payment-rate reductions

The Real Medicare Trustees’ Report

The headline news from today’s release of the 2011 Medicare Trustees’ report is that the Hospital Insurance trust fund is scheduled to be depleted in 2024, five years earlier than projected in last year’s report. The primary reason for the erosion in the condition of the trust fund is, apparently, the anemic economic recovery. It’s even worse than what was projected just a few months ago.

But important as this information appears to be, it’s really not the most important information found in the report. To get that, one needs to skip past all the mind-numbing tables and graphs to the final few pages, specifically page 265. There you will find a “Statement of Actuarial Opinion,” signed by the Chief Actuary of the program, Richard Foster. And in that statement, Mr. Foster once again warns the public not to rely on the information provided in the preceding 264 pages.

Why? Because Obamacare’s arbitrary, across-the-board cuts in what Medicare pays for services will force a large portion of health care providers to stop seeing Medicare patients. When that occurs, Medicare would be insurance in name only, as the enrollees would have a terrible time actually getting the care they need.

Here’s how Foster puts it:

By the end of the long-range projection period, Medicare prices for hospital, skilled nursing facility, home health, hospice, ambulatory surgical center, diagnostic laboratory, and many other services would be less than half of their level under the prior law. Medicare prices would be considerably below the current relative level of Medicaid prices, which have already led to access problems for Medicaid enrollees, and far below the levels paid by private health insurance. Well before that point, Congress would have to intervene to prevent the withdrawal of providers from the Medicare market and the severe problems with beneficiary access to care that would result....

For these reasons, the financial projections shown in this report for Medicare do not represent a reasonable expectation for actual program operations in either the short range (as a result of the unsustainable reductions in physician payment rates) or the long range (because of the strong likelihood that the statutory reductions in price updates for most categories of Medicare provider services will not be viable). I encourage readers to review the “illustrative alternative” projections that are based on more sustainable assumptions for physician and other Medicare price updates. These projections are available at

Unfortunately, the alternative scenario referenced by Foster in his statement does not yet appear to be available on the CMS website. When it is available, it will almost certainly resemble the alternative projection released at the time of last year’s trustees’ report, which effectively showed that, using realistic assumptions, Medicare’s finances are no better off now than they were before Obamacare was enacted.

Indeed, the program is actually far worse off now because of the shameless double-counting in Obamacare. The Medicare cuts — unrealistic as they are — were used to partially “pay for” massive new entitlement promises to 32 million more Americans. When the Medicare cuts inevitably melt away, the entitlement promises made to millions of other Americans will not. The result will be that the federal government will go even deeper into debt, making it that much harder to find a way meet future Medicare obligations.

Even before Obamacare was enacted, the nation’s most difficult long-term economic challenge was runaway entitlement spending. Obamacare is more gasoline on what’s already a raging fire. The law included no real reform of Medicare or Medicaid. It simply doubled down on the failed model of command-and-control payment rate reductions. Those have never worked before to make the programs sustainable, and they won’t work this time either.

[Cross-posted on Critical Condition]

posted by James C. Capretta | 5:41 pm
Tags: Medicare Trustees, Richard Foster, payment rate reductions
File As: Health Care

“Fiscal Consequences of the Health Care Law”

[NOTE: Last week, on January 26, 2011, I testified before the U.S. House Committee on the Budget in a hearing on the new health care law. Anyone interested in watching the hearing can find video here courtesy of C-SPAN; my testimony starts around 56 minutes in. The complete text of my testimony as prepared appears below.]

Mr. Chairman, Mr. Van Hollen, and members of the Committee, thank you for the opportunity to participate in this very important hearing on the fiscal consequences of the health care law.

The most serious threat to the nation’s long-term prosperity is projected large fiscal deficits over the years and decades ahead. And the main reason the nation’s budget deficits are expected to remain at dangerously high levels for the foreseeable future is because of the rapid growth of entitlement spending.

Importantly, entitlement spending was a problem even before the enactment of the Patient Protection and Affordable Care Act (PPACA). In 1975, the combined cost of Social Security, Medicare, and Medicaid was 5.4 percent of GDP. In 2009, these entitlement programs cost 10.1 percent of GDP.

That jump in spending — 4.7 percent of GDP — is the main reason it is so difficult to bring the nation’s budget closer to sustainable fiscal balance. Every year, we are spending more and more to fulfill entitlement promises made years and decades ago, leaving less and less to finance other priorities, even as the growing levels of entitlement spending puts enormous pressure on taxpayers.

And we haven’t even hit the really rough patch yet. Over the coming two decades, the United States will undergo an unprecedented demographic transformation, as the baby boom generation moves from its working years into retirement. The number of Americans age 65 and older will rise from 41 million in 2010 to 71 million in 2030. As these baby boomers enroll in Social Security and Medicare, costs will soar.

We were therefore already racing toward a budget and entitlement crisis before the health care law was considered and passed. Indeed, for the proponents of the legislation, that became a primary argument for its enactment. The president argued that his health care plan would begin to address the entitlement problem, at least from the perspective of the health programs. “Health reform is entitlement reform” was the catch-phrase.

But is that really the case? Did the new health care law ease the entitlement and budget crisis, or did it make matters even worse? That is the crucial question, and this Committee should be commended for taking it up as one of the first items for discussion in this new Congress. I believe the evidence is overwhelming that the new law will make matters not better, but far worse.

The most noteworthy characteristic of the new law is that it is the largest entitlement expansion since the 1960s. So, at a time when the federal budget is already buckling under the weight of existing entitlement programs, the new law stands up three new ones which will enroll tens of millions of Americans into taxpayer-financed programs promising permanent access to uncapped benefits. Moreover, spending on these new entitlements is expected to grow at rates that are above the level of growth of the economy or general inflation.

How then does a new law which increases spending by nearly $1 trillion over the period 2010 to 2019 reduce the federal deficit (by about $130 billion over ten years according to the Congressional Budget Office and by a modest amount in the decade after that)? The only way is by raising taxes and cutting spending by amounts in excess of the new spending commitments. According CBO’s estimate of the final legislation, spending reductions will bring the net increase in spending down to about $430 billion over the next decade. The tax hike to pay for this spending will total about $560 billion over the same period.

Thus, although the legislation has often been described by proponents as a deficit reduction measure, it might be more accurate to say that it is a very large spending bill, offset, at least on paper, by even larger tax increases.

But even these numbers do not tell the whole story. It is also important to look carefully at the assumptions underlying these estimates to determine if the promised deficit reduction will occur in reality, or just on paper. There are a number of reasons to be very skeptical in this regard.


The argument that the new law reduces the federal budget deficit over the coming decade rests in large part on the supposed deficit reduction from the creation of the Community Living Assistance Services and Supports Act, or CLASS Act, which is a new long-term care insurance entitlement program. CBO’s estimate assumes that $70 billion in supposed deficit reduction through 2019 is to come from the CLASS Act.

But, in truth, the CLASS Act is another budgetary time-bomb waiting to explode, not a solution that produces deficit reduction. In the short term, because the program is brand new and no one is eligible for benefits until they have paid in for five years, premiums are collected and no benefits are paid — producing what appears to be a temporary surplus. But beyond the visible ten-year window, those premiums are needed to pay long-term care insurance claims.

Moreover, every actuarial analysis done on the program indicates it will suffer from severe adverse selection. That is, it will attract mainly enrollees who expect to need the benefit. The result is that individual premiums are likely to be quite high because too few healthy workers will enroll. Overall premiums will fall well short of what is needed to cover the implicit benefit promises. Pressure will then build for a future taxpayer bailout to avoid imposing cuts on the vulnerable citizens who elected to enroll and pay premiums. In short, this program is not going to solve our entitlement crisis. Indeed, it is a perfect illustration of why federal entitlement spending is our central budgetary problem.

Disequilibrium in Federal Insurance Subsidies 

The new law promises members of households with incomes between 135 and 400 percent of the federal poverty line new premium subsidies if they get their coverage through the new state-run “exchanges.” Census data show that today there are about 111 million Americans under the age of 65 who are living in households with incomes in that range. But CBO estimates that only 19 million people will be getting the new premium assistance in 2019. They assume the other 90 million Americans will stay in job-based plans.

If that were really to happen, it would be terribly unfair. As Stephanie Rennane and Eugene Steuerle of the Urban Institute have documented, the new premium subsidies in the exchanges are worth far more to low- and moderate-wage workers than today’s federal tax preference for employer-paid premiums (see Chart 1). For instance, a household of four with compensation of $60,000 in 2016 would get $3,500 more in government assistance if they moved from employer coverage to an exchange. The extra subsidies would be even more for lower wage workers.

The new law thus sets up a situation where two families with identical compensation totals from their employers can get very different levels of federal support depending on where they get their insurance.

In my judgment, that’s not likely to be a politically stable situation. Pressure will build on elected leaders to treat every American equally. That is likely to lead to regulatory and legislative decisions making it easier for workers now in job-based plans to migrate to the exchanges.

Over time, what is likely to happen is that those who would be better off in the exchanges will end up there, one way or another, even as higher wage workers retain the tax advantage for job-based coverage. As the labor market segregates, costs will soar well above the $1 trillion in new spending over ten years currently projected for the law.

AMT-Like Bracket Creep

The new law relies heavily on tax increases to cover the new entitlement spending. According to CBO’s latest long-term budget projections, by 2035, the tax increases in the new law will collect revenue equal to 1.2 percent of GDP, which is very substantial. In today’s terms, that’s a $180 billion tax increase, every year.

How can that be, given that the tax hikes do not go nearly that high in the first decade? The answer is AMT-like bracket creep. The new tax on high-cost insurance plans, sometimes called the “Cadillac” tax, applies to policies with premiums for families above $27,500 in 2018. That threshold will only grow with general consumer inflation in 2020 and beyond, not growth of health costs. Thus, by 2030, the tax will be binding on many millions of Americans’ insurance plans.

Similarly, the new Medicare taxes on wages and other sources of income apply only to individuals with incomes above $200,000 per year beginning in 2013 ($250,000 for couples). But those income thresholds are fixed; they won’t rise with inflation at all. In very short order, that means these taxes will begin hitting middle-class Americans with massive tax hikes. By 2030, inflation will have eroded the $200,000 threshold so that it is the equivalent of $130,000 today (assuming 2.5 percent annual inflation).

The Medicare Payment Rate Reductions

The largest spending reduction in Medicare comes from automatic reductions in the inflation updates for hospitals and other institutional providers of care. The notional rationale is that these cuts represent productivity improvement in the various institutions getting Medicare payments. The reductions, amounting to a 0.4-0.5 percentage point reduction off the normal inflation update for Medicare payments, will occur every year, in perpetuity. The compounding effect of doing this on a permanent basis would be massive savings in Medicare — if they really were implemented. CBO says the cuts will generate $156 billion over the first decade alone.

But there are strong reasons to suspect these cuts will not be sustained. Medicare’s actuarial team, led by Richard Foster, has warned repeatedly that these cuts are not viable over the medium and long-term because they would jeopardize access to care for seniors. The cuts would push average Medicare payments to levels that are below what Medicaid is expected to pay, and the network of providers willing to take care of Medicaid patients is notoriously constrained. It is hard to imagine political leaders allowing Medicare to become less attractive to those providing services than Medicaid is today.

It’s worth noting here that these cuts in payment rates do not constitute “delivery system reform,” which the administration has often stated is what it is trying to achieve with the Medicare changes in the new law. These cuts in inflation updates will hit every institution equally, without regard to whether or not the institution is treating its patients well or badly. The savings that are expected from other reforms, such as Accountable Care Organizations, are minor by comparison.

The Budgetary Effect of Tax Hikes and Medicare Cuts in a Second Decade 

The administration and others have noted frequently that CBO’s cost estimate indicates the possibility of modest deficit reduction in the second decade after 2019 (although CBO notes that such an estimate carries more uncertainty than its ten-year projections). But the expectation of long-term deficit reduction is entirely dependent on huge spending reductions from the Medicare inflation cuts and from more and more middle-class Americans paying higher taxes under the new law’s tax provisions.

As shown in Chart 2, the tax hikes from the new law plus the savings from the “productivity adjustment” in Medicare would generate about $180 billion in “offsets” in 2020. By 2030, the spending cuts and tax hikes from these provisions will have more than tripled, to over $600 billion. If these taxes and spending cuts do not materialize, the new law will be a budget-buster of significant proportions.

Debt Subject to Limit

Both CBO and the Medicare actuaries have both noted that the Medicare cuts and payroll tax hikes which are supposed to improve the solvency of the Medicare hospital trust fund in the new law can only be counted once, not twice. Here is how CBO put it in a Director’s blog post from December 2009:

“To describe the full amount of HI trust fund savings as both improving the government’s ability to pay future Medicare benefits and financing new spending outside of Medicare would essentially double-count a large share of those savings and thus overstate the improvement in the government’s fiscal position.”

In other words, these taxes and cuts in Medicare either improve the government’s ability to pay future Medicare claims, or they pay for a new entitlement program — but not both.

One way to see that clearly is by looking at the impact of the health care law on debt subject to limit. According to CBO, the new law will increase that debt, by about $230 billion over the coming decade, because the Medicare tax hikes and spending cuts are double-counted instead of devoted to deficit reduction.


Mr. Chairman, you and your colleagues on this committee face a daunting challenge. The nation is rushing rapidly toward a fiscal crisis, driven by excessive borrowing and debt. Even before the health law was enacted, it was necessary to reform the nation’s entitlement programs to bring spending commitments more in line with what the country can afford. Now, with enactment of the health law, the climb to a balanced budget got much steeper.

The solution is to start by unwinding what was just passed and replacing it with a program that constitutes genuine entitlement reform.

posted by James C. Capretta | 1:44 pm
Tags: Paul Ryan, House Budget Committee, Obamacare, CLASS Act, payment-rate reductions, CBO
File As: Health Care

The Debt Commission and Obamacare

The president’s debt commission had its first meeting this week, and all of the talk was of getting serious about putting our fiscal house in order, with everything “on the table” for consideration.

There’s no arguing with the need to get serious. According to the Congressional Budget Office (CBO), if the Obama budget were adopted in full, just the interest on the national debt would exceed $900 billion in 2020 and consume one out of every five dollars in federal revenue. To put that in perspective, in 2007, before the financial crisis hit with full force, interest payments on debt stood at $237 billion, or just 9 percent of total tax collections. A sudden and steep rise in the percentage of governmental revenue dedicated to servicing past excess consumption is a clear warning sign to lenders and credit-rating agencies that a country’s finances are approaching the point of no return.

Unfortunately, the timeline for taking corrective action may have shortened even in the past few weeks and days. What began as a slow-motion crumble of Greece’s economic house of cards is now threatening to become a serious global crisis. The flight from sovereign debt risk is now spreading to other vulnerable, highly leveraged countries, including Portugal, Ireland, and Spain. The implications for European economic recovery are ominous. And, if Europe’s economy slides backward again into a deep recession, no part of the global economy will be completely spared from the fallout, including the United States.

So we are long past the point when national leaders should have been sitting down together to hammer out a budget framework to avert the crisis everyone could long see coming. Indeed, one might have thought it would be the first order of business for a newly elected president of the United States.

But it wasn’t. Instead, President Barack Obama decided to spend 2009 using unusually large Democratic majorities in the House and Senate to jam a partisan and highly polarizing health care bill through the Congress. No Republican supported the measure, in large part because it vastly expanded federal entitlement commitments at the very moment when it was abundantly clear that the existing entitlements are the problem.

With the health legislation signed into law over the objections of a united Republican party, the president now wants Republicans to help him finance the newly enlarged welfare state.

Of course, the commission itself is a transparent maneuver to pass the buck in an election year. Voters are beyond fed up with the massive spending spree taking place in Washington. To every hostile question Democratic candidates will get in coming months about the exploding national debt, they are therefore planning the following answer: we’re waiting for the commission to make its recommendations in December. Never mind that Democrats control the White House and Congress. If they wanted to cut the budget, they could certainly do so, starting right now. Instead, they will try to use the appointment of a non-binding commission to create the appearance of a proactive agenda.

For the commission itself, the elephant in the room is Obamacare. Former Senator Alan Simpson, the co-chair of the commission, says the president has agreed that even the health law is “on the table” for discussion.

That’s good, if he means it. Because it is not possible to write a durable, bipartisan budget framework with health spending written entirely according to one party’s formulation.

Health care remains the largest problem in the nation’s long-term budget outlook, even after enactment of the health bill. On paper, the bill makes massive cuts in Medicare. But all of the supposed savings would go toward standing up a new entitlement that costs even more than the savings. So, health entitlement spending expands under the legislation, not contracts.

Moreover, the Medicare savings are from arbitrary payment-rate reductions. OMB Director Peter Orszag continues to argue the health law lays the predicate for cost-control through painless efficiency improvement in the delivery of medical services. But that’s either a smokescreen or the most alarming kind of wishful thinking. The “delivery system reforms” in the legislation are at best small pilot projects that will amount to very little. Certainly CBO assumed no savings from them. Neither did the chief actuary of the Medicare program.

The real cuts in Medicare come from reductions in payment rates. The cuts apply to all providers, across-the-board. There’s no attempt to calibrate based on the quality of the patient care or performance. If the debt commission takes Obamacare as a given when looking for additional savings in health care, it will inevitably fall into the same trap. To find quick and “scoreable” savings (that is, savings that CBO will recognize), the easiest thing to do is to further ratchet down payment rates and pretend the cuts will solve the budget problem. Going down that road would be a disaster for the quality of American medicine and would not provide a lasting solution.

What’s needed in American health care is a dynamic marketplace that drives up the productivity of those delivering medical services. That’s the only way to cut costs without harming quality. That’s genuine delivery system reform. Building such a marketplace requires, first and foremost, cost-conscious consumers, which in turn requires fundamental reform of the health entitlement programs and the tax treatment of health insurance. Fortunately, Congressman Paul Ryan’s roadmap has already shown us the way.

Like it or not, the budget debate remains in large part a health-care debate. Obamacare settled nothing because it did not solve the health care cost problem. It papered it over with price controls.

posted by James C. Capretta | 5:20 pm
Tags: debt commission, debt, Alan Simpson, Greece, Peter Orszag, CBO, payment-rate reductions
File As: Health Care