In the Nation's Interest

October 2014 Trustee Update Call: Slowing Healthcare Cost Growth

By Joe Minarik
Senior VP & Director of Research

I was planning to talk about something else today, but a testy exchange (pardon the pun) in our local paper, the Washington Post, caught my attention.  The kerfuffle began when President Obama spoke on the economy at Northwestern University on October 2.  John Podesta, who holds the title of Counselor to the President, issued a Twitter tweet about the speech, and his message got the goat of Fred Hiatt of the editorial page staff of the Post.  Hiatt’s resulting column elicited a rejoinder from Podesta, and by now enough ink and toner have been spilled to make a giant mess.  Let me review the bidding and then offer a few additional thoughts.

Podesta’s tweet neatly summed up his, and the President’s, view of recent healthcare and budget developments.  “A funny thing happened on the way to entitlement explosion,” it read.

The President, and Podesta, were claiming some credit for recent developments in the economy and the budget.  That’s not unusual – particularly in an election year – nor is it totally undeserved.  The economy was in a very bad place when this President took office.  And though the recovery has been far less than epic, that is exactly what economic historians like Carmen Reinhart and Kenneth Rogoff told us to expect.  We avoided the worst, which was far from a sure thing at the outset.

But that was then, and this is now.  The economy has begun to tootle along, and we are starting to face a lingering set of issues that were set aside in the heat of the financial crisis.  One of them is:  When will we finally address our long-term budget problem?

And that is where the President and his Counselor riled Fred Hiatt.  In his speech, the President put heavy emphasis on news of slowing healthcare cost growth under “the Affordable Care Act, AKA Obamacare” – which is how the President referred to the law.  He pointed out that the rate of insurance-premium growth has slowed while the number of uninsured persons has dropped by 26 percent.  He cited a recent Congressional Budget Office (CBO) projection of combined 2020 Medicare and Medicaid costs equal to $188 billion less than was projected four years ago.  He said that “Health care has long been the single biggest driver of America’s future deficits.  It’s been the single biggest driver of our debt.  Health care is now the single biggest factor driving down those deficits.”

Over the past five years, the deficit has been cut by more than half, and is now less than 3 percent of the GDP.  So, according to the President, “...we can shore up America’s long-term finances without falling back into the mindless austerity or manufactured crises or trying to find excuses to slash benefits to seniors that dominated Washington budget debates for so long.”

Instead, as John Podesta and the President said, the nation should rebuild roads and bridges and pay for it with corporate tax reform that is deficit neutral in the long run.  We should subsidize home loans for first-time buyers, invest in clean energy technology, provide high-quality preschool, redesign high school and training and apprenticeships, reform immigration, invest in basic research, increase the minimum wage, and enforce equal pay for women and institute paid leave for parents.

Although many would not buy the President’s entire policy agenda, there are items in there that accord with CED policy.  But the problem is the President’s, and Podesta’s, air that the pressure is off, and it’s time to party.  Responding to Hiatt’s column criticizing that spirit in the President’s speech, Podesta gave his spin on the causal chain in recent developments, and his conclusion as to where we ought (and ought not) to go from here.  “The Affordable Care Act has already helped slow the rate of growth in health-care costs across the board, ...bringing down projected deficits... deficit angst makes it all too easy for policymakers to ignore the fact that we still need to do more to repair the damage from the Great Recession, to grow wages and help middle-class families feel secure, and to invest in the future. This approach isn’t fiscally reckless; indeed, it’s the only serious way to further improve our economy today and strengthen our balance sheet in the future.”  In short, we can’t afford not to “invest in the future,” and we need little or no savings from the federal budget to do that, because we already have much of the savings we need from health care.

Fred Hiatt’s column took on this argument, but I have more time and more space, and therefore would like to go into a little more depth.

So here are the big-picture questions:  Is the President correct that “...we can shore up America’s long-term finances without falling back into the mindless austerity or manufactured crises or trying to find excuses to slash benefits to seniors that dominated Washington budget debates for so long”?  (Sure, it’s election time, but I don’t think any of us would sign up for the “mindless” part.  And “slashing seniors” is not a part of my program, either.)  And is “...[h]ealth care now the single biggest factor driving down those deficits”?

Let me begin the answer by reminding you that no one knows the future – not me, not Fred Hiatt, not John Podesta, not the President.  And just as the Greek philosopher Heraclitus pointed out that the world is constantly changing, and so no man can step into the same river twice, so can a judgment based on even the best understanding of history send us wrong.  (And, of course, there is no guarantee that a judgment contrary to history necessarily will turn out to be right, either.)  The best that anyone can do is to lay out the probabilities and recommend a path that is prudent, in that it minimizes the worst risks.  Though I don’t claim certainty, I do find the President’s and John Podesta’s chosen path, judging from their rhetoric and tone, to be risky and imprudent.

Let me cite five salient facts which illustrate why we need to take much more care of our fiscal situation than the President and Podesta seem to imply in their admittedly rather spare argument.

1. We already are in a very bad place.  The leverage that the rest of the universe has over us is best measured by the size of our debt relative to our GDP – just as would the size of the debt of a corporation relative to its net income be a crucial yardstick of its ability to weather future circumstances.  At the end of fiscal year 2014, as best we can figure just two weeks on, the debt held by the public (the most relevant measure for macroeconomic policy) was slightly north of 74 percent of our GDP.  For historical perspective, that is the highest figure since 1950, when it was falling like a rock from its World War II (1946) peak of 106 percent.  Since the beginning of the War, in only seven years (1944-1950) has the debt burden been higher.  The customary rules of fiscal behavior clearly were suspended during the war, which should highlight just how extraordinary today’s debt burden really is.

But to consider a more contemporary yardstick, in the 1990s, the European Monetary Union held that the maintenance of a debt burden below 60 percent of GDP was a prerequisite of membership.  Today, the United States might be “the best-looking horse in the glue factory” to foreign investors seeking a place to park their funds, but that status would not seem to be the firmest foundation on which to build our future.

Thus, we are in a risky place already, and we clearly should move toward safer ground with all deliberate speed.  But recent “progress” doesn’t really qualify under that standard.

2.  The budget deficit, while much improved, is still too high – even with the recent and projected healthcare savings.  The Administration makes much of the improvement in the deficit from its peak of $1.4 trillion (or 9.8 percent of GDP) in 2009 to about $486 billion (or about 2.8 percent of GDP) in 2014.  But while the drop in the deficit was big, the remaining deficit is still big – too big.  At 2.8 percent of GDP, the deficit is just about at the break-even level for affecting the size of the accumulated debt as a percentage of the GDP; with a deficit of that size, the debt burden isn’t rising, but it isn’t falling, either.  Current projections – uncertain as they are – have the deficit as a percentage of GDP hanging at just about this year’s level for another four or five years, after which it is expected to being to rise again, and to pull the debt burden along with it.  And this incorporates all of the recent data and all of the hopeful projections about healthcare spending.

And that is the good news.  In my experience working this issue for more than 40 years, bad news is a lot easier to come by than good news.  If anything goes wrong, the debt starts back down the slippery slope.  The down side is very steep, and it is much easier to fall in than to climb out.  Prudence suggests that we steer further from that knife edge – especially given that we still have much to understand about the forces that got us here.

3.  The recent slowdown in healthcare cost growth is still unexplained.  The current and recent budget numbers are better than anticipated a few years ago.  Those budget numbers are better because the healthcare cost growth numbers are better.  But we don’t know why the healthcare cost growth numbers are better.  And because we don’t know the cause of the healthcare cost slowdown, we had best think carefully before we start daydreaming about how we are going to enjoy the proceeds.

This slowdown in healthcare costs is by reasonable measure the largest on record, so it is highly unusual.  If it could be traced to any one factor, we would have a better sense of causation; but it is broadly based.  It affects both government and private payers.  It affects prices of both goods and services, and the quantities of both goods and services purchased, and insurance premiums.  (Note that some insurance policies were cancelled because they did not meet the ACA standards, which to some seem arbitrary or paternalistic, but to others enforce basic and necessary consumer protections.  Some of those whose plans were cancelled wound up paying more, though the Administration claims that they got better coverage.  This is a different issue from the decline of the rate of growth of insurance premiums at a constant level of quality.)

So what is slowing cost growth?  One factor is the overall economy.  Scholars of healthcare economics agree that spending on health care slows during economic downturns.  There are multiple reasons.  People who lose their jobs often lose their health insurance; and when they do, they cut back on seeing the doctor.  And price growth throughout the economy slows in recessions, so many inputs to health care become cheaper.  But another reason is that people who are financially insecure or who have lost their jobs hunker down and avoid non-essential expenditures, and even some essential but expensive ones.

The Administration (in a chapter in the annual Economic Report of the President) admits that the recession had something to do with the health-cost slowdown.  But the recession is over, right?  So they sell the economic slowdown short as a cause of the relief in healthcare costs for the last couple of years, and certainly now.

I’m not so sure.  As Heraclitus said, it’s not the same economic downturn, or river (or maybe in the case of this recent economic downturn, it’s a cesspool).  The number of job losers is declining, and the ACA has mitigated the problem of job losers also losing health coverage.  But even though the recession has ended, general inflation has remained unusually low, which also holds down healthcare inflation.  (The Administration correctly notes that lower general inflation is not the whole story, because healthcare inflation has slowed more than general inflation.)  Unemployment is falling, but a large number of former workers who lost their jobs in the slowdown – and presumably would prefer still to be working – remain out of the labor force.  Those people surely feel both poorer and less financially secure than they would like, and probably take very little comfort from the fact that the Business Cycle Dating Committee of the National Bureau of Economic Research says that the recession is history.  So those healthcare-cost-reducing influences of the recent recession continue, even though the recession technically is over; and those influences someday will end, and health spending will rise more rapidly as a result.

But those aspects of the downturn affect the working-aged population.  Medicare spending has been perhaps particularly soft, and some say the recession could not have affected the elderly, who for the most part do not have jobs and therefore did not lose them.  But I think that this is missing something potentially very important.  Again with thanks to Heraclitus, one aspect of this cesspool that is different from previous cesspools – I mean, this economic downturn versus previous economic downturns – is the long, drawn-out period of low interest rates in this recovery.

Many retirees’ standards of living are dependent upon the returns on their accumulated savings.  The data suggest that for those retirees, the “recession” – as it affects them – is by no means over.  It just goes on and on.  You can imagine that some retirees probably drew down their savings balances in the early years of the recovery to maintain their budgets, anticipating a bounceback of interest rates.  When it didn’t happen, those retirees found themselves with eroded nest-eggs and interest rates still on the floor – where they remain to this day.  Certainly, those elderly who have enough wealth to be able to risk more exposure to equities in the last few years have done much better.  But for those – probably more numerous and more vulnerable – who had to play it “safe,” prospects now are pretty dismal.  Those people quite possibly are staying away from the doctor because they are afraid to see the co-pay or the deductible.  Those retirees are holding near-term Medicare spending down, at their own – and possibly Medicare’s – longer-term expense.

There are some non-macroeconomic factors holding costs down as well.  Over many recent years, employers have been increasing employee cost sharing in their insurance plans.  That can be expected to keep people away from the doctor, and to slow cost growth.  Also, healthcare experts observe that we seem to be in a comparative fallow period for the release of new drugs, especially the “blockbusters” that sometimes give a noticeable kick to total spending.  Right now, instead, drugs that are moving off-patent and becoming cheaper are relatively more numerous, while new drugs demanding high prices are comparatively fewer.  This effect is not large enough to explain the entire cost slowdown by any means, but at the margin it contributes.  It is not expected to continue.

And then there is the Affordable Care Act.  The true believers are convinced that the healthcare cost slowdown, which may have begun as early as 2005, was caused by the ACA, which was enacted into law in 2010.  That is not likely.  Still, there are some provisions in the ACA that probably have played some recent role.

Most prominent are cutbacks in Medicare, especially in premiums paid to Medicare Advantage private plans.  Those are real up-front, cash-money cuts, and they surely have helped achieve the Medicare savings we observe.  Notably, despite dire predictions, MA enrollment has continued to grow.  (However, looking forward, once those cuts have taken full effect we should not expect them to bring a continuing slowdown in spending growth rates.)

In terms of program efficiency, the most enthusiastic claims of ACA advocates are based on the reduced frequency of Medicare-reimbursed hospital readmissions.  ACA penalties on hospitals that have contributed to troublingly high frequencies of readmissions for some conditions and procedures are already in effect, and hospitals clearly have responded.  (Those penalties will increase in the future, and so the effect can be expected to grow somewhat for a while.)  This effect is not large enough to drive the overall numbers, but still it is encouraging.

However, much of the rest of the ACA is still in its early days, and so claims of overnight impacts go way too far.  We cannot say with certainty that the ACA will not help to restrain healthcare costs in the future – I am skeptical of major impacts – but we can say with considerable confidence that it has not yet had a big effect.

So healthcare cost growth is down, but we do not know why.  We can point to several likely causes, but some of them might be temporary, and the others are of questionable power.  What will happen going forward?

4.  The projected improvement in healthcare costs is, well, a projection.  In the President’s speech and John Podesta’s op-ed one discerns a tone that victory on healthcare costs and the budget is at hand, and we might as well plan the celebration – with the amount of the healthcare savings as the party budget.

Well, a projection is just a projection.  Not to open a recent wound with my fellow Washingtonians, but you don’t pop the champagne cork with two out in the ninth.  And I don’t want to cause a political squabble, but having once advised (from the outside) one Administration not to rush to apportion a $5.6 trillion projected ten-year budget surplus between tax cuts and defense spending increases, I feel equally comfortable urging a second Administration (of the other political party) not to divvy up projected future healthcare cost savings just yet.

Some of the reasons for caution have been stated earlier.  Unlike in 2001, when the debt burden was low and the budget was apparently in clover, today’s debt burden is clearly excessive and the budget will be in trouble before long even if all of the favorable projections pan out.  If the 2001 decision was too risky, today’s would be even worse.

But beyond generic prudence about the instinctive rose color in our glasses, we need to be cautious about the rose color in our crystal ball.  The most diehard ACA fans are convinced that because the law mentions every buzzword in the health-reform lexicon – pay for performance, Accountable Care Organizations, Independent Payment Advisory Board, readmission penalties, bundling – the entire healthcare system will come immediately to heel.  But the ACA is an incredibly retail approach to a wholesale, systemic problem.  I don’t need to go on at length, but CED has been clear – perhaps the clearest voice out there – that we need system-wide, unrestricted market incentives for better-quality, more cost-effective care.  The ACA’s box-checking exercise – even with a massive number of boxes, all with impressive sounding labels – probably won’t cut it in the long haul.

And we need a bit of modesty based on our lack of understanding of the causes of the cost slowdown that we already observe.  There is a fairly clear precedent that we might want to keep in mind.

In the early 1990s, many experts in healthcare economics were confident enough to state privately, or even to announce publicly, that the healthcare cost war had been won.  There had been several years of slow cost growth, and the revised projections had been blessed by all the right people and organizations.  There were just two problems.

First, with the wisdom of hindsight, it is clear that part of that cost slowdown came from the effects of the economic weakness that led up to the 1990-1991 recession.  People who lost jobs and coverage, or who felt insecure in their jobs and income prospects, were afraid to go to the doctor.  Sound familiar?  But of course, the recession eventually ended.

And second, the entire healthcare system was set fair to be revolutionized and reorganized by a proliferation of highly efficient health maintenance organizations (HMOs), which was spurred on by a reputed miracle piece of federal legislation (the HMO Act of 1973).  Existing HMOs already were streamlining care and cutting costs for the employers who were ordering their employees into these new structures.  But employees took the revolution into their own hands, and rebelled against employers forcing them to change doctors.  And denials of care by over-zealous HMOs became the punchlines of Hollywood jokes – although many people found those jokes more painful than funny.

So the HMO boom ended as suddenly as it had begun.  Previous favorable adjustments to budget healthcare-cost projections became unfavorable, and the healthcare cost problem turned out to be a lot less dead than many experts had thought.

I am not a healthcare economics expert, and I cannot see the future.  It is conceivable that the ACA has touched just the right leverage points in the healthcare system; that perhaps healthcare providers and insurers are highly receptive to change just because they see that the current path is unsustainable, even though they do not feel global incentives; and that the role of the recession already has been washed out of the cost structure, and so it won’t hit the numbers in the next few years.  All of those things are conceivable.  But how much of our future are we willing to bet on their occurrence?  How much would be prudent, given that our public finance wagon already has three wheels in the mud?  Put me down as nervous.

5.  Some of the Administration’s plans to use the projected healthcare savings seem poorly crafted.  I would not advise that the Administration consider the projected healthcare cost savings as “spendable” in any event.  But I am even more anxious considering how they propose to use the assumed money, and the effects that they assume.

Example:  The President asks for investments in quality preschool.  I could not agree more, and CED is a leading voice in the campaign for quality preschool for all, especially for at-risk children.  Furthermore, CED’s argument for quality pre-K is precisely that it is a powerful economic investment.  But that does not mean that the economic payoff will be realized immediately – which is when our budget situation is critical.  Admittedly, some of the benefit comes from less need for remediation in the K-12 years, not too far down the road.  But much comes years and decades later – specifically, the portion of higher earnings that is paid in taxes.  In short, pre-K is a great investment, and we ought to make it; but like all sound investments, it has a cost and must be paid for.

Then there is infrastructure.  This nation has been short-sighted in may respects, and maintaining our infrastructure base is certainly one of them.  But again, infrastructure investments must be paid for, not added on to an already excessive deficit.

Some cite the interstate highway system as a model national infrastructure investment.  And it was.  It was included in the budget, and the great bulk of its cost was paid for with gasoline taxes and other earmarked user fees.  The plan never was to allow this investment to “pay for itself.”  And a good thing, too; much of the benefit of such infrastructure investment is “quality of life,” which is not included in the tax base.  You do not enter reductions in commuting times on you federal Form 1040.

To their credit, the President and John Podesta propose to pay for a bump-up in infrastructure spending with an additional source of revenue: a one-time increase as part of a long-term deficit-neutral corporate income tax reform.  Unfortunately, this entire scheme is ill-conceived.  We don’t need a one-time bump-up in infrastructure spending; we need a long-term program of sustained growth.  The Administration’s plan is drawn as though we had a collection of potholes and loose bolts in bridges in an otherwise pristine infrastructure base.  We can fill the potholes, and they will stay filled; we can tighten the bolts, and they will stay tight; and we all can commute happily ever after.  But the potholes and loose bolts, as ubiquitous as they might be, are just the beginning of the problem.  We are behind the mutually compounding curves of technological advancement and population growth, with a backlog of maintenance besides.  We need a long-term program of modernization, not a one-time bump-up to help us make it through the evening rush hour.

I could go on, but let me note that the entire concept of an “investment” program financed out of the hypothetical future healthcare savings in a still-unsustainable budget smells to me like “supply-side spending” – government initiatives so important and so beneficial that they don’t need to be paid for, because they will pay for themselves.  I did not much like supply-side tax cuts, and I don’t like supply-side spending either.  I remain convinced that we live in a veil of tears where, sadly, you pay for what you get.

I suspect that some of my few remaining friends will attack these thoughts as a plan to crunch a still-too-weak economy.  It isn’t.  CED’s “Savego” proposal would delay fiscal tightening until later, but would plan it now and then make the commitments for the longer term, locked into law.

Nor, clearly, is this an anti-public-investment screed.  With serious budget savings on the books, we can begin to talk about the need for better highways, better airports and air-traffic control, and a more-robust and smarter electricity grid.  We need to do what our forebears did, which was to pay for their investments in our future.  For real.  Not out of assumed future reductions in healthcare costs that still, even if fully realized, would leave our budget in an eternal sinkhole.

Thank you for listening.  I feel much better now.

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