Paying for Health Reform

by Donald Marron

Sunday, June 21, 2009 at 10:08 AM EDT

Lawmakers want to be sure that health care reform -- if it happens -- won't worsen the deficit over the next ten years. That's laudable, but it's not enough. There's a risk that reform could be paid for over ten years, yet still worsen our long-run budget crisis. Policymakers should therefore focus on the long-run trajectory of new spending and offsets, not just the 10-year budget scores.

Faced with a frightening budget situation, lawmakers have rightly decided that health care reform -- if it happens -- should be budget neutral. In practice, that means that any new spending from health reform should be paid for -- by other spending reductions or by increases in tax revenues -- over a 10-year budget window.

That's a laudable goal, but it's not enough.

We also need to ensure that health reform doesn't worsen our already grim long-run budget situation. Unfortunately, that could easily happen, even if its costs are paid for over the next ten years. To illustrate, consider the following stylized example. The red line is a hypothetical path for the net costs of health reform, and the blue line is a hypothetical path for the offsets that would be used to pay for that reform. I've chosen the numbers so that health reform costs $1 trillion over ten years, and so that the offsets total to $1 trillion over the same period.

This combination of policies would satisfy the "budget neutrality" test -- the value of the offsets would indeed offset the net costs of the health reform. Nevertheless, it would substantially widen the deficit after several years, since the annual amount of new spending would eventually exceed the annual amount of offsets. If those trends continued, reform would not really be budget neutral; instead, it would exacerbate the long-term budget crisis.

The importance of this concern was highlighted by the Congressional Budget Office last week.

In a letter to Senators Kent Conrad and Judd Gregg, the Chairman and Ranking Member of the Senate Budget Committee, CBO said:

It also bears emphasizing that if a reform package achieved "budget neutrality" during its first 10 years, budgetary savings in the long run would not be guaranteed even if the package included initial steps toward transforming the delivery and financing of health care that would gain momentum over time. Different reform plans would have different effects, of course, but two general phenomena could make the long-run budgetary impact less favorable than the short-run impact:

First, an expansion of insurance coverage would be phased in over time to allow for the creation of new administrative structures such as insurance exchanges. As a result, the cost of an expansion during the 2010-2019 period could be a poor indicator of its ultimate cost.

Second, savings generated by policy actions outside of the health care system would probably not grow as fast as health care spending. Such would be the case for revenues stemming from the Administration's proposal to limit the tax rate applied to itemized deductions and from proposals to tax sugar-sweetened soda or alcohol, for example.

I designed my stylized graph to illustrate both of these phenomena: new spending takes time to ramp up, and the offsets eventually grow at a slower rate than the new spending (let me reiterate that the graph is stylized -- we don't know yet what the paths of new spending and offsets will look like). Obviously, the actual time pattern of new spending and new offsets could take many other forms. My point is simply that policymakers should pay close attention to those patterns, not just the cumulative 10-year budget scores.

CBO then goes on to point out that:

Some policy options under consideration would yield savings that grew in tandem with health care spending -- reducing the level of federal spending on health care but not affecting the measured rate of spending growth after the first few years. For example, the largest savings proposed in the President's budget would arise from a decrease in payments to private health insurance plans operating under the Medicare Advantage program. If enacted, that change would permanently lower the level of Medicare spending, but it would probably not offset a noticeably larger share of the cost of an expansion of insurance coverage in the second 10 years than in the first.

In short, it is particularly challenging to find offsets for new health spending, since that spending tends to rise faster than other parts of the budget. That suggests that offsets that are also driven by health spending might be particularly attractive. CBO notes that one potential source of such offsets would be reductions in other health spending. On the revenue side, the obvious potential source would be reductions in the tax exclusion for employer-provided health insurance.

Note: To construct the chart, I used the same pattern of net spending (new spending less higher tax revenues) as CBO estimated (on a preliminary basis) for the Kennedy health bill; I simply scaled the 10-year net spending down to exactly $1 trillion. The offset line is completely hypothetical.