The “entitlement Crisis” Is More Than A Health Care Crisis

It’s a growing meme among budget-oriented Democrats that “there is no entitlement crisis,” as the Brookings Institution’s Henry Aaron writes. Obama budget director Peter Orszag made a similar argument at yesterday’s fiscal responsibility summit, saying that “Health care reform is entitlement reform.” Aaron and others argue that future budget shortfalls are almost entirely due to rising per capita health care cost inflation, not to population aging, pensions or other causes. Moreover, they say, budget shortfalls in Medicare and Medicaid cannot be addressed outside of fundamental fixes for rising health care costs economy-wide. As a result, the truly massive projected Medicare and Medicaid deficits become an argument for an overhaul of private sector health care, which most Democrats want in any case and which is almost sure to bring more government control over private sector health care.

The “it’s only a health care crisis” argument has something to it, so it’s wrong to dismiss it out of hand. Medicare and Medicaid are the largest drivers of long-term entitlement costs. However, it’s also worth considering these claims in a different light, since alternate viewpoints may lead to alternate conclusions. To start, here’s how Henry Aaron lays out the argument:

Here is what the projections indicate. Over the next four decades, government spending on all entitlement programs other than Medicare and Medicaid will increase negligibly as a share of national outputÑby only about 1 percentage point of GDP. That change is the difference between a projected increase of roughly 2-percentage points in the share of income going to pay social security benefits and a nearly 1-percentage point drop in spending on other non-health entitlements.

Meanwhile, Congressional Budget Office projections indicate that national health care spending will skyrocket, rising from 16 percent of gross domestic product to 37 percent by 2050. Aging of the baby-boomers explains some of the increaseÑthe old cost more to care for than do the youngÑbut not much. If population aging were all that is going on, national health care spending would rise by less than a quarter as much as current projections indicate.

Aaron then argues:

The challenge is to design ways to pay for and produce health care services, private and public, so that spending goes for services expected to produce benefits worth what they cost, are produced as efficiently as possible, and are available equitably to all Americans. Then, the nation must decide how best to pay for that careÑthrough premiums, out-of-pocket charges, and taxes.

Taken on its face, there’s not much to argue with here: the cause of the fiscal gap is so-called “excess cost growth” – that is, growth of per capita health spending in excess of growth of the economy – and to address it we need to fundamentally reform private and public sector health care provision. That’s pretty much what President Obama’s plans for health reform amount to, although there’s some reason to believe that the two would collapse together: that is, private sector health care would become increasingly untenable under the constraints imposed under Obama’s proposals, and more and more working-age Americans would resort to the government-provided health coverage alternatives that are a central part of Obama’s plans.

But here’s an alternate take on the sources of the overall entitlement “crisis,” based on some previous work I’ve done.

First, Aaron’s argument boosts the health share of total entitlement spending increases by netting out increases due to Social Security – around 2 percent of GDP, or around 10 percent of typical total federal spending – against projected reductions in other non-health entitlement spending. It’s arbitrary to net out certain spending reductions against Social Security instead of Medicare, but in any case CBO’s baselines often tend to project reductions in certain federal spending due to how the baselines are constructed, even if these reductions aren’t likely to come to pass. It’s pretty rare that any sector of federal spending declines by 1 percent of GDP, particularly entitlement spending. So I’m not sure I’d bank on that extra cash. In any case, through this netting out Aaron concludes that the whole action is in the health care sector.

Second, Aaron argues that the action in the health care sector is almost entirely in excess cost growth, not population aging. So if the entitlement crisis is really a health care crisis, and the health care crisis is really an excess cost growth crisis, then it makes sense to focus policy on curbing the growth of per capita health care costs, not on issues related to the aging of the population. Moreover, since health care cost inflation in Medicare is related to health care costs in the private sector, we therefore need to reform private sector health care. In this way, Obama’s proposed health care reforms – which do almost nothing to actually restrain Medicare’s growing costs – can be portrayed as entitlement reforms, while simultaneously giving the increased federal control over private sector health care that many on the left desire.

But there’s a bit of divide and conquer here. Almost all the increases in Social Security spending are due simply to population aging, plus part of the cost increases in Medicare and Medicaid. If we divide total increases in Social Security, Medicare and Medicaid spending between population aging and excess health care cost growth, it comes down to right around 50 percent for each. The chart below shows the annual evolution of cost increases. Population aging includes all cost increases for Social Security, plus Medicare/Medicaid cost increases due to the aging population. Excess cost growth includes costs increases due to the fact that individual health care costs are rising faster than the economy.

Clearly, excess cost growth is the bigger factor over the long term. But in the short and medium term, meaning the next three or four decades, population aging is actually the larger cost driver for federal entitlements. Moreover, the larger role of excess health care cost growth in later years is more or less academic: if we haven’t fixed entitlements over the next several decades, they’ll “fix themselves” by collapsing. The short story is that over the foreseeable policy future, population aging – not structural factors in health care – is the biggest driver of rising entitlement costs.

Aaron and others are correct that we need to address health care cost inflation, for the reason that in many cases Americans aren’t getting full value for their money. But given the large role of population aging, there are other policies besides a potential federal takeover of the health care sector to consider: policies to keep Americans working longer, which effectively holds back aging by raising the ratio of workers to retirees; policies to support families, which may raise birth rates, and potentially even policies to increase immigration. None are magic bullets and all have downsides, but are worth at least considering as we confront large entitlement cost increases in coming years.

The key takeaway here is to look carefully at claims that only health care costs increases are behind the entitlement “crisis.” A good chunk of future entitlement deficits are simply due to the fact that America is getting older, and we can address that without a potential federal takeover of health care economy-wide. 

For a more detailed analysis, see this paper from the American Enterprise Institute.