Comeback America: Turning the Country Around and Restoring Fiscal Responsibility

MIT’s Ethics Initiative

Cambridge, MA October 6, 2010

David M. Walker President and CEO The Peter G. Peterson Foundation and Former Comptroller General of the United States

• • • • • • •

Law Ethics Morality A Higher Calling Stewardship Sustainable Success Leading by Example

Key Concepts

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Duties of Loyalty

“Companies and the directors that oversee them, especially ones that relate to global entities, do not have duties of loyalty to countries. They have a duty of loyalty to their shareholders but should also consider the interests of key stakeholders. However, if companies, management and directors fail to pay attention to the key sustainability challenges that we face as a nation, we will all pay a high price over time.” - Hon. David M. Walker, Former Comptroller General of the United States (1998-2008)

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The Bottom Line

“If we do not take steps to keep our economy strong for both today and tomorrow, our national security, international standing, standard of living, our social safety net, and even our domestic tranquility will suffer over time.” - Hon. David M. Walker, Former Comptroller General of the United States (1998-2008)

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Selected Key Sustainability Challenges

• • • • • • • • • • •

Fiscal Entitlement Programs Health Care Tax System Education System Critical Infrastructure Immigration Policy Savings Rates Innovation Gap Operational Structures and Practices Dysfunctional Political System

3

2%

1800

Total Federal Spending

(As Percentage of U.S. Economy) Total Spending

2010

24%

2040

38% Size of the Total Economy: $8.8 Billion (Constant 2009 Dollars) Projected Size of the Total Economy: $14.4 Trillion (Constant 2009 Dollars) Projected Size of the Total Economy: $28.7 Trillion (Constant 2009 Dollars) SOURCES: Data from the Congressional Budget Office; Long-Term Budget Outlook: June 2010, alternative fiscal scenario. Data from Historical Statistics of the United States, Millennial Edition On Line, Cambridge 2006. Compiled by PGPF.

NOTE: The alternative fiscal scenario includes several changes to current law that are widely anticipated to occur (i.e. adjustments to Medicare payment rates).

4

The total debt includes debt held by the public (domestic and foreign investors) and debt the government owes to various government programs* 16 14 12 10 8 6 4 2 0 Intragovernmental Debt Debt Held by the Public $ 5.6 Trillion $2.2 (23%) $3.4 (35%)

57 % of GDP

$ 13.4 Trillion $4.5 (31%) $8.9 (61%)

92 % of GDP

September 30, 2000 August 31, 2010 SOURCES: Data from the Office of Management and Budget, A New Era of Responsibility: The 2011 Budget: February 2010, Historical Tables; and the Department of Treasury, Daily Treasury Statement August 31, 2010). Compiled by PGPF.

NOTE: Totals may not add due to rounding.

*Intragovernmental debt refers to Treasury securities held by federal trust funds (e.g., Social Security and Medicare) and other government accounts. Debt held by the public refers to all federal debt held by individuals, corporations, state or local governments, and foreign entities.

5

Composition of Federal Spending

(% of Total Spending) Medicare and Medicaid Net Interest Social Security Defense Other Mandatory Other Discretionary 20% 4% 15% 43% 19% 61% 21% 34% 12% 20% 19% 7% 42% 6% 15% Total Spending 1970: $900 Billion (Constant 2009 Dollars) Total Spending 2010 (estimated): $3.5 Trillion (Constant 2009 Dollars) SOURCES: Data from the Office of Management and Budget, A New Era of Responsibility: The 2011 Budget, Historical Tables; and the Congressional Budget Office, Preliminary Analysis of the President’s Budget: March 2010. Compiled by PGPF.

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Total Mandatory 38%

Mandatory programs and interest costs are taking over more and more of the federal budget, crowding out important discretionary programs

Net Interest 7% Total Mandatory 62% Net Interest 5% Total Mandatory 82% Mandatory Programs 31% Discretionary 62% Mandatory Programs 57% Discretionary 38% Discretionary 18% Net Interest 35% Mandatory Programs 47%

Total Spending 1970: $900 Billion Total Spending 2010: $3.5 Trillion (est.) Total Spending 2040: $12.3 Trillion (est.) SOURCES: Data derived from the Office of Management and Budget, FY 2011 Budget, Historical Tables, February 2010; and the Government Accountability Office, The Federal Government’s Long-Term Fiscal Outlook, January 2010 Update, alternative simulation using Congressional Budget Office assumptions. Calculated by PGPF.

Notes: Data are in constant 2009 dollars. Mandatory programs include Social Security, Medicare, Medicaid and other entitlement programs.

7

U.S. dependency on foreign lenders to finance the public debt has risen sharply

1970

Total Debt: $283 billion Foreign Holdings: 5%

1990

Total Debt: $2,412 billion Foreign Holdings: 19%

2010 est.

Total Debt: $8,633billion Foreign Holdings: 46%

SOURCES: Data for 1970 and 1990 from the Office of Management and Budget, A New Era of Responsibility: The 2011 Budget, Analytical Perspectives, February 2010. Data for 2010 from Department of Treasury, Daily Treasury Statement (June 30, 2010) and Treasury International Capital Reporting System, April 15, 2010 release. Compiled by PGPF. NOTE: 2010 data reflects debt levels through February 2010.

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120 100 80 60 40 20 0 1800 Since 1800, U.S. Debt Held by the Public has exceeded 60 percent of GDP (the maximum debt ceiling used by the European Monetary Union) only during World War II until 2010

WWII

1830

Civil War

1860 1890

Great Depression WWI

1920 1950 1980

TARP & Recession

2010 SOURCES: Historical data from the Congressional Budget Office, Long-Term Budget Outlook: June 2009; the Government Accountability Office, The Federal Government’s Long-Term Fiscal Outlook: January 2010 Update, alternative simulation using Congressional Budget Office assumptions. Compiled by PGPF.

NOTE: Debt held by the public refers to all federal debt held by individuals, corporations, state or local governments, and foreign entities.

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The following table illustrates the U.S. government’s explicit liabilities, commitments, and unfunded social insurance promises 

Explicit liabilities

 Publicly held debt  Military & civilian pensions & retiree health  Other Major Fiscal Exposures 

Commitments & contingencies

 E.g., Pension Benefit Guaranty Corporation, undelivered orders

In Trillions of Dollars 2000 $6.9

2009 $14.1

3.4

2.8

0.7

0.5

7.6

5.3

1.3

2.0



Social insurance promises

  Future Social Security benefits Future Medicare benefits    Future Medicare Part A benefits Future Medicare Part B benefits Future Medicare Part D benefits

13.0

3.8

9.2

2.7

6.5

--

$20.4

45.8

7.7

38.2

13.8

17.2

7.2

$61.9

Total

SOURCE: Data from the Department of Treasury,

2009 Financial Report of the United States Government

. Compiled by PGPF. NOTE: Numbers may not add due to rounding. Estimates for Medicare and Social Security benefits are from the Social Security and Medicare Trustees reports, which are as of January 1, 2009 and show social insurance promises for the next 75 years. Future liabilities are discounted to present value based on a real interest rate of 2.9 percent and CPI growth of 2.8 percent. The totals do not include liabilities on the balance sheets of Fannie Mae, Freddie Mac, and the Federal Reserve. Assets of the U.S. government not included. Does not include civil service and military retirement funds, unemployment insurance, and debt held by other government accounts outside of Social Security and Medicare.

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50 45 40 35 30 25 20 15 10 5 0 Without reforms, by 2022, future revenues will only cover Social Security, Medicare, Medicaid, and interest on the debt. By 2046, revenues won’t even cover interest costs.

Discretionary Spending Revenue

9% 2%

Other Mandatory

9%

Medicare & Medicaid

9% 4% 5% 5% 2010 1% 9% 2% 7% 5% 6% 2022 6% 18% 2046

Social Security Net Interest

SOURCE: Data from the Government Accountability Office The Federal Government’s Long-Term Fiscal Outlook: January 2010 Update, alternative simulation using Congressional Budget Office assumptions. Compiled by PGPF.

NOTE: Baseline interest rate is assumed to be 5.0 percent.

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Total government debt in the U.S is higher than some of the most financially troubled countries in Europe 2010 2015 160 140 120 100 80 60 40 20 0 Greece Italy Portugal Ireland Spain United Kingdom United States SOURCE: Data from the International Monetary Fund, IMF Fiscal Monitor Series: Navigating the Fiscal Challenges Ahead (May 14, 2010). Compiled by PGPF.

NOTE: Both 2010 and 2015 figures are estimates. Total government debt (also referred to as general government gross debt) measures all liabilities that require payment or payments of interest and/or principal by the debtor to the creditor at a date in the future. This includes central, state, and local government debt.

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Future U.S. Debt Held by the Public is projected to soar if current policies remain unchanged 900 800 700

Actual Projected

600 500 400 300 200 100 0 1990

60 % of GDP

2000 2010

87%

2020

146%

2030

233%

2040

344%

2050

483%

2060

650%

2070

854%

2080 SOURCES: Historical data from the Congressional Budget Office, Long-Term Budget Outlook: June 2009; projections from Long-Term Budget Outlook: June 2010, alternative fiscal scenario. Compiled by PGPF.

NOTE: Debt held by the public refers to all federal debt held by individuals, corporations, state or local governments, and foreign entities. The alternative fiscal scenario includes several changes to current law that are widely anticipated to occur (i.e. adjustments to Medicare payment rates).

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Foreign purchases of marketable Treasury securities are overwhelmingly in shorter maturities, indicating sizeable interest-rate risk upon rollover 900 800 700 600 500 400 300 200 100 0 30 years 10 Years 2-7 Years 1 year or less 340 443 104 46 5 2001 2002 182 2003 2004 22 2005 2006 2007 2008 2009 291 26 7 2010 SOURCE: Data from the U.S. Treasury, Office of Debt Management, Investor Class Auction Allotments. Compiled by PGPF.

NOTE: Purchases reflect gross foreign purchases of bills (4-week, 13-week, 26-week, 52-week, and cash-management bills); notes (2 year, 3-year, 5-year, 7-year, and 10-year) and bonds (30-year). Data excludes sales of Treasury Inflation Protected Securities (TIPS), and also is not net of sales. Foreign purchases for 2010 as of June 2010.

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Current Treasury interest rates are low by historical standards 16 14 12 10 8 6 3- Month 10-Year 30-Year

Average Interest Rate: 6.5% over past 30 years

4 2 0 1980 1985 1990 1995 2000 2005 Aug-10 SOURCE: Data from the Federal Reserve Statistical Release, Table H.15, Selected Interest Rates, Historical Data, accessed August 16, 2010. Complied by PGPF.

NOTE: The U.S. Treasury Department did not offer 30-year bonds between 2003 and 2006.

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A rate increase of just two percent from baseline levels of 5.0 percent have a dramatic effect on interest costs

25 20 15 10 Additional Interest from Rate Increase from 5.0% to 7.0% Baseline Net Interest

5.7% of GDP 14.1% of GDP

5 0 2010 2015 2020 2025 2030 2035 2040 SOURCE: Data from the Government Accountability Office The Federal Government’s Long-term Fiscal Outlook: January 2010, alternative simulation using Congressional Budget Office assumptions. Compiled by PGPF.

NOTE: The projections use implied CBO interest rates through 2020, and an interest rate of 5.0 percent thereafter.

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Since its inception, the Social Security program has experienced more surpluses than deficits 1,0 0,8 0,6 0,4 0,2 0,0 -0,2 -0,4 1936 1944 1952 1960 1968 1976 1984 1992 2000 2008 SOURCE: Data from the Office of Management and Budget, FY 2011 Budget, Historical Tables, February 2010 and Social Security Administration, 2010 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Federal Disability Insurance Trust Funds, August 2010. Compiled by PGPF.

NOTE: Excludes interest earnings.

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Total U.S. health expenditures (both public and private) are projected to soar to more than one-third of the economy by 2040 40 35 30 25 20 15 10 5 0

5 % 7 % 8 % 12 % Actual Projected 13 % 17 % 22 % 29 %

1960 1970 1980 1990 2000 2010 2020 2030 SOURCE: Data from the Congressional Budget Office, The Long-Term Fiscal Outlook: June 2009. Compiled by PGPF.

34 %

2040

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Generally, while the U.S. spends more on health care than other countries, its health outcomes are no better

Outcome

15% • •

Life Expectancy at 65

U.S. = 17.4 years for men (2006) 20.3 years for women (2006) •

Infant Mortality

U.S. = 0.7% deaths per live birth in 2006 •

Obesity

U.S. = 34% over age 15 in 2006

Rank

(out of countries reporting) 34% 9 th out of 23 19 th 15 th out of 30, men out of 30, women 28 th out of 30 14 th out of 14 SOURCE: Data from OECD, Health Data 2009 (November 2009). Compiled by PGPF.

Chart 29

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The U.S. spent more on defense in 2008 than did the countries with the next 14 highest defense budgets combined 300 200 100 0 700 600 500 400

$581 billion

India Saudi Arabia Italy Japan Germany Russia UK France China Australia Spain Canada Brazil South Korea

$607 billion

U.S.A.

SOURCE: Data from Stockholm International Peace Research Institute, 15 Major Spender Countries in 2008. Compiled by PGPF.

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Individual income and payroll taxes comprise most of federal receipts

2010: Total Revenues $2,177 billion Payroll Taxes 40% Individual Income Taxes 43% Corporate Income Taxes 7% Другой 9% Excise 3% Estate and Gift 1% Customs Duties 1% Miscellaneous 4%

SOURCE: Data from the Congressional Budget Office, Preliminary Analysis of the President’s Budget, March 2010. Compiled by PGPF.

21

“Tax expenditures,” (deductions, credits, and other special provisions) total an estimated $1 trillion annually and provide substantial benefits that are not reflected in the budget

Top 5 Tax Expenditures Estimated Tax Revenue Foregone (FY 2010)

1. Exclusion of employer provided health insurance from taxable income.* $262 billion 2. Exclusion of pension contributions and earnings.** $122 billion $92 billion 3. Deduction of mortgage-interest on a primary residence.

4. Deduction of non-business state and local taxes (includes income, property and sales taxes) 5. Capital gains (except agriculture, timber, iron ore, and coal).*** $53 billion $45 billion

Total of Top 5 $573 billion

SOURCE: Data from the Office of Management and Budget, A New Era of Responsibility: The 2011 Budget, Analytic Perspectives, February 2010. Compiled by PGPF. NOTE: Numbers may not add due to rounding. * Includes the exclusion from payroll taxes and income taxes. ** Includes employer pension plans, employee and employer contributions to 401k plans, IRAs, and Keough plans.

*** In addition, the biodiesel producer tax credit results in a $200 million reduction in excise tax receipts in 2010.

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The top 5 corporate tax expenditures, deductions, credits and other special provisions are relatively small compared to the largest tax expenditures

Top 5 Corporate Tax Expenditures

1. Deferral of income from controlled foreign corporations

Tax Revenue Lost (FY2010)

$31 billion 2. Deduction for U.S. production activities $8.8 billion 3. Credit for increasing research activities 4. Deferred taxes for financial firms on certain income earned overseas 5. Credit for low-income housing investments $5.8 billion $5.5 billion $ 5.4 billion

Total of Top 5 $56.4 billion

SOURCE: Data from the Office of Management and Budget, A New Era of Responsibility: The 2011 Budget, Analytic Perspectives, February 2010. Compiled by PGPF. NOTE: Numbers may not add due to rounding.

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High-income households earn a disproportionate share of pre-tax income and pay a disproportionate share of total federal taxes 100 90

Top 0.5% (15% ) Top 0.5% (23% )

80 70 55% 69% Top Quintile $67,400+ 60 50 Fourth Quintile $45,200-$67,399 40 30 20% Middle Quintile $30,500-$45,199 20 10 0 13% 8%

Share of Total Pre Tax Income

4% 17% 9%

Share of Total Federal Taxes

4% 1% Second Quintile $17,900-$30,499 Lowest Quintile Less than$17,900 SOURCE: Congressional Budget Office, Historical Effective Tax Rates: 1979- 2005: Additional Data on Sources of Income and High-Income Households December 2008. Compiled by PGPF.

NOTE: Data for 2005 in 2005 dollars.

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Effective median individual income tax rates are negative or zero for households with incomes below $34,800 20 15 10.8% 10 5 3.2% 6.4% 0% 0 -5 -4.2% -10 Lowest Quintile <$17,800 Second Quintile $17,800 $34,800 Middle Quintile $34,800 $63,400 Fourth Quintile $63,400 $104,200 Top Quintile $104,200+ 18.8% Top 1% $532,500+ SOURCE: Data from the Tax Policy Center. Compiled by PGPF.

25

U.S. household debt has reached historically high levels as a percent of disposable income

140 120 100 122% 80 60 35% 251% Increase since 1950 40 20 0 1950 1960 1970 1980 1990 2000 2010 (Q1)

SOURCES: Data from the Federal Reserve, Flow of Funds Accounts—Liabilities of Households and Nonprofit Organizations; and Bureau of Economic Analysis, Personal Income and Its Disposition: February 2010. Compiled by PGPF.

26

Current U.S. personal savings as a percent of disposable income has fallen to historically low levels

30 25 20 WWII 15 10 Great Depression 5 0 -5 1930 -1.7% 1940 1950 1960 1970 1980 1990 2000 4.3% 2009

SOURCE: Data from Bureau of Economic Analysis, Personal Income and Its Disposition: February 2010. Compiled by PGPF.

27

The net national savings rate is at its lowest level since the Great Depression

20 WWII 15 10 Great Depression 16.1% 5 0 -5 -10 -7.5% 1930 1940 1950 1960 1970 1980 1990 2000

SOURCE: Data from the Bureau of Economic Analysis, National Income and Product Accounts. Compiled by PGPF. NOTE: The net national savings rate comprises both public and private savings net of consumption-related expenditures.

-2.5% 28

State and local governments face short and long term fiscal challenges as their negative operating balances continue to grow 3 2,5 2 1,5 1 0,5 0 -0,5 -1 1990 1995 2000 2005 2010 2015 2020 2025 2030 2035 2040 SOURCE: Data from the General Accountability Office State and Local Government’s Fiscal Outlook March 2010 Update, alternative simulation. Compiled by PGPF.

29

Future state & local expenditures on health care are the primary source of their poor fiscal outlook.

Non-Health Expenditures Health Expenditures 12 10 8 6 4 2 0 2000 2010 2020 2030 2040 2050 SOURCE: Data from the General Accountability Office State and Local Government’s Fiscal Outlook March 2010 Update. Compiled by PGPF.

NOTE: State level health expenditures are primarily Medicaid and health insurance for government employees and retirees.

2060

30

Unfunded Federal and State Employee Retirement Liabilities in Fiscal Year 2008

$4 000 $3 500 $3 000

$1 162

Pension Liabilities Health Liabilities $2 500 $2 000 $1 500

$2 609

$1 000

$555

$500

$456

$0 Federal Civilian and Military Retirement Liabilities State Employee Retirement Liabilities SOURCE: Pew Center on the States, The Trillion Dollar Gap February 2010; U.S. Treasury Department Financial Report of the U.S. Government 2008.

NOTE: Data is as of the end of fiscal year 2008. The unfunded liability is the difference between the present discounted value of future liabilities and current assets. For the purposes of converting future liabilities into present value, most states use a discount rate of approximately 8%, based on assumed returns on investing their pension funds.

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Federal and State Employee Retirement Liabilities in Fiscal Year 2008 State Pension Liabilities Unfunded 16% State Health Liabilities Funded 5% Funded 84% Unfunded 95%

SOURCE: Pew Center on the States, The Trillion Dollar Gap February 2010; U.S. Treasury Department Financial Report of the U.S. Government 2008.

NOTE: Data is as of the end of fiscal year 2008. The unfunded liability is the difference between the present discounted value of future liabilities and current assets. For the purposes of converting future liabilities into present value, most states use a discount rate of approximately 8%, based on assumed returns on investing their pension funds. ** The data have a few limitations. States have different methods in computing their obligations, and different assumptions of retirement ages and life spans. They also conduct actuarial valuations at different times of the year, which can cause their funding levels to appear better or worse off depending on economic conditions .

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Actuarially Required Contribution to Retiree Health and Pension Funds (as a Share of State Revenue) in Fiscal Year 2008 **

30 25 20 15 10 5 0

16.4 % 12.1 % 14.5 % 11.8 % 16 % 9.5 % 0.6 % 6.6 %

Retiree Pension Benefits Retiree Health Benefits

0.6 % 5.7 % 1.4 % 4.3 % 6.3 % 4.1 % Minnesota Wisconsin New York New Jersey Alabama Hawaii Iowa

NOTE: The actuarially required contribution is the annual contribution to the retiree pension and health funds required for future assets to be in line with future liabilities within 30 years. It has two components: a normal contribution to keep up with new benefit obligations accrued, and a catch-up payment to make up for the current gap between pension assets and liabilities. The data for both revenues and unfunded obligations are for fiscal year 2008. Most states end their fiscal year in June of 2008, and therefore these numbers do not include losses in the stock market that led to losses in most pension funds. ** The data have a few limitations. States have different methods in computing their obligations, and different assumptions of retirement ages and life spans. They also conduct actuarial valuations at different times of the year, which can cause their funding levels to appear better or worse off depending on economic conditions .

33

Moody’s Rating Structure

Obligation Rating Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Ba1 B1 Caa1 Baa2 Ba2 B2 Caa2 CA C Baa3 Ba3 B3 Caa3

Top Rating/ Minimal Risk Bottom Rating/ Typically in Default SOURCE: Data from Moody’s Investors Service, Government-Related Issuers: Methodology Update, July 22, 2010. Compiled by PGPF.

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State and City Moody’s Ratings

State

Georgia –Aaa Texas - Aaa Virginia -Aaa Alabama – Aa1 Florida –Aa1/Aa2 New York – Aa2 Connecticut – Aa2 California – A1

City

Alexandria, VA - Aaa Jacksonville, FL – Aa1 Atlanta – Aa2 /A1 Houston – Aa2 New York – Aa2 Washington, DC – Aa2/Aa1 Bridgeport, CT – A1 Miami - A1 SOURCE: Data from Moody’s website, Compiled by PGPF.

* Most recent rating available is from 2005.

35

Key Systematic Factors Driving Deficits and Debt at the Federal, State and Local Levels of Government

• • • • • • • •

Expansion of government at all levels Health Care Costs Retirement Income Costs Disability and Welfare Related Costs Critical Infrastructure Needs Education Costs Outdated and Inadequate Revenue Systems Myopia, tunnel vision, special interests and self-interest.

36

A Way Forward

• Federal:

Implement statutory budget controls that address discretionary and mandatory spending as well as tax preferences in order to stabilize our debt/ GDP at a reasonable level

•

Achieve Social Security reform that makes the program solvent, secure, sustainable, more savings oriented

•

Reduce the rate of increase in health care costs and more effectively target related taxpayer subsidies and tax preferences

•

Ensure that all future health care reforms adequately consider coverage, cost quality and personal responsibility

•

Pursue comprehensive tax reform to make system more streamlined, simple, equitable and competitive while generating adequate revenues

37

A Way Forward- Continued

• • Review, re-prioritize and re-engineer the base of the federal government to focus on the future and generate real results Ensure that we have process that will enable us to achieve the above objectives within a reasonable period of time • • • •

State and Local:

Reform pension and health systems to make them reasonable, affordable and sustainable Review, re-prioritize and re-engineer the base of government.

Pursue comprehensive tax reform in coordination with the federal government.

Consider an exchange of primary roles, functions and revenue sources as part of a new federalism or devolution effort (e.g., health care, education, infrastructure)

38

A Way Forward

“Yes, we can do what it takes to create a better future, but we all must do our part, and we need to start now.”

- Hon. David M. Walker, Former Comptroller General of the United States (1998-2008)

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