Budget Director Peter Orszag and White House Health Policy Advisor Nany-Ann DeParle (who was a PAD in the Clinton OMB) write in today’s Washington Post:

But some critics complain that the administration has slipped in its commitment to fiscal responsibility in health reform.

These critics are mistaken. The president’s plan represents an important step toward long-term fiscal sustainability: It more than meets the president’s commitments that health-insurance reform not add a dime to the deficit and that it contain measures to reduce the growth rate of health-care costs over time.

I suspect this op-ed is aimed at moderate Democratic House members who are nervous about voting aye. I am one of the critics Orszag and DeParle mention, and I’d like to respond to one of their arguments.

CBO says the Senate-passed bill would reduce budget deficits over the ten-year period 2010-2019 by $132 B relative to what those deficits would otherwise be under current law. I want to focus on this comparison, and in particular on the $438 B of savings CBO scored from Medicare and Medicaid in that bill. I do not question these aspects of CBO scoring, but do disagree with the conclusions drawn from it by others.

$210 B of these $438 B in net Medicare and Medicaid savings come from a single legislative gimmick known as “gaming the budget window.” To a certain extent the Obama Administration isn’t to blame for this problem, but they are taking advantage of it in this legislation. This is a fairly complex technical issue, and by no means the only problem a fiscally responsible person should have with this bill. Still, $210 B and the Administration’s claim of fiscal responsibility rely upon this gimmick, so I’ll do my best to explain it.

Example:

  • Your car has a 15 gallon fuel tank and you fill it up each week.
  • For the past year gas prices have averaged $3 per gallon. Gas has therefore cost you $45 per week.
  • Now gas prices spike upward to $4/gallon. You hear in the news that terrorists damaged a pipeline in Saudi Arabia that will be offline for a few days.
  • Gas therefore costs you $60 this week.
  • Experts say the price will drop back to $3 next week once the pipeline is repaired.
  • So far so good. Now we start getting funky.
  • Suppose you assume that gas prices will remain at $4 forever. You tell yourself you will spend $60 per week on gasoline forever. This isn’t true, but you tell yourself that it could be true if the pipeline is never fixed.
  • Your family budget is constrained enough that you wouldn’t be able to afford this if it were to actually happen. If you actually had to spend $60 per week on gas and didn’t cut back elsewhere, you’d go broke. (Times are tight.) But you assume it anyway.
  • After filling up today, you then decide that you will “cut” your gas price allowance from $60 per week to $45 per week for (only) the next month. You calculate you will “save” $15 per week for four weeks, or $60 over the next month.
  • Having “saved $60 this month,” you immediately spend $50 on a new toy for yourself.
  • You return home and tell your spouse “Honey, I bought this new $50 toy and saved $10!”
  • The gas price returns to its historic average $3 per gallon, so you now hit your so-called $45/week budget target without actually having to cut your gasoline usage.
  • That’s not all. One month from now, when prices are still at $3/gallon, you budget for the next month.
  • You once again “cut your budgeted gasoline spending from $60 per week to $45” and “save another $15 each week for the following month.”
  • Having “saved another $60” for the upcoming month, you buy another $50 toy and tell your spouse you once again saved $10 this month.
  • Repeat the above until you go broke.

This is what happens in Medicare every few years. The Medicare law is written to assume that per-service payments to hospitals will increase each year by an index called the market basket. If payments were to actually increase at the market basket rate each year, they’d grow about 4 percent per year.

Instead, every 3-5 years Congress “cuts” payments to hospitals. They change the law to pay hospitals “market basket minus X” for, say, the next five years. “We’ll pay you market-basket minus 1 for the next five years,” Congress says. That’s roughly +3 percent more per service per year.

“Look!” Congress says to themselves. “We just saved billions of dollars! Let’s go spend it!” In the same law, they spend some of the “savings” CBO scored them with from “cutting” the hospital payment growth rate from 4% per year to 3% per year. They claim deficit reduction for the rest.

And when they write the law, they change it for only the next five years, because that’s the length of their “budget window” established by the budget resolution. The law they write says “Hospitals, we’ll pay you market basket minus 1 for the next five years, but we won’t change it beyond that. That means that six years from now, you’ll return to a market basket growth rate of 4% per year.

You can see it coming. Five years later, Congress returns and does it again. They face hospital payment updates of 4% per year for the indefinite future. They “cut” those payments to 3% for the next five years, spend some of the “savings” on program expansions, and claim they have reduced the deficit.

What I have described is not partisan. Both parties do this and have done this many times. And when they do, they are technically living by the scoring rules. Both parties game the budget window. Democrats tend to spend more of the “savings,” while Republicans tend to claim more of it as deficit reduction.

The policy reality is that, over time, Medicare payments to hospitals increase at an average rate of about 3%, or market basket minus one. Since Congress games the budget window and takes advantage of the scoring convention that deficit reduction is measured relative to current law rather than current policy, they create an environment in which they appear to be making hard choices while allowing themselves to allocate a new pot of money every so often for new spending and claimed deficit reduction.

As a budget policy matter, there are two bad behaviors here: (1) applying this gimmick temporarily and then repeating it; and (2) spending some of the money on new real expansions of government with real deficit costs, while claiming deficit reduction.

The Administration deserves credit in the Senate-passed bill for no longer doing (1). The Senate-passed bill makes permanent long-term reductions in the growth rate of Medicare payments to hospitals. They games the budget window, but only by a little bit. This is good and surprising. I also like the way they implement that change, by incorporating a productivity adjustment into the baseline growth rate for Medicare spending.

Unfortunately, they then take almost all of these long-term “savings” and re-spend them. This is what allows them to both create a massive new entitlement spending program, and claim CBO-scored deficit reduction relative to current law. In our example above, imagine if you agreed to permanently reduce your gasoline spending to $45/month. That would be good and reasonable. But suppose you also legally committed yourself to spending $58 per month for a new toy each month forever. That would be horribly irresponsible – you’d be guaranteeing that you go broke, all while pointing the $2 per month that you had “saved” as proof of your fiscal responsibility.

America’s primary fiscal problem is the long-term growth of health entitlement spending. The Senate-passed bill creates a commitment for a new health entitlement program, and takes advantage of a gimmick to claim that this commitment is paid for. Instead, this bill would guarantee a future fiscal crisis.

(photo credit: Break the Bank (6/365) by swimparallel)