacad. 3) % of Amoccans rooming government sobsay made aV remacots of Social Sauey. Wotan, and Atedcact as no as 'overman, archteas and federal / state /local/ nitrate). Dais etctdos our essmaleddupkases. 4) A Groot NO m7p1es perfect moray equaiy and a, index of 7 eratoes complete nemaNy. the Arty 4%4 ear. the nate innsuatry Owe 4. Eatea data lo. r USA was "matured 796Z 5)818 debt eclederal debt but/ byesescutec. East/ data "ratable an NO. Source: lieweexcvse Office at Uttnegement and Budget 0494rantral Or MOM 8 Mumtin Serviced. Gernert, to 0406$0 Coned. Mint Revenue Servte. Census 8useau. USA Inc. I High Level Thoughls 47 Summary: 40-Year USA, Inc. Trends* • America is spending beyond its means, and the problem - with mounting losses & increasing debt — is getting worse, not better • Healthcare spending and obesity are rising dramatically. • Education spending is growing slower than healthcare spending. • Defense spending is declining on relative basis. • More and more Americans are on the government payroll or receive government subsidies for retirement income, medical care, housing, and food. • Inequality of income and wealth is rising, and fewer Americans pay income taxes to support USA Inc. • Government increasingly resorts to borrowing to fund rising spending levels (primarily for entitlement programs)... Note. We chose a 40-year period from 1965 to 2005 to examine Att.rmat levels of dad points and trends. We old not choose the most latent 40year period 0969 to 2009) as USA was in deep recession ii 2008/2009 and untftvwent significant tax policy audua Woos in t968 it 969 and subsequently many merits (Ake individual income and COtporele profit es well as federal budget surplus / defitg and debt levels) were significardly off Theis normal' levels. USA Inc. I High Level Thosghls 48 EFTA01123275 What's the Proper Level of This and That? What's Normal? We begin with the premise that for an enterprise (even a country that can `print money' and tax) to be sustainable, it cannot lose money on an ongoing basis. Successful businesses (and households) typically base their expenses on their ability to generate present and future revenue — in other words, they don't spend unless they can pay. We analyze the data and present scenarios and options for solving the math and financial challenges facing USA Inc. USA Inc. I Hgh Lev Thoupts 49 This page is intentionally left blank. so EFTA01123276 This page is intentionally left blank. 5, This page is intentionally left blank. 52 EFTA01123277 Income Statement Drilldown K P P USA Inc. I Income Slatemeni DOklovm 53 Income Statement — USA Inc. Shows -8% Median Net Margin Over 15 Years USA Inc. Net Income ($B) USA Inc. Annual Net Income & Median Net Margin, F1996 - F2010 $400 SO 40% -$400 N111147 40% 7 P. -$800 -80°0 Net Income ($6) —15 Year Median Net Margin (%) -$1.200 -$1,600 -160% F1996 F1998 F2000 F2002 F2004 F2006 F2008 F2010 Note. USA Were, fiscal year ends an September. Source. White House Ohre of Management and Budget. USA Inc. I Income Statemeni Onilloor 54 EFTA01123278 Income Statement — F2010 USA Inc. Revenues + Expenses at a Glance Corporate Income Tax $191B Social Insurance Tax $865B KP ce F2010 Revenue = $2.2 Trillion Other $208B 10% Individual Income Tax $899B F2010 USA Inc. Expenses = $3.5 Trillion Discretionary One-Time Items S152B Non-Defense Discretionary $431 B Defense $694B Net Interest Payment S196B Medicare + Federal Medicaid $724B Unemployment Insurance + Other Entitlements $553B Note. USA federal fiscal year ends in September: 'andoidval8 corporate income faxes include capital gains lases- Non- defense <Sacral Nasty inasdes federal spending on edunifon. in I tasbuclure. law enforcement judrJary functions... Source: White House Office of Managemenl and Budget. USA Inc. [ Income Stalemenl Deilelown 55 Income Statement — USA Inc. Supported -60% Net Margin in F2010 USA Inc. Profit & Loss Statement, F1995 F1995 F2000 F2005 Revenue (SB) Y/Y Growth $1,352 $2,026 11% $2,154 15% Individual lucerne Taxes' % of Revenue Social hsurance Taxes % of Revenue Corporate tr-orne Taxes' % of Revenue Other % of Revenue $590 44% $484 36% $157 12% $120 9% $1.005 50% $653 32% $207 10% $161 8% $927 43% $794 37% $278 13% $154 7% Expense (SB) Y/Y Growth $1.516 -- $1.789 5% $2,472 8% Entitlement / Mandatory % of Expense Nun-Defense Discretionary % of Expense 'One-Trne' Items $788 52% $223 15% -- $937 52% $335 19% -- $1.295 52% $497 20% -- % of Expense -- -- -- Defense $272 $294 $495 % of Expense 18% 16% 20% Net Interest on Pudic Debt $232 $223 $184 % of Expense 15% 12% 7% Surplus / Deficit (SB) 4164 $237 -$318 Net Margin (%) -12% 12% -15% F2000 / F20051 F2010 F2010 Comments I $2,163 3% $899 42% $865 40% $191 9% $208 10% $3,456 -2% $1.984 57% $431 12% $152 4% $694 20% $196 6% On average, revenue grew 3% WY over past 15 years Largest driver of revenue Payroll tax on Social Security + Medicare Fluctuates significantly with economic condlions Includes estate & gilt taxes f duties & lees: relatively stable On average, expense grew 6% YA' over past 15 years Significant Increase owing to aging population + rising healthcare cost Includes education / law enforcement / transportation... Includes discretionary spending on TARP. GSEs. and economic stimulus Significant Increase owing to on- going War on Terror Decreased owing to historic low interest rates I 41,293 1 USA Inc. median net margin -60% between 1895 & 2010 = -8% Note. USA federal fiscal year ends in arysfernber: VroWialtal & corporate income faxes include cayital gains ayes- Non- defense discretionary Masks federal spending on Sole86017. s,fmshucawe. law enforcementjuccriary functions... Source: While House Office of Management and Budget. USA Inc. Income Slameranl Chilldown 56 EFTA01123279 Income Statement — Excluding 'Underfunded' Medicare / Medicaid' + One-Time Charges. USA Inc. Shows 4% Median Net Margin Over 15 Years USA Inc. Annual Net Income & Median Net Margin (Excluding Medicare: Medicaid & One-Time Charges). F1996 — F2010 USA Inc. Net Income ($8) 3600 $400 $200 SO -$200 -$400 -$600 -$800 Net Income (ex. Medicare r Medicaid r One-Time Charges) (SB) —15 Year Median Net Margin (%) F1996 F1998 60% 40% 20% — 7. En -20% % CD -40 -60% -80% F2000 F2002 F2004 F2006 F2008 F2010 Noie EAciudes LK>92 .cleacaleti re..tvwe and spcvtakng for MeeScare and Meolca.d. USA legend Assaf year ends in September. Source: Whae House Mabel Managemea and Budget. USA Inc. I Income Statement Driidown 57 Income Statement: USA Inc. Profit & Loss Statement Is Solid, Excluding `Underfunded' Medicare / Medicaid Revenue and Spending + One-Time Charges USA Inc. Profit & Loss Statement (ex. Medicare! Medicaid / One-Time Expense), F1995 / F2000 / F2005! F2010 F1995 F2000 ••• F2005 ••• F2010 Comments Revenue (SB) WY Growth $1,256 $1,890 $1,988 I $1,983 11% 15% 4% On average, revenue (ex. Medicare) grew 3% TY over past 15 years Incfriodual hcorne Taxes° % of Revenue Social Insurance Taxes (ex. Medicare) % of Revenue Corporate Income Taxes° % of Revenue Other % of Revenue $590 51.005 $927 47% 53% 47% $388 $517 $628 31% 27% 32% $157 $207 $278 13% 11% 14% $120 $161 $154 10% 9% 8% $899 45% Largest driver of core revenue $685 Payroll tax on Social Security 35% $191 10% $208 10% Expense (SB) WY Growth Entitlement (ex. Medicare / Medicaid) % of Expense Non-Defense Discretionary % of Expense Defense % of Expense Net Interest on Public Debi % of Expense $1,248 $520 42% $223 18% $272 22% $232 19% $1,474 $1,992 I $2.580 5% 8% 7% $622 $815 42% 41% $1,259: 49% $335 $497 $431 23% 25% 17% $294 20% $223 15% $495 $694 25% 27% $184 9% $196 8% Surplus! Deficit (SB) Net Margin (%) sa 1% Fluctuates significantly with economic conations Includes estate & gilt taxes / duties & lees: relatively stable E.xpenses(ex. Medicare Medicaid) grew 5% Y/Y over past 15 years Significant increase owing to aging population Includes education! law enforcement / transportation... Significant increase owing to on- going War on Terror Decreased owing to historic low interest rates S416 -s4 I 4597 USA Inc. core operations were In 22% 0% -30% surplus 9 out of the past 15 years Note: USA lecfmar fists, year ends In September: Individual & corporate income taxes Inabae caplet gains taxes. Nondefense <Motet:unary intrudes federal spend:Mg on &ANSA Vskasbucture. law enforcemeM. Star-they functions... Source: While House Mesa/Management and Budges USA Inc. I Income Statement Doraorin 58 EFTA01123280 100-Year Review of USA Inc.'s Basic Income Statement Including Revenue & Expense Drivers as Percent of GDP Revenue (SB) $0.7 S7 $4 57 541 $92 $193 $517 $1.032 $2.025 $2424 $2.105 52.163 %of GDP 2% 8% 4% 7% 15% 18% 19% 19% 18% 21% 18% 15% /5% Individual Income Taxes - 31 SI $1 316 $41 $90 $244 $467 $1.004 31.146 $915 1899 % of GDP - 1% 1% 1% 6% 8% 9% 9% 8% 10% 8% 6% 6% Social Insurance Taxes - - - so $4 $15 $45 $158 $380 5653 $900 3891 $865 % of GDP - - - 2% 2% 3% 4% 6% 7% 7% 6% 6% 6% Corporate Income Taxes - - $1 $1 $10 321 533 $65 $94 $207 $304 3138 $191 % of GDP - - 1% 1% 4% 4% 3% 2% 2% 2% 2% 1% 1% Other- 50.7 $6 $3 $3 $10 $16 $24 $51 $92 5161 $174 3161 $208 % of GDP 2% 6% 3% 3% 4% 3% 2% 2% 2% 2% 1% 1% 1% Expense ($6) 50.7 $o 53 $9 $43 $92 $196 $591 $1.253 $1.789 $2983 33.518 $3.456 % of GOP 2% 7% 4% 9% 16% 18% 19% 22% 22% 18% 21% 25% 24% Defense $0.3 $2 Si $2 $14 $48 $82 $134 3299 5294 5616 1661 $694 % of GDP 1% 3% 1% 2% 5% 9% 8% 5% 5% 3% 4% 5% 5% Interest on the De0t SO $1 $1 $1 35 $7 $14 $53 $184 $223 $253 $187 3196 % of GDP 0% 1% 1% 1% 2% 1% 1% 2% 3% 2% 2% 1% 1% Social Security — — — $0 $1 312 $30 $119 $249 $409 $617 $683 3707 % of GDP — — — 0% 0% 2% 3% 4% 4% 4% 4% 5% 5% Healthcare — -- — $0 50 $1 $12 $55 $156 5352 $671 $764 5821 % of GDP — — — 0% 0% 0% 1% 2% 3% 4% 5% 5% 6% Other $0 53 $2 $6 523 $25 $57 5231 $365 5511 3825 $1.222 $1.039 % of GDP — — — 6% 8% 5% 6% 8% 6% 5% 6% 9% 7% I Deficit (6B) -$O SO 51 -$2 -$2 $0 -$3 -$74 -$221 $236 -$459 41.413 41293 ( Surplus % of GOP 0% 0% 1% -2% -1% 0% 0% -3% •% 2% -3% -10% -9% ( I Note: Data are no affected tof 'ribbon. *Me tevenue inapt customs and exese / estate tares - Other expenses include spencer° on law enforcement / educate.° / pzett intrastructutef energy. etc. Source: 1910- 1930 per Census Bureau. 19402010 per While hbuse USA Inc. Inc me Statemem Oseldoen 59 100-Year Review of USA Inc.'s Basic Income Statement Including Revenue & Expense Drivers as Percent of Revenue & Expenses H,.,enue tie) $0.7 $7 $4 57 $41 592 $193 $517 $1.032 $2.025 % of GOP 2% 8% 4% 7% 15% 18% 19% 19% 18% 21% $2.524 $2.105 $2.163 18% 15% 15% Individual Income Taxes - $1 $1 $1 516 $41 $90 $244 $467 $1.004 % of Revenue - 16% 28% 16% 38% 44% 47% 47% 45% 50% Social Insurance Taxes - - - $2 $4 $15 $45 $158 $380 $653 %of Revenue - - - 25% 11% 16% 23% 31% 37% 32% Corporate Intone Tales - - $1 $1 $10 S21 533 $65 $94 $207 % of Revenue — — 31% 14% 26% 23% 17% 12% 9% 10% Other $0.7 $6 $3 S3 $10 $16 524 351 $92 $161 % of Revenue KO% a% 72% 45% 25% 17% 13% 10% 9% 8% $1.146 $915 $899 45% 43% 42% $900 $521 $865 36% 42% 40% $304 $138 $191 12% 7% 9% $174 $161 $208 7% 8% 10% Expense (SS) $0.7 $5 $3 S9 $43 $92 $196 $591 $1.253 $1.789 % of GDP 2% 7% 4% 9% 16% 18% 19% 22% 22% 18% $2.963 $3.518 $3456 21% 25% 24% Defense 30.3 52 $1 $2 $14 $48 $82 $134 $299 $294 % of Expense 45% 37% 25% 20% 32% 52% 42% 23% 24% 16% Interest 041 the De0t $0 $1 $1 $1 $5 $7 $14 $53 $184 $223 % of Expense 3% 16% 20% 11% 11% 8% 7% 9% 15% 12% Social Security - - - 30 $1 $12 $30 $119 3249 $409 % of Expense - -- - 0% 2% 13% 15% 20% 20% 23% Healthcare - -- - 30 SO $1 $12 $55 $156 $352 % of Expense - -- -- 1% 1% 1% 6% 9% 12% 20% Other SO $3 52 36 $23 525 557 $231 $365 $511 % of Expense 52% 47% 55% 68% 54% 27% 29% 39% 29% 29% $616 $661 $691 21% 19% 20% $253 $187 $196 8% 5% 6% $617 $683 $707 21% 19% 20% $671 $764 5821 23% 22% 24% $825 51.222 $1.039 28% 35% 30% I Setplus / Deficit ($8) -SO SO SI -$2 -$2 SO 43 -$74 -$221 $236 %o/GOP 0% 0% 1% -2% -1% 0% 0% -3% .4% 2% -$459 -$1413 41.293 -3% -10% -9% Note. Data are nor aGusted lot inflation. •Other revenue includes customs and excise/ estate faxes - Other expenses Include spenteng on law enforternenft Kf education /public infrasfacture / enewy. etc. &wet 19W -1930 per Census Bureau. 1940.201 per WNW House 0MB. ( I, USA Inc. I Income Staternenl Drilklovm 60 EFTA01123281 Conclusions: 100-Year Review of USA Inc. Income Statement America's government has grown dramatically - USA Inc.'s revenue as percent of GDP has risen from 2% to 15%. Individual / social insurance (Social Security + Medicare) taxes have risen dramatically while customs / excise / estate taxes have declined in relative importance. In addition, USA Inc.'s spending as percent of GDP has risen to 24% in 2010, up from 3% average between 1790 and 1930. • USA Inc.'s average operating income was at or near breakeven for most of the periods from 1910 to 1970. • In the 1970s, as healthcare expenses (related to Medicare and Medicaid) began to surge, USA Inc. reported more frequent — and bigger — losses. Since 1970, USA Inc. showed a profit just 4 times (F1998-F2001, when economic growth was especially robust and defense spending was relatively low). • General expense trends since 1970: non-defense discretionary spending has been flattish (except in recessions with material one-time charges), healthcare spending (largely Medicare + Medicaid) has risen materially, Social Security spending has been flattish, defense spending has been down to flattish, and interest payments varied with interest rates. USA Inc. I Income Slalemenl Diaklovm 61 Operations of USA Inc. Are Solid, Excluding Medicare / Medicaid and One-Time Charges Revenues of USA Inc. (largely from individual and corporate income and payroll taxes) can fund most expenses (largely spending on defense, Social Security, unemployment insurance, education, law enforcement, transportation, energy, infrastructure, federal employee & veteran benefits, and interest payments). In fact, for USA Inc.'s operations besides Medicare / Medicaid and one-time expenses, there's ample scope to increase spending for defense, education, law enforcement, transportation, infrastructure and energy by _4%* in aggregate and still remain break-even. Note. traturAng hfedcare /Mocked revenue 6 expenses. USA Inc.'s expenses are. on average. 4% below revenue levers from F1996 So F2010 based on are cainAafian of Whale House OMB data. USA Inc. I Income Slalerranl Dadown 62 EFTA01123282 Defense Spending Is The Second-Largest Expense Item After Entitlements, But Below Long-Term Trend as Share of GDP • With budget deficits rising, some advocate cutting back on defense spending, the second-largest expense item after entitlements. • Defense spending has risen substantially in recent years, due to the wars in Afghanistan and Iraq, and other costs related to the Global War on Terror. As a percentage of GDP, however, defense spending in the U.S. remains below its 60- year trend. • On an inflation-adjusted basis, U.S. defense spending is at its highest level since World War II. With overhead -40% of all spending, the Defense Business Board found DoD consistently pays "more for less" and fails to attack overhead as the private sector would.' • The Esquire Commission to Balance the Federal Budget, a group of four former Republican and Democratic senators, found over $300 billion2 in defense restructuring opportunities, and other analysts proposed gradual cuts to reduce the defense budget by 14% by 2018. 3 Notes: 1) The Defense Business Board. AectAnn Overhead and ray Business Arsons. '.hn 2010. NIp. Oba.delense.gov.2)see Esquire Convnisson lo Branco the Federal Budges. 3/ Garton Adams and Matthew Leathcvman A Leaner and Afeaner Nsmonal Defense. Foreign Affairs. JanTel)201t) USA hy4. Income Streemenl Dfilklown 63 Defense Spending Has Risen, Driven by Wars in Afghanistan + Iraq... USA Inc. Inflation-Adjusted' Defense Spending by Type, F1948 - F2010 $800B m $600B a. 0 C m m $400B en et 0 $200B $B 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 Korean War Vietnam War Cold War Afghanista / Iraq Gulf War ■ Other RDT&En •• Procurement • Operations & Maintenance ■ Personnel 119 Note. AcOusted lot inflation using GDP once Index. "ROME is Research. Developinea. Test S Evaluabon. Source: Whim House 0318. USA Inc. I Income Streernenl Diiiklown 64 EFTA01123283 ...While Defense Spending Rose to 5% of GDP in F2010 & Is Up from All-Time Historical Low of 3% in F1999 But It Is Still Well Below Post-World War II (1948-2000) Average of 7% USA Inc. Defense Spending as % of GDP, F1948 - F2010 20% KP ( F, a. o • 15% 0 0u C ,Es C, 10°6 Oto CC CI e5 a 1948-2000 Average = 7% 5% 0% 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 Source: Where Moose Otte. USA Inc. I Income Stalemem Coindoinn 65 $950 Billion = Cumulative Cost of Iraq, Afghanistan & Global War on Terror Operations Since 9/11/01 Attacks Cumulative Cost of Iraq, Afghanistan & Global War on Terror Operations of $950 Billion, as Percent of F2001-F2009 Spending: 4% of Total F2001-F2009 Federal Spending 22% of Total F2001-F2009 Defense Spending 28% of Total F2001-F2009 Federal Budget Deficit Cumulative Cost of: $685 Billion = War in Iraq $231 Billion = War in Afghanistan $34 Billion = Other Related Operations Source. IVOre House O1M. ConTesmonal Research Service. The Goo of if Sq. Arghanatan. and Other Global Wa on Terra. Operations Since 911'9220W. USA Inc. Income Statmr.em Coindoem 66 EFTA01123284 While USA Inc. Ranks # 1 in Defense Spending... Top 25 Countries by 2009 Defense Spending. 2009 Defense Spending ($8) $700 S600 S500 $400 S300 $200 S100 JAI. I I I I I I S. ram-rarararm-i—misrarararatr-a-ratr -I * S = • a 71 • v c— c „, cos le i ,c1 0 , . e A t w• — N og g a. c a. s c e • I 1 1 g 1.O I & . a S 5 i- . . 3 8 , o, E . ix LI.- . . . 7, a. a 4 cs 44 Ne So Sat Nrge Data for None Korea unavaaabk. Source: Stockholm Wematonal Peace Reseacch.lwAbln e. USA In:, Income Statement DnIklown 67 ...USA Inc. Ranks # 6 in Defense Spending as Percent of GDP Defense Spending as °. of GDP 10% 8°. Top 25 Countries' by Defense Spending as Percent of GDP, 2009 2 = ).. .ri c .to c, c 0 ,„ a o on Ts . En Z -6 ci g 0 c — r O ct w .z ... I— u. ta 0. South Korea ai :t 0 O T LIJ rp C 'It 0 :E 2 A 8 a E 4 . Q en in co a 4 2 cg Cn 2 O , 2 E 1 O ..) 2 0 Q o IX 0 a 2 OU Saudi Arabia NOW: Ranking among CA f ieS YAM 2009 delense speadIng of .63 69100 at higher: data far Mont) Korea °nave,' or*. Source: Slockholm International Peace Research Insecure. USA Inc. Income Statement Cordons 68 EFTA01123285 Active Troops per 1000 Citizen N.) France Pakistan Malaysia Croatia USA Kuwait II Thailand al Belarus Russia Vietnam jall Colombia Egypt 1.11 Iraq 1 Iran Turkey Saudi Arabia IMO United Arab Emirates _I MO Libya South Korea ,I== Greece Syria .1.=.= Singapore .).= Jordan Israel North Korea Top 25 Countries by Active Number of Troops per 1000 Citizen, 2008 eudeo Jed sdosaa Jo JeqwnN u! 1.3 # sNueH .oul VSf1"' 69 umor1V0 luOw4162S 2w03(11 :AA vsn a I z in a. 2 Saudi Arabia France Japan Germany Colombia Syria Indonesia Thailand Brazil Egypt Vietnam Turkey Iran Pakistan South Korea Russia North Korea India Active Troops (000) ... - ul in o o o o § o China Top 20 Countries by Active Number of Troops. 2008 -sdocui Jo JaqwnN ui E # SNUEd -oul VSfl autAAA EFTA01123286 Drill Down on USA Inc. Entitlement + Interest + One-Time Expenses for F2010 0 0 0 K P B Entitlement Spending Medicaid (-5273B Net Loss') Medicare (-$2728 Net Loss") Unemployment Benefits (-$115B Net Loss") or Social Security (-$758 Net Loss") Rising Debt Level & Interest Payments Debt Level (S9T Outstanding) Effective Interest Rates (2.2%) Debt Composition a Periodic Large One-Time Charges is• TARP ($268 Net Profit'2) Fannie Mae / Freddie Mac (-$418 Net Loss') ARRA -4 (-$1378 Net Loss') Note: 'demotes F20 I 0 nel income me loss &respective programs. data per White House OW 0 Ofedkare am: Medal Seemly nefloss excludes Trust Fund interest income. 2) TARP net loss includes proceeds from sale of warrants. TARP is Trouble," Asset Relief Program: ARRA is American Recovery£ Reinvestmeml Act programs. USA Inc. 0ncome Stammenl Dntown 71 Drill Down on USA Inc. Entitlement Spending for F2010 0 Entitlement Spending Medicaid (-$273B Net Loss') Medicare (-$2728 Net Loss") Unemployment Benefits (-$115B Net Loss") Social Security (-$75B Net Loss") Rising Debt Level & Interest Payments Debt Level ($91 Outstanding) Effective Interest Rates (2.2%) Debt Composition Periodic Large One-Time Charges TARP ($26B Net Profit'2) Fannie Mae / Freddie Mac (-$41B Net Loss') ARRA (-$137B Net Loss') Fa Note: 'denotes F2010 net income/net loss of respective programs. data per Whole House OMB. 1) Meditateam/Soda Securitynet loss excludes Trust Fund irneldli income. 2) TARP net loss includes proceeds from sale of barrel's. TARP is Troubled Asset ReNet Program: ARRA is American Recovery 6 Reinvestment Act programs. USA Inc. Income Salernenl DilOdown 72 EFTA01123287 Entitlement Spending: Lacks Sufficient Dedicated Funding Entitlement programs were created with the best of intentions by the Government. They serve many of the nation's poorest, whose struggles have been made worse by the financial crisis. However. with the exception of Social Security (which was developed with a pay-as-you-go funding plan and constructed to be legally flexible if conditions change) and unemployment insurance (which was designed to be flexible at State level). other entitlement plans (including Medicaid and Medicare) were developed without sufficient dedicated funding. Here we drill down on the funding trends for entitlement plans ... USA Inc. I Income Smemeni Oregon', 73 Entitlement Spending: Expenses Up 2x Over 15 Years Annual Entitlement Spending Per Household = $16,600 per Year USA Inc. Annual Entitlement Programs' Total & Per-Household Expenses. F1995 - F2010 USA Inc. Entitlement Total Expenses (SB) 52.400 52.000 51.600 $1.200 $800 S400 50 ca Entitlement Programs Annual Expenses ($B) —Entitlement Expenses per Household (S) F1995 F1997 F1999 F2001 F2003 F2005 F2007 F2009 520.000 516.000 2 0 CA 0 a a O x 141 C Eco C 512.000 58.000 S4.000 SO Ml Nom Data are not acausted lot .castion. Entatentem programs Mantle Social Security, Arectcare. Medcat& unemploymeru benefits. Mod a nuttabn assistance. housing assistance and other. USA federal Most year ends in September. Source. htote House Office of lt fanagemenl andBudget USA Inc. Income &elegem)! Chindonn 74 EFTA01123288 Entitlement Spending: Expenses Up 169% Over Past 15 Years, While Dedicated Funding Up Only 70%** F1995 •• • F2000 • •• F2005 F2006 F2007 F2008 F2009 F2010 Entitlement Revenue ($8) $484 $653 $794 $838 $870 $900 $891 $865 WY Growth — 7% 8% 6% 4% 4% -1% -3% Social Securty S351 $481 $577 $608 $635 $658 $654 $632 % of Revenue 72% 74% 73% 73% 73% 73% 73% 73% Msclicate $96 $136 $166 $177 $185 $194 $191 $180 % of Revenue 20% 27% 21% 2I% 21% 22% 21% 21% Nkdcad SO SO $0 $0 $0 $0 $0 $0 Unemployment Insurance S29 $28 $42 $43 $41 $40 $38 $45 % of Revenue 8% 4% 5% 5% 5% 4% 4% 5% Other $8 $9 $9 $9 $9 $9 $8 $8 % otRevenue 2% 7% 1% I% 7% I% I% 1% Entitlement Expense ($8) $78E1 $937 $1,295 $1,357 $1,462 $1.582 $1.834 $1.984 Y/Y Growth — 5% 6% 5% 8% 8% 16% 8% Social Securty $336 $409 $523 $549 4586 $617 $683 $707 % of Expense 43% 44% 40% 40% 40% 39% 37% 36% Medicare $160 $197 $299 $330 $375 $391 $430 $452 % of Expense 20% 21% 23% 24% 26% 25% 23% 23% fl,bdcad $108 $118 $182 $181 $191 $201 $251 $273 % of Expense 14% 13% 14% 13% 73% 13% 14% 14% Unemployment Benefits $24 S23 $35 $34 $35 $45 $123 $160 %of Expense 3% 2% 3% 2% 2% 3% 7% 8% Other $161 $189 $256 $264 $275 $328 $347 $392 % of Expense 20% 20% 20% 19% 79% 21% 19% 20% Entitlement Surplus / Deficit ($61) -$304 -$284 4501 -$519 -$592 -$682 -$943 -$1.119 Net Margin (%) -63% -43% -63% -62% -68% -76% -106% -129% Able: USA federal Weal yew was m Scoterraxv:Idechasct wpm* lunch., by federal and state goremerit and as asocial owlearepogram (unhe a sow, nsuratre program Mo MoaVaroa Nero as re &dewedems! heat 'Other capcoses ox-tWo minty a oleo- supped assistance. clamed income tax cede. chW tax arch and payments to stales for losair care / amour. =ataxy. "Ito emicoe Social Seamy a ileckato Pali A hest awes Wavle [41 Antoine as met am accounting gam raft, than real memo So ace: Whoa House Oboe al Mans ern andlituagot USA Inc. I Income Stalemenl Madmen 75 Entitlement Spending: Observation About Social Security & Medicare Part A Trust Fund — More Like Accounting Values Than Real Dollars • Social Security Trust Fund balance (accumulated annual surpluses + interest income) = $2.5 trillion as of 2009: Medicare Part A Trust Fund balance = $304 billion as of 2009. These surpluses were invested in a special (non-marketable) series of U.S. Treasury securities, which were then used to finance budget deficits in other parts of USA Inc. like Medicaid & Nutrition Assistance. • As a result, many observers have argued that Social Security and Medicare Part A Trust Funds' balances are no more than accounting gains on paper owing to: 1) no 'real' assets (such as tradable stocks / real estates...) in these Trust Funds as the special U.S. Treasury securities are non-marketable and 2) the Treasury Department needs to raise taxes / cut other programs' spending / borrow more money in the future to meet any withdrawal requests. • We think that for Social Security and Medicare Part A programs, their Trust Funds' balances have legal value as USA Inc. is legally obliged to repay the principal and interest on the Treasury securities held in respective Trust Funds. • However, we think that these Trust Fund balances have NO economic value as these cumulative surpluses have been spent by USA Inc. to reduce the borrowing need in the past. When Social Security & Medicare begin net withdrawal from their Trust Funds (likely in 2017E). USA Inc.'s debt levels + interest payments growth could accelerate, owing to the double whammy of: 1) loss of revenue source (previous surpluses) and 2) additional Treasury redemption costs related to Trust Funds' withdrawal requests. • Consequently, we exclude Social Security and Medicare Trust Funds' balances and interest income from our financial models and calculate their liabilities on a net basis. Data source: Social Secunly Administration. Dept of Health S. Human Services LBO. Mole: the economy value of SooW Seaway Tnast Fund is suhtect to debate. !Waddle/eta peespetthe. refer to Pelee Dimond and Pelee Orszag. 'Saving Social Security: A EllalS(Wed Appealed,: p51 Box 3.5. USA Inc. I Income Statement Diiiklown 76 EFTA01123289 Entitlement Spending: Non-Partisan CBO Advises Excluding Social Security / Medicare Trust Funds' Balances + Interest Income in Fiscal Analysis Trust funds can be useful mechanisms for monitoring the balance between earmarked receipts and a program's spending, but they are basically an accounting device, and their balances, even if "invested" in Treasury securities, provide no resources to the government for meeting future funding commitments. When those payments come due, the government must finance them in the same way that it finances other commitments -- through taxes or borrowing from the public. Thus, assessing the state of the federal government's future finances requires measuring such commitments independently of their trust fund status or the balance recorded in the funds. -- Congressional Budget Office (C8O) "Measures of the U.S. Government's Fiscal Position Under Current Law," 8/04 USA Inc. I Income Stalemeni Doilklown 77 Entitlement Spending: Funding Patterns of Some Entitlement Programs Work Better than Others Have Worked Relatively Well Financially: Social Security — Has operated at close to break-even - so far - thanks to sufficient payroll tax income from a relatively large working-age population. In fact, Social Security has worked so well, that its surplus net income has been used to finance other government activities such as Medicaid. Unemployment Insurance — Has operated at close to break-even thanks to accumulated net incomes during 'good years' (though expenses spiked to $123 billion / $160 billion in 2009 / 2010 from $45 billion in 2008 owing to recession). Have Worked Relatively Poorly Financially: Medicaid - Has operated at an average annual loss of $160 billion with, in effect, an average net margin of -100% over past 15 years; the annual dollar loss has risen from $108 billion to $273 billion because of rising healthcare costs and expanded enrollment. Medicare — Has operated at an average annual loss of $123 billion with, in effect, an average net margin of -83% over past 15 years; the margin has fallen from -66% to -154% (or -$64 billion in annual loss to -$272 billion) because of rising healthcare costs + expanding coverage (added Part D prescription drug benefits through legislation in 2003, rolled out in 2006). Ml Source. White House Office a Malagemere and Budget USA Inc. Income Stalemenl Dzilklown 78 EFTA01123290 Entitlement Spending: What The Programs Are and How They Have Evolved Social Security Act signed into law by President Roosevelt. Created during the height of the Great Depression, the Act provides monetary support to retired people from payroll taxes paid by current workers and employers. Social Security Trust Fund cash flow = $766 million. Social Security Trust Fund balance started to decline. gaaramlaah r... 1975 . 83 Unemployment Insurance signed into law as part of the Social Security Act, setting up a joint federal- state program (funded via taxing employers) to provide temporary monetary support to laid- off workers. Medicare & Medicaid created to provide hospital & medical insurance to elderly & disabled. Amendments to Soda Security Act raising taxes to shore up funding for the Social Security Trust Fund. Medicare Part D signed into law to provide federal subsidies to prescription drugs for Medicare beneficiaries. Medicare cash flow (incl. Trust Fund interest) turned negative (-$5 billion). 2008 2010E Social Security cash flow (ex. Trust Fund interest) projected to turn negative by Congressional Budget Office. Source: Social Semidry AdmiStration. Dept. of Health & Human Services. USA Inc. I Income Statement Dtilklown 79 Entitlement Spending: 76% Is Directed to Social Security + Medicare + Medicaid Dedicated Entitlement Revenue Breakdown, F2010 Total = $0.877 Unemployment Insurance 5% Medicare 21% Other Social Security $632B Entitlement Spending Breakdown, F2010 Total = $1.98T Other Housing Assistance Food & Nutrition Assistance Unemployment Benefits 8% Medicaid 0 4 14% Social Security $707B 36% of Total Kr' B Nal& USA fetal , Ascot yes ends in September. Source: Whet, House Office of Management and Budget. USA Inc. I Income Statement DO:town 80 EFTA01123291 Entitlement Spending: Observations from Previous Slide • Entitlement revenue was $0.87 trillion, yet entitlement spending was $1.98 trillion in F2010. • Entitlement spending exceeded entitlement revenue by 129% in F2010. • Social Security (ex. Trust Fund interest income) accounted for 73% of dedicated entitlement revenue yet only 36% of entitlement spending in F2010 while Medicare accounted for 21% of revenue and 23% of spending and Medicaid accounted for 0% of revenue and 14% of spending. USA Inc. I Income Slalemenl DiiIklown 81 Entitlement Spending: Clarification On 'Unfunded' / 'Net Responsibilities'... • There is debate about the semantics of using words like unfunded / net responsibilities to describe the financial status of entitlement programs like Social Security, Medicare and Medicaid. • 'Unfunded' — We define 'unfunded' liabilities for Social Security and Medicare as the present value of future expenditures in excess of dedicated future revenue. We call Social Security and Medicare 'partially unfunded' entitlement programs as their future expenditures are projected to exceed dedicated future revenue. • 'Net Responsibilities' - USA Inc. does not record these 'unfunded' financial commitments as explicit liabilities on balance sheet, owing to Federal accounting standards.' - USA Inc.'s Dept. of Treasury calls these commitments 'net responsibilities' or 'net expenditures' in its annual Financial Report of the U.S. Government • Medicaid — We view Medicaid as an 'unfunded' liability as there is no dedicated revenue source to match expected expenses in our financial analysis. Medicaid is jointly funded on a pay-as-you go basis by Federal and State general tax revenue. Now /)per Dept. of Treasury. '2000 Fenancial Report ol the Untied States Govenvoent" USA Inc. [ Income Statemenl Chilklown 82 EFTA01123292 ...Entitlement Spending: Clarification On `Unfunded' / `Net Responsibilities' • Unless they are reduced, USA Inc.'s financial liabilities -- whether they are actual debt or the present value of future promises, whether called 'unfunded' liabilities or 'net responsibilities' and whether funded by dedicated taxes or general revenue — represent significant claims on USA Inc.'s future economic resources. • To be sure, the projected unfunded liabilities are not the same as debt, because Congress can change the laws that are behind those future promises. With a few exceptions, however, over the past 60 years, lawmakers have acted to boost rather than reduce them. K P C USA Inc. I Income Smernenl Dnldowm 83 Entitlement Spending: Social Security Funding Has Worked. So Far While Medicare/Medicaid Are Underfunded by $5.6 Trillion Since Inception in 1965 Annual Net Income of Social Security r Medicare Medicaid (SB) KP CP. 5150 $100 S50 $0 -S50 -$100 -S150 -$200 -S250 Annual Real Net Income of Social Security: Medicare / Medicaid, 1940 — 2009 Social Security Reform of 1983 Raised taxes by 2.3% Reduced benefits by 5% Social Security Medicare (Part A B ! D) Medicaid 2003 mr Medicare Part D (Prescription Drug Benefits) Signed into Law 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Note: Real net income are NIabonnrcOusted using White Nouse OMB's GDP price index (based on Sacs data): cdculated as lots) revenue pax receipts. excluding bust fund interest revenue) ninus WWI expendihoes:Medcaxe Part Et /O and klectictidob not have dedicated fundng source. Source: Said Security Administration. White House Of fice of Msnagernenl end Budget. USA Inc. I Income Stalernenl ChilMown 84 EFTA01123293 Entitlement Spending: Medicare & Medicaid Payments per Beneficiary Have Risen Faster than Social Security Payments Owing to Rising Healthcare Costs + Expanded Coverage 2500% Percent Change in Real' Annual Social Security .! Medicare / Medicaid Payments per Beneficiary From 1966 1966-2009 CAGR Medicare +8% Medicaid 2000% Social Security to to cn — Medicare 1500% E 0 U C 2 1000% Medicaid 500% +3% Social Security 0% +2% 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 No'e O re tale( an so:it/sled using Mate !louse altErs GOP puce axles (based on BEA's data). 52urre: Security Admit's:unseat Dept. of Health & H41011117 Services. USA Inc income Statement Dtilklown 85 Entitlement Spending: Program Beneficiaries (Now 29%* of Population vs. 13%* in 1966) Have Grown Faster than Population Owing to Aging Population + Expanded Eligibility Social Security / Medicare / Medicaid Enrollment & as % of Total Population, 1966 - 2009 160 140 120 s'S 100 C 80 7, 60 0 F- 40 20 0 mM Social Security Medicare rs= Medicaid —% of Total Population' 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 40% 30% C 0 0. 20% gf 0 4 10% Note. 'Exaucks me estimated dual/Sae enrollees in Soria Secunty Areckere /Adecticad. Smite: Sonar Security Administration. Dept. a/Health & Human Semites. USA Inc. I Income Statement Dtilklown 86 EFTA01123294 Entitlement Spending: While Beneficiaries From Aging Population Rose 2x From 1966 to 2009, Beneficiaries From Expanded Eligibility (Low-Income / Disabled) Rose 10x Combined Social Security + Medicare + Medicaid Enrollment by Old Age Group vs. Expanded Eligibility Group. 1966 - 2009 160 Expanded Eligibility (Low Income Disabled) 140 Old Age —% of Total Population 120 100 7'? 80 60 O KP CB 40 20 Ill 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 Note: t 40% 30% 20% 2 10% 0% s oar estimated dual/ lepie enrollees ki Social Seco.* /Me: Sete rarectakt Soviet Social Security Administration. Dept. of Hearth Haman Semites. USA Inc. Income Stalemenl DOklown 87 Entitlement Spending: Entitlement Program + Government Employee Beneficiaries Are Now 36%* of Population vs. 20%* in 1966 Social Security/ Medicare .! Medicaid Enrollment + Government Employees & as % of Total Population, 1966 - 2009 c ; 200 160 40% 35% al o. 30% C O E 120 S O E O. 25% 111 0. 20% e O. o O c 80 15% E E 10% o 40 [cm 5% O. 0 0% Ml 1966 1970 1974 1978 1982 1986 990 1994 1998 2002 2006 I Medicaid Medicare 7 Social Security Federal Government (ex. Military) a Military 7 State & Local Government —% of Total Population' Note. 'Esc:odes our estimated dual:ape erroites Soca( Secanty ANoeare Medce.d. Soume: Social Secunly Ai:mew/aeon. Dept. of Hearth & filonan Services. Bureau of ECO(10Mit Andysis. USA Inc. [ Income Statement COMelown 88 EFTA01123295 Entitlement Spending per Beneficiary: Inflation-Adjusted Average Pre-Tax Income from Entitlement Programs Has Gone Up 3x Since 1966 to $12K in 2008, or 15% of Average Pre-Tax Income Inflation-Adjusted Pre-Tax Income from Entitlement Programs1 per Beneficiary & As % of Average Pre-Tax Income, 1966 - 2008 S14.000 i _ S12,000 2 ii • = a, Lfi 7) $10,000 E 0 t• 1 10%1 2 : g "4; $8,000 ; g I — to ii - 2 $4.000 73 g cr co a. 4 E c o. c - 52.000 SO • i i i 1 11111111 1 ,1 „Iiirliariri Ail - 4% Lu i 2% z. 0% cO ,vc 8% co O c • CO A $6,000 6% i 1966 969 972 1975 1978 1981 1984 1987 1990 1993 1996 999 2002 2005 2008 16% KP • Average Pre-Tax Income from Entitlement Programs —As % of Total Pm-Tax Income Note. ) Enttemtra Imam cetartned as Government Socal Bore/es to pesons'eas Veterans beaters. Source: Social Securny Acenwistrabon. Dept of Health S Human Sena& Bureau of Bromine Analysts. USA Inc. Income Statement Drilidorrn 89 Entitlement Spending: Rising Entitlement Income Is Highly Correlated (82%) with Falling Personal Savings 24% Personal Savings vs. Entitlement' Income as % of Average Disposable Income. 1970 - 2010 —Savings as % of Average Disposable Income • 20% —Entitlement :Welfare Income as % of Average Disposable Income 5 o E s 0 16% c o 0 O :5 • ri 12% E g- o 0 t - E 8% • 4% 0% 1970 - 2010 Correlation: -82% 1970 1975 1980 1985 1990 1995 2000 2005 2010 Ml Note: EnIallernent Income calculated as Government social benefits to persons M the MBA series Table 2.1. Savings rote is the amount of money saved chided by income alter faxes. Sources: BEA USA tic. Income Statement Drilklown 90 EFTA01123296 Entitlement Spending: Observation from Previous Slide • Clearly, lower interest rates have allowed Americans to borrow more and save less. But given the high correlation between rising entitlement income for beneficiaries and declining savings rates. one might also wonder if Americans feel less compelled to save money as they feel that they can depend on the government to give them money. Note: Savings rate is the amount or money saved oNnkted by meome after taxes. USA Inc. I Income Statement DiThown 91 Entitlement Spending: Social Security Now Provides 37% of an Average Retiree's Income, Up From 31% in 1962 Sources of Retirement Income for Average Americans, 1962 - 2008 50°G %Total Pension .20'0 30% 20% 10% 0% Personal Earnings* —Social Security — Pensions + IRAs + 401(k)s- 1962 1968 1974 1980 1986 1992 1998 2004 C I Note: 'Personal earnings Melude income from Mvastmen aSSMS • SidarieS: " OteupatiOnat sins Include regular payMentS Irani private pensions. government employee pensions. IRAs. 401(10. Source: social Seemly AdNilsen0on asce of Retirement and alsebNly Poky USA Inc. I Income Stakenenl Dieklown 92 EFTA01123297 Next, We Drill Down on Entitlement Programs... • We begin with the programs with the least sound financials (Medicaid and Medicare) and end with the programs with the most sound financials (Unemployment Insurance and Social Security), as of today. • We then move to a drilldown of rising healthcare costs after the Medicaid and Medicare drilldowns. USA Inc. I Income Statement Milklown 93 0 Entitlement Spending Medicaid (-$2738 Net Loss') Medicare (-$272B Net Loss") Unemployment Benefits (-$115B Net Loss') Social Security (-$75B Net Loss") Rising Debt Level & Interest Payments Debt Level ($9T Outstanding) Effective Interest Rates (2.2%) Debt Composition Periodic Large One-Time Charges TARP ($26B Net Profin Fannie Mae / Freddie Mac (-$41B Net Loss') ARRA (-$137B Net Loss') NOR: Wenoles F2010 net inovene / nef besot tespective plograns. damper Mee House OMB. I) Metheare and Social Rowley Am toss ovoLdes Roof Fond Veetes! income. 2) TARP net Inca inciodesploceeds from sale of...woes. TARP is Troubled Assaf IWO Program ARRA is ArneOcen Recovery 4 flealroolncenl Acf progeavos. USA Inc. [ Income Statement Dna:town 94 EFTA01123298 Medicaid: Facing Accelerating Cash Flow Deficits • Social Welfare Program — Created in 1965 to provide health insurance to low-income population (2% of Americans under coverage then and 16% nowt). • No Dedicated Funding — Federal funding comes from general revenue (all forms of tax receipts). • Ever-Growing Expenses — $273 billion in F2010, up 2x from 10 years ago. • Rising Healthcare Costs — Owing to aging population + unhealthy life styles + technology advances. • Growing Beneficiary + Benefits — Covered beneficiaries expanded beyond low- income group in 1980s to include additional groups (like individuals who have high medical expenses and have spent down their assets, and some of those who lost their employer-sponsored healthcare insurance coverage in recession), while covered benefits expanded to include prescription drugs / dental services. Total expenditures on these new groups and benefits represented -60% of Medicaid program's spending in 2001, per Kaiser Family Foundation estimates. See slide 319-322 for more details. • Moral Hazard — As a "free good," Medicaid reduced demand for private long-term insurance' while regulation loopholes + need-based benefit policies created incentives to abuse the Medicaid reimbursement system. KP CB Note. I) for more information. please see Jeffrey Bruns and Angry Firstetslab. The farm action of Pub& and Flivate Mswance: Medicaic f and the Long.Teem Care insurance Mocker. 2008. htferkski entailment was 49(61 (pope/aeon 196MM) in I966 and SAW (population 3056019 in 2009. Source; Nalional Genies los Reath Slatimks. Kaiser Family Foundation. World Hank Social &cunt), Administration. USA Inc. - Income Stalemenl DIM:loon 95 Medicaid: Underfunded by $3.7 Trillion Over 45 Years, With No Dedicated Funding Ml SO -$50 o -$100 :2 • -$150 7 g -$200 0 -$250 USA Federal Real Medicaid Expenses & NPV of Liabilities, F1966— F2010 1111 1 I I 11 Real Medicaid Expenses —Net Present Value of Medicaid Liabilities SO -S5 ^ C.J -S10 a -515 7 03 -S20 0 0 -525 73 -530 ‘" a-. -S35 Z -$300 -$40 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 Note. USA federal fiscal year ends in September. Data me infbtion adjusted. Calculation of net present value of AS:01y based on 7Stes Medicad spending projections1mm COO. assurning a 3% &sootier, mie gong-tun average Wrest Ibis treasury yields). Source: White House Once of Management and Budget. Congressionat Budget Mice. USA Inc. I Income Stazereanl Dreldown 96 EFTA01123299 Medicaid: Enrollment Is Up 12x to 49 Million While Annual Payments per Beneficiary Are Up 4x to $5K From 1966 to 2009 Real Annual Medicaid Payments per Beneficiary & Enrollment, 1966 - 2009 Payments per Beneficiary (Syear) $5,000 $4,500 $4,000 $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $500 $0! 1966 MI Enrollment —Annual Benefits per Enrollee 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 50 40 30 C 4.} 20 iE 10 0 Note: Data are Matto adjusted. Source. Dept of Health£ Human Services. USA Inc. Income Statement D.illonn 97 Medicaid: Observations • 49 million (26MM low-income children / 12MM low-income adults / 7MM disabled / 4MM elderly) Americans (16% of population) received an average of $4,684 in tax-payer funded payments from the federal government for healthcare in 2009. For context, $6,872 in healthcare benefits is 13% of average annual per-capita income for Americans. • When Medicaid was created in 1965 to provide health insurance to low- income Americans, 1 in 50 Americans received Medicaid, now 1 in 6 Americans receives Medicaid. • That said, Medicaid is an important benefit for recipients as it provides access to healthcare for low-income adults and their children. In recent years, Medicaid beneficiaries and benefit payments have risen faster than population and per-capita income growth owing to expanded coverage, economic difficulties and associated sluggish wage growth for low- and lower-middle-income families, and continued healthcare cost inflation. Note: Data are inaaboa adjusted. Source: Dept of Heel,£ Human Senates. USA Inc. I Income Statemenl Ddlklown 98 EFTA01123300 Medicaid: While We Focus on Federal Government Dynamics, It's Notable that State Government Medicaid Funding Also Faces Significant Challenges • Medicaid = Major and Growing Expense Line Item for State Governments Medicaid funding responsibility is shared between federal & state governments. States with higher per-capita income (like New York) pay -50% of total Medicaid cost while states with lower per-capita income (like Mississippi) pay -22%. On average, Medicaid accounted for 21% of total state spending in F2009 (ranging from Missouri at 35% to Alaska at 8%). Enrollment growth has been accelerating, in part, owing to more people losing employer-sponsored health insurance in the recession, and thus overall Medicaid costs jumped -11% Y/Y from October, 2009 to June, 2010. State governments (which unlike the federal government must balance their annual budgets) cannot pay for such elevated levels of Medicaid and maintain normal spending levels for other services (like education and public safety). • Enter the Federal Government - ARRA (2009 economic stimulus) provided -$100 billion in support for the states to pay for elevated levels of Medicaid costs and to avoid large budget cuts in education and public safety. This went a long way toward holding down the states' contribution, but it is a one-time unsustainable fix. • Federal Support May Be Expiring by June, 2011 If no action is taken, the Medicaid-related cost burden on the states will rise dramatically in coming years. As a result, many states are on the verge of implementing Medicaid cost containment plans that include cuts in doctor payments, benefit limitations, higher patient co-payments, etc. Moreover, many states are fearful that the recently enacted healthcare reform will lead to additional Medicaid- related costs when it goes into full effect in 2014. Data Source: National Conference of Sass Legislaluses. 'Sims Budge! Wale: Jtsy 2009." USA Inc. Income Statement Dtilklovm 99 0 ll Entitlement Spending Medi (-$273B Net Medicare {-$272B Net Loss- ) Unemployment Benefits (-$115B Net Lose) Social Security (-$75B Net Loss") Rising Debt Level & Interest Payments Debt Level ($9T Outstanding) Effective Interest Rates (2.2%) Debt Composition Periodic Large One-Time Charges TARP ($26B Net Profir2) Fannie Mae / Freddie Mac (-$41B Net Loss') ARRA (-$137B Net Loss') Note. 'denotes F20f0 net mcvone /net loss drespectiveprograns data per White House OMB. 1) Medea,. and Social Seas, net loss excludes Ttust Fund interns) town*. 2) TARP net bss Rclitsfes ptoceeds from sale of wands TARP is Troubled Asset Reel Prognves ARRA is Rainless Recovery B Reinvestment Act programs. USA Inc. I Income Statement Dna:loon 100 EFTA01123301 Medicare: Complex Social Insurance Program With Insufficient Funding • Social Insurance Program — Created in 1965 to provide health insurance to the elderly (65+). • Four Parts — A) Hospital Insurance (to cover inpatient expenses, introduced in 1965); B) Medical Insurance (optional outpatient expenses, 1965) C) Medicare Advantage Plans (private alternative to A&B, 1997) and D) Prescription Drug Coverage (enacted 2003). • Funding Mechanism Varies Part A has dedicated funding via payroll taxes (2.9% of total payroll), though has been running at an annual deficit since 2008 as related payments exceed taxes; Trust Fund is expected to be depleted by 2017E, per Social Security Administration. Part B & D has no dedicated funding (75% of funding came from government allocation / 25% came from enrollees' premium payments). Part C funding came Part A & Part B. • Ever-Growing Expenses — $452 billion expenses in F2010, up 2x from 10 years ago Rising Healthcare Costs — Owing to aging population + unhealthy life styles + technology advances. Moral Hazard — As a "free good," Medicare reduced demand for private long-term insurance' while loopholes in the regulations + need-based benefit policies created incentives to abuse the system. KP CB Note: I) for mote infoimafion. please see Jeffrey Brown and Amy Finkelstein. "Me fnletacbon of Put& and Prarate Inswance: Medicaid and the Long Teem Cale Insurance Madcei. 2006. Source: National Genie for Hearth Stabstics. Kaiser Family Foundation. World Bank Social Secunly Administraflon. USA Inc. I Income Statement Dtaklown 101 Medicare: Underfunded by $1.9 Trillion Over 45 Years USA Inc. Real Annual Medicare Revenue & Expenses, 1966 — 2009 3300 3200 $100 CJ C 0 a UI S -$100 C cc • -3200 O 7 Medicare Part B D Expenditure 0 Es0 -3300 Medicare Part A Expenditure I Medicare Part A Tax Receipts -$400 Total Medicare Net Income -3500 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 Mom: Medc4ie Pall A timapttat tnateance) kis Wdealed 01 NW 14,,Air Ria B vreac.ilinsw.incel .1t0 P01 0 (preemption drug benefas)do not have dedicated funding Data are meadonaoyusfect Source: Dept of Health B Minim Services. USA Inc. [ Income Statement Dzitalown 102 EFTA01123302 Medicare: Enrollment Up 2x to 46 Million While Annual Payments per Beneficiary Up 26x to $8,325 From 1966 to 2009 Real Annual Medicare Payments per Beneficiary & Enrollment, 1966 — 2009 Medicare Payments per Beneficiary ($:year) !al $10,000 50 =Enrollment — Annual Per Cap Benefits (in 2005 dollars) S8.000 40 S6.000 30 :2 S4.000 20 E• $2,000 10 $0 . . . . . . 0 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 Mote. Data are inflation acOusied using SEAS GDP pose index. Smote. Dept. of Heat h& H41011117Sesvices. USA Inc. Income Statement Cailklown 103 Medicare: Observations • 46 million elderly Americans (15% of population) received an average of $8,325 in tax-payer funded payments for healthcare in 2009 ($5,079 for hospital care; $3,246 for medical insurance & prescription drugs). • On the surface, $8,325 in free healthcare benefits every year certainly seems like a high number - 23% of annual per-capita income — (although working Medicare recipients do pay Medicare taxes). • As with employer-sponsored health insurance plans, if people. in effect. get a free benefit (with little personal financial commitment), they may not be especially diligent and frugal about how they 'spend' it. The same concept extends beyond healthcare recipients to the healthcare providers: • When Medicare was created in 1965 to provide health insurance to elderly Americans. 1 in 10 Americans received Medicare. now 1 in 7 Americans receives Medicare...above the initial 'plan.' 1 1 Note: • The issue that peopt overuse services for which They do not have persons! &landed commirmea appoes fo most private insurance as weft For a more detailed olscussion see slide 293. Data ate inflation &gusted using SENs GDP mks index. Source: Dept. of Heel, & Human Services. USA Inc. I Income Statement Dillklown 104 EFTA01123303 Total Government* Healthcare Spending Increases are Staggering — Up 7x as % of GDP Over Five Decades vs. Education Spending, Only Up 0.6x USA Total Government Healthcare vs. Education Spending as % of GDP. 1960 - 2009 KP E 8% • • 8.2% t —Total Government (Federal + State + Local) Spending on Healthcare —Total Government (Federal + State + Local) Spending on Education 0% 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 Note: 'Total government spending on healthcare indudes Medicare. Medicaid dog otherprosparnt such as feasts) emokrtee and veteran heath benefits: total government spenalw on education includes spencang on pre-primary through tertiary edUCalionplogreros Sours: Dept or Educalion. Dept of Healtt 8 Human SOINIO9S. USA Inc. - Income Statemenl Dtilkloon 105 Since Their Creation in 1965, Medicare + Medicaid Have Grown to 35% of Total USA, Inc. Healthcare Spending in 2008 from 0% USA Total Healthcare Spending by Funding Source. 1960 vs. 2009 1960 Total Healthcare Spending = S1878' Other Private Funds Consumer Out-of•pocket Payments Other Government Funds" Private Health Insurance 2009 Total Healthcare Spending = S2.5T' Other Private Funds Consumer Out-of-pocket Payments Private Health Insurance ledicare Other Government Funds" edicaid (Federal + State + Local) Note: %Stinted for inflation. M2005 dollars. "Other government funds include those born Dept. of Defense. Veterans' Adrolnisitalion and federal funding for healthcare research and➢put& heath act/Mies. Source: U.S. Department of Health Human Services. USA Inc. I Income Staternenl Dillklown 106 EFTA01123304 Think About That... • Total government spending on healthcare (including Medicare, Medicaid and other programs) has risen 7x from 1.2% of GDP in 1960 to 8.2% in 2009 while total government spending on education has risen only 0.6x from 4% of GDP in 1960 to 6% in 2009. • Medicare and Medicaid, which did not exist in 1960, rose to 35% of total healthcare spending in 2009, while out-of-pocket spending declined to 12% of total healthcare spending in 2009 (or $894 per person per year*), down from 47% in 1960 (or $478 per person*). • Lifetime healthcare costs for the average American are $631,000, of which the government pays for an estimated 48% while private insurers (like UnitedHealth and Blue Cross Blue Shield) pay 32% and consumers pay just 12%. • When citizens don't need to pay directly for something (like healthcare) and are given an expensive good / service for free (or well below cost), they tend to consume more of it - it's basic supply and demand economics. • This approach faces increasing challenges as USA, Inc. has gone deeper and deeper in debt to pay for it... KP B Note: 71dousted for MAMMA in 2005 dollars, Nominal amount woukt be $972 Oulttpocket healthcare spending per person xi 2008 and $70 per person in 3960. Son: U.S. 0epmtmen t of Health& Hannay Senates. USA Inc. I Income Statemenl Dtilklown 107 USA Healthcare Spending Is Higher Than All Other OECD Countries Combined (with 35% of Other OECD Countries' Combined Population) Total Health Spending (SB) S2,000 S1,500 S1,000 $500 SO Total Expenditure' on Health Among OECD Countries, 2007 Public a Private USA Spending on Healthcare in 2007 = $2.2T All Other OECD Countries' Combined Spending = S2.2T a m 2 -omits Z • . 2 i ri To 42 vEv)-(0 .s 2 8 0 Cali- se 9 >, c 03.7255E23.3En° 42 5 E'42j-- cwa -o .s 1 0 =-7 2 = E or -gs) B 03 •-• 142 Z CaC — as 2t i g" tt ofigz oa 4 4, 7,)0. 1- 3 4 2 > 0 8 r , a. Cn ti CO CO It t 43 0 N._ 0 X jg s i 15 3 V2 t 0 z UJ 0 a 0 Note: OECD data atusteTtor Purchasing Power Panty. *Total ekoenctuse on health measures the final consumption of health goods and Berns (i.e.. current Inman expendeute)plus capThe invesIrnent in healthcare infralductwe. This Mutates spending by both pub& and ',Mate sources gnduang hOuSehOkte)On mead! senates and Oath. public health and pevention programs. and adminisfriaion. Exckded are health-related expendgures such as dating. research. and annionmentai heattli. Source: 0800.0.0am-inn tor Economic Coto:relation and DevelopmeM is an atemabonal organization of 33 devaloped and emerging iiii countries with a shared comnatment to danioattey and the market economy. USA Inc. I Income Staternenl Dtilklown 108 EFTA01123305 Turkey Mexico Korea Poland jansIM Czech ja—a Luxembourg Hungary Ireland Slovak Japan Finland UK Spain . Italy Total Health Spending as % of GDP a OECD Australia Norway Netherlands New Sweden O3 Iceland Greece Denmark Belgium Portugal Canada Austria Germany Switzerland France C cS. • 0 E," 7 g: to 0 0 3 0 m 0 C) O C lD O USA ity a Annual Per Capita Health Spending ($) INJ O Turkey Mexico Poland Hungary Slovak Republic Korea Czech Republic Portugal New Zealand Japan Greece Spain Italy OECD average </) O • O Finland UK Ireland Belgium Iceland Sweden Australia Denmark Netherlands Germany France Austria Canada Switzerland Norway Luxembourg a s CO (/) O 0 O CD C) 11/ iv X O. C 0 0 C) 0 C) O C CD Un O 0 USA C CD cD iv Cam X ,=,.• OD) M (/) em " > a : < CD CO ¢-3 0 CD At ist 0 CD EFTA01123306 USA Spending on Healthcare IS NOT Performance-Based and IS NOT Correlated to Longer Life Expectancy Healthcare Spending per capita vs. Average Life Expectancy Among OECD Countries, 2007 85 0, 'a(.) r .c lt 4 63 80 • •-•". al TO • ra..or • • ›.. S. Korea • • ...-- (.) • ..--- c 03 8 --- - --- UK a) /• — — Linear Trend line (ex. USA) a x ...-- u.i Mexico•• • 0 75 Japan • • Hungary 03 8 70 KR ce • • USA 0 1000 2000 3000 4000 5000 6000 7000 Total Expenditure on Health per capita. SUS (PPP Adj.) Spate: OECD. USA Inc. I Income Stalemenl DOklown 111 In Addition to Life Expectancy, USA Falls Behind OECD Averages in Many Other Health Indicators 2007 Health Indicators Obesity of total population) Infant Mortality (per 1.000 live births) USA 34 OECD Median 15 7 4 USA Ranking (1 = Best, 30 = Worst) RED = Below Average 30 27 Medical Resources Available (per 1.000 population) Total Hospital Beds 3 6 25 Practicing Physicians 2 3 22 Doctors' Consultations per Year 4 6 19 MRI Machines* (per million population) 26 9 1 Cause of Death (per 100.000 population) Heart Attack 216 178 22 Respiratory Diseases 60 45 21 Diabetes 20 12 20 Cancer 158 159 14 Stroke 33 45 8 K ( I Nom 'AfA! Is Afsgrienc Resonance Imaging. Seurat: OECD. USA Inc. Income Stalemenl Drilklown 112 EFTA01123307 Think About That... • USA per capita healthcare spending is 3x OECD average, yet the average life expectancy and a variety of health indicators in the US fall below average. • But if you spend way more than everyone else, shouldn't your results (a.k.a. `performance') be better than everyone else's, or at least near the top? • Should you examine sources of waste/inefficiency given lower output despite greater input? • Definition of `Performance' = Amount of useful work accomplished given certain amount of time and resources. • Definition of `Efficient' = Obtains maximum benefit from a given level of input of cost, time, or effort. Nate. OECD data .14:"...td to Purch4sing Pointy . Pady. heallhaste Costs - ete expeclancy (years) x per capita beauties,. spending (3 pee year. 2006). Source: OECD. US Dept of Kedah .1 Norma Services. USA Inc. Income Statemenl Deklown 113 Patient Protection and Affordable Care Act (PPACA) PPACA — America's new healthcare reform legislation. signed into law on 3/23/10 — creates some reason for concern that it could become an unfunded entitlement. EFTA01123308 PPACA: A Detailed Drilldown into Costs of Recent Healthcare Reform Is Key as it May Increase Budget Deficit... • Congressional Budget Office expects Reform to lower the deficit by $143 billion during 2010-19 Gross cost of $938 billion for expanded coverage, per CBO. Less: $511 billion in spending cuts from lower Medicare reimbursement rate + $420 billion in tax revenues (excl. excise tax) from higher payroll tax rates on high-income families and indoor tanning services + $149 billion in penalty payments by employers/individuals and excise tax on "Cadillac" insurance plans with annual cost exceeding $10,000 for individual / $28,000 for families. SCUMS: LBO. USA Inc. I Income Stalemenl Dntown 115 PPACA- Verdict Is Still Out on Eventual Costs / Deficit Impact • Issues With Official Cost Estimates to Consider Deficit neutral status somewhat reliant on future lawmakers' willingness to implement Medicare savings/reimbursement reductions: • Reductions in payment rates for many types of Healthcare providers relative to the rates that would have been paid under prior law (always a politically difficult decision). • However the good news is that recommendations from the Independent Payment Advisory Board focused on reducing growth in per capita Medicare spending if it exceeds target automatically become the law without congressional intervention if Congress allows IPAB to operate as planned. CBO estimates the effects of proposals as written: CBO acknowledges that it is unclear whether reform can actually reduce the annual growth rate in Medicare spending from 4% (historical average) to 2% for the next two decades, as PPACA estimates assume. - Relies on excise taxes on sectors of the healthcare industry that could be passed through to consumers via price increases. - Starting in 2018, assumes taxation of high premium employment-based health insurance plans. • Opportunities For Cost Savings to Consider Increased access to preventative care could potentially slow down overall healthcare cost growth. Such potential effect is not captured in CBO scoring. - Investments in information technology and new provider & consumer incentives can drive better and more efficient care. Soule: Morgan Stanley Heatthcare Reseamtr. USA Inc. Income Staxemenl Dzeklown 116 EFTA01123309 PPACA — There Is Potential for `Unintended' Consequences • The new law changes some system incentives, which may lead to new behavior patterns, many of which are complex and hard to predict. - The market may adapt to new MLR (Medical Loss Ratio) rules that incentivize and reward a very specific (but ultimately arbitrary) cost structure. - The cost/benefit analysis for employers and consumers may change, and some may opt to re-evaluate their current employer-sponsored coverage offerings. • Health plans that are no longer economically viable may exit markets, potentially adding to the uninsured problem prior to 2014. • Likely acceleration in consolidation of payers as well as providers. Source: Doug Simeon. Morgan SLSM1/4714illhefle Research. USA Inc Income Statemenl Dtilklown 117 Historical Anecdote — "An Accurate Economic Forecast Might Have Sunk Medicare & Medicaid [in 1965]" • In 1965, the official estimate of Medicare's costs was $500 million per year, roughly $3 billion in 2005 dollars.* • The actual cost of Medicare has turned out to be 10x that estimate. Medicare's actual net loss (tax receipts + trust fund interest — expenditures) has exceeded $3 billion (adjusted for inflation) every year since 1976 and was $146 billion in 2008 alone. In other words, had the original estimate been accurate, the cumulative 43-year cost since Medicare was created would have been $129 billion, adjusted for inflation. In fact, the actual cumulative spending has been $1.4 trillion" (adjusted for inflation)...in effect, 10x over budget. While calculations have been flawed from the beginning for some of USA Inc.'s entitlement programs, little has been done to correct the problems. An accurate economic forecast might have sunk Medicare. David Blumenthal and James Morone "The Lessons of Success - Revisiting the Medicare Story", November 2008 KP CB Sources: ' Lyndon a Johnson Library& Museum. Afedkare spending data per Wbiie House OMB. "Dept of Health & Haman Services. CMS. data adjusted for inflation based on SEAS GDP price index. USA Inc. [ Income Staternenl Drilklown 118 EFTA01123310 If History is a Guide, There is Potential for Estimates to Understate Eventual Costs — Medicare Is 10x Higher Than Spending Forecast Actual vs. Estimated Spending on Medicare In reality, total 120 spending increased 61.1x 8 v leo • 13 al 2 80 a 4111 In 1967, the House ^ C In the first year of Ways & Means 2 70 60 11) O. C • Medicare, total Committee estimated $11 spending was spending would ••• 0 40 La $1.8bn increase 6.7x by 1990 20 $128 • $28 0 1966A 1990E (in 1967) 1990A Source: Senate J01(0 Sooner* Commies. Report. 7,J MO9 USA Inc Income Statemenl Dtilklown 119 However, More Recent Healthcare Entitlement Such as Medicare part D Has Cost Less Than Expected • Medicare Part D (the 2006 outpatient drug benefit for seniors) was projected to cost $111 billion annually. • In 2009, Medicare Part II actual cost = $61 billion, 45% below projection. • The government originally projected 43 million beneficiaries in 2009, but only 33 million seniors (23% below projection) elected to participate in 2009. • Medicare Part D was outsourced to the private sector, and seniors elected to enroll in plans operated primarily by managed care organizations, which utilize a variety of techniques to reduce costs and improve the quality of care. • The Washington Times stated on August 16th 2010 — "The lower cost - a result of slowing demand for prescription drugs, higher use of generic drugs and fewer people signing up - has surprised even some of the law's most pessimistic critics." • The Part D experience has given some observers hope that PPACA will not cost more than anticipated. Source: Mogan Slinky h'eaRecene Research. USA Inc. I Income Staternenl Dna:town 120 EFTA01123311 tti Entitlement Spending Medicaid (-$273B Net Loss') Medicare (-$272B Net Loss") Unemployment Benefits (-$115B Net Loss') Soda! Security (-$758 Net Loss") Rising Debt Level & Interest Payments Debt Level ($9T Outstanding) Effective Interest Rates (2.2%) Debt Composition Periodic Large One-Time Charges TARP ($26B Net Profit*2) Fannie Mae / Freddie Mac (-$41B Net Loss') ARRA (-$137B Net Loss') Note. 'denotes F20,0 net income/net loss of tespective programs. dais per Where House OMB.. I) Medicare and Social Sews* net loss nabobs Rust Fund inretes1 'memo. 2) TARP net loss Includes ptoceeds from sak of warrants. TARP is Troubled Asset Relief Prone)) ARM is American Recovery B Reinvestment Act prtgearns. USA Inc. [ Income Statemenl Otilklown 121 Unemployment Benefits: Long-Term Break-Even, Though Prone to Cyclicality • Social Insurance Program — Created in 1935 as part of the Social Security Act to provide temporary financial assistance to eligible workers who are unemployed through no fault of their own (via layoffs or natural disasters). • Funded via Taxing Employers — Employers pay federal government 0.8% of payroll (in addition to various levels of state unemployment insurance taxes) to fund the Federal Unemployment Insurance Trust Fund. • Funding = Pro-Cyclical — Rising employment increases revenue and reduces benefit payments, generally leading to surpluses, while falling employment reduces revenue and increases benefits payments, leading to periodically large deficits during recessions. • Flexible at the State Level by Design - State governments set policies on unemployment benefit eligibility / duration / tax levels, while federal government provide financial and legal oversight. • Generally Break-Even — In 29 of the past 49 years, Federal unemployment insurance programs have had surpluses. Excluding the 2009 / 2010 loss, unemployment insurance had a cumulative surplus of $53 billion from 1962 to 2008. [0 Source. WAtie House OMB. USA Income Stamerem °seldom, 122 EFTA01123312 Unemployment Benefits: Solid, Though Cyclical, Funding But Underfunded by $150B Over 49 Years Owing to -$115B* Deficits in 2010 USA Inc. Real Annual Unemployment Insurance Revenue & Expenses, F1962 — F2010 $70 CO co 0 ce C a ta 430 O U C 5 C • 480 C 0 E o -$130 E C -$180 1962 $20 Unemployment Insurance Expenses • Unemployment Insurance Revenue —Unemployment Insurance Net Income 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 Nat.. USA fecere) fiscal yea ends uz SepTenter. 'ail dela inraton.adnard. based on 2005 dalars. Source: White House Motor Managentere and Budget USA Inc. I Income Statemenl Dtilklown 123 Unemployment Benefits: In the Past. Benefits Paid Have High (70%) Correlation to Unemployment Rate Real Unemployment Benefits & Unemployment Rates. 1962 — 2010 180 160 ra 140 120 C co t 100 E c ao a E c 60 V cc 40 2°0 inft 1 1 111 14 1,1 11111111 Real Unemployment Benefits Unemployment Rate 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 2010 12% 10% 8% 6% 4% 0% ly I1 Able: natal year ends WI September. Source: Mee House Office of Management B Budget Bureau of Labor statistics. USA Inc. I Income Staternenl Dtilklown 124 EFTA01123313 Unemployment Benefits: Good News—Unemployment Change In the Past Has Strong (71%) Inverse Correlation with Real GDP Change. so Economic Growth Should Reduce Unemployment 010 Unemployment Rate Change & Real GDP Change, CCI1 :48 — COLI:10 KP CB -20% -15% O c -10% E -5% E 0 a 0% E 5% 10% 15% Quarterly Unemployment Rate Change Quarterly Real GDP Change (Inverse Scale) 20% -150% 10-48 1053 1058 1063 1068 1073 1078 1083 1088 1093 1098 1003 1008 200% 150% o; 100% t cc 50% .c a. 0% To -50% cc co co -100% 0 Source: Bureau of Etc/tonne Analysis. Bureau of Labor Statistics. USA Inc. I Income Statemenl Dtilklown 125 Unemployment Benefits: Bad News—Newly Extended Unemployment Benefits Could Cost USA Inc. $34 Billion in Next Two Years Cost of Extended Unemployment Benefits (51917) Net Cost of Extended Unemployment Benefits to Federal Government. F2010-2011E 830.000 $25.000 520.000 $15.000 $10.000 $9B $5.000 SO r $255 F2010E F2011E Ml Note. Net costa the Unemployment Compensation Extension Act of 20101s expected to decline sutalantially in F20129 because the Oeadine to ft for extended onernaloymant benefits expires in Novembet 2010 and federal extended onernabymentinsucance provides benefits for up to 99 weeks (less Mon two years). Source: Congressional Budget Office. 7/10. USA Inc. Income Stazemenl Dziarlown 126 EFTA01123314 Unemployment Benefits: Bad News—Structural Problems in Labor Force Could Lead to Prolonged Duration/Increased Rate of Unemployment • Structural Problems in USA Labor Force - Healthcare costs may be a barrier to hiring for employers • Healthcare benefits = 8% of average total employee compensation; grew at 6.9% CAGR from 1998 to 2008 compared with 4.5% CAGR in salaries. • Healthcare benefits are fixed costs as they are paid on an annual per-worker basis and do not vary with hours worked. • As employers try to lower fixed costs to right-size to their reduced revenue levels, layoffs are the only way to reduce fixed healthcare costs. - Skills mismatch may be a barrier to hiring for employers • A large portion of the long-term unemployed may lack requisite skills. • 14% of firms reported difficulty filling positions due to the lack of suitable talent, per 5/10 Manpower Research survey. - Labor immobility resulting from the housing bust may be a barrier to hiring • One in four homeowners are "trapped" because they owe more than their houses are worth, so they cannot move to take another job — until they sell or walk away. Source: Richard Barnet 'Why is US Emproymeer So Weak' (7/23/10). Morgan Stanley Research. USA Inc. - Income Slammenl Diiildonn 127 Unemployment Benefits: Bad News Although economists have shown that extended availability of Ul [unemployment insurance] benefits will increase unemployment duration, the effect in the latest downturn appears quite small compared with other determinants of the unemployment rate. Our analyses suggest that extended Ul benefits account for about 0.4 percentage point of the nearly 6 percentage point increase in the national unemployment rate over the past few years. It is not surprising that the disincentive effects of Ul would loom small in the midst of the most severe labor market downturn since the Great Depression. Despite the relatively minor influence of extended Ul, it is important to note that the 0.4 percentage point increase in the unemployment rate represents about 600,000 potential workers who could become virtually unemployable if their reliance on Ul benefits were to continue indefinitely. Rob Valletta and Katherine Kuang. Federal Reserve Board of San Francisco "Extended Unemployment and Ul Benefits." April 19, 2010. USA Int. Income Stalttenl OnAJOAn 128 EFTA01123315 Entitlement Spending Medicaid (-$2736 Net Loss') Medicare (-$272B Net Loss") Unemployment Benefits (-$115B Net Loss') Social Security (-$758 Net Lose') Rising Debt Level & Interest Payments Debt Level ($91 Outstanding) Effective Interest Rates (2.2%) Debt Composition Periodic Large One-Time Charges TARP ($26B Net Profit'2) Fannie Mae / Freddie Mac (-$416 Net Loss') ARRA (-$137B Net Loss') Note. 'denotes F20,0 net income/net6:ms o' respective programs. data per White House OMB. I) Medicare and Social Security net loss notices Trust Fund interest income. 2) TARP net foss includes proceeds from sob of warrants. TARP is Troubled Assaf Rebel PrOgratni ARM is American Recovery 6 litinvestment Act programs. USA Inc. Income Statemenl Otilklown 129 Social Security: In Good Shape Now, Yet Challenged in Future by Aging Population • Social Insurance Program Created in 1935 — During height of the Great Depression to help elderly (654?) and disabled people avoid poverty. • Pay-as-You-Go Funding — Social Security taxes deducted from current payrolls to pay out to current eligible recipients of Social Security. • For Most of its 8 Decades (1935-1970; 1985 - 2009), Annual Social Security Payments Have Been Funded by Annual Social Security Taxes — However, based on estimates from Congressional Budget Office (CBO), beginning in 2016 (or earlier), Social Security will begin running an annual deficit as payments exceed taxes (at unchanged flat tax rate of 12.4%1 of annual gross wages) - this is a problem! • Social Security Has Been Struck by Annual Deficit Crisis Before - From 1975 to 1981, Social Security expenses exceeded revenue every year, which caused a 45% reduction in the Social Security Trust Fund balance. Legislation recommended by the Greenspan Commission in 1983 reduced average benefits by -5%2 and raised social insurance tax rates for individuals by -2.3%.3 But the Greenspan Commission fix will run out soon as Social Security turns to operating loss in 2016. K P P, Note: 'Early retirees (620 coot drece(ve partial benefits between 62 and 65. I) 6.2% taxes paid by ettployees and marled byemployers on gross wages up lo but not &maiming the Social Security wage base of -5 WOK: 2) fold! benefit Cuts Molded 527B savings from bend*: taxation for the wealthy and 5668 savings from delay in cost of Dying adjustment over /9841989:3) average increase in entitlement psyrog tax rates between 1962 and 1988. iodides Medea payrog taxes. per estimates from 080. Source: Social Semidry Administration. USA Inc. Income Staterranl Dziadown 100 EFTA01123316 Social Security: Financially Sound — So Far — Owing to Increased Revenue / Reduced Spending Post 1983 Reform, But 'Operating Loss' Resumed in 2009 Real Social Security Operating Income. 1957 - 2010 150 Real Net Income of Social Security Program ($B) 100 0 x I Operating Income (Tax Receipts - Expenditures) 50 " 1111 1 11- 1 -50 -100 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 Able. • Ddld is a0. isled tnr mll utul using VY1Ate House OUSo GDP poet gx1e4 (0.1se) on BEAS datal. USA ferrets, feud year ends kySereembev; Source: Social Security Adfnueseabon. USA Inc. I Income Stuemen! Dfilidown 131 Social Security: Enrollment Up 5x to 52 Million While Inflation-Adjusted Annual Payments per Beneficiary Up 2x to $12K From 1957 to 2009 Annual Payments per Beneficiary (Vyear) Real Annual Social Security Payments per Beneficiary & Enrollment, 1957 - 2009 S14,000 60 Enrollment — Annual Per Cap Benefits (in 2005 dollars) S12.000 50 S10.000 40 58.000 *C". 30 c E S6,000 rEs 20 S4,000 10 52,000 Hill. aaaa 0 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 [13 Note: Claus are ;Macon &Woke using SEA GDP price index. Source: Soda, Secuniy AdminUoabon. USA Inc. I Income Statement Cfribeown 132 EFTA01123317 Social Security: Observations • 52 million retired Americans (17% of population) received an average of $11,826 (in 2005 dollars) in Social Security payments (32% of USA per-capita income) in 2009. • By comparison, 10 million retired Americans (6% of population) received an average of $5,447 (in 2005 dollars) in Social Security payments (51% of per-capita income) in 1957. • When Social Security was created in early 20'1' century to provide retirement income to elderly Americans, 1 in 127 Americans' (<1% of population) received Social Security payments. Now 1 in 6 Americans (17%) receive Social Security payments...well above the initial 'plan.' KP CB Noie. I) Social Seca* was athItCO to 1935. rue data on enrollees nor available woe 1945. Source. Social &cosily Adminisoation. USA Inc. Income Stelemeni Onlidonn 133 Social Security: America is Aging. and USA, Inc. Workers Are Required to Support 5x More Beneficiaries (and Rising) than They Did in 1950! 1950 2010 fr 33 •- Social Security Beneficiaries Supported by 100 Workers Set Social Security Beneficiaries Supported by 100 Workers Source: Sacral Seco* Arbrwrisnabon. USA Inc. I Income Statecren113/41:10441 134 EFTA01123318 Social Security: Each Retiree Was Supported by 42 Workers in 1945 & Just 3 Workers in 2009 Supporting Workers per Social Security Beneficiary, 1945 - 2030E 45 Forecast 40 35 a G 0` 30 a 25 in O a o 10 5 0 1945 1955 1965 1975 1985 1995 2005 2015E 2025E Fri Source. Sacral Sew* AtbninNInglem. USA Inc. I Income Stalemenl DiThown 135 Think About That... If you are a worker in USA, Inc. (as 81 million tax-paying Americans are), in effect, you have 5 times more `dependents' than your parents had and 15 times more than your grandparents. KP CB Note: ' 'Dependents' - MS wno name° Social Secunly benefits Orme funded via payroll taxes on current working population. USA Inc. Income Stalemem Dieldoen 136 EFTA01123319 Analysts Often Think of Things as Math Problems... USA Inc. I Income Slalemenl 13,Mown 137 Americans Are Living 26% Longer, But Social Security `Retirement Age' Has Increased Only 3% Since Social Security Was Created in 1935... USA Life Expectancy at Birth, 1935 & 2009 USA Life Expectancy at Birth (Years) 90 80 70 60 50 40 30 20 10 +26% 78 I 1935 2009 USA Full Retirement Age (Years) USA Full Retirement Age, 1935 & 2009 90 80 70 60 50 40 30 20 10 0 +3% 65 1935 67 2009 Note. Foil Fen:even, age is 65 for people born fa MO: 67 for people born in 2009. Seem; Secants A:refs-Sae n1 s of 1961 Mewed early tefiremenf to scan of 62, MO feo1fced benefits. Source: National Genf& fa Health SIZI0S0CS. World Back Social &coolyAdministration. USA Inc. [ Income Statemenl Dillelown 138 EFTA01123320 That's a Math Problem... • If an expense rises by 26% and the ability to pay rises by only 3%, the math doesn't work. A computer in a science fiction movie might blurt out. 'does not compute...does not compute...' • 'Something's Gotta Give...' as the 2003 film put it. • A mathematician or economist would say, `the expense must go down or the ability to pay must rise to match the expense.' • Simple math implies that the age for collecting full benefits should rise from 67 to 72, so that expenses more closely match workers' ability to pay. Under this scenario, while Americans are living 30% longer, the 'retirement' age would rise just 7%, still well below the increase in life expectancy since Social Security was created. KP CB USA Inc. I Income Statement 0iiiidonn 139 Social Security: Unless The Program Is Restructured, Cash Flow Will Turn Negative by 2015E Owing to Aging Population 5200 ri9 • 5100 so 7;4,00 C) rn 753 -S200 0 z c -S300 4 -S400 Real Social Security Annual Operating Income, 1982 - 2036E 2015+ Permanent Negative Cash Flow Projection 1982 1987 1992 1997 2002 2007 2012E 2017E 2022E 2027E 2032E 1 Note. Dom adios:ea kv ^:9a(,00 'u reap 2%9 durors Chool.u'r y fooLowne Prerecoac bySeoul Sew. ay Adaututraison in 840. Source: Social Security Administration. USA Inc. [ Income Ste:envie Diiiidonn 140 EFTA01123321 In Sum... Heretofore, Social Security and Unemployment Insurance have been effectively funded, but two significant entitlement programs (Medicaid and Medicare) were created without effective funding plans / programs. Only one of these (Medicaid) is means-tested (indicating that one is eligible for Medicaid only if he / she does not sufficient financial means). Left unchanged, Unemployment Insurance funding should improve as economic growth resumes. but Social Security will no longer be self-funded within 5-10 years. and the underfunding of Medicaid and Medicare will simply go from bad to worse. USA Inc. I Income &element DoiIttlown Ill Drill Down on USA Inc. Rising Debt Level and Interest Payments O Entitlement Spending Medicaid (-$273B Net Loss') Medicare (-$272B Net Loss") Unemployment Benefits (-$115B Net Loss') Social Security (-$75B Net Loss") 0 Rising Debt Level & Interest Payments Debt Level ($9T Outstanding) Effective Interest Rates (2.2%) Debt Composition 0 Periodic Large One-Time Charges TARP ($26B Net Profit'2) Fannie Mae / Freddie Mac (-$41B Net Loss') ARRA (-$137B Net Loss') Note: 'denotes F2010 net income / nel loss ot tespeceve programs. Jalapa White House OMB. I)Afecroceee and Soda! Sennett net loss excludes nest Fund interest income. 2) TARP net loss includes places& items:deo/ sononts. TARP is Tweeted Asset Rebel Ptogtam. ARRA is Melte. Re...rya FIMVPS01.901AC0.969ITS. USA Inc. I Income Statement Dziltdmon 142 EFTA01123322 Interest Payments: 3 Determinants = Debt Level + Interest Rates + Maturity KP 1-; Interest Payment Maturity Debt Level • 62% of GDP in 2010. up 2x over 30 years • Projected to rise to -146% of GDP by 2030E owing to diminishing surpluses from Social Security and rising expenses from Medicaid and other entitlement spending Effective Interest Rates Effective • At historic low of 2.2% in 2010, vs. 30-year Interest average of 6.4% Rates • Will rise with federal funds target rate & long-term Treasury yield as economy recovers Maturity • Shorter debt maturities imply less leverage to reduce future interest payments via inflation • Long-term debt (10+ year) only 10% of total in 2010, down from 15% in 1985 • Short-term debt (0-1 year) especially large in 2009 Souse.. Historical debt level/ &tease interesi rales dale per IVhOe House OMB. Debt project:G.7 pet C6O. Matson), and corsposePon per Dec.?. ot Treasury. USA Inc. Income Statement Onilio 0- • Drill Down on Debt Levels & Related Expenses We begin with a simple study of current and historical debt levels and key drivers of why debt has risen so much, then we look at interest rates (which are low by historical standards) and the impact they have on interest expense, then we look at the short-term vs. long-term composition of USA Inc.'s debt. USA Inc. I Income Slaltenenl Dnildonn 144 EFTA01123323 Ml O Entitlement Spending Medicaid (-$2738 Net Loss') Medicare (-$272B Net Loss") Unemployment Benefits (-$1158 Net Loss") Social Security (-$758 Net Loss") 0 Rising Debt Level & Interest Payments Debt Level ($9T Outstanding) L Effective Interest Rates (2.2%) Debt Composition O Periodic Large One-Time Charges TARP ($26B Net Profit'2) Fannie Mae / Freddie Mac (-$41B Net Loss') ARRA (-$137B Net Loss') Note. 'denotes P20l0net Simms /net kss of tespective Images= dais per Whirs House OMB. 1) Medicare and SocialSens* net loss excludes Rust Fund Owes, income. 2) TARP net loss Includes ptoceeds from sale of warrants. TARP is Troubled Asset Relief Program: ARRA is Ameslcan Recovery 8 Reinvestment Act programs. USA Inc. I Income Stammenl DnIown Debt Level: Highest (as % of GDP) Since World War II and Rising Rapidly Public Debt As °. of GDP 120% 100% 80% 60% 40% 20% 0% 1940 1946 1952 1958 1964 1970 1976 1982 1988 1994 2000 2006 USA Federal Debt Held by the Public' as % of GDP, 1940 - 2010 4-I World War II 2010 Public Debt = 62% of GDP Ml a:e. :; fat a a:a re-a t<a. a. ss: List: 1-s<iscsi data be ‘a by thy p:41c) rs. grosa debt are aScir 455 to 4f5 in Appendix. Source: WAite HouseO1kt at Manage Trent and Budge) USA Inc. I Income Slatemenl Cheidonn 146 EFTA01123324 Why Has Debt Risen So Much? Public Debt Up 2x Over Past 3 Decades K P CB Source. White HouteOt0ce of ManagerneM end Bu N. USA Inc. I Income Statement Otilklown 147 Debt Level: Why It Has Risen Answer Part 1: Expenses (Entitlement + One-Time Items') Grew Faster Than GDP c/o Change From 1965 K P CB 1200% 1000% 800% 600% 400% 200% 0% •200% USA Real Federal Expenses vs. Real GDP % Change, 1965 - 2010 — Total Expenses — Entitlement Programs — Non•Defense Discretionary Defense Net Interest Payments — -Real GDP 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 Note: 'Dannyitemscould not be shown inched because %change from 1965 is not avails:ie. For comext one•hroe items totaled3377SM 2009and $1528 in 2010 (both in 2005constanf doers), both of which are Asrgesl One item after entitlement expenses and defense spenthag. Data aoyusted for inflation. Source: White Nouse Mee of Management and Budget. USA Inc. [ Income Statement Dziltaown 148 EFTA01123325 Debt Level: Entitlement Spending Increased 11x (1965 to 2010), While Real GDP Grew 3x USA Real Federal Expenses, Entitlement Spending. Real GDP % Change, 1965 — 2010 % Change From 1965 1200% 1000% 800% 600% 400% 200% 0% — Total Expenses — Entitlement Programs — -Real GOP 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 Entitlement Expenses +10.6x Total Expenses +3.3x Real GOP +2.7x Note. Data acausted for anflabon. Source. White House Ohre of Management and Budget. USA Inc. I Income Stammenl DOPown 149 Debt Level: Why It Has Risen Answer Part 2: Revenue (Esp. Corporate Taxes) Fell Below GDP Growth % Change From 1965 USA Real Federal Revenue vs. Real GDP % Change, 1965 — 2010 600% — Individual Income Taxes 500% —Corporate Income Taxes — Social Insurance Taxes 400% —Other Taxes & Fees Total Revenue — -Real GDP 300% 200% 100% 0% -100% 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 Note. AA data arcuated toe 'Manor,. Source: White House Office of Management and Budget. Bureau or Economic AnaNsis. USA Inc. I Income Stalemenl Ddlelown 150 EFTA01123326 Debt Level: Recessions + Corporate Tax Accounting Changes Led to Revenue Underperformance (Relative to GDP Growth) USA Federal Receipts by Type ($6 in 2005 Constant Dollars), 1965 — 2010 1,200 in Individual Income Taxes <n in 1.000 — Corporate Income Taxes 0 CJ Recessions 800 F- E O 600 0 (50 o 400 C.) • 200 0 1981 —> Tax Cuts 1981 Accelerated Cost Recovery System 4 Lower Corporate Taxes \1 2001 2003 Tax Cuts 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 Nora. ' The aclopbon of Accoietated Cost Recovery System stowed companies to uliaze accelerated dapreoaton on capital investments. leading to hignee depteoabon costs and lower taxable income. Smote. White Nouse 011Ne of Management and Budget Note that lecessioneelded tax cuts can be doulNed edged- reducing tax revenue but enhancing GOP growth. USA Inc. Income Statement Olindoten 151 Debt Level: In the Past, Social Security's Surpluses Have Masked USA Inc.'s True Borrowing Needs by $1.4T • Social Security tax receipts exceeded outlays in every year between 1984 and 2008, leading to a cumulative surplus of $1.4 trillion. • These surpluses have been used to fund other parts of federal government operations (including Medicaid, infrastructure and defense...) under the unified budget accounting rules. • Without these past Social Security surpluses, USA Inc. would have to have issued $1.4 trillion more debt (or 16% higher than current level of debt) to fund its operations. Social Security Cumulative Real Operating Surpluses! Deficits, 1982-2010 49. $120 $80 O, $40 is o -$80 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 No Surpluses & *Adis execute Trust Fond interest Income. Stated for Nnalkti. Data source: Cangtessknull Budget Mite. USA Inc. I Income Statement Dtilklown 152 EFTA01123327 Why Will Debt Level Continue to Rise? Public Debt Projected to Rise 2x Over Next 3 Decades Sounze: Consvessions/Budget Office Long Tenn Budget Oulbok (5110). Alternative Fiscal Scenario (assuming a continuation of today's underlying fseal poky. This scenario deviates from CSO's baseline because it incorporates some poky changes That are xi0ay expected to occur and that pokey/Mears have tegulcrly made in the past). USA Inc. Income Stalemenl DO:1mm 153 Debt Level: Projected to Rise 3x Over Next 2 Decades, per USA Inc.'s Own Estimates USA Public Federal Debt as % of GDP, 1982 — 2030 Net Federal Debt As % of GDP K P (=B 160% 140% 120% 100% 80% 60% 40% 20% 0% 1982 1986 1990 1994 1998 2002 2006 2010E 2014E 2018E 2022E 2026E 2030E Source: Congressional Budget Office Long- Tarn Budget Outlook (6110). Aftenualve Fiscal Scenario (assumiga conknuabon of todayk unde0pIng float! polity. This scenano deviates from CSO's baseline because if Incorporates some policy changes that are widely expected10 occur and that pakynytkers have tegu)atly made In the past). USA Inc. I Income Statemenl Dillklown 154 2010 Federal Debt = 62% of GDP EFTA01123328 Debt Level: Why Will It Continue to Rise? Answer Part 1: Notional Social Security "Trust Fund" Surpluses Likely Wi ning Into Deficits Owing to Aging Population Social Security Cumulative Real Operating Surpluses / Deficits, 1982-2037E Social Security Operating Income (SB) 5200 $0 -$200 -$400 -$600 -$800 41.000 1982 1987 1992 1997 2002 2007 2012E 2017E Cumulative Surpluses (1982-2008) Reduced Federal Debt by $1.4T Projected Cumulative Deficits (2009-2037E) Could Increase Federal Debt b 11.67 2022E 2027E 2032E 2037E Note. Sucp(uses & decas enaude Trust Fund 'Wawa( .,came. .34‘..sfe d for od,al.a,nto 26:9 &Mats. Source: Congressional Budge! Ottice. USA Inc. - Income Smemenl Deilklown 155 Debt Level: Why Will It Continue to Rise? Answer Part 2: Notional Medicare* "Trust Fund" Surpluses Likely urnng Into Deficits Owing to Aging Population $100 r e i S go sum  • 4200 03 0. 0 h- 03 0 '0 0) -$300 -$400 1983 1988 1993 1998 2003 2008 2013E 2018E 2023E 2028E 2033E Medicare Part A* Cumulative Real Operating Surpluses / Deficits, 1982-2037E Cumulative Surpluses (1982-2008) Reduced Federal Debt by $218 Projected Cumulative Deficits (2009-2037E) Could Increase Federal Debt b $57 MI Note. Oars are adjusted far 034301 in 2009 dorCits. 'Or* Ak•acate Pan A (Malaita/ anutance)Ms a trust fund (fudcw.1 by payraV faxes). Part B (twat& insurance) and Part 0 (prescriptiondrug beetles) we ptirrumly funded by geneird tax revenue and prerneren /co payments. Source: Medan Trustees. USA Inc. Income Slalemenl Diaklown 156 EFTA01123329 Debt Level: Why Will It Continue to Rise? Answer Part 3: Potential Loss on Guarantees on Fannie Mae / Freddie Mac Originations Could Rise Government-Sponsored Enterprises Gross Debt Composition, 1971 - 2008 Total GSE Debt Outstanding (SB) KP CB $9,000 $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $0 1971 1976 1981 1986 1991 1996 2001 2006 Freddie Mac RMBS' Fannie Mae RMBS' Freddie Mac Corporate Debt is Fannie Mae Corporate Debt Other Debt Note 'RAMIS resdensabochu.ve.bacAectseordies Other debt mcludes those issued byother leders agencies teases Federal Has Loan flanks and Student Loan Marketing A...tenon (Salle Mae). Source: FHFA Report to the Congress 2009. USA Inc. I Income Sisemenl Dieklovm 157 Debt Level: GSEs' Expansion Into 'Non-Conventional' Mortgage Lending Business Has Proved to Be Costly So Far Fannie Mae Credit Losses by Type of Mortgage Product, 1Q08 - 2Q10 $8.000 $6.000 CO 0 0 O L'o= $4,000 C _ sr t co SO 1Q08 2O08 3O08 4O08 1Q09 2Q09 3O09 4O09 1O10 2Q10 Other Non-Conventional Subprime Alt A Interest Only u Conventional } Non- Conventional Mortgages = 30% of Fannie Mae's Total Loan Guarantee Balance, But Causing 70-80% of Losses Owing to Lower Loan Quality Source. Panne Mae. Betsy Grose& Morgan Stanley Research. USA Inc. Income Stalerr.em Orilldonn 158 EFTA01123330 Debt Level: Fannie Mae + Freddie Mac = Latest Estimated Ultimate Cost to Taxpayers Varies* Base-Case Estimated Ultimate Source Comments / Assumptions Net Loss" S389 Billion Congressional Budget Office (CBO) Net accrued loss to be borne by taxpayers, including net cash infusions (with implied default rate of -5- 10%) and risk premiums associated with federal government's implicit guarantee on GSEs' credit. Bulk of the net loss ($291B) occurred prior to and during F2009. On a cash basis, CBO's estimate would have been in line with White House OMB's estimate. S160 Billion White House Office of Management and Budget (OMB) Net cash outlay to be borne by Treasury Dept. (and ultimately taxpayers). including Treasury Dept.'s cash outlays to purchase Fannie Mae & Freddie Mac preferred stock (with implied default rate of -5-10%). minus cash received from dividends. Bulk of the net cash outlay ($112B) occurred prior to and during F2009. Note: 'Latest &Berated cost to Taxpayers vanes and continues Mdse. "ByF.2019E Source: CBO. OMB. USA Inc. I Income Statement Ceiltlown 159 Debt Level: Scenario Math — What Various Default Rates Could Mean for Taxpayer Ultimate Cash Cost of Fannie Mae & Freddie Mac Fannie Mae 1 Freddie Mac Outstanding Loan Guarantees X Default Rate X Loss Severity' Ultimate Cash Cost to Taxpayer Ultimate Cash Cost to Taxpayer Outstanding Loan Guarantees Default Rate Loss Severity* 2% $50 Billion $160 Billion 5% $125 Billion $5 Trillion' Current CSC/ OMB Forecasts (before 10% $250 Billion of Ultimate Cash government 50% Cost of Fannie conservatorship in 15% $375 Billion Mae Freddie Mac 9/08) 20% $500 Billion 25% $625 Billion Note: • Loss *rye Oquidation vane Botecbsure auction o t other meanstas a % of the loan amount aoyusted lot any advances and Mn Bootee: ) Fannie ;tee. F,edde Mac. USA Inc. [ Income Stalmr.em Drilldonn 160 EFTA01123331 KP C B 0 Entitlement Spending Medicaid (-$273B Net Loss') Medicare (-$272B Net Loss") Unemployment Benefits (-$115B Net Loss') Social Security (-$758 Net Loss") 0 Rising Debt Level & Interest Payments Debt Level ($9T Outstanding) Effective Interest Rates (2.2%) O Periodic Large One-Time Charges TARP ($26B Net Profit'2) Fannie Mae / Freddie Mac (-$41B Net Loss') ARRA (-$137B Net Loss') Note: 'denotes F2010 netincome/nef Foss or respective programs dais per While House OMB. 1) Medicate and Social Sawn), net loss extrudes Trust Fund interest income. 2) TARP net toss Includes proceeds from sate of VISITSMS. TARP is Troubled Asset Rae' Preplan ARM is Annyken Recovery B Rein VeSe/1601 Act programs. USA Inc. I Income Stammenl Ceiltlown 161 Effective Interest Rates: While USA Debt Has Risen Steadily Since 1981, Rates Have Fallen Steadily, so the Cost of Debt Has Potentially Been Held Artificially Low Net Debt Outstanding ($B) $10.000 $8.000 $6.000 $4.000 $2,000 10% USA Net Federal Debt Outstanding & Effective Interest Rates. 1980 - 2010 rat Net Debt Outstanding — Effective Interest Rates - - - 30-Year Avg. Effective Interest Rate $0 0% 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 Effective Interest Rates (%) Source. Whtre House anted Management and Budget USA Inc. I Income Stmernenl Chilklown 182 EFTA01123332 Effective Interest Rates: While USA Debt Has Risen, Net Interest Payments Have Fallen ■ Net Debt Outstanding (SB) KP CS $10.000 $8.000 $6.000 $4.000 $2.000 USA Net Federal Debt Outstanding & Net Interest Payments. 1980 - 2010 Net Debt Outstanding —Net Interest Payments $500 $400 $300 $200 $100 $0 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 Net Interest Payments (SB) Source: WM* House Chace or Manage nerve and Budget USA Inc. I Income Statemenl Dtilklown 163 Effective Interest Rates: Hypothetical Exercise — If USA 2009 Cost of Debt Was Paid at 30-Year Average Interest Rate Level of 6% vs. Current 2°/O Annual Interest Cost Would Rise 3x to $566 Billion from $196 Billion $600 $500 $200 $100 USA Actual & Hypothetical Net Interest Payments*, 1980 —2010 — - Hypothetical Net Interest Payments, Assuming 30-Year Average Effective Interest Rate of 6.25% —Actual Net Interest Payments I ' I Would have been $370B higher SO 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 Note. ' ttipolne.c.envl aitere.t:1 oyments c.tiaticui assumes aU olher vamitfes (such as GDP. revem.e. apencang. deaf levers. Sc.) are held commie. Source: WM* House aloe or Management and Budget USA Inc. - Income Staternenl Dieldown 164 EFTA01123333 Effective Interest Rates: But Cost of Debt Unlikely to Continue to Decline For Extended Period If Economy Improves 14% 12% bij 10% ca ca ea 8% 6% 4% 3 2% 0% USA Federal Debt Weighted Average Yields, 1980 — 2010 30-Year Average Yield 7% 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 Seem& US Treasury. USA Inc. I Income Stalemenl Dieklown 185 Effective Interest Rates: If Debt Levels & Interest Rates Rise Dramatically Beyond 2010, Net Interest Payments Could Soar... USA Federal Net Debt Outstanding / Effective Interest Rates / Net Interest Payments, 2009 — 2016E 11.16E 2009 2010 2011E 2012E 2013E 2014E 2015E 2016E CAGR Net Debt Outstanding (SB) $7,545 $9,019 $10,856 $11.881 $12,784 $13,562 $14,301 $15,064 7% WY Growth 30% 20% 20% 9% 8% 6% 5% 5% Effective Interest Rate (%) 2.5% 2.2% 1.9% 2.0% 2.5% 3.1% 3.5% 3.7% Net Interest Payments ($9) $187 $196 $207 $242 $321 $418 $494 $562 22% WY Growth -26% 5% 5% 17% 33% 30% 18% 14% %of Federal Tax Receipts 9 9 10 9 11 13 14 15 Note; CAGR is compound annual growth rue. Source: While House Office of Managamtve and Budget USA Inc. I Income Slammanl Dillelown 186 EFTA01123334 Effective Interest Rates: If Debt Levels & Interest Rates Rise Dramatically Beyond 2010, Net Interest Payments Could Soar USA Net Federal Debt Outstanding & As Percent of Total Revenue. 1980 - 2016E $600 $500 6:7 12. $400 C E /13- $300 B A Net Interest Payment ($B) As % of Total Revenue 30o. 24% 0 18% g 6% 0% 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 2013E 2016E > CC Note; CARR is compound anneal growth rue. Some: Whee House Office of Management and Budget USA Inc. I Income Statement Cailklovm 167 O Entitlement Spending Medicaid (-$273B Net Loss') Medicare (-$272B Net Loss") Unemployment Benefits (-$115B Net Loss') Social Security (-$758 Net Loss") 0 Rising Debt Level & Interest Payments Debt Level ($9T Outstanding) Effective Interest Rates 2.2%) Debt Composition Periodic Large One-Time Charges TARP ($26B Net Profir2) Fannie Mae / Freddie Mac (-$41B Net Loss') ARRA (-$137B Net Loss') Nolo: 'denotes F2010 net Income /net loss of tespective programs. data per White House OMB. 1) Medicare and Social Seoulry net loss evades Chia Fund Owes? income. 2) TARP net loss indocks proceeds from sale of warrants. TARP is Troubled Reset Relief Program ARRA is ROW/Ian Recovery It Reinvestment Act programs. USA Inc. [ Income Statement Chilklown 168 EFTA01123335 Debt Composition: Average Debt Maturity Declining Since 2000, Combined With Declining Interest Rate, Leading to "Artificially Low" Interest Payments USA Inc. Debt Maturity vs. Short-Term Interest Rate. 1980 - 2010 Average Treasury Securities Maturity (Years) 7 6 5 4 3 Average Treasury Securities Maturity Short-Term Interest Rate 1 30-Year Average Maturity 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 20% 15% 10.6 5% 0% Short-Term Interest Rate (°0) Slott: Dept. of Treasury. USA Inc. I Income Statement Dtilklown 189 Debt Composition: Maturity — Temporary High Mix (32%) of Short-Term Treasury Bills in 2009 Took Advantage of Historic Low Interest Rates to Reduce Interest Payments % of Total Marketable Debt Outstand 100% 80% 60% 40% 20% 0/ 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 USA Inc. Outstanding Debt Breakdown by Type & Maturity, 2000 - 2010 7% 6% • TIPS Treasury Inflation Protected Securities Bonds 5% - Long-Term (10+ Year Maturity) 4% • Notes co • - Medium-Term (2- 3% 2 10 Year Maturity) 1% Bills - Shod-Term (0-1 Year Maturity) Short-Term Interest Rate (Fed Funds Rate) — — 10-Year Average Share of 7431lis Not Data as of MUD) each year, composthon exctudes aonmarketabkr securRies. Source: Dept. of Treasury. USA Inc. I Income Statement Dtaklown 170 EFTA01123336 Debt Composition: Foreign Investors & Governments Hold -46% of USA Inc. Public Debt 1989 Total Public Debt Outstanding $2 Trillion ■ Foreign Investors & Government ...a Federal Reserve ■ Mutual Funds State & Local Governments ■ Private Pension Funds .4 Depository Institutions a Insurance Companies al Other Investors 2010 Total Public Debt Outstanding S9 Trillion Note: Puble debt ownership excludes GOVOMMON Accounts Sans (such as Sodal Secunly Dust Fund) as those boklings are inns-government and not badahe input*. Source: Dept. of Treasury. as 010O2:f 0. USA Inc. ' Income Statement DOA:town 171 Debt Composition: Foreign Investors & Governments Hold 46% of USA Inc. Public Debt, Up From 4% in 1970 — How Much Higher Should It Go? Foreign Ownership of USA Inc's Debt (°.) 50% Foreign Ownership of US Treasury Securities, CO1:1970 - CO2:2010 Top Foreign Owners, CO2:10 China 10% 40% Japan 9% UK 3% Oil Exporters' 3% 30% Brazil 2% All Other 18% 20% 10% 0% 1970 1975 1980 1985 1990 1995 2000 2005 2010 Note: 'Oa exported delude Ecuador. Venezuela. Indonesia. Bahrain. Fran. barb KIAVM. Oman. Oahu. Saudi Asaibia. the United Arab &reales. Algeria. Gabon. Libya and bagels. Source: Dept. of Treasury. as of O02: lb. USA Inc. Income Statement Dtilklown 172 EFTA01123337 And — You Guessed It — Here's the Punch Line... By USA Inc.'s Own Forecast... K P CB USA Inc. I Income Slatemenl Dtilklown 173 Entitlement Spending + Interest Payments Alone Should Exceed USA Inc. Total Revenue by 2025E! Entitlement Spending + Interest Payments vs. Revenue as % of GDP, 1980 - 2050E 40% 7/ 45 C 3000 Z + O 4.3 c — a E o 0 ° = ra 20% E 0 W WI a O E C • O. 10% CC O 0% —Revenue — — Entitlement Spending + Net Interest Payments 1980 1990 2000 2010E 2020E 2030E 2040E 2050E Source: Congtessional Budge! Office (CEO) Long Term Budget Outlook (6/10). Note thai entitlement spending Mdudes tedetal government expenditureson Social Seam*. Medicare and Mec6caid. Data in ma shad is based on Ctrs 'alternative fiscal, scenario' forecast. which assumes a continuation of today's underlying fiscal poky. Not Mal CEO also maintains an 'extendedbasehne'scenano. Wed) adhetes closely to current law. The Wietnalive fiscal maned° deviates from CBO's baseline because a incorporates some poky changes that are widefy expected to occur (such as extending the 2001.2003 lax cuts rather Man letting them an payment tales to be in line wadi the Medicare economic index maw Lower than at scheduled fates) and gee' scheduled by tenant law and equating physici that poacymakers have sepia& mode M the past. USA Inc. I Income Statemenl Dtilklovm 174 EFTA01123338 CBO's Projection from 10 Years Ago (in 1999) Showed Federal Revenue Sufficient to Support Entitlement Spending + Interest Payments Until 2060E - 35 Years Later than Current Projection CBO's Projection in the '1999 Long-Term Budget Outlook' on Entitlement Spending + Interest Payments vs. Revenue as % of GDP. 1980 - 2070E 40% C • 30% zn. • Q sd cn 20% W 05 C nl O a. 10% 0 cc 73 O 0% —Revenue / — —Entitlement Spending • Net Interest Payments 1980 1990 2000 2010E 2020E 2030E 2040E 2050E 2060E 2070E Source: Congsessional Budget Office Long-Tenn Cudgel Outlook O999). No* Mai mete was no alrevnarke 'scar scenario in alas forecast back then. USA Inc. Income Statement DnIklown 175 If the Previous Two Slides... USA Inc. - Income Smemenl Chilidown 176 EFTA01123339 Drill Down on USA Inc. Periodic Large One-Time Charges 0 Entitlement Spending Medicaid (-$273B Net Loss') Medicare (-$272B Net Loss") Unemployment Benefits (-$115B Net Loss') Social Security (-$758 Net Lose') Ml Rising Debt Level & Interest Payments Debt Level k($9 1 Outstanding) Effective Interest Rates (2.2%) Debt Composition O Periodic Large One-Time Charges TARP ($26B Net Prottr2) Fannie Mae / Freddie Mac (-$41B Net Loss') ARRA (-$137B Net Lose) Note: 'denotes P2010 nes income / nel loss of respective programs. data per While House OMB. Uhler:rode and Soda! Secunly nel loss excludes Trust Fund interest income. 2) TARP net loss includes proceeds from sale of warrants. TARP is Troubled Asset Reber Program. ARRA is American Recovery£ Reinvestment Act programs. USA Inc. I Income Statement Deja:town 177 One-Time Charges: Unusually High in F2009 & F2010 with Financial + Economic Crisis Net One-Time Charges to USA Inc. ($B) F2008 F2009 F2010 F2011 Net Sum of YTD' 4 Years Government-Sponsored Enterprises(GSEs) Fannie Mae Freddie Mac Troubled Asset Relief Program (TARP)* Banks Automakers AIG Individual Homeowners Other Financial Institutions Consumers & Small Businesses American Recovery and Reinvestment Act (ARRA)" Education Nutrition Assistance Transportation Tax Credits Energy Other $14 $14 $97 $41 60 23 37 18 $261 $26 134 -85 78 -6 49 0 39 22 4 $40 $137 21 50 5 11 4 15 33 1 5 7 23 $152 83 69 -$23 $213 -28 21 -14 58 20 -1 69 38 22 4 $177 71 16 19 35 6 30 Net Total One-Time Charges ($B) $14 $398 $152 -$23 $542 KP CB Note: Federal fiscal year ends in September. 'TARP one-fine charges include repayments & dvdends: F20 f I TARP data as of 241. Ad US Treasury. PRO? f YTO GSE & ARRA data not avaJable. —ARRA onetime charges exclude funds used by enhtternenf programs such as Soda? Sew*/Medicare/ Afeltail/UnempaymerN. Source: Congressional Budge! Mkt. Dept Of Treasury. USA Inc. [ income Statement Deilklown 178 EFTA01123340 One-Time Charges: What Charges from F2008-F2010 May Look Like on Net Basis Over Next 10 Years One-Time Charges from the 'Financial Crisis' are Not Created Equal — While TARP Was the Headliner, When All's Said & Done, TARP may be Smallest Component, by a Long Shot Current Cost ($B, as of 2/11) Ultimate Cash Cost ($B, by F2020E) Comments TARP $213B — — 3. <$51B' May fall from net $213 billion to $51 billion or less' as banks continue to pay back their loans and automakers / AIG seek IPOs / sales to realize value of USA Inc.'s equity stake. GSE $152 — — *. - — $1602 May grow from net $152 billion to -$160 billion (or higher)2as Fannie Mae and Freddie Mac losses on loan guarantees stabilize and they continue to pay dividends on USA Inc.'s shares. ARRA $177 — — * $417 Should rise from $177 billion to $417 billion3 based on commitments...and a payback plan was never factored into these payments. Note: 1) Latest Treasury tamale not 12/10. Wades net profits from Dart of SIM net costs front AIG (SSW/ Automakers (51751/ Consumers 6 Housing programs (5.468) and other. AG net costs exclas potential gains from salting AIG's common shares held by the Treasury. NNW, could turn out to be a 1228 profit foe the Treasury based on t81/10 closing price. Including MP potential gain. TARP uttimate cost to the Treasury would be 5298. 2)What House OMB estimates ultimate cash cost of Fannie Mae / Fredole Macal $1658 while the COO estimates the intimate cash costs at $1608. Both estimates imply an average defamY sate of 5.10% on Fannie Mee • Freddie Macs SST kan guarantee poutto6o and a loss seveMy of 50%. The Federal Housing Finance Agency (FHFA)eslirrunes ultimate costs to range from 51428N 32598. 3) Net cash costs are SyNted to discretionary spending Owns M ARM. Source: DSO. U.S. Dept of Treasury. White House KP OM. FHFA. ( I USA Inc. I Income Stalemenl Deilklown 179 Recipients of $ from USA One-Time Charges (F2008-2011YTD) Total Net 2008-2011 One-Time Charges = $542 Billion (as of 2/11) Other Transportation + Energy + Other Banks 700 Banks received funds, 100 repaid so far Automakers Insurers / Other Financial Institutions AIG + Other Financial Institutions Consumers Homeowners + Consumers & Small Businesses + Education + Nutrition + Tax credits Government- Sponsored Enterprises Fannie Mae + Freddie Mac Source: Dept. of Treasury. as *12/11. USA Inc. I Income SIalemenl Dtilklown 180 EFTA01123341 Drill Down on One-Time Charges Most of USA Inc.'s recent one-time charges are directly or indirectly related to America's real estate bubble and aggressive borrowing. First we look at the drivers of the real estate bubble (we call it `anatomy of a real estate bubble'), then we drill down on the past / present / future financial impact of the three types of one-time charges and the recipients: 1) TARP (Troubled Asset Relief Program) 2) GSEs (Government-Sponsored Enterprises) 2) ARRA (American Recovery and Reinvestment Act) USA Inc. I Income SIAlemenl DtiIklown 181 What created the real estate bubble? USA I Income Staten:en, ComIclown 182 EFTA01123342 Real Estate Bubble: Root Causes—Government Home Ownership Push + Declining Interest & Savings Rates + Aggressive Borrowing and Lending Led to 10+ Years of Rising Home Ownership USA Home Ownership Rates vs. Interest Rates vs. Personal Savings Rates, 1965 - 2010 70% 20% June 2004: US horn, omerenlo MAO 68% t, 66% cc 0 64% x 62% 58% January 1993: HUD began ammonia broatie. Name ~neap. Ug berm ownership a saw - - - 16% 8% 2 4% 0% 1965 1968 1971 1971 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010 — US. Home Ownership Rate U.S. Interest Rate •••PU.S. Home Ownership Rate 30-year (1966-1995) Trendline - US. Personal Savings Rate Nare. HUD is Dept &Housing a Urban Development. 101.165! filf iS theovernight leaner funds rate. Data as of C01:10. Savings late is amount of saying ()MSS by Income alter raves. Data source: Federal Reserve. DOC Bureau of Ecanunta Analysis. USA In:, Income Statemenl Dtilklown 183 Real Estate Bubble: Home Prices Rose Dramatically (7% Annually) for 10 Years — Up -2x Over 10-Year Period Ending 2007 %Change from 1965 Lovel 80% 60% 40% 20% -20% USA Real Home Price & Building Cost Indexes, % Change 1965 — 2008 -USA Real Home Price Index USA Real Building Cost Index 1965 1968 1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 Nare. Rear home prices ti buVrAng costs ate innatiorvaa)umed. Source: Robe's Sfraet. Irate University. USA Inc. Income Staterr.en1 Chnklown 184 EFTA01123343 Banks & Other Mortgage Originators Helped Fuel Housing Bubble as They Originated Lower Quality Mortgages - Alt-A & Subprime Origination Volumes Up 374% & 94% in 2006 vs. 2003 USA Residential Mortgage Origination by Product Type. 2001 - 2010 Total Residential Mortgage Origination ($B) KP CB 4.000 3.000 A 2005 2008 2009 2010 2001 2002 2003 2004 2006 2007 Conventional ImMJumbo aim Subprime Alta Home Equity srFHA/VA —Total Non-Conventional as % of Total 50% 45% 40% 35% 30% 25% 20% 15% 10% 5% 0% Subprime + Home Equity + Alta as to of Total Source: Inside Mortgage Fount& USA Inc. I Income Stalemenl Ceilklovm 185 Real Estate Bubble: Investors Helped Fuel It, Too, as They Reached For Yield Without Questioning AAA Ratings of A Subprime-Backed Investments Investors picked up 25-35bps over U.S. Treasuries with comparable maturity, typically levered 10:1 and generated 2.5-3.5% yield, meaningful against an 8% annual yield target Illustrative AAA-Rated Subprime RMBS Yield Spread* with 10x Leverage, 2/05 — 2J07 4.0% cc 3.6% to t 3.2% rr 76 2.8% 03 CC CC ; 2.4% .o co 2.0% 2/05 4/05 6/05 8105 10/05 12/05 2/06 4/06 6:06 8.06 10:06 12/06 Wore. Oust:atty. AvlAlated subpnins MOSS spies°. reixesented as lifewarune COO spread vs. 7.year swap refs. Sauce: BetsyGases* Moron Stanley Research. USA Inc. I Income Stalemenl Dctheovm 186 EFTA01123344 Investors Struggle with Today's Low -4% Risk Free Rate • Pension funds & other investors look for -8% annual returns in order to meet promised payouts. • The challenge is far greater than before given: • Rising obligations relative to income • Lower interest rates • Promises (e.g.. pension, healthcare) made during an 8% interest rate environment are much harder to meet when the risk free rate has fallen from 8% to 3.6%.' • The choice is either to reduce obligations... or ...Invest in riskier assets. Now. tthysw Treasury othepon rale as o12482010. Source: Beaty Cossack. Morgan Manley Research. USA Inc. I Income Statement Dtaklown 187 O Entitlement Spending Medicaid (-$273B Net Loss') Medicare (-$2726 Net Loss") Unemployment Benefits (41156 Net Loss') Social Security (-$75B Net Loss") Rising Debt Level & Interest Payments Debt Level ($91 Outstanding) Effective Interest Rates (2.2%) Debt Composition Periodic Large One-Time Charges TARP ($26B Net Profir2) I m Fannie Mae / Freddie Mac (-$416 Net Loss') ARRA (-$137B Net Loss') Mate. •denotes F20,0 net Imams/nth bss of respective grogram data per Mae House OMR 1) Medrcals and Social Seaway net loss excarces Rust Fond agates! Income. 2) TARP net Wu Trades placeeds from seas of warrants. TARP is TesoMed asset Read Program ARRA is ArnaliCall Recovery a Reinvestmen Ath progearns. USA Inc. [ Income Statement DnIklown 188 EFTA01123345 Troubled Asset Relief Program (TARP): Recipient of 38% of Net Government (Taxpayer) Funding* In TARP, the financial rescue program (created in October, 2008), USA Inc. purchased assets and equity from financial institutions to provide the capital and liquidity needed during the 2008 financial crisis (which followed the real estate bubble). In 2009. TARP recipients were broadened to include automakers, an insurance company (AIG), individual homeowners. small & medium- sized businesses and other non-bank financial institutions. To date. USA Inc. loaned these institutions $464 billion and received $250 billion in repayment and warrant proceeds for a net outstanding loan balance of $214 billion. Note: 'As of 2,1 f. numbers are Founded. Source: Dept. of Treasury. USA Inc. [ Income Statemenl Deilelown 189 TARP Distribution — Equally Distributed Among Financial Institutions Automakers / Insurer / Individuals as of 2/ 1 Outstanding Troubled Asset Relief Program (TARP) Balance of $214B1 as of 211 Insurance Company Auto Companies jo t M62 omeowners S698 Individuals rs & esses4 Financial Institutions SunTrust Banks -$58 Regions Financial - $3.5B Noie. II as ale ,ounded. includes warrant proceeds of 510.9 from banks. 2) Todd primp& • accrued (Metes, on AIG pielerred stock purdiased by US Treasury prior to I .! I - $498. on 1/Ida f. MG detail additional 5208 TARP funding to buy art Federal Reserve's irmsstnent 3) includYN banks and other financial instilubons: done via PutAdPilyafeMyestmem Pt *yam (PP1P) under which Treasury pioyides equity and debits/lancing to newly formed pubktriymehlyestmemf funds fPFIFs) estat'dhed by fund managers RAI, investors for the puipose of purchasing legacy securities from financial intik:bons. These setufibes are commercial mottgagm backed secuMies and nom agency residential rnoiNagetadied securities. 4) Consumers and small & mecirumsized businesses that need bans would benefit from the Tenn Asse.BackedSecteibes Loan Featly (TALE). through of tich the Fed provides loans to help supped the issuance of asseltacked securities Which wog& ift 1:41 Mn fund a substantial portion of the consumer oval and snail business loans). Source:Dept of Treasury. NG. data as of 20440. USA Inc. - Income Sueemenl Dillelown 190 EFTA01123346 TARP Repayments and Outstanding Loans: Most Large Banks Have Repaid $222 Billion Paid Back1, $23 Billion Outstanding 1 Citigroup' Bank of America Wells Fargo JPMorgan Goldman Sachs Morgan Stanley TARP Repayments: Top 8 Principal PNC Financial US Bank 1 SunTrust Warrant & Regions Other Financial Proceeds Key Corp. CIT Group' Marshall & Ilsley Zions Synovus Popular TARP Outstanding: Top 8 $- $10 $20 $30 $40 $50 $60 $- $10 $20 $30 $40 $50 $60 Mee: Henan:les warrant proceeds from banks; 'Cifigroup's repayments include $2.38 repayment on Me Asset Guarantee program and $6.98 addebnal proceeds from segeg Treasury's ownership. 'Treasurys preferred Waal/WOW/WM in SIT Group was lost as a tomato( CtTs bankruptcy fling. Source: Dept of Treasury. data as e2/1l. USA Inc. I Income Statement Drilklown 191 TARP Repayments And Outstanding Loans: Most Non-Bank TARP Recipients Have Not Repaid $27 Billion Paid Back, $171 Billion Outstanding General Motors TARP Repayments 1 il Chrysler Chrysler Floanchil AIG TARP Outstanding General Motors I PPIP• GMAC Chrysler FHA' TALF• Ii GM Suppliers Chrysler Suppliers $- $20 $40 $60 S- $20 $40 $60 Note: ' PP1P is PubdoPtiyate Investment PI09,301. FHA represents the FHA Short Refinance Program. TALE is Term Asset. Bathed Securees Loan Featly. Source: Dept at Treasury. data as of MI. USA Inc. I Income Statement Drilklown 192 EFTA01123347 0 Entitlement Spending Medicaid (-$273B Net Loss') Medicare (-$272B Net Loss") Unemployment Benefits (-$115B Net Loss') Social Security (-$75B Net Loss's') Rising Debt Level & Interest Payments Debt Level k($9 T Outstanding) Effective Interest Rates (2.2%) Debt Composition 0 Periodic Large One-Time Charges TARP ($26B Net Protir2) Fannie Mae . Freddie Mac (-S41B Net Loss") ARRA (-$137B Net Loss') Note: ?boobs F2010 net income/net bss ol respect/reprograms dais per White House OMB. 1) Meobare and Social Sectully net loss exdudes Trust Fund interest income. 2) TARP net bss includes proceeds from sab of vadards. TARP is Troubled Asset Relief Program: ARM is AMeliCall Recovery B Rdnvestmen1 Act programs. USA Inc. Income Statemenl DOPown 193 Government-Sponsored Enterprises (GSEs): Recipients of 28% of Net Government (Taxpayer) Funding • GSEs Fannie Mae & Freddie Mac extended their guarantees on residential mortgages from conventional loans into Alt-A, interest-only and subprime loans. • While technically not part of the federal government, Fannie Mae & Freddie Mac have enjoyed an implicit government guarantee on their debt and RMBS securities as investors believed (correctly, as it turned out) that the federal government would support these entities if they failed. As a result, GSEs' long- term debt securities receive AAA/Aaa ratings from all rating agencies and are classified by financial markets as "agency securities" with interest rates above USA Treasuries but below AAA corporate debts. • Post placing Fannie Mae & Freddie Mac into a government conservatorship, USA Inc. has so far invested $152B' into these two GSEs with an estimated $8- 13B2 more likely over the next 10 years, given the ongoing weakness in housing market and the poor underwriting by Fannie Mae & Freddie Mac. Ki CI Source. 1) US. Dot of Treasury. as of 121f0. 2) While House OMB/U.S. Congrombnal Budget office. USA Inc. I Income Slalemenl Dieklown 194 EFTA01123348 Fannie Mae & Freddie Mac: A Brief History of Government-Sponsored Enterprises Fannie Mae established in 1938 to provide liquidity to the primary and secondary mortgage markets Freddie Mac established in 1970 atter the Emergency Home Finance Act to provide further liquidity to the mortgage markets Fannie Mae became a publicly traded company in 9/68, in part to reduce rising government debt levels from the Vietnam War by taking Fannie Mae debt off USA Inc.'s balance sheet Fannie Mae and Freddie Mac placed into conservatorship at a time when they guaranteed 57% of the $12 trillion USA mortgage market Freddie Mac became a publicly traded company in 12/88 with an initial market cap of $3 billion Fannie Mae & Freddie Mac — What do they do? They are insurance and investment companies. Both buy residential and multifamily mortgages which conform to their underwriting standards from banks and other originators. They either hold them in their portfolios or package them into residential mortgage-backed securities (RMBS). These securities, which carry Fannie and Freddie's guarantee on them, are then sold to investors (banks, insurance companies, bond funds, etc.). Source: Fannie Mat Freddie Mr Los Angst rtes. USA Inc. I Income Statement Dtilklown 195 Fannie Mae & Freddie Mac: What Went Wrong? Market Cap (SB) Fannie Mae and Freddie Mac Public Market Capitalizations, 1990 — 2010 $100 $80 9/99 — Fannie Mae expanded mortgage availability to low-income borrowers —31' under pressure from White House $60 1/93 - HUD began promoting broader $40 home ownership $20 $0 1990 1992 1994 1996 1998 —Freddie Mac 7/05 - Fannie Mae and Freddie Mac agreed to restrictions on growth of their retained portfolios 9108 — Fannie Mae and Freddie Mac placed into conservatorship 2000 2002 2004 2006 2008 2010 —Fannie Mae Nols HUD is Dipmenent of Housing and Wean Development Source: FactSet. USA Inc. I Income Statement Dtilklown 196 EFTA01123349 Fannie Mae & Freddie Mac: Accounted for Majority of Total Residential Mortgage-Backed Securities (RMBS) Issuance Since 1990s Fannie Mae! Freddie Mac Residential Mortgage-Backed Securities Issuance and as % of Total Market Volume. 1998-2010 Mortg ate-backed Security Volume (8n) 2.000 1.800 1.600 1.400 1.200 1.000 800 600 400 200 0 1988 1992 1996 2000 2004 2008 80% 72% 64% 56% 48% 40% 32% 24% 11 16% 8% 0% Fannie Mae RIMS 7 Freddie Mac RUBS — Fannie + Freddie RUBS as % Total RMBS As % ot Total MBS Martel Volume Sowces. 19882006 data from Cata'ated Ruk, Fanne Mae Fredow #4w data from SHEA Annual Report to ine Congress 2009.2009/2010 dale per EMUS and Hybrid Weekly. USA Inc. Income Stalemeni Deiniown 197 Fannie Mae & Freddie Mac: Latest Estimated Ultimate Cost to Taxpayers Varies* Base-Case Estimated Ultimate Net Loss" Source Comments / Assumptions S389 Billion S160 Billion Congressional Budget Office (CBO) White House Office of Management and Budget (OMB) Net accrued loss to be borne by taxpayers, including net cash infusions (with implied default rate of -5- 10%) and risk premiums associated with federal government's implicit guarantee on GSEs' credit. Bulk of the net loss ($291 B) occurred prior to and during F2009. On a cash basis. CBO's estimate would have been in line with White House OMB's estimate. Net cash outlay to be borne by Treasury Dept. (and ultimately taxpayers). including Treasury Dept.'s cash outlays to purchase Fannie Mae & Freddie Mac preferred stock (with implied default rate of -5-10%). minus cash received from dividends. Bulk of the net cash outlay ($112B) occurred prior to and during F2009. Hole. 'Lams, esbmated cost to invents varies and bannnues to nse. • 'By F2019E. Source: CEO. OMB. USA Inc. Income Stalerrani Dnfldown 198 EFTA01123350 Fannie Mae & Freddie Mac: Scenario Math — What Various Default Rates Could Mean for Taxpayer Ultimate Cash Cost Fannie Mae / Freddie Mac Outstanding Loan Guarantees X Default Rate Loss Severity Ultimate Cash Cost to Taxpayer Outstanding Loan Guarantees Default Rate Loss Severity* Ultimate Cash Cost to Taxpayer 2% $50 Billion $160 Billion 5% $125 Billion $5 Trillions Current CBO / OMB Forecasts (before 10% $250 Billion of Ultimate Cash government 50% Cost of Fannie conservatorship in 15% $375 Billion Mae Freddie Mac 9/08) 20% $500 Billion 25% $625 Billion Note: Loss seventy's liquidation value (orer-bsure auction mother means) a s a % of the loan amount sainted for any advances and Mee Sowce: )Fannie Mae. Fiedde Mac. USA Inc. I Income Statement Dtilklown 199 O Entitlement Spending Medicaid (-$2738 Net Loss') Medicare (-$2728 Net Loss") Unemployment Benefits (-$1158 Net Loss") Social Security (-$758 Net Loss") Rising Debt Level & Interest Payments Debt Level ($91 Outstanding) Effective Interest Rates (2.2%) Debt Composition Periodic Large One-Time Charges TARP ($26B Net Profit'2) Pm Fannie Mae / Freddie Mac -$41B Net Loss') ARRA (-$1378 Net Loss') Note. 'denotes P2010 net income/el kiss of respective programs. dam per MuTe House OMB. 1) Medicare and Social Seem, net loss notices Trust Fund interest income. 2) TARP net ass includes proceeds from sate of warrants. TARP is Troubled Asset React Program: ARRA is Arnefican Recovery a Reinvestment Act programs. USA Inc. [ Income Statement Dtilklown 200 EFTA01123351 America Recovery & Reinvestment Act (ARRA): Recipient of 34% of Net Government (Taxpayer) Funding In ARRA (the economic stimulus program created in February, 2009), USA Inc. aims to create jobs and promote investment and consumer spending by cutting taxes, expanding unemployment benefits, and increasing spending in education, healthcare, infrastructure, and energy. These measures are projected to increase federal spending by $500+ billion while reducing federal tax receipts by $275 billion over 10 years ($177 billion of which occurred in F2009 and F2010). KP ( Source: While House Office *Management &Budget USA Inc. I Income Stammenl DeilOown 201 ARRA*: Negative Effect on Discretionary Budgets Should Peak in F2010, But Spending Commitments through F2019E Total $417 Billion ARRA Discretionary Items' Net Effect on Federal Budget (SB) ARRA' Discretionary Items' Net Effect on Federal Budgets. F2009 - F2019E F2009 F2011E F2013E F2015E F2017E 0 20 40 60 80 100 120 140 Education ■ Nutrition Assistance Transportation • Tax Credits Energy is Other F2019E Nom. *ARRA is American Recovery and Reinvestment Act of 2009. US federal basal year ends in September. Net effects on budgets we Smiled to eAscrettonary spendang items M ARRA Source: Conglesdonal Budge! Office. USA Inc. Income Slalereanl Chilldown 202 EFTA01123352 ARRA: Spending Examples Education - Used ARRA funding and saved education jobs, such as teachers, principals, librarians, and counselors Tax Credits — Provided higher Earned Income Tax Credits Transportation — Repaired roads and bridges Energy — Provided additional funding for renewable energy and energy efficiency projects Nutrition Assistance — Provided additional assistance for low-income families to purchase food Other — Funding for various programs related to homeland security and law enforcement... USA Inc. I Income Slatemenl Dlil lown 203 Longer-term taxpayer impact of GSE Loans + ARRA + TARP varies... regardless, it is material USA I Income Staterr.en, DmIcion.n 204 EFTA01123353 What `One-Time Charges' from F2008-F2010 May Look Like on Net Basis Over Next 10 Years One-Time Charges from the 'Financial Crisis' are Not Created Equal — While TARP Was the Headliner, When All's Said & Done, TARP may be Smallest Component, by a Long Shot Current Cost ($6, as of 2/11) Ultimate Cash Cost ($B, by F2020E) Comments TARP $214B — — — <$51B1 * May fall from net $214 billion to $51 billion or less' as banks continue to pay back their loans and automakers / AIG seek IPOs / sales to realize value of USA Inc.'s equity stake. GSE $152 _ _ * - _ $1602 May grow from net $152 billion to -$160 billion (or higher)2as Fannie Mae and Freddie Mac losses on loan guarantees stabilize and they continue to pay dividends on USA Inc.'s shares. ARRA $177 — — — * $417 Should rise from $177 billion to $417 billions based on commitments...and a payback plan was never factored into these payments. programs aerate KV (:B- Note: 1) Latest Treasury &Ornate as of 12/10. Wsoudes net profits from banks of 5 MB. net costs from AIG (S59)/ Automakers ($175)/Gonswnees A Housem (5-468) and direr. AIG net costs excludes potential gains from seging AG's common shares held by the Treasury. which could turn out to be a 5228 profit to We Treasury based on tW1/10 closing price. 4n0rdng this potential gain. ARP ultimate cost to the Treasury would be 5298 2) While House OMB estimates cash cost of Fannie Mae / Predate Mac al $1656 while the GBO estimates the ultimate sash costs at 51608. Both estimates imply a7 average default sate of 5.10% on Fannie Mae • Freddie Mack 55T ban guarantee ponfolio and a loss severity o150%. The Federal Housing Finance Agency (FHFA)estfritsles ultimate costs to range from SIAM to $2598. 3)Net cash oasts are Smiled to discretionary spending items in ARRA. Spume: COO. U.S. Debtor Treasury. White House OMB. FHFA. USA Inc. I Income Stalemenl Deineown 205 This page is intentionally left blank. 206 EFTA01123354 This page is intentionally left blank. 207 This page is intentionally left blank. 208 EFTA01123355 Balance Sheet Drilldown KP CB USA inc. I Balance Sneer OriMovm 209 Balance Sheet: USA Inc Federal Debt + Unfunded Entitlement Liabilities (Social Security + Medicare...) Exceed Stated Assets F1996 ... F2003 ... F2009 F2010 Comments ASSETS ($8) Cash & Other Monetary Assets $193 $120 $393 $429 $2008 cash balance owing to Accounts/ Loans/ Taxes Receivable 206 278 626 783 temporary Fed market stabilization Inventories 232 241 285 286 Initiatives Property, Plant & Equipment 969 658 784 829 TARP + GSE Investments 304 254 Includes $145B TARP direct loans 8 Other assets 124 97 275 303 equity Investment + $1098 in GSEs a: al Assets (SB) 1.724 1.394 2.668 2.881 Growth primarily owing to TARP WY Growth 33% 40% 35% 8% capitalization + Fed liquidity program LIABILITIES (SB) Accounts Payable $162 $62 $73 $73 Significant rise in debt owing to on- Accrued Payroll & Benefits 100 161 164 going budget deficits + stimulus Federal Debt 3.730 3.945 7,583 9.060 spending Federal Employee & Veteran Benefits Payab 1.652 3.880 5,284 5.720 Federal employee 8 veteran benefits Liability to GSEs 92 360 rose 3x owing to scheduled annual Other Liabilities 530 512 932 979 pay raises + rising benefit costs Unfunded Net Entitlement Liabilities 5.415 20.825 45,878 30.857 Unfunded entitlement liabilities up 6x WY Growth 16% 7% -33% between F1996 and F2010. NPV of Unfunded Social Security $3.600 $4.927 37,677 37.947 Medicare NPV down sharply V/V NPV of Unfunded Medicare 1.815 15.819 38.107 22.813 owing to new assumptions from the NPV of Unfunded Other Benefits 79 94 97 Healthcare reform legislation Total Liabilities (SB) 11.488 29.324 60,002 47.214 Significant Increase from rising levels WY Growth 14% 9% -21% of debt + unfunded future benefits NET WORTH (58) 49.764 427.930 457.334 444.330 -$44T of net worth for USA Inc. more Y/Y Growth 13% 8% -23% than tripled, from $101 In 1996 KP CB Able: LSA Int's balance slew peascwed taro does MI mode me Asannal vac ',fhb Gobeennwts sovoragn pow•vxio tax. 109uato commeco. and se monow, irks& also excludes es COAVOI over nanceceanonal resources. mcluctry nanonai and manner losolnros. lot who, tea Gorommonns a samara. Total Wafts ockdo 070 nor thew( veLe Wor unatnded entatemeni &WNW Me Social Sectany/ efedeare / Mar payments. onion the rteastrey Dept consVoes orlludenco sheer eptoSitufte U S gOvernmenf SUS year 0149 M Sep.emtet Source as Depermeot oat. TrebStay. Finande RdpOrr On the Vs. GW(wNiWor. 1996 - 2010. USA Inc. I Balance Sheet D/ilklown 210 EFTA01123356 KP B USA Inc. Net Worth: -$44 Trillion in Perspective There are doubts about the accuracy of such a big negative number, especially when the value of USA Inc.'s assets is so hard to calculate. The value of natural resources, the power to tax, the ability to print the world's reserve currency, the human capital in our educational system — these and other assets would clearly reduce that number, if they could be accurately calculated. Given the differences between government and corporate accounting, what matters is not the exact number, but the trend — which is clearly moving in the wrong direction. Liabilities have been growing faster than assets. Just to put that $57 trillion into context... -$44 Trillion = S142,999 per Person in USA, S370,961 per Household' 20x USA Inc. Annual Revenue2 3.8x S&P500 Total Market Capitalization3 3.0x USA Annual GDP4 0.9x Global Stock Market Capitalizations 0.8x Total USA Household Wealth6 Soya: 1)PopulalionS household data as of 1/10. pee Census Bureau estimates:2)6Nya) (edam) Income in F2010. pee Dept. &Treasury:3)as./ tot. per say. 4) GOP is 20,0 nominal figure. pet ea 5) as or IttO. pee Work) Federation of Exchanges: 6) as of CO3:10. calculated as total net worth or households S nonpeord otganizalions. per Federal Resew. 02110 data' USA Inc. I Balance Sheet Drilldonn 211 We Believe Citizens Should Consider These 'Off-Balance Sheet' Liabilities For A 'More Complete' Understanding of USA Inc.'s Finances "...the Government's responsibilities to make future payments for social insurance and certain other programs are not shown as liabilities according to Federal accounting standards... These programmatic commitments remain Federal responsibilities and as currently structured will have a significant claim on budgetary resources in the future... The reader needs to understand these responsibilities to get a more complete understanding of the Government's finances." Department of the Treasury, '2004 Financial Report of the United States Government" USA Inc. I Balance Sheet Chilldonn 212 EFTA01123357 Balance Sheet: USA Inc. Total Liabilities*: $47 Trillion in F2010, or $395,093 per Household Owing Largely to Entitlement Spending Total Assets / Liabilities / Net Worth of USA Federal Government, Using Corporate GAAP Accounting, F1996-F2010 S10 $ O ▪ -S10 -S20 n -S30 0° • -$40 4 73 IS -S50 -560 to -S70 • Unfunded Entitlement Benefits Current Liabilities a Total Assets • Net Worth r Medicare liabilities down sharply owing to slower healthcare cost growth assumptions associated with 2010 Healthcare reform tra r- oa On o ,- (NJ el It 0 CO 0. CD 0" 0 O 0 0 0 0 0 0 0 0 0) 0) 01 0) 0 0 0 0 0 0 0 0 0 0 g LL LL CV CV CV U. U. U. CV CV CV CV CV 04 04 CJ U. U. U. U. U. U. U. LI. Note: USA /,,c s D.WanCe sheet presented here does nor inarde the financial value of the G0i0010161(S S0Vele194 powers to tax. regutate commerce. and set monetary poky. it also excludes as control over nonoperational resources. includang national and natural resources. /or which the Government's a steward. Total Arab:Ries include the net present value (NFU) of unfunded en Clement liafrhties Ore Social Security / Afrnacare I other payments. vrtach the Treasury Gept. considers all-balsam sheer responsitraties. U.S. government fiscal year ends in September. Source: U.S. Department ol the Treasury. Financial Report on the U.S. Government. 1996 - 2009. USA Inc I Balance Sheet Dlillaown 213 Balance Sheet: USA Inc. Total Liabilities: $47 Trillion in F2010 Up 5x From 1996. Driven by Medicare Liabilities USA Inc. Total Liabilities ($T) S10 S20 $30 S40 S50 S60 S70 Total Liabilities of USA Federal Government. Using Corporate GAAP Accounting, F1996-F2009 F1996 F1998 F2000 F2002 F2004 F2006 F2008 F2010 1 1 1 1 1 • Net Medicare (Part D) Liabilities • Net Medicare (Part A & B) Liabilities • Net Social Security Liabilities I Federal Employee & Veteran Benefits Payable • Federal Debt I All Other A Medicare liabilities down sharply owing to slower healthcare cost growth assumptions associated with the 2010 Healthcare reform Note: USA Inca balance sheet presented here does nor include the 0.1871Cial value of Ihe Governments sovereign powers to tar. regulate commerce. and set monetary poky. It also excludes its 0201(0, over nonoperational resources. includang national and natural resources. for Sect, the Government Sa steward. Total habarbes include the net present oak* (NFU) ol unfunded enhtlernent liafrhties Ore Sochi Security/ Medicare /other payments. which the Treasury Gept. considers xrnbaiance sheer responstagies. U.S. government fiscal year ends in September. Source. U.S. Department of the Treasury. Financial Report on the U.S .Government. 1996- 2009. USA Inc I Balance Sheet Dzillaown 21a EFTA01123358 Important Caveats on F2010 Medicare Liability Improvement • Medicare Part A and Part B unfunded liability improved to -$16 trillion in F2010, up 47% from -$31 trillion in F2009, per the Board of Medicare Trustees. • The improvement was driven primarily by downward revisions of future cost growth assumptions following enactment of healthcare reform in 2010. • However. Medicare's Chief Actuary Richard Foster noted that "while the Patient Protection and Affordable Care Act as amended. makes important changes to the Medicare program and substantially improves its financial outlook. there is a strong likelihood that certain of these changes will not be viable in the long range... Without major changes in health care delivery systems. the prices paid by Medicare for health services (as scheduled by current law) are very likely to fall increasingly short of the costs of providing these services...Congress would have to intervene to prevent the withdrawal of providers from the Medicare market and the severe problems with beneficiary access to care that would result. Overriding the productivity adjustments. as Congress has done repeatedly in the case of physician payment rates, would lead to far higher costs for Medicare in the long range than those projected under current law...For these reasons, the financial projections shown (here] for Medicare do not represent a reasonable expectation for actual program operations in either the short range (as a result of the unsustainable reductions in physician payment rates) or the long range (because of the strong likelihood that the statutory reductions in price updates for most categories of Medicare provider services will not be viable)." KP CB Note. Emphasis added Source. &semen( of Actuatial Opinion. 2010 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Meckaltrisurake Trust Funds USA Inc I Balance Sheet Driarlown 215 Balance Sheet: Even Excluding Unfunded Entitlement Benefits, USA Inc.'s Net Worth = -$13 Trillion in F2010, Owing to $9 Trillion of Debt USA Inc. Total Assets Liabilities Networth (ST) $5 $ -S5 -S10 -SIS -S20 Total Assets / Liabilities / Net Worth of USA Federal Government, Using Government GAAP Accounting, F1996-F2010 ta ge Liabilities (ex. Unfunded Entitlement Benefits) a Total Assets • Net Worth (cx. Unfunded Entitlement Benefits) CO N. CO m o r N Cl a N cl) N. CO m 0 0 0 0) 0) 0) 0) 0 0 0 0 0 0 0 0 0 0 la: la: la: ra: N N Note: USA inc's LuglOCe shall presented here does not include the financial value of the Governments sovereign powers to lax. regulate rommerce, and set monetary poky. ft also excludes is control over nonoperational resources. inductingnational and naval resources. for which the Government is a steward. Teal liabtlibes exclude the net present wake (NPV)ol unhanded entitlement liabilthes Me Social Secuny/ Medicate / other payments. which the Treasury Dept. considers ntAbalance sheer responsikftes. U.S. government fiscal year ends in September. Source: U.S. Department of the Treasury. Financial Repot! on the U.S. Government 1996 - 2010. CB USA Int I Balance Sheet Dna:town 216 KP EFTA01123359 Balance Sheet: Observations of Last Ten Years • Unfunded promise of future entitlement spending grew 6x to -$31 trillion, owing to rapidly rising healthcare cost + new Medicare Part D program + aging population in the medium-future. • Federal net debt outstanding more than doubled to $9 trillion on the back of chronic budget deficits, two major recessions in 2001 and 2008, and growing entitlement spending. • Federal employee & veteran benefits outstanding also more than doubled, to $5.7 trillion, thanks to rising healthcare costs and ongoing war on terror. USA In. I Balance Sheer Orilklown 217 This page is intentionally left blank. 218 EFTA01123360 This page is intentionally left blank. 219 This page is intentionally left blank. 220 EFTA01123361 What Might a Turnaround Expert— Empowered to Improve USA Inc.'s Financials Consider? KP CB USA Inc. I What Might a TUffialCUrld Expect Conskler? 221 First, Examine USA Inc. Key Drivers of Revenue & Expenses... • USA Inc.'s Revenue = Highly Correlated (83%) with GDP Growth* - 90% of USA Inc.'s 2010 revenue derived from taxing individual and corporate income. which depends on GDP growth and changes to tax rates / composition. • USA Inc.'s Expenses = Less (73%) Correlated with GDP Growth* Entitlement Programs = 57% of USA Inc.'s expenses in 2010 • driven by government policy + demographic changes Defense Programs = 20% of expenses • driven by external threat levels and policy Net Interest Payments = 6% of expenses • driven by net debt level + interest rates + composition of debt maturity Observation: while revenue is highly correlated with GDP growth, expenses are less so. Note: 'H,sloRW intlatiumaGusted correlation between GDP and revenue/expense Y/Y overdo rates from 1940 to 2010. GDP/revenue as:basted using GDP del tarot expenses aGusted using White House OMB's composite outlay dela I or. Nominal revenue / GDP correlation over the same &mind is 84%.' expense/GDP correlation is 71%. Data sowce: While House Orrice of Management & Budget. COO. USA Inc. I What Might a Tumatmind Expert Constet? 222 EFTA01123362 Then, Aim to Determine What `Normal' Is... • We review 40-year income statement patterns and focus on 'average' / 'normal' levels of USA Inc.'s revenue drivers (primarily related to taxes) and expense drivers (by category) as a percent of revenue, as a starting point to help define 'average' / 'normal.' • Established businesses typically determine their expense levels based on their revenue trend / outlook. • In a perfect world, the government (and its citizens) would continually review the multiple variables in the income statement of USA Inc. (in a bipartisan way) and would work hard to foster compromise, in order to optimize revenue and expenses for the long term AND the short term. USA Inc. I What Alight a Turnaround Expert Consider? 223 Considering USA Inc. `Normal' / Average Financial Metrics / Ratios For... 1) Revenue Growth 2) Revenue Drivers as Percent of Revenue 3) Expense Growth by Category 4) Category Expenses as Percent of Expenses USA Inc. I What Alight a Turnaround Expert Consider? 22a EFTA01123363 Revenue Growth: Average Federal Revenue (Driven by Taxes) In-Line With GDP Growth 1965 — 2005 USA Real Federal Income Growth by Category vs. Real GDP Growth Revenue Growth 1965 Y/Y 2005 Y/Y Individual Income Taxes 11% 11% Corporate Income Taxes 15 Social Insurance Taxes 12 5 Other Taxes & Fees -5 1 Total Federal Revenue 9% 11% Real GDP 7% 3% KP CB "Normal" 40-yr CAGR 3% 2 41 0 '05 vs 40-yr Variance Comments 8% Individual & corporate income taxes are cyclical: 2005 YtY growth were significantly affected by economic recovery post 2001 recession. Social insurance taxes & other fees are less cyclical. Social insurance taxes grew significantly faster than GDP. 3% 8% 0% Note. AN data ate (Ninon aguskd usang GOP price irvlex from BEA; VS vs. 40.yr vanance is rounded. Data source: While Nouse Office of Management & Budget USA Inc. I What Might a Tumaneaxl Expert Cont.:lei? 225 Revenue Growth: Observations from Previous Slide We chose a 40-year period from 1965 to 2005 to examine `normal* levels of revenue and expenses. We did not choose the most recent 40-year period (1969 to 2009) as USA was in deep recession in 2008 / 2009 and underwent significant tax policy fluctuations in 1968 /1969 and subsequently many metrics (like individual income and corporate profit) varied significantly from 'normal' levels. Total USA Inc. revenue (collected via taxes) has grown at an average 3% annual rate, in-line with 40-year GDP growth rate. Corporate taxes have — on average — grown at 2% annually over 40 years. Social insurance taxes (for Social Security and Medicare) have grown at an average 5% annual rate, above the 3% GDP growth. Questions: 1) How crucial is the role played by lower relative tax rates — especially for corporations — in stimulating job and GDP growth and helping American maintain / gain / constrain loss of global competitive advantage? 2) Should social insurance tax growth be more closely aligned with GDP growth? Note; Midst& ate innalion acgusfed using GOP price index from BEA; VS vs. 40yr variance's rounded. Data source: While House Office of ManagemeN & Budget USA Inc. I What Might a Tumaneaxl Expert Contilei? 226 EFTA01123364 Revenue Drivers as Percent of Total Revenue: Average Federal Revenue Are Skewed to Social Insurance (Entitlement) Taxes and Away from Corporate Income Taxes 1965 - 2005 USA Real Federal Income Mix by Category Share of Total Revenue 1965 2005 40-yr Average 05 vs 40-yr Variance Individual Income Taxes 42% 43% 46% -,3OO Corporate Income Taxes 22 13 12 1 Social Insurance Taxes 19 37 33 4 Other Taxes & Fees 17 7 10 -3 Total Federal Revenue 100% 100% 100% 0% "Normal" Motu AN data are inflation equaled using GDP pike index from BEA: VS vs. 40.yr variance is rounded. Data source: While House Office of Management & Budget USA Inc. I What Might a Turnaround Expert Consder? 227 Revenue Drivers as Percent of Revenue: Observations from Previous Slide Social Insurance taxes (for entitlement programs) have risen materially to 37% of revenue (vs. 33% 40-year average), and have risen aggressively from 19% in 1965, owing to introduction of Medicare in 1965 and the 1983 reform of social security taxes. Questions: 1) What level of social insurance / entitlement 'tax' can USA Inc. support on an on-going basis? Rising from 19% of revenue in 1965 to 33% of revenue in 2005 — of which 75% was spent on healthcare — takes its toll on other areas of spending / growth. There are serious tradeoffs - every dollar that goes to entitlement programs is not spent on education, infrastructure, and defense. 2) Why have corporate income taxes fallen to 13% of revenue in 2009 from 22% in 1965 aside from recession? How crucial has this been to maintain global competitive advantage and stimulating American job and GDP growth? lit Mott AN data are inflation acfiusled using GOP price index from BEA: VS vs 40 yr valiance is rounded. Data source: While House Office of Management & Budget. USA Ins. I What Might a Turnaround Expert Contder? 228 EFTA01123365 Expense Growth by Category: Entitlement Spending Growing Much Faster than Other Expenses and 2% Higher than GDP Growth 1965 - 2005 USA Real Federal Expenses Growth by Category vs. Real GDP Growth 1965 YY Expenses 2005 YY Growth 40-yr CAGR '05 vs. 40-yr Variance Entitlement Expenses Defense Non-Defense Discretionary' Net Interest Payments 12% 12 10 7 6 6 12 6°. 2 3 3% -3% 4 4 8 Total Federal Expenses 11% 5% 2% Real GDP 7% 3% 3% 0% Normal Comments Entitlement expenses grew 2 percentage points faster than GDP and overall expenses Defense spending grew 2 percentage points below overall expenses Note: All data are inflation adjusted using GDP paw Wes from BEA: VS es 40-yr rafiance is rounded. 'Nondefense iNscretrontry spending includes education. irteastrudure. agrkulture. houskig. eta Data source: Wee House Cake of Managementd Budget. USA loadMal Might a TUM3f0Und [Apr, Cort.ideit 229 Expense Growth by Category: Observations from Previous Slide While GDP and USA Inc. tax revenue have grown at a 3% annual rate for 40 years, entitlement spending has grown 5%, net interest payments have risen 3%, and defense plus non-defense discretionary spending (including education, infrastructure, law enforcement and judiciary) have risen by 1%. These different growth rates have become even more pronounced in recent years. Questions: 1) Isn't it time for a re-set and acknowledgment of trade-offs? Should taxes. non-defense discretionary spending, and defense spending grow in line with GDP over time? Should entitlement spending be restructured to be more efficient and supportable by the ongoing financial dynamics of USA. Inc. and also grow in line with or below GDP? ,Vol , Au dal e inflation agusted using GDP price irides from BEA: VS vs. 40-yr variance is rounded. Data source: Male House Mite of Management JI Budget. USA reed What Might a Turnaround Expert Conskler? 230 EFTA01123366 Expense Drivers as Percent of Total Expenses: Entitlement + One-Time Items Are Crowding Out Other Federal Spending 1965 - 2005 USA Real Federal Expenses Mix by Category Share of Total Expenses :i .i ' 1965 2005 40-yr Average 05 vs. 40-yr Variance Entitlement Expenses 21% 51% Defense 43 20 Non-Defense Discretionary* 29 22 Net Interest Payments 7 7 42% 24 23 11 9% -4 -1 -4 Total Federal Expenses 100% 100% 100% 0% Note: NI data are infistion adjusted using GOP pnce index !Corn BEA: VS vs. 401, ng spending includes education. in:intrude/a. agikulture. housing. etc. Data source:WhileHouse USA T Normal discretionmy Management & Budget. Expel Conde.? valiance is sounded. Woncleknse Office of Inc. I Mal Might a TUMICI.11121 Category Expenses as Percent of Expenses: Observations from Previous Slide Entitlement spending has risen to 51% of total spending, higher than 40- year average of 42% (and much higher than the 21% in 1965), defense spending has fallen to 20% from 24% average, non-defense discretionary spending (including education, infrastructure, energy, law enforcement and veteran services) has fallen to 22% from 23%, and net interest payments have fallen to 7% from 11%, despite higher debt (largely because of declining interest rates). These trends have become more pronounced in recent years. Questions: 1) Should entitlement spending account for 51% (and rising) share of total USA Inc.'s spending, while other key areas (such as education, infrastructure. energy, law enforcement...) account for only 22% (and falling) of spending? Note: AN data ate ingation as:gusted using GOP peke index from BEA: VS vs. 40.yr valiance is (Dundee'. Data sowce: Mae House Office of Management & Budges USA Inc. 11Vhal Might a Turnaround Expert Contalei? 232 EFTA01123367 Bottom Line, as Data in This Presentation Indicate... KP CB USA Inc.'s expenses far exceed revenue — and government projections imply this trend will get worse, not better. In addition - while not addressed in depth in this presentation - USA Inc. (while still a global powerhouse), at the margin, is losing competitive advantage to many other countries. Instead of ignoring the problems, we simply ask the question... How would a financial / turnaround expert look at USA Inc.'s financials, business model, strategic plans, efficiency and aim to drive the `business' to break-even (or a modest profit) over the next 5-10 years? USA Inc. What Might a Turnaround Expect Conskier? 233 Matching Expenses & Revenue: Imperatives & Constraints There are many reasons to make changes - USA Inc. is losing money, and forecasts imply it will continue to lose money. - Net debt levels (62% in F2010) are expected to surpass 90% threshold` — above which real GDP growth could slow by more than one percentage point — by 2021E. - Spending (primarily related to entitlement programs) is at unsustainable levels based on USA Inc.'s ability to fund the spending (without increasing debt levels). - Americans rank 'reducing America's debt' as one of country's top priorities, according to a national survey by Peter G. Peterson Foundation in 11/09. - We are now in the midst of a major generational baton-passing (from the Baby Boomers to Generation X) which requires preparation for policy change. - Foreigners own 46% (and rising) of USA Inc.'s debt, per Treasury Department — Are they going to keep funding USA Inc.'s spending? Note: taupe° Reinke,' and Kennett Rego,' observed from 3.700 hisexical medal dam palms from 44 counfries that Ole relationship bemeen govettenerN debt and seal GDP giewlh is weak for detWGDP moos below a ihteshold of 90 percent of GDP. Above 90 percent. me than 0%6mMsafes lad by one percent. and overage glower !WU considerably mote. We note that whole Rearhad and Rogers observations ate based on' oss deal' data. in tie U.S.. debt held by to pulale is closer Maw Ewopean coutatiel definition of government gross debt For mom inionnalion. see Reinnati and Roped 'Growth in a Time °Wear 1/10. USA Inc. i Whal Might a Turnaround Expert Conde,? 234 EFTA01123368 Matching Expenses & Revenue: Imperatives & Constraints There are many constraints to making changes - -90 million citizens (29% of Americans)' have grown accustomed to entitlement programs - 47MM on Medicaid, 45MM on Medicare, and 51MM on Social Security, and many of them vote. - Politicians depend on re-election campaigns, which can create conflicts, especially given that only 12% of the population are willing to cut Social Security and Medicare benefits, per Pew survey in 2/11. - Low personal savings rates (near 6% of disposable income in CQ2:10), high unemployment (near 10%) and economic uncertainty, which can limit ability to make radical change. - 14 million healthcare-related workers2 have grown accustomed to relatively high healthcare spending. No(e: I) as of 2008. excludes doubt. toupee's, of beeetidaties of enuttiple entitlement pop/ants: 2)as of 2008. pee BEA. Soares: Serial Security MeniseStrabOll. Dept. of mem s Hums, Services. BEA. USA Inc. I Mal Might a Tumaicond Expel Consklet? 235 And Then There's the Constraint of USA Inc.'s Weak Economy [The] typical error most countries make coming out of a financial crisis is they shift too quickly to premature restraint. You saw that in the United States in the 30s, you saw that in Japan in the 90s. It is very important for us to avoid that mistake. If the government does nothing going forward, then the impact of policy in Washington will shift from supporting economic growth to hurting economic growth. Timothy Geithner, Secretary of US Treasury The Wall Street Journal, September 12, 2010 Ml USA Inc. I What Alight a TUMalOund Expel Consdet? 236 EFTA01123369 High-Level Thoughts on How to Turn Around USA Inc.'s Financial Outlook KP B USA Inc.I Whal Alight it TURI£11.2404 Expect Consklei? 237 Negative Cash Flow = USA Inc.'s Fundamental Financial Problem • Negative cash flow implies that USA Inc. can't afford the services it is providing to 'customers' (citizens). • USA Inc. needs to re-prioritize its services and offer them in a more cost-effective way to stop losing (and borrowing) money. • The financial data imply that USA Inc.'s operations must be restructured. USA Inc.I Whal Alight a Turnaieurxt Expert Consklei? 238 EFTA01123370 The First Step to a 'Turnaround' is Acknowledging There is a Problem A turnaround situation is first recognized when there is serious concern or dissatisfaction with the firm's [organization's] performance, results, and/or near-term forecasts of [financial] performance and results. - Richard Sloma, The Turnaround Manager's Handbook If your organization is in trouble, be honest. Make it absolutely clear to everyone in the company that survival [long-term viability] depends on cost management. - Jon Meliones, "Saving Money. Saving Lives," Harvard Business Review on Turnarounds KP CB USA Ina. I Whet Might a TUfflalCUMI Expect Consitlec? 239 How Might a 'Turnaround Expert' Look at an Organization that Needs to be 'Turned Around?' The recovery of a [challenged] company [or country]... depends on the implementation of an appropriate rescue plan or turnaround prescription. Characteristics of the appropriate remedy are that it must: 1) address the fundamental problems; 2) tackle the underlying causes (rather than the symptoms) and 3) be broad and deep enough in scope to resolve all the key issues. - Stuart Slatter, David Lovett, Laura Barlow, Leading Corporate Turnaround USA Ina. I Whet Might a TIONIICUMI Expect Consitlec? 240 EFTA01123371 Aim to Answer Questions Like These About USA Inc.... Strategy / Financial Model • Which countries (or states) have test practices' (based on productivity and outcomes) in key areas of operations (like healthcare, retirement plans, welfare, defense, education, infrastructure) — which of these best practices can / should be implemented by USA Inc.? • What is the organization trying to solve for - what is USA Inc.'s mission? / Who are USA Inc.'s customers? • Is USA Inc. providing its customers an optimized mix of services, based, in part. on ability to fund the services? • Are there 'business lines' that USA Inc. should exit / scale back / expand? • Why is USA Inc. spending more money than it brings in (and borrowing more money) — what are the checks and balances? • What do USA Inc.'s financials tell us about the health of the business? • Should USA Inc. consider a capital budget separated from the operating budget to ensure sufficient levels of investment in education, technology and infrastructure? • What are the best attributes / biggest problems of USA Inc.'s business? • Does USA Inc. have a path to profitability (or break-even)? • How should the government improve transparency in long-term budgeting and projections? How can USA Inc. engage the public in this process? Source: )(PCB and fl ares S Marsei Pub& Seder Services. LLC. USA Inc. I Whal Might a Turnaround Expert Consder? 241 ...Aim to Answer Questions Like These About USA Inc.... People / Organizational Structure • Has management effectively articulated a sound mission to its employees and constituents - is USA Inc. properly organized to effectively achieve its mission? • Does the organization have the right people, in the right places, at the right time? • Does the business have a best-in-class leadership team and are they empowered to make change? • Are employees motivated / empowered / accountable for maximum performance? • Are employees properly trained and compensated? • Has the organization 'run the numbers' and effectively quantified the things that are quantifiable? • Do leading performance measures exist that support proactive management? • How do you change the culture to be one that is steeped with focus on costs savings and operating efficiency? Source: )(PCB and Alvan S Martel Pub& Seam SP9114093. LW. USA Inc. I Whal Might a Turnaround Expert Conskier? 242 EFTA01123372 ...Aim to Answer Questions Like These About USA Inc. Productivity Operations • How does USA Inc. measure performance and progress — are tools in place to measure success / failure? • Should USA Inc. empower an independent / 3rd party auditor with expertise in government operations around the world AND corporate turnarounds to conduct a broad-ranging audit of USA Inc.'s operations to measure efficiency and productivity of each business lines? • Does USA Inc. have tight management and financial controls? • What is the best way to measure and improve individual program performance? Can Congress, the administration and the agencies agree on common metrics? • Are there operations that should be centralized (like procurement, human resources, employee payroll and benefits) and decentralized? • Are there operations that USA Inc. can autsource to local private companies to improve efficiency and reduce costs? • Where should USA Inc. increase and or decrease investment? • Is USA Inc. investing for the future in a responsible way? • Should USA Inc. drive public / private partnership in infrastructure investment with collective 'skin in the game?' • Is the organization leveraging technology to improve productivity and connect with customers and suppliers? • How can USA Inc. improve business process related to time, cost and quality? • Does USA Inc. own assets it doesn't need that it can sell at attractive prices? Source: KPCS and Alvarez B Manse Public Sector Semtes. LLC. USA Inc. i What Might a Tumaicund Expert Cortsalei? 243 Three Principles for a USA Inc. `Turnaround' from Louis Gerstner • Do not impose "across-the-board" cost reductions This is a simple and tempting remedy for an organization in fiscal trouble. But it is almost always unproductive. A truly effective organization needs incremental investments in programs that drive innovation and higher productivity. Moreover, across-the-board cuts are almost guaranteed to reduce morale, promote short-sighted choices, and encourage accounting gimmicks that send people looking for loopholes instead of creative solutions. • Focus on programs, not costs - The greatest productivity gains come from asking questions such as: What things are we doing now that we do not need as much in the future? Can we eliminate them? Reduce their size? Provide them in a totally restructured fashion? • Allow no exceptions To drive a truly effective restructuring program, everything must be on the table. There can be no sacred cows—no part of the organization that is exempt from scrutiny. Every unit of the organization may not face a cut, but every unit needs to be rethought. Source: Louis V. Geese, r Jr. Dont Jusl Cu! Government. Reinvent be The WaYSteeelJoumal 211201f. USA Inc. i What Might a Tumaicund Expert Cortsalei? 244 EFTA01123373 Financial Experts Tend to `Assume What Can Go Wrong, Will Go Wrong,' and Usually Manage Expenses in that Way • In projecting scenarios, financial experts would note that USA Inc.'s revenue and expenses are highly correlated to economic changes — for example, a 0.1 percentage point slowdown in real GDP annual growth rate could worsen USA Inc.'s F2011-F2020E budget deficit by $2888. or 5% owing to lower tax revenue and higher welfare spending. F2011-F2020E Impact on USA Inc.'s - N Key CBO Base-Case Economic What it... Assumption Variables Revenue ($6 / % of Base- Case) Spending ($B1% of Base- Case) Deficit ($B1% of Base. Case) 2.1% F2011E Real GDP growth Real GDP Y Y Growth Rate 4.4% F2012-14E rates are 0.1 percentage point -$2478 (-1%) +S418 (--%) -$288B (-5%) lower per year 2.4% F2015-20E 4.6% on 3-month T- Interest bills Rates Interest rates are 1 percentage point +$94B +$1,214B (+0.3%) (+3%) -$1,120B (-19%) higher 5.5% on 10-year T- notes Inflation 1.7% Inflation is 1 percentage point +$2,4758 +53,191B -$715B (+7%) (+7%) (-12%) higher Source: C80. The Budget and Econont Out took Fiscal Years 2010fo 2020." f/f0. USA Inc. I What Might a Turnaceund Expect Conger? 245 Past Performance Does Not Guarantee Future Results — Japan's Economic Miracle From 1960 to 1990 Rapidly Deteriorated Into the 'Lost Decades' of 1990's & 2000's Japan Real GDP Annual Growth Rates, 1960 — 2010 Real GDP Annual Growth Rates (%) -5% 1960 1975 1980 1985 1990 1995 2000 2005 1965 1970 Inflection Point - Bursting of Real Estate Bubble in 1991 Average Annual Real GDP Growth, Japan vs. USA, 1960's — 2000's 1960's 1970's 1980's 1990's 2000's Japan 10% 5% 4% 1.5% 0.7% USA 4% 3% 3% 4% 2% Source: World Sank IMF. USA Inc. I What Might a illffialCUM Expect Conselei? 246 EFTA01123374 Unfunded Entitlement (Medicare + Social Security) + Underfunded Entitlement Expenditures (Medicaid) = Among Largest Long-Term Liabilities on USA Inc.'s Balance Sheet USA Balance Sheet Liabilities Composition, F2010 Federal All Employee Other Benefits Veteran Benefits Federal Debt Unfunded Medicare Unfunded $22.8T Social Security $1.6T $2.1T $3.7T $9.1T I $7.9T 4 40 si 110 Medicaid* $35.3T Note; Medicaid funding is appropriated by Congress (from generality revenue) on an as-needed basis every year. therefore. there S no need to maintain a contingency reserve. and. umlke Meekly& the %Sandal statueof Me program is not in question from an actuarial perspective. Here we estimated the net present valued future Medicaid spending through 2085E. assuming a 3% discount rale. Gala source: Dept of Treasury. Dept of Heald, 8 Human Services Center for Medicare MeMcaid Semkes. USA Inc. I What Might a Turnaround Expert Consdet? 247 USA Inc.'s Financial Disconnect The country faces a fundamental disconnect between the services the people expect the government to provide. particularly in the form of benefits for older Americans, and the tax revenues that people are willing to send to the government to finance those services. That fundamental disconnect will have to be addressed in some way if the budget is to be placed on a sustainable course. - Douglas Elmendorf, Director of U.S. Congressional Budget Office, 11/10/2009 USA Inc. I Whal Might a Turnaround Expect Conside,? 248 EFTA01123375 An Observation from Ben Bernanke, Current Chairman of the Federal Reserve A famous economist once said anything that can't go on forever will eventually stop, and this [government liabilities from entitlement programs] will stop, but it might stop in a very unpleasant way in terms of sharp cuts, a financial crisis, high interest rates that stop growth, continued borrowing from abroad. So, clearly we need to get control of this over the medium term. and specifically we're going to have to look at entitlements because that's a very big part of the obligations of the federal government going forward. -- Ben Bernanke, Chairman of the Federal Reserve Testimony before House Budget Committee, June 9. 2010 Ervhasis added. USA Ira. I What Might a Turnaround Even Confider. 249 Bad News: USA Inc.'s Entitlement Programs are Inflation Indexed, Thus Potential Inflation — Which Would Reduce General Consumer Purchasing Power — Would Not Reduce Entitlement Liabilities Social Security, Medicare, Medicaid Spending (All Indexed to Inflation) as 46 Total Federal Spending 1970-2020E 60% 50% z o 40% 30% 12" 20% 10% 0% 1978 1986 1994 2002 2010E 2018E 1970 ElSocial Security Medicare • Medicaid 50% Oats sources: Me Budge and Econornk Outlook 0806'W. USA Inc I Wthal Might a Turnaround Even Conaklei? 250 EFTA01123376 Good News: While 'Unfunded' Liabilities Have Helped Bankrupt Companies, USA Inc.'s Unfunded Liabilities are Not Legal Contracts • Medicare / Social Security — While beneficiaries have a legal entitlement to receive benefits as set forth under the Social Security Act, Congress has the legal authority to change the levels of benefits and/or the conditions under which they are paid. Congress's authority to modify provisions of the Social Security program was affirmed in the 1960 Supreme Court decision in Flemming v. Nestor, wherein the Court held that an individual does not have an accrued "property right" in Social Security benefits. The Court has made clear in subsequent decisions that the payment of Social Security taxes conveys no contractual rights to Social Security benefits. • Medicaid — Benefit levels & eligibility are determined jointly by Federal and State governments. Federal funding is met through an appropriation by Congress (and can be adjusted annually). Source, CacgroSSIOnal Research Sem... Soc./ Socturty Rearm Legal AnalySio of Social Security Sonobto Entitlement issues. USA Inc. I Waal Might a Turnaround Expert Consklef? 251 What Might a Turnaround Expert Consider? 0 Focus on Expenses Reform Entitlement Programs Focus on Operating Efficiency O Focus on Revenues Drive Sustainable Economic Growth Change Tax i Policies USA Inc. I Waal Might a Tumaaaaad Even Gonadal? 252 EFTA01123377 Focus on Expenses: Reform Entitlement Programs + Focus on Operating Efficiency 0 Focus on Expenses Reform Entitlement Programs Focus on Operating Efficiency KP CB Restructure Social Security Restructure Medicare & Medicaid Review Federal Wages & Benefits Review Government Pension Plan Characteristics & Compare with Private Sector Plans Review Role of Unions Review Government Cost Structure & Consider Reducing Federal Headcount Determine if There are Non-Core 'Business Lines' That Can Be Centralized / Locally Out-Sourced USA Inc I What Might a Tumaicond Expert Gonadal? 253 For Each of the Major Problems, We Highlight: 1) Mathematical Illustrations and 2) Policy Options • Mathematical Illustrations - Here we simply calculate how big a revenue increase and/or expense decrease each major entitlement program needs to reach financial break- even. - These calculations are merely mechanical illustrations and are not meant to portray realistic solutions. • Policy Options - We do not take a view on preferred policy options. — We present policy options from our healthcare experts + 3rd party organizations (such as the Congressional Budget Office and National Commission on Fiscal Responsibility and Reform) in an easy-to-understand format to raise awareness and illustrate the financial impact of policy decisions. iki USA Inc I Whal Alight a Tumatcood Expert Gonadal? 254 EFTA01123378 0 Focus on Expenses ReforiM Entitlement Programs Focus on Operating Efficiency Restructure Social Security Restructure Medicare & Medicaid Review Federal Wages & Benefits Review Government Pension Plan Characteristics & Compare with Private Sector Plans Review Role of Unions Review Government Cost Structure & Consider Reducing Federal Headcount Determine if There are Non-Core 'Business Lines' That Can Be Centralized / Locally Out-Sourced USA Inc. What Might a Turnaround Expert CenseeR 255 Restructure Social Security: Variables To Make the Program Financially Break-Even for the Long-Term Mathematical Illustrations* Slide 257-259 1) Retirement age — increase it to 73, from 67? or 2) Social Security benefits — decrease them by 12%? or 3) Social Security tax rate — increase it by 2 percentage points? Policy Options Slide 261-267 1) Combination of some / all mathematical illustrations above? and/or 2) Consider / implement CBO's various policy options on Social Security's tax rates / taxable payroll / initial benefit formulas / cost-of-living adjustment... (July 2010)"? and/or 3) Consider / implement National Commission on Fiscal Responsibility and Reform's policy proposals (November 2010)***? Atte. Pot tnethemancalt.VosItations.tte simply calculate how big a revenue increase AND r OR expense decrease each trnvor enetterrtent program needs to reach financial 0tealoewen. These calculettons are Intros), mechanocalektsitaoons and ate no meant to portray reaXsbc solutions. "See. COO. *Social &cuoTy Options 1010.' "'See. Melton& Corrom'ss.ton an Fiscal ResponstOty and Reform. CoChai,s' Ptoposai. ILJ[0.100,3ft Document. USA Inc I What might a Turnaround Expert Centric'? 256 EFTA01123379 Restructure Social Security: Mathematical Illustration #1 — Increase Retirement Age From 67 to 73 Increase Retirement Age 80 KP P Full Retirement Age (Years) 70 60 50 40 30 20 10 0 67 4 nc 73 Current Proposed Note: Fet mathematical din/rations. we simply calculate how beg a revenue increase AND/ OR expense decrease each major enfitlernent program needs to teach financial Lveak-even. These calculations ate merely mechanical Nusbaum and are not meant to portray realistic solutions. Note: Increase MP taliewnent age fo 73 we reduce average Ate er;oeciancy al refitment f o the same level as when Social Security was introduced in the late 1930s. Source: Are0ssa M. Fay/earth and Richard W. Johnson. The Urban Inslifide. 'Raising SodalSeturgys Retirement Age.' 7/10. USA Inc. i What Might a Tumaicand Expert Gonsdei? 257 Restructure Social Security: Mathematical Illustration #2 — Reduce Social Security Expenses (Benefits) By 12% Reduce Social Security Benefits by 12%, Immediately & Permanently $14,000 ry z $12.000 $10.000 •-" co .e3 58.000 0 c ° 56.000 54.000 4 52.000 ritt $0 KP CB 513.010 -12% N S11.489 2009 2010&Beyond Note: ForillelL•018fital AUSfraZiOnS. WO simply callable how big a revenue increase AND / OR expense decrease each major entitlement program needs to Nadi financial freak-even. These calculations are moiety mechardcal Anfrations and are not meant to portray Nabs& solutions. Source: Social SecwifyAdmibistration forecast in -The 2010 Annual Report of Me Board of Trustees of The Federal addlge and Survivors Insurance and Federal °Satiny Insurance Trust Funds."840. USA Inc. i What Might a TUM8IP.IIM Expert Gonsdei? 258 EFTA01123380 Restructure Social Security: Mathematical Illustration #3 — Increase Social Security Tax Rate From 12.4% to 14.2% Increase Social Security Tax Rate by 1.92 Percentage Points Immediately & Permanently 16 14.2% Payroll Tax Rate (%) 12 8 4 0 12.4% 7 +1.92 Percentage Points 20128.Bavn Note: For mathematical MUsfralionli we siantlate now big a revenue Acrease AND/ OR expense ore eaocg mayor erNillernent program needs to reach financial beak-even. These cdcutalions are merely mechanical ihrthations and are nor meant to pert ay mask :Wuhan. Note: 1.92% is the emintaied aduahal deficit for Soda) SetUnly Trust Fund over a 75-year period from 201010 2081 Source: Social Secunly AdrnliSsfralion forecas1in The 2010 Annual Report of the Board of Trusteesdine Federal 010Age and Survivors Insurance and Federal &sad:Cy/appliance Trust Funds.' 8110. USA Inc. I Waal Might a Turnaround Expert Consider? 259 Good News: Mathematical Illustrations to Fix Social Security's Financial Problems Do Not Seem Drastic In fact, when Social Security was nearing bankruptcy in 1983, a combination of moderate reforms led to 25 consecutive years of operating surpluses. Highlights of 1983 Social Security Reform 1) Raised full retirement age to 67 by 2027 (from 65)* 2) Reduced annual benefits by 5% (via a 6-month delay in cost-of-living adjustment in 1983 & subsequent changes in benefit formulas and tax schemes) . 3) Raised Social Security tax rates by 2.3% (via an advancement in scheduled tax increase). 4) Made Social Security benefits (up to 50%) taxable income. Wore: Toe people born St 1937 or earlier. &A retirement age (ugh 100% Social Seamy tenth!) remained al 6S For people born after 1960. hi retirement age was raised:0 67. For people born between 1937 and 1960. the hi retirementage progressivelyincreases horn 6510 67. Source: Social Secunly Administration &Ohre. USA Inc. i What Might a Turnaround Expert Gonadal? 260 EFTA01123381 Restructure Social Security: Policy Options #1 — Combining Raising Retirement Age + Reducing Benefits + Raising Tax Rates Consider: 1) Increase retirement age by 0-9% and/or 2) Reduce social security benefits by 0-12%? and/or 3) Increase social security tax rate from 12.4% to 14.2%? and/or 4) Combination of some / all of the above & more? Lki USA Inc. i Whal Alight a Turnaround Expert Cons:Jet? 261 Restructure Social Security: Policy Options From the Congressional Budget Office (CBO) to Reduce Social Security Future Deficits By 1) Changing Tax Codes' Policy Options Future Deficit Reduction2 (%) 2% gradually over a 20-year period 100% Increase Payroll Tax 3% gradually over a 60-year period 83 Rate by ... 1% in 2012 50 No limit, without Increasing benefits 150% No limit 100 Raise the Taxable Earnings Limit3 to ... $250,000, without Increasing benefits 83 90% of earnings 33 $106,800, without Increasing benefits 50% Impose 4% Tax on { Earnings Above ... $250,000, without Increasing benefits 17 Note. ft Benefits we achusled as taxation is changed. unless specified otherwise 2)As of the estimated psesent vabse of Social Seaway Oust fund atmstaltre deficit A Solute 75 yeNs. 3)Currently al 5106.800 Source: C90. 'Social Secunly Options 2010.' USA Inc. i Wham Might a Turnateund Expert Consdet? 262 EFTA01123382 Restructure Social Security: CBO's Policy Options to Reduce Social Security Future Deficits By 2) Changing Benefit Formula Policy Options Reduce Primary Insurance Amount' Factors ... To Index Initial Benefits to Prices Rather Than Earnings By -33% for top 2 tiers of earnings3 By 15% for all tiers of earnings By 0.5% every year for all tiers of earnings By -33% for the top tier of earnings Index ... Future Deficit Reduction (%) 167 % 117 83 67 17 Earnings in AIME2 + Bend Points in PIA' to price 100% Bend Points in PIA' formula to price 83 Earnings in AIME2 formula to price 33 Initial benefits to changes in life expectancy Lower Initial Benefits° for .. The top 70% of earners The top 50% of earners 33 83% 67 Note:UP/Amery insurance Amount (PM). the benefit a person would receive it hdshe elects to begin teeekhng retirement benefits al Nth*" normal retirement age 2) Average Indexed Montt* Earnings (AIME): an averaged monthly income tanked by a benermiaty during del war* Me 3)Ourventry Mee area lien of earnings in calculation of PM - top tier - 15% of montNy earnings over $0.586; der 2 - 32% of monthly earnings belWeen $761 and $4.586: ley 3 - 90% ol monthly earnings below $761 4) Benefits for newly quaked individuals Sante: O8O. -soda Seam))' Options 2010." USA Inc. I Whal Might a TUffialCUM Expect Consklei? 283 Restructure Social Security: CBO's Policy Solutions to Reduce Social Security Future Deficits By 3) Raising Retirement Age / Lower Cost-of-Living Adjustment Policy Options To 70 Adjust Full Retirement Index to life expectancy Age To 68 Adjust Cost-of-living Reduce It by 0.5 Percentage Points 50% Base It on the Chained CPI for All Urban Consumers Adjustment' 33 Future Deficit Reduction (%) 50% 33 17 KP CB Notes: 1)Cosboardng Adusbnent (COLA): increases o/ Social Secunlys general benefit based on cost of *Mg. as currently measured by CPI for Urban Wage Earned and etched Workers (CPI-W). Source: C9O. Social Security Options 2010." USA Inc. I Whal Might a Turnateuml Expert Conselei? 284 EFTA01123383 Restructure Social Security: Policy Options From Report of the National Commission on Fiscal Responsibility and Reform Policy Options Future Social Security Deficit Reduction) Gradually reduce future benefit payments to high earners while increasing them for low earners by 2050 Gradually increase taxable maximum to 90% of covered earnings by 2050 Apply refined inflation measure (chained-CPI) to cost-of-living index Gradually increase retirement ages to 68 by 2050 / 69 by 2075 Other2 37% 35% 26% 21% Total Future Social Security Deficit Reduction 116W Note: 1) As % of the estimated present valued Sodal Secunty bus! fund cumutishVe data in future 75 years. 2) Mt! measures include boosting bane% to okfesf old retirees and calming newly tweed state and local *others arid 2020.3) total deficit reduction does not equal to the sum of indthdual reductions owing to poky interplay. Source; MOONY Commission on Fiscal Responsitaly and Reform. 'The Moment of Truax Report of the National Comnission on Fiscal Responsibay and Belo/m."124M. USA Inc. I Whal Might a Turnairnind Expert Consider? 265 Restructure Social Security: Declining USA Household Savings Rate Creates Challenge to Reducing Benefits as Americans are Under-Saving. Thus Limiting Financial Cushion Personal Savings Rate (%) Personal Savings Rate, 1965 — 2009 9% 1965 — 1985 Average 3% 2000s Average 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 Note Personal savings rale is calculated as the amount of savings dvided by dsposable income (income after faxes). Source; BEA. USA Inc. I Whal Might a Turnaround Expert Conoder? 266 EFTA01123384 5% Restructure Social Security: Especially High Unemployment Levels Also Create Challenge to Reducing Benefits USA Unemployment Rate, 1928 — 2010 YTD 25! 20% 1948-2010 Average Unemployment Rate 5.7% 0% 1928 1933 1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 2008 Sauce. 81.5. 2010 daia as oft W. USA Inc. I Whal Might a Turnalcond Even Conde? 267 Focus on I Expenses Reform= Entitlement Programs Focus on Operating Efficiency Restructure Social Security Restructure Medicare & Medicaid Review Federal Wages & Benefits Review Government Pension Plan Characteristics & Compare with Private Sector Plans j Review Role of Unions Review Government Cost Structure & Consider Reducing Federal Headcount Determine if There are Non-Core 'Business Lines' That Can Be Centralized / Locally Out-Sourced KP CB USA Ire. Whal Might a Turnalcond Expect Conde? 268 EFTA01123385 Restructure Medicare & Medicaid: Observations About America's Healthcare System 1) High Expenses — however measured, the costs are high: a) total dollars; b) share of GDP relative to other countries; c) cost relative to ability to pay (government, business, or individual), and 2) Inefficiencies — both the data and the insights of doctors, nurses, patients, and healthcare professionals identify opportunities for more efficient communication, data sharing and cost saving. K P CB USA Inc.l What Might a Turnaround Expert Consklei? 289 Restructure Medicare & Medicaid: Mathematical Challenge Related to Government Healthcare Programs Facing USA Inc. per CBO Forecasts Medicare & Medicaid Have Been Crowding Out Spending for Other Federal Programs and are Projected to Exceed All Federal Revenue by 2080E Federal Revenue & Medicare / Medicaid Spending as °/0 of GDP, 1965 - 2080E '5 25% ca ea C 'o 20% a 0, 10% ea O • 5% to CC 0% 1965 1975 1985 1995 2005 2015E 2025E 2035E 2045E 2055E 2065E 2075E Source: COO Long-Tenn Budget Outlook ationailve tiscoiscenakto. 640. USA ire. I What Might a Tumaieund Expert Cortsklei? 270 Federal Revenue as % of GDP (forecast based on historical trend line) Federal Spending on Medicare & Medicaid as % of GDP EFTA01123386 Restructure Medicare & Medicaid: Variables in Restructuring Medicare & Medicaid to Reduce Material Impact on USA Inc.'s Expenses Mathematical Illustrations* Slide 273-274 1) Medicare benefits — reduce them by 53% (or cap them)? or 2) Medicare tax rate — increase it by 4 percentage points? Policy Options Slide 275-328 1) Combination of mathematical illustrations — reduce benefits and/or increase taxes? and/or 2) Isolate and address the drivers of medical cost inflation? and 3) Improve efficiency / productivity of healthcare system? and 4) Reduce services for some Medicaid beneficiaries? and 5) Consider / implement CBO's 26 policy options that could reduce annual budget deficit by up to 38%?" and/or 6) Consider / Implement National Commission on Fiscal Responsibility and Reform's medium- and long-term policy options*** nil Note: 'Each mathematical dustamon would bind Medea.* Part A kilo long:tem (now) adaanal balance. Mere is no onalhemalicalaushatron for Meocaid or Medea& Part B S Das tweed no' edicated fuming. "See COO. 'Budge' Options. Vestune 1: HeeNh Care: 12200S.. —See. National Commission on Fiscal ResponsibiAly and Reform. td-Chairs'Praposar/1/10/10. USA Inc. l What Might a Turnaround Expert Cons:ger? 271 Restructure Medicare & Medicaid: Mathematical Illustrations* Mathematical Illustrations * 1) Medicare benefits — reduce / cap them? or 2) Medicare tax rate — increase it? Now. 'For mathematical iihrstrariona we sandyask-Ware how big a revenue increase AND/OR expense decrease each major entitlement program needs lo (Ma lanancug bteak-everr. These catchier:2ns we merely mechanical Dustman.), and are nor /Meld to portray malaria soh:boas. USA Inc. I What Might a Turnaround Expert Consdei? 272 EFTA01123387 Restructure Medicare & Medicaid: Mathematical Illustration #1 — Reduce Medicare Benefits* By 53% Sizing the problem: It would take massive (53%) benefit cuts to address the shortfall of Medicare' $6.000 funding $5.179 $5.000 13 u $4000 u 73 4) c $3,000 C 0 O. 0 IA on "a 2 o E 0 $2,000 > >, as $1,000 -53°, $2.434 90 I Note: Farmathernatica) rAnations. we simply calculate a revenue increase AND/ OR expense deureaseggninn9gent program needs fo reach Mandel break-even. These calculations are merely mechanical Variations and ate nor meant to porvay redist strtions. Source: Dept of Health B Hunan Services forecast a 2009 Annual Report oldie Boards 0/ Trustees of the Federal Hospital Insurance and Federal Supplementary Medal Inswance Dud Funds.' 509. Wee that data preserved here are limited to Medicare Pa A (Hospital Insurance) Trust Fund. llea)c.ste Pad B dada Ow ante) and Pad D (Prescription Orug Bene la)d!! plimaay funded via insurance premiums and general lax revenue frallSterS. Note also that data presented hale ate estimates Oar to PPACA (2009 healthcare reform). USA Inc. I mai might a TUM81“119 Expert Gonader? 273 Restructure Medicare & Medicaid: Mathematical Illustration #2 — Increase Medicare Tax Rate From 2.9% to 6.8% Sizing the problem: It would take massive (3.9 percentage points) payroll tax hikes on individual and a businesses to address the Medicare' funding shortfall Payroll Tax Rate (%) 7 6 5 4 3 2 1 0 2.9% +3.9 Percentage Points 6.8% 2009 20109Beyond Note: For malhernalical illustrations. we simply calculate how big a revenue Increase AND/OR expense decrease each major entitlement program needs to reach financial brvalveven. These calculations went* attar ittustrations and ate not meant to portray restos softens. Soutar: Dept. of Hest A Heenan Services forecast in 2009 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and Federal Supplementary Medal Insurance Trust Funds.' St79. 'Note rat data presented here ate ailed to Medicare Pan A (Hospital insurance) Trust Fund. Matta Part B (Medal w inurance) and Pail 0 (Presaption Drug Benefits) we primarily aided via insurance pentiums and general tax :cleave !Masts. Note also that data presented here are estimates pia to PPACA (2009 healthcare re town). USA Inc. I What Might a Tumaicund Expert Gonsdei? 274 EFTA01123388 Restructure Medicare & Medicaid: Policy Options Policy Options 1) Combination of mathematical solutions - reduce benefits and / or increase taxes? and/or 2) Isolate and address the drivers of rising healthcare costs? and 3) Improve efficiency / productivity of healthcare system? and 4) Reduce services for some Medicaid beneficiaries? and 5) Consider/ implement CBO's 26 policy options that could reduce annual budget deficit by up to 38%? and/or 6) Consider / Implement National Commission on Fiscal Responsibility and Reform's medium- and long-term policy options? USA Inc. I what Mighl a Turnaccund Expect Consitlet? 275 Restructure Medicare & Medicaid: Policy Option #1 Combination of mathematical solutions — reduce benefits and/or increase taxes? USA Inc. I what Might a Turnaccund Expert Consitlet? 276 EFTA01123389 Restructure Medicare & Medicaid: Combination of Reducing Benefits (Including Covered Lives) & / or Raising Taxes Consider: 1) Reduce Medicare benefits by 53%? and/or 2) Increase Medicare tax rate from 2.9% to 6.8%? and/or 3) Some combination of all / some the above However you look at it, this math is draconian. A 53% cut in Medicare benefits and / or more than doubling taxes are unrealistic. The situation for Medicaid is even worse. as Medicaid has no dedicated funding source. Neither Medicare nor Medicaid has yet fully faced up to the crisis and reform that Social Security experienced in the early 1980s. USA Ina. i What Might a Turnaieund Expmt Censelei? 277 Restructure Medicare & Medicaid: Policy Option #2 Isolate and address the drivers of rising healthcare costs USA Ina. i What Might a Turnaieund Expect Censelei? 278 EFTA01123390 Restructure Medicare & Medicaid: Isolate and Address the Key Drivers of Rising Healthcare Costs USA Total Healthcare Spending Has Risen Faster than Peers' (France. UK and Japan)* Total Healthcare Spending as % of GDP 1970 2007 I I KP CB 5% 5% 5% Note. Ranked toy tote hosiascare spencOng 2007: 1970 seroparable data not available for Genuses because of reunikralion. Source: OECD. U.S Degrease"! of Health & Muir. Services. Kaiser Sanely Founciabon. USA ire. I Weal Might a Turnaieund Expect Contxlei? 279 Restructure Medicare & Medicaid: Incentives Support Healthcare Cost Growth • Consumers demand healthcare services with less regard for the full economic impact as they pay only a fraction of the true cost out of pocket. • Healthcare service providers are generally rewarded for pushing more services through the system, largely with relatively less regard for cost effectiveness. Bottom line = Powerful forces encourage spending related to social / economic / legal issues throughout the healthcare system. Source: Doug Simpson. Allegan Surges ilea'escare Resew's-h. USA Ir. I Mal might a Tumatiaced Expert Con,dec? 280 EFTA01123391 Restructure Medicare & Medicaid: Social + Economic + Legal Factors Drive Incentives to Spend 1) Social — Growing + aging population (with related disproportionate spending on end-of-life care) and unhealthy lifestyles. 2) Economic— Healthcare service providers have financial incentives to perform more services and drive revenue while consumers often have little incentive to manage incremental cost. 3) Legal - Rising overhead from defensive medicine (to avoid lawsuits) and from regulatory compliance costs. Source. Morgan Stanley Healthcare ft ...h. USA ex. I WAN Might a Turnaround Expert Consider? 281 Restructure Medicare & Medicaid: Social Forces that Push Up Healthcare Spending 1) Growing and Aging Population 2) Unhealthy Lifestyles 3) Possible Solutions USA Inc. I Whal Might a Turnaround Expect Consider? 282 EFTA01123392 1) Growing and Aging Population 2) Unhealthy Lifestyles 3) Possible Solutions USA Inc. I Whal Might a Tomah:taxi Expert Gonsdei? 283 Restructure Medicare & Medicaid: Social Factors- USA is Aging...13% of Americans Over 65 Years Old, Up from 5% in 1930 Older Population (65+) as Percent of Total Population. 1930 1970 r 2010E Total Population 310MM Total Population 123MM 1$ of Elderly 6MM Total Population 203MM # of Elderly 20MM 1930 1970 2010E # of Elderly 40MM Soured US Census Bureau. USA Inc. I Whal Might a TUMati".119 Expect Contact? 28a EFTA01123393 Restructure Medicare & Medicaid: Social Factors— Older People Spend 2x More per Year on Healthcare than Younger Americans Share of Population vs. Healthcare Spending by Age Group, 2004 70% a, 50% C c • 40% • 0. 0 U co 30% .c 20% .0 10% 0 0% 25% 63% 53% 511 0-18 19-64 Ai Share of Population o Annual Healthcare Spending per Person 514.797 12% 34% 65+ 1 Share of Healthcare Spending $16.000 $14.000 tl * cn $12.000 ac 0. $10.000 6- .c $8.000 r3 $6.000 ex ex 54.000 Q. e) 52.000 itt $0 Source. Dem. of Health 6 Human Sorbets. US Census Bureau. USA Inc.I What Alight a Turnaround Expert Conseler? 285 Restructure Medicare & Medicaid: Social Factors- -28% of Annual Medicare Spending Geared Toward End-of-Life Care (Last 12 Months) 2008 Medicare Total Benefit Expense $363B Medicare Spending on Recipient's Final Year of Life $101B • People 65+ spent $14,797 per year on healthcare on average in 2004, 3x what working-age people (19-64) spend. • It's notable that -28% of average Medicare recipient spending occurs in the final year of life and 12% occurs in the final two months of life. Sources: CMS. Meese. Report lathe Congress: Medicare Payrnmk Porky. 3/10 USA Inc. Inc.I What Alight a Turnaround Expert Conseler? 286 EFTA01123394 I ) Growing and Aging Population 2) Unhealthy Lifestyles 3) Possible Solutions USA Inc. I What Might a Turnaround Expert Conselet? 287 Restructure Medicare & Medicaid: Social Factors- 32% of Americans Considered Obese in 2008, Up from 15% in 1990... USA Adult Obesity Levels by State. 1990. 1999. 2008 1990 10 aillimp 6 111a10.11ML' 4614-4 7811: Obesity-Related Diseases Diabetes Cancer Respiratory .' Heart Joint Diseases ... Obesity-Related Medical Costs $147 billion in 2008, up 2x from 1998 to 7% of Healthcare Cost 1999 ility ;NE 7 .11 VIII II I atiMS .11141t. • 2008 ailerati, Act iraSe 1111MWeir vtdr- ■ No Data ■ <10% • 10%-14% ■ 15%-19% ■ 20%-24%. 25%-29% ■ 230% KP E Note: An Wulf is fed obese / Am Body Mass Index (BMA is on., 30. Source: Centers tar Disease Casital Behavioral Risk Facia Surveillance System. 'Amalie:0S MAMA Ranksms. A cait I* Action be People and Theis Communities. 2009 Eonion'. USA no I What Might a %malacca Expert Sensate'? 288 EFTA01123395 Restructure Medicare & Medicaid: Social Factors— Rising Obesity Pushes Up Healthcare Cost • An estimated 7% of $2.1 trillion healthcare costs (including those linked to diabetes, cancer, heart / respiratory / joint diseases) were related to obesity in 2008. By comparison, that's more than all corporate income tax revenue that year. Note: Nearly NW of aa peop.,e the U.S. vele European ancesey carry a vanent d the 'Sense end obenly associaled (PTO) gene. vs. 25% ol U.S. Hispanics. 15% of Meow Ameficans and 15% ol ASWI Americans. per UCLA. Source: 'Annual AtecenelSpencLug AnAbolabie To away: Payee And Service-Speak Esfiesues.• Eric A. Fveke(slee. Anna G. Papaw. Jon. W. Cohen. and Wiliam am,. Heath Affairs . July 27. 2009. USA Inc. I Wnal Night a Turnateued Expert Conn.:let? 289 1) Growing and Aging Population 2) Unhealthy Lifestyles 3) Possible Solutions USA Inc. I Whal Alight a TIONSICUIld Expect Consitlet? 290 EFTA01123396 Restructure Medicare & Medicaid: Social Factors—Possible Solutions Boost Healthcare Education & Incentives to Drive Better Choices • Emphasize on disease prevention and wellness. - Education and information - Highlight health risk associated with certain behaviors and lifestyles - Financial incentives for healthy habits - Create social programs to champion healthy lifestyles and consumption - Subsidize healthy foods for lower income population • Discourage unhealthy behavior and consumption. - Penalize poor health choices (create new incentives based upon lessons learned from higher life insurance fees for smokers and car insurance fees for speeders) - Consider additional / new taxes on cigarettes, non-diet sodas, etc. SOurte: Afor9&) Slinky Heswta,e Rest...MA. USA Inc. I What Mien, a Tumateund Expel Cons:Set? 291 Restructure Medicare & Medicaid: Economic Forces that Push Up Healthcare Spending 1) Open access healthcare plans can increase access to care (via greater choices of care providers), but can also increase cost. 2) Consumers and providers are not always incentivized to constrain their healthcare costs. 3) Even when appropriate, poor information & lack of price transparency complicate comparison shopping for consumers. 4) Advances in medical technology drive demand and costs. USA Inc. I What Might a Turnateund Expect Conselet? 292 EFTA01123397 K P C Restructure Medicare & Medicaid: Economic Factors— Rise in Usage of "Open Access" Healthcare Plans Makes It Harder to Control Patient Choices...Subsequently. Cost of Care Increases Societal demand for less restrictive health insurance has driven a gradual switch to open access plans. These plans offer consumers greater choices of medical providers, but at higher costs. Share of Tightly Managed vs. Open Access Healthcare Plans in USA, 1988 - 2008 t00% °/0 of All Healthcare Plans 80% 60% 40% 20% 0% — Open Access (PPO + POS) — Tightly Managed (Conventional + HMO) — Other (HDHP) 1988 1996 2000 2002 2004 2006 2008 Hole: PPO is Preferred Provider Organization. which Mows entotkes le soled any dada/hospital Odle Humane.. ~Hasa network without going through a plmary tare physician. HMO is Health Maintenance Orpanizabon. WhiCh requires enrollees to cooniaaret# healthcare via a primary ease physician (a ramify doctor). POS is Porn! Or Service. Whialcontines the leans or an HMO and a PPO. HOHP is High-Deoloclible Health Ran a bon of catastrophic coverage with lower premiums and higher deductibles than a tradzional pia Source: KaisenHRET Survey of EmployesSponsored Health Benefits. f999-2009; AMC Survey or Employer•Sponsored Health Benefits. 1941 1996: The hkaithInsurance Association of America (HIM). 1988 USA Ire. I What Might a Tumatcund Expert Consdet? 293 Restructure Medicare & Medicaid: Economic Factors— Less Incentive for Consumers or Providers to Control Costs When Someone Else (Government / Taxpayers) Pays the Bills Out-of-Pocket Spending Accounted for Just 12% of Healthcare Spending in 2009, Down from 48% in 1960 50% c mc 40% o. O =, 30% 0 O 75 20% c E 10% ta 0% 48% Medicare Introduced 4% — Out of-Pocket Payments — Medicare + Medicaid Payments — - Out-of-Pocket Medical Payments as % of Disposable Income 7% 35% 12% 3% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Source: DepartMen? of !kalt 6 Human Services. Centers for Medkare 8 Medicaid Services. USA Inc I What Might a Tumaicond Expect Conde'? 294 EFTA01123398 Restructure Medicare & Medicaid: Economic Factors — Employer and Government Funding System Separates Consumers from True Costs of Healthcare • When one doesn't pay directly and gets an expensive good / service for free (or well below cost), one tends to consume more — it's basic supply and demand economics. • Count up the subsidies: - Medicaid: 47 million (24MM children / 12MM low-income adults / 7MM disabled / 4MM elderly) Americans (15% of population) each received $6,872 in taxpayer funds, on average, for healthcare in 2008 through Medicaid. That $6,872 equals -19% of annual per-capita income for Americans. - Medicare: 45 million elderly Americans (15% of population) averaged $7,991 per person for healthcare in 2008 ($4,875 for hospital care; $3,116 for medical insurance and prescription drugs). That equals -23% of annual per capita income. - Private Market: 157mm Americans with private health coverage (subsidized by employers) in 2008 paid just 16% of the total premium cost themselves for single coverage and 27% for family coverage. In effect, that represented tax- free "earnings" of $3,951 for singles or $9,256 for families (not including the tax savings on their personal premium contributions). Saone. Departmete of Heath6 Human Senates. Centers for MecCr-are B Medicaid Services. USA Inc.l What Might a Tumaicund Expert Constet? 295 Restructure Medicare & Medicaid: Economic Factors— Healthcare Providers Are Rewarded for Driving Revenue • While striving to provide the best care possible, healthcare providers tend to have financial / legal / societal incentives to provide more care, all else equal. • Reimbursement for providers is generally volume-based (e.g., more procedures generate more revenue for care providers), though there are efforts to increasingly focus on quality. • Unlike car buyers, for example, who often disregard a dealer's maxed-out model and choose only the features that are important to them and what they can afford, healthcare buyers tend to buy all the "features" as: 1) buyers (patients in this case) are typically not medical experts, so they defer to doctors / care providers for decisions; and 2) buyers only bear a small portion of the costs as someone else (employer or government) is paying for the features. USA Inc. Inc.l What Might a TUffialCUrld Expect Consalet? 296 EFTA01123399 Restructure Medicare & Medicaid: Economic Factors— Rising Healthcare Costs Disproportionately Borne by Employers and Individuals Over the last few decades, private payors (employer-sponsored health insurance plans) have consistently paid more than government payors (Medicare / Medicaid) and have, in effect, subsidized government reimbursement. 140% 130% 120% 0 Cu cc 110% UI O o 100% 90% O. 80% 70% 60% K P CB Healthcare Service Payment to Cost Ratio, 1990 - 2006 —Private Payor Medicare —Medicaid 1990 1992 1994 1996 1998 2000 2002 2004 2006 Saute: Avatie Health Analysis ol Amenicao Hosoital Association Annual Survey Ma. 2006. for comma* novae& USA Inc. I Waal Might a Taman:9nd Expert Consklei? 297 Restructure Medicare & Medicaid: Differential Payment Rates Can Create a Negative Cycle Leading to Erosion of Private Healthcare Coverage and Higher Entitlement Spending 5. Employers/ Consumers Drop Insurance Coverage 4. Higher Health Insurance Premiums 3. Higher Private Market Cost Trend 2. Cost Shifting onto the Private Market 6. Increasing Number of Uninsured 7. Increasing Use of Medicaid / Medicare 8. Government Reimbursement Pressure Rises 1. Providers Charge Higher Prices to 9. Government Lowers Private Market than to Reimbursement Rate to Government Market Providers : Doug Sunpson. Moigan Siwgey Healthcare ReStsrth. USA Inc.I Whal Might a Tumaicund Expel Consklei? 298 EFTA01123400 Restructure Medicare & Medicaid: Economic Factors— Reimbursement Reform Is Easier Said than Done Owing to Political Sensitivity... Percentage Contribution to Medicare Medical Cost Growth Rate by Spending Type, 2019E Nursing Home & Home Health All Other Rx Drugs Physician & Clinical Services [11 Hospital Care Key Issues: - Consumers understandably do not like constraints on their care location. - Doctors, nurses and hospitals are fulfilling a difficult task at the core of the healthcare delivery system. - Care providers are very important to local communities. - Local hospitals are large employers. - Many hospitals are struggling financially. Source: Data per CMS' National Heagh Expendaute database. Doug Surpson. Morgan Stanley Neonate Research. USA inc. I What Might a Tumaimand Expert Gonadal? 299 Restructure Medicare & Medicaid: Economic Factors— Healthcare Service Providers are Already "Underpaid" by Government USA Community Hospital Profit Margins & Inpatient Discharges by Payor Class 32% Profit margins by payor class (%), 2007 Percent of total inpatient discharges, by payor class (%), February 2009 36% Employer Sponsored Insurance Medicare Medicaid Self-Pay 4.5% 100% Total Profit margins from patients with employer sponsored insurance are sufficient to leave hospital industry with positive overall margin, despite being only 36% of inpatient discharges. Reimbursement cuts to Medicare and/or Medicaid would pose significant challenges, as hospitals already realize negative margins from those payor classes. Ml Soo ire. Avatere Health analysts of American Rosati's! Association Annual Survey data. 2007. lot community hospitals. Mogan Smolt/Healthcare Research. USA Inc.I What Might a Turnaround Evert Gonadal? 300 EFTA01123401 Restructure Medicare & Medicaid: Economic Factors— Poor Information & Lack of Price Transparency Make it Harder for Consumers to "Comparison Shop" Patients are at a healthcare information disadvantage in two respects': Lack of transparency: It's harder for consumers to compare prices of healthcare services from different healthcare providers than in other consumer markets given the complexity of healthcare market. With employer- / government-subsidized insurance, many patients are `locked in' with their insurance plans that do not incentivize "shopping around." Knowledge gap: Unlike other markets where consumers tend to use their own information and preferences, consumers depend more on the advice and guidance of physicians or other healthcare suppliers. Unlike other "merchandise," healthcare is literally of life-and-death importance to consumers, making risk aversion — and price insensitivity — higher. This price insensitivity is exacerbated because the consumer, in effect, gets it at a discounted price anyway. Source: 1)Accounring her Me cos! DIES healthcare. McKinsey Global Ins& rile USA Inc. I Weal Might a Turnaround Expert Consider? 301 Restructure Medicare & Medicaid: Economic Factors— Consumers Increasingly Demand Expensive Treatment and Are Able to Pay for it With Government Subsidies Total High-End Surgeries up 50x from 1970-2004, Driven by Medical Advancements + Consumer Ability to Spend Assisted by Government Payments # of Patients (Aged 50+) Undergoing Advanced Procedures in USA Typical Costs per Procedure ($) Coronary Procedures 1970 <20,000 2004 1.1 million $12,000 Angioplasty / Stent Implantation Pacemaker / ICD1 <10,000 350,000 $15.34,000 Bypass <10,000 220,000 $28,000 Dialysis Procedures <10,000 480,000 $24.72,000 per year Joint Replacement Procedures Hip <20,000 390,000 $12,500 Knee 440,000 $12,500 Note; ICA is Impiargarble Carceoverke OeTheftlot. Meth is tenger to a pacemaker bur for a heart rhythm that bears too lass. Cos! of ptoceduse approxinuded by Atectr-tee rerothumement USA Inc. I PALM Might a Turnaround Expert Consider? 302 EFTA01123402 Restructure Medicare & Medicaid: Economic Factors— Unconstrained Access to Medical Technology Increases Cost of Care... • Researchers generally agree that advances in medical technology have contributed to rising US Health Spending' • Medical technology affects the costs of care through several "mechanisms of action"2 New treatments for previously untreatable terminal conditions Major advances in clinical ability to treat previously untreatable acute conditions New procedures for discovering and treating secondary diseases New indications for a treatment over time Ongoing. incremental improvements in existing capabilities Major advances or the cumulative effect of incremental gains extending clinical practice to conditions once regarded beyond its boundaries • Very expensive, high-end medical procedures (such as dialysis and heart bypass) — which can easily cost as much as the average annual income of an American — are increasingly 60-70% subsidized by taxpayer dollars. Source: ) Wow Changes in Medcal Technalogy Aged Heatthcare COSIS.• Kaiser Family Foundation. March 2007. 2)Fachard A. Raging. 'ArecCcal Innovation Duets Cost Confarnment•Health Attain (Summer f994). USA inc. I What Might a Tumalaand Expert Conadel? 303 Opportunity for Two Mutually Reinforcing Cycles: Information + Incentives... • More widespread adoption of healthcare information technology, in particular clinical decision support software, should yield better information and provider decisions. Healthcare is at the cusp of leveraging decision-support technology after historically lagging other industries. Opportunity to develop best practices to improve patient care and outcomes and reduce medical errors and costs. More evidence-based care could help to narrow the variation in practice norms - The American Recovery and Reinvestment Act of 2009 provided approximately $19 billion for Medicare and Medicaid Health IT incentives. • Medpac summarizes the opportunities and issues succinctly. "Drivers of investment in IT include the promise of quality and efficiency gains. Barriers include the cost and complexity of IT implementation, which often necessitates significant work process and cultural changes. Certain characteristics of the health care market—including payment policies that reward volume rather than quality, and a fragmented delivery system—can also pose barriers to IT adoption." Source: Morgan Stanley Healthcare Research. USA Inc. I What Might a ?unwound Expert Canada'? 304 EFTA01123403 ...Opportunity for Two Mutually Reinforcing Cycles: Information + Incentives • Improving incentives for providers and consumers is also critical. Providers need appropriate incentives to improve quality of care and lower costs. Drivers include more widespread adoption of bundled payments and accountable care organizations. Tort reform could play an important role. Consumers need to take more responsibility for their own health and to utilize the healthcare system appropriately. Appropriate social and financial incentives are key. &turret Morgan Manley Harahan Research. USA Inc. I What Might a Tumaicund Expert Canada'? 305 Restructure Medicare & Medicaid: Economic Factors—Possible Solutions 1) Cost-Sharing and/or 2) Reimbursement Reform and/or 3) Improving Cost & Quality Transparency and/or 4) Deploy Cost-Benefit Analysis for Medical Technology Spending USA Inc. l What Might a Turnamund Expel Conde'? 306 EFTA01123404 Restructure Medicare & Medicaid: Economic Factors—Possible Solutions 1) Cost-Sharing • Cost-sharing can help control demand for a portion of healthcare by creating incentives for consumers to shop for most cost-effective treatments (although those benefits would be somewhat mitigated by the skew in health spending toward high users). • Once again, a Math Problem: Consider a routine physician office visit in which a provider suggests and / or patient requests various tests, procedures, etc. Patient #1 covered by a plan with a $20 co-pay (i.e., a flat fee regardless of the level or intensity of care performed during the visit) Patient #2 covered by a plan with a 10% co-insurance for in-network care (i.e., responsible for 10% of the aggregate billed charges) Clearly, patient #2 will become more sensitive to necessity and cost of care beyond a level of $200 of total healthcare services Note that deductibles drive similar dynamic as a co-pay: once the deductible is met, the member has little or no "skin in the game" Only 14-18% of employer-sponsored health insurance plans use pro-rata cost sharing (i.e. co-insurance in example #2 above). Most (77%) insurance plans only use a co-pay (in example #1), which gives consumers little incentive to shop the most cost-effective treatment path. Sowce: KaisenrilRET Survey& ErmalayepSponsmed Heath Benefits. 2009 USA Inc. I What Might a Tumaicund Expert Gonsklei? 307 Restructure Medicare & Medicaid: Economic Factors—Possible Solutions 2) Reimbursement Reform Reimbursement reform could help shift drivers of payment from quantity of care to quality of care. The following list provides a few options to consider. • Bundled Payments: Providers get a fixed budget to treat an episode of care (i.e. a broken hip). Exceeding the budget means providers absorb additional costs; staying under it lets provider benefit from savings. • Examples: PROMETHEUS Payment System', Medicare Acute Care Episode Demonstration2 • Global payment system3 (i.e., capitation): Providers are paid up-front to provide care that their patient receives over a period, incentivizing them to manage costs and quality. This global payment is adjusted periodically to reward accessible and high-quality care. • Pay for performance': Reimbursement for care providers varies, based on various quality and efficiency measures such as discharge rate and readmission rate. • Accountable Care Organizations (ACOs): Provider groups accept responsibility for the cost and quality of care for a specific population of patients5 • The recently enacted Patient Protection and Affordable Care Act includes regulations supporting the creation of Accountable Care Organizations • Other models often discussed to improve coordination / efficiency and reduce costs : 1) integrated delivery systems; 2) multispecialty group practices; 3) physician-hospital organizations; 4) independent practice associations; 5) virtual physician organizations Sowce: t) [prong Healamate Costs by Puffing Doctors coat:fudge?. Time I) Adopted in Rockford.) L Al Jan 2010 2) Almada,. Demonsfrakon Prefect Ovemaws. avncons.govAlernoptfecfs 3) Recommendacons of the Special Commission on the Healthcare Payment. Common-neon.) ol Massachusetts 4) Pay her Pettatmance Incentive Programs in Heatthcate. Geoffrey Baker 5) How the Genie, to A4edcate & Medr-aid Innovation Shoed Test Accounts?* Cate [1 • 1 Orpanuabons. Stephen Snorted. Lawrence P. Lasagna and MU S. Fisher to Health Affairs. Joy 2010 USA Inc. I What Might a Turnanomad Expert Gonadal? 308 EFTA01123405 Restructure Medicare & Medicaid: Economic Factors—Possible Solutions 3) Improving Cost & Quality Transparency • Improving cost and quality transparency of healthcare services could help doctors and patients make more informed decisions for each situation. • Though enhancing competition and price transparency in healthcare is not easy, new models for encouraging "comparison shopping" are emerging: • Castlight Health, a start-up financed by venture capitalists and the Cleveland Clinic, is working to build a search engine for healthcare prices2 • Other services beginning to publish price information: Thomson Reuters. Change: healthcare. and health insurers (e.g., the Aetna Navigator)2 A 2007 study by Deloitte proposes a "Price Transparency Checklist for States": • provide prices for services that matter to consumers • make it easy to understand • keep care providers, insurance & pharmaceutical companies engaged and informed • provide price and quality measures • keep expanding price transparency initiatives • maintain methodological rigor • promote access and use of price information • evaluate impact and ROI Source. I) The Mame la Medical Care. Why You Don) Know the Pelee Why You Dont Know about Ouffily: And What Can Be Done About lt. by Devon M. Herrick and John C. Goodman. Match M. 2007: 2) tinging Cornoanson Shopping to the Doctor's Office.' The New Yolk Tines. June 10. 2010: 3)Healtheare Price Transparency: A Shategic Peopeceve for Stale Government Leaders. by Debit* Center tor Health Solutions. 2007 USA Inc.1Whal Might a Turnaround Expert Consclei? 309 Restructure Medicare & Medicaid: Economic Factors—Possible Solutions 4) Deploy Cost-Benefit Analysis for Medical Technology Spending • Deploying cost-benefit analysis for medical technology spending can help ensure we are spending resources wisely. • Directly measuring the impact of new technology on total healthcare spending — and its true value — is very difficult' • The Kaiser Foundation outlines some of the more common policy suggestions for dealing with this driver of costs: Cost-effectiveness analysis (i.e., comparative effectiveness) Rationing (unlikely to be adopted owing to political sensitivity), regulation, budget-driven constraints (used by other countries but generally not popular in the U.S.) Market-based rationing (consumer-driven healthcare. pay-for- performance, information technology) Source. 1) •How Changes in Afectcal Technology Affect Healthcare Gods.' Kaiser Famig Foundation. March 2007. USA Inc.1Whal Might a Turnaround Expert Constlei? 310 EFTA01123406 Restructure Medicare & Medicaid: Legal Forces that Push Up Healthcare Spending 1) Defensive Medicine 2) Possible Solutions USA Ina.l Whal Might a TUrnalCUrld Expect Cons::lei? 311 Restructure Medicare & Medicaid: Legal Factors— "Defensive Medicine" Drives up Healthcare Spending • Defensive Medicine consists of procedures or tests that a doctor orders to avoid possible future malpractice lawsuits. • The practice is prevalent among US physicians and is contributing factor to healthcare spending. According to a survey of 824 physicians in 20051: • 93°A, said they had engaged in the practice of Defensive Medicine • 59°A, said they often ordered more diagnostic tests than medically necessary • 52°/O said they referred patients to other specialists in unnecessary circumstances • 33°A, said they often prescribed more medications than medically necessary Sousse. I) David Saidden. N al.. Arntvic-vn lifedeal Association. 'Defensive Me:60v Among HigIvRisli Speciakst Physfesans in a Volaide Malone). Envisonmens• 62001 USA inc. l Wham Night a Turnaletind Expert Constlei? 312 EFTA01123407 Restructure Medicare & Medicaid: Legal Factors—Possible Solution Tort Reform Could Reduce Incentives of Defensive Medicine Ways to control costs from tort litigation without jeopardizing patient health The CBO listed a package of tort reform proposals (10/09): • Cap of $250,000 on awards for noneconomic damages for malpractice • Cap on awards for punitive damages of $500,000 or twice the award for economic damages, whichever is greater • Modification of the "collateral source" rule to allow evidence of income from such sources as health and life insurance, workers' compensation, and automobile insurance and subtract it from jury awards • A statute of limitations — one year for adults and three years for children — from the date of discovery of an injury • Replacement of joint-and-several liability with fair-share rule: Defendants would be liable only for the percentage of a final award equal to their share of responsibility Source: Congressional Budget Office. Letter to the HonoraLt Orrin G. Hatch dazed Octobtv 9.2009: Congresssana, Budget Pace. Letter to the Nonacid* John D. Rockefeller IV dated Bewails& t0. 2009 USA Mc. I Whal Might a TUM81C4.11/d Expert Conitcleil 313 Restructure Medicare & Medicaid: Legal Factors—Possible Solution Tort Reform Could Save USA Inc. $54 Billion Over Next 10 Years • CBO estimates that a package of typical tort reform proposals could reduce total US health spending by 0.5% annually: - Direct savings: Roughly 0.2% of this reduction stems from lower national premiums for medical malpractice insurance. - Indirect savings: Another 0.3% stems from slightly lower utilization of services related to defensive medicine. • Over 10 years, CBO estimated tort reform could reduce net healthcare spending by $54 billion: • Spending for Medicare, Medicaid, Children's Health Insurance Program, and Federal Employees Health Benefits could fall -$41 billion over the next decade (with the greatest savings in Medicare). • Federal tax revenues could rise by -$13 billion as lower health insurance costs for employers could lead to higher take-home pay for employees and therefore higher income taxes for USA Inc. Source: Congressional Budget Once. Letter to the tionorabte Orrin G. Hatch dated October 9.2009: Congtessona Budge: Pace. Letter ro the Honorath1/4. John D. Roche/See IV dated December t0.2009 USA Inc. I Whal might a TUM8ICOIld Expert Consdei? 31 EFTA01123408 Restructure Medicare & Medicaid: Policy Option #3 Improve Efficiency / Productivity of Healthcare System USA Inc. I weal Might a TUffialCUM Expect Cons:Jet? 315 Restructure Medicare & Medicaid: Most Businesses are Performance- Based, Many Components of Healthcare System are Not USA Healthcare Outcome (based on Life Expectancy) Have Room For Improvement Relative to Other Countries Healthcare Spending per capita vs. Average Life Expectancy Among OECD Countries, 2007 E CO 0) } 85 Japan • • • t :5. 0,./....... • In 80 • ......• • S. Korea • • • • ft. • C ` ..... ../' • • i CO ...•••• C.) oO. x iu .....• ..... • ....., • UK — — Linear Trend line (ex. USA) USA 0 = 75 • —1 Mexico • 0 cn 2 • Hungary 0 > 70 0 1000 2000 3000 4000 5000 6000 7000 Total Expenditure on Health per capita, SUS (PPP Adj.) &wet OECD. USA ^c ei l m Might a Tumateund Expect Consklec? 316 EFTA01123409 Restructure Medicare & Medicaid: In Addition to Life Expectancy, USA Falls Behind OECD Averages in Many Other Health Indicators 2007 Health Indicators USA OECD Median USA Ranking (1 = Best, 30 = Worst) RED = Below Average Obesity of total population) 34 15 30 Infant Modality (per 1.000 live births) 7 4 27 Medical Resources Available (per 1.000 population) Total Hospital Beds 3 6 25 Practicing Physicians 2 3 22 Doctors' Consultations per Year 4 6 19 MRI Machines` (per million population) 26 9 1 Cause of Death (per 100.000 population) Heart Attack 216 178 22 Respiratory Diseases 60 45 21 Diabetes 20 12 20 Cancer 158 159 14 Stroke 33 45 8 Note: 7.4R1 is Magna& Resonance knaging. Source: OECD. USA Inc. I What Might a Turnaround Expert Consdei? 317 Restructure Medicare & Medicaid: Effectiveness Research Could Improve Efficiency (i.e., Outputs Track Inputs) • Comparative Effectiveness evaluates different options for treating a condition for a specific set of patients' Either relative benefits and risks of various treatment options (technology assessment, evidence-based medicine), or - Both clinical effectiveness and relative cost (cost-benefit analysis). • Without rigorous data about comparative effectiveness, according to the CBO: - Treatment decisions often depend on anecdotal evidence, conjecture, and the experience/judgment of involved physicians. Treatments and types of care vary widely from one area of the country to another. • To affect healthcare spending meaningfully, comparative effectiveness must alter doctor and patient behavior, potentially through reimbursement scheme changes, the CBO notes. • Note that by law, Medicare is effectively precluded from considering costs when making coverage decisions. Source: Research on He Corrawahve Effectiveness of Arfedr-ai Tteternents: A COO Pant December 2007. USA Inc. I What Might a Turnaround Expel Conskler? 318 EFTA01123410 Restructure Medicare & Medicaid: Policy Option #4 Reducing Optional Services + Optional Beneficiary Groups' Could Save Up to -60% of Annual Medicaid Cost, per Kaiser Family Foundation Note: 1)MerAcaSt is a Toady financed federal and staie program that provides health and Middertn care services fa SS minnow oroincome Americans. As a condition of participatingSs ArecCr-aid. stales ate required to cover certain 'mandatory populations and to provide a sodded set of Omaha. Statesatm have discretion to cover addlionallomincorne indvicluals in each of these categories notional droops? and ItCMt federal matchWgi payments Optional etiglIstly categories Mask children and parents. persons with disabOrties and the eh:terryabove mandatory coverage finds: persons residing Al mining facialies: and tie mec6caRy needy. Smote: Kaiser Family Foundation. 2005 USA Inc.1 What Might a Tumaicund Expert Consider? 319 Restructure Medicare & Medicaid: Policy Option # 4 — Reducing Optional Services + Beneficiary Groups' Could Save Up to 60% of Annual Medicaid Spending Medicaid Expenditures by Eligibility Group and Type of Service, 2001 Eliminating optional groups could save -42% of total Medicaid spending Mandatory Services' for Optional Groups Optional Services' tor Optional Groups Optional Services for ar, Mandatory Groups Eliminating optional services could save -30% of total Medicaid spending Mandatory Services for Mandatory Groups \ \It Federal-required mandatory services .! groups = -40% total spending Nam 1) Medicaid ajar ny financed (odes:and stoic peg, an yid? provides reach and to/spiel/nova services to 55 million broincome Americans. As a conoMon of paniapating in MerIcasid. states are required to cover certain Inanctaiory' poputadons and to provide a specified set of benefits. Slates dm have cOscrelion to cover millions lowMoorne ino1vidurds in each of these categories roptional groupetand receive federal matching payments. Optimal thVgitiay categories include chridren and parents. persons valh cOsatiOties and the &deny above rnandaray coverage Smits: persons residng kt nursing laciNdes: and the meolcally needy. Source: Keiser FanMy Foundalion 2005 USA Inc. I What Might a Tumaicund Expert Conde'? 320 EFTA01123411 Restructure Medicare & Medicaid: Examples of Medicaid's Mandatory Beneficiaries & Services Examples of Mandatory Beneficiaries • Children under age 6 with family annual income below $20,841 • Children age 6 or older with family annual income below $15,670 • Pregnant women with annual income below $12,382 • Elderly and disabled with annual income between below $6,768 (for an individual) Ml Examples of Mandatory Services • Physician services • Laboratory & x-ray services • Inpatient hospital services • Outpatient hospital services • Rural health clinic services • Certified pediatric and family nurse practitioner services • Early & periodic screening, diagnostic, and treatment (EPSDT) services for individuals under 21 Note: SuppkmentaySecunly Anton m and Federal Poverty Levees are 2005 leves. Source: Kaiser Fansly Famdafion. 2005. USA Inc. I Weal Might a Tumatcund Expert Conselet? 321 Restructure Medicare & Medicaid: Examples of Medicaid's Optional Beneficiaries & Services Examples of Optional Beneficiaries • Disabled and elderly with annual income between $7,082 (Supplementary Security Income, or SSI) and $9,310 (Federal Poverty Level, or FPL) • Nursing home residents with annual income between $7,082 (SSI) and $21,000 (3x SSI) • Pregnant women with annual income above $12,382 (>133% of FPL) • Children under 6 with annual family income above $20,841 Examples of Optional Services • Prescription drugs • Dental services • Rehabilitation and other therapies • Prosthetic devices, eyeglasses, durable medical equipment • Hospice services • Inpatient psychiatric hospital services for individuals under age 21 • Other specialist medical or remedial care Note: Supp'ementary Security Income and Federal Poverty Levels are 200510ves. Source: Kaiser Family Foundation. 2005. USA Inc. I Waal Might a Tumatcund Expert Conselet? 322 EFTA01123412 Restructure Medicare & Medicaid: Policy Option #5 Consider / Implement CBO's 26 policy options that could reduce annual budget deficit by up to 38% over the next 10 years USA Inc. I What Might a TUMIIICUM Expect Consider? 323 Restructure Medicare & Medicaid: CBO Policy Options— Regulate Private Health Insurance Market; Modify Tax Code; Modify Insurance Eligibility; Improve Efficiency Policy Options Require large employers to either pay government for providing insurance or offer employees basic insurance coverage Replace the income tax and payroll tax exclusion with a refundable credit Replace the income tax exclusion for employment•based health insurance with a deduction Reduce the tax exclusion for employment-based health insurance and the health insurance deduction for self-employed individuals Raise the age of eligibility for Medicare to 67 Gov. Future Deficit Reduction (%)' 0.7% 8.8% 8.0% 6.6% 1.2% Convert Medicare and Medicaid "Disproportionate Share Hospital Payments" into a block grant 1.2% Consolidate Medicare and Federal Medicaid payments for graduate medical education costs at teaching hospitals; set consolidated payment equal to: Adjusted IME3 payments using a 2.2% adjustment factor + DGMEI and Medicaid GME2 funding inflated by the CPI-Us minus 1 percentage point 0.8% 90% total mandatory GME2 funding inflated by the CPI-U minus 1 percentage point 0.4% Note. I) As % of Granulative Total Government Delta from 2010 to 2019 2) Graduate Medical Eduction 3) (tidied Medical Education 4)0irect Gradate ?deck& Education 5) Consume, pace index tot all wban consumers SNIT!: CEO USA Inc. I What Might a Tumatcend E *pert Conedet? 324 EFTA01123413 Restructure Medicare & Medicaid: CBO's Policy Options — Reduce Medicare / Medicaid Payments: Modify Premium and Cost-Sharing in Federal Health Programs Policy Options Gov. Future Deficit Reduction (%)' Reduce Medicare's payment rates across the board in high-spending areas 0.7% Remove or reduce the floor on Federal matching rates for Medicaid services Remove the floor on the federal medical assistance percentage 3.3% Reduce the floor on the federal medical assistance percentage to 45% 1.9% Reduce the taxes that states are allowed to levy on Medicaid providers 0.7% Increase the basic premium for Medicare Part B to 35% of the program's costs 3.2% Combine changes to Medicare's cost sharing with restrictions on Medigap policies? 1.1% Require a copayment for home health episodes covered by Medicare 0.7% Restrict Medigap coverage of Medicare's cost sharing 0.6% Introduce minimum out-of-pocket requirements under TRICARE for life 0.6% Nokt If As of Total Cum: ilatf.ee Go:omit-fit De/to/fon, 20W to 2019 2) intki.dlia' XI>Ci f .2.We pa,C.CS devrecl to cove: motto, Moe Mackneen eta-shawl requvemeas. source. COO USA Inc. I What Might a Tumatound Expert Consoler, ..2; Restructure Medicare & Medicaid: Policy Option #6 Consider / Implement National Commission on Fiscal Responsibility and Reform's medium- and long-term policy options USA Inc. I What Might a Turnaround Expert Conseler? 326 EFTA01123414 Restructure Medicare & Medicaid: Medium-Term Policy Options From the Report of the National Commission on Fiscal Responsibility and Reform Medium-Term Policy Options Deficit Reduction F2012-F2020E1 Convert the federal share of Medicaid payments for long-term care into a $89 billion capped allotment Reform Tricare for Life2 to increase cost sharing for Military retirees $55 Cut federal spending on graduate and indirect medical education $54 Reduce taxes that States may levy on Medicaid providers $49 Expand ACOs, payment bundling, and other payment reform $38 Accelerate phase-in of DSH payment cuts3, Medicare Advantage cuts and home health cuts in PPACA Other4 $37 $73 Total Deficit Reduction F2012-F2020E $395 billion Mole. Cost reductions are htacal Canvass« staff estimates based &I WO and ohs« somatae sautes. ATOM numbers were generated preMealthcare Worm and may differ significantly. 2) Theme lor Lik is a SuppleMenla y Military health insurance designed !a minimine Medieste-eGgiblerniNary retirees' our-a/pocket medical ~eases. 3)1TSH is the labbcare and llectcaid disproportionate share hospital payments for hospitals that receive chproporbonataly lame teradene and Reed:cad patients, 4)Other indirdes 'educe Meditaid adminisaative onus. increase nominal Medicaid copaya cut Medicare payments for bad Ø. inennite rost shaang for federal than 'Mimes and place dual-L.69MM inMvidoatskt Medeakt Managed Cam. Source: National Commission on Fiscal Responsibibb and Ream. -The Moment of Truth. Report of the National Commissftm on Fiscal Responothlty and Reform- 12/1110. USA Intl What Alight a Tumateunel Expert Consklet? 327 Restructure Medicare & Medicaid: Lona-Term Policy Options From the Report of the National Commission on Fiscal Responsibility and Reform • Set global target for total federal health expenditures after 2020 (Medicare, Medicaid, CHIP, exchange subsidies, employer health exclusion), and review costs every two years. Keep federal health expenditure growth to one percentage points above GDP growth. • If costs have grown faster than targets (on average of previous 5 years), require President to submit and Congress to consider reforms to lower spending, such as: Increase premiums (or further increase cost-sharing) Overhaul the fee-for-service system - Develop a premium support system for Medicare - Add a robust public option and/or all-payer system in the exchange - Further expand authority of the Independent Payment Advisory Board (IPAB)' Nore: SPAS is a ISsnember Mdependenr Payment Advisory Bond established under PPACA wm sigtvecant authority with respect to Stetare payment rates. &Viewing MOM. ,^ any yeann which the Medicare pee capita giG•rlh tare exreeded a target growth late the IPAB wank( be required to recommend ~bare spending reductions. The recomnendaians would become law anima Congress passed an allernative proposal that achieved the same Muer of budgetary savings. Source: National Commission on fleas! Responsel 1y and Reform 'The Moment of Than Report of the National Commission on Fiscal Response:nth. and Reform:12/1/10. USA Ire. I \Vhal Might a Turnaround Expert Consalet? 328 EFTA01123415 Focus on Expenses- Reform Entitlement Programs + Focus on Operating Efficiency 0 Focus on Expenses Reform Entitlement Programs Focus on Operating Efficiency Restructure Social Security Restructure Medicare & Medicaid Review Federal Wages & Benefits Review Government Pension Plan Characteristics & Compare with Private Sector Plans Review Role of Unions Review Government Cost Structure & Consider Reducing Federal Headcount Determine if There are Non-Core 'Business Lines' That Can Be Centralized / Locally Out-Sourced USA inc. I What Might a Turnaround Expert Conooler? 329 Start with the Basic High-Level Math — Review Government Cost Structure Government (federal + state + local, including military) spending per household has steadily risen to 82% of median post-tax household income, up from 51% in 1967. Federal spending (ex. entitlement + interest payments + one-time items) per household has remained flat since 1967, while entitlement + interest payments + one-time items spending per household rose 3x. Including federal, GSE, state and local (excluding military) employees, there is one public worker for every six households in the country. unchanged from 1967 or 1980 levels. No.. 'Real speolog accusted tor aMsbon. m 2005 doNars. Sow.: Census Bureau. Sue. of Ecronoen'c Analyse. USA Inc. What Might a Turnaround Expert Conooler? 330 EFTA01123416 Total Government (Federal + State + Local, including Military) Spending Has Risen to 82% of Median Household Income*, Up from 51% in 1967 Real USA Government Spending per Household and as Percent of Post-Tax Median Annual Household Income. 1967 - 2010 550.000 O .c 0 540.000 X a cn 530.000 C C 0 • 520.000 U 0 so 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 Real Government (Federal+State+Local) Spending per Household ($) —Government Spending per Household as % of Median Household Income (%) 100% 80% 60% 40% 20% 0% be oa 1 O 0 2 • 0 O ro C Co O r 0. c CO 03 E E C., Wore. *Post lax. Real spending &rusted for unlabon Luang SEAS GOP price index. in 200Sdollars. Data source: Census &flag Bureau*/ Econoink MO's& USA Inc. I What Might a Turnaround Eapen Consklei? 331 Federal (Including Military) Spending Has Risen to 65% of Median Household Income*, Up from 39% in 1967, Driven by Entitlement Spending + Interest Payments S40,000 .c 530.000 am 520.000 O. VI 12 $10,000 U- so so 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 Entitlement 1 Interest Payments / One-Time Real Federal Spending per Household Real Federal Spending per Household (ex. Entitlement / Interest Payments! One-Time Items) —Federal Spending per Household as % of Median Household Income (%) Real USA Federal Spending per Household and as Percent of Post-Tax Median Household Income, 1967 — 2010 111 70% g 0 60%- 0 at(' 50% 03 * 2 E 40% 0 0 C 0 = 30% 4,o. 0 cn c 20% vx a 10% To 0% Note: 'Post tar. Real spending accusled tor infraoon. rn 2005 darters. Costs source. IIINTe House Office of Management and Budget. Census &treat. Blotto of Economic Anays,e. USA Inc. I Whal Alight a Turnaround Erpen Corader? 332 EFTA01123417 Federal (Including Military) Spending Per Household = $29,043 in F2010 Federal Entitlement Spending Per Household = More Than Half ($16,670) F2010 USA Inc. Expenses = $3.5T Net Interest Discretionary Payment One-Time Items $196B Social $1528 Security $7078 Non-Defense Discretionary $4318 Defense $6948 Unemployment Insurance + Other Entitlements $5538 care + deral edicaid $724B F2010 USA Inc. Expenses Per Household = $29,043 Entitlements $16,670 Social Security $5.939 Medicare + Federal Medicaid $6,087 Unemployment Insurance + Other $4.644 Defense $5,828 Non-Defense Discretionary $3,619 Discretionary One-Time Items $1,277 Net Interest Payments $1,649 Wore. Abu-defense discretionary spa tag inctdes infrastructure. education. taw entocceraenf. etc Discretionary one-time items inchades TARP. ARM. and spenang on GSEs. Source: Wake House Office of Management and Budget. Census Bureau. Bureau of Econtwac Analysis. USA Inc. I What Might a Turnaround Expert Consider? 333 At a High Level. With Focus on Improving Operating Efficiency. USA Inc. Might Consider Ways to Do Things Like... • Consider empowering an independent / 3'd party auditor with expertise in government operations around the world / corporate turnarounds to conduct a broad-ranging audit of USA Inc.'s operations. • Restore strong rules for budget process: Require annual budget resolutions and reconciliation; PAYGO* to limit spending, enforce annual appropriations process consider biennial budgeting. • Consider giving the President 'line-item' veto / rescission authority. • Empower commissions analogous to the military base closing panels to review and consolidate government functions and agencies, as well as aid to State and local governments. • Seek flexibility to manage performance and terminate poor-performing Federal employees. • Develop flexible / long-term compensation plans including bonus payments for Federal employees when annual budget deficit reduction goals are met. • Privatize government real estate and other assets with little use, expanding on current efforts to trim $3 billion in government-owned real estate. • Identify additional opportunities to increase public/private investment, management and operations to drive innovation and investment in infrastructure Role: PAY GO is the practice of finanong expendluees with funds that are currently available ratan than borrowed. Source: KPCB zodiac:ten 8 Masai Pub Ceara Services. LLC. USA Inc. I What Might a Turnaround Expert Condor? 334 EFTA01123418 Focus on Expenses Reform Entitlement Programs Focus on Operating Efficiency Restructure Social Security Restructure Medicare & Medicaid Review Federal Wages & Benefits Review Government Pension Plan Characteristics & Compare with Private Sector Plans Review Role of Unions Review Government Cost Structure & Consider Reducing Federal Headcount Determine if There are Non-Core 'Business Lines' That Can Be Centralized / Locally Out-Sourced USA Inc. What Might a Turnaround Expert Consoler? 335 Review Wages: A Comprehensive / Independent Review of Federal Wages & Benefits System May Be Worthwhile • Analysis of existing data on federal wages & benefits is controversial. • USA Today and the Cato Institute examined simple averages of federal (excluding military) wages & benefits vs. private sector using Bureau of Economic Analysis (BEA) data and concluded that federal wages & benefits are -100% higher than private industry — wages are 58% higher while benefits are 3x higher.' (March 2010, updated in August 2010) • The White House Office of Management and Budget (OMB) and the U.S. Office of Personnel Management (OPM) responded that gross average comparisons are 'unfair and untrue.' And when one holds education and age constant, federal employees earn slightly less than those in the private sector on average, although the difference is not statistically significant.2 (March 2010) • The Heritage Foundation, in response to OPM and OMB's comments, released a statistical analysis based on BEA data, and claimed that adjusting for variables such as age, education, marital status, race, gender, size of the metropolitan area, and several others, federal wages & benefits are 31% higher than private industry for occupations in both government and private sector.3 (July 2010) Sou 1 Smelts EauChan USA Today. Federal V/orkers earnmp doubt Mee private caunteeparM 4 ft) Tad Derrayen. Federal Employees Continue to Prosper." lapoiammedak-at.feterty.orglederabernproyeepcontoue4mprosper.. 2) John Deny. -OPM Statement on Federal Employee Pay- Recent Compmisons of Federal Pay to Pointe Sector are Valet. and Untrue." htno.ArrAyopnipotopen_ federstenyabyeepay: Pelee Crazed. 'Salary Stalsiics:Mo.4.Yerwynnaenoose.poronebtop104310,Salmy-Staf rums. 3) James Sited. -Coopering Pay in the Federal Government and the Private Seder.' hitplAnwtheniagedresearchimports20101Catomparingparimax-tecloral-povernmenf- E and-thepayate.sector USA Inc. What Might a Turnaround Evert Conoder? 336 EFTA01123419 Review Wages: A Turnaround Expert Would Drill Down on Compensation Differences Between Public & Private Sectors • In the absence of reliable, generally accepted adjustment factors, USA Inc. needs a comprehensive Td-party review of its compensation practices. • Most businesses constantly review their compensation practices; these reviews typically intensify when the financials of the core business erode. • Considerations include compensation for comparable jobs, uniqueness of skill sets and education required for particular roles, productivity, hours worked, regional cost of living, job security, years of service, and financial health of the business unit. USA Inc. I What Might a Tamale...I Even Conaalei? 337 Focus on Expenses Reform Entitlement Programs Focus on Operating Efficiency Restructure Social Security Restructure Medicare & Medicaid Review Federal Wages & Benefits Review Government Pension Plan Characteristics & Compare with Private Sector Plans Review Role of Unions Review Government Cost Structure & Consider Reducing Federal Headcount Determine if There are Non-Core 'Business Lines' That Can Be Centralized / Locally Out-Sourced KP CB USA Inc. What Might a Tamale...I Even Gonad.? 338 EFTA01123420 Review Pension Plans: 70% of Federal Government Employees Still Enjoy "Guaranteed" Pensions, While Such Defined-Benefit Pension Plans Are Increasingly Rare in Private Sector (now at 32% vs. 84% in 1980) Employees with Guaranteed Pensions (% Participating in Defined Benefit Pensions) Federal Government vs. State & Local Government vs. Private Sector, 1980-2007 100/ 16pps % Employees w; Guaranteed Pension KP CB 80% 60% 40% 20% 0% - - State & Local Government —Federal Government —Private Sector 1980 1985 1990 1995 2000 2005 SNI(CeS. EOM Da f &oak on Empbyee Benefits. LISA Inc. I What Might a Turnatcend Expeet Genteel? 339 Review Pension Plans: Private Sector Has Embraced -Defined Contribution" Pension Plans. While Federal + State & Local Governments Lag Behind Participation Rate of Defined Contribution Program: Federal, State/Local vs. Private Sector, 1980-2007 O 60% C a. O S O 40% 0 2 IT a o. 20% 0% —Private Sector —Federal Government — - State /Local Government 0 1984 1989 1994 1999 2004 SOuttet: EBRI DalarbOOk an Erniobyee Bin as USA Inc. I What Might a Taman:end Expect Consklet? 340 EFTA01123421 Review Pension: Pension Plan Definitions / Characteristics • "Guaranteed" Pension Plan — Retirees receive predetermined monthly retirement benefits from employers despite the funding status / investment returns of their pension funds. Also known as defined benefit pension plan. • Defined Contribution Pension Plan — Retirees contribute specified amounts to their pension funds and receive variable monthly retirement benefits depending on investment returns. Examples include Individual Retirement Accounts (IRAs) and 401(k) plans. USA Inc. I What Might a Tantamad Even Gonad.? 341 0 Focus on Expenses Reform Entitlement Programs Focus on Operating Efficiency Restructure Social Security Restructure Medicare & Medicaid Review Federal Wages & Benefits Review Government Pension Plan Characteristics & Compare with Private Sector Plans Review Role of Unions Review Government Cost Structure & Consider Reducing Federal Headcount Determine if There are Non-Core 'Business Lines' That Can Be Centralized / Locally Out-Sourced KP CB USA Inc. I What Might a Tumataund Even Gonad.? 342 EFTA01123422 Review Unions: Government Employee Union Membership Rate = 5x of Private Sector Union Membership Rate & Rising • More government (federal / state / local) employees belong to unions (8 million) than did private sector employees (7 million) in 2009. • Government employee union membership rate of 37% is 5x higher than private sector employee union membership rate of 7% in 2009. • Private sector union membership rate declined 180 basis points to 7% in 2009 from 9% in 2000, while government employee union membership rate rose 50 basis points 37.4% in 2009 from 36.9% in 2000. Sane: Bureau of Leber Seinen. USA Inc. I Waal Might a Turnanund Expert Gonstlei? 343 Review Unions: Union Membership Rates by Industry — Government = 37% Unionized vs. Private Sector's 2-22% Union Membership Rates by Industry. 2000 - 2009 2009 Union Members (000) Union Membership Rate (%) 40% 30% 20% 10% 0% —Government 8,407 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Transportation & Utilities 1,043 —Construction 826 Manufacturing 1,257 Information 275 Mining 58 Education & Health 1,664 Wholesale & Retail 1.056 Leisure 403 Other 154 Business Services 379 Finance 138 Sown: Berne of Lebo, Smasees. USA Inc.I Whal Might a Turnaround Expert Gonstlei? 344 EFTA01123423 Focus on Expenses Reform Entitlement Programs Focus on Operating Efficiency Ml Restructure Social Security Restructure Medicare & Medicaid Review Federal Wages & Benefits J Review Government Pension Plan Characteristics & Compare with Private Sector Plans Review Role of Unions Review Government Cost Structure & Consider Reducing Federal Headcount Determine if There are Non-Core 'Business Lines' That Can Be Centralized / Locally Out-Sourced USA Inc. Whal Might a Temafound Even Conanlei? 345 Consider Reducing Federal Headcount Federal government headcount (ex. military) grew by 56,000 (or 2%) in 2008 and another 107,000 (or 3%) in 2009, while private sector unemployment rose to 10% from 5% in 2007 and private sector headcount fell 1% in 2008 and 6% in 2009. . Source: Census Bureau. Bureau of Economic Analysis. USA Ire. What Might a Tumaiound Expert Contdei? 346 EFTA01123424 Federal Headcount Has Risen Over Past Five Years and Is Above Trendline Level Federal Civilian Headcount & Share of Total Employment, 1988 - 2009 a 2,500 2,000 Federal % Federal Share Civilian Civilian of Total Full Employment Headcount -Time Equivalent Linear (right Employees axis) Trendline 2.5% 2.0% — — 1,500 1.5% W -300K § Potential Headcount 1,000 Reduction 1.0% U. C 2 0.5% 1 0S% 0 rkikt 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 % of Total Employment Data source: BEA (1989-2009). USA Inc. I What Might a TUM31“111:1 Exam! Conadei? 347 Reduce Headcount: Mathematical Illustration on Reducing Federal Headcount — Could Save Up to $275 Billion Over Next 10 Years, or 4% of Total Deficit Scenario Analysis on Potential Federal Headcount Reduction & Impact on Budget Deficits Savings ($B) For USA Inc. Over Headcount Reduction F2009 F2010-19E F2010.85E (000) Scenario 1 -- Trim Headcount by 1% $2 $17 $44 20 % of Budget Deficits 0% 0% 0% Scenario 2 -- Trim Headcount by 50/0 $11 $91 $219 98 % of Budget Deficits 1% 1% 1% Scenario 3 -- Trim Headcount by 10% $23 $183 $439 195 % of Budget Deficits 2% 3% 3% Scenario 4 - Trendline" -- Trim Headcount by 15% $34 $274 $658 293 % of Budget Deficits 2% 4% 4% [al Mate: Bedevil! Lust year ends in September. 'Based on 20.year:tendert.. federal elvalsn headcount woad have ben* 15% below actual levels. USA Int.I Whal Might a Tumatcund Expect Consalet? 348 EFTA01123425 0 Focus on Expenses Reform Entitlement Programs Focus on Operating Efficiency Restructure Social Security Restructure Medicare & Medicaid Review Federal Wages & Benefits Review Government Pension Plan Characteristics & Compare with Private Sector Plans Review Role of Unions Review Government Cost Structure & Consider Reducing Federal Headcount Determine if There are Non-Core 'Business Lines' That Can Be Centralized / Locally Out-Sourced USA Inc. I What Might a Turnamund Even Con44el? 349 Local Outsourcing/Consolidation: Improve Efficiency of Public Services Through Automation / Scale / Flexibility 1. Automation — Government agencies cannot afford to perform manual routine-based processes that can be replaced more efficiently by technology. 2. Scale — Consolidation of non-core processes across agencies or outsource non-core processes to local companies can deliver scale efficiencies. 3. Flexibility - Outsourced labor enables temporary employment in situations where hiring full-time workers would be costly and unnecessary. Sources: lidera Frisch Sloven Stanley Research. USA Inc. I What Might a Turnaround Expen Cond.? 350 EFTA01123426 Local Outsourcing/Consolidation: Proven to Be Viable Cost-Cutting Measures for State / Local Governments Automation a) C C) Cl) Years Public Sector Details 2002-2010 1993-2010 Missouri State Government Port Authority of New York and New Jersey Digitized State Medicaid health record E-ZPass (electronic toll collection) can process 2.5x to 3x more vehicles per lane than toll attendants Total Cost Saving (5) As % of Total Budget' As % of Program Budget' -87MM 2003 2002-2004 2004-2005 2010 Maywood, CA Pennsylvania State Government Dept. Management Services, FL Health and Human Services Commission. TX Consolidated office supplies + computer procurement Oulsourced HR and supporting IT system to local contractors Outsourced HR. payroll and enterprise service center to private vendors Outsourced police force to county sheriff In an effort to avoid bankruptcy -530MM - - -173MM 0.3% 11.5% —16 0.8% 5.0% —3.7M/di 25% 50.7% 15 _ 2005 LL Note. V MnaP Budget of die year 'then outsourcing program started Sources: KR Oulsourniv M Government Organizations. The Conference Board. Outsourcing Whorls Case Sallies. 2009: Maywood CA data per The Economist. PA state government data pee Ed Sanded. Governor of Pennsylvania )E-ZPass per E- MI Z ss New Jersey Customer Sente Censer. Missouri Meckaid case study per ACS: Americas Red Cross per ?Talons. Government Serra CulsourcIng. USA Inc. 11Vhal Might a Tumaicund Expert Cont.:lei? 351 American Red Cross Sat up a Family Assistance Hotline within 10 days via an outsourcer (vs. 3-6 months doing It In-house) Focus on Operating Efficiency - Policy Options From National Commission on Fiscal Responsibility and Reform Co-Chairs' Proposal USA Inc. 11Vhal Might a Tomah:tine Even Contdet? 352 EFTA01123427 Focus on Operating Efficiency: Illustrative Policy Options From the Report of the National Commission on Fiscal Responsibility and Reform Illustrative Policy Options Deficit Reduction in F2015E Eliminate 250,000 non-defense service and staff augmentee contractors $18 billion $16 Freeze federal salaries, bonuses, and other compensation at non- $15 Defense agencies for three years Eliminate all earmarks' Cut the federal workforce by 10% (2-for-3 replacement rate) Create a Cut-and-Invest Committee charged with trimming waste and targeting investment Slow the growth of foreign aid Other2 $13 $11 $5 $22 Total Deficit Reduction F2015E $100 billion /NOW nan eannath is a *lithe*. (eaPedideurn8mddibruMPAdvision that aim% *Proved funds to be spent an specific fl ied& of that &acts specific exemptions Mani taxes o 'mandated lees. 2) Gther includes eSminste NASA among Mr commercial spacetSght. fenninate lomptionly Army Corps of Eyelets ptomains. seN excess federal properly. reduce congressional & MiteMuse budgetsby 15%. reduce unnecessary pthating costs and more. Scamp. National 1M:0 Commission on Thai FlesponsibiAry and Reform. —The Moment of Truth: Report oldie National Commission on Fiscal ResponsibiMy aid Reform- 12/1/10. USA Inc. I Waal Might a Turnaround Esperl Consoler? 353 ra -.1 What Might a Turnaround Expert Consider? 0 Focus on Expenses Reform Entitlement Programs Focus on Operating Efficiency O Focus on Revenues Drive Sustainable Economic mil Growth Consider mil Changing Tax Policies L 1-J USA Inc. I Mal Might a Turnaround Expert Consoler? 354 EFTA01123428 Real Federal Receipts WV (%) Focus on Revenues — Drive Sustainable Economic Growth + Change Tax Policies Focus on g Revenues Drive Sustainable Economic Growth Consider Changing Tax Policies Invest in Technology / Infrastructure / Education Increase / Improve Employment Improve Competitiveness Review Tax Rates Reduce Subsidies / Tax Expenditures"/ Broaden Tax Base Note: 'Tax subsides / expencrautes &abases lo the U.S. Treasury !rampant -Jag certain decktcsals. exempions. u, credts IssrA as those an mortgage fl ares! payments and enployenponsoted health insurance payments) to specific categories of taxpayels. USA Inc. I What Might a Taman:rind Expert Consdei? 355 GDP Growth Biggest Driver of Federal Revenue Growth...& 85% Correlation 1940 - 2009 Historical Correlation Between USA Real GDP Y/Y & Real Federal Receipts Y/Y = 85% • Real GDP Y/Y vs. Real Federal Receipts YN — - Linear Trendline (y=2.77x-0.0438, RA2=0.73) / • • / • / • • 60% 40% 20% • • • ••., • ••••°2". • ,7 •• • lb% 0 • • .5% • ifba S • 5% '• • ". • • -20% • • • 10% 15% 20% Real GDP YN (%) 25% 2010E If Real GDP WY is — 2019E Real Federal Revenue Could Grow... 5% 7% 4 5 3 2 2 0 1 -2 0 -4 -1 -7 -2 -9 -3 -11 4 -13 -5 -16 Current Consensus GDP Forecasts Data source: While House Cate& managamera & Budget 0940 - 2009). USA Inc. I What Might a Taman:pea Expert Conscler? 356 EFTA01123429 It's Easy to Gripe About USA Inc.'s High Expense Levels... That Said, High Expenses Could be Covered by High Revenue • There are two primary drivers of USA Inc.'s revenue: 1) GDP growth and 2) related tax levies on consumers and businesses. • To bring its income statement mechanically to break-even for 2009 (excluding one- time charges), USA Inc. would have needed to raise individual income tax rates by -2x across-the-board to an average of -26-30% (from -13%) of gross income.1 This certainly seems draconian. And a tax increase of this nature would surely have a significant negative impact on USA's GDP growth as consumers would have far less disposable income to buy goods and services. • This brings us to a key element of USA's financial challenges — the need to drive economic (GDP) AND related job growth. This is not easy. A material portion of GDP growth over the past few decades was driven by rising consumption aided by rising leverage and we have now entered a period of de-leveraging. • Stronger economic growth would be hugely beneficial for USA Inc.'s revenues. But the legacy of the financial crisis — severe housing imbalances and the need to complete the long process of writing off private mortgage debt — means that the US recovery will probably remain slow for at least several years. The silver lining: A booming global economy should provide a modest lift to US growth. Note: l)USA kw_ a F2009 revenue shoalaN was .59978 (excite:Ong onetime discretionary spending stems). F2009lotal income tax receipts horn incevicluais were S9 ISO. As a result. if one were to raise inchtedualincorne lac rates alone lo achieve finatioalbreaak even. one would have to more than double inotvidual income fax cafes across•rhetomd. USA Inc. I Whal Might a Turnaround Expert Conde? 357 Drive Growth: If Real GDP Grows 0.1 Percentage Point Faster Than Current CBO Projection For F2011-F2020E, the Budget Deficit Could Shrink by 5% Without Other Policy Changes • CBO analysis shows that for every 0.1 percentage point (pps) increase in real GDP annual growth rate above CBO's baseline estimate for F2011-F2020E, USA Inc.'s revenue (driven by taxes) could be $247 billion higher, spending could be $41 billion lower (driven by reduced welfare spending) and the budget deficit could be reduced by $288 billion, or 5%. F2011-F2020E Impact on USA Inc.'s — N CBO's baseline assumption for annual real GDP growth 2.1% F2011E 4.4% F2012-14E 2.4% F2015-20E What if real GOP grows faster than CBO's forecast by... 0.1 pps 0.5 pps 1 pps 2 pps Revenue ($B / %) +$247 +1% +$1,235 +3% +$2,470 +6% +$4,940 +13% Spending ($B / %) -$41 -$205 -$410 -1% -$820 -2% I Deficit Reduction ($8 / %) -$288 -5% -$1,440 -23% -$2,880 -46% -$5,760 -92% Note; pps is Pet etyllel9e Podal(s). $ amount and % chaps in revenue/ spentang/ clerk!, are over the entire F201 f -F2020E period Source: WO. 'Me Budget and Emhart Outlook: Fiscal Years 2010to 2020.' &TO. USA Inc. Inc.I Whal Might a Turnaround Expect Conskier? 358 EFTA01123430 How Much Would Real GDP Need to Grow to Drive USA Inc. to Break-Even Without Policy Changes? 6-7% in F2012E-F2014E & 4-5% in F2015- F2020E...Well Above 40-Year Average of 3% CBO's Baseline Real GDP Growth vs. Required Real GDP Growth for a Balanced Budget Between F2011E and F2020E 8% Real GDP YrY Growth (%) 6% 4% 2% 0% -2% .4% 200.1 2011E 2013E 2015E 2017E 2019E Real GDP Annual Growth (CBO Baseline Forecast) —Real GDP Annual Growth Needed to Eliminate Fiscal Deficit — 1970-2009 Average Real GDP Growth Source: C8O. The Budges and Economic Outlook: Fiscal Years 201010 2020.'100. USA Inc. What Might a Turnaround Expert Consider? 359 It's Highly Unlikely That Annual Real GDP Can Grow Faster Than 6%... It Happened Only 8 Times in Past 60 Years and Was Always Linked to a Cyclical Bounce Back 2 CBO's Baseline Real Annual GDP Growth vs. Required Real Annual GDP Growth for a Balanced Budget Between F2011E and F2020E in Historical Context (1950-2020E) 10% 8% 6% 4% a. 2% -2% -4% 1950 1960 1970 1980 1990 2000 2010E 2020E —Real GDP Mnual Growth (Historical) Real GDP Mnual Growth (CBO's Baseline Forecast) - - Real GDP Mnual Growth Needed to Eliminate Fiscal Deficit Source. C8O. The Budge! and Econome Ourtook. Fiscal Years 2010 to 2020.'840. USA Inc. I What Might a Turnaround Expert consdei? 380 EFTA01123431 USA Consumers = Biggest Demand Driver For GDP Growth. Until 2007 Personal Consumption's Contribution to Real GDP Growth, 1950 - 2009 Real GDP WY Growth (%) Ml -2% • Real GDP 11..Y Growth Personal Consumption Expenditure's Contribution to Real GDP Growth -4% 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 Source:BEA. USA Inc. I What Might a Tumaicund Expert Consdei? 361 Beginning in 2007. Wealth Destruction + High Unemployment Forced Consumers to Save Again. Potentially Reducing Short-Term Demand for Goods & Services 3% average annual GDP growth (1981 - 2007) was helped as the average USA consumer: 1) Increased personal consumption as percent of GDP to 71% from 62%; 2) Decreased personal savings rate to 2% of disposable income from 11%; Beginning in 2007, things changed as: 1) The average US consumer experienced a material decline in the value of his / her largest investment assets (real estate and equities) from 2007 to 2009 when peak-to-trough valuations for USA residential real estate declined 30% and the S&P 500 declined 56%; 2) Unemployment rose to 10% in 2009 / 2010 from 30-year trough of 4% in 1999, creating uncertainty regarding future personal income levels; 3) Personal savings rate increased to 6% in 2009 / 2010 of disposable income from 2% in 2007, as uncertainty grows and appetite for consumption ebbs; All in, the key driver of US GDP growth — the US consumer's ability to spend — is severely constrained in the short term as he / she aims to rebuild savings and contain spending. This raises the question —'How fast can US GDP grow annually over the next ten years?' Determining ways to drive GDP (and related job growth) is crucial... Source. Res.derVta: red' elide decii”e based on C01.07 to C01.09 changes St SSP Cthe.Shillee Home Price Index. GOP growth 6 composition/ personal savings rale per BEA. Unerrptyment sale per BLS. USA Inc. I What Might a Turnaround Expert Consider? 362 EFTA01123432 Economic Policy—Short-Term vs. Long-Term KP B • Economic theory + experience of the Great Depression suggest government can use fiscal policy (increase direct spending + investment) to offset near-term shortfalls in private demand. • In the long term, USA Inc. cannot sustain higher levels of direct spending / investment without crowding out private consumption / investment. • Therefore, USA Inc. should prioritize and allocate available resources to stimulate growth in productivity + employment. which drive long-term GDP growth. USA Inc. I What Alight a Turnaround Expect Gonnelei? 383 Improving Employment. Productivity. & Hours Worked Are Source of Sustainable Long-Term GDP Growth USA Long-Term GDP Growth' (1970-2009) 2.83% Productivity Growth 1.53% DRIVEN BY: Technology Infrastructure Education (Labor Quality) Other (Total Factor Productivit!!„i ) employment Growth 1.53% DRIVEN BY: Unemployment Rate Labor Force Growth Hours Worked Per Worker -0.22% Has Been Consistent At ^39-40 Hours per Week Note. I) s0 growth numbers are rounded average annual 91.O119mb and are asNumed tor 'Maroon. 2.83nr a tne menage annual GDP growth late nom 1970 to 2009. per BEA. Labor force growth of 1.53% is the average annual growth rate from 1970 le 200. pee BLS. Hours workerg per worker per OECD. Prod./Hey gra.4hol I.53% is calculated by subhadang emplopnenf womb end hours workedpex mocker Now" horn real GDP growth Average Annual growth rate el 1.53% is roughly re, Nne with 00101 estimates lethal Dale W. Jorgenson. Mon S. Ho. Kevin J. SOYA 'Growth of U.S. Induslhes and lnvesbnentsln Mformallen Teohnorbgy and Hight r Education' elabW/rnmonber.orgthapfersre10627. USA Inc. I What Might a Tomaicund Expmt Consider? 364 EFTA01123433 Focus on Productivity & Employment Growth, Each of Which Accounts for -50% of Long-Term Real GDP Growth • Investments in Technology / Infrastructure / Education Boost Productivity. Newer technology improves efficiency of communication and lowers costs of providing goods and services. - Better infrastructure reduces transportation costs for input and output materials - Better education improves general labor quality and enables specialization for more efficiency. • Removing Restrictions / Uncertainties in Various Regulations Can Stimulate Private Employment. - Immigration does not reduce employment opportunities for US-born workers, per Federal Reserve study in 8/10. Removing tax / regulatory uncertainty could help create hiring incentives for private industries. • Hours Worked per Worker Have Remained Steady at -39-40 Hours per Week From 1970 to 2009 and Will Likely Remain Steady. Source. OECD. Dace W Jorgtvuon, Men S. Ho. Kevin J. Duo& 'Graver a U.S. Induaties and Investhears in .Inlormarion Techeology and fisgher Educator,* frgolitymv.nlxv.orpthapferat10627. Federal Reserve. USA inc. I What Might a Turnaround Expert Cont.der? 365 Focus on Revenues Drive Sustainable Economic Growth Consider Changing Tax Policies Invest in Technology Infrastructure Education Increase Improve Employment Improve Competitiveness Review Tax Rates Reduce Subsidies Tax Expenditures"/ Broaden Tax Base KP CB USA Ix. I Whal Might a Tomah:toe Expert Conselei? 366 EFTA01123434 Technology + Infrastructure + Education Investments Drove -90% of Labor Productivity Growth for Past -30 Years Sources of USA Average Labor Productivity Growth, 1977-2000 Average Annual Growth Rate (%) 2.5% 2.0% 2.21% Annual Productivity Growth ■ Technology Investment 1.5% 1.13% 1.28% ■ Infrastructure & Other Investment 1.0% 4 Education (Labor Quality) 0.5% Other (Total Factor Productivity) 0.0% -0.5% 1977-1990 1990-1995 1995-2000 Note: TorolFacioa Productivity is roe poroon of output not explained by the amount of inputs used in production. Source: Oak W Jorgenson. Man S. Ho. Kevin J. &von. Cronin of U.S. Industries and Investments in rolormatron Technobgy and »ghee Education'snop.//www.Ma.orgthaplastc10627a USA Ire. I Whal Might a Turnaround Expert Consider? 387 However, USA Inc. Has Increasingly Allocated Resources Away from Productive Technology + Infrastructure + Education Investment /Spending Toward Less-Productive Entitlement Program Spending % Share of Total Federal Spending 100.0 80% 60% 40% 20% 0% 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 USA Real Federal Productive vs. Less-Productive Spending', 1970-2009 U Productive (Investment Spending on Defense. Education. Infrastructure. Technology...) K Less-Productive (Spending on Entitlement and Interest Payments) NO, e. of eAc.Udv crz•'eoeae:n as TARP , GSE • ARRA) tor F2008 / P2009 data. Data source. White House Office &Management et Budget (19704009). USA Inc.l %Vital Might a Turnaround Expert Consider? 388 EFTA01123435 Drive Growth: Technology Technology Improves Efficiency of Communication and Lowers Costs of Providing Goods and Services USA Inc. I What Might a Turnateund Expert Contelet? 369 Technology Has Driven Significant Wealth & Job Creation S&P 500 Sector Market Value Share, 1995 — 2010 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Information Technology 9% 12% 12% 18% 29% 21% 18% 14% 18% 16% 15% 15% 17% 15% 20% 19% Financials 13 15 17 15 13 17 18 20 21 21 21 22 18 13 15 16 Consumer Staples 13 13 12 11 7 8 8 9 11 10 9 9 10 13 12 12 Health Care 11 10 11 12 9 14 14 15 13 13 13 12 12 15 12 11 Energy 9 9 8 6 6 7 6 6 6 7 9 10 13 13 11 11 Industrials 13 13 12 10 10 11 11 12 11 12 11 11 12 11 10 10 Consumer Discretionary 13 12 12 13 13 10 13 13 11 12 11 11 8 8 10 10 Utilities 5 4 3 3 2 4 3 3 3 3 3 4 4 4 4 4 Materials 6 6 4 3 3 2 3 3 3 3 3 3 3 3 3 4 Telecom Services 9 7 7 8 8 5 5 4 3 3 3 4 4 4 3 3 SSP 500 Mkt Cap (ST) $5 $6 $8 $10 812 $12 $10 88 $10 $11 $11 813 $13 $8 $10 $11 Note: 2010 data as of 12e31/10. Soule& FactSel. Bloomberg. USA Inc.I What Might a Turnaround Expect Conskier? 370 EFTA01123436 But USA Inc. Has Steadily Scaled Back Investment in Technology Since the 1960s...the Good News is That Private Industry Has Picked Up Lots of Slack. So Far Total USA Technology Research & Development Spending as % of GDP by Funding Source, 1953 — 2008 3% a. aa c • 2% V 0. U) 5 0 0% 1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 ▪ Other (Non•Profit /University / Other Government) m- Private Industry • Federal Government Soome: Alabona) Science Foundation. Science and Engineering Imliealms. 2008. USA Inc. Waal Might a Turnaround Expert Consiler? 371 For GDP Growth & Job Creation, It's Key for Private Industry to Remain Incentivized to Invest in As we contemplate our future, we must accept the fact that many of the assumptions under which business operated for the past 50 years no longer hold true...lf we are committed to investing in ideas to improve - not just maintain - what we have and what we know, the United States will do more than just recover from this recession. We will emerge, once again, as a competitive, global powerhouse...Innovation...accrues to countries in proportion to the quality and rigor of their educational systems... The future of every nation will be shaped by new ideas and creativity. These are the engines of future prosperity. — Paul Otellini, CEO, Intel Corporation, 2/10/09 Government targeted and 'blue sky' investment in technology (and defense) has led to crucial technology inventions for America — such as ARPANET / Internet (1970s) and Global Positioning System (1980s)..., which, on a net basis, have created jobs, wealth and related tax revenue. Government investment in technology remains important, but, perhaps more important, government must help incentivize private industry (via tax policies such as allowing companies to repatriate overseas cash at lower tax rates' and other tools) to invest in domestic research & development and to create jobs...and create a stable environment in which to operate. lit Wore. R See John Chambers and Salta Cart The Overseas Prohls Sephan in The Room; The Wall Seee Joutnal 1020 70. USA Inc. I Waal Might a Turnaround Expect Cortsiler? 372 EFTA01123437 Drive Growth: Infrastructure Better Infrastructure Reduces Transportation Costs For Input and Output Materials LISA Inc What Might a Turnaround Expert Consoler? 373 Public Investment in Infrastructure Has Helped Drive GDP Growth USA Real 5% GDP and Public Investment in Infrastructure Average Y/Y Growth, 1950 -2007 1950 - 1979 4.1% 4.0% 2: 4% C c 1980 - 2007 — cc 2.9% 3% to 2 2.3% `1) 0 0 >- = 2% .0 e. 1,11, Y/Y Growth in Y/Y Growth in Y/Y Growth in Y/Y Growth in GDP Public GDP Public Investment in Investment in Infrastructure Infrastructure Source: Political Economy Research Mrtrtuie. Wow Inetartructure investments Support the U.S. Economy: Emeloymeni. ProduttRily and Growth: frOg. USA Inc Whal Might a Turnaround Expect Consider? 374 EFTA01123438 But USA Inc.'s Investment in Infrastructure Has Been Steadily Declining for Five Decades... USA Inc. (Federal) Investment in Infrastructure as % of GDP, 1950 -2008 1.5% USA Inc's Investment in Infrastructure as %of GDP [ai 1.0% 0.5% 0.0% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 &tyre: BEA. USA Inc. I what Might a Tumacound Expect Conskrne? 375 ...Leading to Deteriorating Infrastructure in America and Pent-Up Demand for Investment American Society of Civil Engineers' Report Card Grades for America's Infrastructure, 1988 vs. 2009 1988 2009 Aviation Bridges Dams Drinking Water Energy Hazardous Waste Inland Waterways Levees Rail Roads School Buildings Solid Waste Transit Wastewater B- D C D B- D- D+ B D D - D- C- C+ D- D D C- C+ C- D- Overall USA Infrastructure Cost to Improve $2.2T We. The firg Infrastructure grades were 92Ven by the National Canaan Pubic Works linCIOVeirlerge in es report 'Fragile Foundations A Report on Pubit Works. reWased in February I 988.' Source: Arnentan Sudety ol Civil Engineav&1009 Reporl USA Inc. I Weal Alight a Tumatund Mfr Consitt; 376 EFTA01123439 Drive Growth: Education Better Education Improves General Labor Quality and Enables Specialization For More Efficiency USA Inc. I What MigN a Turnaround Expect Consider? 377 Education = High Long-Term ROI* Investment Each $1 of Government Spending Could Generate Up to $3 of Incremental Tax Return USA Inc. Net Present Value (NPV) for an Individual" Obtaining Secondary / Higher Education, 2005 a O • g 72.4 • U • w c D- . 0.c o al `I> 2* c • o 111., z 0 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $0 -$20,000 -$40,000 NPV = $32,257 ROI = 109% NPV = $100,119 ROI = 299% 1 n Unemployment Effect Social Insurance Tax Revenues 4 Income Tax Revenues Public Foregone Tax , Revenues I Public Direct Cost Secondary Education Higher Education Note. • ROI (return on investmenNcakulaNd as NPV of haute inolemenS fax revenues ctnedet: I by cost for government to support an indhedutt for eduCabOn."Limited to male tangles. female samples lend to fovea hower public NPV. Source: OECD. USA Inc. 11Vhal Might a TUM31C4.111:1 Expert Consget? 378 EFTA01123440 While Government Spending on Education Increased 60% Over Past 50 Years, At Margin, Government Spent More on Healthcare... USA Total Government Healthcare vs. Education Spending as % of GDP, 1960 - 2008 8% 6% 0. 0 C 0 g 4% 2% 0% U) —Total Government (Federal + State + Local) Spending on Health Care —Total Government (Federal + State + Local) Spending on Education 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 Nom. Total government spendng an healthcare includes Modcate. Medaad and other pop, afTS and total 90).011Talr spending on education induces suendwg on pee primary Oomph Infamy edtrafen programs. Source: Dept of EdUCIlb0.9. Deur. or Health 6 Homan Services. USA Inc I What Might a Turnaround Expert Conodet? 379 Despite Increased Government Spending, USA Education is Falling Behind — Math / Science Tests Scores Well Below OECD Average & Getting Worse Though Self Confidence Rising USA Ranking Out of 30-34* OECD Countries in PISA (Program for International Student Assessment for 15-Year Olds) 2000 / 2003 / 2006 / 2009 2000 2003 2006 2009 2000-2009 Trend Mathematics 18 23 25 Science 14 19 21 Reading 16 15 —It* 25 17 14 Self 2 1 1 Confidence) Kf ( Nore: *30 OECD counrnes participated in 2000 / 2003 PISA. 34 OECD countries parlicipaled 412006/2009 PISA 1)Conficienc is the seapeiceived efficacy ki hicuryng &banes Om year 2000): mathernadcal problem sorying abates (br yew 2003) and emend& problem &clung abates Ow yes 2006). USA fled M confidence ranidng wan Canada tangavy. SbvMia. Swirzedimd and Liedeenslein in 2003 and lied wen Poland and Canada M2000 "2006 temeng stores kr USA were rendered invalid because eta minting error M questionnaire Peruclions. Solace: OECD. USA Inc.I What Might a Tumatcund Expect Conselet? 380 EFTA01123441 USA Student Achievement Rankings* in Mathematics / Science Have Fallen vs. Other OECD Countries Mathematics Ranking* 2000 2009 Science Ranking* 2000 2009 1 Japan S. Korea Korea Finland 2 S. Korea Finland 2 Japan Japan 3 New Zealand Switzerland 3 Finland S. Korea 4 Finland Japan 4 UK New Zealand S Australia Canada Canada Canada 6 Canada Netherlands 6 New Zealand Estonia 7 Switzerland New Zealand 7 Australia Australia 8 UK Belgium 8 Austria Netherlands 9 Belgium Australia 9 Ireland Germany 10 France Germany 10 Sweden Switzerland 11 Austria Estonia 11 Czech Republic UK 12 Denmark Iceland 12 France Slovenia 13 Iceland Denmark 13 Norway Poland 14 Sweden Slovenia 14 USA Ireland 15 Ireland Norway 15 Hungary Belgium 16 Norway France 16 Iceland Hungary 17 Czech Republic Slovakia 17 Belgium USA 18 USA Austria 18 Switzerland Czech Republic 19 Germany Poland 19 Spain Norway 20 Hungary Sweden 20 Germany Denmark 21 Spain Czech Republic 21 Poland France 22 Poland UK 22 Denmark Iceland 23 Italy Hungary 23 Italy Sweden 24 Portugal Luxembourg 24 Greece Austria 25 Greece USA 25 Portugal Portugal 26 Luxembourg Ireland 26 Luxembourg Slovak Republic 27 Mexico Portugal 27 Mexico Italy 28 Spain 28 Spain 29 30 31 Italy Greece Israel 29 30 31 Luxembourg Greece Israel 32 Turkey 32 Turkey 33 Chile 33 Chile 34 Mexico 34 Mexico Hole: WA ranking our of OECD count/1es in PISA (Program lot international Student ASSOSSIneel for 15-Year OMs). Source: OECD. USA Inc.I Whal Might a Turnaround Expect Consider? 381 USA Young Adults' (25-34) Higher-Education* Penetration Significantly Lags Behind Canada / Korea / Russia / Japan Percentage of 25- to 34-Year-Olds with an Associate Degree or Higher Among OECD Countries, 2007 60% O C 50% g 400 CO CV '0 § 2 O .cn 4 0 cn O 2 U O N cr: C 0. 30% 10; I=IN/ r 1.11 4 1!111/111 •1 11 11111. t 1 753 1 3, is . oho ox 2 gig a' s. ,o I a .F. O co A 3 E i— 2- < 2 c. = •- O 0. O O > " sic t ° u.a X 3 = < LU B .- • 0 r:c 0. z 8 w O 1 ,1 t O .t c) c.) w=z _I e la N O O 20% • V) 2 E 8 13 lciAll) 't; C E.°2 S', a a O it 2 • - L- - O • CD LL 'Co Z N S z Nom. %ghee education cleaned as postsecondary rootage univeray) taxation. Source: OECD. USA Inc I Whal Might a Turnaround Expect Conskler? 382 EFTA01123442 0 Focus on Revenues Drive Sustainable Economic Growth Consider Changing Tax Policies Education Increase / Improve Employment Improve Competitiveness Review Tax Rates Reduce Subsidies / Tax Expenditures"/ Broaden Tax Base USA Inc. What Might a Turnamund Expert Conti:lei? 383 Employment = Key to Growth in Federal Revenue & Expenses The deficit problem is exacerbated by the business cycle. A stagnant or declining job market means lower income (via tax revenue) and higher outlays (via entitlement expenses) for USA Inc. Unemployment Tax Revenue Entitlement Expenses USA Inc. I What Might a Turnamond Expert C naclei? 384 EFTA01123443 Though Entitlements Are Structural, Not a Cyclical Problem, Entitlement Outlays Go Up with High Unemployment Real Entitlement Spending Y/Y Growth & Unemployment Rates, 1962 - 2009 Real Entitlement Spending YN & Unemployment Rates (%) 20% 15% 10% 5% 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 — Real Entitlement Spending Y/Y — Unemployment Rate .... ex ex ... ex er N. I \ 86% Correlation Between 1986 & 2009 Note. Real spentng adjusted for inflation. Fiscal yet ends ret Sepleater. Source. WMe House Office of Management rf Budget. Bureau of Labor Statistics. USA Inc. I What Might a TUM8IC011d Expert Constlei? 385 Increase Employment — High-Level Policy Options to Consider Short-run options: 1) Payroll tax holiday and/or 2) Employment tax credit and/or 3) Job training and/or 4) Restore labor mobility by reducing housing imbalances Medium- to long-run options: 1) Reduce employer health care costs and/or 2) Improve vocational training/education and/or 3) Encourage inward foreign direct investment, "onshoring" which would increase domestic employment Sotto: Richard Beats 'ErnptymerN Prospects and Policies w twos. Them' (2:2640). Morgan Stanley /*Setif Cel. USA Inc. I What Might a Tumatound Expert Cons:eel? 386 EFTA01123444 Increase Employment: Structural Problems in USA Labor Force High Healthcare Costs + Skills Mismatch + Labor Immobility • Healthcare costs may be a barrier to hiring for employers - Healthcare benefits = 8% of average total employee compensation; grew at 6.9% CAGR from 1998 to 2008 compared with 4.5% CAGR in salaries. - Healthcare benefits are fixed costs as they are paid on an annual per-worker basis and do not vary with hours worked. - As employers try to lower fixed costs to right-size to reduced revenue levels, layoffs are the only way to reduce fixed healthcare costs. • Skills mismatch may be a barrier to hiring for employers - A large portion of the long-term unemployed may lack requisite skills. - 14% of firms reported difficulty filling positions due to the lack of suitable talent, per 5/10 Manpower Research survey. • Labor immobility resulting from the housing bust may be a barrier to hiring - One in four homeowners are "trapped" because they owe more than their houses are worth, so they cannot move to take new jobs — until they sell or walk away. Ml Source: Richard Seiner. 'Why is US EnWoymerti So Weak' (712340). Morgan Stanley Research. USA Inc.l What Might a Tumaicund Expert Consdei? 387 Increase Employment: Immigration Does Not Take Away Jobs in USA; It Improves Productivity + Boosts Income per Worker • Immigration = Positive Impact on USA Productivity & Income per Worker • Immigration = Neutral Impact on Employment for U.S.-Born Workers % Change in USA Productivity / Income per Worker / Employment for U.S.-Based Workers In Response to an Inflow of Immigrants Equal to 1% of Employment 1.6 t -6 as to 1.2 • o to 03 • • 0.8 E _ 0 e -en 2 • E 0.4 E .O1 E E i 0.0 E E w -0.4 1 —Productivity — Income per Worker — Employment for U.S.-Born Workers 2 4 7 10 Years After Immigration Source. Giovanni Peri. -The Elleor of lervnegranis on US. ErrpbymerN and Produclivey.' W302010 Federal Reserve Board of San Wancisco (MGM Economic Left' 2010-26. USA Ix. I What Might a Taman:rand Expert Gonsdel? 388 EFTA01123445 Focus on Revenues Drive Sustainable Economic Growth Consider Changing Tax Policies Invest in Technology / Infrastructure / Education Improve Competitiveness Review Tax Rates Reduce Subsidies Tax Expenditures"/ Broaden Tax Base USA Inc. I What Might a Turnaictind Eitpen Conde? 389 Without appropriate government incentives in Education / Technology / Infrastructure / Employment, USA Inc. may continue to lose relative competitive strength to other countries. KF' CB USA Inc. I What Might a TUrrI8IPOld Eitpen Conde? 390 EFTA01123446 Compared to 10 Years Ago, USA is Losing Competitiveness at the Margin vs. Its Peers • McKinsey conducted a study in 2010 that compares the USA with other countries on 20 attributes related to economic fundamentals, business climate, human capital and infrastructure. McKinsey compared current status vs. status in 2000. • We augmented the McKinsey study with 9 additional attributes across those aforementioned areas as well as government spending metrics. • Through this study, we found that America, relative to other countries, improved on none of the 29 attributes, remained the same on 9 attributes (including GDP per capita, public debt as % of GDP, public spending on healthcare, public spending on education, growth in local innovation clusters, population & demographic profile, retention of foreign-born talents, total healthcare spending and cost-adjusted labor produca and deteriorated on 20 (including trade surplus, national spending on , industrial •irS ction, corporate tax rate, business environment, FDI, tax incentives for M, number of patent applications, availability of high-quality labor, higher education penetration, telecom & transportation infrastructure, etc.). Ml USA Inc. I What Might a illffialCUrld Expect Gamete'? 391 USA Ranking High in Country Attractiveness Indicators But Losing Share at the Margin... Key metrics US Relative Position Trend Ten Years Ago Today Economic Household consumption ■ • • Fundamentals Household consumption growth ■ X GDP • • • GDP per capita2 ■ • Stock market capitalization ■ X Technology company market cape ■ • Industrial production ■ • Trade as % of GDP ■ Trade surplus2 • National spending on • Government Defense spending2 ■ • Spending Government public debt as % GDP2 Public healthcare spending as % of GDP2 Government surplus as % of GDP2 ■ • • Public expenditure on education ■ • ■ Top Ranked ■ Top Quartile ■ Average • Bottom Quartile Source. ) Growth awe competiMewess An Me Uneerl &Me& The foie of its rnultinetional companies. McKinsey & Corrpany. 2)estimefes based an dais horn ?Mr / OECD USA Inc. I What Might a Turnaieund Expect Consklei? 392 EFTA01123447 ...USA Ranking High in Country Attractiveness Indicators But Losing Share at the Margin US relative position Key metrics Ten Years Ago Today Trend Business climate Statutory corporate tax rate in IN V Business environment E • • FDI as % of GDP • a • Growth of local innovation clusters X M — Tax incentives for • • • Human capital Population and demographic profile • • — Availability of high-quality labor X • • Retention of foreign-born talent X • — Cost-adjusted labor productivity E M — Total healthcare spending per Capital X • — Higher education penetration2 X • • Number of patent applications X • • Infrastructure Transportation • • • Telecommunications MI • • E Top Ranked • Top Quartile M Average • Bottom Quartile Source: I) Growth and compeoliyaness in the United Males; The role Mils mullinefional companies. NI McKinsey& Company. 2)eserne I es based on dela from IMF/OECD USA inc. i What Might a Tumaneoxl Expert Gonadal? 393 USA's Share of Global GDP Has Declined from 33% in 1985 to 24% in 2010, While China / Brazil / Korea's Shares Have Risen Share of World GDP (%) Share of World GDP, USA vs. China / Brazil / India, 1985 - 2010E 100% 80% 60% 40% C 20% 0% 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 33% let Rest of World 1985-2010E Largest Share Gainers China +6% to 9% Brazil +1% to 3% Korea +1% to 2% USA 1985-2010E Share Loss = -9% NoM: Dais are NOT &fasted forpurchasengpower pally. Source: IMF. USA Inc. I What Might a Tumaicund Expert Gortsdei? 394 EFTA01123448 Focus on Revenues Drive Sustainable Economic Growth Consider Changing Tax Policies KP CB Invest in Technology / Infrastructure / Education Increase / Improve Employment Improve Competitiveness Review Tax Rates Reduce Subsidies / Tax Expenditures"/ Broaden Tax Base USA Inc. I What Might a Turnaround Expert Conde? 395 Simple Tax Math* — Big Across-the-Board Tax Rate Increases Would Be Needed to Potentially Generate Meaningful Revenue Improvements Each one percentage point across-the-board tax rate increase would generate an incremental $127 billion revenue for USA Inc. in F2010E...excluding any related negative impact on spending / GDP growth, which is difficult to do... .. Across-the-Board Hypothetical Revenue Increase for .Which Would Reduce Tax Rate Increase USA Inc. in F2010E ($ billions) Estimated Losses in F2010E by 1 Percentage Point $127 2 Percentage $254 Points (pps) 3 pps $381 4 pps $508 5 pps $635 10 pps $1,270 8% 16% 24% 33% 41% 82% Ml Note. 'The simple lax math presented here are pule mathemattaltibutahons - we sernpry calculated how bg a broachbased tax rate Inc:ease (for mohodoal and corporate 'name. as nett as payroll; womb have 10 be Ate USA Mc. to linancgt breaWeven. These catUations ate merely mechanical iaustrahons and ate not meant to portray reabsbc sobtens. 11 Mceemental &Pat amount calculated as 1% of protected totalpersonal6 corporate income. which hstoncavy has been at -137%ot GDP. Soucce. F2010E revenue 6 deka per While House OMB. GDP per LSO. USA Irc What Might a Turnaround Expert Centric'? 396 EFTA01123449 More Complex Tax Math: If Lower Brackets Excluded, Draconian Rate Hikes Required to Attempt to Bring USA Inc. Budget Into Financial Balance Current Federal Income Tax Rates vs. Rates Needed to Reduce Deficit to 3% of GDP in 10 Years 100% 80% co co S cc 60% I - a 40% 11. 20% 0% Ml ■ Current Federal Income Tax Rates O Marginal Tax Rates Required to Balance USA Inc.'s Budget' 10% L.41 10°' 15% 15% an 25% 25% 28% 28% Tier 1 Tier 2 Tier 3 Tier 4 72% 33% 35°. 77% Tier 5 Tier 6 Note: 'The fax math !Nescafe.] hete are pure mathematical ilinfretions - it is simply calculated to measure how much lax 'ales need to manseMN the tcp Mo income beathetsito achieve a deficit-soGOP :ado .213%1:72019E assuming a baseline budge? path and :eking on persona) income tax cafe hikes alone. Thesecalculations are merely mechanical ilbsttations and ate not meant to potbay teMslic sollutions. SOU/Ce: The Urban Insteute (Desperately Seeking Revenue. By AffshuMr. Lim and Moms. IS2010. USA Inc. I What Might a Tumatound Expert Constet? 397 Pros + Cons of Tax Rate Hikes • A more progressive income tax system could lower tax burden from potential subsidy cuts and carbon taxes on the low-income population. • Addressing income inequality may enhance perceived fairness — and political chances — of comprehensive deficit measures. • Across-the-board tax rate increases would hurt nearly everyone, but especially lower-income taxpayers. • Rate increases on upper brackets usually spur tax avoidance, and revenues often fall short of targets. • Rate increases, which discourage savings, amplify distortions in the economy from tax subsidies, exclusions and tax expenditures, all of which encourage consumption. Ml USA Inc. Inc.l Whal Might a Tumateural Expect Conskiet? 398 EFTA01123450 Despite Multitudes of Tax Rate Changes. USA Inc.'s Tax Revenue as Percent of GDP Remained Roughly Stable at 15-20% from 1960-2002 Federal Tax Receipts by Category as % of GDP, 1960 - 2009 25% • Individual Income - Corporate Income • Social Insurance • Excise & Other 0. 20% 0 0 0 :g 15% CC x 10% a 3 LT°. 5% 0% Cali 0 L 11 1 Ili! !I 1 1 1111 1 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Sow et What House 0148. USA Inc. I Whal Might a Temateund Expect Consider? 399 Focus on Revenues Drive Sustainable Economic Growth Consider Changing Tax Policies Invest in Technology / Infrastructure / Education Increase / Improve Employment Improve Competitiveness Review Tax Rates Reduce Subsidies; Tax Expenditures"/ Broaden Tax Base USA Inc. I Weal Might a Tureen:end Expert Cont:xlet? 400 EFTA01123451 Illustrating the Revenue Tradeoffs — Changing Tax Rates vs. Broadening the Tax Base Mathematical Illustrations* 1) To eliminate F2010 deficits by increasing individual / corporate / payroll tax rates across-the-board would require +12 percentage points of tax rate increase (raising $1.4 trillion) — and would likely damage economic growth? or 2) To eliminate primary budget deficit" by F2019E by increasing top two tiers of income tax rates would require moving marginal rates to 72% / 77% from 33% / 35% — also likely to damage growth and encourage tax avoidance? or 3) Broadening tax base could require reducing `tax expenditures' and subsidies, e.g., limiting deductions and subsidies for housing & healthcare? Policy Options 1) A combination of somewhat higher rates and a broader tax base? and/or 2) Changing taxation of individual income to encourage saving / investment rather than consumption (perhaps a value-added tax and/or carbon tax)? and/or 3) Changing taxation of corporate income to reflect global competition? !Owe. 'The simple tax math presented here are pule maihernaf Mal aVusitarions - we simply calculated how lag a broacTbasecl tax rale increase floe incishkal and corporate income. as wee as papotn would nave to be lot USA Mc. to financial bteak.eren. These calculations ate merely mechanical ahrsoanons and ate not meant so portray tusking solutions. "Primary budget demo) is the budget Oeficif exclocOng net interest payments. USA Inc. I What Might a Taman:and Expert Gonadal? 401 Changing USA Inc.'s Tax System Could Help Rebalance the Economy & Reallocate Resources • Though there would be adjustment costs, reducing subsidies and `tax expenditures' could broaden the tax base and collect more revenue, while allowing income tax rates to stay low or go lower. • The current system favors consumption, penalizes saving; a tax based on consumption (or "value added") could offset some of that penalty, though there are risks and drawbacks. • Subsidies create incentives to consume more health insurance and housing — both account for 20% of GDP, vs. 11% in 19651 — and take resources from other sectors like education, technology, infrastructure. • A worldwide corporate tax system with a lower tax rate could reduce incentives for companies to keep income offshore. • A carbon tax could raise some additional revenue to reduce the deficit, while encouraging sustainable economic development. Seine: 1) per SEA and CMS. USA Inc. I What Might a Tumaicond Expert Canada'? 402 EFTA01123452 Changing Tax Policy to Broaden Tax Base: Subsidies + Tax Expenditures = 70% of USA Inc.'s Cash Flow Deficit KP CB F2009 Subsidies & Tax Expenditures & Deficit (SB) USA Inc.'s Deficit vs. Aggregate Subsidies and Tax Expenditures*, F2009 1.600 1.400 1.200 1.000 800 600 400 200 $1,4138 $981B* $30 it Some tax expenditures favor consumption... Such as tax exemption on employer contnbutions to health insurance & deductibility of mortgage interest on owner- occupied homes... ...But others favor saving, investment, and growth Such as tax exemptions / deductibility on capital gains / dividends / pension contributions & savings / accelerated depreciation of equipment... F2009 Deficit F2009 Subsidies & Tax Expenditures Note: 'Each lomgone revenue estimate assumes al abet pads of Me Tax Code lemma unchanged dwing F2009. Aggregate tax subsides presented bete is Away Me sum of inthathial &shades. kr teary. tieaggtegaleeslimate would be admen? if tax subsides were Mange.] siintitaneask because of potential interactions among plovidons. Source: White House Ma. 'Anaybcal Perspective- Budget of th U.S. GOVOITMeent Fiscal Yes 201 USA Inc. I What Might a ?unwound Expert Gonadal? 003 Raising Revenue by Reducing Tax Expenditures & Subsidies: Examples • Reducing the biggest tax expenditures and subsidies could net $1.7 trillion in additional revenue over the next decade, per CBO and the Committee for a Responsible Federal Budget: - Reduce the tax exclusion for health insurance or replace with a credit - Cap the deduction for state and local taxes - Gradually reduce the mortgage interest deduction or change to a credit - Limit the tax benefit of other deductions, e.g., charitable contributions • Some subsidies encourage saving or investment...and cutting them could mean short-term revenue gain but a net loss over time. Examples: — Favorable taxation of capital gains, dividends, and pension contributions — Exclude investment income from life insurance and annuities in taxable income — Accelerated depreciation or expensing of capital equipment outlays Sounr. Sources. Ccosee tt.1 Budge, Office. axigel Vo,afre 1. Heallh Cate ard Volume 2. 2009: Cdtrirrinee lot a Responsible Federal Budget. Let's Get Speak: Tax Expenditures (October 2010) USA Inc. I What Might a Turnamood Expert Gonadal? 404 EFTA01123453 USA's Unbalanced Economy — Personal Consumption (Driven in Part by Healthcare) = 71% of GDP vs. 62% From 1950 To 1980... Personal Consumption as % of GDP, 1950 - 2009 75% —Personal Consumption as % of GDP Personal Consumption as % of GDP 70% 65% 60% 55% — Personal Consumption (ex. Healthcare) as % of GDP 1950.1980 Trend line for Personal Consumption as % of GDP n v 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 Noie. Personal COMUMpli011inctudes househald ronsumption ol .0 goods and services. Source: BEA. Federal Reserve. LISA Inc What Might a Tumaicond Expect Consklei? 005 ...USA's Unbalanced Economy — National Savings (Personal + Corporate + Government Savings) = -3% of GDP, vs. 10% From 1950 To 1980 16% USA Net Saving as % of GDP, 1950 - 2009 1950-1980 Trend line for Net Saving as % of GDP 4% 4n 0% • • -4% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 N.:qt. Nat cora: :;:n.ngs 4.6c46.6 49g,regsc .54 e cgs by heidnehatil cwpwate a6dgoi SMIWS Source: BEA. Federal Reserve. USA Inc. I What Might a Turnaround Expert Con6dni? 406 EFTA01123454 Current Tax Policies Help Spur Consumption — USA's Taxes on Consumption of Goods & Services Lowest Among Peers 20% FcS4 0: a 16% in 12% co 0 8% 0 O CO 0 CO 0% rn Taxes on Consumption of Goods & Services as % of GDP Among OECD Countries, 2007 ,11. mry11);,.111,11,1,1111:•!11,1111:111c! R• ` ce co ▪ < CC C) .c N TT U ▪ Z ILI O rn Source: OECD. 2009 database. USA Inc. I What Alight a %matter< Expect Consklet? 407 America's Resources Allocated to Housing + Healthcare Nearly Doubled as a Percent of GDP Since 1965, While Household and Government Savings Fell Dramatically As % of GDP 25% 20% 15% 10% 5% 7% Healthcare + Housing Spending vs. Net Household + Government Savings as % of GDP, 1965-2009 — Housing + Healthcare Spending as % of GDP —o —Net Household + Government Savings as % of GDP 11% 0% -5% -10% 1965 1970 1975 1980 1985 1990 1995 2000 2005 20% -9% Note: Housing inefutleS percher& rent and home iMpI0NNYIS0L Government sty/Inge Ottur when gOverninent runt a Serpkri Saute: BEA CMS Ina Havel Analylitt. USA Inc. I What Might a Tumatcurbd Expect Consklet? 408 EFTA01123455 USA Income Taxes Higher. Consumption Taxes Lower Than OECD Peers Government Tax Revenue as % of GDP. USA vs. OECD Average. 2007 Tax Type USA OECD Average Variance (USA — OECD) Individual Income Taxes 10.8% 9.4% 1.4% Property Taxes 3.1 1.9 1.2 Other 4.7 5.0 -0.3 Corporate Income Taxes 3.1 3.9 -0.8 Social Security Taxes 6.6 9.1 -2.5 Value Added Taxes 6.5 -6.5 Total 28.3% 35.8% -7.5% Source:OECD Tax Database. USA Inc. Inc.I What Ali ht a Turnaround Expect COnskier? 009 Tax Policy Options From Report of the National Commission on Fiscal Responsibility and Reform • Consolidate the tax code into three individual income rates (15% / 25% / 35%) and one corporate income rate (26%) • Eliminate the complex tax codes such as AMT', PEP2, and Pease3 • Triple standard deduction to $30,000 ($15,000 for individuals) • Repeal state & local tax deduction and miscellaneous itemized deductions • Limit mortgage deduction to exclude 2I'd residences, home equity loans, and mortgages over $500,000 • Limit charitable deduction with floor at 2% of Adjusted Gross Income • Cap income tax exclusion for employer-provided healthcare at the amount of the actuarial value of Federal Employees Health Benefits Plan (FEHBP) standard option • Permanently extend the research tax credit for businesses • Eliminate and modify several business tax expenditures (domestic production deduction / LIFO" method of accounting / energy tax preferences for the oil and gas industry I depreciation rules) • International tax reform including a territorial systems Nakk I) Awns ine Mensal. tahienum Mx: 27 PEP is Personal &erosion Passe-out destract to Saint* pewits, imams arempams kw AO snit 3) Peale is a airaVar phass-Otot. Dot MelnO Dot Meroaeo aqoasina repenanai exenpaen. it earn to ma.V or It itemgeof 091ActiOns atS tawayels Naves (mongaga **mar. chanailas pas. Wale $ Walton pelf eft): Ante is WWI Nay Repesenteare Mudd Pease 10.01.00to owned be its enachnen r MO 4) UFO ie Las? fo. Far Our •01101 Fend 10 Woos cola:ramie' inCtera flail in Pass onaaaaaa 5)A reamoaaf ran menu is afar sysiktu teal tares ea/imam. Nbf is Mated yaw/ the 00ederS 0fa SpoleAlt lemtay (aRAMS, e Ctuney). Sane AltiliOnel Commission on Fiscal AeSpOn&Only en1 /101011h, "TtuMonteiv of Tam' RepOn Nmp NetiOnSI Cnnenasittn on Final Aexponatialy and Resoaa' 124/10 Note Mu Me Awed also snaked two elver sccaanas cad me -The Zero Phan' union amine*: a0 tax experaVtatn aid Tax Patna rawer rata forces Covens to mama** coaareacrawa tax Sam, by 207, 2 by caning taxes Contacli year Covets/as toad. KP Cs USA ICC.I What Might a Turnaround Expert Constler? 010 EFTA01123456 This page is intentionally left blank. 011 This page is intentionally left blank. 012 EFTA01123457 Consequences of Inaction USA Inc. I Consequences of Inaction 413 To Take a Step Back... • We Asked the Question How would public shareholders view USA Inc.? • What Have We Found? USA Inc.'s finances — short-term and long-term. income statement and balance sheet — are challenged. Management's policies have created incentives to invest in healthcare. housing. and current consumption rather than in productive capital. education, and technology — the tools needed to compete in the global marketplace. [i1 USA Inc. I Consequences of Inaction 414 EFTA01123458 Consequences of Inaction — Investor Perspective • Short Term, No Problem Yet Global bond investors, in part. have looked past USA Inc.'s deteriorating financials because growth, inflation. and Fed purchases matter more, and because income statements and balance sheets of many other developed countries (such as Greece / Spain / Portugal / Ireland) are worse. • Long Term, Consequences of Inaction Could Be Severe If USA Inc.'s "managers". and -board- continue to ignore rising unfunded entitlement spending, investors could eventually demand a higher return to lend money to USA Inc. — leading to rising bond yields / higher borrowing costs for USA Inc. At some point, USA Inc.'s currency could also weaken significantly. Scorce. Ratan, Amenca's Racal R 4'11 Wren,' t7a2:2009). Morgan &ante/ Research KP CB USA Inc. I Consequences of Inaction 415 For Perspective, USA Inc.'s 55% Public Debt as % of GDP (2009) is in Middle of Pack When Compared with 'Top 25' Global Peers, Though Rising to 90% 'Warning' Level* As % of 2009 Net Debt World Rank Country Outstanding 48) TN Total Net Debt a. % ol GDP 05-09 2009 2006 Change 181% 162% 19% 116 106 11 111 99 12 98 92 77 68 11 76 68 70 64 6 69 80 -12 66 42 24 ea 70 -0 64 52 12 59 59 0 SS 37 17 53 47 53 43 10 51 46 44 51 44 44 0 44 53 4 40 38 3 37 52 45 34 36 -3 27 27 0 13 18 4 7 14 -7 As % ol 2009 Budget As % ol 2009 2009 GDP World Surplus World Gross Unemploy- VtV (SB) WY Total Deficit (SB) Deficit ment Rate (pp.) 1 Japan 2 Italy 3 Greece 4 Belgium 5 France 6 Germany 7 Austria 8 India 9 UK 10 Canada 11 Netherlands 12 Argentina 13 USA 14 Poland 15 Spain 18 Norway 17 Sweden 18 Brazil 19 Switzerland 20 Denmark 21 Turkey 22 Australia 23 Venezuela 24 China 25 Russia 59.149 12% 28% 2.434 0 7 374 8 1 454 0 1 2.028 5 6 2.423 1 7 263 2 1 854 -3 2 1.444 3 4 870 -5 3 503 -1 1 178 1 Lim 23 23 223 .11 1 757 20 2 187 -17 1 175 -5 1 650 -6 2 212 5 1 125 7 0 219 -14 1 309 -3 1 96 11 0 609 7 2 92 -15 0 55.049 -6% 9% -960 33% % 41 2.090 4 4 -0 — .1 338 1 -27 1 .2 481 4 1 .1 0 .1 2.636 6 -105 4 .2 3.236 4 8 -16 1 .0 374 -4 1 .5 0 41 1.243 6 2 31 -- — — 2.198 4 4 -49 2 7 .2 1.319 3 2 44 -. 8 .2 790 -4 1 4 — 4 41 301 1 1 14 — — — 14.266 25 -1.438 50 9 41 423 2 1 26 - - - 1.438 4 2 -125 4 18 47 369 1 38 - 3 41 398 1 9 - 8 .2 1.482 0 1 40 — — — 484 •1 1 -10 0 4 41 308 .5 1 4 0 3 .2 594 -5 1 38 — — — 920 1 2 8 — 6 41 353 4 1 -9 0 — — 4.758 9 8 48 1 — — 1255 -8 2 17 — Top 1-25 332,438 0% 94% Global 34,632 8 100 Now: •Cannxn ;tannin and honneM Regal elasernml from 3.) weak for dolnGOP ra SOS below a Stun OW Or 90pin:en! 101 (NW own Barnhart and Floors cOdravaliOn$ ant bleed MI 7055 debt Forma,* restrmttaerz tea Avow 55% 62% 3% 68 68 2 Alrencalannuar data panes 69/17 GDR Above 90percent. median On Wen *V dela al the LIS.. and D01700. 'etenth In 8 renew 547.081 -3% 81% $2.790 97% 7% 67.937 100 2.885 100 7 .2 44 memos Mat the rolassonshpbowseon government debt and real GOP wens, growth rates laY by One pattern. and Orange prong, lab considerably mare. . We debt Itekt by the MC*0 is closet rode Etatlpekin COunt0earlennatoolgovernment Deer.• 1/ lg. Ppir a pertWiltige points SWOP. WE. BusOess InlervenCe Mora USA Inc. I Consequences of Inaction 416 EFTA01123459 KP C On a Net Worth Basis, USA Inc. Also Sits in Middle of Pack vs. Western European Peer Governments Illustrative Estimates' of Government Net Worth, 2009 Estimated Government Net Worth as °•b of GDP 40V. 0'. -400% -800% -1200% -1600% Better Than USA C Worse Than USA E S En co 0 C Ts 4 Y cn 0 0 z 0 0., c o 1 I 1 Cost of Ageing • Structural Deficit *Initial Debt Level Nolo: 'Estimates of government net worth depends hem* on vocally:mg assunpfWns such as projections for GOP. demographics. pokychanges. eta Nef worth estimates may differ from U.S. Dept of Treasury's dam (used in eat Odes). For more doses on underlying assurrymoas. ;Pease refer to Morgan Stookey Research's Gaul Outlook piece 'Sovereign Sulhatts. Ask Nor Whether Governments WA Death Gut Hay-825, 10. Source: Amour/ Mares. Mogan Stanley Research. USA Inc. F Consequences of Inaction 417 Combined With US Dollar's Reserve Currency Status. Investors Still Prefer USA Inc.'s Debt, For Now Global Foreign Exchange Reserves (USSB) Global Aggregate Foreign Exchange Reserves by Currency. 1999 - 2010' $6.000 a Other Currencies Euros $5.000 US Dollars —US Dollars' Share of Total $4.000 $3.000 $2.000 $1,000 $0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010' 100% 75% 50% 25% 0% US Dollars' Share of Total Note: 2010 data are preammary and as of CO3. Source: IMF. USA Inc. I Consequences of Inaction 418 EFTA01123460 K P ( However, in Longer Term, Credit Rating Agencies Have Begun to Worry About USA Inc.'s Debt Affordability On balance, we believe that the ratings of all large Aaa governments [including USA Inc.] remain well positioned, although their distance-to-downgrade' has in all cases substantially diminished...Growth alone will not resolve an increasingly complicated debt equation... Preserving debt affordability at levels consistent with Aaa ratings will invariably require fiscal adjustments of a magnitude that, in some cases, will test social cohesion. ' - Pierre Cailleteau Managing Director of Sovereign Risk at Moody's, 3/16/2010 ...if there are not offsetting measures to reverse the deterioration in negative fundamentals in the U.S., the likelihood of a negative outlook over the next two years will increase. 2 Sarah Carlson, Senior Analyst at Moody's, 1/14/2011 SOUICOS: IffRoomberg. The New Tech Times; 2) The Wan Street Journal USA Inc. I Consequences of Inaction 019 Treasury Swap Spread' Turned Negative For First Time in History2 — Now Cheaper for Some Private Companies to Borrow than USA Government 10-Year Treasury Swap Spreads & Federal Budget Deficit / Surplus, 1988 - 2010 160 140 .O 120 O ig 100 a ft 80 60 co co ▪ 40 .42 • 20 -20 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 4% 0 2% # co co 0% .O 6 O .2% 4% mil• O • 7. .., •O U' a -6% v m 4% 2i .109 -12% —10y Treasury Swap Spreads (left axis) —Federal Budget Deficit/Surplus as % of GDP (right axis) Note: I) Treasury swap spread Treasury yield - swap rate (between bonds of coenpatabre mammy): swap rare is the Need interest rate that the buyer demands in exchange for the uncertaintyof paying the shonitevm LIBOR (((Dating) rate over time: swap rates are sena* higher than Treasury0MS valh corresponoVng II18!WibeS as they include Mcrementa( pv441411/4 associated 1401 Me banks that provide swaps coowaeed lb Tretthilles alien are viewed as risk-free. 2)10year Treasury swap spread turned negative on 324/10. while 30 year Treasury swap spread Armed negative in 1003 and shorter-term Treasury swap spies:Ism° still positive. Source: Bloomberg. USA Inc. I Consequences of Inaction 020 EFTA01123461 Financial Challenges for Countries are Not Uncommon Of course, there are no exact precedents for the financial challenges faced by America and many other countries in the world today. Yet a quick overview of a few government and corporate financial crises may illustrate how managements have addressed — or failed to address — the problems of their day. KP CB USA Inc. I Consequences of Inaction 021 History Doesn't Repeat Itself. But It Often Rhymes' — What Can We Learn From These Credit Crises? Sovereign Credit Crisis 2010 — Greece ($374B Debt Outstanding — 113% of GDP) 2009 — Dubai ($26B - 32% of GDP) 2001 — Argentina ($132B - 130% of GDP) 1998 - Russia ($73B - 27% of GDP) State / Loc- 1- 1 Financial Woes 1975 — New York City ($14B' Debt Outstanding) Corporate Bankruptcy 2009 — General Motors ($95B Debt Outstanding) Note: t)AttnbutedloMak Twain. WYCgOvemmerc and subsiarcieshadSUBdetd ovistancendrc 071 Meshed he inaelion. $148 of 1975 dollars tossed have been •$506 in ladays doh.. Source: sovereign dale poiNs per IMF and World Bank. NYC dsta pedal per Cafilonds Research Burred Yrcenried of New Yolk Caya Fiscal Crchs.•3/1/1995. USA Inc. I Consequences of Inaction 022 EFTA01123462 Simple Pattern Recognition From Historical Debt Crisis Reveal Common Drivers (Leverage & Entitlements) + Triggers Year of Crisis Debt Restructured Long-Term Drivers Short-Term Triggers Key Stakeholders Amount % of GDP Rising Underfunded International Bond Greece 2010 $3748 113% Financial Crisis Entitlement Spending Investors Leveraged Construction / International Bond Dubai 2009 26B 32 Financial Crisis Real Estate Bubble Investors Rising Underfunded International Bond Argentina 2001 1328 130 Entitlement Spending + Financial Crisis Investors Currency Peg Declining Productivity + International Bond Russia 1998 73B 27 Financial Crisis Currency Peg Investors Bond Investors + New York Rising Underfunded 1975 14B' Recession Federal City Entitlement Spending Government Note. 1 )NYC goyernroeN and subskOsies had 5)48 debt oursiandog in 1975. Aguseng for inflation. $148 of 1975 dollars wood have been -5508 in today's do9ars. Source: sovereigndata points per IMF and World Bank. NYC data poi'N per Cafiromia Research Bureau theesiew of New York Gays Fiscal Crisis.' 3/1/1995. USA Inc. I Consequences of Inaction 423 Lessons Learned: Historical Debt Crisis • Rising Unfunded Entitlement Spending = Often a Long-Term Driver of Debt Crisis - Countries such as Greece / Argentina and cities such as New York all nearly brought down by unfunded entitlement spending. • Financial Crisis / Economic Downturn = Often the Short-Term Trigger of Debt Crisis - All cases had similar short-term triggers. • External Forces = Often Key Stakeholders in Crisis & Driving Ensuing Changes - Most sovereign credit crises + ensuing reforms were driven by loss of confidence of international bond investors. - New York City's near default was driven by demands from bond holders + refusal of bailout from federal government. USA Inc. I Consequences of Inaction 424 EFTA01123463 While High Government Debt Levels Could Hasten Economic Recovery Post Recession, There Are Many Long-Term Negative Consequences • Crowding Out Investment 4 Lower Output & Income - A growing portion of people's savings would be diverted to purchase government debt rather than toward investment in productive capital goods. • Higher Interest Payments 4 Higher Tax Rates & Lower Output & Income - Government may be forced to raise marginal tax rates and / or reduce spending on other programs to meet interest payments. • Reduced Ability to Borrow 4 Less Policy Flexibility - In case of economic downturns or international crises, government may not be able to raise substantially more debt. • Increased Chance of Sudden Fiscal Crisis 4 Social / Economic Disruption - Investors may lose confidence in government's ability to repay debt & interest without causing inflation. KP CB Some& Coors Bodge Office. 'Fed& al Debi and Me Risk of a Fiscal Crisis." 740. USA Inc. I Consequences of Inaction 425 Lessons Learned: For Countries Burdened by High Debt Levels, Austerity Measures are Necessary Greece • = Ireland I I Spain 2009 Deficit as % of GDP Gross Debt as % of GDP 2009-2010 Austerity Measures New Revenue Streams • Wage freeze & bonus cut of 14% on all public sector employees • Reduction in government contract 14% 113% workers • 11% reduction in pensions & Increase in retirement age to 65 from 58 • Joint IMF-EU bailout of $1466 • Tax increases for VAT (+2%) / fuel / alcohol / cigarette (+10%) • Clamp down on tax evasion 11% 66% • 5-15% pay cut & 4% benefit reduction for all public sector employees • $1.5B+ broad spending cuts in healthcare & infrastructure • Carbon tax on fuel • 1% tax rise on personal income about 120K euros 11% 54% • Hiring freeze for public sectors • Increase of retirement age to 67 from 60 • Total budget cut of $708 10-13E • Sold $78 in new bonds 9% 78% • Wage freeze on all public sector employees • Reduce state payroll via attrition • 50% bonus tax on top bank executives • Privatize state-owned industries Source: Eurostat European Commission. IMF. New York Times. Financial Tenn BBC. WaVSWeel Journal. USA Inc. I Consequences of Inaction 426 EFTA01123464 European Countries (including Greece, Portugal, Ireland and Spain) Have Committed A Rising Share of GDP to `Social Benefits' Over Past Decade Social Benefits Paid by Government as % of GDP, 1999 vs. 2009 25% Social Benefits Paid by Government as c/o of GDP 20% 15% 10% 5% • 2009 11999 European Union 2009 Average = 17.1% 111[111R t u g irl i t z on I r I s2 o i n i I O I • E l -2 IL 1 i 1 40 O. O I I X I I I S O a Source: Eurnsfaf. Social Beneltil iodide both socks, insurance rconpasatde So Soda! Secusity rind Meolcase) and soca! assistance benefits (compatable to Madcap provided by goverment units as wet as aN maid:insurance basalts provided uncle private funded and unfunded social 'mutants schemes. whether in cash or in kind. USA Inc. l Consequences of Inaction 427 Austerity Measures to Take Away Entitlement Benefits Could Spark a Vicious Cycle Less Revenue for Corporations & Small Businesses Higher Unemployment Lower Consumption Lower ff uctivity Social Unrest Lower Government Tax Receipts Less Investor Confidence Higher Tax Rates More Austerity Measures USA Inc. I Consequences of Inaction 428 EFTA01123465 Social Unrest Can Shake Investor Confidence And Contagion Can Spread 10-Year Sovereign Yield Spread (over German Bonds) for Greece / Portugal / Spain Ireland, April 1 — May 10, 2010 10% 10-Year Treasury Yield Spread (Over German Bond) (%) 8% 6% 4% 2% 0% 5/6 — Greek parliament formally approves austerity —> package agreed w/ EU & IMF 4/22 — Greek civil servants stage a 24-hour strike 5/5 — Violent protests in Athens against proposed austerity measures 411 4/4 4/7 4/10 4/13 4/16 4119 4/22 4/25 4/28 511 5/4 5/7 —Greece — Portugal Spain —Ireland Source.: FactSet USA Inc. I Consequences of Inaclion 429 Government Deficits and Changes in Sovereign Credit Default Swap Rates = Positively Correlated Cumulative Government Deficits as % of GDP vs. Change in Sovereign CDS between 2007 and 2011E 600 I.• CSI 500 O O 4.8▪ 400 4.O C•I : , 04 O. 300 Portugal * .O O R2 = 0.1996 • E. CO csi 200 ,.. E g 2 --- Italy • -- -- • Ireland • -$Pain cn 100 Germa France -- -- --- Jap an ** (.) UK • 0 Ao_ -- C •• *Netherlands USA *. 10% 20% 30% Austria • 0% . 40% 50% 60% o -100 • Greece Cumulative Government Deficits as % of GDP for 2007-2011 (10.11 Projections) lit Sources: OECD: Mandl: moons DES USA Inc. I Coosequences of Inaclion 430 EFTA01123466 When Corporations Like General Motors Run Out of Cash, Eventually They File for Bankruptcy Assets / Liabilities / Net Worth (SB) $200 $150 $100 $50 -$50 -$100 -$150 -$200 General Motors Balance Sheet, 2000 — CO1:09 $27B Cash' I 6/09 — 3"I Largest Bankruptcy Filing in USA History mi Cash & Marketable TT/ $12B Securities Cash* a Assets (ex. Cash) I I $23B Accrued Pension + OPEB Liabilities -Liabilities (ex. Pension & OPEB) Short-term Debt— O O O ot cP of° 0 4' 0 • (6) • • 4) • v o Note; Net Worth (Shareholders' Equity) stash 8 equivalents. as weil as inarkeiabte securities. "snort-term Ma also inchgks current portion of long+ Seim debt. Source: Genera' Motors. USA Inc. I Consequences of Inaction 431 General Motors — Entitlement Spending Became Too Onerous for this Great American Company 1908 - Founded in Flint, Michigan to manufacture automobiles 1954 - Shipped 50 millionth automobile 1988 - Free cash flow peaked at $6.3B 1999 - Reached a peak market capitalization of $61B 2006 - Revenue peaked at $207B 2009 - Filed for bankruptcy Why did GM file for bankruptcy? Products became increasingly uncompetitive. In addition, pension plans to support 650,000 retirees and their dependents (compared with 80,000 active employees in N. America as of 2010) rose to 4.8% of GM's annual expenses and $4,679 in annual pension payments per worker to former workers. Ml Source. General Moron. FactSet. ClataStiettin. History News Nehtiork. USA Inc. I Coosequences of lnaclion 432 EFTA01123467 Comparing GM & USA, Inc... USA 2010 General Motors 2008 Nti Gross Debt as % of GDP 93% 82% Gross Debt as % of Revenue' Federal Spending as % of GDP 24 114 Total Cost as % of Revenue Federal Budget Surplus as % of GDP -9 -21 Net Income as % of Revenue Interest Payments as % of GDP 1 2 Interest Payments as % of Revenue % of Citizens Receiving Government % of Total GM Population2 36 75 Subsidy or on Government Payroll Dependent on the company KP CE Note: 1) Gross &Idol GM catroulafed as totalgabblies - &aro OPES B pension Stades. as Mese NaMwes are not /abetted in LISA gross debt 2) % of fetal GM population dependent on the company - allaying retirees /Laving retirees • current waken). Source: Wale House Of ace of Management and Budget. OECD. Heritage Foundation. General Motors. USA Inc. I Consequences of Inaction 433 ...Good News for GM Is It Has `Taken Its Medicine' and Has Begun to Implement a Successful Turnaround Basic Framework of GM Turnaround: • Focus on Expenses Eliminated some of the legacy entitlements - swapped employee healthcare for equity ownership. Significantly changed operating efficiency - took out costs so that GM was able to operate at breakeven at bottom of the cycle and turn cash flow positive during other parts of its business cycle. • Focus on Revenue Changed business model to move away from lowering cost to improving vehicle quality. engineering and styling. USA Inc. I Consequences of Inaction 434 EFTA01123468 This page is intentionally left blank. 435 This page is intentionally left blank. 436 EFTA01123469 Summary USA Inc.' Summary 037 Highlights from F2010 USA Inc. Financials • Summary — USA Inc. has challenges. • Cash Flow — While recession depressed F2008-F2010 results, cash flow has been negative for 9 consecutive years ($4.8 trillion, cumulative), with no end to losses in sight. Negative cash flow implies that USA Inc. can't afford the services it is providing to 'customers,' many of whom are people with few alternatives. • Balance Sheet — Net worth is negative and deteriorating. • Off-Balance Sheet Liabilities — Off-balance sheet liabilities of at least $31 trillion (primarily unfunded Medicare and Social Security obligations) amount to nearly $3 for every $1 of debt on the books. Just as unfunded corporate pensions and other post-employment benefits (OPEB) weigh on public corporations, unfunded entitlements, over time, may increase USA Inc.'s cost of capital. And today's off-balance sheet liabilities will be tomorrow's on-balance sheet debt. • Conclusion — Publicly traded companies with similar financial trends would be pressed by shareholders to pursue a turnaround. The good news: USA Inc.'s underlying asset base and entrepreneurial culture are strong. The financial trends can shift toward a positive direction, but both 'management' and 'shareholders' will need collective focus, willpower, commitment, and sacrifice. Note. USA federal fiscal year ends in September: Cash low- total revenue - total &omicrons, on a cash basis: net worth includes unfunded future Asbities from Social Seoul, and Alcamo on an accrual:psis over the next 75 years. Source: e3SI) Now per White NOUS! Office olatanagemeN and Budget. net wort per Dept. of Treasury. '2010 Finn& Report of the U.S. Government.' accusled to ;nab° whim:led babblers of Social Semagy and Atectrarre. USA Inc. I Summary 038 EFTA01123470 Drilldown on USA Inc. Financials... • To analysts looking at USA Inc. as a public corporation, the financials are challenged - Excluding Medicare / Medicaid spending and one-time charges, USA Inc. has supported a 4% average net marginl over 15 years, but cash flow is deep in the red by negative $1.3 trillion last year (or -$11,000 per household), and net worth2 is negative $44 trillion (or -$371,000 per household). • The main culprits: entitlement programs, mounting debt, and one-time charges Since the Great Depression. USA Inc. has steadily added "business lines" and, with the best of intentions, created various entitlement programs. Some of these serve the nation's poorest, whose struggles have been made worse by the financial crisis. Apart from Social Security and unemployment insurance, however, funding for these programs has been woefully inadequate — and getting worse. Entitlement expenses (adjusted for inflation) rose 70% over the last 15 years, and USA Inc. entitlement spending now equals $16,600 per household per year: annual spending exceeds dedicated funding by more than $1 trillion (and rising). Net debt levels are approaching warning levels, and one-time charges only compound the problem. Some consider defense spending a major cause of USA Inc.'s financial dilemma. Re-setting priorities and streamlining could yield savings — $788 billion by 2018, according to one recent study3 — perhaps without damaging security. But entitlement spending has a bigger impact on USA Inc. financials. Although defense nearly doubled in the last decade, to 5% of GDP, it is still below its 7% share of GDP from 1948 to 2000. It accounted for 20% of the budget in 2010, but 41% of all government spending between 1789 and 1930. Note; 51 Net marMn defined as net Moon* alvided by total revenue: 2) net math defined as assets Mx. stewards?* assets Me national paths and Amen& assets Me the Washington Monumettipnirrus Nal:gibes minus the net plasm), value of unfunded entitlements (such as Social Secunly and Medicate). data pee Tteasuly Dept.'s 1010 Annual Repartee the U.S. Govemmenfl 3) Gordon Adams and Matthew Leafhtfill311. 'A Leaner and !leaner National Defense.-ForMan AK airs. JanTeb 20ft) USA Inc. I Summary 439 ...Drilldown on USA Inc. Financials... • Medicare and Medicaid, largely underfunded (based on `dedicated' revenue) and growing rapidly, accounted for 21% (or $724B) of USA Inc.'s total expenses in F2010, up from 5% forty years ago - Together, these two programs represent 35% of all (annual) US healthcare spending: Federal Medicaid spending has doubled in real terms over the last decade, to $273 billion annually. • Total government healthcare spending consumes 8.2% of GDP compared with just 1.3% fifty years ago; the new health reform law could increase USA Inc.'s budget deficit - As government healthcare spending expands, USA Inc.'s red ink will get much worse if healthcare costs continue growing 2 percentage points faster than per capita income (as they have for 40 years). • Unemployment Insurance and Social Security are adequately funded...for now. The future, not so bright Demographic trends have exacerbated the funding problems for Medicare and Social Security — of the 102 million increased enrollment between 1965 and 2009, 42 million (or 41%) is due to an aging population. With a 26% longer life expectancy but a 3% increase in retirement age (since Social Security was created in 1935), deficits from Social Security could add $11.6 trillion (or 140%) to the public debt by 2037E, per Congressional Budget Office (CBO). USA Inc.' Summary 440 EFTA01123471 ...Drilldown on USA Inc. Financials • If entitlement programs are not reformed, USA Inc.'s balance sheet will go from bad to worse Public debt has doubled over the last 30 years. to 62% of GDP. This ratio is expected to surpass the 90% threshold' — above which real GDP growth could slow considerably — in 10 years and could near 150% of GDP in 20 years if entitlement expenses continue to soar, per CBO. As government healthcare spending expands, USA Inc.'s red ink will get much worse if healthcare costs continue growing 2 percentage points faster than per capita income (as they have for 40 years). • The turning point: Within 15 years (by 2025), entitlements plus net interest expenses will absorb all — yes, all — of USA Inc.'s annual revenue, per CBO That would require USA Inc. to borrow funds for defense, education, infrastructure, and spending. which today account for 32% of USA Inc. spending (excluding one-time items), down dramatically from 69% forty years ago. It's notable that CBO's projection from 10 years ago (in 1999) showed Federal revenue sufficient to support entitlement spending + interest payments until 2060E - 35 years later than current projection. K P CB Note. 'Carmen Reinhart and Kenneth Regal/ observed from 2700 historical amide) data points from 44 countnes that the relationshipbetweengovernment debt and real GOP growth is weak lot debtGDP ratios below a threshold 0190 percent of GOP Above 90 percent. median grow(/' sates lab by one percent. and averagegrowth tails considerably more. We note that while firrithart and Rowel's observations are based on gross debt data. in the U.S.. debt herd by the public is close/ to the European counsel definition of government gloss del. For more information. see Reinhart and Regal( -Growth in a Tuned Debt.-1/10. USA Inc. I Summary 041 How Might One Think About Turning Around USA Inc.?... • Key focus areas would likely be reducing USA Inc.'s budget deficit and improving / restructuring the `business model'... One would likely drill down on USA Inc.'s key revenue and expense drivers, then develop a basic analytical framework for 'normal' revenue / expenses, then compare options. Looking at history... Annual growth in revenue of 3% has been roughly in line with GDP for 40 years' while corporate income taxes grew at 2%. Social insurance taxes (for Social Security / Medicare) grew 5% annually and now represent 37% of USA Inc. revenue, compared with 19% in 1965. Annual growth in expenses of 3% has been roughly in line with revenue, but entitlements are up 5% per annum - and now absorb 51% of all USA Inc.'s expense - more than twice their share in 1965; defense and other discretionary spending growth has been just 1-2%. One might ask... Should expense and revenue levels be re-thought and re-set so USA Inc. operates near break-even and expense growth (with needed puts and takes) matches GDP growth, thus adopting a 'don't spend more than you earn' approach to managing USA Inc.'s financials? Note: 'We Moses 40-year period from 1965 to 2005 to exam,. /vernal' levels of revenue and expenses. We did not choose the most recent 40.year penort (196910 2009) as USA was in deep recession in 2008/2009 and underwent significant tax poky !Valuations in 1969/1969. so many metrics (Ake individual income and corporate pion') vatted significantly from Ponnar LISA Inc. I Summary 042 EFTA01123472 ...How Might One Think About Turning Around USA Inc.? One might consider... • Options for reducing expenses by focusing on entitlement reform and operating efficiency Formula changes could help Social Security's underfunding. but look too draconian for Medicare/Medicaid; the underlying healthcare cost dilemma requires business process restructuring and realigned incentives. Resuming the 20-year trend line for lower Federal civilian employment, plus more flexible compensation systems and selective local outsourcing, could help streamline USA Inc.'s operations. • Options for increasing revenue by focusing on driving long-term GDP growth and changing tax policies USA Inc. should examine ways to invest in growth that provides a high return (ROI) via new investment in technology, education, and infrastructure and could stimulate productivity gains and employment growth. Reducing tax subsidies (like exemptions on mortgage interest payments or healthcare benefits) and changing the tax system in other ways could increase USA Inc.'s revenue without raising income taxes to punitive — and self-defeating — levels. Such tax policy changes could help re-balance USA's economy between consumption and savings and re-orient business lines towards investment-led growth, though there are potential risks and drawbacks. • History suggests the long-term consequences of inaction could be severe - USA Inc. has many assets, but it must start addressing its spending/debt challenges now. USA Inc. I Summary 043 Sizing Costs Related to USA Inc.'s Key Financial Challenges & Potential AND / OR Solutions • To create frameworks for discussion, the next slide summarizes USA Inc.'s various financial challenges and the projected future cost of each main expense driver. The estimated future cost is calculated as the net present value of expected 'dedicated' future income (such as payroll taxes) minus expected future expenses (such as benefits paid) over the next 75 years. • Then we ask the question: `What can we do to solve these financial challenges?' The potential solutions include a range of simple mathematical illustrations (such as changing program characteristics or increasing tax rates) and/or program-specific policy solutions proposed or considered by lawmakers and agencies like the CBO (such as indexing Social Security initial benefits to growth in cost of living). • These mathematical illustrations are only a mechanical answer to key financial challenges and not realistic solutions. In reality, a combination of detailed policy changes will likely be required to bridge the future funding gap. USA Inc. I Summary 044 EFTA01123473 Overview of USA Inc.'s Key Financial Challenges & Potential and/or Solutions Rank Financial Challenge Net Present Cost' ($T f % of 2010 GDP) Mathematical Illustrations and/or Potential Policy Solutions2 • Isolate and address the drivers of medical cost inflation 1 Medicaid $35 Trillion3 / 239% • Improve efficiency / productivity of healthcare system • Reduce coverage for optional benefits & optional enrollees • Reduce benefits 2 Medicare $23 Trillion / 156% • Increase Medicare tax rate • Isolate and address the drivers of medical cost inflation • Improve efficiency / productivity of healthcare system • Raise retirement age • Reduce benefits 3 Social Security $8 Trillion / 54% • Increase Social Security tax rate • Reduce future initial benefits by indexing to cost of living growth rather than wage growth • Subject benefits to means test to determine eligibility 4 Slow GDP / USA • Invest in technology / infrastructure / education • Remove tax & regulatory uncertainties to stimulate employment growth Revenue Growth • Reduce subsidies and tax expenditures & broaden tax base Government • Resume the 20-year trend line for lower Federal civilian employment 5 Inefficiencies • Implement more flexible compensation systems • Consolidate / selectively local outsource certain functions Note: t) Net Present Cosl is calculate: as Ore present value of expected future net liabilities (expected revenue minus expected costs) for each program tissue over the near 75 yews. Afmkare estimate per Dept of Treasury. TOW Financial Report of Are U.S. Govenvnenr Social Security &Ornate per Social Security Trustees' Report 40). 2) Far more detailson potential sohnions. see skies 2524 (0 or furl USA Inc. presentation. 3)Methcard does not have dedicated revenue source and its $357 net g Modes funcring from general fax revenue. NPV analysis based on 3% discount roe appLed to CCM projection be annual infrationAchirsted expenses. USA Inc. I Summary 445 The Essence of America's Financial Conundrum & Math Problem? While a hefty 80% of Americans indicate balancing the budget should be one of the country's top priorities, per a Peter G. Peterson Foundation survey in 11/09... ...only 12% of Americans support cutting spending on Medicare or Social Security, per a Pew Research Center survey, 2/11. Some might call this 'having your cake and eating it too...' USA Inc. _urn. 446 EFTA01123474 The Challenge Before Us Policymakers, businesses and citizens need to share responsibility for past failures and develop a plan for future successes. Past generations of Americans have responded to major challenges with collective sacrifice and hard work. Will ours also rise to the occasion? KP CB USA Inc. I Summary 447 Current Observations About America... • On many fronts, USA Inc. is in great shape, but it has one big problem - USA Inc. spends too much and, in effect, is maxing out its credit card. USA Inc. must address the problem. In 2009, 64% of America's revenue went to Social Security, Medicare & Medicaid, compared with 31% in 1980 and 20% in 1970. Using current projections, 100% of America's revenue in 2025 will go to Social Security, Medicare, Medicaid and Net Interest Expense. This raises the question, 'How will America pay for the likes of education, national defense, homeland security, infrastructure improvement, law enforcement, postal service, etc.?' USA Inc.'s fundamental tradeoff is that it must balance its FUTURE (education) with its PRESENT (national defense & homeland security) and its PAST (Social Security & Medicare & Medicaid). Source. 2009 data per White House Oh07. 2025 forecast pee atas Alternative Fiscal Scenario. USA Inc. l Summary 048 EFTA01123475 ...Current Observations About America • It's Time to Rise to the Occasion, It's America's Tradition... • The essence of the 'American dream' is about the underdog succeeding / the turnaround story...every generation or so has an opportunity to rise to an occasion (and sacrifice) and show why America (and its democratic form of government) are great. For this generation, the biggest challenge may be staving off financial hardship. • Collective Sacrifice and Hard Work are the Two Inter- Related Ways out of USA Inc.'s Problems... USA Inc.l Summary 449 This page is intentionally left blank. 450 EFTA01123476 This page is intentionally left blank. 451 This page is intentionally left blank. 452 EFTA01123477 Appendix USA Inc. I Appends 453 Appendix Additional Datapoints on Federal Debt USA ,n.c. I Appends 454 EFTA01123478 Federal Debt Held by the Public vs. Gross Debt • Federal Debt Held by the Public ($9 Trillion Outstanding, 62% of GDP in 2010) Value of all federal securities sold to the public that are still outstanding. Represents the cumulative effect of past federal borrowing on today's economy and on the current federal budget. Net interest payments represent a burden on current taxpayers. • Gross Debt ($14 Trillion Outstanding, 94% of GDP in 2010) Public debt + intragovernmental debt (related to entities including the Social Security Trust Fund and federal employee / veterans' pension fund) + net liability of GSEs (related to likes of Fannie Mae and Freddie Mac). Represents a claim on both current and future resources. • We Focus on Public Debt Levels Public debt is the base for calculating net interest payments. Gross debt level could be misleading (to take an extreme example, simply eliminating all trust funds without changing promised benefits for the associated programs would dramatically reduce gross debt from 94% of GDP to 62% of GDP without improving long- term fiscal outlook at air). In the future, when intragovernmental debt + net liability of GSEs begin demanding repayments, it is likely financed via material increases in public debt levels. Note: la more details. see James R. Homey. 'Recommendation That President's Fiscal Convnissron Focus on Gross Debt is Misgurdect' 527/ I O. Data source: While House OMB. COO. USA Inc. I Appends 455 Public Debt = Gross Debt — Intra-Governmental Holdings — Net Liabilities of Government-Sponsored Enterprises (GSEs) 1960 Real Gross Debt Outstanding $2.0 Trillion Other Intragoyemmental Other Holdings Intragoyernmental Holdings 2010 Real Gross Debt Outstanding $13.5 Trillion Net Liabilities of GSEs* Social Security Trust Fund Social Securi Trust Fund Public Debt $9.0T Debt Held By the Public 62% KP CB Note: Data are inflation mpusted.' Net notaries of CBEs assumes 50% loss ratio on $2500 delinquent loans hefd by Fannie Afse / Freddie Mac. Data source: Dept of Treasury. Where House Dike of Management and Budget USA Inc. I Appends 456 EFTA01123479 Gross Debt Level = Approaching 100% of GDP USA Gross Federal Debt as % of GDP, 1940 — 2010 120% 100% Gross Debt As % of GDP 80% 60% 40% 20% Debt Held By the Public 2010 Gross Federal Debt = 94% of GDP ragovernment Debt 0% ' 1940 1946 1952 1958 1964 1970 1976 1982 1988 1994 2000 2006 Source: Wfule House OMB. USA Inc. I Appends 057 Gross Debt Level = Would Exceed Current Statutory Limit of $1.43T* Within One Year 16,000 14,000 12,000 a 10,000 8,000 co 2 O 6,000 4,000 2,000 0 USA Gross Federal Debt vs. Statutory Debt Ceiling, 1990 — 2011E USA Inc. Gross Debt —11— Statutory Debt Limit 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010E Now. As of 1/11. Source. Whale House OMB. USA Inc. I Appends 458 EFTA01123480 'Top 75' Countries Ranked by Net Debt as % of GDP... Rank Country 2009 Net Debt Outstanding ($8) WY AS% of World Total 1 Zimbabwe 37 13% 0% 2 Japan 9.149 12 26 3 Italy 2.434 0 7 4 Singapore 186 3 1 5 Greece 374 8 1 6 Egypt 198 16 1 7 Belgium 454 0 1 8 Sudan 53 -6 0 9 Hungary 104 -8 0 lo cote= 19 -3 0 11 France 2.028 5 6 12 Portugal 167 3 0 13 Germany 2.423 1 7 14 Austda 263 2 1 15 India 854 -3 2 16 Uruguay 21 -2 0 17 UK 1,444 3 4 18 Canada 870 -5 3 19 Netherlands 603 -1 1 20 Morocco 58 2 0 21 Ireland 140 19 0 22 Albania 7 -3 0 23 Argentina 178 -7 1 24 Philippines 93 -2 0 25 USA 7.811 23 23 Top 1.25 329.836 i% 86% Global 34.632 8 100 Net Debl as % of GDP 2009 2005 0549 Change 190% -- - 181 162 19 116 106 11 114 99 15 111 99 12 105 -- - 98 92 6 97 -- - 84 62 22 81 •• — 77 66 11 76 63 13 75 68 7 70 64 6 69 80 -12 67 67 0 66 42 24 66 70 -4 64 52 12 64 -- - 62 27 34 60 57 3 59 59 0 59 71 -13 55 37 17 75% 67% 8% 68 66 2 2009 GDP As % of 2009 Budget As %of 2009 World Surplus / World Gross Unary,loy- Y/Y ($B) WY Total Deficit ($9) Deficit ment Rate (pps) 34 4% ti 41 0% 5.049 -5 -980 33 5% .1 2.090 -5 4 — 8 .1 163 -2 -5 0 3 •1 338 -2 -27 1 9 .2 188 5 -27 1 -- 461 -3 -1 0 8 .1 54 5 4 -- 124 -6 9 -- 23 - 0 -- " 2,635 -2 -105 4 9 .2 220 -3 -6 0 9 .2 3,235 -5 -16 1 7 0 374 -4 -5 0 5 .1 1,243 6 31 - - - 32 2.198 3 -5 0 -- -- 49 2 7 •• .2 1,319 -3 44 - 8 .2 790 4 4 - 4 .1 91 5 -1 0 - .. 227 -7 -23 1 12 .6 12 3 0 -- - - 301 14 - - - 159 1 2 14.266 -2 2 -1,438 $35,595 -2% 61% 52,662 92% 8% 1 57.937 -2 100 2.586 100 7 2 Source: MC Business InteMgente Mona. USA Inc. I Appends 459 ...'Top 75' Countries Ranked by Net Debt as % of GDP... Rank Country 2009 Net Debt Outstanding ($B) WY As%ol World Total Net Debl as % of GDP 2009 GDP (38) WY As % of World Total 2009 Budge! As %of 2009 Surplus / World Gross Unemploy - Deficit (38) Deficit ment Rate WY (pps) 2009 2005 05-09 Change 26 Tunisia $22 -3% 0% 55% 55 0 $40 3% 0% 1 0 27 Ethiopia 18 29 0 55 -- 34 10 0 -4 0 28 Colombia 123 -5 0 54 54 0 229 0 0 7 - 29 Cyprus 12 2 0 54 68 -14 21 -2 0 -0 5 .2 30 Poland 223 -11 1 53 47 6 423 2 1 26 - - - 31 Spain 757 al 2 53 43 10 1,438 4 2 425 4 18 .7 32 Kenya 15 2 0 51 -- - 30 2 0 -0 0 - -- 33 Norway 187 -17 1 51 45 6 389 -2 1 38 - 3 .1 34 Ghana 7 -11 0 48 -- - 15 4 0 1 - -- 35 Bolivia 8 6 0 46 46 0 18 1 0 -0 - - -- 36 Sweden 175 4 1 44 51 -7 398 4 1 9 - 8 .2 37 Brazil 860 4 2 44 44 0 1.482 0 3 40 - - - 38 Switzerland 212 5 1 44 53 -9 484 -1 1 40 0 4 .1 39 Latvia 10 56 0 43 12 30 24 -18 0 -4 0 - -- 40 Malawi 2 15 0 42 - - 5 8 0 -0 0 - 41 Malaysia 84 0 0 41 44 -3 207 -2 0 0 - 42 Denmark 125 7 0 40 38 3 308 4 1 4 0 3 .2 43 Gabon 4 -25 0 38 - 11 -1 0 1 - -- 44 Finland 91 -2 0 37 42 -4 242 -8 0 2 8 .2 45 Turkey 219 44 1 37 52 -15 594 4 1 36 - - - 46 Czech Republic 68 6 0 36 30 6 190 4 0 -4 0 7 .2 47 Slovenia 17 43 0 35 27 8 50 -7 0 -5 0 6 .2 48 Slovakia 30 10 0 34 44 .10 88 -5 0 -3 0 49 Croatia 21 -5 0 34 38 .5 62 -6 0 1 -- 60 Australia 309 -3 1 34 36 -3 920 1 2 8 - 6 .1 Top 28-50 $3,392 0% 10% 44% 44% 0% 57.6432 -2% 13% 3164 6% 6% 2 Global 34632 8 100 68 66 2 57.937 -2 100 2.886 100 7 2 KI) ce Source; IMF. BIAVIIOSS leINgence Walla. USA Inc.1 Appends 460 EFTA01123481 ...'Top 75' Countries Ranked by Net Debt as % of GDP As % of 2009 Net Debt World Rank Country Outslandkvg (Sal NW Total Net Debt as % of GDP 05-09 2009 GDP 2009 2005 Change (38) As %ol World WY Total 2009 Budget As %of 2009 Surplus World Gross Unernploy- YIY Deficit (BB) Deficit men! Rale (pps) 51 Zambia SO -16% 52 Macedonia 3 1 53 Ecuador 17 2 54 Lithuania 11 45 55 Peru 37 0 56 South Africa 78 0 57 Paraguay 4 -15 68 Venezuela 95 11 59 New Zealand 29 -10 60 Thailand 64 1 61 Namibia 2 2 62 Tanzania 5 7 63 Senegal 3 -6 64 Mozambique 2 -2 65 Romania 35 29 66 Uganda 3 8 67 Bulgaria 7 -4 68 Nigeria 24 -20 69 Angola 10 -18 70 Cameroon 3 -8 71 China 609 7 72 Kazakhstan 11 3 73 Algeria 13 -16 74 Russia 92 -15 75 Estonia I 15 0% 32% 32 - $12 6% 31 47 -16 9 - 30 30 0 56 0 30 18 11 36 -15 29 29 0 127 1 28 -- - 277 -2 V V 0 14 -5 27 27 0 363 -3 26 V -1 110 -2 24 26 -2 266 -2 24 - - 9 -1 24 -- - 22 5 23 -- - 13 2 22 -- - 10 6 22 16 6 161 -7 21 -- - 16 7 15 29 -14 45 -5 15 -- - 165 6 15 -- - 70 0 14 -- - 22 2 13 18 -5 4,758 9 11 -- - 107 1 10 •• - 135 2 7 14 -7 1,255 -8 7 5 5 IS -11 1 -0 0 -0 0 -3 0 O -- -0 0 1 -9 0 3 6 .2 -0 0 -0 -0 0 O -- O -- -8 0 -0 0 0 6 2 0 -38 1 -0 0 2 17 -- O 0 Top 51.75 31.163 0% 3% 23% 27% -4% $8.064 0% 14% 560 2% 6% 2 Global 34.632 8 100 68 66 2 57.937 -2 100 2586 100 7 2 141 Note: China's net dela may be undepteponed as it excludes potential habiebes from bad loans of slate owned bait. Source: IMF. ElleineSS Inlagente /40440f. USA Inc.l Appendx 461 OECD Countries Ranked by Gross Debt as °/0 of GDP 2009 Gross Debt As %01 Rank Country Outstanding (5B) WY OECD Tota Gross Debt as %of GDP 05-09 2009 GDP As % of 2009 2005 Change (58) TN OECD Total 193% 175% 18% 55.049 -5% 13% 129 120 9 2.090 -5 5 123 53 70 12 -28 0 119 114 5 338 -2 1 101 96 5 461 -3 1 87 74 13 220 -3 1 86 76 11 2,635 -2 7 84 69 16 124 -s 0 63 61 22 14266 -2 36 82 72 11 1,319 -3 3 76 71 5 3,235 -5 8 72 46 26 2,198 -5 6 70 71 -1 374 -4 1 70 33 38 227 -7 1 69 61 7 790 -4 2 63 51 12 1,438 -4 4 58 55 4 423 2 1 53 48 4 242 -8 1 52 46 6 308 -5 1 52 60 -6 398 -a 1 49 49 0 369 -2 1 42 34 a 190 -a 0 42 56 -15 484 -1 1 39 38 1 88 -5 0 35 27 a 110 -2 0 35 27 8 833 -11 2 19 16 3 920 1 2 18 e 11 52 -11 0 1 Japan 2 Italy 3 Iceland 4 Greece 5 Belgium 6 Portugal 7 France 8 Hungary 9 USA 10 Canada 11 Germany 247 -2 7 12 UK 159 4 4 13 Austria 26 -4 1 14 Ireland 16 23 0 15 Netherlands 54 -6 1 16 Spain 90 18 2 17 Poland 25 -14 1 18 Finland 13 15 0 19 Denmark 16 11 0 20 Sweden 21 -8 1 21 Norway 18 -28 0 22 Czech Republic 8 2 0 23 Switzerland 20 -5 1 24 Slovakia 3 17 0 25 New Zealand 4 3 0 26 Korea 29 -3 1 27 Australia 18 28 0 28 Luxembourg 1 -5 0 5974 14% 27% 269 1 7 1 -8 0 40 8 1 47 -1 1 19 4 1 227 5 6 10 -13 0 1.184 17 32 109 4 3 OECD Total 55648 9% 100% 90% 76% 14% 539,261 -4% 100% KP cc Note:Data km Sbevenia and Estonia not available. Data may after from Eurasia( Aedonal government figures. Gross dad data are not always comparable across countries due to Simms definitions or treatment of debt components Notably. USA and Austria gross debt include he funded portion of government employee pension kabala:es. YAM overstates Ter deb/levels relative to other cou4/444 Source: OECD. USA Inc.l Appends 462 EFTA01123482 Total Government + Private Debt in USA — At Historic High of 360% of GDP USA Total Credit Market Debt Outstanding as % of GDP, 1929 - 2009 350% 300% EL • 250% 1°. 200% 0 co • 150% 2 100% 0% GSE 1929 1934 1939 1944 1949 1954 1959 1964 1969 1974 1979 1984 1989 1994 1999 2004 2009 ■Households ■Corporates • Financials ■GSE • Government Souse& Dept of Dengue/. Fedefailleseme USA Inc. ] Appends 083 Appendix Useful Links USA Inc. I Appends 464 EFTA01123483 Appendix — Useful Links • Congressional Budget Office, "The Long-Term Budget Outlook," 6/2010 • Congressional Budget Office, "Budget and Economic Outlook, Fiscal Years 2011 Through 2021," 112011 • Department of Health & Human Services, Centers for Medicare & Medicaid Services. "The 2010 Annual Report of the Board of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds," 8/5/2010 • Department of the Treasury, "2010 Financial Report of the United States Government: 12/2010 • National Commission on Fiscal Responsibility and Reform, 'The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform," 12/1/2010 • Social Security Administration, "The 2010 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds: 8/9/2010 • White House Office of Management and Budget, "Budget of the United States Government, Fiscal Year 2012," 2/2011 USA Inc. Append. 465 Disclaimer This report has been compiled by Mary Meeker and her co-contributors (collectively referred to below as the "Contributors") for informational purposes only. It is not intended to serve as the basis for investment, legal, political, tax or any other advice. Furthermore, this report is not to be construed as a solicitation or an offer to buy or sell securities in any entity, including any entity that is associated with the Contributors. The information contained in this report has been compiled from public sources that the Contributors believe to be reliable. While the Contributors find no reason to believe that the data relied upon and presented in this report are factually incorrect, they have made no separate investigation or otherwise independently verified the accuracy of such data. As such, the Contributors cannot guarantee the accuracy of any of the data (raw or interpreted) and accordingly the Contributors make no warranties (express, implied or statutory) as to the information in this report. This report summarizes a significant amount of publicly available data, and is not intended to be all- inclusive. The Contributors have complied this report based on selected sources that they believe to be most pertinent to the presented subject matter. Furthermore, the graphic illustrations are based on generalized calculations and are provided for illustrative purposes. Readers are encouraged to conduct their own analysis of the data underlying this report, as well as data from other sources, so as to come to their own conclusions. The information presented in this report represents the view of the Contributors, and does not necessarily reflect the views of Kleiner Perkins Caufield & Byers or any of its associated management personnel, investment vehicles, investors, portfolio companies or any affiliates or associates of the foregoing. USA Inc. App=nth 466 EFTA01123484 This page is intentionally left blank. 487 This page is intentionally left blank. 488 EFTA01123485 Glossary Accountable Care Organization (ACO) - A health system model with the ability to provide, and manage with patients, the continuum of care across different institutional settings, including at least ambulatory (outpatient) and inpatient hospital care and possibly post acute care. ACOs have the capability of planning budgets and resources and are of sufficient size to support comprehensive, valid, and reliable performance measurement. The ACO model is one of the latest designs for managing healthcare costs and especially Medicare costs, and is gaining traction among policymakers desperate to control costs and boost quality in healthcare. Accrual accounting - A system of accounting in which revenues are recorded when they are earned and outlays are recorded when goods are received or services are performed, even though the actual receipt of revenues and payment for goods or services may occur, in whole or in part, at a different time. Compare with cash accounting. Adjusted Gross Income (AGI) - All income that is subject to taxation under the individual income tax after "above-the-line" deductions for such things as alimony payments and certain contributions to individual retirement accounts. Personal exemptions and the standard or itemized deductions are subtracted from AGI to determine taxable income Alternative Minimum Tax (AMT) - A tax intended to limit the extent to which higher- income people can reduce their tax liability (the amount they owe) through the use of preferences in the tax code. Taxpayers subject to the AMT are required to recalculate their tax liability on the basis of a more limited set of exemptions, deductions, and tax credits than would normally apply. The amount by which a taxpayer's AMT calculation exceeds his or her regular tax calculation is that person's AMT liability. American Recovery and Reinvestment Act of 2009 (ARRA) - This act provided appropriations for several federal programs and increased or extended some benefits payable under Medicaid, unemployment compensation, and nutrition assistance, among others. ARRA also reduced individual and corporate income taxes and made other changes to tax laws. Asset-Backed Security - Security backed by real estate or another type of asset; a claim on an income flow, such as expected interest payments on loans, payments on leases, royalty payments, or receivables; a claim on the principal of a loan; or a claim on the expected appreciation of an asset. Automatic Stabilizers - Taxes that decrease and expenditures that increase when the economy goes into a recession (and vice-versa when the economy booms) without requiring any action on the part of the government. Stabilizers tend to reduce the depth of recessions and dampen booms. K P CB USA Inc. xix EFTA01123486 Bundled Payment (Healthcare) - Also known as episode-based payment, defined as the reimbursement of health care providers (such as hospitals and physicians) on the basis of expected costs for clinically- defined episodes of care. It has been described as "a middle ground" between fee-for-service reimbursement (in which providers are paid for each service rendered to a patient) and capitation (in which providers are paid a "lump sum" per patient regardless of how many services the patient receives). Business Cycle - Fluctuations in overall business activity accompanied by swings in the unemployment rate, interest rates, and corporate profits. Over a business cycle, real (inflation-adjusted) activity rises to a peak (its highest level during the cycle) and then falls until it reaches a trough (its lowest level following the peak), whereupon it starts to rise again, defining a new cycle. Business cycles are irregular, varying in frequency, magnitude, and duration. (NBER) See real and unemployment rate. Cash Accounting - A system of accounting in which revenues are recorded when they are actually received and outlays are recorded when payment is made. Compare with accrual accounting. Centers for Medicare & Medicaid Services (CMS) - US federal agency which administers Medicare, Medicaid, and the Children's Health Insurance Program. Copayment — A flat amount paid out of pocket per medical service, e.g., $5 per office visit. Congressional Budget Office (CBO) — A non-partisan federal agency within the legislative branch of the U.S. government, charged with reviewing congressional budgets and other legislative initiatives with budgetary implications. Conservatorship - The legal process by which an external entity (in the case of Fannie Mae and Freddie Mac, the federal government) establishes control and oversight of a company to put it in a sound and solvent condition. Consumption - In principle, the value of goods and services purchased and used up during a given period by households and governments. In practice, the Bureau of Economic Analysis counts purchases of many long-lasting goods (such as cars and clothes) as consumption even though the goods are not used up. Consumption by households alone is also called consumer spending. See national income and product accounts. Cost-of-Living Adjustment (COLA) - An annual increase in Social Security and other entitlement payments to reflect price inflation. Current-Account Balance - A summary measure of a country's current transactions with the rest of the world, including net exports, net unilateral transfers, and net factor income (primarily the capital income from foreign property received by residents of a country offset by the capital income from property in that country flowing to residents of foreign countries). Cyclical Deficit or Surplus - The part of the federal budget deficit or surplus that results from the business cycle. The cyclical component reflects the way in which the deficit or surplus automatically increases or decreases during economic expansions or recessions. Cyclically Adjusted Budget Deficit or Surplus - The federal budget deficit or surplus that would occur under current law if the influence of the business cycle was removed—that is, if the economy operated at potential gross domestic product. USA Inc. xx EFTA01123487 Debt - In the case of the federal government, the total value of outstanding bills, notes, bonds, and other debt instruments issued by the Treasury and other federal agencies. That debt is referred to as federal debt or gross debt. It has two components - debt held by the public federal debt held by nonfederal investors, including the Federal Reserve System) and debt held by government accounts (federal debt held by federal government trust funds, deposit insurance funds, and other federal accounts). Debt subject to limit is federal debt that is subject to a statutory limit on the total amount issued. The limit applies to gross federal debt except for a small portion of the debt issued by the Treasury and the small amount of debt issued by other federal agencies (primarily the Tennessee Valley Authority and the Postal Service). Deductible (Medical Insurance) - A fixed amount, usually expressed in dollars in the form of an annual fee, that the beneficiary of a health insurance plan must pay directly to the health care provider before a health insurance plan begins to pay for any costs associated with the insured medical service. Deficit - The amount by which the federal government's total outlays exceed its total revenues in a given period, typically a fiscal year. The primary deficit is that total deficit excluding net interest. Defined Benefit Pension Plan — Retirees receive predetermined monthly retirement benefits from employers despite the funding status / investment returns of their pension funds. Defined Contribution Pension Plan — Retirees contribute specified amount to their pension funds and receive variable monthly retirement benefits depending on investment returns. Examples include Individual Retirement Accounts (IRAs) and 401(k) plans. Disposable Personal Income - Personal income—the income that people receive. including transfer payments—minus the taxes and fees that people pay to governments. Economic Stimulus - Federal fiscal or monetary policies aimed at promoting economic activity, used primarily during recessions. Such policies include reductions in taxes, increases in federal spending, reductions in interest rates, and other support for financial markets and institutions. Entitlement - A legal obligation of the federal government to make payments to a person, group of people, business, unit of government, or similar entity that meets the eligibility criteria set in law and for which the budget authority is not provided in advance in an appropriation act. Spending for entitlement programs is controlled through those programs' eligibility criteria and benefit or payment rules. The best-known entitlements are the government's major benefit programs, such as Social Security and Medicare. Excise Tax - A tax levied on the purchase of a specific type of good or service, such as tobacco products or air transportation services. Federal Poverty Level (FPL) - Income amounts set each February by the U.S. Department of Health and Human Services used to determine an individual's or family's eligibility for various public programs, including Medicaid and the State Children's Health Insurance Program. Federal Reserve System - The central bank of the United States. The Federal Reserve is responsible for setting the nation's monetary policy and overseeing credit conditions. See central bank and monetary policy. K P CB USA Inc. xxi EFTA01123488 Fiscal Policy - The government's tax and spending policies, which influence the amount and maturity of government debt as well as the level, composition, and distribution of national output and income. See debt. Fiscal Year - A yearly accounting period. The federal government's fiscal year begins October 1 and ends September 30. Fiscal years are designated by the calendar years in which they end—for example, fiscal year 2011 will begin on October 1, 2010, and end on September 30, 2011. GDP price index - A summary measure of the prices of all goods and services that make up gross domestic product. The change in the GDP price index is used as a measure of inflation in the overall economy. General Fund - One category of federal funds in the government's accounting structure. The general fund records all revenues and offsetting receipts not earmarked by law for a specific purpose and all spending financed by those revenues and receipts. Government-Sponsored Enterprise (GSE) - A financial institution created by federal law, generally though a federal charter, to carry out activities such as increasing credit availability for borrowers, reducing borrowing costs, or enhancing liquidity in particular sectors of the economy, notably agriculture and housing. Two housing GSEs (Fannie Mae and Freddie Mac) were taken into federal conservatorship in 2008. Health Maintenance Organization (HMO) - A managed care plan that combines the function of insurer and provider to give members comprehensive health care from a network of affiliated providers. Enrollees typically pay limited copayments and are usually required to select a primary care physician through whom all care must be coordinated. HMOs generally will not reimburse all costs for services obtained from a non-network provider or without a primary care physician's referral. HMOs often emphasize prevention and careful assessment of medical necessity. Independent Payment Advisory Board (IPAB) - A 15-member Independent Payment Advisory Board created under PPACA with significant authority with respect to Medicare payment rates. Beginning in 2014, in any year in which the Medicare per capita growth rate exceeded a target growth rate, the IPAB would be required to recommend Medicare spending reductions. The recommendations would become law unless Congress passed an alternative proposal that achieved the same level of budgetary savings. Subject to some limitations—hospitals, for example, would be exempt until 2020—the IPAB could recommend spending reductions affecting Medicare providers and suppliers, as well as Medicare Advantage and Prescription Drug Plans. Labor Force - The number of people age 16 or older in the civilian non-institutional population who have jobs or who are available for work and are actively seeking jobs. (The civilian non-institutional population excludes members of the armed forces on active duty and people in penal or mental institutions or in homes for the elderly or infirm.) The labor force participation rate is the labor force as a percentage of the civilian non-institutional population age 16 or older. Marginal Tax Rate - The tax rate that would apply to an additional dollar of a taxpayer's income. Compare with effective tax rate and statutory tax rate. Ml USA Inc. xxii EFTA01123489 Medicaid - Public health insurance program that provides coverage for low-income persons for acute and long-term care. It is financed jointly by state and federal funds (the federal government pays at least 50 percent of the total cost in each state) and is administered by states within broad federal guidelines. Medicare - Federal health insurance program for virtually all persons age 65 and older, and permanently disabled persons under age 65, who qualify by receiving Social Security Disability Insurance. Mortgage-Backed Securities (MBSs) - Securities issued by financial institutions to investors with the payments of interest and principal backed by the payments on a package of mortgages. MBSs are structured by their sponsors to create multiple classes of claims, or tranches, of different seniority, based on the cash flows from the underlying mortgages. Investors holding securities in the safest, or most senior, tranche stand first in line to receive payments from borrowers and require the lowest contractual interest rate of all the tranches. Investors holding the least senior securities stand last in line to receive payments, after all more senior claims have been paid. Hence, they are first in line to absorb losses on the underlying mortgages. In return for assuming that risk, holders of the least senior tranche require the highest contractual interest rate of all the tranches. National Commission on Fiscal Responsibility and Reform - A bipartisan commission created by President Obama to address the nation's fiscal challenges. The Commission is charged with identifying policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run. Specifically, the Commission shall propose recommendations designed to balance the budget, excluding interest payments on the debt, by 2015. In addition, the Commission shall propose recommendations that meaningfully improve the long-run fiscal outlook, including changes to address the growth of entitlement spending and the gap between the projected revenues and expenditures of the Federal Government. Net Interest - In the federal budget, net interest comprises the government's interest payments on debt held by the public (as recorded in budget function 900), offset by interest income that the government receives on loans and cash balances and by earnings of the National Railroad Retirement Investment Trust. See budget function and debt. Office of Management and Budget (OMB) — White House office responsible for devising and submitting the president's annual budget proposal to Congress. Organization for Economic Co-operation and Development (OECD) — An international organization of 31 developed and emerging countries (see list on slide 354) with a shared commitment to democracy and the market economy. Other Post-Employment Benefits (OPEB) — An accounting concept created by the Governmental Accounting Standards Board (GASB) by pronouncements designed to address expenses that entities may or may not be legally bound to pay, but pay as a moral obligation (such as retirees' healthcare costs). Pay-As-You-Go (PAYGO) - Procedures established in House and Senate rules that are intended to ensure that laws that affect direct spending or revenues are budget neutral. The Senate and the House have had such rules in place since 1993 and 2007, respectively. K P CB USA Inc. xxiii EFTA01123490 PEP I Pease (Tax Policy) - PEP is Personal Exemption Phase-out designed to eliminate personal income exemptions for high earners; 3) Pease is a similar phase-out, but instead of applying to personal exemption, it applies to most of the itemized deductions of a taxpayer's claims (mortgage interest, charitable gifts, state & local taxes paid, etc.); Pease is named after Representative Donald Pease (D-OH) who pushed for its enactment in 1990. Present Value - A single number that expresses a flow of current and future income (or payments) in terms of an equivalent lump sum received (or paid) today. The present value depends on the rate of interest used (the discount rate). For example, if $100 is invested on January 1 at an annual interest rate of 5 percent, it will grow to $105 by January 1 of the next year. Hence, at an annual 5 percent interest rate, the present value of $105 payable a year from today is $100. Patient Protection and Affordable Care Act (PPACA) — A federal statute as the result of the healthcare reform. Signed into law on 3/23/10, the PPACA aims to expand Medicaid eligibility, incentivize businesses to provide health care benefits, prohibit denial of coverage/claims based on pre-existing conditions, establish health insurance exchanges, and support for medical research. The costs of these provisions are offset by a variety of taxes, fees, and cost- saving measures, such as new Medicare taxes for high-income brackets, taxes on indoor tanning, improved faimess in the Medicare Advantage program relative to traditional Medicare, and fees on medical devices and pharmaceutical companies. Productivity - Average real output per unit of input. Labor productivity is average real output per hour of labor. The growth of labor productivity is defined as the growth of real output that is not explained by the growth of labor input alone. Total factor productivity is average real output per unit of combined labor and capital services. The growth of total factor productivity is defined as the growth of real output that is not explained by the growth of labor and capital. Labor productivity and total factor productivity differ in that increases in capital per worker raise labor productivity but not total factor productivity. Tax Expenditures - Losses to the U.S. treasury from granting certain deductions, exemptions, or credits to specific categories of taxpayers. Tax breaks are one method Congress uses to promote certain policy objectives. For example, deductions for mortgages encourage home ownership, while credits for childcare expenses allow single parents to work. Tax expenditures are an alternative to direct government spending on policy programs. Troubled Asset Relief Program (TARP) - A program that permits the Secretary of the Treasury to purchase or insure troubled financial assets. Authority for the program was initially set by the Emergency Economic Stabilization Act of 2008 at $700 billion in assets outstanding at any one time and remains in effect until October 3, 2010. The TARP's activities have included the purchase of preferred stock from financial institutions, support to automakers and related businesses, a program to avert housing foreclosures, and partnerships with the private sector. K P CB USA Inc. xxiv EFTA01123491 Trust Funds - In the federal accounting structure, accounts designated by law as trust funds (regardless of any other meaning of that term). Trust funds record the revenues, offsetting receipts, or offsetting collections earmarked for the purpose of the fund, as well as budget authority and outlays of the fund that are financed by those revenues or receipts. The federal government has more than 200 trust funds. The largest and best known finance major benefit programs (including Social Security and Medicare) and infrastructure spending (such as the Highway Trust Fund and the Airport and Airway Trust Fund). KP CS USA Inc. xxv EFTA01123492 Xxv: EFTA01123493 Index Accounting, Government, 31 ARRA, 200-203 Balance Sheet, 209-217 Budgeting, Government, 32 Business Lines, 38-43 CBO (Congressional Budget Office) Entitlement Spending, 77 Forecasts, 11 Healthcare, 313 Long Term Outlook, 174, 175, 270 Policy Options, 262-264, 324-326 Tort Reform Proposals, 313, 314 Cash Flow, 14, 15, 26, 27, 33 Competitiveness, 390-394 Consequences of Inaction, 413-434 Austerity Measures, 426 Credit Rating, 419 Credit / Debt Crisis, 422-430 Deficits / Swap Rate Correlation, 430 Public Debt, Net Worth vs. Peers, 416-417 Short Term / Long Term, 415 Social Unrest, CDS, 429 Costs & Headcount, 345-348 Debt Composition, 168-172 Crisis, 422-447 Level, 145-160, 247 Defense Spending, 38-41, 63.70 by % GDP, 65, 68 by Country, Rank 67 by Number of Troops, 69, 70 by Type, 64 Deficit 35, 36, 54, 56 Deficit Commission, 256, 265, 326-328, 352, 353, 410, 465 Disability Insurance, 39 Economist vs. Investor Language, 36 Education, 377-382 Employment, 383-388 Entitlement + Interest vs. Revenue, 174, 175 Entitlement Covered Population, 86 Expanded Eligibility, 87 History, 74, 75 Income per Beneficiary, 89 Income vs Personal Savings, 90 Inflation Indexed, 250 Not Contracts, 251 Programs, 15, 17, 37, 43 Social Security % of income, 92 Spending, 72-82 Spending, "Unfunded", 82, 83 Spending Breakdown, 80, 81 Spending Deficit, 75 Spending per Household, 74 Trust Funds, 76, 77 Unfunded, 247 Fannie Mae / Freddie Mac, 182-187, 194-199 Federal Wages & Benefits, 335-337 Financial Challenges, 20, 21, 37, 49 GDP, 44, 356-368, 392, 405, 408 General Motors, 431-434 Growth, Sustainable Economic, 356-368 Ml USA Inc. xxvir EFTA01123494 Headcount, 346-348 Healthcare, 16, 39 Costs 118-120, 279 Indicators, 112, 307 Performance, Life Expectancy, 111 Reform (PPACA), 114-120 Spend, 105-120 Spend vs. OECD countries, 108-112 Spend by funding source, 106 Spend per capita vs. OECD countries, 109 Spend vs. Education, 105 Income Statement, 54, 54-60 India GDP, 44 Infrastructure, 373-376 Interest Rates, 161-167 Medicaid, 16, 95-99, 280-328 Enrollment, Payments Up, 97 Underfunded, 96 State Budgets, 99 Medicare, 16, 43, 101-107, 280-328 Enrollment, Payments Up, 103 Medicare, Medicaid Beneficiaries, 86 Medicare, Medicaid per Beneficiary, 85 Medicare, Medicaid Underfunded, 84 Underfunded, 102 Medicare & Medicaid Restructure, 280-328 CBO Policy Options, 323-325 Deficit Commission Options, 326-328 Economic Factors, 292-310 Growing and Aging Population, 283-286 Improve Efficiency / Productivity, 315-318 Legal Factors, 311-314 Possible Solutions, 290, 291 Reduce Services, Medicaid, 319-322 Social Forces, 282-328 Unhealthy Lifestyles, 287-279 National Commission on Fiscal Responsibility and Reform, see Deficit Commission Net Debt/EBITDA, 34 Net Income, 54 Net Interest Payments, 17 Net Margin, 15, 54, 56 Net Worth, 27, 30 Non-Core 'Business' Out-Sourcing, 350-351 Off Balance Sheet Liabilities, 14, 212, 438 One Time Charges, 177-205 Operating Loss, 35 Out-Sourcing, 350-351 Pensions, 339-341 M, 56, 58 Real Estate, 182-187 Retirement, 42, 257 Social Security, 16, 130-141, 255-267 Solutions, 21 Summary, 13-23, 437-449 Surplus, 54, 56 TARP, 188-192 Tax Policies, 395-410 Tax Rates, 396-399 Tax Subsidies / Expenditures / Broaden Base, 401-410 Technology, 369-372 Tech I Infrastructure I Education, 366-382 USA Inc.xmAir EFTA01123495 Turnaround, 18, 19, 221.410 Competitiveness, 390-394 Constraints, 235 Costs & Headcount, 345.348 Drive Sustainable Growth 355.365 Expense Drivers, 231, 232 Expense Growth, 229, 230 Expenses, 252.353 Federal Wages & Benefits, 325-337 Imperatives, 234 Increase Employment, 383-388 Invest in Education, 377-382 Invest in Infrastructure, 373.376 Invest in Technology, 366.372 Invest in Tech / Infrastructure / Education, 366- 382 Japan Experience, 246 Non-Core 'Business' Out-Sourcing, 350.351 Operating Efficiency, 329.353 Pensions, 338.341 Principles, 244 Questions, 240.243 Reform Entitlements, 253-328 Restructure Medicare & Medicaid, 268.328 Restructure Social Security, 255.267 Revenue Drivers, 227, 228 Revenue Expense Correlation, 222 Revenue Growth, 225, 226 Sensitive, 245 Tax Policies, 395.410 Tax Rates, 396-399 Tax Subsidies / Expenditures / Broaden Base, 401.410 Unions, 342-344 Weak Economy, 236 Unemployment Benefits, 122-128 Insurance, 16 Rates, 267, 346 Unions, 342-344 USA Inc. Data Points, 47 USA Inc .Trends, 48 Wages, 336-337 War in Iraq, Afghanistan, Terror, 66 Ml USA Inc. xxix EFTA01123496 EFTA01123497 EFTA01123498 9 SBN I 781450 978-1-45 h 764506 V 7-6450-6 90000> ll USA inc. -A Basic Summary of America's Financial Statements EFTA01123499