Opinion Column

Gazing Into CBO’s Budget and Health Care Crystal Ball

Last week, Peter Orszag, the president’s outgoing Director of the Office of Management and Budget, released updated budget projections on behalf of the Obama administration.  The numbers are unsettling, to put it mildly, which probably explains why they were released late on a Friday afternoon. 

The federal budget deficit is expected to set a record this year, at nearly $1.5 trillion, or 10 percent of GDP, and next year will be about the same, with a deficit exceeding $1.4 trillion for a third straight year.  Over the period 2010 to 2020, the Obama budget plan would run up deficits totaling nearly $10 trillion.  At the end of 2008, total government debt stood at $5.8 trillion.  It is now expected to reach $18.5 trillion in 2020, or 77 percent of GDP.

Last month, the Congressional Budget Office issued its own set of updated projections, but the frame of reference was the long-term, and not just the next 10 years.  Unfortunately, the farther out one looks, the worse the picture gets.  CBO’s latest projections again make it clear that the nation is rushing headlong toward a fiscal crisis, and the health law does nothing to head it off. 

According to CBO, Social Security costs will rise from 4.8 percent of GDP in 2010 to 6.2 percent in 2035.  Over the same period, spending on Medicare, Medicaid, the state children’s health insurance program and the new premium subsidy entitlement created in the health law will increase from 5.5 percent of GDP this year to about 9.7 percent of GDP in 2035.  In total, federal spending on the nation’s main retirement and health programs will jump by 5.6 percent of GDP over the next quarter century, and that assumes all of the Medicare cuts enacted in the health law go into effect as written.

But that is almost certain not to happen.  Despite all of the talk of “reforming the delivery system,” the big savings in Medicare come from indiscriminate, across-the-board payment rate reductions that will hit all institutional providers of services proportionally, without regard to any metric of quality. 

The biggest cut comes in the form of a “productivity adjustment” in the annual inflation updates applied to Medicare’s payment rates for hospitals, rehabilitation facilities, nursing homes, hospices and home health providers.  Beginning as early as next year, these payments won’t be increased to fully reflect the rise in input costs.  Instead, a “productivity adjustment” will reduce the inflation update by varying amounts, depending on the provider.  In most instances, the “productivity adjustment” is not a one-time hit; rather, it is assumed to take place every year, in perpetuity.  The compounding effect of reducing provider payment rates each and every year in this manner produces very significant Medicare savings–on paper, that is.

But it begs the question: if Medicare’s payment rates do not keep up with inflation, will those who supply services to Medicare’s patients continue to do so?  Richard Foster, the chief actuary of the Medicare program thinks a large number of them won’t, predicting that about 15 percent of the nation’s hospitals would run into serious financial distress in just the first decade if they accepted such low reimbursement for caring for Medicare beneficiaries.  Over the longer-run, the problem would of course become much more acute, which is why Foster has expressed serious doubts that the savings will materialize.

CBO did everyone a favor by producing an alternative baseline forecast which does not assume these Medicare reductions continue cutting deeper into rates after 2020.  In 2035, in CBO’s alternative baseline, health entitlement spending including Medicare would reach 10.9 percent of GDP, or a full 1.2 percent of GDP higher than the baseline that assumes the unrealistic Medicare cuts will continue forever. 

It is also clear from CBO’s forecast that the health law represents one of the largest tax increases ever enacted.  By 2020, CBO estimates that the tax hikes in the new law will add 0.5 percent of GDP to federal revenue collection.  By 2035, the tax hike will jump to 1.2 percent of GDP.

Like the Medicare cuts, however, those revenue projections are based on dubious assumptions.  The health law imposed a Medicare payroll tax hike of 0.9 percent and a 3.8 percent tax on non-wage income.  These new taxes would apply to individuals with incomes exceeding $200,000 per year and couples with incomes exceeding $250,000 per year.  But those income thresholds are not indexed for inflation, so by 2035 the new taxes would be hitting a large portion of the American middle class, and more so with every passing year. 

Similarly, the so-called “high cost” insurance tax will apply to family coverage plans in 2018–well after the president will have left office, by the way–with premiums of at least $27,500 per year.  But once imposed, the tax would hit more and more households every year as the threshold would rise with general consumer inflation, not health costs.  By 2035, it wouldn’t be just “Cadillac” plans bumping up against the premium threshold.

Unfortunately, there is also a strong possibility that the cost of the new premium subsidy entitlement program provided through the law’s “exchanges” will far exceed current projections.  CBO’s estimate assumes that most low and moderate wage workers will continue to get their insurance on the job, and thus be ineligible for the new federal assistance program.  But former CBO Director Doug Holtz-Eakin has estimated that some 35 million workers would be better off in the exchanges than in employer plans. 

The history of federal entitlement programs is that potential beneficiaries eventually find their way to the money.  One way or another, it seems likely that firms will adjust to make workers eligible for maximum federal assistance, especially over the long run.  Holtz-Eakin estimates that migration of more low-income workers into the exchanges could add $500 billion to the new law’s cost over the first  decade compared to CBO’s forecast, and much, much more over long-run.

The primary threat to the nation’s long-term prosperity is runaway federal entitlement spending.  Entitlement costs are set to rise so fast and so quickly that the implications for federal deficits and debt are staggering.  If allowed to stand, the health law has dramatically reduced the flexibility of the federal government to respond to the coming budget crisis.  It locks in massive new spending commitments, and uses every trick in the book to make it look like those commitments have been paid for. 

The truth is that the new law did not match the dead-certain new spending commitments with realistic and sustainable reforms, much less make a dent in the underlying problem of rising entitlement costs.

James C. Capretta is a Fellow at the Ethics and Public Policy Center. He served as an associate director at the White House Office of Management and Budget from 2001 to 2004.