February 16, 2006
js-4052
Speech to Hartford Area Business Economists
Assistant Secretary Mark J. Warshawsky
The US Economy and the Administration's Health Care Policies
In recent years, the economy's resilience in the face of a range of unprecedented shocks has been perhaps its most outstanding characteristic. That resilience was evident once again this year in the face of the energy price shock generated by the Gulf of Mexico hurricanes. Despite, at times, record high oil prices, the expansion has continued with solid growth of real GDP, steady job creation, and low core inflation. The economy remains well-positioned to maintain healthy economic and employment growth with benign inflation.
The year 2005 marked the fourth straight year of expansion and, in our view, economic performance was right on target. Real GDP grew 3.5 percent on an annual average basis, in line with the Administration's projection of 3.6 percent growth made at the beginning of the year. Personal consumption expenditures grew by 3.6 percent while business investment in equipment and software rose at a double-digit pace for the second straight year. Residential building was a source of strength again in 2005: housing starts hit a 33-year high, and single family homes sales posted a fresh record. The economy generated 2 million jobs in 2005, and the unemployment rate trended down throughout the year.
This performance was particularly remarkable given the continued hike in energy prices. The energy component of the consumer price index rose by 17 percent during 2005 for the second straight year, as hurricanes battered oil- and gas-producing facilities in the Gulf of Mexico. While headline consumer price inflation was 3.4 percent last year, core price inflation (excluding food and energy) remained low at 2.2 percent, the same as in 2004. The ability of the economy to grow strongly in the face of the energy price increases without these costs being passed into other prices is a tribute to the flexibility and ingenuity of American business. The economy recovered quickly from the hurricanes and the related spike in energy prices and is now on firm footing.
Although real gross domestic product rose by a fairly modest 1.1 percent annual rate in the fourth quarter, a deeper look at the GDP numbers shows that growth was restrained by a number of special factors. Real consumer spending slowed sharply after employee pricing incentives in the auto industry pulled motor vehicle sales into the third quarter; oil imports surged to replace domestic oil production disrupted by the hurricanes; and defense spending plunged temporarily because of budget and accounting issues. All of these developments are expected to be transitory. Indeed, consumer spending already appears on track for a significant rebound in the first quarter of 2006, oil imports are slowing as domestic production comes back on line, and the drop in defense spending is unlikely to be repeated.
Labor market statistics for January were favorable. The economy created 193,000 jobs in January, and job gains have averaged 229,000 in the three months since October. From the low point in labor market activity in August 2003, the economy has generated almost 4.8 million new jobs. The unemployment rate dropped to 4.7 percent in January, the lowest since July 2001.
The recent data on labor earnings has also been good. Real average hourly earnings of production and non-supervisory workers increased 1.6 percent during the last three months of 2005, when declining energy prices lowered the overall CPI inflation rate. The longer-term trend in real hourly earnings is positive: real average hourly earnings are up 1.5 percent since December 2000. During the same period in the previous business cycle, real average hourly earnings were down 2.5 percent.
A more comprehensive measure of labor compensation published by the Bureau of Labor Statistics is the Employment Cost Index, which allows us to separate the compensation package into wages and salaries, and benefits. For private industry workers, total compensation grew 3.0 percent over the four quarters of 2005, down from 3.8 percent during 2004. Wages and salaries increased 2.5 percent during 2005, an improvement over the 2.4 percent rise in 2004. The slowdown in overall compensation was due to a deceleration in benefit costs from 6.9 percent during 2004 to 4.1 percent last year, the lowest rate since 1999. Growth in employer contributions for health insurance slowed from 7.3 percent during 2004 to 6.4 percent during 2005.
Benefit cost growth has exceeded wage and salary growth every year since 1999, taking a progressively larger bite out of the overall compensation package and leaving a smaller share for wages and salaries. In the third quarter of 2005 – the latest data available – wages and salaries accounted for about 70 percent of labor compensation, compared with about 72.5 percent in 1999. Health care costs made up about 5.8 percent of total compensation in 1999 but have jumped to 7.6 percent of compensation in the latest data.
The rise in benefit costs poses a problem for employers, employees, and government alike. For employers, benefit costs put upward pressure on the whole business cost structure, and potentially reduce profits, which immediately affects stockholders and could reduce expansion plans. For employees, as businesses resist raising the overall compensation package, the effect of rising benefit costs is a reduction in discretionary income. Government also faces significant costs not only for its employees but also for citizens covered by Medicare and Medicaid. Getting a handle on rising health care costs poses a special challenge for policymakers, but also an opportunity to raise worker discretionary income, reduce downward pressure on profits, and control government costs.
This is a long-term challenge. Health care cost growth has been exceeding GDP growth by two percentage points annually since 1940. Health care spending currently stands at 16 percent of GDP, and it is predicted to come to 18.7 percent of GDP by 2014. Thus, the strain of high and rising health care costs on the government, among employers, and on consumers is not projected to go away anytime soon. And if we do not begin to face these challenges, the strain on our society will become far worse than anything we are seeing today. Over the next 75 years, the Medicare program is expected to cost taxpayers $29.7 trillion more than the revenue dedicated to it; that's 4.7 percent of the GDP over that time period. Thus, we have to begin to find ways to reduce the growth of unproductive health care spending while preserving the incentives for the health care sector to innovate to provide people with longer and healthier lives.
We are already witnessing one important consequence of rapidly rising health insurance costs in the continued erosion of the group health insurance market, particularly in the small group market. According to the Kaiser Family Foundation's annual survey, nearly 100 percent of firms with 200 or more workers offer health insurance to their employees, yet only 59 percent of firms with between 3 and 199 workers do, a drop of 9 percentage points from 2000. Rising health insurance costs and concerns about access are a significant public policy challenge. The experience of the early 1990s showed that the American public has little appetite for a wholesale overhaul of the health system to fix the gaps in insurance coverage. In addition, this Administration is very cognizant of the problems that ensue when the government crowds out the private sector. Therefore, the Administration is proposing a set of incremental reforms that will help restrain health care spending and help people get and maintain insurance coverage despite income, health, or employment shocks.
Many of the proposals are anchored in the expansion of health savings accounts, and because HSAs are a relatively new product innovation, I would like to explain a little about what these accounts are and why the Administration believes they hold promise.
Health savings accounts are accounts that individuals can contribute tax free to save for future medical expenses. Contributions can be made to them as long as you have an HSA-qualified high-deductible health plan, what I'll call an HDHP, a comprehensive health insurance policy with deductibles of at least $1,050 for self-only coverage and $2,100 for family coverage. Annual out-of-pocket expenses associated with the HDHP are limited to $5,250 for self-only coverage and $10,500 for family coverage. Annual contributions can currently be made up to the amount of the deductible. Withdrawals from the HSA can be made, tax free, at any time for qualified health expenses, which includes most out-of-pocket medical expenses. Thus, someone with an HDHP can contribute, every year, an amount equal to the deductible to his HSA and use those funds, which are exempt from income taxes, to meet the deductible. Any amount remaining in his HSA at the end of the year is rolled over to future years, to be used for future health care expenses.
The reason we believe these accounts should be encouraged is to correct the distortions created by the tax code that incent an inefficiently large amount of sometimes wasteful health care consumption, and to help people better plan for future health care needs.
The tax code encourages health insurance take-up by allowing employer contributions to insurance premiums to be excluded from taxable income. The combined income and payroll tax deductibility leads to discounts for health insurance of over 40 percent in some cases relative to other forms of consumption. The effect of this is to encourage over-insurance among the working population, so that people are encouraged to purchase insurance through their employers that has generous coverage and little cost-sharing.
This trend wipes out any notion of a market for routine or non-emergency expenses. The "first-dollar" or close-to-it structure of employer provided coverage – a structure induced by rational responses to tax incentives - leads to over-consumption of health care. Because of the coverage, people make health care decisions without comparing the price of the good or service to the benefit they receive from it.
HSAs reduce the incentive to purchase overly generous health insurance by equalizing the tax treatment of out-of-pocket expenses and covered care. If routine or non-emergency expenses purchased out-of-pocket are taxed the same way routine expenses are under health insurance, then the demand for insurance coverage for those goods and services falls, and people will consume those services in a way that takes into account the price and benefit they receive. HSAs still encourage insurance take-up, but they also discourage over-insurance that effectively removes market signals from the health care sector and inefficiently drives up the price of health care. Obviously, people may have concerns about whether individuals will stop getting needed care once they are in an HDHP. The famous RAND health experiment of the 1970s found that people in high deductible plans had 40 percent lower expenditures than those who paid no deductible, but there were no measurable differences in health status. This evidence suggests that people can distinguish between low value care and high value care at low levels of expenditures.
And because I have already spoken at length about the burdens associated with the rising cost of health insurance, I would like to bring up another characteristic of HSAs that often gets lost in discussions--that they actually encourage savings for future health care needs. Obviously, the funds in an HSA can be used to pay for health care consumed while enrolled in a health plan to meet the deductible or to pay for coinsurance. But after accumulating, they can serve as savings that may insulate an individual from the shock of losing employer-sponsored health insurance.
The uninsurance rate is twice for the unemployed than it is for the employed, and less than a quarter of the COBRA-eligible population takes up COBRA coverage. It's no surprise, with average family insurance premiums now exceeding $10,000 a year that someone without employment would forego health insurance. With health care consuming 16 percent of the economy, public policy is finally recognizing and addressing the shock of losing one's employer-sponsored health insurance subsidy by giving people an incentive to save for that possibility, because HSA-accumulated funds may be used to pay for COBRA premiums or for someone receiving unemployment insurance to pay for health insurance premiums on the individual market. Or, for that matter, to purchase long-term care insurance to insulate against post-retirement health shocks.
With the benefits of HSAs in mind, the Administration has crafted a set of proposals to further encourage HSA/HDHP participation. The Administration is proposing that the limit on annual HSA contributions be raised from the deductible to the policy's out-of-pocket maximum. Next, the Administration proposes full income tax deductibility of premiums on all HSA-qualified policies, whether the premiums are paid for by an employer or by an individual. These proposals are designed to encourage people to move into HSA-qualified plans, for the reasons I outlined above, and to encourage health insurance take-up by people without group insurance. This is important because millions of taxpayers have no access to health insurance through their employer. Small business owners are also not on equal footing with workers who get their insurance through the employer system.
A further expansion of deductibility being proposed by the Administration would allow for an income tax credit equivalent to the payroll tax on premiums for HSA-qualified plans and HSAs, whether the plan is purchased on the individual or group market. This, we hope, will make health insurance more affordable to the low-income populations -- groups that often have significant payroll tax liability but little income tax liability. Another proposal to help the low-income population has been in the President's budget for several years. It is a refundable tax credit to help low-income people purchase health insurance on the individual market. As structured in this year's budget, low-income families could get up to $3,000 in a refundable tax credit to purchase HSA-qualified insurance. If enacted, we believe the tax credits will be a significant help to low-income individuals who would otherwise be unable to afford health insurance.
Taken together, we expect these proposals to increase take-up of HDHP/HSA plans from a projected 14 million to 21 million by 2010.
The Administration is not only looking at HSA expansions to address the shortcomings of the health insurance market. One of the major changes accompanying the run-up in health care costs is the greater emphasis on treating people with chronic health problems, who now account for 75 percent of the health care expenses in this country. This group, of course, is more difficult to insure because of their predictably high expenses.
One new proposal in this year's budget to help these people get health insurance coverage is a new fund of $500 million annually that would provide competitive grants to up to ten states to find innovative ways to increase health insurance coverage among the chronically ill. States are trying various approaches to cover the chronically ill, such as with high risk pools and reinsurance, and the Administration believes these grants can accelerate the process of testing other solutions to covering the chronically ill.
Another new idea that we are developing is one that would allow greater portability of health insurance. Although COBRA and HIPAA provide some portability, the Administration would like to go further to allow people to maintain the same health insurance policy regardless of their employment status. We recognize that this is not an easy undertaking, but the payoff is potentially great. Workers would no longer fear losing insurance coverage if they left a job that provided it, reducing job lock and improving long-term access to the health insurance market.
In a world in which people assume more responsibility for their health care expenses, they need better information about prices and quality to make more informed decisions. The Administration is encouraging private providers of health care to publicize information that allows consumers to make informed decisions. And the Administration is using public programs to help collect quality information, through programs like the hospital quality reporting program in Medicare. I'd also like to point out that we are impressed by the efforts of private insurers like Aetna, who are making price and quality information more available to their enrollees.
And while we believe it is important for consumers to have better information about quality, we also believe the government has a role in promoting quality itself. One of the greatest opportunities for improving health care quality, reducing errors and unnecessary tests and procedures, and lowering costs is through the greater application of health information technology. We've got 21st century clinical care, but a 19th century paperwork system. The Administration is pursuing a broad range of policy initiatives to further the President's vision of widespread adoption of electronic health records within 10 years.
The policy initiatives underway include demonstrating success with high-tech electronic health record systems for the Veterans and Defense communities, removing regulatory barriers, establishing standards for health data transmission, and certifying health IT systems to high standards of interoperability, privacy, and functionality. Guiding this agenda is the American Health Information Community, of which I am fortunate to be a member. We are a group of government officials, health care professionals, and business executives who are giving HHS recommendations on how to implement electronic health records smoothly and effectively.
In conclusion, I would like to emphasize that the situation we find ourselves in -- high, rising health care costs, some people consuming too much health care, while others are consuming too little -- is not hopeless. And there are many features about our health care system -- innovation, widespread availability of technological advances, strong degree of consumer choice of providers and treatment -- that are worth preserving. We need to address the shortcomings in the health care system so as to make business and government finances sustainable now and in the long-run.