Health Spending Trends: Key Questions

V. Key Health Policy Issues >> B. Health Spending >> Health Spending Trends >> Key Questions (last updated 6.26.16)

How Much Does the Government Owe?

In the aggregate, the fiscal gap–namely, debts and unfunded liabilities across all levels of government–amount to $244 trillion as of late 2013 inclusive of federal, state and local debts and the federal, state and local fiscal gap.Debt represents money already spent and owed, whereas unfunded liabilities represent the difference between promised spending and projected revenues based on current policy, i.e., assuming no changes in commitments or taxes. Note that current debts are not included in estimates of unfunded liabilities since the latter occur in the future but they are included in what’s called the fiscal gap.
These are net present value figures measured in 2013 dollars, meaning that they are inflation-adjusted and discounted to reflect the time value of money. The discount rate used for such purposes is generally the long-term U.S. Treasury bill rate (usually 3%) since that is viewed as the rate of return on a “safe” investment; thus, it is the rate that U.S. citizens require to be paid to give up a dollar today to get a dollar in the future. Thus, a dollar today is worth $1 whereas $1 (of revenues or spending) a year from now is worth only $1/1.03. Another way of viewing the $244 trillion then, is that it is the amount the U.S. Treasury would need in the bank today–earning interest at 3%–to generate the stream of payments over future generations needed to finance all the promises of government above and beyond the realistically-projected government revenues that are expected during the same period (i.e., assuming no change in tax rates/policy during that period). Put another way, it is the lump-sum annuity payment required to cover in perpetuity all additional government promises that cannot be paid under the current tax structure.
However, it’s worth noting that a recent paper shows that from 1836 to 2011,  U.S. Treasury bills (generally viewed as a risk-free asset) earned an average annual inflation-adjusted return of 1.0% (gold’s real rate of return was 1.1%). The return for long-term bonds was 2.9% and that for stocks was 7.4%. If unfunded liabilities were discounted using a 1% rate rather than 3%, they would be much higher.

Government Debt

The federal debt ($19.2 trillion in April 2016) and state and local government debt ($3.1 trillion in April 2016) are reported continuously at the U.S. Debt Clock. Technically, the federal debt includes a public component (e.g., what is owed to other nations and individual U.S. citizens who have purchased Treasury bonds) and an internal component, i.e., what the U.S. Treasury owes the Social Security and Medicare trust funds in principal and interest payments in light of the many decades of borrowing payroll taxes paid into those trust funds to instead pay for other activities of government. Given that the U.S. government is most unlikely to renege on its obligations to seniors, many analysts view the distinction as meaningless. At some point, all those debts will have to be repaid in some fashion which means that the taxes or borrowing used to do so cannot be spent on other government purposes.

Federal Fiscal Gap

At the end of 2013, Laurence Kotlikoff estimated that the federal fiscal gap–which includes the federal debt–was $205 trillion, calculated as the net present value of all projected federal revenues and expenditures under current policy. This is equivalent to 10.3% of the net present value of GDP over the same time period. The 75-year US fiscal gap is only 40 percent of the true $205 trillion fiscal gap. Kotlikoff argues that any clear picture of the gap requires an infinite horizon since otherwise a finite horizon measure will depend on labeling terms (p. 11).

How the Gap is Calculated

These estimates were based on the Congressional Budget Office’s alternative fiscal scenario for the next 75 years. The alternative fiscal scenario (AFS) essentially reflects current policy as opposed to current law. For example, current law requires physician fees under Medicare to be cut drastically (24% in 2014), but every year for more than a decade, Congress has enacted a temporary “doc fix” that averted these steep fee reductions. Since these fixes are only temporary, the CBO in making its 75 year projections would have to assume  that a steep cut in fees was adopted as soon as the current fix expires–since that’s what “current law” requires. But this would result in a very unrealistic projection of Medicare spending: such drastic fee cuts would have such adverse consequences for the ability of Medicare recipients to find physicians willing to serve them that it is quite unlikely Congress ever will permit such cuts to take effect.
The AFS, in contrast, assumes Congress will continue doing what it has always done for this and other elements of policy. The alternative minimum tax is another illustration of where the law technically requires this to apply to many millions more taxpayers, but every year Congress enacts a  temporary reprieve, resulting in lower revenues than would otherwise be the case.  For spending beyond the 75 year window included in CBO’s annual projections of long-term federal revenues and spending, Kotlikoff assumed that annual non-interest spending, as well as taxes, would grow indefinitely by 2 percent a year beyond the point at which the CBO’s estimates end. Kotlikoff used the same method to calculate that by 2012, the federal fiscal gap had grown to $222 trillion–an increase of $11 trillion in just one year.  At least $122 trillion of this $222T was related to health entitlements, Medicare, Medicaid and new subsidies to be provided through health exchanges under the Affordable Care Act. The Affordable Care Act is estimated to have added $17 trillion to unfunded liabilities.

Trends

In 2011, the equivalently calculated fiscal gap was $211 trillion. In 2003, it was $60 trillion, but had risen to $175T by 2008 (p. 12). The 2013 tax hikes and budgetary sequestration represent significant policy changes. They shaved $17 trillion present value off the fiscal gap (p. 12).

Comparisons to Other Countries

Kotlikoff estimates the 2013 fiscal gap (10.3% of GDP) is essentially equivalent to that of Greece, Belgium and Japan. Finland (7%), Germany (5%) and Italy (5%) have substantially lower fiscal gaps (Table 1).

State and Local Government Fiscal Gap

The equivalently-calculated figure of unfunded liabilities for state and local governments is $38 trillion, according to economic historian Niall Ferguson and in excess of $30 trillion according to Kotlikoff (footnote 3). For example, as of fiscal year 2009, 61 major cities had promised at least $118 billion more than they had in hand to cover health care benefits for current and future retirees. Cities had set aside enough money to cover 6 percent of their promises, compared with slightly more than 5 percent in states.
The unfunded liabilities for retiree health benefits alone exceed $1 trillion. A Manhattan Institute study has examined the legal status of retiree health benefits for public sector workers.
Mercatus Center has ranked states according to their fiscal condition. Pension liabilities are broken out explicitly. Unfunded liabilities for retiree health benefits are part of another separately-reported aggregate called OPEB (other post-employment benefits), but there is no way of telling from the reported figures how much of each state’s OPEB is accounted for by retiree health benefits.

What Would it Take to Close the Fiscal Gap?

Short Term

The CBO estimates that $2T in budgetary savings over the next 10 years would be required to keep the debt to GDP ratio constant at current levels. This would not eliminate current levels of debt, but it would prevent things from getting any worse during this period.

Long Term

The fiscal gap can be closed either through higher revenues or lower spending, or some combination. The figures below relate to close the federal fiscal gap of $205T. Thus, to address the entire $264T owed by governments at all levels would require these adjustments to be 29% larger.

  • Revenue Increases. Kotlikoff estimates that in late 2013, closing the federal fiscal gap ($205T) using taxes would require an immediate and permanent 57% increase in all federal taxes (in 2012, closing the $222T gap would have required a 64 percent increase in all federal taxes). If the decision were delayed, the required revenue increase would rise to 63.2% in 2023, 69,3% in 2033, and 75.9% in 2043 (Table 2).
  • Spending Cuts. Alternatively, the U.S. could cut, immediately and permanently, all federal purchases and transfer payments, including Social Security and Medicare benefits (i.e., all non-interest spending), by 37% (in 2012, this figure was 40 percent). If the decision were delayed, the required spending cuts would rise to 40.2% in 2023, 43.0% in 2033, and 46.3% in 2043 (Table 2).
  • Distributional Effects. Based on the projections in CBO’s The 2014 Long-Term Budget Outlook, CBO estimated that the 75-year fiscal gap was 1.8 percent of GDP; in other words, a permanent increase in federal revenues or reduction in federal spending equal to 1.8 percent of GDP each year starting in 2015 would cause debt to equal 74 percent of GDP, its 2014 level, in 2089. CBO then analyzed five stylized changes in federal fiscal policy that would close this fiscal gap of 1.8% of GDP by immediately and permanently increasing tax revenues or decreasing spending. The study showed that for households containing working-age adults or retirees, tax increases are less costly than benefit cuts, whereas for future generations, cuts to Social Security and Medicare benefits are the least costly of the options analyzed. The choice of policy has a relatively small effect on the economy’s output in the long run, and a policy’s effect on output is a poor predictor of how its implementation would affect households’ well-being. [The Costs to Different Generations of Policies That Close the Fiscal Gap 12.15]. The central findings:
    • Retirees (age 65 and older) and older workers (ages 41 to 64) experience the smallest reduction in net transfers and welfare from the payroll tax increase and the largest reduction in net transfers and welfare from the cuts to OASDI/HI benefits.
    • Younger workers (ages 21 to 40) experience the smallest reduction in net transfers from the cuts to OASDI/HI benefits or lump-sum transfers and the largest reduction in net transfers from the increase in income tax rates. In terms of their welfare, by contrast, younger workers tend to fare better under the increases in payroll or income taxes than under the cuts in transfers or increases in consumption taxes.
    • Very young people (up to age 20) and future generations experience the smallest reduction in net transfers and welfare from the cuts to OASDI/HI benefits and the largest reduction in net transfers and welfare from the increases in income tax rates or the cuts to lump-sum transfers.
  • Meeker, Mary.
    • USA, Inc. (February 2011). This report looks at the federal government as if it were a business, with the goal of informing the debate about our nation’s financial situation and outlook. In it, we examine USA Inc.’s income statement and balance sheet. We aim to interpret the underlying data and facts and illustrate patterns and trends in easy-to-understand ways. We analyze the drivers of federal revenue and the history of expense growth, and we examine basic scenarios for how America might move toward positive cash flow.
    • 2012 USA Inc. Key Points (10.24.2012). This 50-slide report summarizes the federal government’s current situation and how to improve it.

How Much Public Debt is Sustainable?

Why High Government Debt is a Problem

CBO identifies four risks of high debt levels:

  • “Federal spending on interest payments will increase substantially as interest rates rise to more typical levels.”  Former Director of the National Economic Council Keith Hennessey notes that once interest rates return to normal levels (5% 10-year Treasury rate assumed by CBO), this will increase interest payments on debt by 1.85% of GDP above where they used to be prior to the 2008-09 fiscal crisis (in late 2014, debt levels were 37% above their pre-crisis average, hence 5% x 37% = 1.85%)
  • “Because federal borrowing generally reduces national saving, the capital stock and wages will be smaller than if debt was lower.”
  • “Lawmakers would have less flexibility … to respond to unanticipated challenges.”
  • “A large debt poses a greater risk of precipitating a fiscal crisis, during which investors would lose so much confidence in the government’s ability to manage its budget that the government would be unable to borrow at affordable rates.”

Is There a Maximum Threshold for Public Debt?

According to Kotlikoff: “A country’s fiscal sustainability matters. It matters to a country’s growth path to its future tax rates, to its saving behavior, to its net domestic investment, to its labor supply, to its inflation rate, to its employment, to its wages, to its returns on capital, to the integrity of its financial markets, to the viability of its political institutions—indeed, it matters to virtually any question one might pose about a country’s economic future” (p. 5).

Current Debt Trends Depend Heavily on Fiscal Scenario

As of mid-July 2014, U.S. public debt amounted to 74% of GDP. Public debt is the amount owed to others, as opposed to amounts owed by one part of government (e.g., Treasury Department) to another (e.g., Social Security Trust Fund.  There may be a moral obligation to pay back the Social Security and Medicare trust funds for past borrowing, but there is no economic obligation, i.e., interest rates will not rise were these amounts not repaid, whereas they assuredly would if the U.S. defaulted on its debts to other buyers of U.S. Treasury bonds. As of mid-July 2014, CBO projects that debt will continue to climb over the coming decades, reaching 100 percent of GDP by 2036, and twice the size of the economy by 2089. However, under the more realistic alternative fiscal scenario, public debt reaches 100% of GDP by 2029 and double GDP by 2045. Moreover, incorporating the negative effects of accumulating debt on the economy makes this picture worse.

Cross-National Evidence

A comprehensive cross-country study has shown that economic growth slows noticeably when a country’s public debt-to-GDP ratio exceeds 90%.  [Reinhart, Carmen M. and Rogoff, Kenneth, This Time Is Different: Eight Centuries of Financial Folly (2009)]. Thus, there is a large penalty to be paid for letting public debt grow beyond this limit since a slower economy means less government revenue available to repay the debt or interest on the debt.
Whereas individuals have to balance their budgets over their lifetimes (since creditors will not lend if they do not expect to be repaid), stable governments hypothetically can maintain some debt in perpetuity (i.e., creditors will keep lending since they know they will get repaid even if the government has to borrow again from someone else to make that happen). Generally, a sustainable level of debt is one where the debt-to-GDP ratio is kept stable. Under such circumstances–barring some catastrophe that independently drives up interest rates, such as a world war–creditors are assured of being repaid and hence long-term interest rates should remain stable.
But more precisely, a sustainable level of debt is one where the interest payments on the debt grow at or below the rate of growth in the economy. Interest payments on the U.S. debt currently are only a little more than 1 percent of GDP (out of government revenues that absorb less than one-fifth of GDP). If such payments grow substantially faster than the economy, then there would come a point at which interest payments could exceed the government’s ability to pay them. The political costs of financing debt payments–either by cutting spending or raising revenues drastically–might be too great, at which point defaulting on the debt may become the preferred option.
Either definition implies that debt can grow in absolute terms in perpetuity so long as this growth is at or below the rate of growth in GDP. But since the rate of economic growth itself can be affected by the level of debt, should it get too high, a country with a debt-to-GDP ratio below 90% can afford to let its debt grow faster than a country where the ratio exceeds 90%.

Are Current Health Spending Trends Affordable?

  • A CBO presentation (11.20.15) on long-term projections shows that under the extended baseline scenario, federal debt as a percent of GDP will be 107% in 2040. But it would reach 129% if the upper range estimate of federal health spending growth were assumed, versus 89% if the lower range estimate were used in the projection (p. 9).
  • A report prepared for the U.S. Department of Health and Human Services systematically examines The Effect of Health Care Cost Growth on the U.S. Economy (9.1.07). The report presents various perspectives on how growth in health care spending affects the US economy. The report summarizes a review of the literature, focusing on the mechanisms through which health care spending could affect the U.S. economy, including aggregate economic outcomes, employers, the government, households, and local economies. As well, available state-level data are used to analyze the effects of health care cost growth on aggregate economic indicators, industries, and state governments.
  • The Congressional Budget Office (12.1.05) shows spending growth has exceeded real GDP growth. If these trends continue in the future, can the US afford to sustain their current spending habits?
  • According to Micheal E. Chernew (7.03), our current trends are affordable only if excess health spending growth is limited to a 1% increase each year. He also illustrates how reform could keep things more affordable in the future. His insight has implications for many employers nation-wide whose employees are jeopardized by the rising health care costs.

Innovation and the Future of Medicine

Medical innovation has the potential to either increase or decrease health spending trends relative to the economy. Eric Topol’s The Creative Destruction of Medicine: How the Digital Revolution Will Create Better Health Care argues that dramatic advances in genomics, personalized medicine, cellphone technology (mHealth), new imaging and new devices have the potential to fundamentally change how medical care is delivered. However, many of these digital medical innovations lie unused because of the medical community’s profound resistance to change.

What are the Key Drivers of US Health Spending?

Overview

  • Statement of Peter R. Orszag, Director. Growth in Health Care Costs before the Committee on the Budget United States Senate. January 31, 2008. Table 1 provides a summary of findings from 3 major studies of health spending growth regarding the major contributors to grow in real per capita health spending from 1940-1990:
    • Technology-related Changes in Medical Practice. There is a consensus across all 3 studies that this is the dominant contributor to health spending growth (accounting for anywhere from 38 to 65% of growth over a half century).
    • Prices in the Health Care Sector. Of the 2 studies that examined this, both concluded it was the second most important factor, accounting for 11 to 19% of growth.
    • Growth of Personal Income.  This accounted for anywhere from 5 to 23% of health spending growth.
    • Changes in Third Party Payment. These accounted for 10 to 13% of spending growth.
    • Administrative Costs. These accounted for 3 to 13% of spending growth.
    • Aging of the Population. This accounted for only 2% of spending growth in all 3 studies.

Technology-Related Changes in Medical Practice

In her issue brief, Cara S. Lesser addresses many problems of growing health care costs. Advances in technology and quality improvements in the health field are two key drivers of rising health costs. Paul B. Ginsburg notes that new medical technology has been the dominant driver of increases in health care costs and insurance premiums, and he discusses this implication in politics. The cost-effectiveness of new technologies raises a great debate. Furthermore, a peer group report of health care quality and cost indicated that more knowledgeable consumers today are demanding better quality of care, which in turn raises prices.

Prices in the Health Care Sector

Changes in Third Party Payment

  • See Out-of-Pocket Spending for a discussion of the declining share of health spending accounted for by out-of-pocket costs.

Administrative Costs

  • See Reduce Administrative Waste for a complete discussion of the size of the administrative waste problem and policy options for addressing it.

Aging of the Population

  • See Age and Health for more discussion of the relationship between aging and health.
  • See Expenditures by Age for more complete discussion of how health spending varies by age.

How Does the US Compare to the Rest of the World in Terms of Health Care Spending?

The Commonwealth Fund examined health care spending in the US and other OCED nations and found that U.S. health spending per capita significantly and consistently outpaces that of other industrialized nations. National health spending as a percentage of GDP is the highest in the US, thus health spending places more of a burden on the economy, says Uwe E. Reinhardt. This can partly be attributed to the fact that the US health system relies more heavily on specialty care than other developed nations. According to Leiyu Shi, the 70% of physicians in the United States are specialists, compared with 25-50% in other industrialized nations.

An NCPA report (2009) examines the evidence on Does the United States Spend Too Much on Health Care?

Global GDP and Health Expenditure Data

  • WHOGlobal Health Expenditure Database. The global health expenditure database provides internationally comparable numbers on health expenditures. WHO updates the data annually, adjusting and estimating the numbers based on publicly available reports (health account reports, reports from the Ministry of Finance, Central Bank, National Statistics Offices, public expenditure information and reports from the World Bank, the International Monetary Fund, etc.) The estimates are sent out to the Ministries of Health for validation prior to publication but users are advised that country data may still differ in terms of definitions, data collection methods, population coverage and estimation methods used. This database is the source also for the health expenditure tables in the World Health Statistics and the WHO Global Health Observatory (GHO).
  • IMF. World Economic Outlook Database provides annual estimates of gross domestic product based on purchasing-power-parity (PPP) valuation of country GDP for the years 2012-2019.

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