The Specter of Financial Armageddon — Health Care and Federal Debt in the United States

Even with healthcare reform behind us and everyone's new focus on its implementation, there is still one tiny little detail that lacks the attention and focus that it deserves -- the nation's rising debt from health care.  Earlier today, we came across an article published in the New England Journal of Medicine by Michael E. Chernew, Ph.D., Katherine Baicker, Ph.D., and John Hsu, M.D., M.B.A., M.S.C.E.  This article was published just before the passage of healthcare reform.  Although the article is several months old, it is a great reminder of why we need to continue to look for innovative ways to change healthcare, because without significant change our nation's debt will grow to hurt future generations. 

The most important force shaping the U.S. health care systemover the coming decades may well be the federal debt. The governmentnow pays for approximately half of all health care costs inthe United States, and projections of growing federal debt largelyreflect anticipated increases in health care spending. Becausefederal debt and health care policy in the United States areso deeply entwined, it is important to understand the basicsof deficits and debt and their implications for health carereform.

The deficit is the gap between expenditures and revenues inany given year ($1.4 trillion in the United States in 2009),whereas debt is defined as accumulated past deficits, or thestock of what we owe ($7.5 trillion at the end of 2009).¹ Economistsdistinguish between two types of deficit: cyclical and structural.Cyclical deficits rise or fall in the short term in responseto economic conditions. In economic downturns, tax revenue fallsand government spending on public programs such as unemploymentinsurance increases, leading to larger deficits and higher debt.These deficits are not necessarily a problem: they can boosteconomic activity and mitigate economic downturns. When theeconomy expands, revenues rise and spending falls, creatinga cyclical surplus that, holding all else constant, can reducethe debt.

In contrast, structural deficits represent an underlying, persistentimbalance between revenues and expenditures. The United Stateshas a substantial, growing structural deficit, much of whichreflects current and projected increases in federal spendingon Medicare and Medicaid. This federal health care spendingamounted to 5% of the gross domestic product (GDP) and 20% offederal outlays in 2009 and is forecast to reach 12% of theGDP by 2050.¹ Health care spending is thus a key driver of long-termdebt. This does not mean that we cannot run a structural deficit,but deficits must be small enough that debt grows more slowlythan the GDP.

So why does debt matter, and how much is too much? Economistsoften measure the size of the debt relative to the overall economy,or the debt-to-GDP ratio. To finance this debt, the governmentissues interest-bearing bonds. Doing so imposes several economiccosts. First, interest payments consume an increasing shareof income (1.3% of the GDP in 2009, or 5.3% of total federalspending),¹ thereby reducing the resources available for publicprograms. Second, growing debt can lead to higher interest ratesfor all borrowers (government, businesses, and individuals),thus impeding economic growth. Finally, high debt reduces ourcapacity to respond to sudden economic shocks and magnifiesthe detrimental effects of any deficit.

Economies can bear substantial debt without dire economic consequences,but there is a limit to how high debt can rise and still befinanced without causing serious economic harm. Economists,however, do not agree on where the threshold lies. The EuropeanUnion has set a target debt-to-GDP maximum of 60% for its membercountries (although the table shows that a number of them exceededthis threshold in 2008²), but some economic research suggeststhat levels approaching 90% can be managed without substantialeconomic harm. In 2009, the U.S. debt-to-GDP ratio was 53%,according to the Congressional Budget Office. Although thisfigure suggests that we have some short-term flexibility, ourlarge and increasing structural deficits will push us past the90% mark by the end of 2020, absent major policy changes.¹

The consequences of high debt levels depend on the treatmentsthat policymakers prescribe. One approach is generating inflationto erode the value of the debt, but the adverse economic consequencesof this strategy can be severe. Another option is raising taxes.Taxes reduce economic growth.

Projections made by the Congressional Budget Office in 2007,before the current fiscal crisis began, suggest that to financefederal spending, the highest federal tax bracket would haveto rise to 92% by 2050, assuming health care spending grows2.5 percentage points faster than GDP, which is approximatelythe historical average.³ A final option is cutting spendingon valued public programs. For Medicare and Medicaid beneficiaries,this approach could mean large increases in cost sharing, poorerbenefits, limited eligibility, and diminished access. For healthcare providers, it could mean drastic reductions in Medicareand Medicaid payments.

Most likely, some combination of tax increases and spendingcuts will be needed to avoid unsustainable debt, but the higherour debt climbs, the more likely it is that we will find ourselvesin an economic crisis and the more painful the unavoidable responsewill be. The economic stresses apparent in Greece and in Californiaprovide some glimpse into what such a fiscal Armageddon mightbring.

The clear implication for health care reform is that as we evaluateoptions (or the possibility of maintaining the status quo),we should focus on the path to a sustainable fiscal situationrather than on short-run deficits. Growth in health care spendingis one of the primary contributors to increases in debt overthe long run, so the long-term strategy must involve slowingthat growth. The current reform proposals incorporate a numberof promising strategies for controlling spending and raisingrevenue (see Proposed Strategies for Reducing Health Care Spending⁴). The impact of these strategies will depend on the detailsand the effectiveness of implementation, and no one knows whichstrategies will prove successful. Projections suggest that thereform package, including additional revenues, will reduce thedeficit (relative to the unsustainable baseline).

If the entire reform package is required in order to achievethe deficit reduction — perhaps because of an interactionbetween expanded coverage and the fiscal effects of reform orperhaps because expanded coverage is needed to generate sufficientsupport for passage — then the fiscal case for reformis much stronger. However, if the provisions for cost savingsand revenue gains can be implemented without expanding coverage,we must ask whether the money saved should be spent on coverageexpansions (or any other policy goal) or on debt reduction.

The net impact of reform on the deficit should not be the metricof fiscal virtue. If all the money saved through reductionsin future spending on existing health care programs were devotedto new health care programs, our fiscal situation would be littleimproved. Similarly, if other fiscal tools, such as tax increases,are used to cover new programs, those tools will not be availableto achieve broader reductions of the structural deficit. Thus,although covering the uninsured is a laudable policy goal thatwould improve access to health care for many, it would alsoadd substantially to our structural spending and thus necessitatemore draconian fiscal austerity elsewhere.

This does not mean that we should not expand coverage —but rather that we must evaluate the cost of doing so in thecontext of the extent to which it will limit our options toaddress our broader fiscal imbalances, recognizing that thechallenge posed by these imbalances is Herculean. Even if wehalve the gap between the growth in health care spending andthe growth in the GDP, some estimates suggest that our debt-to-GDPratio would drop only from 300% to 200% by 2050.⁵

The goals of health care reform must therefore be addressedin light of our short-term and long-term fiscal situation. Ourcurrent debt is manageable, and we can afford projected deficitsfor several years, but our structural deficits place us on apath of debt growth that is unsustainable, largely because ofhealth care programs. The sooner we start to rein in healthcare spending, the less painful the changes may be (since slowingspending now will help us avoid drastic cuts in the future),and the more time we will have to find the most effective strategies.Physicians and the health care community must play a strongrole in this process, preparing their practices for the inevitablechanges that will come as we address spending growth and helpingto identify clinically informed strategies that permit qualityto improve in an environment of slower spending growth.