Code Red: Two Economists Examine the U.S. Healthcare System

January 19, 2012

A Promise Made to be Broken

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 2:39 pm

In today’s Wall Street Journal, Princeton economist Alan Blinder exposes four myths about the federal deficit. He saves the most important myth for last. After noting that the long term deficit problem does not cut across all areas of spending, he observes that the problem is almost entirely rooted in the need to fund Medicare and Medicaid. If we base future spending projections on past trends, then Blinder is absolutely correct. Spending growth on Medicare and Medicaid nearly always outstrips the growth in tax revenues. The main contributors to spending growth – demographics, labor costs, and, especially, technology – are likely to keep this trend alive indefinitely. Blinder challenges us to focus the debate about the deficit on the key facts, which essentially means that we should focus on Medicare and Medicaid spending. Let me take up his challenge.

Let’s start with the obvious debating points. There is a lot of fat in both programs. CMS just acknowledged that as much as 10 percent of spending in Medicare and Medicaid is “improper.” This does not include spending on defensive medicine, unnecessary services demanded by fully insured patients, unwarranted variations in practice, and all the other usual suspects. Nor does it reckon with all the waste due to poor health behaviors, although eventually the grim reaper will have his say and dying is usually very costly no matter how well you have pampered your body along the way.

The obvious solution is to find ways to cut the fat. By some estimates, tort reform could cut spending by a few percentage points. Shifting everyone on Medicare into high deductible health plans could do the same. Cutting “excessive” salaries of pharmaceutical and insurance company executives might shave off another point or two. If we do all of this we may save ten percent on total spending, although we had better cut with a sharp scalpel lest the unintended consequences cost more than we save. Maybe we can save even more if we moved everyone into private insurance, but the argument about the relative efficiency of public versus private health insurance is mostly philosophical rather than empirical.

This is the easy part of the debate. Everyone wants to see CMS eliminate fat, although it has not been particularly effective at doing so. I imagine that CMS will redouble its efforts to cut fat. If it does not make the effort, then taxpayers have every right to demand fundamental reform.

Now for the hard part of the debate – the part where philosophical divides will show. Suppose that CMS does make the effort to cut fat. Better still, suppose that CMS finds enough fat to cut ten percent off of Medicare and Medicaid spending. Although this would be welcome news, at historic rates of inflation it will take just two years for Medicare and Medicaid spending to return to the pre-fat cutting levels. Finding another ten percent gives us just a four year respite. It is not sufficient to cut the baseline level of spending. CMS has to cut the rate of spending growth. (Fat cutting will affect the growth trend only if fat has been trending faster than lean. If anything, I suspect the percentage fat is trending slightly down.) This means that CMS has to confront the ever growing lean, or the day of reckoning must eventually arrive. A few years later, perhaps, but with consequences that are just as devastating.

That day approaches because Medicare and Medicaid programs have built into them the seeds of their own destruction. These programs do not promise to spend a given amount of money on beneficiaries. Instead, they promise to provide all beneficiaries with access to near state-of-the-art medical care. Unless there is a dramatic and unforeseen change in the nature of innovation in medicine, a change large enough to offset inexorable changes in demographics, this is a promise that will be increasingly costly to keep. For Medicaid, the financial obligations for keeping those promises fall on current wage earners. For Medicare, the obligations are fulfilled from a trust fund that increasingly relies on the contributions of current wage earners. Even if there is no fat in the system, the cost of keeping that promise, and the resulting burden on current taxpayers, will inexorably increase.

So any debate about the long term solvency of Medicare and Medicaid must eventually answer one simple question: Do we want to keep our promise?

One can make a very good argument that the benefits of costly new technologies have outweighed the costs in the past, and conclude that the promise is worth keeping. One might also argue that failing to keep this promise will create a two-tiered health care system in which most citizens are denied access to services available to wealthier Americans. But keeping the promise threatens to wreck the entire economy. The alternative is to convert Medicare and Medicaid from entitlements to certain levels of access to entitlements to certain levels of spending.

Congressman Paul Ryan’s Medicare reform plan goes down the latter path, converting Medicare from an access entitlement to a spending entitlement. If you support Ryan’s plan, you no longer believe that we can keep our promise about access. If you support Ryan’s plan, you either believe that it is worth sacrificing the nation’s prosperity to fulfill this promise, or you are willing to take a leap of faith that healthcare spending inflation is going to reverse a 100 year long march towards infinity.

I will finish by pointing out one irony. The cost of keeping the access entitlement for Medicare and Medicaid strongly depends on the level of technology available to the privately insured. HMOs, which tended to limit access to technology, thrived until baby boomers spurned them in the name of unfettered access and physician autonomy. If HMOs had survived the backlash of the 1990s, private sector health spending would be much lower, and CMS would need to spend lot less to assure Medicare and Medicaid beneficiaries equal access. As baby boomers move into retirement, their demands for gold plated medical care when they were young may be precisely what dooms them in their dotage to be second class citizens in a two tiered medical system.

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