A correction and clarification on aging and health care cost growth

Recently I authored a Health Policy Outlook for AEI that looked at the relative roles of aging and per capita health care cost increases – called 'excess cost growth' – in driving increases in overall entitlement spending. The piece took on a increasingly common view that excess cost growth is really the only player in the entitlement game, making Social Security reform and policy issues regarding population aging seemingly irrelevant. New York Times columnist Paul Krugman, for instance, wrote that "the whole Beltway obsession with the fiscal burden of an aging population is misguided." Krugman and others cited a November 2007 CBO report as evidence; the report contained a chart showing that over the next 75 years almost 9 out of every 10 dollars in increased Medicare and Medicaid spending would be driven by excess cost growth, not population aging. This graph got my attention when it was featured in a blog post from Mark Thoma entitled "It's Not Social Security."Here's my recreation of the original CBO Medicare/Medicaid chart.

Now, for the correction: in my article, I quoted an op-ed from CBO Director Peter Orszag that appeared in the Wall Street Journal in December, 2007 in which he said "The fiscal gap does not arise, as many believe, primarily from the coming retirement of the baby boomers. Rather, the rate at which health-care costs grow will be the primary determinant of the nation's long-term budget picture." In my article, I pointed out that you could not infer this conclusion from the November 2007 CBO study because it did not include Social Security and did not express cost increases in present value form. However, in subsequent conversations it was pointed out to me Orszag's op-ed was referring to CBO's December 2007 Long Term Budget Outlook, in which the fiscal gap for the entire government, including Social Security, was calculated. This mischaracterization was an error on my part which I should have caught, and I regret not doing so.

That said, the fiscal gap calculations in the December Long-Term Budget Outlook shared the principal shortcoming of the November 2007 analysis, which was that interactions between aging and excess cost growth were attributed entirely to excess cost growth, not shown separately (as CBO has done in subsequent papers) or divided proportionatley between aging and excess cost growth (as I did in my paper). In addition, CBO used a technique for accounting for the effects of aging and excess cost growth on GDP – the denominator in the costs/GDP calculation – that tends to increase the share attributable to excess cost growth. (See CBO's May 2008 policy brief.) An equally plausible approach, I argued, showed a somewhat higher share deriving from population aging. (In the May policy brief, CBO's preferred method is called "approach 1" while I have used "approach 3.")

Here's a chart that attributes to aging and excess cost growth their proportionate shares of the interactions between the two, and uses CBO's "approach 3" from their May policy brief to account for effects on GDP.

Now here's an additional chart using the same methods, except that it adds to aging's share cost increases attributable to Social Security. As you can see, this is moving away from the original chart from which outside commentators drew so many conclusions.

This final chart expresses total Social Security, Medicare and Medicaid spending increases due to aging and excess cost growth in present value form. This discounts future cost increases at a 3 percent real interest rate, and more closely resembles methods used for Social Security and Medicare actuarial accounting as well as for calculations of the fiscal gap. You can see here that the roles of aging and excess cost growth are practically equal. (In this instance, aging is very slightly larger than excess cost growth, at 51%-49%, using CBO's "approach 1" for handling interactions with GDP, aging's share is 42% of the total.)

The point of these calculations isn't to show that aging is the primary cost driver of future entitlement spending; rather, it is simply to rebut the argument that aging is a bit-player in total entitlement spending – in other words, to show that concern over an aging population isn't misguided. Moreover, these numbers don't lead to the conclusion that we need less research on health care cost growth. Population aging, and the potential policy responses to it, have been much-studied and are well understood, why the drivers of health care cost growth and the relationship between health care cost and quality are much less well understood. What the results do show, which is what I argued in the original piece, was that we need continued research and policy work on both fronts.

Click here to download a spreadsheet containing these figures.