How to measure health care cost control

How to measure health care cost control

I want to propose a four-part test for measuring any particular bill on health care cost control.

short run

long run

Federal deficit

1

2

Government health care spending

X

3

Private health care spending

X

4

In each case, I will define the test so that “yes” is a good outcome:

Test 1: The bill does not increase the federal deficit in the short run.

Test 2: The bill significantly reduces the federal deficit in the long run.

Test 3: The bill significantly slows the growth of government health care spending in the long run.

Test 4: The bill significantly slows the growth of private health care spending in the long run.

I believe our Nation’s long-term fiscal problems, and the problems resulting from the growth of per capita health care spending, are higher priorities to solve than reducing the number of uninsured Americans now. I would rather solve America’s health care cost problems of the future than expand government now. This is my value choice. I expect and accept that others will disagree.

As a result of this value choice, I believe any bill that fails any one of these four tests is fiscally and economically irresponsible, and therefore worth defeating.

There does not have to be a tradeoff. A bill could go after the core policy drivers of health care cost growth, especially the tax exclusion for employer-provided health insurance, and replace it with incentives for individuals to shop for high-value health insurance and high-value health care. Such a bill could meet all of the above tests and significantly reduce the number of uninsured. I will describe such a bill in a future post. Such a bill is not going to be passed by this Congress.

I think the administration would agree with my test. They might define Test 3 to be a subset of Test 2. I think it’s important analytically to separate the two.

In practice the test gets slightly more complex. Test 1, “The bill does not increase the federal deficit in the short run,” breaks down into (1A) “over the next five years” and (1B) “over the next ten years.” The Congressional budget rules require that a bill not increase the federal deficit over the next five years. To his credit, the President and his advisors have also been emphasizing that it is important to meet the same test over the next ten years. From a formal legislative process standpoint, only the five-year window is formally binding, because Congress passed a 5-year budget plan (called a budget resolution). In particular, proponents of a bill will need 60 votes in the Senate for any bill that fails (1A). All other tests can be violated and passed with a simple majority.

I will apply this four-part test framework to each major legislative proposal considered by Congress. I want to begin today by walking briefly through each test.

Test 1: The bill does not increase the federal deficit in the short run.

I would like to make this test more stringent – my personal policy preference would be “The bill reduces the federal deficit in the short run,” especially given the path of expected budget deficits under the President’s budget. The actual test, “does not increase,” is the test in the Congressional budget resolution. It says that at a minimum, any new spending should be offset.

I would also like to make the test apply to federal spending, rather than just the federal budget deficit. I would almost certainly oppose a bill that increases government spending over the next ten years by a few hundred billion dollars, and offsets it with the same amount of tax increases. Again, I’m matching my test to the minimally binding one that Congress will apply to itself. This means that this test for me is one-way: any bill that fails it should be opposed, and some bills that pass it should still be opposed, because they dramatically increase the size of government. Still, for the purpose of this exercise I am applying the looser deficit-based short-term test.

By choosing a looser short-term test than I would prefer, I believe I accomplish two goals:

  1. This test conforms with the formal budget rules that will govern this bill (measured over a five year period).
  2. This test fits the “Blue Dog” / conservative Democrat / moderate Republican view of the world. I think I’m taking away an excuse for them to object to my four-part test.

Test 2: The bill reduces the federal deficit in the long run.

For each of these tests, I’m defining “long run” as more than ten years. That’s an arbitrary breakpoint.

While I’m willing to say I could swallow some bills that do not increase the short-term budget deficit, a bill must significantly reduce the long-run federal deficit to be fiscally responsible. Given that our long-term federal deficit path is unsustainable to the point of national economic collapse, and given that health care cost growth is one of the primary drivers of that deficit path, not making the problem worse is insufficient. A bill must result in dramatic reductions in future budget deficits to be fiscally responsible.

This test interacts with Test 3 in a somewhat subtle way. While Test 1 is a deficit test, the facts of our long-term budget problem mean that Test 2 is driven by Test 3, which is about government spending on health care.

Test 3: The bill significantly slows the growth of government health care spending in the long run.

Test 2 is about the long-term budget deficit. Test 3 is about long-term government spending on health care. The President and his budget director are correct when they identify unsustainable per capita health care spending as a primary driver of long-term deficits. (They are incorrect when they identify it as the primary driver of long-term deficits, and dismiss the importance of Social Security spending and aging of the population, as the President did yesterday. I will return to this point in a future post.)

In mid-April I explained that America’s long-term budget problems are driven by unsustainable spending growth, and not by the level of taxation. I think it’s one of my most important posts. I hope you will find time to read it if you have not done so already. Here is the key graph:

taxes and spending long term trends

On the above graph, the white line is federal spending, and the dotted lines are various tax policies. The expanding gap between the white line and the dotted lines is the federal budget deficit. You can see the gap (deficit) explodes as the spending line pulls away from the tax lines.

America’s long-term budget problems are driven entirely by the difference between the slope of the white spending line and the dotted tax lines. Over the long run, a constant tax policy always grows as fast as the economy, and so it remains flat on a graph that measures quantities as a share of the economy. So while we can and do debate about the level of the dotted tax lines, they’re always going to be flat.

You can see that any flat tax line cannot keep up with a rapidly growing upwardly sloped white spending line. Even if you were to rais the flat dotted line to 25% of GDP, you would still have a long-term deficit problem because of the slope of the spending line. The key to success is not just lowering federal spending, it’s tilting that white line dramatically downward. This is what the President and his budget director correctly mean when they say we need to bend the (government) cost curve downward. And they deserve praise for identifying federal health care spending as a major driver of that white line’s slope.

It is therefore odd and self-contradictory that they have proposed raising taxes to offset the higher spending of a new health care entitlement for the uninsured. While you can technically meet my short-term Test 1 by doing so (in a Blue Dog / centrist way that I would oppose, but you’d meet it), it is mathematically impossible in the long run to offset a new health care entitlement with higher taxes, unless your bill also slows the growth of health care spending in other ways.

To put it graphically:

  • The new health care entitlement for those who are now uninsured would raise the level of the long-term white federal spending line.
  • Even if you increase taxes, raising the dotted federal tax lines so that the deficit gap between spending and taxes over the next five or ten years does not increase (thus meeting my Test 1), in the long run the new health care spending will grow faster than the economy, while the new tax revenue stream will grow at the same rate as the economy. You will therefore be exacerbating the long-term deficit problem caused by the white spending line above.
  • The only way to solve this is if you make other changes in the bill that bend downward the slope of the white line.

This last bullet is the President’s stated solution. In effect, he is saying, I’m OK raising long-term federal spending on a new health care entitlement, and thus raising the level of the white line in the long run, as long as we raise the dotted tax lines to offset it in the short-run, and as long as we make other changes to tilt that white line downward (or at least not upward so much.)

The President and his allies have a problem, in that their specific policy of expanding pre-paid health insurance to tens of millions of uninsured Americans will instead increase the slope of the white spending line. The academic evidence is clear that as third-party payment for health care increases, sensitivity to cost decreases and health care spending (total and governmental) increases. Creating a new entitlement for the uninsured helps the uninsured. But it worsens our long-term budget problem in two ways: it raises the level of the long-term spending line, and it increases its slope. Both exacerbate an already-devastating long-term federal budget picture.

So for the President to meet his stated goal, and to make any significant progress on our long-term budgetary problems, the rest of the bill must not only bend the spending line downward, it must do so by more than these two factors that raise the white line by creating a new health care entitlement. I think it’s a mistake to make your most serious problem worse before trying to solve it.

Test 4: The bill significantly slows the growth of private health care spending in the long run.

This is closely related to but separate from Test 3. I praise the President for correctly identifying society-wide health care cost growth as the problem to be solved, rather than just government health care cost growth or the number of uninsured. Private sector health care cost growth is what keeps the number of uninsured high, and it is what squeezes the wages and budgets of more than 200 million Americans with private health insurance. We must make policy changes that stop distorting behavior to encourage unsustainable cost growth in private sector health care.

As I said above, the expansion of third-party payment for the uninsured exacerbates this problem, as would any policy changes that might discourage people from moving to high-deductible plans, or discourage people from shopping for health insurance or medical care based on quality and price.

The President correctly identifies this problem. He admirably says it is a condition that must be met by health care legislation. Unfortunately, he has made no specific policy proposals that would achieve this goal. The President and his budget director emphasize policies that would provide private sector consumers with better information about the health care they use. They have proposed policies that would change government spending policies. They have proposed no policies that would change incentives for private consumers of health care. (I wrote about this in April.) Without such policies, you cannot meet Test 3 or Test 4. And without such policies, expanding government entitlement spending is horribly irresponsible in the long run.

Understanding the House Democrats' health care bill

Understanding the House Democrats' health care bill

Yesterday I posted and described the draft Kennedy-Dodd health care bill. Today I would like to do the same for an outline produced by House Democrats.

Here is a three-page outline of “Key Features of the Tri-Committee Health Reform Draft Proposal in the House of Representatives,” dated yesterday (June 8, 2009).

The three committees are:

  • The House Ways & Means Committee, chaired by Rep. Charlie Rangel (D-NY). The Health Subcommittee is chaired by Rep. Pete Stark (D-CA).
  • The House Energy & Commerce Committee, chaired by Rep. Henry Waxman (D-CA). The Health Subcommittee is chaired by Rep. Frank Pallone, Jr. (D-NJ).
  • The House Committee on Education & Labor, chaired by Rep. George Miller (D-CA). The Health, Employment, Labor and Pensions Subcommittee is chaired by Rep. Robert Andrews (D-NJ).

The document suggests this is a joint product of the three committees and/or their subcommittees. My sense, however, is that it is Speaker Pelosi who is driving the bus. This is in contrast to the Senate, where the committee chairmen (Kennedy/Dodd and Baucus) appear to have the pen, in less well-coordinated efforts.

Kennedy-Dodd and the House bill outline are remarkably similar. Whether this represents House-Senate coordination or parallel thought processes is unclear.

I think the easiest way for me to present the House bill outline is in comparison with the Kennedy-Dodd bill. So here my description from yesterday of the Kennedy-Dodd bill, with today’s comparison to the House bill outline in red. I hope it’s comprehensible and useful this way. If you read yesterday’s post, you can skim the text in black and focus on the new text in blue.

Here are 15 things to know about the draft Kennedy-Dodd health bill and the House bill outline.

  1. The Kennedy-Dodd bill would create an individual mandate requiring you to buy a :qualified” health insurance plan, as defined by the government. If you don’t have “qualified” health insurance for a given month, you will pay a new Federal tax. Incredibly, the amount and structure of this new tax is left to the discretion of the Secretaries of Treasury and Health and Human Services (HHS), whose only guidance is “to establish the minimum practicable amount that can accomplish the goal of enhancing participation in qualifying coverage (as so defined).” The new Medical Advisory Council (see #3D) could exempt classes of people from this new tax. To avoid this tax, you would have to report your health insurance information for each month of the prior year to the Secretary of HHS, along with “any such other information as the Secretary may prescribe.” The House bill also contains an individual mandate. The outline is less specific but parallel: Once market reforms and affordability credits are in effect to ensure access and affordability, individuals are responsible for having health insurance with an exception in cases of hardship.
  2. The Kennedy-Dodd bill would also create an employer mandate. Employers would have to offer insurance to their employees. Employers would have to pay at least a certain percentage (TBD) of the premium, and at least a certain dollar amount (TBD). Any employer that did not would pay a new tax. Again, the amount and structure of the tax is left to the discretion of the Secretaries of Treasury and HHS. Small employers (TBD) would be exempt.The House bill outline also contains an employer mandate that appears to parallel that in Kennedy-Dodd: “Employers choose between providing coverage for their workers or contributing funds on behalf of their uncovered workers.”
  3. In the Kennedy-Dodd bill, the government would define a qualified plan:
    1. All health insurance would be required to have guaranteed issue and renewal, modified community rating, no exclusions for pre-existing conditions, no lifetime or annual limits on benefits, and family policies would have to cover “children” up to age 26.The House bill outline is consistent with but less specific than the Kennedy-Dodd legislative language. The House bill outline would “prohibit insurers from excluding pre-existing conditions or engaging in other discriminatory practices.” I will keep my eye on what “other discriminatory practices” means in the legislative language. Does that mean that a health plan cannot charge higher premiums to smokers? Like the Kennedy/Dodd bill, the House bill outline would preclude health plans from imposing lifetime or annual limits on benefits: “Caps total out-of-pocket spending in all new policies to prevent bankruptcies from medical expenses.” This would raise premiums for new policies. The House bill outline “introduces administrative simplification and standardization to reduce administrative costs across all plans and providers.” I don’t know what this means, but suggest keeping an eye on it.
    2. A qualified plan would have to meet one of three levels of standardized cost-sharing defined by the government, “gold, silver, and bronze.” Details TBD. Same: “… by creating various levels of standardized benefits and cost-sharing arrangements…” It also contains this addition relative to Kennedy-Dodd: “… with additional benefits available in higher-cost plans.” But note the “various levels of standardized benefits.” This appears to be more expansive government control of health plan design than in the Kennedy-Dodd draft.
    3. Plans would be required to cover a list of preventive services approved by the Federal government.This is unspecified in the House bill outline. We’ll have to wait to see legislative language.” The House bill would require plans to “waive cost-sharing for preventive services in benefit packages.”
    4. A qualified plan would have to cover “essential health benefits,” as defined by a new Medical Advisory Council (MAC), appointed by the Secretary of Health and Human Services. The MAC would determine what items and services are “essential benefits.” The MAC would have to include items and services in at least the following categories: ambulatory patient services, emergency services, hospitalization, maternity and new born care, medical and surgical, mental health, prescription drugs, rehab and lab services, preventive/wellness services, pediatric services, and anything else the MAC thought appropriate.This appears parallel but is less specific for now: “Independent public/private advisory committee recommends benefit packages based on standards set in statute.” I find the “standards set in statute” interesting. It suggests that provider and disease interest groups will have two fora in which to lobby for their benefits to be mandated: Congress, and the advisory committee.
    5. The MAC would also define what “affordable and available coverage” is for different income levels, affecting who has to pay the tax if they don’t buy health insurance. The MAC’s rules would go into effect unless Congress passed a joint resolution (under a fast-track process) to turn them off.The House bill outline is silent on this.
  4. Health insurance plans could not charge higher premiums for risky behaviors: “Such rate shall not vary by health status-related factors, … or any other factor not described in paragraph (1).” Smokers, drinkers, drug users, and those in terrible physical shape would all have their premiums subsidized by the healthy. The House bill outline says it would “prohibit plans [from] rating (charging higher premiums) based on gender, health status, or occupation and strictly limits premium variation based on age.” If the bill were to provide nothing more, this would appear to parallel the Senate bill and preclude plans from charging higher premiums for risky behaviors.
  5. Guaranteed issue and renewal combined with modified community rating would dramatically increase premiums for the overwhelming majority of those Americans who now have private health insurance. New Jersey is the best example of health insurance mandates gone wild. In the name of protecting their citizens, premiums are extremely high to cover the cross-subsidization of those who are uninsurable.The House bill outline is silent on guaranteed issue and renewal. I’m going to make an educated guess that the bill includes these provisions as part of “other discriminatory practices,” and they have just left them out of the outline. Given the philosophy behind this outline (with which I disagree), it would be a striking omission. But for now, the outline says nothing specific on these topics.
  6. The bill would expand Medicaid to cover everyone up to 150% of poverty, with the Federal government paying all incremental costs (no State share). This means adding childless adults with income below 150% of the poverty line.The House bill outline “expands Medicaid for the most vulnerable, low-income populations,” so we have no specifics other than that there’s an expansion.” I cannot tell if this is expanding eligibility or benefits. The outline also “improves payment rates to enhance access to primary care under Medicaid.” I assume this means the bill would expand the Federal share paid of each dollar spent by a State Medicaid program on primary care, rather than the Federal government actually mandating specific payment rates to be implemented by States. Federal micromanagement of specific Medicaid provider payment rates was eliminated in the mid 1990s.
  7. People from 150% of poverty up to 500% (!!) would get their health insurance subsidized (on a sliding scale). If this were in effect in 2009, a family of four with income of $110,000 would get a small subsidy. The bill does not indicate the source of funds to finance these subsidies.The House bill outline has a sliding scale up to 400% of poverty. If this were in effect in 2009, a family of four with income of $88,000 would get small subsidy.
  8. People in high cost areas (e.g., New York City, Boston, South Florida, Chicago, Los Angeles) would get much bigger subsidies than those in low cost areas (e.g., much of the rest of the country, especially in rural areas). The subsidies are calculated as a percentage of the “reference premium,” which is determined based on the cost of plans sold in that particular geographic area.The House bill outline is not specific on this point. I would not expect it to be – this is something you can tell only from legislative language.
  9. There would be a “public plan option” of health insurance offered by the federal government. In this new government health plan, the federal government would pay health care providers Medicare rates + 10%. The +10% is clearly intended to attract short-term legislative support from medical providers. I hope they are not so naive that they think that differential would last.The House bill outline “creates a new public health insurance within the Exchange … the public health insurance option competes on ‘level field’ with private insurers in the Exchange.” There are no specifics on how the public plan would work, or on provider payment rates.
  10. Group health plans with 250 or fewer members would be prohibited from self-insuring.” ERISA would only be for big businesses.The House bill outline is silent on this point.
  11. States would have to set up “gateways” (health insurance exchanges) to market only qualified health insurance plans. If they don’t, the Feds will set up a gateway for them.The House calls it an Exchange rather than a Gateway. While the Senate bill would tell each State, “Create a Gateway or we’ll create one for you,” the House bill outline says to each State, “We’re creating a single new national Exchange. You’re in it unless you develop your own State or Regional Exchange.”
  12. Health insurance plans in existence before the law would not have to meet the new insurance standards. This creates a weird bifurcated system and means you would (probably) be subject to a different set of rules when you change jobs.The House bill outline appears to parallel the Kennedy-Dodd draft: “Phases-in requirements to benefit and quality standards for employer plans.” This means that new plans will be more expensive than old plans. It also means they’re creating a bifurcated system with all sorts of perverse unintended consequences for employment flexibility.
  13. The bill does not specify what spending will be cut or what taxes will be raised to pay for the increased spending. That is presumably for the Finance Committee to determine, since it’s their jurisdiction. The House bill outline lists specific topics for changes to Medicare reimbursement:
    • Changing (how?) the Medicare reimbursement for doctors, called the “Sustainable Growth Rate” (SGR).
    • “Increasing reimbursement for primary care providers”
    • “Improving” the Medicare drug program. I won’t be surprised if, when I see the specifics, I disagree that their changes are “improvements.” In the past this has meant having the federal government mandate specific prices for drugs.
    • Cutting payments to Medicare Advantage plans.
    • Expanding low-income subsidies for seniors and eliminating cost-sharing for all preventive services in Medicare.

    The House bill outline also uses positive language to describe things that might generate budgetary savings from Medicare and/or Medicaid. The hospital readmissions point is specific. The first two points could increase or decrease federal spending, depending on the specifics.

    • “Use federal health programs … to reward high quality, efficient care, and reduce disparities.”
    • “Adopt innovative payment approaches and promote[s] better coordinated care in Medicare and the new public option through programs such as accountable care organizations.”
    • “Attack the high rate of cost growth to generate savings for reform and fiscal sustainability, including a program in Medicare to reduce preventable hospital readmissions.”
  14. The bill defines an “eligible individual” as “a citizen or national of the United States or an alien lawfully admitted to the United States for permanent residence or an alien lawfully present in the United States.” The House bill outline is silent on this point.
  15. The bill would create a new pot of money for state gateways to pay “navigators” to educate people about the new bill, distribute information about health plans, and help people enroll. Navigators receiving federal funds “may include … unions, …” The House bill outline is silent on this point.

This would have severe effects on the more than 100 million Americans who have private health insurance today:

  • The government would mandate not only that you must buy health insurance, but what health insurance counts as “qualifying.”
  • Health insurance premiums would rise as a result of the law, meaning lower wages.
  • A government-appointed board would determine what items and services are “essential benefits” that your qualifying plan must cover.
  • You would find a tremendous new disincentive to switch jobs, because your new health insurance may be subject to the new rules and would therefore be significantly more expensive.
  • Those who keep themselves healthy would be subsidizing premiums for those with risky or unhealthy behaviors.
  • Far more than half of all Americans would be eligible for subsidies, but we have not yet been told who would pay the bill.
  • The Secretaries of Treasury and HHS would have unlimited discretion to impose new taxes on individuals and employers who do not comply with the new mandates. (The House bill outline is not specific on this point.)
  • The Secretary of HHS could mandate that you provide him or her with “any such other information as [he/she] may prescribe.” (The House bill outline is not specific on this point.)

I strongly oppose the Kennedy-Dodd bill and the House Tri-Committee bill.

If this topic interests you, I highly recommend Jim Capretta’s blog Diagnosis.

(photo credit: speaker.house.gov)

Understanding the Kennedy health care bill

Understanding the Kennedy health care bill

Over the weekend a draft of Senator Kennedy’s (D-MA) health care bill leaked. After playing with Adobe Acrobat, here is the text of the draft Kennedy bill as a text file (173 K), and as a single Acrobat file (3.4 MB). Update: I fixed the broken link to the PDF. Unlike the leaked version, both of these are searchable.

Calling it the “Kennedy” bill is something of an overstatement. Senator Kennedy chairs the Senate Health, Education, Labor, and Pensions committee, and his staff wrote the draft. By all reports, however, Chairman Kennedy’s health is preventing him from being heavily involved in the drafting. Senator Reid has designated Senator Chris Dodd (D-CT) to supervise the process, but as best I can tell, it’s really the Kennedy committee staff who are making most of the key decisions. For now I will call it the Kennedy-Dodd bill.

As the committee staff emphasized to the press after the leak, this is an interim draft. I assume things will move around over the next several weeks as discussions among Senators and their staffs continue. This is therefore far from a final product, but it provides a useful insight into current thinking among some key Senate Democrats.

Update: I now have a three-page outline of the House Democrats’ health care bill. I have a new post which contains all of the content below, and compares it to the House bill. If you read the new post, you’ll get two for the price of one: Understanding the House Democrats’ [and Kennedy-Dodd] health care bill[s].

Here are 15 things to know about the draft Kennedy-Dodd health bill.

    1. The Kennedy-Dodd bill would create an individual mandate requiring you to buy a “qualified” health insurance plan, as defined by the government. If you don’t have “qualified” health insurance for a given month, you will pay a new Federal tax. Incredibly, the amount and structure of this new tax is left to the discretion of the Secretaries of Treasury and Health and Human Services (HHS), whose only guidance is “to establish the minimum practicable amount that can accomplish the goal of enhancing participation in qualifying coverage (as so defined).” The new Medical Advisory Council (see #3D) could exempt classes of people from this new tax. To avoid this tax, you would have to report your health insurance information for each month of the prior year to the Secretary of HHS, along with any such other information as the Secretary may prescribe.”
    1. The bill would also create an employer mandate. Employers would have to offer insurance to their employees. Employers would have to pay at least a certain percentage (TBD) of the premium, and at least a certain dollar amount (TBD). Any employer that did not would pay a new tax. Again, the amount and structure of the tax is left to the discretion of the Secretaries of Treasury and HHS. Small employers (TBD) would be exempt.
    1. In the Kennedy-Dodd bill, the government would define a qualified plan:
        1. All health insurance would be required to have guaranteed issue and renewal, modified community rating, no exclusions for pre-existing conditions, no lifetime or annual limits on benefits, and family policies would have to cover children up to age 26.
        1. A qualified plan would have to meet one of three levels of standardized cost-sharing defined by the government, gold, silver, and bronze. Details TBD.
        1. Plans would be required to cover a list of preventive services approved by the Federal government.
        1. A qualified plan would have to cover “essential health benefits,” as defined by a new Medical Advisory Council (MAC), appointed by the Secretary of Health and Human Services. The MAC would determine what items and services are “essential benefits.” The MAC would have to include items and services in at least the following categories: ambulatory patient services, emergency services, hospitalization, maternity and new born care, medical and surgical, mental health, prescription drugs, rehab and lab services, preventive/wellness services, pediatric services, and anything else the MAC thought appropriate.
        1. The MAC would also define what “affordable and available coverage” is for different income levels, affecting who has to pay the tax if they don’t buy health insurance. The MAC’s rules would go into effect unless Congress passed a joint resolution (under a fast-track process) to turn them off.
    2. Health insurance plans could not charge higher premiums for risky behaviors: “Such rate shall not vary by health status-related factors, … or any other factor not described in paragraph (1).” Smokers, drinkers, drug users, and those in terrible physical shape would all have their premiums subsidized by the healthy.
    1. Guaranteed issue and renewal combined with modified community rating would dramatically increase premiums for the overwhelming majority of those Americans who now have private health insurance. New Jersey is the best example of health insurance mandates gone wild. In the name of protecting their citizens, premiums are extremely high to cover the cross-subsidization of those who are uninsurable.
    1. The bill would expand Medicaid to cover everyone up to 150% of poverty, with the Federal government paying all incremental costs (no State share). This means adding childless adults with income below 150% of the poverty line.
    1. People from 150% of poverty up to 500% (!!) would get their health insurance subsidized (on a sliding scale). If this were in effect in 2009, a family of four with income of $110,000 would get a small subsidy. The bill does not indicate the source of funds to finance these subsidies.
    1. People in high cost areas (e.g., New York City, Boston, South Florida, Chicago, Los Angeles) would get much bigger subsidies than those in low cost areas (e.g., much of the rest of the country, especially in rural areas). The subsidies are calculated as a percentage of the “reference premium,” which is determined based on the cost of plans sold in that particular geographic area
    1. There would be a “public plan option” of health insurance offered by the federal government. In this new government health plan, the federal government would pay health care providers Medicare rates + 10%. The +10% is clearly intended to attract short-term legislative support from medical providers. I hope they are not so naive that they think that differential would last.
    1. Group health plans with 250 or fewer members would be prohibited from self-insuring. ERISA would only be for big businesses.
    1. States would have to set up “gateways” (health insurance exchanges) to market only qualified health insurance plans. If they don’t, the Feds will set up a gateway for them.
    1. Health insurance plans in existence before the law would not have to meet the new insurance standards. This creates a weird bifurcated system and means you would (probably) be subject to a different set of rules when you change jobs.
    1. The bill does not specify what spending will be cut or what taxes will be raised to pay for the increased spending. That is presumably for the Finance Committee to determine, since it’s their jurisdiction.
    1. The bill defines an “eligible individual” as “a citizen or national of the United States or an alien lawfully admitted to the United States for permanent residence or an alien lawfully present in the United States.”
  1. The bill would create a new pot of money for state gateways to pay “navigators” to educate people about the new bill, distribute information about health plans, and help people enroll. Navigators receiving federal funds “may include … unions, …”

This would have severe effects on the more than 100 million Americans who have private health insurance today:

    • The government would mandate not only that you must buy health insurance, but what health insurance counts as “qualifying.”
    • Health insurance premiums would rise as a result of the law, meaning lower wages.
    • A government-appointed board would determine what items and services are “essential benefits” that your qualifying plan must cover.
    • You would find a tremendous new disincentive to switch jobs, because your new health insurance may be subject to the new rules and would therefore be significantly more expensive.
    • Those who keep themselves healthy would be subsidizing premiums for those with risky or unhealthy behaviors.
    • Far more than half of all Americans would be eligible for subsidies, but we have not yet been told who would pay the bill.
    • The Secretaries of Treasury and HHS would have unlimited discretion to impose new taxes on individuals and employers who do not comply with the new mandates.
  • The Secretary of HHS could mandate that you provide him or her with “any such other information as [he/she] may prescribe.”

I strongly oppose this bill.

Update: If this topic interests you, I highly recommend Jim Capretta’s blog Diagnosis.

(photo credit: kennedy.senate.gov)

Will the stimulus come too late?

I began this blog at the end of March after the stimulus bill had become law. I had been struck by how much the stimulus debate had focused on whether the bill was efficient. (It clearly was not.) There was much less discussion of whether the stimulus would be effective, and of the timing of the macroeconomic boost.

Everyone wants to know when the U.S. economy will start growing. I will focus on a related question: when will the stimulus law begin to have a significant positive effect on U.S. economic growth? And could it have come sooner if the Administration had done something different?

I believe the Administration made an enormous mistake in its legislative implementation of the stimulus. As a result, the boost to GDP will come six to nine months later than it needed to (maybe more). Given the President’s desire to do a large fiscal stimulus, and given his policy preferences, he could have had a different bill that would have been producing significant GDP growth beginning now, rather than in the middle of next year. That’s a huge mistake with real consequences for the U.S. and global economies.

To illustrate this point, let me classify four types of fiscal stimulus:

  1. a permanent tax cut;
  2. a temporary tax cut;
  3. one-time checks to people independent of their tax liabilities; and
  4. increased government spending through federal and state bureaucracies: infrastructure, energy spending, etc.

There is of course a fifth option: no fiscal stimulus law.

If you’re going to do a fiscal stimulus (big if), the best kind is a permanent tax cut. It is effective, efficient, and fast:

  • effective – People spend a large proportion of a permanent tax cut. This is derived from Milton Friedman’s “permanent income hypothesis.”
  • efficient – People spend their own money on themselves, so they waste very little of it, and they spend it on things that matter to them. Again, see Milton Friedman.
  • fast – Checks are delivered quickly, and people spend most of their own money soon after they get the check.

This was part of the short-term logic behind the 2003 tax cut, which we designed to foster both short-term and long-term economic growth. I also have a strong general policy preference for lower taxes rather than more government spending, but that’s a separable question from how it works as short-term stimulus.

In 2008 we knew we could not get a Democratic Congress to enact a permanent tax cut. Q: Do you then go for a temporary tax cut, or do nothing? The President thought the risks of an economic slowdown in 2008 were significant enough that it made sense to pursue a (second best) temporary tax cut with the Congress.

Like the 2003 law, the 2008 law got the bulk of its short-term GDP boost by advancing tax refunds from the year to come, and delivering them as checks from the IRS to taxpayers. As in 2003, the checks were delivered to taxpayers in the summer (mid-June to early-August), and consumers immediately started spending a portion of their rebates.

Because the 2008 law was a temporary tax cut, taxpayers spent a smaller proportion of it than anyone would have liked. While designing the law, we assumed about 1/3 would be spent, and much of that fairly quickly. The rest would be saved, which is also good but doesn’t help short-term GDP growth. Economists agree that GDP in Q3 and Q4 of 2008 was higher than it otherwise would have been because of the 2008 stimulus law. It was efficient, fast, yet only partially effective, with a smaller GDP boost than we would have liked:

  • efficient – People were again spending their own money on themselves. You get very little waste, and people know what they want and need.
  • fast – Checks were delivered quickly, and much of the spending that did occur happened in Q3, with some in Q4, and with very little left by Q1 of 2009.
  • only partially effective – Because it was a temporary tax cut, people saved a lot of their checks, as we expected. Still we got a GDP bump in Q3 and Q4, and in retrospect we certainly needed it.

The 2008 law was mostly (2) from my list above – a temporary tax cut. Some of the money went to (3), checks to people who didn’t pay income taxes. This was necessary to reach a compromise with a Democratic Congressional leadership that placed a high priority on the distributional effects of the law. Speaker Pelosi insisted that poor people who owed no income taxes still get “rebate” checks, and that high-income taxpayers get nothing. So the 2008 stimulus law was mostly (2) with a little bit of (3).

Now fast forward to January of 2009, when President Obama proposed an enormous fiscal stimulus. The President’s mistake was in largely deferring to Congress on the composition of the stimulus bill. Rather than allowing Congress to pump hundreds of billions of dollars through slow-spending and inefficient bureaucracies, the President should have insisted that Congress instead send all the funds directly to the American people and let them spend it quickly and efficiently. Given his policy preferences, he could have directed a large share of those funds to poor people who don’t pay income taxes. He could have again mislabeled these payments as “tax cuts,” or just correctly labeled them as one-time entitlement payments. I would not have liked that policy, but it would have generated a faster macroeconomic boost than what he allowed Congress to do instead.

Let’s compare the two scenarios. The enacted 2009 stimulus is:

  • effective (eventually) – Most of the spending through government bureaucracies will (eventually) increase GDP. Some of the funds transferred to State governments will be used to offset State spending or tax cuts that otherwise would have occurred, so there’s a loss. But clearly the proportion of the $787 B that will eventually increase GDP will be high, and much higher than if all the funds were given to individuals and families.
  • inefficient – It will be inefficient in two senses. The spending represents the policy preferences of legislators (and all their ugly legislative deals and compromises), rather than the choices of hundreds of millions of Americans who presumably know better how they would like money spent on them. The spending will also be wasteful, and we are starting to see signs of this in the press.
  • s-l-o-o-o-w – CBO says that $25 B of spending had gone into the economy by May 22nd. That’s less than 4% of the total budgetary impact of that bill. Other news reports suggest that about $40 B is in the economy if you include the revenue side. Remember that almost all of the 2008 stimulus was in private hands by August 1. We will get very little GDP boost from fiscal stimulus in Q3 of 2009, and not much in Q4 either. The stimulus will begin to ramp up in Q1 of next year, and be in full swing by Q2 and Q3 of 2010.

Had the President instead insisted that a $787 B stimulus go directly into people’s hands, where “people” includes those who pay income taxes and those who don’t, we would now be seeing a stimulus that would be:

  • partially effective but still quite large – Because it would be a temporary change in people’s incomes, only a fraction of the $787 B would be spent. But even 1/4 or 1/3 of $787 B is still a lot of money to dump out the door. The relative ineffectiveness of a temporary income change would be offset by the enormous amount of cash flowing.
  • efficient – People would be spending money on themselves. Some of them would be spending other people’s money on themselves, but at least they would be spending on their own needs, rather than on multi-year water projects in the districts of powerful Members of Congress. You would have much less waste.
  • fast – The GDP boost would be concentrated in Q3 and Q4 of 2009, tapering off heavily in Q1 of 2010.

Why did the President not do this? Discussions with the Congress began in January before he took office, and he faced a strong Speaker who took control and gave a huge chuck of funding to House Appropriations Chairman Obey (D-WI). I can think of three plausible explanations:

  1. The President and his team did not realize the analytical point that infrastructure spending has too slow of a GDP effect.
  2. They were disorganized.
  3. They did not want a confrontation with their new Congressional allies in their first few days.

I think the Administration now recognizes this problem. Last month when they released a CEA paper “Estimates of Job Creation from the American Recovery and Reinvestment Act of 2009,” the paper danced around the timing of job growth and government outlays in 2009 and 2010. Tips for reporters: (1) ask the Administration to give you OMB estimates of quarterly cash flows for the stimulus law, and (2) ask them to give you the quarterly GDP and job growth estimates behind this CEA paper. I know the first one exists, and I’d bet heavily the second does as well.

Fortunately, CBO Director Doug Elmendorf just gave a presentation titled “Implementation Lags of Fiscal Policy” to the IMF’s conference on fiscal policy. All of the following data are from his presentation.

The final 2009 stimulus law broke down like this:

10-yr total

% of total

Discretionary spending (highways, mass transit, energy efficiency, broadband, education, state aid)

$308 B

39%

Entitlements (food stamps, unemployment, Medicaid, refundable tax credits)

$267 B

34%

Tax cuts

$212 B

27%

Total

$787 B

100%

The problem is that only 11% of the first line (discretionary spending) will be spent by October 1 of this year. In contrast, 31-32% of the entitlement and tax cuts lines will be out the door by that time. (I have questions about the speed of the entitlement part. The bulk of that is Medicaid spending, and it’s not clear to me that a Federal payment to a State means the cash is immediately flowing into the private economy.)

If we extend our window to October 1, 2010, then less than half the discretionary spending will be out the door, while almost 3/4 of the entitlement spending and all of the tax cuts will be out the door and affecting the economy. The largest part of the stimulus law is therefore also the slowest spending part. This is fine if you’re trying to increase GDP growth over the next 2-4 years. If you’re going for short-term GDP growth, it makes no sense.

Director Elmendorf drills down further into discretionary spending and shows that defense spending happens quickly, highways and water extremely slowly:

  • If you allocate $1 to defense spending, 65 cents has been spent within one year.
  • If you allocate $1 to highway spending, 27 cents has been spent within one year.
  • If you allocate $1 to water projects, only 4 cents has been spent within one year.

In fact, the infrastructure spending in the stimulus law will peak in fiscal year 2011, which goes from October 1, 2010 to September 30, 2011. That’s too late from a macro perspective.

The Director further points out that the 2009 stimulus law created many new programs. This slows spend-out, as it takes time to create and ramp up the new programs.

The Administration has made much of working with federal and state bureaucracies to find “shovel-ready” projects to accelerate infrastructure spending. All of my conversations with budget analysts suggest this claim is tremendously overblown, and Director Elmendorf asks, “Is this practical on a large scale?”


The 2009 stimulus law will increase U.S. economic growth. But the actuals are matching the budget analysts’ projections for the speed at which that effect will occur.

I would not have liked a stimulus law that would have given cash to people who didn’t pay income taxes. But from a macroeconomic perspective, we need the faster economic growth now. Had the President and his team insisted on giving money to people (taxpayers or not) rather than to bureaucracies, we would be seeing a huge growth spurt in Q3 and Q4 of this year.

It is sad that instead we have to wait until the middle of next year because the White House deferred to Congressional desires to spend on infrastructure. This strategic mistake was avoidable, and the recovery will be delayed because of it.

Parsing the President’s health care reform letter

Parsing the President’s health care reform letter

The White House has released a letter from the President to the two Senate Chairmen who are working on (different) versions of health care reform: Senator Kennedy (D-MA), Chairman of the Health, Education, Labor, and Pensions (HELP) Committee, and Senator Max Baucus (D-MT), Chairman of the Senate Finance Committee. The letter is dated yesterday and was delivered as part of a White House meeting between the President and Senate Democratic leaders, including the two Chairmen.

This important letter attempts to shape the pending legislation. It makes new proposals, and it tries to set boundaries to constrain the work of the Chairmen. I am going to walk through the letter and explain what I think it means. I will walk through it in sequence, but will cut out the fluff, and occasionally add emphasis in bold. Each of these quotes could merit a post by itself. I will instead provide a survey of the whole letter. The first notable text is the second paragraph:

Soaring health care costs make our current course unsustainable. It is unsustainable for our families, whose spiraling premiums and out-of-pocket expenses are pushing them into bankruptcy and forcing them to go without the checkups and prescriptions they need. It is unsustainable for businesses, forcing more and more of them to choose between keeping their doors open or covering their workers. And the ever-increasing cost of Medicare and Medicaid are among the main drivers of enormous budget deficits that are threatening our economic future.

This is fantastic, especially as 2. He is focusing on health cost growth as the underlying problem, rather than just focusing on the uninsured, which is only one symptom of the problem. I wrote about this in mid-April: By focusing only on covering the uninsured, are we solving the wrong problem? Here’s the key picture from that post. We need to focus on the red box, and not just the blue box.

hc cost flowchart

The President’s letter continues:

We simply cannot afford to postpone health care reform any longer. This recognition has led an unprecedented coalition to emerge on behalf of reform — hospitals, physicians, and health insurers, labor and business, Democrats and Republicans. These groups, adversaries in past efforts, are now standing as partners on the same side of this debate.

There is a less noble explanation for the existence of this coalition. I wrote in mid-May, “[The provider groups] want to share in the spoils of increased government spending on health care, they want to avoid being the political and policy targets of legislation, and they see no political downside to supporting a popular and powerful President with Democratic supermajorities in both the House and Senate.”

At this historic juncture, we share the goal of quality, affordable health care for all Americans. But I want to stress that reform cannot mean focusing on expanded coverage alone. Indeed, without a serious, sustained effort to reduce the growth rate of health care costs, affordable health care coverage will remain out of reach. So we must attack the root causes of the inflation in health care.

This is an astonishing paragraph from a Democratic President. As he has done in the past, he says his goal is health care for all Americans, rather than health insurance for all Americans. This language will allow him to declare victory with a bill that does not provide universal pre-paid health insurance.

He then reiterates that expanded coverage is insufficient. A bill “must attack the root causes of the inflation in health care.” This is fantastic and unexpected from a Democrat.

The President’s letter then veers wildly off course. That paragraph continues:

… So we must attack the root causes of the inflation in health care. That means promoting the best practices, not simply the most expensive. We should ask why places like the Mayo Clinic in Minnesota, the Cleveland Clinic in Ohio, and other institutions can offer the highest quality care at costs well below the national norm. We need to learn from their successes and replicate those best practices across our country. That’s how we can achieve reform that preserves and strengthens what’s best about our health care system, while fixing what is broken.

Geographic disparities in health spending are enormous, and if we could somehow magically reduce spending in high-cost areas to match that in low cost areas, without sacrificing too much quality, then we would make major progress in reducing the level of national health spending. Budget Director Peter Orszag is the primary proponent of this argument, since before he entered the Administration.

But the Administration has no plan and no proposals that would actually reduce geographic disparities in health care. They have proposals which would provide people with more information about the health care they use, but they have not proposed to change the incentives people have to use that care. If you don’t change the incentives, you will make no significant progress in reducing geographic spending disparities or slowing health cost growth. I wrote about this in late April: Slowing health cost growth requires information AND incentives, and then found that CBO had already made this point.

More importantly, it is absurd to say that geographic disparities are “the root causes of the inflation in health care.” We know what drives health cost growth: (1) technology, (2) income growth, (3) increases in third party payment, and (4) aging of the population. Some argue that administrative costs also contribute to growth, but I’m skeptical. We also know that the first three reasons account for two-thirds to nearly all of cost growth, depending on which study you prefer.

The President’s letter correctly identifies the problem to be solved as health cost growth, and then completely misdiagnoses the sources of that growth. The Administration continues to grossly foul up the problem definition, not propose a solution, and get a free ride from a lazy and compliant press corps. You cannot slow health spending growth merely by stating a vague intent to do so.

The letter continues:

The plans you are discussing embody my core belief that Americans should have better choices for health insurance, building on the principle that if they like the coverage they have now, they can keep it, while seeing their costs lowered as our reforms take hold.

Two things jump out from this sentence. The first is a clear and oft-repeated signal that “if [you] like the coverage [you] have now, [you] can keep it.” The President says this is a core belief. It also protects the Administration from one of the most effective attacks on expansions of government health care: that it will squeeze our your private care. This is tactically smart.

The second is the return to “seeing their costs lowered as our reforms take hold.” This addresses the first box on the right side in my diagram above, and I compliment the President and his team for identifying that growing health spending hurts the more than 100 million Americans who now have health insurance, and not just those who lack it.

But for those who don’t have such options, I agree that we should create a health insurance exchange … a market where Americans can one-stop shop for a health care plan, compare benefits and prices, and choose the plan that’s best for them, in the same way that Members of Congress and their families can.

  • A (singular) exchange, or 50 State exchanges? There’s a big difference.
  • I have never been enamored of the “one-stop shopping” argument. I’m not opposed to it, it just doesn’t excite me. Mostly I fear that exchanges become vehicles for Washington-directed redistribution.
  • It is fascinating that he takes the traditional liberal argument that “you deserve health care that is good as Members of Congress get,” and turns it into “Americans can … choose the plan that’s best for them, in the same way that Members of Congress and their families can.” This is creative.

None of these plans should deny coverage on the basis of a preexisting condition, …

The hardest problem in health care reform is how to deal with the small percentage of Americans with predictably high health costs. To quote Harvard’s Dr. Kate Baicker:

Uninsured Americans who are sick pose a very different set of problems. They need health care more than health insurance. Insurance is about reducing uncertainty in spending. It is impossible to “insure” against an adverse event that has already happened, for there is no longer any uncertainty. If you were to try to purchase auto insurance that covered replacement of a car that had already been totaled in an accident, the premium would equal the cost of a new car. You would not be buying car insurance – you would be buying a car. Similarly, uninsured people with known high health costs do not need health insurance – they need health care. Private health insurers can no more charge uninsured sick people a premium lower than their expected costs. The policy problem posed by this group is how to ensure that low income uninsured sick people have the resources they need to obtain what society deems an acceptable level of care and ideally, as discussed below, to minimize the number of people in this situation.

We need to distinguish between the uninsured and the uninsurable. The uninsured lack health insurance for a wide variety of reasons. Some uninsured are healthy, some are sick.

The uninsurable are those who are already sick or injured, and who have predictably high future health costs. If you have an incurable disease, you are uninsurable, because there is little uncertainty about your future spending. (I’m oversimplifying -there is little uncertainty that you will have high health costs.) As Kate points out, “Uninsured people with known high health costs do not need health insurance – they need health care.”  The policy problem posed by this group is how to ensure that low income uninsured sick people have the resources they need to obtain what society deems an acceptable level of care.

So when the President says that “None of these plans should deny coverage on the basis of a preexisting condition,” the practical effect is that health insurance plans will be required to provide health care to the uninsurable, label it as “insurance,” and then charge healthy people higher premiums than are merited by their own health status. It’s a way of hiding the cross-subsidization.

… and all of these plans should include an affordable basic benefit package that includes prevention, and protection against catastrophic costs.

The word “basic” is unusual from a Democrat. The traditional Washington health debate has Republicans (generally) arguing that we should want more people to be able to afford access to “basic” health insurance, while Democrats (especially those farther Left) saying everyone has a right to “good” health insurance. Setting aside the access vs. right debate for the moment, the word “basic” is a more centrist choice than I would have expected from this President.

He then runs into one of the classic problems of government-designed health care reform: who defines the benefit package? By saying that all of these plans should include X, he is punting the question of who gets to define X, and how specific will they be?Governments have a terrible track record of political micromanagement of medical benefits.

I strongly believe that Americans should have the choice of a public health insurance option operating alongside private plans.

Note that he chose “I strongly believe that Americans should have” rather than the stronger “Americans must have.” Despite the urgings of the Left, the President is leaving himself room to jettison the “public option” if that is the price of getting the Republican votes he may need. Also, he says “alongside private plans,” again emphasizing that the public option will not, in his view, squeeze out private coverage. I think he’s wrong and it will squeeze out private coverage, and would point to what his Administration is trying to do to Medicare private plans as proof.

I understand the Committees are moving towards a principle of shared responsibility — making every American responsible for having health insurance coverage, and asking that employers share in the cost. I share the goal of ending lapses and gaps in coverage that make us less healthy and drive up everyone’s costs, and I am open to your ideas on shared responsibility. But I believe if we are going to make people responsible for owning health insurance, we must make health care affordable. If we do end up with a system where people are responsible for their own insurance, we need to provide a hardship waiver to exempt Americans who cannot afford it. In addition, while I believe that employers have a responsibility to support health insurance for their employees, small businesses face a number of special challenges in affording health benefits and should be exempted.

This is a fairly hard slap at a mandate (individual or employer). “I understand [you] are moving toward … I share the goal … and I am open to your ideas on shared responsibility” is not a ringing endorsement of a mandate. He then guts the universal nature by saying that it should exempt “Americans who cannot afford it” as well as small businesses. These exemptions would create tremendous distortions and inequities. The resulting patchwork mandate would be a mess. With this paragraph, I think the President weakens the prospect of a mandate becoming law.

Health care reform must not add to our deficits over the next 10 years — it must be at least deficit neutral and put America on a path to reducing its deficit over time. To fulfill this promise, I have set aside $635 billion in a health reserve fund as a down payment on reform. This reserve fund includes a numb

er of proposals to cut spending by $309 billion over 10 years –reducing overpayments to Medicare Advantage private insurers; strengthening Medicare and Medicaid payment accuracy by cutting waste, fraud and abuse; improving care for Medicare patients after hospitalizations; and encouraging physicians to form “accountable care organizations” to improve the quality of care for Medicare patients. The reserve fund also includes a proposal to limit the tax rate at which high-income taxpayers can take itemized deductions to 28 percent, which, together with other steps to close loopholes, would raise $326 billion over 10 years.

I am committed to working with the Congress to fully offset the cost of health care reform by reducing Medicare and Medicaid spending by another $200 to $300 billion over the next 10 years, and by enacting appropriate proposals to generate additional revenues. These savings will come not only by adopting new technologies and addressing the vastly different costs of care, but from going after the key drivers of skyrocketing health care costs, including unmanaged chronic diseases, duplicated tests, and unnecessary hospital readmissions.

  • “It must be at least deficit neutral” – Good.
  • “and [must] put America on a path to reducing its deficit over time” – Even better, if he were to actually propose a policy that might do this. Without such a proposal, this is empty and weak.
  • “I have set aside $635 billion in a health reserve fund as a down payment on reform” – Horrible. He wants to create the entire new obligation, but fund only about half of it.
  • “… cut spending by $309 billion over 10 years” – True, but his budget hides $330 B in additional spending on doctors and $17 B to expand Medicaid, so the net is a Medicare/Medicaid spending increase of $38 billion over 10 years. (See table S-5 on page 121 of the President’s budget.) The President’s budget increases spending on these entitlements, and uses a baseline game to claim budgetary savings to offset a new health entitlement.
  • “… cutting waste, fraud and abuse” – This is the old chestnut to suggest that the cuts are good policy and won’t hurt. There is waste, fraud, and abuse, but the cuts will also involve real reductions in payments to health providers, and they will hurt (which doesn’t make them wrong to do).
  • “… a proposal to limit the tax rate at which high-income taxpayers can take itemized deductions to 28 percent” – Democrats in Congress rejected this months ago.
  • “… by reducing Medicare and Medicaid spending by another $200 to $300 billion over the next 10 years” – Excellent. Will he provide specifics? I would be happy to suggest some.
  • “… and by enacting appropriate proposals to generate additional revenues.”- aka “raise more taxes” – Horrible from my perspective.
  • “… going after the key drivers of skyrocketing health care costs, including unmanaged chronic diseases, duplicated tests, and unnecessary hospital readmissions.” – As I said earlier, these are not the key drivers of skyrocketing health care costs, and it is misleading and irresponsible to claim they are.

To identify and achieve additional savings, I am also open to your ideas about giving special consideration to the recommendations of the Medicare Payment Advisory Commission (MedPAC), a commission created by a Republican Congress. Under this approach, MedPAC’s recommendations on cost reductions would be adopted unless opposed by a joint resolution of the Congress. This is similar to a process that has been used effectively by a commission charged with closing military bases, and could be a valuable tool to help achieve health care reform in a fiscally responsible way.

This is new and interesting to me. “A commission created by a Republican Congress” is odd, since MedPac is not known as a nonpartisan advisory group. It is also odd to imagine giving MedPac real decision-making authority, given that it is comprised of representatives of provider groups (doctors, hospitals, nurses, etc.)

I know that you have reached out to Republican colleagues, as I have, and that you have worked hard to reach a bipartisan consensus about many of these issues. I remain hopeful that many Republicans will join us in enacting this historic legislation that will lower health care costs for families, businesses, and governments, and improve the lives of millions of Americans. So, I appreciate your efforts, and look forward to working with you so that the Congress can complete health care reform by October.

I can read this either way. My gut says this means, “Get me a bill by October.” I would prefer it be broadly bipartisan, but don’t let the lack of Republican support prevent you from getting me a bill.

Summary & Conclusions

The news in this letter is:

  • The President continues his rhetorical focus on reducing long run health costs in addition to expanding coverage.
  • While appearing to push for a public option and universality, he is leaving himself room to compromise on both if needed to get a bill to his desk.
  • He has made a mandate harder to legislate by insisting on large exemptions, and he has not signaled any support for a mandate. Goodbye mandate, I think.
  • He is insisting on deficit neutrality over 10 years and reducing the deficit in the long run, while not proposing policies that achieve either goal. He is opening the door to more Medicare and Medicaid savings to reach these goals and has floated a $200-$300 B number without specifics.
  • He has opened the door to a binding commission to cut Medicare and Medicaid spending, modeled after the Base Realignment and Closure (BRAC) process.

I have mixed conclusions:

  • At the 30,000-foot level, he has broken new ground for Democrats in defining the problem correctly as unsustainable health cost growth, rather than the subsidiary problem of the uninsured. I compliment him for this.
  • At the 5,000-foot level, he botches the problem definition by focusing on geographic disparities while ignoring the commonly acknowledged major drivers of health spending increases: technology, income growth, and third party payment. This is a fatal flaw.
  • He continues to assert that we must slow cost growth, without proposing any policy changes that would do so in a measurable way. This is an abdication of leadership and irresponsible.
  • To genuinely slow health cost growth, you need to change incentives. Doing so involves political pain. Congress will not want to do that pain, and will not do so if the President doesn’t propose specifics.
  • In addition, the short-term budget numbers still don’t add up. He has problems with the “down payment” meaning they’re not paying for the full new obligation, ignoring the doctors and Medicaid spending hidden in the baseline, and Congress rejecting his biggest tax increase proposal.
  • I am glad that he is leaning against, or at least undermining, the case for a mandate.
  • The MedPAC idea is interesting. It probably won’t work, but I don’t want to dismiss it out of hand.

The President’s letter makes it harder, not easier, to get a bill. While I like some elements of the letter, it is inconsistent with the President’s actual proposals. You cannot magically slow health spending growth without proposing policy changes that affect incentives and behavior. If the President is not willing to bite the bullet and lead on slowing long-term health cost growth, he will instead get a bill which is just a straight entitlement expansion, partly offset by Medicare Advantage cuts and tax increases, and obscured by budget gimmicks. His advisors will then have to construct a bogus argument that they have addressed long-term spending growth.

That would be a terrible outcome.

Third party payment in health care (part 3): Technology drives cost growth

Third party payment in health care (part 3): Technology drives cost growth

Imagine that Sony plans to bring to market a new TV that is twice as good as the old $500 TV but costs $200 more to produce. If instead it is twice as good but costs $2,000 more, they will probably hold off and look for a less expensive way to improve quality.

Now imagine that TV insurance covers 90% of the incremental cost, so the consumer only sees a price increment of $200 for a TV that costs $2,000 more to make. You, and many others, would demand this new TV, which is high quality but probably low value for you, since the true incremental cost is probably more than you’re willing to pay for that quality increase.

Knowing this, Sony will likely make lots of new high-tech TVs, and will expand their R&D programs to push the limits of TV quality improvement. They won’t care much about the higher costs, because demand for any new quality-improving technology is increased by the presence of TV insurance.

This is likely to be true even if you were also told that your TV insurance premium comes out of your wages, because the cost of that insurance depends mostly on how many of your work colleagues buy new and better TVs. In addition, that insurance premium is both hidden to you and distant when you’re at the store buying the TV.

Americans would have the best TVs in the world, and companies would compete based on who can produce the highest quality TVs, almost regardless of cost.

We don’t have TV insurance today, and yet TV quality improves fairly rapidly. The market, as an aggregated collection of individual purchasing preferences, determines a balance of improved quality and high cost that results in “high value technology improvements.” Sony and its competitors try to meet the demand for high value technology improvements, rather than for any technology improvements without regard to cost.

The hidden nature of employer-provided health insurance and the tax subsidy for that insurance distort people’s decisions so that they purchase health insurance with low deductibles and high premiums. This encourages us to use lots of health care without too much regard for the cost of that care.

In her testimony before the Senate Finance Committee, Kate Baicker explained why insurance causes greater consumption of health care:

Insurance, particularly insurance with low cost-sharing, means that patients do not bear the full cost of the health resources they use. … The RAND Health Insurance Experiment (HIE), one of the largest and most famous experiments in social science, measured people’s responsiveness to the price of health care. Contrary to the view of many non-economists that consuming health care is unpleasant and thus not likely to be responsive to prices, the HIE found otherwise: people who paid nothing for health care consumed 30 percent more care than those with high deductibles. This is not done in bad faith: patients and their physicians evaluate whether the care is of sufficient value to the patient to be worth the out-of-pocket costs.

This is why Kate (and I, having learned from Kate) talks about “high value health care.” As a policy matter, we should not want to encourage people to use either more or less health care. We should instead want people to be free to choose high value health care without distortion, in which each person decides how to get the greatest value per dollar spent and what is the right balance of improved quality and higher cost.

Everything that I have explained so far about third party payment in health care contributes primarily to a high level of health spending. None of these factors alone, however, explain the extraordinary growth of health spending. This is where we grasp the rose by the thorn: the primary driver of long-term health care cost is technology. America spends more on health care each year primarily because we demand more and better health care each year. We just don’t know that we’re demanding it, because government policies push us toward high-premium low-deductible health insurance that increases our demand for high-quality but low-value technology improvements.

In January of 2008, the Congressional Budget Office reviewed three studies of the sources of cost growth in real per capita health care spending in the U.S. Here is their summary of two of the studies in chart form. (The third study had ranges and was too difficult to graph. It assigned a range for technology of between 38% and 62%.)

health cost growth graph

You can see that technology explains half to two-thirds of the long-term growth in real per capita health spending. Another 10-13% is the direct result of changes in third-party payment that further insulate us from the cost of the medical care we use (mostly the creation of Medicare and Medicaid).

There are two points here:

  1. Our employer-based health insurance system hides the cost of premiums and subsidizes those premiums. This encourages those with employer-provided health insurance to ignore some of the higher premium costs, and pushes us toward policies with low deductibles and copayments (at the expense of higher hidden subsidized premiums). These low deductible policies encourage us to use low value health care and result in unsustainably high and rapidly growing insurance premiums that crowd out wage growth.
  2. These low deductible policies also reduce our sensitivity to the costs of new medical technologies. We choose improved technology without proper regard for whether that technology is worth the higher cost, because government policies are distorting our decisions.

According to the two studies shown above, the interaction of these two factors is responsible for 2/3 to 3/4 of health care cost growth. This is where we get to the politically uncomfortable part.

  • Health care costs are on an unsustainable path. We must slow the growth of those costs.
  • 2/3 to 3/4 of health care cost growth comes from policies that push us toward low deductible policies and cause us to demand technology improvements without much consideration of the cost of those improvements.
  • Any solution that addresses the “change in third-party payment” source of cost growth will mean that people pay more out-of-pocket when they go to the doctor or hospital. In exchange they will get lower premiums. Still, this higher out-of-pocket spending is higher for some politicians to swallow (especially Democrats).
  • Any solution that addresses the technology source of health care cost growth will mean that new medical technologies will be developed less rapidly.

Nobody in Washington wants to tell you that last point. We argue about administrative costs, about medical liability costs, about insurance company profits, and about waste, fraud, and abuse. All of those are important contributing factors to high levels of health spending, and we should definitely make reforms that try to lower those levels. But our long-term problem is principally about the growth rate, and addressing the growth rate involves a real tradeoff. New medical technologies and drugs will still be developed, but not quite at the breakneck rate that we’re used to. This is grasping the rose by the thorn.

The only question left then becomes who will make those determinations. Should determinations of “high value health care”and “high value technology improvements” be made by the government, or as the result of the decisions of millions of Americans acting independently based on their own preferences?

You can probably guess my answer.

Budget: Baby Terminator

Budget:  Baby Terminator

Today the Administration released more detail for the President’s budget. The President tried to emphasize his fiscal responsibility by highlighting some of the programs he proposes to terminate or reduce. Budget Director Orszag released the Terminations, Reductions, and Savings volume.

This morning the President said,

But one of the pillars of this foundation is fiscal responsibility. We can no longer afford to spend as if deficits don’t matter and waste is not our problem. We can no longer afford to leave the hard choices for the next budget, the next administration — or the next generation.

That’s why I’ve charged the Office of Management and Budget, led by Peter Orszag and Rob Nabors who are standing behind me today, with going through the budget — program by program, item by item, line by line — looking for areas where we can save taxpayer dollars.

Today, the budget office is releasing the first report in this process: a list of more than 100 programs slated to be reduced or eliminated altogether. And the process is ongoing.

Here is a comparison of the budgetary savings from President Obama’s proposed discretionary program terminations and reductions, compared to those proposed by President Bush in his last budget:

comparison of discretionary savings

Some observations:

  • President Bush proposed $6.6 B (57%) more in discretionary program terminations and reductions than President Obama.
  • Three-fourths of President Obama’s T&R savings come from defense.
  • President Bush proposed 6.7 times more non-defense T&R savings than President Obama. (= 18.1 / 2.7)

Now this graph covers only the proposed savings from annually appropriated (“discretionary”) programs. The bulk of federal spending is in the mandatory programs. I will cover that separately.

Today the President said, “But these savings, large and small, add up.” It’s too bad they don’t add up to more.

Intro to TARP — TARP II: Direct investment

Tuesday I began with a simple example, which I am calling Large Bank.

Yesterday we looked at TARP I, in which the government would buy troubled/toxic assets from banks.

Today I will describe TARP II, the plan we (the Bush Administration) implemented, in which the government made direct equity investments in banks to help fill their capital holes. We called this the Capital Purchase Program.

As a reminder,we are trying to address two problems:

  1. Large Bank does not have enough capital.
  2. Large Bank has downside risk on its balance sheet due to the uncertain value of these bad loans. That downside risk makes the firm’s value uncertain and scares away investors.

Here is the balance sheet for Large Bank:

Assets Liabilities and Equity
Good loans 800 Deposits 600
Bad loans 120 Debt 300
Equity 20
Preferred 0
Total 920 . . . . . . . Total 920
  • Total capital: 20
  • Leverage: 46:1

TARP I solves problem #2 if you buy all the bad loans, but it is extremely inefficient in addressing problem #1, the capital hole. Spending 120 from the TARP to buy the bad loans would provide no new equity capital. Spending 150 to buy the loans valued at 120 would provide a net 30 of capital for 150 outlayed from the TARP.

The constraint is not the ultimate cost to the taxpayer. It is instead the legislated limit on how much outstanding cash can be invested/spent at any one time from TARP: $700 B.

To fill the capital hole, our first choice would be for the bank to attract private capital. Bank management appears reluctant to do this, because they don’t want to dilute the value of their existing shareholders. In addition, private investors were unwilling (at least last Fall) to invest in banks that had significant downside risk on their balance sheets. So temporary public capital, provided by the taxpayers, was the only option to recapitalize the banking system.

If we take the same 120 from the first TARP I case, but instead use it to buy preferred stock in Large Bank, we end up with this:

Assets Liabilities and Equity
Good loans 800 Deposits 600
Bad loans 120 Debt 300
Cash 120 Equity 20
Preferred 120
Total 1,040 Total 1,040
  • Total capital: 140
  • Capital added by this transaction: 120
  • Leverage: 7.4:1
  • Risk of bad loans: still lies entirely with Large Bank
  • Taxpayer outlay from TARP: 120
  • Long-term cost to taxpayer: Zero if the firm remains solvent, up to 120 if the firm goes bankrupt.

Results:

  1. Large Bank has 120 more capital from the government. It is now well capitalized and has a good leverage ratio. (I am for now glossing over the difference between preferred and common stock.)
  2. Large Bank still has all the downside risk associated with the bad loans. This may continue to scare away private capital, depending on estimates of the relative size of the strengthened capital cushion and the downside risk of those bad loans.
  3. The government has spent 120 of the TARP pool.
  4. The taxpayer will get dividends from the preferred stock (which look a lot like interest payments at a fixed interest rate).
  5. The government is now the majority investor in Large Bank and has both an ongoing taxpayer interest in and leverage over how the bank is run.

TARP II gets tremendous bang for each TARP buck in recapitalizing banks. If you are more worried about the capital hole than the downside risk, then TARP II has far better arithmetic.

If you are worried that the capital problem being bigger than you think, then you want to use TARP resources in the most efficient way possible. Remember that you do not have good information about the size of either the capital hole or the downside risk. You know what the banks report about their balance sheet, but especially last fall, we had to be extremely skeptical about the information being reported about the size of both problems. This is one reason why the stress tests are so valuable — regulators and policymakers presumably have much better information now about the absolute and relative sizes of each problem, at least for the 19 largest banks.

Over the past few months we have been experiencing a significant policy downside of direct equity investment, and it is a major difference between TARP I and TARP II. Under TARP I, the government buys the asset and the relationship between the government and the bank ends. Under TARP II, the government has an ongoing relationship with the bank. This creates policy tension among three different governmental roles:

  1. government as rule-setter and regulator;
  2. government as investor on behalf of the taxpayer; and
  3. government as an interested party with other policy (or non-policy) goals.

This tension is playing out in several uncomfortable and unpleasant ways. The government is involved in compensation decisions within the firm. The government is leveraging its investment to pursue other goals, like encouraging the banks to lend and maybe leveraging some of them to write down auto manufacturers’ debt. And the government may trade off other policy goals against the taxpayer’s investment by allowing banks to convert preferred equity to common equity.

Returning to the original two goals, you can see the two extremes in TARP I and TARP II. TARP I was focused on removing downside risk from balance sheets. The danger with TARP I is you might buy $700 B of bad assets, and have only made a medium-sized dent in the downside risk problem, while doing far less to fill the capital holes. TARP II ignores the downside risk problem while getting a huge bang in filling capital holes. TARP II also has other problems derived from the ongoing linkage between Uncle Sam and the banks.

Tomorrow I will describe TARP III, the Geithner approach, and how it tries to address both problems by tapping into non-TARP resources.

As in the rest of this series, I thank Donald Marron for his examples and assistance.

Will the Administration fund CSI: New Haven and Tattoo removal in L.A.?

President Obama may not realize that the people who work for him are required to ignore hundreds (thousands?) of Congressional earmarks. The President has the ability to stop them from doing so. I hope that he will not.

Thanks go to former OMB General Counsel Jeff Rosen for pointing this out.

An Executive Order is a document signed by the President that establishes how he organizes and manages the Executive Branch. This power is derived from the first sentence of Article II, Section 1 of the Constitution: “The executive power shall be vested in a President of the United States of America.”

Some Executive Orders are time limited. Others remain in place until they are modified or repealed. Executive Orders span Presidential terms, so any Executive Order issued before President Obama’s term began that has not yet “sunset” is still legally binding upon the Executive Branch. President Obama can unilaterally modify or repeal such an E.O., but until he does, Executive Branch employees are legally required to continue implementing it.

On January 29, 2008, President Bush signed Executive Order 13457, “Protecting American Taxpayers From Government Spending on Wasteful Earmarks.” This E.O. has no sunset date. It continues to be legally binding until modified or repealed by our current President.

On March 11, President Obama publicly stated his own principles on earmarks, but he has not modified or or repealed E.O. 13457.

Let us therefore look at the current policy of the Executive Branch regarding implementation of earmarks. I have seen no public indication that anyone in the Executive Branch is following these requirements, or is even aware of them. Here is the key language from the Executive Order.

Section 1 – For appropriations laws and other legislation enacted after the date of this order, executive agencies should not commit, obligate, or expend funds on the basis of earmarks included in any non-statutory source, including requests in reports of committees of the Congress or other congressional documents, or communications from or on behalf of Members of Congress, or any other non-statutory source, except when required by law or when an agency has itself determined a project, program, activity, grant, or other transaction to have merit under statutory criteria or other merit-based decisionmaking.

Section 2 implements this requirement by requiring “Agency Heads” (Cabinet Secretaries and others who run sections of the government) to do certain things. The language is easy to understand:

Section 2. Duties of Agency Heads. (a) With respect to all appropriations laws and other legislation enacted after the date of this order, the head of each agency shall take all necessary steps to ensure that:

(i) agency decisions to … expend funds for any earmark are based on the text of laws, and in particular, are not based on language in any report of a committee of Congress …

(ii) agency decisions to … expend funds for any earmark are based on authorized, transparent, statutory criteria and merit-based decision making

(iii) no oral or written communications concerning earmarks shall super-sede statutory criteria, competitive awards, or merit-based decisionmaking.

This language is formally telling Executive Branch employees “If an earmark is not in the law, you must ignore it.” Use your merit-based decisionmaking process, even if the committee report that accompanies the bill says “we think you should spend money on project X,” and even if you get a phone call from a Member of Congress or Congressional staffer.

As a reminder, we define an “earmark” like this:

(T)he term “earmark” means funds provided by the Congress for projects, programs, or grants where the purported congressional direction (whether in statutory text, report language, or other communication) circumvents otherwise applicable merit-based or competitive allocation processes, or specifies the location or recipient, or otherwise curtails the ability of the executive branch to manage its statutory and constitutional responsibilities pertaining to the funds allocation process.

Let’s look at the report that accompanied the omnibus appropriations bill that President Obama signed into law on March 11. Here are four earmarks from the committee report.

The first is by Rep. Rosa DeLauro (D-CT). It’s $600,000 of “Byrne Discretionary Grants” from the Department to Justice support an Evidence Response Training Center at the Henry C. Lee Institute of Forensic Science in West Haven, CT. You can find it on page 268 here.

eamark_forensics

Here is another, by Rep. Howard Berman (D-CA). It’s $200,000 of Byrne Grants for a Tattoo Removal Violence Prevention Outreach Program at the Providence Holy Cross Foundation in Mission Hills, CA. You can find it on page 283 here.

earmark_tattoo We also have $1.791 M for Swine Odor and Manure Management Research at Ames, IA, sponsored by Sen. Tom Harkin (D-IA).you can find it on page 77 here.

eamark_swine

To show that this is bipartisan behavior, here is one from Rep. Bill Shuster (R-PA) and Sen. Arlen Specter (R-PA) for $713,625 for the Juniata Hybrid Locomotive. You can find it on page 263 here.

earmark_choochoo

Although all four of these earmarks are in the report language, they have different legal statuses. The first two are pure report language earmarks. There is nothing legally binding about them, and they are therefore subject to E.O. 13456. The third and fourth (swine odor research and the hybrid locomotive) are “incorporated by reference” into the law, so the Executive Branch would be breaking the law if they tried to ignore them. I will write about incorporation by reference in the future.

Now according to E.O. 13456, Attorney General Eric Holder, as the “Agency Head” for the Justice Department, has been directed to not allocate of Byrne Discretionary Grant funds based on the inclusion in the conference report of the earmarks for CSI: West Haven or Mission Hills tattoo removal. That does not mean that those institutions may not be funded. It means that if they are funded, DoJ must determine that they deserve funds “based on authorized, transparent, statutory criteria and merit-based decisionmaking.” And DOJ is not permitted to allow a phone call from Mrs. DeLauro or her staff, or from Mr. Berman or his staff, to supercede those criteria.

The process point is important in earmark reform. There are certain earmark recipients that could win funding in a competitive or merit-based decision making process. Relying on such a process ensures that funds will be allocated on merit rather than political power.

One of two scenarios can now play out. I will rank them in my order of preference:

  1. The Executive Order stays in place and unmodified. Budget Director Orszag issues an implementation memo parallel to the one issued by Director Nussle last October on the FY 09 continuing resolution. Throughout the Executive Branch, Agency employees are required to ignore earmarks that are not in the law.
  2. The President repeals or modifies E.O. 13456.

If the first scenario plays out, I will heartily congratulate the President for being as strong as he says he is on earmark reform.

If the second scenario plays out, then the President will have weakened the earmark rules put in place and implemented by his predecessor.

If the Executive Order is not modified and no apparent action is taking place to comply with it, then I believe Agency Inspector Generals have an obligation to make certain that the E.O. is being implemented within their respective agencies.

The President said on March 11,

I ran for President pledging to change the way business is done in Washington and build a government that works for the people by opening it up to the people.  We eliminated anonymous earmarks and created new measures of transparency in the process.

All the President has to do now to change earmarking for the better is make certain this Executive Order is enforced.

Apparently $634 B is only the down payment for health care reform

I had missed this from the President’s remarks to Congress on February 24th:

This budget builds on these reforms. It includes a historic commitment to comprehensive health care reform – a down-payment on the principle that we must have quality, affordable health care for every American.

Budget Director Peter Orszag repeated the “down payment” language on his blog Monday, and was slightly more specific:

And in the President’s budget, we make a historic down payment on fundamental health care reform – a commitment also embodied in the budget resolutions passed in Congress.

This clearly suggests that the Administration thinks that the $634 B “reserved” over the next ten years in the President’s budget (table S-6) will not suffice to fulfill “the principle that we must have quality, affordable health care for every American.” By combining and repeating the “down payment” language with the “every American” language, they are covering themselves for later as they now create a political commitment that exceeds their budgetary commitment.

There are two other details to the President’s language that are interesting, and that he has repeated several times since the February address:

  1. He says all Americans should have “health care” rather than “health insurance.” This allows him wiggle room to accept a solution that does not provide universal pre-paid health insurance coverage for every American. This mitigates my down payment point somewhat, but only if the Congress decides to go for less than universal coverage. I would lay extremely high odds that before this speech there was a West Wing debate about whether the President should say “health care” or “health insurance,” with the Lefties arguing for “insurance” and getting overruled to allow flexibility to later define a win with legislation that provides something less than universal coverage.
  2. He consistently says “quality health care” or “high-quality health care.” That is more expensive than “basic health care,” and opens the question about who defines “high quality,” as well as the government-mandated benefits problem.

The growth of federal health care spending is one of our top two short-term and long-term budgetary problems. The President’s budget commits to making that problem worse by creating a new promise, only partially funding that promise, and then not specifying policies that will produce the long-term savings for which the Administration wants to claim credit. I am stunned that the White House staff let the President say this without the policies and numbers to back it up:

It’s a commitment that’s paid for in part by efficiencies in our system that are long overdue. And it’s a step we must take if we hope to bring down our deficit in the years to come.

I am not disappointed but not surprised that the press corps has not called the Administration to back this claim up. I can find no evidence of policies that will produce “efficiencies in our system,” or that will “bring down our deficit in the years to come.” As CBO wrote in December, better information and research alone will not achieve those goals.

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