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The Fiscal Consequences of the Affordable Care Act

Charles Blahous | 04/10/2012 |

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This morning the Mercatus Center is publishing my study, “The Fiscal Consequences of the Affordable Care Act,” which evaluates the comprehensive health care reform law (the ACA) enacted in 2010. In this study, I project that the ACA will add over $1.15 trillion to net federal spending and more than $340 billion to federal deficits over the next ten years, and far more thereafter.

That this law on which so many high hopes were placed will significantly worsen federal finances is an unfortunate but unambiguous result. The finding is based upon analyses published by the Congressional Budget Office (CBO) and CMS Medicare Actuary, and it reflects an optimistic fiscal scenario in which all of the law’s cost-saving provisions work as currently envisioned.

Quantifying the Fiscal Consequences of Health Care Reform

The fiscal stakes of health care reform are high. Prior to the law’s passage its proponents and opponents disagreed on many things but they agreed on one: rising health care cost commitments were a key driver of an unsustainable federal fiscal outlook. Motivations and goals for the 2010 legislation were various, but among the most prominent was the view that such action was necessary to correct the course of federal finances. For this landmark legislation to actually worsen the fiscal situation would represent a substantial failure of governance, and it threatens disastrous consequences if the law is not corrected before its provisions become fully effective.

The ACA unambiguously worsens federal finances. As the accompanying graph shows, under a variety of possible assumptions (all based on the analyses of CBO and CMS), our annual deficits will be much larger because of the ACA than they would have been under prior law. As visually represented in this picture, up is good and down is bad from a budgetary perspective.

annual fiscal effects

The top two lines on the graph show that the law appears to have a helpful effect on the federal budget under a particular government scorekeeping convention. This is true both as originally scored by CBO and as adjusted for last year’s suspension of one of the law’s provisions, the CLASS program. The bottom three lines, however, show that the ACA greatly worsens the situation relative to actual previous law.

Under each of optimistic, mixed-outcome, and pessimistic assumptions concerning the future implementation of ACA’s various provisions, the law would add between $340 and $530 billion to federal deficits over the next decade. Under the pessimistic scenario – by no means a worst-case scenario, but one assuming that Congress acts in the future according to historical precedent – the law would add over $100 billion annually to federal deficits by 2021. This suggests that it would add more than $1 trillion to deficits in its second decade.

There are two important yardsticks for measuring the fiscal effects of health care reform. Measuring its effects on federal deficits is one. The other -- its effect on total federal health care spending – is equally important. This is because under current law, federal health care spending commitments are widely acknowledged to be unsustainable. A “solution” that appears to reduce federal deficits while adding to total federal health care spending is no solution at all, as it would subject future generations to tax burdens far higher than the American public has ever tolerated. This is why health experts across the ideological spectrum have stressed the necessity not only of reducing federal deficits, but also of “bending the health care cost curve” downward.

Unfortunately, the ACA fails this second test by an even wider margin. Under any realistic scenario it would add to federal outlays by more than $1.15 trillion over the next ten years.

The Use of Medicare Savings to Finance a New Health Entitlement

Why are these dire fiscal consequences not more widely understood? A great source of confusion lies in government scorekeeping methods, which compare the effects of legislation to a hypothetical baseline scenario rather than to enacted law. To understand the difference, it is necessarily to go briefly into the weeds of Medicare trust fund accounting.

The ACA contains many provisions designed to slow the growth of Medicare spending. This matters here because the federal Medicare program is financed in a particular way – from special, separate trust funds. The Medicare Hospital Insurance (HI) Trust Fund in particular is governed under law by certain rules. Medicare HI is only permitted to spend money on benefits as long as there is a positive balance in its trust fund. If that trust fund is depleted, then under law benefit payments must automatically be cut to the level that can be financed from incoming tax revenues.

This is relevant to an evaluation of the ACA because the CMS Medicare Actuary has projected that had the ACA not been passed the Medicare HI Trust Fund would have been depleted in 2016. If that were allowed to happen, Medicare HI payments would have been sharply cut in that year.

Due to the ACA’s Medicare cost-savings provisions, however, these automatic spending cuts are no longer projected to begin in 2016. Medicare HI is now projected to remain solvent until 2024, postponing forced outlay reductions until then. In other words, the ACA’s Medicare provisions decrease the level of Medicare HI spending prior to 2016, but then increase it from 2016-2024 relative to previous law. Considered separate and apart that would be a good thing, but it has inescapable fiscal ramifications in the context of the ACA’s other spending expansions.

Here’s a simple way to think of it: under law Medicare is permitted to spend any proceeds of savings in the Medicare HI program. If we cut $1 from Medicare HI spending in the near term, then an additional $1 is credited to the HI Trust Fund as a result. The Trust Fund thus lasts longer and its spending authority is expanded, permitting it to spend another $1 in a later year.

A core fiscal problem with the ACA is that the same $1 in Medicare savings that expands Medicare’s future spending authority by $1 is also assumed to finance the creation of a large new federal health program. Taken together, these two expansions of spending authorities – the new health program and Medicare’s solvency extension – far exceed the cost-savings in the legislation.

Many people understood this instinctively when the law was originally debated. They wondered how a law could simultaneously extend the solvency of Medicare, provide subsidized health coverage to 30 million new people, and also reduce the deficit. The answer is that it can’t. The cost-savings of the ACA are insufficient to both extend Medicare solvency and finance a new health program without adding enormously to the federal debt.

The government scorekeeping conventions now in wide use are useful and appropriate for many policy purposes, but unfortunately they do not account for this phenomenon. CBO is diligent in carefully noting that these scoring conventions, dating back to the 1985 Deficit Control Act, do not represent actual law. As CBO states, “CBO’s baseline incorporates the assumption that payments will continue to be made after the trust fund has been exhausted, although there is no legal authority to make such payments.” The scorekeeping convention thus ignores the additional spending authority created when the HI trust fund is extended as occurs under the ACA. Unfortunately, few people read or understand these critical disclosures.

As a result, much of the cost-savings attributed to the ACA is actually not net new savings, but rather substitutions for those required under previous law. Under previous law, Medicare payments either would have been suddenly cut in 2016, or lawmakers would have had to enact other Medicare cost-savings (indeed, perhaps much like those in the ACA). The difference is that under previous law this all would have happened without also creating an expensive new spending program.

The graph below shows the vast difference between the Medicare cost-savings attributed to the ACA under the prevailing scoring convention, and the much lesser amount of actual net new savings.

Medicare Savings scenarios

It is critical to understand that this is not merely a presentational matter. It is reflective of something far more important than the dueling press releases of health care reform’s proponents and opponents. It means that under law, substantial real additional spending and real additional debt will accrue as a result of the legislation having been passed.

Alternative Scenarios

The results presented thus far assume that all of the ACA’s cost-savings provisions work as currently envisioned, even those that would require future Congresses to behave in ways considerably different from historical precedent. Unfortunately, the projected fiscal results of the ACA grow still worse when various plausible legislative scenarios are taken into account.

The ACA contains various provisions that aim to constrain the growing costs of federal health care spending, as well as various provisions that would expand its spending commitments. There is a substantial risk that its cost-increasing provisions will cost more than currently projected, and that its cost-containing measures will accomplish less than currently projected.

The law’s new health insurance exchanges are particularly susceptible to future expansion. This is generally the case with major federal entitlement programs. The original design of Social Security, for example, did not include any of cost-of-living-adjustments, early retirement options, disability benefits, or today’s more generous benefit formula. All of those were added later as individuals grew more dependent on the program.

The ACA’s new health exchange subsidies are currently designed so that their total cost will not grow faster than our gross domestic product (GDP). Because health care costs tend to grow faster than the underlying economy, this means that low-income participants in the exchanges would over time shoulder an increasing share of their health care expenses. Would this be politically sustainable, or would lawmakers yield to pressure expand the subsidies to spare poor participants from these cost increases? Even if participation were as projected by the CMS Actuary, if it grew afterward by a mere 1% annually, and if the subsidies grew only with health care inflation, this would add $50 billion to their costs in the first ten years and far more afterward.

On the other hand, the law’s cost-savings measures could well produce considerably less savings than now assumed. The law establishes a controversial new Independent Payment Advisory Board, charged with facilitating measures to hold down the growth of Medicare costs over time. There is a substantial risk that its recommendations could be overridden or that the board will be eliminated altogether.

In addition, various new taxes under the law could unleash a dynamic much like the one that now exists with the federal Alternative Minimum Tax (AMT). Under current-law projections, the AMT would bring in dramatically rising federal revenues over time because its income thresholds are not indexed. Each year, Congress acts to raise these thresholds so that rapidly rising numbers of Americans are not newly subject to the AMT. The ACA’s “Cadillac-plan tax” and 3.8% Medicare surcharge are similarly designed such that they would subject rapidly rising numbers of Americans to these taxes every year. If Congress simply allows the thresholds triggering these taxes to rise with general economic growth, they will produce far less revenue than currently projected.

None of this is to suggest that the ACA’s various cost-savings measures are necessarily bad policies. But their proceeds cannot safely be spent until they have verifiably accrued.

Under a plausible “pessimistic” scenario in which future Congresses handle such provisions roughly in keeping with historical precedent, the ACA will add nearly $530 billion to federal deficits over the next ten years, and far more thereafter.

Fiscal Corrections

Properly understood, the ACA stands to precipitate dire fiscal consequences. To forestall these, sharp corrections are required before 2014, when millions of Americans would begin to depend on its various new benefits.

To meet the original promise that the legislation would bend the federal health care cost curve downward, fully $1.15 trillion in spending over the next ten years would need to be stripped out of the law. This would gut the preponderance of its subsidized coverage expansions, both through the health exchanges and through Medicaid and CHIP.

A more modest standard would be to require that the law simply not make the federal deficit situation worse under a more pessimistic (but plausible) scenario. This would still allow the law to add to overall federal health care obligations, but would at least provide protection against the possibility of accelerating severe federal fiscal problems. Aiming for this weaker standard could allow the law’s Medicaid/CHIP expansion to remain in place but would require eliminating roughly two-thirds of the law’s health exchange subsidies.

There are many important issues surrounding health care reform that my study does not speak to. Among them are: the constitutionality of the law’s health insurance purchase mandate; the appropriate role for the federal government in facilitating expanded coverage; the long-term viability of the ACA’s Medicare cost restraints; how central the role of employer-provided coverage should remain; and the merits of the IPAB concept. My paper instead focuses on a central fiscal question: does this law improve or worsen the federal government’s fiscal predicament?

The answer, unfortunately, is that it greatly worsens the fiscal outlook. Only by considerably scaling back the new spending commitments made under the law, or by finding new financing sources for these commitments, will it make the positive contribution to federal finances that experts across the ideological spectrum agree is required.

Charles Blahous is a research fellow with the Hoover Institution, a senior research fellow with the Mercatus Center, and the author of Social Security: The Unfinished Work.


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