How curbing health care spending will affect the deficit
Rapidly growing health care costs have been a major driver of actual and projected federal budget deficits and the national debt. In recent years, the rate of growth in medical spending has slowed, leading many to ask whether a permanent decline could solve the nation鈥檚 long-term fiscal problem.
Along with University of California at Berkeley economist Alan Auerbach,聽we recentlythe role of health spending in budget projections. Our conclusions: Yes, a long-term slowdown in medical cost growth could have a dramatic positive impact on future deficits. But no decline within the realm of our historical experience could fix the nation鈥檚 fiscal imbalance.
We take no position on whether the current slowdown will continue鈥攁nd, in fact,聽聽suggests costs may again be bumping up. Rather, we incorporated different health cost scenarios into a budget calculator to see how they change fiscal outcomes.
We did this by modeling a range of possible changes in health spending using a concept known as 鈥渆xcess cost growth鈥� or ECG. The Center on Medicare and Medicaid Services defines this measure as the growth rate of health spending after adjusting for population aging, sex composition, and overall economic growth. Thus, excess cost growth captures the rate of growth in both per-person utilization and prices, controlling for demographics and the economy. Absent demographic changes, excess cost growth of zero means that health care spending would grow at the same rate as GDP.
Annual excess cost growth has averaged聽1.9 percent between 1975 and 2011, but has varied a lot; the five-year averages range from -0.3 percent in 1995鈥�2000 to 2.7 percent in 2000鈥�2005. The overall rise in excess cost has been driven by a diverse set of factors, including improved medical technology, expanded health insurance coverage, and growth in personal income鈥搘hich increased utilization.
ECG has been lower recently, averaging 1.3 percent in 2005-11, and many believe this could be the beginning of a new long-term trend. For example, the Congressional Budget Office recently聽its ten鈥搚ear estimates of Medicare and Medicaid spending.
Our simulations highlight two key points. First, even if health care costs are brought under control immediately and permanently, the nation still faces a sizable fiscal imbalance. Under a scenario in which excess cost growth immediately falls to zero and stays unchanged for the next 75 years, the deficit in 2040 will still grow to more than 6 percent of GDP鈥攍eading public debt to rise to 112 percent of GDP. The nation would still face a long-term fiscal gap of 2.6 percent of GDP鈥攁bout $400 billion per year, every year in the future.
However, even a change in medical spending that is 鈥渟mall,鈥� in the sense that it is within the range of recent historical values, could nonetheless have enormous impact on the size of the fiscal shortfall. If excess cost growth is 2.5 percent over the next 75 years鈥攁 high rate of growth to be sure, but still within historical range鈥攄eficits shoot up to 15 percent of GDP by 2040 and public debt skyrockets to 187 percent of GDP.
Even though the short-term federal budget outlook has improved markedly in recent years鈥攚ith steep reductions in discretionary spending, repeal of tax cuts for high-income households, and an improving economy driving deficits down to聽2.8 percent of GDP聽in 2014鈥攗nderlying challenges remain. As we show, steady excess cost growth in health spending鈥攅ven at relatively low levels by historical standards鈥攕till will put strains on the federal budget and US economy barring higher taxes or substantial cuts in other spending.
