The Corner

Where Are Health Costs Headed?

Several reports this week, from the actuaries at HHS and from the Congressional Budget Office, have shed light on where government economists expect health costs (and with them government costs) to be headed in the coming years. They suggest that the slowdown in health inflation we have seen over the past decade is likely at an end, that Obamacare will not be bending the cost curve downward (as its champions promised it could), and that we are in dire need of health-care and entitlement reform that could better help contain costs. They also help us see just how daunting a challenge that really is.  

That these are federal health economists and actuaries doesn’t mean they know more than other health economists and actuaries, and while their projections are well within the mainstream, there are some experts whose expectations are more optimistic and some whose expectations are even more dire. But this week’s reports offer a lot of data, and a well-informed sense of where we might be headed. It’s worth taking a look at the details. 

The most significant report, published on Wednesday, offered the annual national health expenditure projections of the actuaries who work for the Centers for Medicare and Medicaid Services at HHS. These are their expectations of how fast health costs will be growing in the coming years. 

I’ve written a lot over the past few years, here and elsewhere, about the pattern we have witnessed in the growth of health costs in recent decades, but simply put: After a massive explosion of health inflation in the early 1980s, we have seen a gradual decline in the annual growth of overall health costs, with a few significant reversals. The most recent reversal occurred from the mid ’90s through 2002 (as annual health inflation rose from 5.3 percent in 1996 to 9.7 percent in 2002), at which point began a major decline in health inflation — with every year from 2003 through 2009 showing lower health inflation (though not lower health costs, of course) than the prior year. Since 2009, health inflation appears to have been steady just below 4 percent. There has been some dispute about whether that relatively low level (relative, that is, to the past few decades, not to economic growth or overall inflation) has been sustained primarily because the economy has been weak, or because there have been some more significant structural changes in the health-care system, and therefore there has been some dispute about whether such low levels can be sustained or whether we are on the verge of another major reversal. 

On this question, the CMS actuaries are on the same side as the vast majority of other health-financing experts. They summarize their basic expectations at the outset of their paper:

Annual national health spending growth is projected to remain near 4 percent through 2013, primarily as a result of the recent recession and modest recovery. This projection is consistent with the historical relationship between health spending and economic cycles.

In 2014 the implementation of provisions of the Affordable Care Act related to major coverage expansions is expected to accelerate health spending growth to 6.1 percent. Through the remainder of the projection period discussed in this article, this rate of growth is sustained as a result of improved economic conditions and an aging population’s increased demand for health care.

In fact, they expect the higher rate of annual cost growth not only to be sustained but to increase somewhat further after the major increase in 2014, reaching 6.5 percent in 2022. Here’s how their projection for the next decade would compare to what has happened in the last decade:

They do not expect the resurgence of cost growth to quite fully undo the inflation decline of the past decade, but nearly so. Annual health inflation averaged 5.9 percent from 2002 to 2012, and the actuaries expect it to average 5.8 percent from 2012 to 2022. (I should note that the paper provides specific annual projections for 2013–2015, 2018, and 2022 and then provides an average for the entire decade, so the other specific years in the charts in this post are extrapolated from that combination; that means some individual years may be very slightly off, but not in a way that would affect the trend.) 

The actuaries expect Obamacare to be a major contributor to the huge increase in health inflation in 2014, although this year’s report actually expects that contribution (and that growth rate) to be lower than was projected last year by the actuaries. The reason for the lower projection is a bit of a bombshell buried in the report: The actuaries now expect that 11 million uninsured Americans will become insured in 2014 — that’s half the projection of 22 million newly insured the actuaries made just last year. The paper does not specifically explain this extraordinary reduction, but the data provided with it suggest they think the primary reason by far is the unwillingness of some states to participate in Obamacare’s Medicaid expansion. Last year’s report (which must have been prepared largely before the Supreme Court permitted states to opt out of the expansion) projected that just under 20 million people would be added to Medicaid in 2014; now the actuaries expect fewer than half that many (8.7 million) to enter the program. 

After 2014, Obamacare continues to contribute to the growth of health costs in their projections, but much more modestly so. The actuaries project that, on net, the law will bend the cost curve up a little over this period, not down. It is important to note, moreover, that this expectation is based on a very rosy projection about the implementation of Obamacare, which assumes that the Medicare cuts required by the law and the further steps that would need to be taken by the IPAB to contain cost growth would all occur as scheduled. The actuaries do not express an opinion in this report about whether that was in fact likely to happen, but in the past they have expressed grave doubts about it, noting in one report that these provisions (which would take Medicare reimbursement rates below those that now drive many providers away from Medicaid) could cause 15 percent of Medicare providers to drop out of the program, badly undermining seniors’ access to care, and that Congress was unlikely to allow that to happen when push came to shove. If those cuts in fact do not occur, then both health inflation and Obamacare’s effect on that inflation would be significantly greater than these already unpleasant projections. 

But even if, along with the actuaries, we accept present-law assumptions, the path they project for health inflation suggests very serious trouble for the federal budget. The gradual downward trend in overall health inflation has not, after all, been matched by a downward trend in federal health spending. On the contrary, while the past three decades of health inflation and the actuaries’ projections for the next decade look like this:

Federal health spending over the same period (using historical figures and projections from the Congressional Budget Office, released just this week) looks like this:

The CBO’s expectations of national health expenditures are very much like those of the CMS actuaries. In other words, even a modestly downward-pointing trajectory of overall health inflation has translated to a completely unsustainable upward trajectory of federal health costs, and the trend is projected to continue. 

It’s not hard to see why: The first chart measures annual growth in spending while the second measures annual levels of spending. Even the historically low levels of health inflation of recent years, just below 4 percent, have after all been well above the rate of economic growth and of general inflation in this period. 

And as a greater share of overall health costs become public costs (a long-term trend set to be dramatically exacerbated in the coming years, with government spending accounting for 49 percent of all national health spending by 2022, according to the actuaries), the growth of health costs becomes an even greater portion of our broader public fiscal problem. And to be clear: it has long been at the heart of that broader fiscal problem already. The entirety of the net increase in federal non-interest spending as a percentage of GDP over the last forty years has been a function of federal health spending, and CBO expects that to continue, leaving the federal budget on what the agency considers an entirely unsustainable path in the coming years. National health spending and federal health spending cannot continue to grow faster than the economy forever.

This basic fact may be hard for us to understand because, after all, health costs and federal health spending have been growing faster than the economy for almost half a century now. But if we stay on the course we are on, the coming decades will not look like the past few decades, or like anything we have seen in our history. The latest Long Term Budget Outlook from the Congressional Budget Office, published earlier this week, makes that plain enough. Here is how its alternative fiscal scenario (which has generally been its most accurate projection of future trends) paints the future of our national debt, compared to its past:

This projection doesn’t reach into the unimaginably distant future. It ends in 2038, when this year’s college graduates will be at the peak of their working years, and it does not bode well for those years. 

The growth of the debt in this projection is on net almost entirely a function of health spending and interest payments. We have no choice about interest payments (regardless of what those now heedlessly talking of default may say). The only means we have for making this path more sustainable are significantly better economic growth and significantly slower growth in federal health spending. Neither the Obama administration’s actuaries nor the Congressional Budget Office seem to expect Obamacare to help us achieve either of those things at this point. I think that some kinds of entitlement reform (most notably a premium-support reform of Medicare, a subject of yet another CBO report released this week) could help a great deal with federal health costs in this period while protecting the elderly — assuming we do not wait a decade before starting it, as House Republicans still pledge to do. But anyone who tells you they know for sure just what can set us on a sustainable path at this point is telling you a lie. 

Projections, to be sure, are educated guesses. The actuaries may well be too optimistic or too pessimistic. There is no consensus on the fine details of where our health-care system is headed, or where our economy is headed. But the general trends painted by these estimates are fairly well accepted. And the challenges they point to are grave and serious, and will only grow more so the longer we wait to address them. 

Yuval Levin is the director of social, cultural, and constitutional studies at the American Enterprise Institute and the editor of National Affairs.


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