� 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. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 304 …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. Source: Morgan Stanley Healthcare Research. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 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 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 306 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. www.kpcb.com Source: Kaiser/HRET Survey of Employer-Sponsored Health Benefits, 2009 USA Inc. | What Might a Turnaround Expert Consider? 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 1 , Medicare Acute Care Episode Demonstration 2 • Global payment system 3 (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 4 : 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 patients 5 • 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 Source: 1) Cutting Healthcare Costs by Putting Doctors on a Budget, Time 1) Adopted in Rockford, IL in Jan 2010 2) Medicare Demonstration Project Overviews, www.cms.gov/demoprojects 3) Recommendations of the Special Commission on the Healthcare Payment, Commonwealth of Massachusetts 4) Pay for Performance Incentive Programs in Healthcare , Geoffrey Baker 5) How the Center for Medicare & Medicaid Innovation Should Test Accountable Care Organizations, Stephen Shortell, Lawrence P. Casalino and Elliott S. Fisher for Health Affairs, July 2010 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 308 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, 1 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 prices 2 • 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: 1) The Market for Medical Care: Why You Don’t Know the Price; Why You Don’t Know about Quality; And What Can Be Done About It, by Devon M. Herrick and John C. Goodman, March 12, 2007; 2) “Bringing Comparison Shopping to the Doctor’s Office,” The New York Times, June 10, 2010; 3) Healthcare Price Transparency: A Strategic Perspective for State Government Leaders, by Deloitte Center for Health Solutions, 2007 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 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 1 � 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-forperformance, information technology) www.kpcb.com Source: 1) “How Changes in Medical Technology Affect Healthcare Costs,” Kaiser Family Foundation, March 2007. USA Inc. | What Might a Turnaround Expert Consider? 310 Restructure Medicare & Medicaid: Legal Forces that Push Up Healthcare Spending 1) Defensive Medicine 2) Possible Solutions www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 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 2005 1 : • 93% said they had engaged in the practice of Defensive Medicine • 59% said they often ordered more diagnostic tests than medically necessary • 52% said they referred patients to other specialists in unnecessary circumstances • 33% said they often prescribed more medications than medically necessary www.kpcb.com Source: 1) David Studdert, et al., American Medical Association, “Defensive Medicine Among High-Risk Specialist Physicians in a Volatile Malpractice Environment,” 6/2005. USA Inc. | What Might a Turnaround Expert Consider? 312 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 www.kpcb.com Source: Congressional Budget Office, Letter to the Honorable Orrin G. Hatch dated October 9, 2009; Congressional Budget Office, Letter to the Honorable John D. Rockefeller IV dated December 10, 2009 USA Inc. | What Might a Turnaround Expert Consider? 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. www.kpcb.com Source: Congressional Budget Office, Letter to the Honorable Orrin G. Hatch dated October 9, 2009; Congressional Budget Office, Letter to the Honorable John D. Rockefeller IV dated December 10, 2009 USA Inc. | What Might a Turnaround Expert Consider? 314 Restructure Medicare & Medicaid: Policy Option #3 � Improve Efficiency / Productivity of Healthcare System www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 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 85 Average Life Expectancy at Birth (Years) 80 75 Mexico S. Korea Hungary Japan UK Linear Trend line (ex. USA) � USA 70 0 1000 2000 3000 4000 5000 6000 7000 www.kpcb.com Total Expenditure on Health per capita, $US (PPP Adj.) Source: OECD. USA Inc. | What Might a Turnaround Expert Consider? 316 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 Mortality (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 www.kpcb.com Note: *MRI is Magnetic Resonance Imaging. Source: OECD. USA Inc. | What Might a Turnaround Expert Consider? 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 1 � � 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. www.kpcb.com Source: “Research on the Comparative Effectiveness of Medical Treatments”, A CBO Paper, December 2007. USA Inc. | What Might a Turnaround Expert Consider? 318 Restructure Medicare & Medicaid: Policy Option #4 � Reducing Optional Services + Optional Beneficiary Groups 1 Could Save Up to ~60% of Annual Medicaid Cost, per Kaiser Family Foundation Note: 1) Medicaid is a jointly financed federal and state program that provides health and long-term care services to 55 million low-income Americans. As a condition of participating in Medicaid, states are required to cover certain “mandatory” populations and to provide a specified set of benefits. States also have discretion to cover additional low-income individuals in each of these categories (“optional groups”) and receive federal matching payments. Optional eligibility categories include children and parents, persons with disabilities and the elderly above mandatory coverage limits; persons residing in nursing facilities; and the medically needy. Source: Kaiser Family Foundation, 2005 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 319 Restructure Medicare & Medicaid: Policy Option # 4 – Reducing Optional Services + Beneficiary Groups 1 Could Save Up to 60% of Annual Medicaid Spending Medicaid Expenditures by Eligibility Group and Type of Service, 2001 Mandatory Services* for Optional Groups 30.1% 39.4% Mandatory Services for Mandatory Groups Eliminating optional groups could save ~42% of total Medicaid spending Optional Services* for Optional Groups 12.3% 18.1% Federal-required mandatory services / groups = ~40% total spending Optional Services for Mandatory Groups Eliminating optional services could save ~30% of total Medicaid spending Note: 1) Medicaid is a jointly financed federal and state program that provides health and long-term care services to 55 million low-income Americans. As a condition of participating in Medicaid, states are required to cover certain “mandatory” populations and to provide a specified set of benefits. States also have discretion to cover additional low-income individuals in each of these categories (“optional groups”) and receive federal matching payments. Optional eligibility categories include children and parents, persons with disabilities and the elderly above mandatory coverage limits; persons residing in nursing facilities; and the medically needy. Source: Kaiser Family Foundation, 2005 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 320 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) 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 www.kpcb.com Note: Supplementary Security Income and Federal Poverty Levels are 2005 levels. Source: Kaiser Family Foundation, 2005. USA Inc. | What Might a Turnaround Expert Consider? 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 www.kpcb.com Note: Supplementary Security Income and Federal Poverty Levels are 2005 levels. Source: Kaiser Family Foundation, 2005. USA Inc. | What Might a Turnaround Expert Consider? 322 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 www.kpcb.com USA Inc. | What Might a Turnaround Expert 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 Gov. Future Deficit Reduction (%) 1 0.7% Replace the income tax and payroll tax exclusion with a refundable credit 8.8% Replace the income tax exclusion for employment-based health insurance with a deduction 8.0% Reduce the tax exclusion for employment-based health insurance and the health insurance deduction for self-employed individuals 6.6% Raise the age of eligibility for Medicare to 67 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 IME 3 payments using a 2.2% adjustment factor + DGME 4 and Medicaid GME 2 funding inflated by the CPI-U 5 minus 1 percentage point 0.8% • 90% total mandatory GME 2 funding inflated by the CPI-U minus 1 percentage point 0.4% www.kpcb.com Note: 1) As % of Cumulative Total Government Deficit from 2010 to 2019 2) Graduate Medical Education 3) Indirect Medical Education 4) Direct Graduate Medical Education 5) Consumer price index for all urban consumers Source: CBO USA Inc. | What Might a Turnaround Expert Consider? 324 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 (%) 1 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 2 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% www.kpcb.com Note: 1) As % of Total Cumulative Government Deficit from 2010 to 2019 2) Individual insurance policies designed to cover most or all of Medicare’s cost-sharing requirements. Source: CBO USA Inc. | What Might a Turnaround Expert Consider? 325 Restructure Medicare & Medicaid: Policy Option #6 � Consider / Implement National Commission on Fiscal Responsibility and Reform’s medium- and long-term policy options www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 326 Restructure Medicare & Medicaid: Medium-Term Policy Options From the Report of the National Commission on Fiscal Responsibility and Reform Medium-Term Policy Options Convert the federal share of Medicaid payments for long-term care into a capped allotment Deficit Reduction F2012-F2020E 1 $89 billion Reform Tricare for Life 2 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 cuts 3 , Medicare Advantage cuts and home health cuts in PPACA $37 Other 4 $73 Total Deficit Reduction F2012-F2020E $395 billion Note: 1) Cost reductions are Fiscal Commission staff estimates based on CBO and other available sources. Most numbers were generated pre-healthcare reform and may differ significantly. 2) Tricare for Life is a supplementary military health insurance designed to minimize Medicare-eligible military retirees’ out-of-pocket medical expenses. 3) DSH is the Medicare and Medicaid disproportionate share hospital payments for hospitals that receive disproportionately large Medicare and Medicaid patients. 4) Other includes reduce Medicaid administrative costs, increase nominal Medicaid copays, cut Medicare payments for bad debt, increase cost sharing for federal civilian retirees and place dual-eligible individuals in Medicaid Managed Care. Source: National Commission on Fiscal Responsibility and Reform, “The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform,” 12/1/10. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 327 Restructure Medicare & Medicaid: Long-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)* Note: IPAB is a 15-member Independent Payment Advisory Board established 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. Source: National Commission on Fiscal Responsibility and Reform, “The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform,” 12/1/10. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 328 Focus on Expenses– Reform Entitlement Programs + Focus on Operating Efficiency 1 Focus on Expenses Restructure Social Security Restructure Medicare & Medicaid Reform Entitlement Programs Focus on Operating Efficiency 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 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 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. www.kpcb.com Note: *Real spending adjusted for inflation, in 2005 dollars. Source: Census Bureau, Bureau of Economic Analysis. USA Inc. | What Might a Turnaround Expert Consider? 330 Total Government (Federal + State + Local, including Military) Spending Has Risen to 82% of Median Household Income*, Up from 51% in 1967 Total Government Spending per Household ($) Real USA Government Spending per Household and as Percent of Post-Tax Median Annual Household Income, 1967 – 2010 $50,000 $40,000 $30,000 $20,000 $10,000 $0 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 Real Government (Federal+State+Local) Spending per Household ($) Government Spending per Household as % of Median Household Income (%) 100% 80% 60% 40% 20% 0% Government Spending per Household as % of Median Household Income (%) www.kpcb.com Note: *Post tax. Real spending adjusted for inflation using BEA’s GDP price index, in 2005 dollars. Data source: Census Bureau, Bureau of Economic Analysis. USA Inc. | What Might a Turnaround Expert Consider? 331 Federal (Including Military) Spending Has Risen to 65% of Median Household Income*, Up from 39% in 1967, Driven by Entitlement Spending + Interest Payments Federal Spending per Household ($) $40,000 $30,000 $20,000 $10,000 $0 Real USA Federal Spending per Household and as Percent of Post-Tax Median Household Income, 1967 – 2010 1967 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2006 2009 Entitlement / 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 (%) 70% 60% 50% 40% 30% 20% 10% 0% Federal Spending per Household as % of Median Household Income (%) www.kpcb.com Note: *Post tax. Real spending adjusted for inflation, in 2005 dollars. Data source: White House Office of Management and Budget, Census Bureau, Bureau of Economic Analysis. USA Inc. | What Might a Turnaround Expert Consider? 332 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 F2010 USA Inc. Expenses Per Household = $29,043 Non-Defense Discretionary $431B Discretionary One-Time Items $152B Net Interest Payment $196B 12% 6% 4% 20% Social Security $707B Entitlements $16,670 Social Security $5,939 Medicare + Federal Medicaid $6,087 Unemployment Insurance + Other $4,644 Defense $694B 20% 16% 22% Medicare + Federal Medicaid $724B Defense $5,828 Non-Defense Discretionary $3,619 Discretionary One-Time Items $1,277 Net Interest Payments $1,649 www.kpcb.com Unemployment Insurance + Other Entitlements $553B Note: Non-defense discretionary spending includes infrastructure, education, law enforcement, etc. Discretionary one-time items includes TARP, ARRA, and spending on GSEs. Source: White House Office of Management and Budget, Census Bureau, Bureau of Economic Analysis. USA Inc. | 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 rd 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 www.kpcb.com Note: PAYGO is the practice of financing expenditures with funds that are currently available rather than borrowed. Source: KPCB and Alvarez & Marsal Public Sector Services, LLC. USA Inc. | What Might a Turnaround Expert Consider? 334 1 Focus on Expenses Restructure Social Security Restructure Medicare & Medicaid Reform Entitlement Programs Focus on Operating Efficiency 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 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 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. 1 (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) Source: 1) Dennis Cauchon, USA Today, “Federal Workers earning double their private counterparts,” http://www.usatoday.com/money/economy/income/2010-08- 10-1Afedpay10_ST_N.htm Tad DeHaven, “Federal Employees Continue to Prosper,” http://www.cato-at-liberty.org/federal-employees-continue-to-prosper/; 2) John Berry, “OPM Statement on Federal Employee Pay – Recent Comparisons of Federal Pay to Private Sector are Unfair and Untrue,” http://www.opm.gov/opm_federalemployeepay/ & Peter Orszag, “Salary Statistics,” http://www.whitehouse.gov/omb/blog/10/03/10/Salary-Statistics; 3) James Sherk, “Comparing Pay in the Federal Government and the Private Sector,” http://www.heritage.org/research/reports/2010/07/comparing-pay-in-the-federal-governmentand-the-private-sector www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 336 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 3 rd -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. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 337 1 Focus on Expenses Restructure Social Security Restructure Medicare & Medicaid Reform Entitlement Programs Focus on Operating Efficiency 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 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 338 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% % Employees w/ Guaranteed Pension 16pps 80% 60% 40% 20% 37pps State & Local Government Federal Government Private Sector 0% 1980 1985 1990 1995 2000 2005 www.kpcb.com Sources: EBRI Databook on Employee Benefits. USA Inc. | What Might a Turnaround Expert Consider? 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 % of Employees Participating in Defined Contribution Pension Plans 60% 40% 20% 0% 1984 1989 1994 1999 2004 Private Sector Federal Government State / Local Government www.kpcb.com Sources: EBRI Databook on Employee Benefits USA Inc. | What Might a Turnaround Expert Consider? 340 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. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 341 1 Focus on Expenses Restructure Social Security Restructure Medicare & Medicaid Reform Entitlement Programs Focus on Operating Efficiency 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 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 342 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. www.kpcb.com Source: Bureau of Labor Statistics. USA Inc. | What Might a Turnaround Expert Consider? 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) 40% Government 8,407 Transportation & Utilities 1,043 Union Membership Rate (%) 30% 20% 10% Construction Manufacturing Information Mining Education & Health Wholesale & Retail Leisure 826 1,257 275 58 1,664 1,056 403 Other 154 Business Services 379 0% Finance 138 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 www.kpcb.com Source: Bureau of Labor Statistics. USA Inc. | What Might a Turnaround Expert Consider? 344 1 Focus on Expenses Restructure Social Security Restructure Medicare & Medicaid Reform Entitlement Programs Focus on Operating Efficiency 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 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 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. www.kpcb.com . Source: Census Bureau, Bureau of Economic Analysis. USA Inc. | What Might a Turnaround Expert Consider? 346 Federal Headcount Has Risen Over Past Five Years and Is Above Trendline Level Federal Civilian Headcount & Share of Total Employment, 1988 - 2009 Federal Civilian Full-Time Equivalent Employees (000) 2,500 2,000 1,500 1,000 500 Federal Civilian Full-Time Equivalent Employees % Share of Total Employment (right axis) Federal Civilian Headcount Linear Trendline ~300K Potential Headcount Reduction 2.5% 2.0% 1.5% 1.0% 0.5% % of Total Employment 0 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 0.0% www.kpcb.com Data source: BEA (1988-2009). USA Inc. | What Might a Turnaround Expert Consider? 347 Reduce Headcount: Mathematical Illustration on Reducing Federal Headcount – Could Save Up to $275 Billion Over Next 10 Years, or 4% of Total Deficit Scenario Analysis on Potential Federal Headcount Reduction & Impact on Budget Deficits Headcount Savings ($B) For USA Inc. Over 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 5% $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 $658 293 % of Budget Deficits 2% 4% 4% Note: Federal fiscal year ends in September. *Based on 20-year trend line, federal civilian headcount would have been 15% below actual levels. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 348 1 Focus on Expenses Restructure Social Security Restructure Medicare & Medicaid Reform Entitlement Programs Focus on Operating Efficiency Review Federal Wages & Benefits Review Government Pension Plan Characteristics & Compare with Private Sector Plans Review Role of Unions Review Government Cost Structure & Consider Reducing Federal Headcount Determine if There are Non-Core ‘Business Lines’ That Can Be Centralized / Locally Out-Sourced www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 349 Local Outsourcing/Consolidation: Improve Efficiency of Public Services Through Automation / Scale / Flexibility 1. Automation – Government agencies cannot afford to perform manual routine-based processes that can be replaced more efficiently by technology. 2. Scale – Consolidation of non-core processes across agencies or outsource non-core processes to local companies can deliver scale efficiencies. 3. Flexibility – Outsourced labor enables temporary employment in situations where hiring full-time workers would be costly and unnecessary. Sources: Adam Frisch, Morgan Stanley Research. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 350 Local Outsourcing/Consolidation: Proven to Be Viable Cost-Cutting Measures for State / Local Governments Automation Years Public Sector Details 2002-2010 1993-2010 Missouri State Government Port Authority of New York and New Jersey Total Cost Saving ($) As % of Total Budget 1 As % of Program Budget 1 Digitized State Medicaid health record ~87MM -- -- E-ZPass (electronic toll collection) can process 2.5x to 3x more vehicles per lane than toll attendants -- -- -- 2003 Pennsylvania State Government Consolidated office supplies + computer procurement ~$30MM -- -- Scale 2002-2004 2004-2005 Dept. Management Services, FL Health and Human Services Commission, TX Outsourced HR and supporting IT system to local contractors Outsourced HR, payroll and enterprise service center to private vendors ~173MM 0.3% 11.5% ~1B 0.8% 5.0% Flexibility 2010 Maywood, CA 2005 American Red Cross Outsourced police force to county sheriff in an effort to avoid bankruptcy Set up a Family Assistance Hotline within 10 days via an outsourcer (vs. 3-6 months doing it in-house) ~3.7MM 25% 50.7% -- -- -- Note: 1) Annual Budget of the year when outsourcing program started. Sources: HR Outsourcing in Government Organizations, The Conference Board; Outsourcing Methods & Case Studies, 2009; Maywood, CA data per The Economist. PA state government data per Ed Rendell, Governor of Pennsylvania. ) E-ZPass per E- Zpass New Jersey Customer Service Center; Missouri Medicaid case study per ACS; American Red Cross per Tholons, Government Sector Outsourcing. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 351 � Focus on Operating Efficiency – Policy Options From National Commission on Fiscal Responsibility and Reform Co-Chairs’ Proposal www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 352 Focus on Operating Efficiency: Illustrative Policy Options From the Report of the National Commission on Fiscal Responsibility and Reform Illustrative Policy Options Eliminate 250,000 non-defense service and staff augmentee contractors Deficit Reduction in F2015E $18 billion Eliminate all earmarks 1 $16 Freeze federal salaries, bonuses, and other compensation at non- Defense agencies for three years $15 Cut the federal workforce by 10% (2-for-3 replacement rate) $13 Create a Cut-and-Invest Committee charged with trimming waste and targeting investment $11 Slow the growth of foreign aid $5 Other 2 $22 Total Deficit Reduction F2015E $100 billion Note: 1) an earmark is a legislative (especially congressional) provision that directs approved funds to be spent on specific projects, or that directs specific exemptions from taxes or mandated fees. 2) Other includes eliminate NASA funding for commercial spaceflight, terminate low-priority Army Corps of Engineers programs, sell excess federal property, reduce congressional & White House budgets by 15%, reduce unnecessary printing costs and more. Source: National Commission on Fiscal Responsibility and Reform, “The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform,” 12/1/10. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 353 What Might a Turnaround Expert Consider? 1 2 Focus on Expenses Focus on Revenues Reform Entitlement Programs Drive Sustainable Economic Growth Focus on Operating Efficiency Consider Changing Tax Policies www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 354 Focus on Revenues – Drive Sustainable Economic Growth + Change Tax Policies 2 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 www.kpcb.com Note: *Tax subsidies / expenditures are losses to the U.S. Treasury from granting certain deductions, exemptions, or credits (such as those on mortgage interest payments and employer-sponsored health insurance payments) to specific categories of taxpayers. USA Inc. | What Might a Turnaround Expert Consider? 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 Federal Receipts Y/Y (%) 60% 40% 20% 0% Real GDP Y/Y vs. Real Federal Receipts Y/Y Linear Trendline (y=2.77x-0.0438, R^2=0.73) -5% 0% 5% 10% 15% 20% 25% Real GDP Y/Y (%) 2010E – 2019E If Real GDP Y/Y is 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 -20% www.kpcb.com Data source: White House Office of Management & Budget (1940 – 2009). USA Inc. | What Might a Turnaround Expert Consider? 356 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 onetime 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. www.kpcb.com Note: 1) USA Inc.’s F2009 revenue shortfall was $997B (excluding one-time discretionary spending items). F2009 total income tax receipts from individuals were $915B. As a result, if one were to raise individual income tax rates alone to achieve financial break-even, one would have to more than double individual income tax rates across-the-board. USA Inc. | What Might a Turnaround Expert Consider? 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 $288 billion, or 5%. F2011-F2020E Impact on USA Inc.’s CBO’s baseline assumption for annual real GDP growth What if real GDP grows faster than CBO’s forecast by… Revenue ($B / %) Spending ($B / %) Deficit Reduction ($B / %) 0.1 pps +$247 +1% -$41 --% -$288 -5% 2.1% F2011E 4.4% F2012-14E 2.4% F2015-20E 0.5 pps 1 pps +$1,235 +3% +$2,470 +6% -$205 --% -$410 -1% -$1,440 -23% -$2,880 -46% 2 pps +$4,940 +13% -$820 -2% -$5,760 -92% www.kpcb.com Note: pps is percentage point(s). $ amount and % changes in revenue / spending / deficit are over the entire F2011-F2020E period. Source: CBO, “The Budget and Economic Outlook: Fiscal Years 2010 to 2020,” 8/10. USA Inc. | What Might a Turnaround Expert Consider? 358 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% 8% CBO’s Baseline Real GDP Growth vs. Required Real GDP Growth for a Balanced Budget Between F2011E and F2020E 6% Real GDP Y/Y Growth (%) 4% 2% 0% 2009 2011E 2013E 2015E 2017E 2019E -2% -4% Real GDP Annual Growth (CBO Baseline Forecast) Real GDP Annual Growth Needed to Eliminate Fiscal Deficit 1970-2009 Average Real GDP Growth www.kpcb.com Source: CBO, “The Budget and Economic Outlook: Fiscal Years 2010 to 2020,” 8/10. 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 10% 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) 8% Real GDP Y/Y Growth (%) 6% 4% 2% 0% -2% -4% 1950 1960 1970 1980 1990 2000 2010E 2020E Real GDP Annual Growth (Historical) Real GDP Annual Growth (CBO's Baseline Forecast) Real GDP Annual Growth Needed to Eliminate Fiscal Deficit www.kpcb.com Source: CBO, “The Budget and Economic Outlook: Fiscal Years 2010 to 2020,” 8/10. USA Inc. | What Might a Turnaround Expert Consider? 360 USA Consumers = Biggest Demand Driver For GDP Growth, Until 2007 8% Personal Consumption’s Contribution to Real GDP Growth, 1950 - 2009 6% Real GDP Y/Y Growth (%) 4% 2% 0% -2% Real GDP Y/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 www.kpcb.com Source: BEA. USA Inc. | What Might a Turnaround Expert Consider? 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… www.kpcb.com Source: Residential real estate decline based on CQ1:07 to CQ1:09 changes in S&P Case-Shiller Home Price Index. GDP growth & composition / personal savings rate per BEA. Unemployment rate per BLS. USA Inc. | What Might a Turnaround Expert Consider? 362 Economic Policy–Short-Term vs. Long-Term • 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. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 363 Improving Employment, Productivity, & Hours Worked Are Source of Sustainable Long-Term GDP Growth USA Long-Term GDP Growth 1 (1970-2009) 2.83% Productivity Growth 1.53% DRIVEN BY: Technology / Infrastructure Education (Labor Quality) Other (Total Factor Productivity) 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: 1) all growth numbers are rounded average annual growth rates and are adjusted for inflation. 2.83% is the average annual GDP growth rate from 1970 to 2009, per BEA. Labor force growth of 1.53% is the average annual growth rate from 1970 to 2009, per BLS. Hours worked per worker per OECD. Productivity growth of 1.53% is calculated by subtracting employment growth and hours worked per worker growth from real GDP growth. Average annual growth rate of 1.53% is roughly in line with other estimates such as Dale W. Jorgenson, Mun S. Ho, Kevin J. Stiroh, “Growth of U.S. Industries and Investments in Information Technology and Higher Education” www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 364 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. www.kpcb.com Source: OECD, Dale W. Jorgenson, Mun S. Ho, Kevin J. Stiroh, “Growth of U.S. Industries and Investments in Information Technology and Higher Education” http://www.nber.org/chapters/c10627, Federal Reserve. USA Inc. | What Might a Turnaround Expert Consider? 365 2 Focus on Revenues Drive Sustainable Economic Growth Invest in Technology / Infrastructure / Education Increase / Improve Employment Improve Competitiveness Consider Changing Tax Policies Review Tax Rates Reduce Subsidies / Tax Expenditures*/ Broaden Tax Base www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 366 Technology + Infrastructure + Education Investments Drove ~90% of Labor Productivity Growth for Past ~30 Years Sources of USA Average Labor Productivity Growth, 1977-2000 2.5% Annual Productivity Growth 2.21% Average Annual Growth Rate (%) 2.0% 1.5% 1.0% 0.5% 0.0% 1.13% 1.28% Technology Investment Infrastructure & Other Investment Education (Labor Quality) Other (Total Factor Productivity) -0.5% www.kpcb.com 1977-1990 1990-1995 1995-2000 Note: Total Factor Productivity is the portion of output not explained by the amount of inputs used in production. Source: Dale W. Jorgenson, Mun S. Ho, Kevin J. Stiroh, “Growth of U.S. Industries and Investments in Information Technology and Higher Education” USA Inc. | What Might a Turnaround Expert Consider? 367 However, USA Inc. Has Increasingly Allocated Resources Away from Productive Technology + Infrastructure + Education Investment / Spending Toward Less-Productive Entitlement Program Spending USA Real Federal Productive vs. Less-Productive Spending*, 1970-2009 100% % Share of Total Federal Spending 80% 60% 40% 20% Productive (Investment / Spending on Defense, Education, Infrastructure, Technology…) Less-Productive (Spending on Entitlement and Interest Payments) 0% 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 www.kpcb.com Note: *Total spending excludes one-time items (such as TARP / GSE / ARRA) for F2008 / F2009 data. Data source: White House Office of Management & Budget (1970-2009). USA Inc. | What Might a Turnaround Expert Consider? 368 Drive Growth: Technology Technology Improves Efficiency of Communication and Lowers Costs of Providing Goods and Services www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 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 S&P 500 Mkt Cap ($T) $5 $6 $8 $10 $12 $12 $10 $8 $10 $11 $11 $13 $13 $8 $10 $11 $10 www.kpcb.com Note: 2010 data as of 12/31/10. Source: FactSet, Bloomberg. USA Inc. | What Might a Turnaround Expert Consider? 370 But USA Inc. Has Steadily Scaled Back Investment in Technology R&D 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% Total Technology R&D Spending as % of GDP 2% 1% 0% 1953 1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 Other (Non-Profit / University / Other Government) Private Industry Federal Government www.kpcb.com Source: National Science Foundation, Science and Engineering Indicators, 2008. USA Inc. | What Might a Turnaround Expert Consider? 371 For GDP Growth & Job Creation, It’s Key for Private Industry to Remain Incentivized to Invest in R&D � 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…If 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 1 and other tools) to invest in domestic research & development and to create jobs…and create a stable environment in which to operate. Note: 1) See John Chambers and Safra Catz, “The Overseas Profits Elephant in the Room,” The Wall Street Journal, 10/20/10. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 372 Drive Growth: Infrastructure Better Infrastructure Reduces Transportation Costs For Input and Output Materials www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 373 Public Investment in Infrastructure Has Helped Drive GDP Growth USA Real GDP and Public Investment in Infrastructure Average Y/Y Growth, 1950 -2007 Real GDP & Public Investment in Infrastructure Average Y/Y Growth Rates (%) 5% 4% 3% 2% 1% 0% 1950 - 1979 4.1% Y/Y Growth in GDP 4.0% Y/Y Growth in Public Investment in Infrastructure 2.9% . Y/Y Growth in GDP 1980 - 2007 2.3% Y/Y Growth in Public Investment in Infrastructure www.kpcb.com Source: Political Economy Research Institute, “How Infrastructure Investments Support the U.S. Economy: Employment, Productivity and Growth”, 1/09. USA Inc. | What Might a Turnaround Expert Consider? 374 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 1.0% 0.5% 0.0% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 www.kpcb.com Source: BEA. USA Inc. | What Might a Turnaround Expert Consider? 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 B- D Bridges -- C Dams -- D Drinking Water B- D- Energy -- D+ Hazardous Waste D D Inland Waterways B D- Levees -- D- Rail -- C- Roads C+ D- School Buildings D D Solid Waste C- C+ Transit C- D Wastewater C D- Overall USA Infrastructure G.P.A. C D Cost to Improve -- $2.2T Note: The first infrastructure grades were given by the National Council on Public Works Improvements in its report “Fragile Foundations: A Report on America’s Public Works, released in February 1988.” Source: American Society of Civil Engineers, “2009 Report Card for America’s Infrastructure”. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 376 Drive Growth: Education Better Education Improves General Labor Quality and Enables Specialization For More Efficiency www.kpcb.com USA Inc. | What Might a Turnaround Expert 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 Public Net Present Value for an Individual Obtaining Secondary or Higher Education $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 -$20,000 -$40,000 www.kpcb.com $0 NPV = $32,257 ROI = 109% Secondary Education NPV = $100,119 ROI = 299% Higher Education Unemployment Effect Social Insurance Tax Revenues Income Tax Revenues Public Foregone Tax Revenues Public Direct Cost Note: * ROI (return on investment) calculated as NPV of future incremental tax revenues divided by cost for government to support an individual for education. **Limited to male samples, female samples tend to have a lower public NPV. Source: OECD. USA Inc. | What Might a Turnaround Expert Consider? 378 While Government Spending on Education Increased 60% Over Past 50 Years, At Margin, Government Spent More on Healthcare… 8% USA Total Government Healthcare vs. Education Spending as % of GDP, 1960 – 2008 Spending as % of GDP 6% 4% 2% 3.7% Total Government (Federal + State + Local) Spending on Health Care Total Government (Federal + State + Local) Spending on Education 6.0% 0% 1960 1964 1968 1972 1976 1980 1984 1988 1992 1996 2000 2004 2008 www.kpcb.com Note: Total government spending on healthcare includes Medicare, Medicaid and other programs and total government spending on education includes spending on pre-primary through tertiary education programs. Source: Dept. of Education, Dept. of Health & Human Services. USA Inc. | What Might a Turnaround Expert Consider? 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 25 ��� Science 14 19 21 17 � Reading 16 15 --** 14 � Self Confidence 1 2 1 1 -- � Note: *30 OECD countries participated in 2000 / 2003 PISA, 34 OECD countries participated in 2006 / 2009 PISA. 1) Confidence is the self-perceived efficacy in learning abilities (for year 2000); mathematical problem solving abilities (for year 2003) and scientific problem solving abilities (for year 2006). USA tied in confidence ranking with Canada, Hungary, Slovakia, Switzerland and Liechtenstein in 2003 and tied with Poland and Canada in 2006. **2006 reading scores for USA were rendered invalid because of a printing error in questionnaire instructions. Source: OECD. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 380 USA Student Achievement Rankings* in Mathematics / Science Have Fallen vs. Other OECD Countries Mathematics Ranking* 2000 2009 1 Japan S. Korea 2 S. Korea Finland 3 New Zealand Switzerland 4 Finland Japan 5 Australia Canada 6 Canada Netherlands 7 Switzerland New Zealand 8 UK Belgium 9 Belgium Australia 10 France Germany 11 Austria Estonia 12 Denmark Iceland 13 Iceland Denmark 14 Sweden Slovenia 15 Ireland Norway 16 Norway France 17 Czech Republic Slovakia 18 USA Austria 19 Germany Poland 20 Hungary Sweden 21 Spain Czech Republic 22 Poland UK 23 Italy Hungary 24 Portugal Luxembourg 25 Greece USA 26 Luxembourg Ireland 27 Mexico Portugal 28 Spain 29 Italy 30 Greece 31 Israel 32 Turkey 33 Chile 34 Mexico www.kpcb.com Science Ranking* 2000 2009 1 Korea Finland 2 Japan Japan 3 Finland S. Korea 4 UK New Zealand 5 Canada Canada 6 New Zealand Estonia 7 Australia Australia 8 Austria Netherlands 9 Ireland Germany 10 Sweden Switzerland 11 Czech Republic UK 12 France Slovenia 13 Norway Poland 14 USA Ireland 15 Hungary Belgium 16 Iceland Hungary 17 Belgium USA 18 Switzerland Czech Republic 19 Spain Norway 20 Germany Denmark 21 Poland France 22 Denmark Iceland 23 Italy Sweden 24 Greece Austria 25 Portugal Portugal 26 Luxembourg Slovak Republic 27 Mexico Italy 28 Spain 29 Luxembourg 30 Greece 31 Israel 32 Turkey 33 Chile 34 Mexico Note: *USA ranking out of OECD countries in PISA (Program for International Student Assessment for 15-Year Olds). Source: OECD. USA Inc. | What Might a Turnaround Expert 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, 2007 60% 50% 40% 30% 20% 10% 0% Percentage of 25- to 34-Year-Olds with an Associate Degree or Higher Among OECD Countries, 2007 Brazil Turkey Czech Republic Chile Italy Austria Mexico Portugal Hungary Germany Greece Poland Slovenia Iceland OECD Average Estonia Switzerland Luxembourg Netherlands UK Spain Finland Sweden Denmark USA Australia Belgium France Israel Norway Ireland New Zealand Japan Russia Korea Canada www.kpcb.com Note: *Higher education defined as post-secondary (college / university) education. Source: OECD. USA Inc. | What Might a Turnaround Expert Consider? 382 2 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 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 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 = www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 384 Though Entitlements Are Structural, Not a Cyclical Problem, Entitlement Outlays Go Up with High Unemployment Real Entitlement Spending Y/Y & Unemployment Rates (%) Real Entitlement Spending Y/Y Growth & Unemployment Rates, 1962 - 2009 20% Real Entitlement Spending Y/Y Unemployment Rate 15% 10% 5% 0% 86% Correlation Between 1986 & 2009 -5% -10% 1962 1966 1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 www.kpcb.com Note: Real spending adjusted for inflation. Fiscal year ends in September. Source: White House Office of Management & Budget, Bureau of Labor Statistics. USA Inc. | What Might a Turnaround Expert Consider? 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 www.kpcb.com Source: Richard Berner, “Employment Prospects and Policies to Improve Them” (2/26/10), Morgan Stanley Research. USA Inc. | What Might a Turnaround Expert Consider? 386 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. www.kpcb.com Source: Richard Berner, “Why is US Employment So Weak” (7/23/10), Morgan Stanley Research. USA Inc. | What Might a Turnaround Expert Consider? 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 Immigration's Impact as % of Employment / Income / Productivity Increase www.kpcb.com 1.2 0.8 0.4 0.0 -0.4 1 2 4 7 10 Years After Immigration Productivity Income per Worker Employment for U.S.-Born Workers Source: Giovanni Peri, “The Effect of Immigrants on U.S. Employment and Productivity,” 8/30/2010 Federal Reserve Board of San Francisco (FRBSF) Economic Letter 2010-26. USA Inc. | What Might a Turnaround Expert Consider? 388 2 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 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 389 Without appropriate government incentives in Education / Technology / Infrastructure / Employment, USA Inc. may continue to lose relative competitive strength to other countries. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 390 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 productivity) and deteriorated on 20 (including trade surplus, national spending on R&D, industrial production, corporate tax rate, business environment, FDI, tax incentives for R&D, number of patent applications, availability of high-quality labor, higher education penetration, telecom & transportation infrastructure, etc.). www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 391 USA Ranking High in Country Attractiveness Indicators But Losing Share at the Margin… Economic Fundamentals Government Spending US Relative Position Key metrics Ten Years Ago Today Trend Household consumption � � � Household consumption growth � � � GDP � � � GDP per capita 2 � � � Stock market capitalization � � � Technology company market cap 2 � � � Industrial production � � � Trade as % of GDP � � � Trade surplus 2 � � � National spending on R&D � � � Defense spending 2 � � � Government public debt as % GDP 2 � � � Public healthcare spending as % of GDP 2 � � � Government surplus as % of GDP 2 � � � Public expenditure on education � � � � Top Ranked � Top Quartile � Average � Bottom Quartile Source: 1) Growth and competitiveness in the United States: The role of its multinational companies, www.kpcb.com McKinsey & Company. 2) estimates based on data from IMF / OECD USA Inc. | What Might a Turnaround Expert Consider? 392 …USA Ranking High in Country Attractiveness Indicators But Losing Share at the Margin US relative position Business climate Human capital Infrastructure Key metrics Ten Years Ago Today Trend Statutory corporate tax rate � � � Business environment � � � FDI as % of GDP � � � Growth of local innovation clusters � � � Tax incentives for R&D � � � Population and demographic profile � � � Availability of high-quality labor � � � Retention of foreign-born talent � � � Cost-adjusted labor productivity � � � Total healthcare spending per Capita 2 � � � Higher education penetration 2 � � � Number of patent applications � � � Transportation � � � Telecommunications � � � www.kpcb.com � Top Ranked � Top Quartile � Average � Bottom Quartile Source: 1) Growth and competitiveness in the United States: The role of its multinational companies, McKinsey & Company. 2) estimates based on data from IMF / OECD USA Inc. | What Might a Turnaround Expert Consider? 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 100% Share of World GDP, USA vs. China / Brazil / India, 1985 – 2010E Rest of World Share of World GDP (%) 80% 60% 40% 33% 1985-2010E Largest Share Gainers China +6% to 9% Brazil +1% to 3% Korea +1% to 2% 24% 20% 0% USA 1985-2010E Share Loss = -9% 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 www.kpcb.com Note: Data are NOT adjusted for purchasing power parity. Source: IMF. USA Inc. | What Might a Turnaround Expert Consider? 394 2 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 www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 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 $127 billion revenue for USA Inc. in F2010E 1 ...excluding any related negative impact on spending / GDP growth, which is difficult to do… Across-the-Board Tax Rate Increase Hypothetical Revenue Increase for USA Inc. in F2010E ($ billions) …Which Would Reduce Estimated Losses in F2010E by 1 Percentage Point $127 8% 2 Percentage Points (pps) $254 16% 3 pps $381 24% 4 pps $508 33% 5 pps $635 41% 10 pps $1,270 82% Note: *The simple tax math presented here are pure mathematical illustrations – we simply calculated how big a broad-based tax rate increase (for individual and corporate income, as well as payroll) would have to be for USA Inc. to financial break-even. These calculations are merely mechanical illustrations and are not meant to portray realistic solutions. 1) Incremental dollar amount calculated as 1% of projected total personal & corporate income, which historically has been at ~87% of GDP. Source: F2010E revenue & deficit per White House OMB, GDP per CBO. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 396 More Complex Tax Math: If Lower Brackets Excluded, Draconian Rate Hikes Required to Attempt to Bring USA Inc. Budget Into Financial Balance 100% Current Federal Income Tax Rates vs. Rates Needed to Reduce Deficit to 3% of GDP in 10 Years Federal Income Tax Rates (%) 80% 60% 40% 20% Current Federal Income Tax Rates Marginal Tax Rates Required to Balance USA Inc.'s Budget* 28% 28% 25% 25% 15% 15% 10% 10% 33% 72% 35% 77% 0% www.kpcb.com Tier 1 Tier 2 Tier 3 Tier 4 Tier 5 Tier 6 Note: *The tax math presented here are pure mathematical illustrations – it is simply calculated to measure how much tax rates need to increase (for the top two income brackets) to achieve a deficit-to-GDP ratio of 3% by 2019E assuming a baseline budget path and relying on personal income tax rate hikes alone. These calculations are merely mechanical illustrations and are not meant to portray realistic solutions. Source: The Urban Institute (Desperately Seeking Revenue, By Altshuler, Lim and Williams, 1/5/2010. USA Inc. | What Might a Turnaround Expert Consider? 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. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 398 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 Federal Tax Receipts as % of GDP 20% 15% 10% 5% 50-year Trendline 0% 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 www.kpcb.com Source: White House OMB. USA Inc. | What Might a Turnaround Expert Consider? 399 2 Focus on Revenues Drive Sustainable Economic Growth Invest in Technology / Infrastructure / Education Increase / Improve Employment Improve Competitiveness Consider Changing Tax Policies Review Tax Rates Reduce Subsidies / Tax Expenditures*/ Broaden Tax Base www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 400 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 Illustrating the Revenue Tradeoffs – Changing Tax Rates vs. Broadening the Tax Base � 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? Note: *The simple tax math presented here are pure mathematical illustrations – we simply calculated how big a broad-based tax rate increase (for individual and corporate income, as well as payroll) would have to be for USA Inc. to financial break-even. These calculations are merely mechanical illustrations and are not meant to portray realistic solutions. **Primary budget deficit is the budget deficit excluding net interest payments. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 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 1965 1 – 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. www.kpcb.com Source: 1) per BEA and CMS. USA Inc. | What Might a Turnaround Expert Consider? 402 Changing Tax Policy to Broaden Tax Base: Subsidies + Tax Expenditures = 70% of USA Inc.’s Cash Flow Deficit F2009 Subsidies & Tax Expenditures & Deficit ($B) www.kpcb.com USA Inc.’s Deficit vs. Aggregate Subsidies and Tax Expenditures*, F2009 1,600 1,400 1,200 1,000 800 600 400 200 0 $1,413B F2009 Deficit $981B* $673B* $308B* F2009 Subsidies & Tax Expenditures Some tax expenditures favor consumption... Such as tax exemption on employer contributions to health insurance & deductibility of mortgage interest on owneroccupied homes… …But others favor saving, investment, and growth Such as tax exemptions / deductibility on capital gains / dividends / pension contributions & savings / accelerated depreciation of equipment… Note: *Each foregone revenue estimate assumes all other parts of the Tax Code remain unchanged during F2009. Aggregate tax subsidies presented here is simply the sum of individual estimates. In reality, the aggregate estimate would be different if tax subsidies were changed simultaneously because of potential interactions among provisions. Source: White House OMB, “Analytical Perspective – Budget of the U.S. Government, Fiscal Year 2011.” USA Inc. | What Might a Turnaround Expert Consider? 403 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 www.kpcb.com Source: Sources: Congressional Budget Office, Budget Options Volume 1: Health Care and Volume 2, 2009; Committee for a Responsible Federal Budget, Let’s Get Specific: Tax Expenditures (October 2010) USA Inc. | What Might a Turnaround Expert Consider? 404 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% Personal Consumption (ex. Healthcare) as % of GDP 1950-1980 Trend line for Personal Consumption as % of GDP 55% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 www.kpcb.com Note: Personal consumption includes household consumption of all goods and services. Source: BEA, Federal Reserve. USA Inc. | What Might a Turnaround Expert Consider? 405 …USA’s Unbalanced Economy – National Savings (Personal + Corporate + Government Savings) = -3% of GDP, vs. 10% From 1950 To 1980 USA Net Saving as % of GDP, 1950 - 2009 16% USA Net National Saving as % of GDP 12% 8% 4% 0% 1950-1980 Trend line for Net Saving as % of GDP -4% 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 www.kpcb.com Note: National savings equal the aggregate savings by household, corporate and government sectors. Source: BEA, Federal Reserve. USA Inc. | What Might a Turnaround Expert Consider? 406 Current Tax Policies Help Spur Consumption – USA’s Taxes on Consumption of Goods & Services Lowest Among Peers Taxes on Consumption as % of GDP, 2007 20% 16% 12% 8% 4% 0% Taxes on Consumption of Goods & Services as % of GDP Among OECD Countries, 2007 USA Japan Switzerland Canada Australia Korea Mexico Spain Luxembourg UK Germany France OECD Average Belgium Italy Czech Republic Ireland Netherlands New Zealand Slovak Republic Turkey Greece Austria Norway Finland Sweden Poland Portugal Hungary Denmark Iceland www.kpcb.com Source: OECD, 2009 database. USA Inc. | What Might a Turnaround Expert Consider? 407 America’s Resources Allocated to Housing + Healthcare Nearly Doubled as a Percent of GDP Since 1965, While Household and Government Savings Fell Dramatically 25% 20% Healthcare + Housing Spending vs. Net Household + Government Savings as % of GDP, 1965-2009 Housing + Healthcare Spending as % of GDP Net Household + Government Savings as % of GDP 20% As % of GDP 15% 10% 5% 11% 7% 0% -5% 1965 1970 1975 1980 1985 1990 1995 2000 2005 -10% -9% www.kpcb.com Note: Housing includes purchase, rent and home improvement. Government savings occur when government runs a surplus. Source: BEA, CMS via Haver Analytics. USA Inc. | What Might a Turnaround Expert Consider? 408 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% www.kpcb.com Source: OECD Tax Database. USA Inc. | What Might a Turnaround Expert Consider? 409 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 1 , PEP 2 , and Pease 3 � Triple standard deduction to $30,000 ($15,000 for individuals) � Repeal state & local tax deduction and miscellaneous itemized deductions � Limit mortgage deduction to exclude 2 nd 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 4 method of accounting / energy tax preferences for the oil and gas industry / depreciation rules) � International tax reform including a territorial system 5 Note: 1) AMT is the Alternative Minimum Tax; 2) 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. 4) LIFO is ‘Last In, First Out’ which tend to reduce corporations’ income taxes in times of inflation. 5) A territorial tax system is a tax system that taxes only income that is created within the borders of a specific territory (usually a country). Source: National Commission on Fiscal Responsibility and Reform, “The Moment of Truth: Report of the National Commission on Fiscal Responsibility and Reform,” 12/1/10. Note that the Report also identified two other scenarios called the ‘The Zero Plan’ which eliminates all tax expenditures and ‘Tax Reform Trigger’ which forces Congress to undertake comprehensive tax reform by 2012 by raising taxes for each year Congress fails to act. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 410 This page is intentionally left blank. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 411 This page is intentionally left blank. www.kpcb.com USA Inc. | What Might a Turnaround Expert Consider? 412 Consequences of Inaction www.kpcb.com USA Inc. | 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. www.kpcb.com USA Inc. | Consequences of Inaction 414 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. Source: Richard Berner, “America’s Fiscal Train Wreck” (7/2/2009), Morgan Stanley Research. www.kpcb.com USA Inc. | 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* Rank Country 2009 Net Debt Outstanding ($B) Y/Y As % of Net Debt as % of GDP As % of 2009 Budget As % of 2009 World Total 2009 2005 05-09 Change 2009 GDP ($B) Note: *Carmen Reinhart and Kenneth Rogoff observed from 3,700 historical annual data points from 44 countries that the relationship between government debt and real GDP growth is weak for debt/GDP ratios below a threshold of 90 percent of GDP. Above 90 percent, median growth rates fall by one percent, and average growth falls considerably more. . We note that while Reinhart and Rogoff’s observations are based on ‘gross debt’ data, in the U.S., debt held by the public is closer to the European countries’ definition of government gross debt. For more information, see Reinhart and Rogoff, “Growth in a Time of Debt,” 1/10. Pps is percentage points. Source: IMF, Business Intelligence Monitor . www.kpcb.com USA Inc. | Consequences of Inaction 416 Y/Y World Total Surplus / Deficit ($B) World Gross Deficit Unemployment Rate 1 Japan $9,149 12% 26% 181% 162% 19% $5,049 -5% 9% -960 33% 5% +1 2 Italy 2,434 0 7 116 106 11 2,090 -5 4 -0 -- 8 +1 3 Greece 374 8 1 111 99 12 338 -2 1 -27 1 9 +2 4 Belgium 454 0 1 98 92 6 461 -3 1 -1 0 8 +1 5 France 2,028 5 6 77 66 11 2,635 -2 5 -105 4 9 +2 6 Germany 2,423 1 7 75 68 7 3,235 -5 6 -16 1 7 +0 7 Austria 263 2 1 70 64 6 374 -4 1 -5 0 5 +1 8 India 854 -3 2 69 80 -12 1,243 6 2 31 -- -- -- 9 UK 1,444 3 4 66 42 24 2,198 -5 4 -49 2 7 +2 10 Canada 870 -5 3 66 70 -4 1,319 -3 2 44 -- 8 +2 11 Netherlands 503 -1 1 64 52 12 790 -4 1 4 -- 4 +1 12 Argentina 178 -7 1 59 59 0 301 1 1 14 -- -- -- 13 USA 7,811 23 23 55 37 17 14,266 -2 25 -1,438 50 9 +3 14 Poland 223 -11 1 53 47 6 423 2 1 26 -- -- -- 15 Spain 757 20 2 53 43 10 1,438 -4 2 -125 4 18 +7 16 Norway 187 -17 1 51 45 6 369 -2 1 38 -- 3 +1 17 Sweden 175 -5 1 44 51 -7 398 -4 1 9 -- 8 +2 18 Brazil 650 -6 2 44 44 0 1,482 0 3 40 -- -- -- 19 Switzerland 212 5 1 44 53 -9 484 -1 1 -10 0 4 +1 20 Denmark 125 7 0 40 38 3 308 -5 1 -8 0 3 +2 21 Turkey 219 -14 1 37 52 -15 594 -5 1 36 -- -- -- 22 Australia 309 -3 1 34 36 -3 920 1 2 8 -- 6 +1 23 Venezuela 95 11 0 27 27 0 353 -3 1 -9 0 -- -- 24 China 609 7 2 13 18 -5 4,758 9 8 -38 1 -- -- 25 Russia 92 -15 0 7 14 -7 1,255 -8 2 17 -- -- -- Top 1-25 $32,438 0% 94% 55% 52% 3% $47,081 -3% 81% $2,790 97% 7% +1 Global 34,632 8 100 68 66 2 57,937 -2 100 2,885 100 7 +2 Y/Y (pps) On a Net Worth Basis, USA Inc. Also Sits in Middle of Pack vs. Western European Peer Governments Illustrative Estimates* of Government Net Worth, 2009 Estimated Government Net Worth as % of GDP 400% 0% -400% -800% -1200% -1600% Better Than USA Worse Than USA Cost of Ageing Structural Deficit Initial Debt Level Italy Germany Belgium France Portugal USA UK Spain Ireland Greece Note: *Estimates of government net worth depends heavily on underlying assumptions such as projections for GDP, demographics, policy changes, etc. Net worth estimates may differ from U.S. Dept. of Treasury’s data (used in earlier slides). For more details on underlying assumptions, please refer to Morgan Stanley Research’s Global Outlook piece “Sovereign Subjects: Ask Not Whether Governments Will Default, But How,” 8/25/10. Source: Arnaud Mares, Morgan Stanley Research. www.kpcb.com USA Inc. | Consequences of Inaction 417 Combined With US Dollar’s Reserve Currency Status, Investors Still Prefer USA Inc.’s Debt, For Now Global Aggregate Foreign Exchange Reserves by Currency, 1999 – 2010* Global Foreign Exchange Reserves (US$B) $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 Other Currencies Euros US Dollars US Dollars' Share of Total 100% 75% 50% 25% US Dollars' Share of Total $0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010* 0% www.kpcb.com Note: 2010 data are preliminary and as of CQ3. Source: IMF. USA Inc. | Consequences of Inaction 418 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. 1 � - 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 www.kpcb.com Sources: 1) Bloomberg, The New York Times; 2) The Wall Street Journal USA Inc. | Consequences of Inaction 419 Treasury Swap Spread 1 Turned Negative For First Time in History 2 –Now Cheaper for Some Private Companies to Borrow than USA Government 160 10-Year Treasury Swap Spreads & Federal Budget Deficit / Surplus, 1988 – 2010 4% 10yr Treasury Swap Spread (bps) 140 120 100 80 60 40 20 0 -20 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2% 0% -2% -4% -6% -8% -10% -12% USA Federal Budget Surplus / Deficit as % of GDP (%) 10y Treasury Swap Spreads (left axis) Federal Budget Deficit/Surplus as % of GDP (right axis) Note: 1) Treasury swap spread = Treasury yield – swap rate (between bonds of comparable maturity); swap rate is the fixed interest rate that the buyer demands in exchange for the uncertainty of paying the short-term LIBOR (floating) rate over time; swap rates are generally higher than Treasury yields with corresponding maturities as they include incremental credit risk associated with the banks that provide swaps compared to Treasuries, which are viewed as risk-free. 2)10-year Treasury swap spread turned negative on 3/24/10, while 30-year Treasury swap spread turned negative in 10/08 and shorter-term Treasury swap spreads are still positive. Source: Bloomberg. www.kpcb.com USA Inc. | Consequences of Inaction 420 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. www.kpcb.com USA Inc. | Consequences of Inaction 421 History Doesn’t Repeat Itself, But It Often Rhymes 1 – What Can We Learn From These Credit Crises? Sovereign Credit Crisis State / Local Financial Woes Corporate Bankruptcy 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) 1975 – New York City ($14B* Debt Outstanding) 2009 – General Motors ($95B Debt Outstanding) www.kpcb.com Note: 1) Attributed to Mark Twain. *NYC government and subsidiaries had $14B debt outstanding in 1975. Adjusting for inflation, $14B of 1975 dollars would have been ~$50B in today’s dollars. Source: sovereign data points per IMF and World Bank. NYC data point per California Research Bureau “Overview of New York City’s Fiscal Crisis,” 3/1/1995. USA Inc. | Consequences of Inaction 422 Simple Pattern Recognition From Historical Debt Crisis Reveal Common Drivers (Leverage & Entitlements) + Triggers Year of Crisis Debt Restructured Amount