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Frequent commenter and part time contributor to Outside the Beltway Bernard Finel is disputing claims that there are serious fiscal imbalances facing the United States.

Yesterday I posted an analysis that refuted the notion, common among conservatives, that the federal budget is out of control and growing a rapid rate. Instead, I demonstrated that government spending as a percentage of GDP maxed out in the early 1980s and has been declining slowly on average ever since.

Today, I will address a variant of this argument that focuses on spending on social program, including Medicaid, Medicare, and Social Security. My argument is simple: We don’t have a crisis of entitlements or social programs, we have, very narrowly, a health care crisis. Non health-related social spending — entitlements, Social Security, welfare, etc — is actually declining as a percentage of GDP since 1980.

This is a common theme with liberals like Bernard. We don’t have any crisis in Medicare or Social Security don’t touch them. Problem is we do. We can see the problem when looking at this picture from the CBO,

And note that the above graph does not include interest on the debt.

Now what Bernard has done is look at historical budget data as a percentage of GDP and has concluded our problem is health care. In this I agree with him. Health care expenditures in general are growing anywhere from 2 to 2.5 percentage points faster than GDP. Eventually it will cause a problem in terms of budgets, taxes and debt.

Where I disagree with Bernard is where is states this conclusion,

We face a health care crisis today, not a crisis in social programs or in federal spending overall. Our problems are almost wholly a function of exploding health care costs.

But our social spending is very much determined by health care costs. Medicare and Medicaid are a problem precisely for this very reason. Bernard is almost arguing, health care spending isn’t a problem except for health care spending. Well…yeah.

What is particularly annoying is that I’ve pretty much acknowledged this in past posts and comments. We have a medium to long term fiscal problem. That problem can be traced to two sources (for the most part). The first is demographics–the baby boomers are going to start retiring in larger and larger numbers in the next decade or so. By itself this aspect of the problem wouldn’t be that large of a problem, in my view. If we simply had more people retiring than normal we could likely handle it with marginal changes to Medicare, Social Security and Medicaid and possible a few other programs.

However, there is a second cause. Health care costs have been rising at an unsustainable rate. Here is a simple exercise to show the problem. Suppose today you are spending $1 on health care and that you have $2 in income. Further you income grows at 3% per year and health care expenditures grow at 5% per year. How long until you can no longer afford health care? At about the 37 year mark your expenditures on health care is just about equal to your income. In short you’ll have no more money for food, housing, transportation, and entertainment. Clearly that is not sustainable. In reality, something would “give” well before you got to that point.

I also agree that we need to address the problem with the growth rate of health care expenditures. If we act now it might be quite a bit less painful than if we don’t do anything and let nature take its course (so to speak). After all unsustainable trends are not sustained. Eventually the situation will correct itself. Problem is if we wait for that moment it might make our current economic crisis look like a trip to Disneyland.

My overall position is that since health care is a complex and contentious issue, we should “plan for the worst”. We should look at all of the federal budget for places where cuts can be made, taxes can be increased, programs reformed and so forth. As such Social Security should not be “off the table”. By the same token Social Security should not be viewed as the only means by which to solve the health care expenditure problem. Precisely because Social Security is not the cause of that problem. Increasing the tax base, increasing the age for eligibility, indexing the age of eligibility to life expectancy, and adjusting things like COLA adjustments are marginal changes that wouldn’t impact current beneficiaries. Future beneficiaries will be impacted, but quite frankly I think many of them would welcome these changes.

As I noted unsustainable trends are not sustained and if nothing is done regarding health care is it possible that Social Security is gutted to fund Medicare? Maybe. If by making marginal changes to Medicare and Social Security we reduce the fiscal imbalance it might very well be the case we’d help ensure that both programs continue to exist.

And to be clear, the changes I noted for Social Security should be made to Medicare as well. After all, I think it is fair to say that one reason why health care expenditures have increased so much is in part due to Medicare. For example, this NBER Digest points to the research of Amy Finkelstein on the impact of Medicare in regards to health care.

At an annual cost of $260 billion, Medicare is one of the largest health insurance programs in the world. Providing nearly universal health insurance to the elderly as well as many disabled, Medicare accounts for about 17 percent of U.S. health expenditures, one-eighth of the federal budget, and 2 percent of gross domestic production. Medicare’s introduction in 1965 was, and remains to date, the single largest change in health insurance coverage in U.S. history.

Finkelstein estimates that the introduction of Medicare was associated with a 23 percent increase in total hospital expenditures (for all ages) between 1965 and 1970, with even larger effects if her analysis is extended through 1975.

[…]

Finkelstein suggests that the reason for the apparent discrepancy is that market-wide changes in health insurance – such as the introduction of Medicare – may alter the nature and practice of medical care in ways that experiments affecting the health insurance of isolated individuals will not. As a result, the impact on health spending of market-wide changes in health insurance may be disproportionately larger than what the estimates from individuals’ changes in health insurance would suggest. For example, unlike an isolated individual’s change in health insurance, market wide changes in health insurance may increase market demand for health care enough to make it worthwhile for hospitals to incur the fixed cost of adopting a new technology. Consistent with this, Finkelstein presents suggestive evidence that the introduction of Medicare was associated with faster adoption of then-new cardiac technologies.

[…]

Such evidence of the considerable impact of Medicare on the health care sector naturally raises the question of what benefits Medicare produced for health care consumers. Finkelstein and McKnight investigate this question, noting. two potential benefits that public health insurance might provide to the elderly:: better health and risk- reduction.

Things like new and better technologies and better health and risk reduction are all good things, but they obviously have come at a cost. A cost we cannot keep incurring. So reducing the future expenditures of Medicare by simply doing things like changing age of eligibility may have some sort of feedback effect and reduce the growth rate of health care costs providing an ancillary reduction in Medicare costs.

To recap, while personally I think Social Security is a badly designed program I’m not advocating getting rid of it. I’m not advocating gutting it. Any claims to the contrary are simply not an accurate reflection of my position. I am arguing that Social Security should be one area we look to to shore up our fiscal situation for the medium and long term. It shouldn’t be the top priority. The top priority should be growth rate of health care costs.

Note: The graph above is from 2007 and does not reflect the current economic situation, as such it is probably overly optimisitc in terms of revenues.

FILED UNDER: Economics and Business, Government, , , , ,
Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.

Comments

  1. Joe says:

    It’s all such a mess. Social Security and MediCare are both outdated social programs that badly need to be revised in order to be efficient.

  2. Considering the policy initiatives announced in the first month of the Obama Administration, I think keeping Other Federal Non-Interest Spending flat is downright delusional. That doesn’t change the nature of the overall problem, only its magnitude and the difficulty of getting politicians with the intelligence and guts to address it.

  3. Bithead says:

    (sound in background: popcorn popping in microwave)

    But our social spending is very much determined by health care costs.

    Agreed. But I suggest the reverse is true as well; Government’s constent infusion of cash distorts the healthcare market, raising prices.

  4. Raoul says:

    On SSA- you seem to ever so slightly change your position. I agree with two of your suggestions but not on raising the eligibility age. Why? Well-at 67 – the median male will be dead by 72- and one should not advocate another working until they drop. I noticed you support some kind of elderly welfare but not SSA. The fact is that SSA payments are very modest, anything less and you will be tossing millions into poverty (to then help them!?). SSA administrative costs are less than <1%, no private industry can compete with that. It should be noted that 1/3 of SSA outlays go to individuals who are not retired- perhaps one can advocate placing the disabled at the base of unmonitored volcanoes.

    A big issue missed on discussing healthcare- the U.S. is essentially subsidizing the rest of the world on developing and applying medical advances. I do not have an answer but it is something that ought to be considered. We spend billions here for other countries to then use the cures at a pittance of what we pay for.

  5. My response to part of this is here.

    I think we can fix health care, and that we will. And that in doing so, not only will it not take up a larger and larger percentage of GDP, but it will actually decline as a percentage of GDP over time. This is a complex argument, and I will make it in detail on my site as well.

    We currently spend 4% of GDP on Social Security. If we continue to spend 4% of GDP on Social Security into the future, we will not have to cut benefits at all (assuming 2% real GDP growth per year). We will need to rejigger who pays for Social Security and where revenues come from. It is unlikely that the payroll tax as currently structured will be able to sustain these expenditures. Social Security is in actuarial imbalance with regard to present revenue streaks and benefits, but Social Security is not unsustainable otherwise.

    The problem with the notion that we need to cut pretty much everywhere in order to make room for health care costs is that it does not make a difference. Let’s say you managed to cut Social Security by 30% due to means testing, capping of benefits, whatever. Would that make projected health care costs sustainable? No. At the current rate of growth, by something like 2060, we’ll be spending 100% of national income on health care. Every body will work in the health care profession, and all our non-work time will be spent getting treated. The health care sector is a bubble, just like the dotcom sector and the financial sector and housing sector recently. It will burst as well, though how and what will follow is unclear — though I have some ideas.

    Making major policy changes to accomodate — even in a small way — the continued increase in health care costs makes no sense since we are already spending way more than makes any economic sense.

    And now, with that, I look forward to being called “stupid,” “innumerate,” or whatever else passes for reasoned debate nowadays.

  6. Raoul says:

    Finel: Good insight in comparing healthacre expenditures to a bubble, please share how do you think it will blow.

  7. anjin-san says:

    The attempt to link SS with Medicare/Medicaid seems to me to be motivated entirely by politics and ideology.

  8. Triumph says:

    This is a common theme with liberals like Bernard.

    Yeah, boyeee!! Bernie Mac on de attack!!!!

  9. Dave Schuler says:

    Bernard:

    I read your post over at your place and look forward to the next installment. I think that Social Security is fairly easy to resolve using essentially the same tools we’ve used in the past but Medicare/Medicaid is probably intractable without basic changes in the system which are likely to be fought tooth and nail.

    I wonder if your assumptions about what the economy will look like at the end of Obama’s (first) term are different from mine. I think that GDP will have been flat or even declined a little and that debt service will, at the very least, have gone up by 50%.

  10. Dave Schuler says:

    BTW, I read Steve’s comments a little differently. I think the short form is that if you take enough off the table in resolving the structural component of the deficit the problem becomes intractable.

  11. Steve Verdon says:

    Raoul,

    No, I haven’t changed my position if anything all I’ve done is lay it out more carefully and completely.

    And even though I think SSA is badly structured if we were to replace I wouldn’t argue that whatever replaces it provide drastically less benefits.

    As for ther eligibility age you could make is 70 years old and then index it to life expectancy.

    A big issue missed on discussing healthcare- the U.S. is essentially subsidizing the rest of the world on developing and applying medical advances.

    I have touched on this in regards to prescription drugs actually. I don’t have an answer either other than to note that is should be taken into account when making cross country comparisons.

    Bernard,

    We currently spend 4% of GDP on Social Security. If we continue to spend 4% of GDP on Social Security into the future, we will not have to cut benefits at all (assuming 2% real GDP growth per year).

    Yes, but that is a rather optimistic assumption/projection IMO. Most baseline scenarios from most people who look at this conclude that SS will go closer to 6% of GDP. That is a 50% increase. We could probably obtain that 4% by making some changes to the program, but nothing drastic mind you.

    The problem with the notion that we need to cut pretty much everywhere in order to make room for health care costs is that it does not make a difference. Let’s say you managed to cut Social Security by 30% due to means testing, capping of benefits, whatever. Would that make projected health care costs sustainable? No.

    Of course not, I’m not arguig this. Please stop implying I am or I will simply start editing it out of your comments. You have been warned.

    My response is that we need to cut Medicare as well, either via reforms to health care or by implementing measures similar to the ones in reducing Social Security. In fact, this could be part of the strategy to reduce health care costs. Medicare is undoubtedly one reason why health care costs have risen so fast.

    Making major policy changes to accomodate — even in a small way — the continued increase in health care costs makes no sense since we are already spending way more than makes any economic sense.

    In an academic/theoretical sense I agree with you. The real problem is health care spending, so that is what should be fixed. Problem is we don’t live in an academic or theoretical world and as such we have to also factor in the politics of the situtation. The politics may very well make a viable academic/theoretical solution infeasible.

    And one last thing Bernard, if you’d stop assuming bad intentions on my part I’ll stop treating you badly.

    anjin-san,

    The attempt to link SS with Medicare/Medicaid seems to me to be motivated entirely by politics and ideology.

    No it is motivated by the rather grim fiscal outlook. On my side are people like Eugene Steurle, Edward Gramlich, Alice Rivlin, Laurence Kotlikoff, etc. On Bernard’s side are people like Ezra Klein and Kevin Drum. If we go back to a post from a few days agoe we even have a link to this article given to us by Bernard…which indicates that Obama is even on my side.

    WASHINGTON — President-elect Barack Obama said Wednesday that overhauling Social Security and Medicare would be “a central part” of his administration’s efforts to contain federal spending, signaling for the first time that he would wade into the thorny politics of entitlement programs.

    Of course there hasn’t been much on this yet, and given Obama is a politician nothing might come of it.

    Dave,

    BTW, I read Steve’s comments a little differently. I think the short form is that if you take enough off the table in resolving the structural component of the deficit the problem becomes intractable.

    Essentially yes. I’m arguing we shouldn’t take anything off the table at least not until we’ve looked at all the options and how likely they are to succeed. I think the idea that we can contain health care quickly and easily is a pipe dream. Very few developed nations have a sustainable health care sector. This is a global problem and is likely the result of politics. Although I imagine the rhetoric from the Left will be that it is once again market forces.

    And I’ll also add I did ask Bernard what he thought would be a good strategy to contain health care spending, his response was rather a disappointing assertion that we’d contain spending. Not exactly a strategy to give one much hope of success.

  12. Yes, but that is a rather optimistic assumption/projection IMO. Most baseline scenarios from most people who look at this conclude that SS will go closer to 6% of GDP.

    I can’t address this in sufficient detail here, but I promise I will shortly. Short version — if we make a POLICY decision to increase benefits — then yes, we may hit 6%. I know some projections show that… but they do so for all sort of bizarre reasons, some methodological, some statuatory, etc. The only thing we have a pretty good projection on is the number of elderly because the elderly we are talking about are already walking among us. Everything else is a morass of assumptions. And the elderly population is slated to grow by about 2% a year from now until, I believe, something like 2045. (I will post full details shortly.) It varies from year to year of course, but the average increase is 2%. So… if you assume that the economy grows at 2% per year, then then social security should cost about what it does now. What throws it off are all sorts of assumptions about labor productivity, immigration, price deflators, etc. The problem is that all of these assumptions are ultimately free-standing. They are not required to reconcile back into some bottom line.

    If the Social Security eligible population grows at the same rate as the economy grow, the analytic bias should be towards a model that suggests a rough steady-state in Social Security expenditures. There are good ways to create such models — effectively using attractors along projection curves.

    It isn’t that I claim to be smarter than folks at the CBO. I am not. They know the details of this much better than I do. But they are so down in the weeds, tweaking assumptions about issues I can’t even begin to understand, that they are not seeing the big picture.

    I get the confidence for challenging them because, CBO projections are just not that good. Again, I will post more details on this later. But look back at the 2002 CBO economic projections and compare them with reality. In 2002, the projected 2007 GDP at $13.4 billion in nominal terms, it was actually $13.8 billion. GDP was 3% larger than they estimated a mere 5 years after their estimate. The GDP projection was the best of the lot. The less sexy projections — about 10 year T-bills, wages/salaries as percentage of GDP, were worse. And those less sexy projections, because they drive the actuarial models for Social Security can add up to huge mistakes.

    So… and I have gone on longer than I expected… once you realize that these projections are error-prone, what do you do? Most people, without giving it a second thought, assume that any errors will be random clustering around the projection. But that biases thing even more because now you get worst case models that look even worse. I would argue that once you accept that there is a margin of error, you have to move the cone of projections toward whatever data points are actually known… in this case… the elderly population figures. If you do that, you come up with an assessment closer to mine than the middle CBO model.

  13. And I’ll also add I did ask Bernard what he thought would be a good strategy to contain health care spending, his response was rather a disappointing assertion that we’d contain spending. Not exactly a strategy to give one much hope of success.

    Actually, I think I said somewhere that I would have a full-length post on that on my site at the end of my budget series. But I have been quite verbose recently, so it is quite possible it got lost in the shuffle.

  14. DocJim says:

    One of the major “costs” of health care relates to lawyers. If a new patient comes complaining of severe headaches for the past month and a physician does not immediately order a $1,000 MRI of the brain, rather than some other tests and a trial of treatment with another visit in a week or two, a brain tumor is a possibility. IF that patient goes to another physician in a week or two, because the doc’s first attempt didn’t fix the problem and a brain tumor is found now on MRI, then Doc #1 gets a law suit.

    This real life problem is called defensive medicine. As an aging internist, I confess that I have been practicing “defensive medicine” much of the past 40 years.

    Cut down the tort problem and a LOT of health care technology will be reduced in use.

    We also are providing health care to anyone who comes across the border and that is mushrooming in costs to hospitals with losses to the doctors.

    If these two problems are factored out, the GROWTH in costs will slow noticeably.

    The administration’s plan to have a “board of experts” decide what procedures will be paid will turn out to be an anti-scientific medical disaster for the 30-40 % of people who fall outside the median. The experts will aim for the median. In this kind of program, a patient who fails to be average will die from his or her illness.

  15. Steve Verdon says:

    Bernard,

    I find it hard to believe that an expert on international security can see a major flaw in the work of not just the CBO and their economists, but just about every other economist out there such as William Gale, Laurence Kotlikoff, Jagdeesh Gokhale, all the other economists I’ve mentioned prior to this and many more.

    [Note: there is, generally speaking, broad agreement that we face serious fiscal issues in the medium to long term with Medicare and then Social Security being factors. This agreement spans the political spectrum as well (the differences are in how to address the problem). Bernard kind of reminds me of a Global Warming skeptic or a Creationist.]

    And your claim that these projections the other assumptions are so error prone that only you have seen that together they constitute an unreasonable set of projections? Really?

    I get the confidence for challenging them because, CBO projections are just not that good. Again, I will post more details on this later. But look back at the 2002 CBO economic projections and compare them with reality. In 2002, the projected 2007 GDP at $13.4 billion in nominal terms, it was actually $13.8 billion. GDP was 3% larger than they estimated a mere 5 years after their estimate.

    Yes, however, there are ranges of projections. They don’t look at just one set of assumption or one set of projections. What you are arguing is that, not only are their projections wrong they are all pessimistic, so basically we need do nothing and there we go, all problems solved because the projections were overly pessimistic.

    Funny, just a week ago you were the one saying I was “behind the curve” and implying I’m too optimistic and now we’ve reversed. You are the one arguing for the optimistic view and that we should ignore not only the pessimistic view but everything other than the pessimistic.

  16. Steve:

    With all due respect… I don’t think you fully understand how the CBO does projections. In an effort to isolate them from political pressure, they adopt all sorts of restrictive requirements on how they make projections. In fact, on Social Security, there are plenty of people closer to my view than the CBO view… and I will document fully in my full post on the topic.

    But look… can we use common sense here? The CBO projection for Medicare and Medicaid is that it will eat up something like 16% of GDP. Right now, Medicare and Medicaid represent 1/3 of U.S. health care spending — the rest is private sector. Keep the ratios the same. Do you really think it is even possible for nearly 50% of GDP to be devoted to health care. Even if we do nothing about it… how is that possible? Yet, that is what the CBO projects will happen.

    Look, I can see I’m wasting my time with you. I’ll continue writing on these issues elsewhere where hopefully some open-minded people will want to discuss the issues with me.

    Respectfully,

    –Bernard

  17. Anderson says:

    In other news, if a bacterium divides every 15 minutes, its descendants’ mass will equal that of the entire earth … if we believe the projected rate will continue indefinitely.

    Makes about as much sense as that upward slope on the CBO graphs.

  18. Drew says:

    If anyone believes we have the political will to cut benefits and costs of health care expenditures I simply request they first examine the spending trajectory of the last 40 years and the explain the moment of clarity; and I paraphrase Sean Connery from Red October (wrt to Obama’s budget): “Gentlemen, I present to you, the Red Budget.)

  19. Drew says:

    “Look, I can see I’m wasting my time with you. I’ll continue writing on these issues elsewhere where hopefully some open-minded people will want to discuss the issues with me.”

    Fascinating. Exasperation. I’m doing the Texas three step right now…….looking at businesses for investment in San Antonio, Austin and Dallas, but I’d like to (and will) read first hand your post, Bernard. But if Steve had it right, that you sighted total government expenditures as a percent of GDP, but did not acknowledge the rotation from defense to social spending and the obvious implications….everything you and I have debated the last week…..well, talk about exasperation.

    I have to reserve judgement on “open minded” until I read your analysis first hand. But Verdon is not prone to misquoting. I’m not optimistic.

  20. odograph says:

    I think we should design a “basic healthcare” coverage, package it as a voucher, and give it to every American. It should probably map to basic HMO coverage. Let people then take their vouchers to a private market. It is single payer, multiple provider.

    Start if off by giving vouchers to vets, and scraping the VA system.

    I’m tellin’ ya, you’ll have more “market” in your solution that way than the mess we’ll have in 10 years.

    (And Steve, that is the opportunity with the confusion of change to reign costs/coverage back.)

  21. odograph says:

    BTW, before someone says we have free market now, remember that my Kaiser fees pay for the mandated free medical care Kaiser must give poor people off the street. We have socialized medicine. It is just the worst of both worlds – complex, costly, and still ineffective.

  22. Steve Verdon says:

    I think we should design a “basic healthcare” coverage, package it as a voucher, and give it to every American.

    Oddly enough Odograph, I’ve argued for something similar using catastrophic health care and a voucher system.

    This notion Benard peddles that I’m a conservative just wanting to destroy the social safety net just isn’t accurate, to be charitable to Bernard.

  23. Steve Verdon says:

    And one last parting shot at Bernard.

    Bernard I seriously doubt you know how to read. I noted in the opening post that it would be unlikely we’d get to a point where we end up way down the CBO projections.

    However, there is a second cause. Health care costs have been rising at an unsustainable rate. Here is a simple exercise to show the problem. Suppose today you are spending $1 on health care and that you have $2 in income. Further you income grows at 3% per year and health care expenditures grow at 5% per year. How long until you can no longer afford health care? At about the 37 year mark your expenditures on health care is just about equal to your income. In short you’ll have no more money for food, housing, transportation, and entertainment. Clearly that is not sustainable. In reality, something would “give” well before you got to that point.

    Prehaps a course in remdial reading, or maybe some work on improving your memory.

    Most cordially,
    –Steve

  24. odograph says:

    In that case Steve, you are absolutely right!