CBO clarifies presentation of aging and health care inflation issues

As you may know from my endless rantings, I've argued against the claim that rising per capita health care costs are – in OMB direction Peter Orszag's words – the "real deficit threat." Rather, simple population aging will for the next several decades be the largest driver of rising entitlement costs. If so, this undercuts the administration's case that the only way to save Medicare and Medicaid is to exert increased control over private sector health care for working age Americans in order to, at least in the administration's hopes, reduce health cost growth.

In any event, the CBO's new Long Term Budget Outlook, which is worth reading for any number of other reasons – especially the excellent chapter on Social Security – includes a new and (in my view) greatly improved presentation of aging and excess cost growth issues. In Box 1-2, the CBO says:

Aging is the more important factor over the next 25 years or so. If the interaction is allocated between the two factors, aging accounts for about 64 percent of the projected growth in spending on the major entitlements by 2035. That result is not surprising because the aging of the baby-boom generation significantly expands the number of Medicare, Medicaid, and Social Security beneficiaries. Over the longer term, however, the situation reverses: 56 percent of the growth in total federal spending for those three programs by 2080 is attributable to health care costs per person rising more rapidly than per capita GDP.

My view is that while health care inflation is indeed the largest cost driver in the long run – here meaning, from around mid-century onwards – you first have to get through the short and medium terms. And in the next four decades aging-generated entitlement spending increases will generate so much additional debt that a budget crisis is very likely to occur. In that case, the predominant role later played by excess cost growth gets to be a bit academic.

What this means for the current debate is that the administration's focus on reforming private sector health care in order to fix Medicare and Medicaid is misplaced, even aside from the legitimate questions raised by others regarding the effects of these reforms. Even if the administration's health reforms were successful beyond their already-optimistic aspirations, if they don't confront the true drivers of entitlement costs it's unlikely they'll fix the problem.

Also check out this post from the Committee for a Responsible Federal Budget, which gives a good explanation of aging versus excess cost growth issues.

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Obama Budget Office Says Aging, Not Health Care Inflation, Primary Entitlement Cost Driver Thru 2040s

As I've discussed here before, there's been some debate over the sources of future entitlement deficits: the traditional view has been that it's the aging population, which pushes more people onto the Social Security, Medicare and Medicaid rolls. A new view says the real culprit is rising per capita health care costs – called "excess cost growth" – which push up spending even if the population doesn't get older. Under the first view, the likely reform approaches are traditional ones like raising taxes, cutting benefits, increasing the retirement age or trying to pre-fund future benefits. Under the new view, only comprehensive health care reform – meaning, reform of private sector health provision in addition to government health plans – can stop rising prices.

(For background on these debates, see my longer paper here, a short article here, and a recent AEI forum here. All contain references to opposing points of view.)

The recent budget proposal from the Obama administration has an interesting chart on what's driving entitlement costs. It's on page 191 of the Analytical Perspectives (here's a link). The text accompanying the chart is pretty standard new view stuff, which is not surprising since Obama budget chief Peter Orszag is one of the most forceful proponents of the excess cost growth argument. Here's what it says:

Sources of Increased Spending for Medicare, Medicaid, and Social Security: The most important factor driving the long-run budget outlook is the excess growth of health care costs.

Population aging gets some verbiage in the next paragraph, but you don't get the sense it has the same importance.

Ok, but now take a look at the accompanying chart.

What the chart shows is that aging will be the largest driver of entitlement cost growth out through 2040 and likely beyond. You can judge for yourselves, but it seems to me that given what the chart shows the emphasis of the text could be at least somewhat different.

Over the next 30 years, population aging is our main entitlements problem and it makes sense to seek solutions that are based on the problem we have, not the problem we want to have. Without downplaying healthcare funding issues, which are significant today and will grow even more so in the future, I can't help but think that some on the left have latched onto this new view because it promotes a policy outcome they happen to favor: increased government control over private sector health care provision for working-age people. I suspect that many of these folks would favor more government control even if health care costs weren't rising.

Update: Welcome, Andrew Sullivan readers. This material can be a little dense as I've written it. Here's a link to another blog post that walks through the issues more clearly. I also wrote a full length paper for AEI on this topic, available here.

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Fiscal child abuse

Courtesy of the always-interesting Carpe Diem:

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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.

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