CLASS Act Fails the Offset Test

by Donald Marron

Tuesday, July 07, 2009 at 01:12 PM EDT

If you take budgeting seriously, people sometimes think you are a curmudgeon. When I was at the Congressional Budget Office, for example, we were once denounced as anti-housing because we concluded that increasing subsidies for low-income housing wasn’t free. CBO reached that conclusion using an advanced tool known as “arithmetic”, but some advocates tried to portray it as an anti-housing policy statement.

At the risk of again appearing curmudgeonly, I would like to draw your attention to a provision in the health care reform bill being considered by the Senate HELP Committee. That provision, the Community Living Assistance Services and Supports Act, would create a new program to insure participants against some of the financial costs of disability and long-term care.

I have nothing to say about the merits of this provision, except to note that it has one of the best acronyms in legislative history: the CLASS Act.

I have a great deal to say, however, about the arithmetic of the CLASS Act, because it illustrates just how hard it will be for our legislative process to really pay for health care reform.

The provisions in the latest HELP bill that expand health insurance coverage would have a net cost of $645 billion over the next ten years according to CBO’s preliminary cost estimate. Lawmakers have committed (much to their credit) to paying for health reform, so they need to find offsets — lower spending on other programs or higher tax revenues — in order to pay for it.

Enter the CLASS Act. CBO estimates that this act would reduce the budget deficit by $58 billion over the next ten years. It would thus offset almost one-tenth of the cost of expanded coverage over the next decade. Not bad for a single new program.

If this seems strange to you — can the government really create a new insurance program and use it to pay for one-tenth of health care reform? — you’ve got good instincts. The CLASS Act should not really count as an offset. Why? Because the near-term surpluses in the program will eventually turn into deficits.

CBO expects the new insurance program to take in more in premiums during its early years than it would pay out in benefits. Of course, that’s exactly what you would want a long-term insurance program to do. However, benefit payments will grow more rapidly than premiums in subsequent years. That has two implications:

• First, the amount of annual savings will start declining after a few years. CBO estimates, for example, that budget savings from the program will peak at $10 billion in 2015 and then decline to only $3 billion by 2019 (the end of the budget window).

• Second, benefit payments will eventually exceed premiums. As a result, the program will add to the deficit at some point beyond the 10-year budget window.

The potential budget benefits of the program are thus front-loaded into the 10-year budget window, while the potential budget costs of the program are backloaded.

That means that the 10-year budget score significantly overstates the ability of this program to help offset the long-run costs of expanding health coverage. As I discussed at length in my first post on paying for health reform, to pay for health reform over the long term, policymakers need to identify offsets — spending decreases and revenue increases — that will grow as fast as any new spending.

The CLASS Act fails that test.

That doesn’t mean that the CLASS Act is bad policy (notice that I haven’t said anything about its merits), but it does mean that policymakers should not rely on it as a source of budget savings.

P.S. These concerns about the time pattern of savings and costs are hardly unique to the CLASS Act; indeed, they have arisen many times before. Loan guarantees, for example, used to pose a similar problem: upfront fees for providing the guarantees would appear to improve the budget inside the budget window, but the eventual payments on defaults would be outside the window. That problem was resolved in the early 1990s when a special form of budget accounting was created to deal with government loans and loan guarantees.

More recently, the 2005 passage of the Tax Increase Prevention and Reconciliation Act raised similar concerns. To keep the overall tax reductions in the bill within the amounts allowed under Senate procedures, lawmakers needed to include some provisions to increase taxes. One of them was a provision that would allow individuals to convert from traditional IRAs into Roth IRAs. As Len Burman has noted, allowing such conversions boosted tax revenues within the budget window, but significantly reduced revenues in the long-run.