April 16, 2014

The Federal Budget's "Health Care Problem" Isn't Quite What Everyone Thinks It Is

Among budget wonks who discuss the long-term fiscal challenge, there is something of a consensus -- the projected upward trajectory of our debt is caused primarily by the projected growth in federal health care programs.

For some, this consensus has developed into short-hand: The nation’s fiscal challenge is really “just a health care problem.” This leads to the conclusion that the nation’s unsustainable fiscal future can only be redirected by reforming the entire health care sector of the economy. Or perhaps by simply converting Medicare into a “premium support” program.

The latest CBO report, which takes into account three consecutive years of dramatically slower health care cost increases, should serve as a warning (and a reminder) that it is misleading to say the problem with the federal budget “is just a health care problem.”

If one only looks at the two CBO updates over the last six months, projected 10-year Medicare spending has been revised downward by $306 billion. Projected Medicaid spending has been revised downward by $273 billion (not counting revised estimates of lower Medicaid enrollment due to the Supreme Court’s ruling on Medicaid expansion in the Affordable Care Act (ACA)).

Yet even under that “better case scenario,” federal outlays for health care will soon be greater than outlays for Social Security -- placing it at the top of all federal budgetary commitments. Over the 10-year budget window, health care spending will experience growth of 1.2 percent of GDP, second fastest only to net interest.

The reason is simply that the “health care problem” actually reflects the large increase in the number of people who will become eligible for Medicare due to the retirement of the baby-boom generation. Over the next 10 years, 18 million new beneficiaries are expected to sign up for Medicare. 

Nearly three-quarters of the spending increases in Medicare over the next two decades can be attributed to aging alone. And, as I will explain, the remaining increase in costs due to health care inflation will be very difficult to avoid because even that amount of projected growth is lower than anyone realistically believes we can sustainably achieve. Thus, the major problem in Medicare really is one of an aging population. In this case, the Medicare problem is no different than the Social Security problem. 

By simply looking at any graph of federal budget projections, it is easy to jump to the conclusion that the federal budget problem is a health care one -- and one mainly located in the Medicare program. By 2035, the debt held by the public is projected to be around 180 percent of GDP -- representing a growth in debt that is universally acknowledged as dangerous (especially given that the projections assume a growing economy during the same time period).

The largest programmatic growth on that road is in Medicare and Medicaid -- even with the revisions in the CBO estimates. 

However, it is important to unpack why the programs are growing. Spending can grow either because more people are getting their health care services paid for -- a growth in beneficiaries -- or because those services are becoming more costly and numerous. In the political debate, when people use the phrase “it is a health care problem,” they usually are not arguing that the federal government provides health insurance for too many people. Instead they are trying to say that the problem is the growth in the cost of health care from too many services at too high a price.

This growth, either called “health care inflation” or the even more technical term “excess cost growth,” is the bogeyman of the “health care problem” story. The story is that our nation’s health care system doesn’t do a good job at keeping health care costs down. That the best measurement of that failure is the per-person growth rate above the per-person rate of growth in the economy (GDP) -- the “excess” in the term “excess cost growth.” And, that this explains why federal budget spending is projected to rise so dramatically in the future.

Yet, while our overall health care system is incredibly inefficient, and the general story above is true, the CBO report, along with recent reports by HHS and the GAO, show that this excess cost growth isn’t actually a big problem for Medicare -- at least not over the next 20 years.

Using assumptions from the Medicare trustees, which include continuous doctor payment fixes (SGR) but adherence to the ACA’s cost control provisions,1 and were made without incorporating the recent slowdown of health care spending the way CBO’s recent estimates have, the graph below from HHS shows that for the next 10 years, excess cost growth is non-existent. 

Note: Chart from ASPE.hhs.gov Issue Brief: "Growth in Medicare Spending Per Beneficiary Continues to Hit Historic Lows." by Richard Kronick and Rosa Po. H/T Austin Frakt in the JAMA Forum. 

Beyond then, it exists, but at growth rate much slower than the historical average (over GDP +2 percent). In fact, the assumed growth rate is slower than most health care economists, along with the Simpson-Bowles Commission use as a target (GDP +1 percent).

The total increase in Medicare costs from inflation is only 0.7 percent of GDP. Alternatively, growth due to aging accounts for 1.9 percent of GDP. 

In some ways this is good news for those who want to put the nation on a more sustainable fiscal course -- because it means the solutions are technically easier to figure out. With health care inflation, scholars have yet to find a “silver bullet” that would easily transition our inefficient health care system as a whole into either a much more efficient public-private hybrid, or even to a public system with the government obtaining more power to lower health care prices.

Instead, the solution needed is to simply lower promised benefits, increase cost-sharing, or more generally increase government revenues to pay for new beneficiary spending, or some combination. We would just need to mathematically account for the new ratio of workers to retirees we are expecting once the baby boomers leave the workforce.

Yet, in a political sense, this makes solutions harder in two ways. When dealing with health care inflation, there is a promise that we can get more bang-for-the-buck without anyone really “losing” since we can call a substantial chunk of health care spending “waste” as our high costs aren’t giving us concomitant health benefits. The ratio problem is not one that can be perpetually solved by riding the system of waste. 

The other political difficulty is that it is much more difficult to argue for delaying action if we are trying to correct a ratio problem. With health care inflation, it might take a long time to figure out the best systemic changes to accomplish our goals. The ratio problem however, is one we know is coming, and the sooner we act, the better off everyone involved is since the sooner you take action to correct it, the less dramatic steps you have to impose on any single generational cohort.

It is worth pointing out that it is possible, even likely, that current projections for the slower-than-normal growth in health care inflation are far too optimistic. Either the recent slowdown will dramatically reverse as the economy picks up after a drawn-out recovery, or the projected reductions for provider payments in Medicare will prove too austere relative to the private sector and thus become unsustainable. Yet, even were this to be the case, the resulting increase in spending will still come on top of the increased spending due to aging -- thus not changing the basic budgetary case for tackling that problem as soon as possible. Especially since the ideal reforms to deal with the aging problem should be phased in over a long period of time. 

As the recent GAO study highlighted:

“Reducing health care cost growth alone...is not sufficient to put the federal budget on a sustainable path. Even in simulations assuming health care cost growth can be constrained for an extended period, our simulations show debt held by the public rising as a share of GDP over time, particularly assuming historical trends and policy preferences for revenue and other spending continue. Therefore, more needs to be done to change the fiscal path.” (p. 40-41)


1Between 2020 and 2035 there is only a small divergence (a Medicare spending difference of about 0.28% of GDP) between the Trustee’s “Full Alternative Scenario” and the Trustee’s alternative used here -- which assumes the ACA’s productivity updates and spending reductions, with only the “doc fix” taken into account.