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Health Is the Health of the State

Tuesday, July 19, 2011

Between 1966 and 2007, the entire increase in the size of government relative to the economy resulted from growth in tax-financed health spending.

The country is currently engaged in a pitched battle over the size of government and the fierce struggle over the debt ceiling is a skirmish in this much larger war. Health spending is central to this debate. But many Americans may not realize the degree to which healthcare has dominated the growth of government over time. Between 1966 and 2007, the entire increase in the size of government relative to the economy resulted from growth in tax-financed health spending.

As the chart below illustrates, as a share of GDP, publicly financed health spending in 2007 was five times as large as it was in 1965 (the year immediately before Medicare and Medicaid began). In contrast, the share of the economy attributable to government spending on all other activities unrelated to health was identical in 1966 and 2007.

When 2007 is compared to 1966, the entire amount of the increase in the size of government between those years was accounted for by rising public expenditures on healthcare. Much of this, of course, was related to the rapid growth in Medicare and Medicaid spending.


The rise in government-funded healthcare has been extraordinary by any measure. In terms of constant purchasing power for everyday goods, tax-financed healthcare has increased 30-fold just since 1960. This includes all federal, state, and local government spending for healthcare, such as public health, direct delivery of health services, public health insurance, and investments in medical R&D and facilities construction.

However, real federal spending on healthcare grew far faster than tax-paid healthcare overall. This reflects a substantial shift in the relative roles of federal government vis-à-vis state and local governments in financing (and regulating) healthcare. This shift will increase under the new healthcare law.


In per capita terms, the overall increase was 17-fold. This does not mean that real per capita health output funded by taxpayers rose 17-fold in 50 years. The inflation adjustment used for all series in figure 5.1a is based on the GDP price deflator rather than a medical price deflator. Thus, the increase represents how much more real output in the general economy was foregone to bankroll the tax-financed share of U.S. health spending in 2007 relative to 1966. This rapid increase in government health spending was approximately five times as large as the increase in overall government spending per person during the same time.

As a share of GDP, publicly financed health spending in 2007 was five times as large as it was in 1965.

The tax-financed health share of the economy has risen every single year since 1929. Driven by continued growth in Medicaid and Medicare, that pattern was projected by the Congressional Budget Office to continue over the next 75 years even before President Obama was sworn into office. Unfortunately, rather than reverse this trend, the president devoted a considerable amount of political capital in his first 15 months in office to securing the enactment of a law that will accelerate its growth.

Alternative Reality

The latest CBO figures show that under current law—i.e., assuming that everything works as planned under the new healthcare law—the share of GDP devoted to federal spending on mandatory health programs (Medicare and Medicaid) will be 68 percent higher in 2035 compared to 2011. But the CBO recognizes that certain components of the law intended to slow the growth in health costs may not work as planned. Under an alternative, more realistic scenario, the share of the economy absorbed by mandatory federal health programs will be 84 percent higher than this year.

Why is this alternative scenario more realistic? One good reason is that for nearly a decade, Congress has refused to follow its own law to hold down physician spending. In 1997, Congress adopted a “sustainable growth rate” (SGR) formula to ensure that physician payments under Medicare grew at a reasonable rate. This resulted in a 4.8 percent cut in physician fees in 2002, but that was the only year the formula worked as designed. Since then, the same formula has called for continued cuts in physician fees to offset the ever-rising volume of physician services billed to Medicare.

Under an alternative, more realistic scenario, the share of the economy absorbed by mandatory federal health programs in 2035 will be 84 percent higher than this year, CBO predicts.

From 2003 forward, however, Congress has on 13 different occasions taken legislative actions to prevent these fee reductions from being adopted. The latest such fix was signed into law last December and runs through the end of this year. Consequently, a series of small fee reductions now has accumulated to a statutorily required 29.5 percent cut in Medicare physician fees that will be need for calendar year 2012 to remain in compliance with SGR.

Not surprisingly, such an enormous cut is being resisted by physicians, and, not surprisingly, Congress is likely to continue kicking this can down the road. After all, its own panel of experts—the Medicare Payment Advisory Commission (MedPAC)—concedes that "fee cuts of that magnitude would be detrimental to beneficiary access to care."

Yet the fee reductions implied by the Patient Protection and Affordable Care Act would, by 2085, result in Medicare physician fees being 70 percent lower than the fees paid by private health insurers. Yet the current law projections done by CBO require them to assume that such cuts take place, since that is what the statute now on the books mandates until and unless Congress again enacts another temporary statutory fix to avert this. CBO’s alternative scenario more sensibly concludes these cuts are unlikely to happen; hence Medicare spending will be higher.

The False IPAB Hope

Another mechanism that CBO has concluded may not work is the Independent Payment Advisory Board (IPAB). Under the new healthcare law, IPAB will be required to submit proposals to reduce Medicare’s spending per enrollee if the growth in such spending is projected to exceed specified targets.

Why is IPAB needed? In the words of one proponent: “A common theme in the healthcare reform debate in recent years has been the need for a board of impartial experts to oversee the healthcare system ... Congress is too driven by special-interest politics and too limited in expertise and vision to control costs.”

To circumvent this reality, IPAB’s recommendations (in contrast to MedPAC’s, which are purely advisory) would go into effect automatically unless (as the CBO puts it) they are “blocked or replaced by subsequent legislative action.” Sound familiar? IPAB will work so long as Congress—an institution driven by special-interest politics—doesn’t do to IPAB what it already has done repeatedly with the SGR.

What’s interesting is that CBO projects in their baseline scenario that under current law, growth in Medicare spending will remain below IPAB’s target growth rate over the next decade. In short, IPAB will have nothing to do because nothing will trigger the need for it to take action.

But in their alternative fiscal scenario, CBO further assumes IPAB will be “difficult to sustain” and therefore would not continue past 2021. Bottom line: in their more realistic scenario (one that accounts for the actual past behavior of Congress, not just its good intentions), CBO has implicitly assumed that IPAB will have zero impact on spending either in the short term or long term.

The tax-financed health share of the economy has risen every single year since 1929.

The third Medicare policy that might be difficult to sustain over a long period, in CBO’s estimation, is tying increases in payment rates to increases in productivity in the general economy. Once again, this provision flies in the face of historical experience, which shows that hospital productivity growth was “small or negligible” from 1981 to 2005. Even Medicare’s own actuary has stated these “are unlikely to be sustainable on a permanent annual basis.” Roughly 15 percent of Medicare Part A providers (hospitals, skilled nursing facilities, home health agencies, and hospice providers) would become unprofitable within the first decade if these productivity adjustments were adopted as scheduled by law. By 2065, these rules would result in Medicare and Medicaid payments for hospital inpatient services falling to 60 percent below the amounts paid by private health insurers. Who can possibly believe this would ever happen?

CBO’s well-warranted pessimism regarding the ability of government to control Medicare spending extends even further. CBO makes its projections of long-term health spending based on assumptions about “excess cost growth.” Excess cost growth is the annual increase in healthcare spending per person relative to growth in GDP per person after controlling for the effects of demographic changes on healthcare spending, such as changes in the age distribution of those eligible for Medicare, Medicaid, and private insurance.

Historically (from 1975 to 2007), Medicare’s excess cost growth has been 2.4 percent, compared to only 2.0 percent for Medicaid and 1.9 percent for all other (i.e., predominantly private) health spending.

These figures may seem small and the difference between them even smaller. But the excess cost growth for Medicare implies that the program doubles as a share of the economy every 29 years, whereas for the private health sector, that doubling period is every 37 years.

But CBO argues that “healthcare expenditures cannot rise more quickly than GDP per capita forever.” Consequently, CBO analysts assume that pressures to hold down costs will result in excess cost growth for Medicaid and private health insurance premiums being driven to 0 percent in 2085.

In contrast, it assumes that excess cost growth in Medicare will decline from 1.7 percentage points in 2022 to 1.0 percent in 2085. Why the difference? Well, as CBO concedes, “in the absence of changes in federal law, state governments and the private sector have more flexibility to respond to the pressures of rising healthcare spending than does the federal government.”

Deadweight Losses

Of course, all of the figures understate the true impact of tax-financed healthcare on the economy. Every dollar of taxes imposes hidden costs on the economy in the form of lower output (also called “deadweight losses”). That is, we get less of whatever we tax, be it labor, commodities, or even health services.

At the margin, each incremental dollar of federal taxes is likely generating deadweight losses amounting to 44 cents on the dollar. Thus, unless one can make the case that tax-financed healthcare is 44 percent more efficient than the same dollar raised and spent privately, every dollar we shift away from the private sector onto the books of government is a losing proposition.

With that in mind, it is difficult to justify using tax dollars to bankroll Medicare for people like Warren Buffett, or to retain a system of tax subsidies for private health insurance that provides a much larger subsidy (dollarwise and as a percent of premium) to Bill Gates than a low-income laborer.

But rather than fix the pervasive inefficiencies or inequities created by tax-financed healthcare, the Obama health plan has amplified both. The level of government that has shown itself least capable of disciplining growth in healthcare has been assigned an even greater responsibility for this task going forward.

And instead of eradicating the upside-down subsidies endemic in the tax exclusion for employer-provided coverage, the new health plan not only retains these, but will create even more massive inequities by offering a worker lucky enough to get coverage through health exchanges literally thousands of dollars more in subsidies than if that identical worker remains stuck in an employer-based health plan. To paraphrase Ronald Reagan, “government-funded healthcare isn’t the solution to the problem: it is the problem.” When will we ever learn?

Christopher J. Conover is a research scholar at Duke University’s Center for Health Policy and Inequalities Research and an adjunct scholar at AEI. The charts shown are from his new book American Health Economy Illustrated, to be released in January 2012 by AEI Press. See PowerPoint version of Figure 5.1a and Excel spreadsheets on real total health expenditures and real federal health expenditures for data, sources, and methods. See Powerpoint version of Figure 5.1b and companion Excel spreadsheets on total government health expenditures and government health and non-health spending for data, sources, and methods.

FURTHER READING: Conover has collaborated with Thomas Miller on the AEI working paper “Why a Public Plan Is Unnecessary to Stimulate Competition,” and contributes to the Enterprise Blog. He has also participated in the AEI event Private Health Insurance Markets: Facts, Fables, and Fixes.

Image by Rob Green/Bergman Group.