Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis (MD&A) is intended to help the reader understand the results of operations and financial condition of our Government. MD&A is provided as a supplement to, and should be read in conjunction with, Item 8. Financial Statements and Supplementary Information.

About Management’s Discussion and Analysis

Fiscal years presented

In this MD&A, we analyze the one-year, five-year, and 10-year periods ending September 30, 2018, the most recent period for which a nearly complete set of federal, state, and local financial data is available. A public company is generally required to analyze its immediately prior three fiscal years. While decisions can be made and implemented quickly within companies, and the impact of those decisions may be seen shortly thereafter, this is not generally the case within government. Therefore, we have provided a longer-term view within this MD&A than we would for a company.

Which changes are discussed

Throughout this MD&A, we discuss key changes in revenues and expenditures during the periods presented. We define key changes as those that are the largest dollar changes that when added together comprise at least 75% of the total change being explained. These key changes are highlighted in gray in the tables and then are discussed in the sections following each table. Note that only key changes are discussed, though all changes in major categories are shown in the tables for your information.

Modification of data

In cases where only calendar year annual data was available, we used one simple formula to create federal fiscal year (October 1 to September 30) data – 25% of the prior calendar year figure plus 75% of the current calendar year figure. All the figures in this MD&A that were converted from calendar year to federal fiscal year in this manner are indicated by * (one asterisk). To create state and local fiscal year (July 1 to June 30) data, we used a formula of 50% of the prior calendar year figure plus 50% of the current calendar year figure. All the figures in this MD&A that were converted from calendar year to state and local fiscal year in this manner are indicated by ** (two asterisks). Finally, for tax revenues, we calculated the impact of tax rates vs. tax bases by holding one constant while fluctuating the other. See more information at Exhibit 99.13.

Comparability of data

See discussion of the comparability of data within this MD&A in Exhibit 99.12 Data comparability considerations.

Overview

The United States of America (US) is a federal republic composed of 50 states, a federal district of Washington, D.C., five major and various minor insular areas, as well as over 90,000 local governments, including counties, municipalities, townships, school districts, and special district governments. At 3.8 million square miles and with over 329 million people (as of 2020), the US is the world’s third-largest country by total area and the third most populous.

The people of the US, through our Government as outlined in our Constitution, seek to form a more perfect union, establish justice, ensure domestic tranquility, provide for the common defense, promote the general welfare, and secure the blessings of liberty to ourselves and our posterity.

To achieve the vision of the people, our Government raises money, spends money, and exercises, grants, and rescinds authorities. Our Government generates revenue mainly by taxing individuals and businesses in the US, and to a lesser degree through income on assets invested and charges for government services. Our Government’s most significant expenditure is transfer payments to individuals and subsidies, comprising 47% of expenditures in 2018, most significantly for Social Security, Medicare, and Medicaid. Personnel and compensation costs is our Government’s second-largest expenditure, comprising 27% of expenditures in 2018. By segment, our Government’s most significant expenditures are for securing the blessings of liberty to ourselves and our posterity, comprising 53% of expenditures in 2018.

Trends

During the one-year, five-year, and 10-year periods ending in 2018, we saw a mixture of stagnation, progression towards, and retreat from, achievement of our Constitutional objectives. Our Government’s role in these trends is not clear. However, we believe it may be useful to observe these trends in evaluating our Government. The 10 year comparison in this year’s report is particularly noteworthy, as the Great Recession was underway during 2008; the Great Recession began in December 2007 and was accompanied by a financial crisis that peaked in September-October 2008 as major financial institutions were on the brink of collapse, prompting the federal government to act. Highlights in key metrics for these years are summarized below.

When comparing 2018 to 2008, we made progress towards our objectives by:

• growing our economy, by many measures, including most notably increasing: the S&P 500; private fixed investment; GDP; new home sales; net asset accumulation, including total and average household financial and real estate assets paired with lower mortgage debt; numbers of pension participants, total pension assets, and the rates of return thereon; and numbers of businesses, including those less than one year old; while decreasing workers at or below minimum wage, our overall trade deficit, and bankruptcy filings;
• reducing overall crime and physical harm, including most notably reducing reported crime and arrests and certain jailed and imprisoned populations, border apprehensions and persons removed or returned, and workplace violations and non-fatal workplace injuries;
• improving quality of life for certain populations, including reducing: the number of children ages four and older that are victims of maltreatment; the median time children spend in foster care; the number of children in poverty; and the number of active duty military personnel who are stationed abroad, while increasing passports in circulation and the number of visas granted; and
• tending to our environment, including reducing numbers of poor air quality days in certain large cities and net energy consumption, while increasing energy consumption from nuclear and renewable sources.

We retreated from our objectives through:

• continuing fiscal unsustainability of our Government, as our Government’s debt continues to grow as a percentage of GDP and per capita;
• increasing specific crime and physical harm, including increasing civilian deaths from highway vehicle and other non-structure fires (despite decreased vehicle fires), consumer complaints, intellectual property seizures, airport firearm discoveries, and unauthorized persons with a prior criminal conviction who are removed;
• increasing challenges to the health of our population, including increasing rates of obesity and death from most leading and select other causes, costs of natural disasters and acres burned in forest fires, increased crop failures, and increased personal healthcare expenditures;
• insufficiently protecting our children, including increasing: child fatalities as a result of maltreatment, primarily neglect and abuse and of children ages birth to one year old and ages eight to 11; children receiving free and reduced price lunch; and homeless children enrolled in school; and
• increasing challenges to the affordability of higher education and housing, including increasing costs of higher education, median new home prices, and rent.

Our Government’s operations are financially unsustainable. It continues to spend more than it takes in each year, amassing total liabilities and an overall accumulated deficit that reached $36.8 trillion and $15.2 trillion, respectively, at September 30, 2018. Expenditures increased 35% between 2008 and 2018, when they reached a record high of $6.3 trillion annually. Our Government has, however, reduced its annual deficit by 75% from its peak of $2.3 trillion in 2009 to $576 billion in 2018 through increased revenue. Increases in revenue have been driven by both overall economic prosperity (primarily increased taxable income and income on invested Government assets) and tax policy changes. See Part I, Item 1A. Risk Factors, Recently enacted legislation and tax avoidance put downward pressure on tax revenues, reducing Government resources, for discussion of recent significant tax policy changes that could further impact these trends.

Macroeconomy and related government actions

Key economic indicators

Below are some key economic indicators for the periods discussed in this MD&A:

The first five years discussed in this MD&A

Between fiscal years 2008 and 2013, nominal GDP increased by 14%, with the following sectors experiencing the largest increases: finance, insurance, real estate, rental, and leasing; educational services, healthcare, and social assistance; professional and business services; and government. The S&P 500 index grew 14%, while the average annual US inflation rate decreased from 4.4% in 2008 to 1.6% in 2013. However, there were significant shocks in the system during this period.

In 2007, the housing bubble peaked and shortly thereafter gave way to a financial crisis. The Great Recession began in December 2007 and was accompanied by a financial crisis that peaked in September-October 2008 as major financial institutions were on the brink of collapse, prompting the federal government to act. Major government action first began in March 2008 when the investment firm Bear Stearns collapsed, and the federal government assisted in J.P. Morgan’s takeover of the failed entity. Then in September 2008, Fannie Mae and Freddie Mac were placed in conservatorship by the Federal Housing Finance Agency. Ultimately, a broader package called the Troubled Asset Relief Program (TARP) was authorized by Congress in October 2008 to stabilize the financial system amid the most severe economic downturn since the Great Depression. Its original goal was to buy distressed assets, such as mortgage-backed securities, from financial firms. That was later changed to inject capital directly into banks through the purchase of bank senior preferred shares and warrants. The program was also broadened to include bailouts for auto firms General Motors Company and Chrysler Corporation, mortgage relief for homeowners, and measures to restart credit markets. Congress originally authorized $700 billion for TARP, which was later reduced to $475 billion (96% of which has since been returned to our Government, along with a surplus on certain investments that totals more than $7.9 billion).

During this period, federal and state budget deficits reached record highs as revenues declined and spending increased. Revenues for state and local governments declined significantly because of the economic downturn, prompting some cuts to spending and higher tax rates as states (except Vermont) are not allowed to spend more than they receive.

After President Obama took office in January 2009, he and the Democratic-controlled Congress enacted the American Recovery and Reinvestment Act (ARRA), which was a stimulus package of temporary tax cuts and spending increases with the aim of boosting the macroeconomy. The legislation’s numerous spending and revenue provisions can be grouped into several categories according to their focus:

• Providing funds to states and localities – for example, by raising federal matching rates under Medicaid, providing aid for education, and increasing financial support for some transportation projects;
• Supporting people in need – such as by extending and expanding unemployment benefits and increasing benefits under the Supplemental Nutrition Assistance Program (formerly food stamps);
• Purchasing goods and services – for instance, by funding construction and other investment activities that could take several years to complete; and
• Providing temporary tax relief for individuals and businesses – such as by raising exemption amounts for the Alternative Minimum Tax, increasing the Earned Income Tax Credit, adding a new Making Work Pay tax credit and a new American Opportunity Credit for higher education, and creating enhanced deductions for depreciation of business equipment.

At the end of fiscal year 2009, the recession waned, and a gradual recovery began. In December 2010, some tax cuts enacted in ARRA and those enacted during President George W. Bush’s term were extended for two more years. Some of those were eventually allowed to expire in December 2012 – primarily those affecting high-income taxpayers. In March of 2010, the Affordable Care Act (ACA) was enacted, with most of the associated government revenue increases taking effect on January 1, 2013. 

The following five years

The second and final five years of the 10-year window included in this MD&A was marked by economic growth. Overall, between fiscal years 2013 and 2018, nominal GDP grew by 23%, with the following sectors experiencing the largest increases: finance, insurance, real estate, rental, and leasing; professional and business services; educational services, healthcare, and social assistance; and government. The S&P 500 index grew 75%, while the average annual US inflation rate increased from 1.6% in 2013 to 2.4% in 2018.

This period was also one of numerous changes in individual income tax law. In December 2012, following President Obama's reelection, he signed into law an extension of the Bush tax cuts again, albeit this time without the lower tax rates on high-income taxpayers.  So, the top two individual income tax rates reverted to their pre-2001 levels of 39.6% and 36%, while the top income tax rate on capital gains moved from 15% to 20%. These tax rates went into effect in January 2013.

Also going into effect in January 2013 were some new taxes from the ACA. This included most notably a new 3.8% tax on unearned income for high-income taxpayers. That is, taxpayers with Adjusted Gross Income (AGI) higher than $200,000 (single) and $250,000 (married) began paying a 3.8% tax on income from interest, dividends, and capital gains, among other sources. Furthermore, there was a 0.9 percentage point increase in the employee Medicare tax for those with AGIs higher than $200,000 (single) and $250,000 (married). This applies to payroll sources of income such as wages and self-employment income. The ACA also put into effect a higher AGI threshold for the medical expenses itemized deduction. Specifically, taxpayers under the age of 55 can deduct medical expenses in excess of 10% of AGI. Before, it was 7.5% of AGI.

In tax year 2014, key new healthcare coverage provisions of the ACA went into effect, including healthcare exchange cost subsidies provided to individual taxpayers through the Premium Tax Credit and the individual mandate requiring Americans pay a penalty if they lacked adequate health insurance.

In January 2017, Donald Trump was sworn in as the 45^th president of the US, marking the transition from a Democrat to a Republican and the beginning of many policy changes. Among the policy changes was the Tax Cuts and Jobs Act (TCJA), which became law effective January 1, 2018 and for which elements are effective at various dates. The TCJA reduced the top individual income tax rate from 39.6% to 37%, changed the income tax brackets associated with each tax rate, eliminated personal exemptions, capped the state and local tax deduction at $10,000, nearly doubled the amount of the standard deduction, increased the child tax credit, provided for a 20% deduction of qualified business income and certain dividends for individuals, reduced the corporate income tax rate from 35% to 21%, and required a one-time tax on all foreign profits accumulated prior to the passing of the act, among other provisions.

Subsequent event

At the time of the publishing of this 10-K, the US is grappling with a worldwide pandemic of a respiratory disease, COVID-19, which is spreading from person-to-person caused by a novel (new) coronavirus. This pandemic, as well as our responses to it, have had a significant negative impact on the health and well-being of the US population, as well as on the US economy. Certain positive economic and other trends noted in management’s discussion below will likely reverse during the time of COVID-19. Aggregate individual and corporate income will likely decline, and our Government’s primary source of revenue – taxes – will decline accordingly, at least temporarily. Another significant source of revenue for our state and local governments, revenue from investments they make, may also be negatively impacted by stock and bond market volatility. In response to this crisis, our Government will need to spend more to help the population regain its health, to support those who are in need of assistance due to the economic impacts of the crisis, and to stimulate the economy once the serious public health risk abates. To date, our Government has passed two major COVID-19 relief bills into law, which will cost an estimated $3.6 trillion in Government spending and revenue reductions through tax cuts. See key aspects of these laws and other information on COVID-19 outlined in Item 1A. Risk Factors, The COVID-19 pandemic may hinder our Government’s ability to achieve its constitutional objectives, at least in the short-term.

Other factors affecting this discussion

For each revenue and expenditure table below, we include two rows at the bottom of the table which show the potential impact of inflation and US population growth on the revenues or expenditures analyzed. These inflation and population figures are not meant to provide a precise measure of the impact of inflation and population growth on the respective revenues or expenditures, as such a measurement is not possible. Rather, we have provided these figures as possible benchmarks for how the revenues and expenditures might have been anticipated to change over time due to these factors. To calculate the inflation and population adjustment figures, we multiplied the prior period total revenues or total expenditures by the rates of inflation (using CPIU) and population growth for the respective periods.

Rates of inflation are shown in the Key economic indicators table above. During the periods discussed in this MD&A, our total population grew by:

• 2017 to 2018 – 1.7 million people or 1%, 1.0 million through births and deaths and 0.7 million through migration;
• 2013 to 2018 – 10.7 million people or 3%, 6.0 million through births and deaths and 4.7 million through migration; and
• 2008 to 2018 – 22.4 million people or 7%, 13.7 million through births and deaths and 8.7 million through migration.

Our population aged 65 years and older grew by:

• 2017 to 2018 – 1.6 million people or 3%;
• 2013 to 2018 – 7.7 million people or 17%; and
• 2008 to 2018 – 13.6 million people or 35%.

Summary results of operations