Cuts and Reforms

by Yuval Levin
The idea that Republicans in Washington just don’t know how far the president is leaning in their direction in the ongoing fiscal debates has been a prominent theme of liberal political commentary in the past few weeks, and it has focused especially on the view among Republicans that President Obama hasn’t offered meaningful entitlement-reform ideas. The president’s defenders insist that in fact he has offered such ideas, and that they should be much more appealing to Republicans than the sequester that they (along with tax increases, of course) are intended to replace. But this line of argument has revealed more about the left’s lack of understanding of what Republicans are after when it comes to entitlement reform than about any Republican misunderstanding of the president.
To begin with, here is what the president has offered. On the key entitlements (Medicare, Medicaid, and Social Security), the list is basically this (and the dollar amounts are 10-year savings):
  • Reduce payments to drug companies, $140 billion 
  • Reduce hospital payments such as reimbursement for patients who don’t pay, $30 billion
  • Encourage efficient care after a hospital stay, $50 billion
  • Encourage beneficiaries to seek high value health care and ask the most fortunate to pay more, $35 billion
  • Medicaid, Pay-for-Delay, IPAB, program integrity, $25 billion
  • Other health savings, $120 billion
  • Savings from Superlative CPI with protections for vulnerable, $130 billion
The president’s defenders are certainly right to say that this is not nothing, but they are wrong to suggest that this should persuade Republicans to accept an additional $680 billion tax increase over the decade, which the president is also proposing.
They are wrong because they assume that Republicans just want to cut entitlement spending. They say so rather plainly. Ezra Klein, for instance, describes the Republicans’ goals at this point as: “1) Cut the deficit, 2) Cut entitlement spending, 3) Protect defense spending, and possibly even increase it, 4) Simplify the tax code by cleaning out deductions and loopholes, 5) Lower tax rates.” Jonathan Chait says that by proceeding with the sequester rather than Obama’s substitute, Republicans are “giving up a chance to cut spending on Medicare and Social Security.”
But Republicans are trying to do more than simply cut spending on entitlement programs. They’re trying to reform these programs—especially the health entitlements—so that they better serve their purposes and spending on them doesn’t keep growing at the sorts of rates that make it totally unsustainable in the coming years. They’ve proposed a premium-support reform of Medicare and a cap on federal Medicaid spending combined with greater flexibility for the states, in both cases in an effort to drive these programs and the underlying health-care system toward a more economically rational financing model that would help restrain cost growth without undermining quality and access. With the exception of his CPI reform for Social Security, the president’s proposals above simply don’t meet these goals and do not constitute a step forward on entitlement reform.
Let’s stipulate that it’s hard to analyze what “other health savings” means and analyze the rest. “Reduce payments to drug companies” is a reference to having Medicare dictate prices in the prescription-drug benefit, badly undermining its competitive design (the benefit is now basically a premium-support system), which has allowed it to come in significantly below CBO’s cost estimates for years now (including this year). It is plainly a step in the wrong direction.
The other elements of his health proposals are basically all greater price controls—lowering the amounts that Medicare will pay for certain services and trying to micromanage behavior with a mallet. These kinds of policies further consolidate the fee-for-service structure of Medicare and create profound perverse incentives for providers that lead to precisely the inefficiency that entitlement reform should seek to reverse. Lower payment rates without the freedom to engage in business-model innovation drive increases in the volume of medical services, which increase overall costs while reducing the efficiency and value of medical care. (The CBO, among others, has done some great work on this phenomenon over the years, perhaps most notably here.) These reforms, in other words, would exacerbate the problem conservative health reformers are hoping to solve. They, too, are steps in the wrong direction. It’s not that they don’t cut enough, or that they reduce spending in a way that’s just not ideal: They’re outright bad policy that pushes in the wrong direction and would harm our health-care system, and Republicans should oppose them on the merits—as they did when the Democrats pursued such Medicare cuts in Obamacare to the tune of about $700 billion. 
The one possible exception on the president’s list is the proposal to “encourage beneficiaries to seek high value health care and ask the most fortunate to pay more.” I’m not sure quite what the first part means (and the president’s budgets do not offer any obvious answer as far as I’ve found) so it might not be bad, and some additional means testing in Medicare would be a good idea—though ideally it should involve giving less to the wealthy rather than charging them more and then giving that money back to them in the form of a highly inefficient benefit. Even if we assume the best about this one, it apparently involves $35 billion in savings over a decade, which suggests it doesn’t do all that much since Medicare is projected to spend about $8 trillion over that period.
If the president wants to just enact a CPI change by itself (which, by the way, would be a “balanced” approach, as it would reduce spending by $130 billion and increase revenue by about $100 billion over a decade), I think Republicans would (and should) agree to that. But if he wants this whole package of changes—which would make Medicare’s problems worse and significantly increase taxes—then they certainly shouldn’t. That’s not because they don’t know what he’s offering, but because it’s a very bad offer.  
So what would real Medicare reforms that the president might accept look like? Let’s start from what conservatives want to achieve with Medicare reform. We know Republicans seek to transform Medicare into a premium-support system, but why? They want to do that because that sort of reform would use the leverage of the program’s immense spending to drive efficiency improvements in the health system by having insurers (and their affiliated systems of providers) compete for seniors’ business and taxpayer dollars. The goal of that kind of reform is to move away from administrative pricing and centralized command and control economics to competitive pricing and a more economically sensible health system—providing the same comprehensive, guaranteed package of benefits but at a much lower cost and with more choices for seniors. Basically, it would turn beneficiaries into consumers and providers into competitors. 
Such a reform is not on the table while Barack Obama is president, unfortunately. And to the extent that it will be possible to take steps in this direction, they will be pretty modest, since Democrats are expressly opposed to both the means and the ends of this approach to Medicare’s future. Those modest steps would have the two kinds of goals that the larger reform has, and which would tend to reinforce one another: to encourage providers of care to pursue more efficient business practices and to encourage Medicare beneficiaries to behave more like consumers. A combination of these two forces is what makes markets work, and what could turn Medicare into a sustainable public program that fosters a competitive and productive health-care system rather than a program careening toward fiscal doom and taking American health care with it.
Encouraging providers to be more focused on efficiency and cost would require a move away from Medicare’s open and unmanaged payment system, which does not distinguish between more and less cost effective providers. This is the more important of the two goals of Medicare reform, but it will be by far the harder to champion in the remaining Obama years. There may be ways to introduce some limited instances of genuine binding competition within the fee-for-service system (like the “administrative service organization” idea recently proposed by Avik Roy) or the improvements to Accountable Care Organizations in Medicare proposed by James Capretta), but those are unlikely to be scoreable in a way that would make them useful in budget negotiations in the near-term. Concrete and scoreable reforms would therefore need to focus on the other element of a pro-market reform: introducing economic incentives for more cost-effective consumer decisions. 
Encouraging more sensible consumer behavior in Medicare would require enabling greater sensitivity to cost, by making sure retirees (especially wealthier ones) share more of the cost of their care and limiting the reach of secondary insurance programs that mask that cost. Last year, senators Lieberman and Coburn proposed a series of measures for doing this that make a lot of sense as incremental steps for conservative reformers: First, they would cap total out of pocket spending for all but the wealthiest seniors at $7,500 in any one year (Medicare has no such catastrophic cap today). But then they would combine the Medicare parts A and B deductibles into a single deductible (of around $550) and prevent supplemental “Medigap” policies from paying for the $550 or more than half of remaining co-payments up to the new catastrophic cap, so that seniors in fact had to share in those costs.
This combination of reforms (which Senator Hatch has also endorsed in this congress) would simultaneously provide seniors with greater security against catastrophic costs and with sensitivity to the costs of more routine care. The specific Coburn-Lieberman version of this reform was estimated (using CBO’s rather static approach to such things) to reduce federal spending by roughly $130 billion over the next decade and, no less important, it would begin to help seniors become more cost-conscious consumers even in today’s broken Medicare system. Some version of this approach would make eminent sense—both moving the system (a bit) in the right direction and saving money without undermining seniors’ coverage. Increasing Medicare’s age of eligibility—ideally in a means-tested way—would also make some sense, and save roughly another $130 billion on net.
And there are Medicaid reforms that could also help move our healthcare system in the same constructive direction—especially caps on federal Medicaid spending that would give the states far more freedom to design and manage their programs while encouraging them to move toward a means-tested premium support model of coverage. While Democrats have been staunchly opposed to an outright block grant for Medicaid, the notion of a per-capita cap on federal Medicaid spending has garnered significant Democratic support in the past and would also be attractive to many governors of both parties. CBO scored one version of that idea in the course of the supercommittee negotiations in 2011 that, I gather, would have saved about $300 billion over a decade, but by its nature such a reform could be scaled up or down fairly readily.  
Needless to say, the president so far has not offered such reforms, and the reforms he has offered are, on the whole, simply not better than nothing. That’s why those Republicans who follow entitlement and health-care policy incline to say that he has made no meaningful offer.