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Job One for the Budget Super-Committee: Cut the New Health Entitlement’s Cost

Charles Blahous | 08/23/2011

The recent drama over the federal debt ceiling resulted in legislation that resolves the government’s operational debt management issues through early 2013. Left unresolved, however, was the critical matter of how to repair the government’s larger fiscal imbalance. The next step in this process will be taken by a bipartisan budget “super committee” consisting of twelve Senators and Congressmen, established in that same legislation.

This special committee is charged with developing recommendations, due later this fall, to achieve $1.5 trillion in deficit reduction over the next ten years. The White House, continuing its rhetorical approach employed during recent budget negotiations, has publicly expressed the hope that this committee will “seek a balanced approach to larger deficit reduction.”

Different observers will inevitably have different opinions of what constitutes “balance.” I offer the view that no deficit-reduction agreement can credibly be called balanced if it fails to do one simple and necessary thing: cut the projected cost of new spending enacted in last year’s health care law.

Background: In March, 2010, Congress passed and President Obama signed legislation that would make several sweeping changes to federal health care spending. At the core of the legislation were provisions mandating that U.S. residents obtain health insurance, along with provisions expanding eligibility for Medicaid and establishing federally-subsidized exchanges through which individuals could buy their own insurance. These expansions of the federal government’s commitment to health care were to be financed in a number of ways, most notably an assortment of tax increases and reductions in projected Medicare payments.

There are several reasons why scaling back the spending provisions of the new law should be a primary focus of the budget super-committee, and why only a very imbalanced approach would avoid this focus. Among them:

Health care cost growth is a primary driver of the federal government’s financial problem. Republicans and Democrats disagree on many things, but they do generally agree on one: spending on health entitlements remains a primary driver of the federal government’s financial predicament. Without reforms to correct the unsustainable path of federal health spending, no lasting solution to our budget woes is attainable.

The Congressional Budget Office (CBO) estimates that in 2011 federal spending on Medicare, Medicaid and other health entitlements will equal $870 billion in 2011, or 5.8% of GDP. CBO’s own words make abundantly clear why all health entitlements, and particularly the new health entitlement, must be on the table:

In CBO’s baseline projections, spending for health programs more than doubles between 2011 and 2021, rising by an average of about 7 percent per year and reaching $1.8 trillion in 2021. That spending is projected to represent 7.4 percent of GDP in 2021—a jump of 1.6 percentage points from its share in 2011. Of that growth, higher spending for Medicare accounts for about 30 percent, higher spending for Medicaid accounts for roughly 40 percent, and the remainder stems primarily from the new subsidies to be provided through health insurance exchanges beginning in 2014.

For further perspective on these trends, consider this. That 7.4% of GDP devoted to federal health programs in 2021 would exceed CBO’s baseline projection for all appropriated spending combined (including both defense and non-defense) in that year.

And, under CBO’s January projection scenario in which the military drawdown from Iraq and Afghanistan occurs roughly as anticipated, spending growth on just the new health exchanges alone would exceed the growth in all appropriations outlays over the next decade. See the graph below, which shows the increases in annual spending levels for various spending categories by 2021. 

To be sure, part of this phenomenon reflects recent-year elevations of appropriations spending, both for overseas military operations and for intended economic stimulus. But on the other hand, the new Budget Control Act will cut future appropriations below the levels shown on this graph, further accentuating the relative importance of health entitlement growth.

Simply put: it is difficult to conceive of a balanced approach to deficit reduction that does not start by addressing the growth in federal health spending, including the contributions of the new health care law to that growth.

Constraining the new spending is essential to strengthening Medicare. As a Medicare trustee, I am often asked what elected officials can to do improve the government’s ability to finance the program. Unfortunately the question admits of few easy answers. Medicare’s projected financing shortfall is substantial and both Republicans and Democrats struggle to find ways to reliably reduce projected cost growth without harming beneficiaries.

There is, however, one clear way to strengthen Medicare financing: by ensuring that savings achieved within Medicare are kept available to finance that program’s operations rather than being diverted to other purposes. This in turn requires that we scale back last year’s health care law.

By way of explanation: in a January, 2010 letter to Senator Jeff Sessions, CBO indicated that its preliminary scoring of the pending version of the health care bill (not yet then a law) showed an improvement of $358 billion in Medicare’s HI Trust Fund balances over the following ten years. These Medicare savings broke down as $245 billion in reductions of projected Part A Medicare spending, and $113 billion in new payroll tax receipts.

Under law, the amount that Medicare can spend on benefits is limited by the assets in its Trust Funds. Accordingly, a change in law that results in $358 billion more in assets being held by Medicare’s HI Trust Fund effectively gives the program permission to spend a further $358 billion on benefits.

But here’s the problem: CBO also projected that the health bill’s other effects on the broader budget would increase federal deficits by $226 billion over the same period. In other words, CBO found that roughly 63% of the amount of the bill’s Medicare savings would be spent elsewhere on other new federal health benefits.

This combination of provisions produces an unambiguous weakening of the government’s ability to finance Medicare. This is generally because the projected net improvement in the government’s financial position under the law is only 37% as large as the additional amounts the law gives Medicare permission to spend. (The figures would be somewhat different for the final version of the law, but the principle remains the same).

A solution to this problem requires that the non-Medicare components of the recent health care law be amended to be, at worst, deficit-neutral. Only then can we avoid increasing our spending commitments by more than our projected savings. This in turn could be accomplished by scaling back the spending on the new health exchanges under the law. This would represent the single best thing that this super-committee could do from the perspective of Medicare financing.

People are not yet dependent on the new health exchanges. One of the factors rendering it so difficult to extract significant savings from Medicare and Medicaid is that so many people are already dependent upon them. This however is not yet true of the new health law, which doesn’t become fully effective until 2014.

In general, policy makers prefer to make any changes to federal benefits prospective if they can. It’s not perceived as fair to change the rules when an individual has planned around having a benefit, is already receiving it, and it’s too late to make alternate plans. This is a big reason why costs in Social Security, Medicare and Medicaid have proved so hard to contain; elected officials simply don’t want to cut spending on people who are already dependent.

Unfortunately, Medicare and Medicaid’s financing problems are already so severe that it will be virtually impossible to correct them without reassessing the levels of benefits promised to people already on the rolls. That’s unfortunate, but we shouldn’t unnecessarily make that problem worse. As we search for savings in future federal health spending, we should first concentrate on benefits that people aren’t yet receiving. That in turn argues for putting the new law’s health exchanges – scheduled to ramp up starting in 2014 – at the very center of these efforts.

How to Do It: According to CBO, the federal government is projected to spend $524 billion over the next ten years on the new health exchanges, subsidies, and related spending. Specifically, this spending includes premium assistance for individuals and families between 133% and 400% of the poverty line. If negotiators are unwilling to scale back spending elsewhere in the health care law, the 400% figure could be reduced by whatever amount is enough to ensure that the non-Medicare portions of the health law are no worse than deficit-neutral, with the sliding scale of premium support applied to that reduced income range. (Alternatively, if negotiators are absolutely determined that individuals and families up to 400% of the poverty level be served, then they should increase other non-Medicare savings in the law sufficient to finance this objective.)

The bottom line is that, though involving difficult choices, further federal health entitlement cost savings must be found if the super-committee is to make a credible down payment on deficit reduction. If subsidized benefits for this new law’s target population are important enough to be enacted, they are important enough to finance without resorting to twice-allocating savings also earmarked for financing Medicare benefits. A credible budget process must choose one purpose for the Medicare savings; failing that, we must not claim to have financed an expansion of health care coverage.

Clearly, many elected officials are heavily politically invested in last year’s health care law. But that in and of itself is not a compelling substantive reason to keep it off the negotiating table. Were it not for such political considerations, it would be obvious that spending on the new health exchanges is the first area that the deficit reduction super-committee should target – not only to preserve the financing integrity of Medicare, but indeed to ensure a truly balanced approach to deficit reduction.

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.