Slowing the Growth of Medicare and Medicaid Costs

Without major changes, the federal deficit will explode and U.S. national debt will reach dangerous levels within the next twenty years. Any realistic plan to balance the federal budget must include two main elements.

1. A significant reduction in the growth rate of federal healthcare costs — primarily Medicare and Medicaid.

2. An increase in taxes.

The more we can slow the growth of Medicare and Medicaid costs, the less we will need to increase taxes.

Medicare and Medicaid cost growth can’t be slowed without similar changes in the private healthcare system

Attempts by Congress to slow the growth of federal healthcare costs have been unsuccessful primarily because Medicare and Medicaid are so closely linked to the rest of our healthcare system. All doctors and hospitals treating Medicare and Medicaid patients also have private patients. If Medicare and Medicaid payments are cut much below the standard charges to private patients, healthcare providers will stop seeing the poor and elderly. If the government restricts treatments available to Medicare and Medicaid patients, Congress will quickly receive complaints that it has created an inferior healthcare system for the poor and old. Consequently, slowing government healthcare costs in the long run is not politically possible without reforms that also apply throughout the U.S. healthcare system.

Slowing the growth of healthcare costs

Between 1975 and 2005, per capita healthcare costs grew much faster than costs in the rest of the U.S. economy — 2.4% faster for Medicare, 2.2% faster for Medicaid, and 2.1% faster for private patients. Rising costs are now threatening to bankrupt not only the federal government, but also many businesses and private patients. How can the growth of healthcare costs be slowed? That is now the $64,000,000,000,000 question.

There are three main approaches to reducing healthcare costs: reducing the need for treatment, paying less for treatment, and using less treatment.

Needing Less Treatment

The U.S. is currently suffering from an epidemic of obesity and diabetes. Getting Americans to eat better diets and exercise would reduce chronic illnesses now and in the future. However, we all will eventually get old and die, so the main effect of healthier lifestyles is to delay healthcare costs. The studies are inconclusive about long-run savings and, unfortunately, finding ways to motivate people to change their lifestyles is difficult.

Paying Less For Treatment

Congress has passed and rescinded many laws to reduce Medicare and Medicaid payments. Government efforts to pay less have so far been unsuccessful in reducing cost growth. Increasing competition among providers might reduce charges, but is very difficult to implement because of the special characteristics of the doctor-patient relationship (I’ll have more on this in a later blog entry.) More competition among insurance companies could reduce costs and this is one of the reasons the Task Force supported a voucher plan. However, unless government takes over the healthcare system, it is unlikely that the growth in payments per treatment can be slowed enough to solve our problem.

Using Less Treatment

This is where the hope (if there is any) lies. Evidence from two sources indicates that about one third of medical treatments have little if any benefit and, in some case, may harm the patient. For twenty years, researchers at Dartmouth have been examining Medicare payment records and have published the data in the now famous Dartmouth Atlas of Health Care.

Large variations exist in the cost of healthcare in different parts of the U.S. — with some areas spending twice as much as other areas. The surprise is that patients in high cost areas don’t do any better than those that receive less treatment in low cost areas.

The second source comes from international studies of healthcare. The U.S. spends about a third more of its GDP on healthcare than any other advanced country and other advanced countries usually have as good or better outcomes. See this report from the White House, particularly the discussion starting on page 9.

Our healthcare system seems to be surprisingly inefficient. If we can make better treatment decisions, we should be able to reduce costs without affecting the quality of care. How can this be accomplished? I’ll discuss this in the next blog entry.

Is the U.S. going the way of G.M.?

My first Deficit Task Force meeting took place at the American Farm Bureau headquarters in Washington, D.C. last December 17th — the day I turned 65 and became eligible for Medicare. I was the oldest Task Force member and the only one close to actually experiencing Social Security and Medicare.

Our first presentation was from the “Fiscal Wake-up Tour” — three experts on the federal deficit representing the Concord Coalition (non-partisan) , the Heritage Foundation (conservative) and the Brookings Institution (liberal). They were unanimous in their message — without major changes, the federal deficit would explode and bankrupt our country over the next thirty years (or less). They certainly got our attention.

As I mentioned in the previous post, I came to the meeting with the mistaken belief that the looming retirement of the baby-boomers and the resulting increase in Social Security payments were primarily responsible for the deficits.

Social Security

The Social Security Trust Fund is projected to run out of money in 2043. However, Social Security payments are currently equal to 4.4% of GDP and it is taking in payroll tax receipts equal to 4.8% of GDP — so the Trust Fund is growing and will be for the next decade. If nothing is done, SS payments are projected to grow to 6.1% of GDP in 2033 and then stabilize. A .5% of GDP increase in revenue or a cut in expenditures now would bring SS back into actuarial balance. This could be done by increasing the payroll tax from the current 12.4% to 13.7%. The required increase in the payroll tax would be less if combined with an increase in the “full retirement age” (the Task Force favored automatically increasing the “full retirement age” as longevity increases) and/or a increase in the cap on earnings subject to SS tax ($106,800 in 2009).

Social Security has a serious long-term funding problem that must be faced soon. However, since Congress controls both the revenue and expenditure sides of the Trust Fund, many options exist that will bring SS back to solvency. Only the political will is lacking.

Medicare and Medicaid

The government now pays directly or indirectly for well over half of U.S. healthcare. The biggest contributors to government costs are the Medicare and Medicaid programs and the tax revenue lost by not taxing employer-provided health insurance. Government costs are rising rapidly because healthcare costs are rising much faster than inflation in the rest of the economy. I’ll have much more to say about this in future posts.

Unless dramatic action is taken, steadily rising healthcare costs are projected to bankrupt the federal government. The Congressional Budget Office (CBO) has projected that the combined cost of Medicare and Medicaid will increase from 4.9% of GDP in 2010 to 10.6% in 2040 (an increase three times bigger than the increase in SS). During the initial meetings of the Task Force, we saw two graphs from the CBO that dramatically illustrate this point.

Notice that the top graph excludes interest payments on the national debt. If nothing is done and interest payments are added, the federal budget is projected to grow to 43% of GDP in 2050 with interest payments on the skyrocketing national debt alone costing 16% of GDP (and these estimates were done before the current recession). Federal tax revenue has averaged about 18% of GDP for the last 30 years. Hence, without a very large increase in taxes, the federal deficit in projected to explode in the near future — mainly due to rising healthcare costs.

Why worry about the federal deficit?

We’ve been hearing dire warnings about federal deficits at least since the 1980’s when the Reagan tax cuts caused the yearly federal deficit to jump to unprecedented levels. However, none of the predicted bad effects has materialized yet. Interest rates have stayed low. Buyers have lined up to eagerly buy our Treasury bonds. Interest payments as a share of federal outlays have actually fallen from 14% in 1985 to a projected 7% in 2009. Why is action so urgent now?

I believe the situation we currently face is different in two fundamental ways. First, the size the projected long-term deficits is much larger than we have ever experienced in peacetime. See the graphs on page 4 and the title page of the CBO’s most recent “Long-Term Budget Outlook.”

Second, our government is now selling most of its debt to foreigners. After the waves of currency crises that swept around the world between 1996 and 2001, many countries decided they needed to increase their reserves of U.S. dollar assets. By purchasing U.S. bonds, foreign governments caused the U.S. dollar to rise in value relative to their currencies and this promoted a rapid growth in their exports. Maintaining an undervalued exchange rate turned out to be a spectacularly successful development strategy — one that China and other other developing countries have been reluctant to give up. China now has accumulated over $1.5 trillion in U.S. debt and knows it will suffer large capital losses on this debt as soon as it stop buying dollars and lets the Yuan appreciate.

During the last decade, the U.S. has not experienced rising interest rates and the other negative consequences of its large federal deficits because foreigners have willingly accumulated U.S. dollars. They now have more dollars than they want and may soon start selling rather than buying. Interest rates will soon rise dramatically.

Because more than half of U.S. Treasury debt is now foreign-owned, foreigners have also gained a powerful foreign policy tool they can use against us. Sudden large sales of foreign-owned U.S. Treasury bonds would dramatically raise U.S. interest rates and disrupt our financial system. The U.S. threatened this financial weapon against the British an French governments and forced them to withdraw from the Suez Canal in the 1950’s. The Chinese could now do the same in a conflict with us.

Are we going the way of G.M.?

For sixty years, G.M. was the largest and strongest car company in the world. Because it was so powerful, G.M. could delay facing up to its mounting losses during the last decade. Neither management nor the unions stepped up to make the painful changes necessary to confront G.M.‘s problems and save the company. G.M. ended up bankrupt. Unfortunately, the U.S. faces a similar situation.

A final complication

A federal budget deficit for a year or two is not necessarily bad. During our current severe recession, the federal deficit has ballooned to an unprecedented $1.5 trillion. This deficit is due partly to the additional spending from the stimulus package, but mostly to a decline in tax collections. Both lower taxes and increased government spending are stimulating our economy at a time that stimulus is sorely needed. There is no doubt that the debt we are accumulating is adding to our long-term problem. However, large deficits are necessary until the recession ends. As soon as the economy gets back on it feet, the federal budget must be balanced.

AFBF Task Force

My postings to this blog have been few and far between lately and I’d be surprised if anyone is still checking. I hope to do better going forward.

Last November, I was appointed to an American Farm Bureau Task Force charged with studying the long-term federal deficits. The Task Force absorbed most of my free time between December and July. It was made up of nine farmers from around the U.S. (Iowa, Connecticut, Virginia, Mississippi, Kentucky, Missouri, South Dakota, California, and Oregon) and was set up by the AFBF Board of Directors after they heard a presentation from the “Fiscal Wake-up Tour” about the dangers posed by the large projected federal deficits over the next forty years. The “Fiscal Wake-up Tour” is sponsored by the Concord Coalition and includes both a conservative economist from the Heritage Foundation and a liberal economist from the Brookings Institution — to show that reducing the deficits isn’t a partisan issue. The Task Force had monthly meetings through the spring, mostly in Washington, D.C. We heard interesting presentations from experts on many topics related to the deficits.

The charge for our Task Force was to develop background materials to help Farm Bureau members develop resolutions at their county and state meetings this fall. You can read this background material and view a video featuring the members of the Task Force at

The video is about 15 minutes long. The AFBF staff did a great job in putting it together and it is worth watching.

I’ve learned a lot over the last six months. Before I joined the Task Force, I thought the major obstacles to balancing the federal budget in future years would come from the looming retirement of the baby-boomers and the resulting insolvency of Social Security. I was mostly wrong. Making the Social Security system solvent is politically difficult, but can be accomplished with some relatively simple changes. The real elephants in the room are exploding medical costs that affect the Medicare and Medicaid programs and a structural imbalance that has developed over the last thirty years between federal revenue and expenditures. I will discuss what I’ve learned about each of these topics in future blog entries.