Time to Act on Health Care Costs: Near-Term Changes to the Consumer and Provider Sides of Health Care Financing Are Essential to Prevent the Nation from Being Overwhelmed by Rapidly Rising Health Care Expenditures

By Orszag, Peter | Issues in Science and Technology, Spring 2008 | Go to article overview

Time to Act on Health Care Costs: Near-Term Changes to the Consumer and Provider Sides of Health Care Financing Are Essential to Prevent the Nation from Being Overwhelmed by Rapidly Rising Health Care Expenditures


Orszag, Peter, Issues in Science and Technology


Popular discussions of the long-term fiscal challenges confronting the United States usually misdiagnose the problem. They typically focus on the government expenses related to the aging of the baby boomers, with lower fertility rates and longer life expectancy causing most of the long-term budget problem. In fact, most of the long-term problem will be driven by excess health care cost growth; that is, the rate at which health care costs grow compared to income per capita. In other words, it is the rising cost per beneficiary rather than the number of beneficiaries that explains the bulk of the nation's long-term fiscal problem.

One can see this phenomenon manifesting itself even in the next decade: Figure 1 shows the Congressional Budget Office's (CBO's) projections for spending on Social Security, Medicare, and Medicaid through 2017. As Figure 1 shows, Social Security rises by about 0.5% of gross domestic product (GDP), from 4.2 to 4.8%, over that period. Spending on Medicare and the federal share of Medicaid rises from 4.6 to 5.9% of GDP--an increase of 1.3%, or roughly twice as much as that for Social Security.

If one looks further into the future, the basic point is accentuated. Figure 2 portrays a simple extrapolation in which Medicare and Medicaid costs continue to grow at the same rate over the next four decades as they did over the past four decades. (Fortunately, even with no change in federal policy, there are reasons to believe that this simple extrapolation overstates future cost growth in Medicare and Medicaid. The CBO has recently released a long-term health outlook that presents a more sophisticated approach to projecting Medicare and Medicaid costs under current law, but this simple extrapolation is adequate to illustrate the key point.) Under this scenario, Medicare and Medicaid would rise from 4.6% of the economy today to 20% of the economy by 2050. To appreciate the scale of this increase, all of the activities of the federal government today make up 20% of the economy.

[FIGURE 1 OMITTED]

[FIGURE 2 OMITTED]

[FIGURE 3 OMITTED]

The most interesting part of Figure 2 is the bottom line, which isolates the pure effect of demographics on those two programs. The only reason that the bottom line is rising is that the population is getting older and there are more beneficiaries of the two public programs. The increase between today and 2050 in that bottom dotted line shows that aging does indeed affect the federal government's fiscal position. But that increase is much smaller than the difference in 2050 between the bottom line and the top line. In other words, the rate at which health care costs grow--whether they continue to grow 2.5% per year faster than income per capita, or 1%, or 0.5%--is to a first approximation the central long-term fiscal challenge facing the United States.

Conventional wisdom tells us that the sooner we act, the better off we are, and convention certainly has it right in this case. Figure 3 shows that if we slow health care costs' excess growth from 2.5 to 1% per year starting in 2015 (which would be extremely difficult if not impossible to do, but is helpful as an illustration), the result in 2050 would be that federal Medicare and Medicaid expenditures would account for 10% rather than 20% of GDP.

On its face, this challenge looks pretty daunting. And it is further complicated by the fact that it is implausible that we will slow Medicare and Medicaid growth unless overall health care spending also slows. The reason is that if all one did was, say, reduce payment rates under Medicare and Medicaid, and then tried to perpetuate that over time without a slowing of overall health care cost growth, the result would probably be that fewer doctors would accept Medicare and Medicaid patients, creating an access problem that would be inconsistent with the underlying premise and public understanding of these programs. …

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