Congressional Budget Office
Robert A. Sunshine, Acting Director
Director’s Blog

Today we released a paper on updated long-term projections for Social Security. (Our last long-term projection for social security was included in the December 2007 Long-Term Budget Outlook.) As CBO has highlighted in previous reports, the number of Social Security beneficiaries will grow considerably as the baby boomers become eligible for retirement benefits. Absent legislative changes, spending for the program will therefore climb substantially and exceed the program’s revenues. CBO projects that the 75-year actuarial imbalance in the program amounts to 0.38 percent of GDP, or 1.06 percent of taxable payroll.

The projections released today differ somewhat from earlier results because of newly available programmatic and economic data, updated assumptions about future demographic and economic trends, and improvements in CBO’s models. For example, these projections assume that future immigrants will be younger and more numerous than was assumed in 2007. (This change was included in the 2008 Social Security trustees’ report; CBO adopts the trustees’ aggregate demographic assumptions.) As a result of this and other changes, CBO projects somewhat smaller future deficits than we did in our 2007 projections.

CBO’s long-term Social Security projections have always shown both a point estimate and the range within which 80 percent of the possible values are likely to fall. In this update, however, CBO has expanded its uncertainty presentation. Many figures and tables still show the 10th and 90th percentiles of various measures, but new presentations show the probabilities of specific outcomes.

Here is an example of our new presentation. A table in today’s report shows the probability that Social Security outlays will exceed revenues by a specified percentage of GDP in a selected year. For example, the likelihood that outlays will exceed revenues in 2030 is about 97 percent, CBO projects, and there is almost a 50 percent chance that the gap will be larger than 1 percentage point of GDP; the chance of its being 2 percentage points (or more) of GDP is only 6 percent.

Another new table shows the probability, for different birth cohorts, that the Social Security trust funds will be sufficient to pay specified percentages of scheduled benefits. According to CBO’s projections, the 1940s cohort, for example, is virtually certain to receive all of its scheduled first-year benefit. The 1990s cohort has only a 32 percent chance of receiving all of its scheduled first-year benefit but an 84 percent chance of receiving at least 70 percent of that benefit.

Both the analyses that show 10th and 90th percentiles and the new presentations are based on the same underlying data, but we hope that the different perspectives will help to communicate uncertainty more fully to readers.

I was on a panel this morning at the Aspen Ideas Festival on the future of health care reform. For video from the panel, see here .

During a session earlier in the conference, David Brooks delivered an important talk about how policymakers should pay more attention to neuroscience, emotion, peer effects, and other related factors in the design of public policies. Many of his themes are echoed in, and reflect, the growing field of behavioral economics (see here for a related discussion).

RAND researchers recently sent me a letter and an attachment , which they have circulated to others, commenting on CBO’s analysis of a recent RAND health IT study. Our analysis is summarized here and the full analysis is here . As I have noted previously, I will occasionally use this blog to respond to critiques of our work, and that is the purpose of this entry.

The RAND study estimated potential savings of approximately $80 billion per year from health IT if it were widely adopted. As CBO concluded in its recent report, however, that $80 billion figure is not an appropriate guide to the effects of legislative proposals aimed at increasing the use of health IT for several reasons. For example, the RAND study attempted to measure the potential impact of the widespread adoption of health IT — assuming the occurrence of “appropriate changes in health care” — rather than the likely impact, which would take account of factors that might impede its effective use. In addition, the RAND study was based solely on empirical studies from the literature that found positive effects for the implementation of health IT systems; it excluded studies of health IT that failed to find favorable results.

Nothing in the RAND letter would cause us to modify our previous conclusions. The letter emphasizes that the RAND study was published in a peer-reviewed journal (Health Affairs ), was implemented with the advice and review of a steering group of experienced and respected professionals, and was carried out with transparency with respect to its methods and assumptions. CBO did not, though, criticize the report for failing to be peer-reviewed, having inappropriate leadership, or lacking transparency. Our concerns are instead based on the substance of the study itself — especially the questions it was designed to answer — and perhaps more importantly how it has been used in the policy debate. (Similarly, CBO did not criticize the RAND study for being funded "by companies interested in health information technology." The issue we addressed is instead the analysis itself and how that analysis has been presented in policy circles.)

The letter also argues that CBO did not take account of other possible benefits of adopting health IT beyond those considered in the RAND report (such as improvements in health and safety), and that those benefits imply that RAND’s estimate of savings is conservative. In our paper we specifically identified the sources of savings considered in the RAND study and also described some other possible areas of savings. For example, our paper stated that “One significant potential benefit of health IT that has thus far gone relatively unexamined involves its role in research on the comparative effectiveness of medical treatments and practices.” However, we also recognized that obtaining those benefits would require a number of steps beyond merely a greater diffusion of health IT. For example, it would require creating databases, commissioning studies, and then most importantly using the results of those studies to alter the practice of medicine. In other words, much more would have to change to obtain these benefits than just the adoption level of IT.

Another area of confusion appears to be the question of the appropriate counterfactual: that is, what are the scenarios one is trying to compare when evaluating the impact of health IT? For our work at CBO, we compare what would happen under a proposed piece of legislation with what would happen if current laws remained in place. RAND’s $80 billion savings estimate, by contrast, is generated by comparing the level of adoption in 2004 with the level of adoption attained in a future year if IT were to follow a diffusion pattern that has been observed in other industries. Even if we agreed with other assumptions and calculations that led RAND to the $80 billion estimate (which we do not), we believe that health IT will continue to diffuse under current law, so that the appropriate calculation for our purposes is to compare savings under a new law with savings under the current-law pattern of diffusion. The point matters because health IT in the future will almost certainly have attained greater adoption rates than had occurred in 2004. Indeed, in a different RAND study, the authors compared savings under a baseline of continued adoption with a subsidy program that would speed adoption by 50 percent. That study’s estimate of the impact of the subsidy program follows more closely the approach that CBO would take.

Our published analysis covers, in more detail, the other technical reasons why we believe that the RAND study’s estimates overstate the cost savings from policy interventions to increase the adoption of health IT.

Finally, we very much appreciate and value the input that outside reviewers provide as we prepare our reports. As I have noted in a previous post , the fact that someone is listed as a reviewer of our paper in no way implies that the reviewer agrees with the analysis in the paper.

CBO released an issue brief today on different approaches for splitting the projected growth in the costs of the major federal health care programs into “excess cost growth” and demographic effects (these two factors reflect, respectively, rising costs per beneficiary and the number and age of beneficiaries). For more information about CBO’s projections of long-term health care costs, see here.

The key points of the issue brief are:

• If health care costs per beneficiary grew at the same rate as per capita gross domestic product (GDP) and the age distribution of the population did not change, Medicare and Medicaid spending would remain a constant share of the economy. In reality, however, health care costs per beneficiary will grow more quickly than per capita GDP and the population will age.

• Although many observers portray aging as the dominant cause of future growth in federal spending on Medicare and Medicaid, most of the increase that CBO projects reflects rising costs per beneficiary rather than rising numbers of beneficiaries. The effect of population aging is smaller but still results in substantial spending growth. Rising costs and population aging also interact with each other: The rapid growth of health care costs is a more important factor when the population is aging over time; conversely, population aging looms larger when health care costs are rising over time.

• Understanding the relative contributions of those two factors to the growth in federal spending on Medicare and Medicaid is important. The aging of the population, which has a smaller impact on spending growth, cannot be easily influenced by policy changes, but efforts can be made to stem the rising costs per beneficiary relative to per capita GDP—by far the larger factor in spending growth in the two programs.

• To estimate the relative contributions of the two factors, CBO based its projections on three sets of reasonable assumptions. Regardless of the assumptions and methods used in the projections, the results were basically the same: More than half of the growth in federal spending on Medicare and Medicaid is attributable to health care costs per person growing more rapidly than per capita GDP. Depending on the approach used, by 2082 between 53 percent and 60 percent of the accumulated growth is attributable solely to cost growth, between 14 percent and 17 percent is attributable solely to aging, and the remainder (between 26 percent and 30 percent) is attributable to the interaction of those two factors as costs grow and the population ages at the same time. Over the next 25 years, aging will be relatively more important, accounting for between 27 percent and 35 percent of projected growth by 2032, but even during that period, CBO’s estimates suggest that more than half of the growth in spending will result from rising costs per beneficiary.

The issue brief was written by Noah Meyerson, who works in the long-term modeling group within our Health and Human Resources Division.

Many people believe that health information technology (health IT) has the potential to transform the practice of health care by reducing costs and improving quality. CBO just released a significant study, prepared at the request of the Chairman of the Senate Budget Committee, examining the evidence on the costs and benefits of health information technology.

“Health IT” generally refers to computer applications for the practice of medicine. (Those applications may include computerized entry systems for physicians’ orders for tests or medications, support systems for clinical decisionmaking, and electronic prescribing of medications.) Relatively few providers—as of 2006, about 12 percent of physicians and 11 percent of hospitals—have adopted health IT.

When used effectively, health IT can enable providers to deliver health care more efficiently. For example, it can:

• Eliminate the use of medical transcription and allow a physician to enter notes about a patient’s condition and care directly into a computerized record;

• Eliminate or substantially reduce the need to physically pull medical charts from office files for patients’ visits;

• Prompt providers to prescribe generic medicines instead of more costly brand-name drugs; and

• Reduce the duplication of diagnostic tests.

Indeed, many analysts and policymakers believe that health IT is a necessary ingredient for improving the efficiency and quality of health care in the United States. Research does indicate that in some instances, health IT appears to have reduced the cost of providing health care, helped eliminate inappropriate services, and improved the quality of care. In general, however, health IT appears to be necessary but not sufficient to generate cost savings; that is, health IT can be an essential component of an effort to reduce cost (and improve quality), but by itself it typically does not produce a reduction in costs.

The most auspicious examples involving health IT have tended to involve relatively integrated health systems. For providers and hospitals that are not part of integrated systems, however, the benefits of health IT are not as easy to capture, and perhaps not coincidentally, those physicians and facilities have adopted electronic health records (EHRs, the primary health IT package commonly purchased by a provider) at a much slower rate. For example, office-based physicians in particular may see no benefit if they purchase such a product – and may even suffer financial harm. Even though the use of health IT could generate cost savings for the health system at large that might offset the EHR’s cost, many physicians might not be able to reduce their office expenses or increase their revenue sufficiently to pay for it.

The search for improved efficiency in delivering health care has prompted numerous proposals for increasing the adoption of health IT. For example, a recent study by the RAND Corporation estimated about $80 billion in net annual savings that is potentially attributable to such technology. This study has received significant attention, but unfortunately it suffers from significant flaws and is therefore not an appropriate guide to estimating the effects of legislative proposals aimed at boosting the use of health IT:

• The RAND researchers attempted to measure the potential impact of widespread adoption of health IT, assuming that it was used effectively—rather than the likely impact, which would take account of factors that might impede its effective use. For example, health care financing and delivery are now organized in such a way that the payment methods of many private and public health insurers do not reward providers for reducing costs—and may even penalize them for doing so.

• The RAND study is based solely on empirical studies from the literature that found positive effects for the implementation of health IT systems; it excluded the studies of health IT, even those published in peer-reviewed journals, that failed to find favorable results. The decision to ignore evidence of zero or negative net savings clearly biases any estimate of the actual impact of health IT on spending.

• The RAND study was not intended to be an estimate of savings measured against the rates of adoption that would occur under current law, but rather, against the extent of adoption in 2004. That is, the study did not allow for growth in adoption even without a policy intervention, as CBO would in a cost estimate for a legislative proposal.

One significant potential benefit of health IT that has thus far gone relatively unexamined involves its role in comparative effectiveness research. Widespread use of health IT could make available large amounts of data on patients’ care and health, which could be used for empirical research that might not only improve the quality of health care but also help make the delivery of services more efficient. By making clinical data easier to collect and analyze, health IT systems could support rigorous studies to compare the effectiveness of different treatments for a given disease or condition. Then, in response to the studies’ findings, they could aid in implementing changes in the kinds of care provided and the way those services are delivered, and track progress in carrying out the changes. Such comparative effectiveness studies would, on average, probably lead to reductions in total spending for health care because of the tendency in the current health care system to adopt ever more expensive treatments even though rigorous evidence about their effectiveness is lacking. The likelihood of such reductions in spending would be higher if the studies’ findings were linked to the payments that providers received or the cost sharing that patients faced.

If the federal government chose to intervene directly to promote the use of health IT, it could do so by subsidizing that use or by imposing a penalty on failing to use a health IT system. From a budgetary perspective, the subsidization approach is less likely to generate cost savings for the federal government because it involves up-front costs. (It is also possible that, for any given underlying financial incentive, a penalty may be more effective at triggering adoption than a subsidy if a penalty carries a negative connotation that does not apply to failing to receive a subsidy.)

Stuart Hagen of CBO’s Health and Human Resources Division and Peter Richmond, formerly of CBO, prepared the report under the supervision of Bruce Vavrichek and James Baumgardner.

Under current law, rising costs for health care and the aging of the population will cause federal spending on Medicare, Medicaid, and Social Security to rise substantially as a share of the economy. At the request of the Ranking Member of the House Budget Committee, CBO released a letter examining the potential economic effects of (1) allowing federal debt to climb as projected under the alternative fiscal scenario presented in CBO’s December 2007 Long-Term Budget Outlook; (2) slowing the growth of deficits and then eliminating them over the next several decades; and (3) using higher income tax rates alone to finance the increases in spending projected under that scenario.

How Would Rising Budget Deficits Affect the Economy? Sustained and rising budget deficits would affect the economy by absorbing funds from the nation’s pool of savings and reducing investment in the domestic capital stock and in foreign assets. As capital investment dwindled, the growth of workers’ productivity and of real (inflation-adjusted) wages would gradually slow and begin to stagnate. As capital became scarce relative to labor, real interest rates would rise. In the near term, foreign investors would probably increase their financing of investment in the United States, but such borrowing would involve costs over time, as foreign investors would claim larger and larger shares of the nation’s output and fewer resources would be available for domestic consumption.

How much would the deficits projected under the alternative fiscal scenario presented in the December 2007 Long Term Budget Outlook affect the economy? For its analysis, CBO used a textbook growth model that can assess how persistent deficits might affect the economy over the long term. According to CBO’s simulations using that model, the rising federal budget deficits under this scenario would cause real gross national product (GNP) per person to stop growing and then to begin to contract in the late 2040s. By 2060, real GNP per person would be about 17 percent below its peak in the late 2040s and would be declining at a rapid pace. Beyond 2060, projected deficits would become so large and unsustainable that the model cannot calculate their effects. Despite the substantial economic costs generated by deficits under this model, such estimates greatly understate the potential loss to economic growth because the effects of rapidly growing debt would probably be much more disorderly and could occur well before the time frame indicated in the scenario.

How Would the Slowing the Growth of Deficits Affect the Economy? The minority staff of the House Budget Committee provided CBO with a target path slows the growth of budget deficits. In evaluating the economic effects of the target path, CBO did not examine how specific policies to achieve that path would affect the economy; instead, CBO limited its attention solely to examining how the deficits produced by the target would affect the economy, assuming that such effects would play out as they have in the past. (CBO has not evaluated either the political feasibility or the economic effects of reducing spending sufficiently to accomplish this path for the deficit. Furthermore, the spending and revenue targets provided by the Committee staff are not the only way to achieve a sustainable budget path. Alternative policies will have different effects on the economy, and changes in taxes and spending can exert influences on the economy other than the effects of reducing budget deficits.)

Under the target path, federal outlays excluding interest (that is, primary spending) would rise from 18 percent of GDP in 2007 to 20 percent in 2030 and then decline to 19 percent in 2050 and 13 percent in 2082. For almost all years, revenues would remain at 18.5 percent of GDP. Under those assumptions, the budget deficit would gradually increase to about 6 percent of GDP in 2040 but then would decline to almost zero in 2075. By 2082, the target path would generate a budget surplus of about 2 percent of GDP. Under this path, real GNP per person would continue to grow over the entire projection period, rising from about $45,000 in 2007 to about $165,000 in 2082 in inflation-adjusted dollars. By 2060 (the last year for which it is possible to simulate the effects of the alternative fiscal policy using the textbook growth model), real GNP per person would be about 85 percent higher under the target path than under the alternative fiscal scenario.

How Would Increasing Income Tax Rates to Finance the Projected Rise in Spending Affect the Economy? How would the economy be affected if the projected rise in primary spending under CBO’s alternative fiscal scenario (from about 18 percent of GDP in 2007 to about 35 percent in 2082) was financed entirely by a proportional across-the-board increase in individual and corporate income tax rates? Answering that question is difficult because the economic models that economists have developed so far would have to be pushed well outside the range for which they were initially developed.

Nonetheless, tax rates would have to be raised by substantial amounts to finance the level of spending projected for 2082 under CBO’s alternative fiscal scenario. Before any economic feedbacks are taken into account, and assuming that raising marginal tax rates was the only mechanism used to balance the budget, tax rates would have to more than double. Such tax rates would significantly reduce economic activity and would create serious problems with tax avoidance and tax evasion. The letter provides more details about possible scenarios. (Raising revenue in ways other than increasing tax rates would have a less marked effect on economic activity.)

Conclusion. The United States faces serious long-run budgetary challenges. If action is not taken to curb the projected growth of budget deficits in coming decades, the economy will eventually suffer serious damage. The issue facing policymakers is not whether to address rising deficits, but when and how to address them. At some point, policymakers will have to increase taxes, reduce spending, or both.

Much of the pressure on the budget stems from the fast growth of federal costs on health care. So constraining that growth seems a key component of reducing deficits over the next several decades. A variety of evidence suggests that opportunities exist to constrain health care costs both in the public programs and in the health care system overall without adverse health consequences, although capturing those opportunities involves many challenges.

Last week, the LBJ School at the University of Texas-Austin held a conference on the history and future of Medicare, as part of a series of activities to commemorate Lyndon Johnson’s 100th birthday. (The conference was co-sponsored by the Center for Health and Social Policy at LBJ School, Commonwealth Fund, and the Robert Wood Johnson Foundation.) The conference brought together many of the nation’s leading health policy thinkers, and I was honored to give a lunch-time talk there. The video is posted here.

CBO issued a letter today responding to a request from the Chairman of the House Budget Committee. In December 2007, we issued a report on the nation’s 75-year fiscal gap (roughly speaking, the gap between the present value of projected spending and projected revenue, as a share of GDP).

In today’s letter, we provide estimates of the impact on the 75-year fiscal gap from net spending under current law on Medicare Part D (the prescription drug benefit) and possible permanent extension of the individual income tax provisions enacted in 2001, 2003, and 2004 past their scheduled sunset in 2010. In particular:

• The effect of spending for Part D (net of income from premiums) on the 75-year fiscal gap amounts to 0.9 percent of GDP.
• The effect of extending the expiring individual income tax provisions would amount to 0.7 percent of GDP in the absence of further reform to the Alternative Minimum Tax (AMT) and 1.4 percent of GDP if the AMT ’s parameters were indexed to inflation.
• CBO limited its analysis to the estimated effects of extending the individual income tax provisions and did not assess the effects of permanently extending provisions applicable to the estate and gift tax. If the only result of extending the estate and gift tax provisions were to eliminate all revenues from those taxes from CBO’s long-term baseline, the fiscal gap would increase by an additional 0.7 percent of GDP over the next 75 years. Under that assumption and assuming the AMT is indexed to inflation, the combined effect of extending all the tax provisions (including the gift and estate tax ones) on the 75-year fiscal gap would amount to slightly over 2 percent of GDP.

This morning, CBO released a new report, Technological Change and the Growth of Health Care Spending. I am testifying before the Senate Budget Committee on the new report and on our long-term health projections, which we released in November. (For video of the hearing, here.) The report on technological change was authored by Colin Baker of our Health and Human Resources Division.

My oral remarks for today’s hearing summarize the report as well as our long-term health outlook, and my notes for those remarks are below.

• The rising costs of health care represent the nation’s central long-term fiscal challenge, and this morning CBO is releasing a new study on the factors contributing to health care cost growth.
• Over the past four decades, health care spending has roughly tripled as a share of the economy - from about 5 percent of GDP in 1960 to more than 15 percent today.
• A common way of measuring the rate at which health care costs are rising is the growth in cost per beneficiary relative to income per capita. This concept is referred to as “excess cost growth” - which doesn’t necessarily mean excessive growth, just that health care costs are rising faster than income.
  • Excess cost growth has averaged slightly more than 2 percent per year over the past 30 years.
  • Note that the rate has been similar in Medicare, in Medicaid, and in the rest of the health system. That’s because many of the same forces that drive the growth of federal health care spending also affect private health care spending.
  • Also note that cost growth in the 1990s slowed relative to that of previous decades.
    • Some analysts attribute that lull to greater enrollment in managed care plans as well as to excess capacity among some types of providers, which increased health plans’ negotiating leverage.
    • Since the late 1990s, however, a combination of slower economic growth and accelerated spending on health care has led to a sharp increase in health care costs as a share of GDP-from 12.5 percent in 1999 to 14.5 percent in 2005.
• In explaining why health costs rose over the past several decades, most analysts agree that the most important factor has been the emergence, adoption, and widespread diffusion of new medical technologies and services.
  • Some advances permit the treatment of previously untreatable conditions, introducing new categories of spending. Others, relative to older modes of treatment, improve medical outcomes at added cost, boosting existing types of spending.
  • Available empirical estimates suggest that approximately half of all long-term growth in health care spending has been associated with technological advances. Those estimates are arrived at largely through the process of elimination - that is, trying to explain cost increases caused by all other variables.
  • One example is the aging of the population. Among adults, health care spending generally increases with age. However, the population aged only gradually over the past half century, and aging played only a minor role in the large increases in spending that occurred. Published analyses suggest that aging can account for only about 2 percent of all spending growth from 1940 to 1990, for example.
  • Other examples of factors contributing to spending growth include the growth in personal income and the rising share of health care costs paid by third-party insurers over recent decades; both of those trends contributed to spending growth by increasing demand for medical care. But again these factors, by themselves, explain only a modest part of the long-term rise in health care spending.
  • The rising price of medical goods and services relative to prices outside the health sector - itself perhaps reflecting differential productivity trends - has also played some role in causing relative real per capita costs to increase, although measurement of prices on a quality-adjusted basis can be difficult and in any case this factor seems to explain a fifth or less of the increases.
  • Other factors such as defensive medicine and physician-induced demand do not appear to explain a significant part of the growth in spending, at least according to published analyses.
  • Another factor that has recently raised concern involves the increased prevalence of obesity. The fraction of Americans who are overweight or obese has increased in recent years, and obesity raises an individual’s risk of serious illnesses such as cardiovascular disease and diabetes.
    • In 2001, spending for health care per person of normal weight was $2,783, compared with $3,737 per obese person and $4,725 per morbidly obese person.
    • If health care spending per capita remained at 1987 levels for each category of body weight but the prevalence of obesity changed to reflect the 2001 distribution, health care spending would have risen by only 1.4 percent per capita on average. Because actual spending per capita rose by 34.6 percent, this implies that the change in the prevalence of obesity could account for only about 4 percent of all spending growth from 1987 to 2001.
    • In other words, most of the increased spending on obese people occurred not because of greater obesity prevalence, but rather because spending increased on each obese person - which itself likely reflected changes in technology. In 1987, spending per morbidly obese person was about 18 percent higher than spending per person of normal weight, but by 2001 it was 70 percent higher.
  • Stepping back, the bottom line from all these analyses is that the single most important factor driving the long-term increase in health care costs involves medical technology.
    • Technological advances on average have brought major health improvements, but they often then get applied in settings where their benefits seem much less obvious.
• Turning to the future, in the absence of an unprecedented change in these long-term trends, national spending on health care will grow substantially.
  • CBO’s projections of health care spending assume that federal law affecting Medicare or Medicaid does not change. Those projections should thus be interpreted as providing a measure of the scope of the potential problem posed by rising costs rather than a prediction of future developments, because the magnitude of the problem will ultimately necessitate changes in the government’s programs.
  • Under CBO’s projections, health care spending will double by 2035, reaching 31 percent of GDP. Thereafter, health care costs will continue to account for a steadily growing share of GDP, reaching 41 percent by 2060 and 49 percent by the end of the 75-year projection period.
  • Net federal spending on Medicare and Medicaid now accounts for about 4 percent of GDP. That rises to 12 percent by 2050 and 19 percent by 2082.
  • Most of that increase is due to excess cost growth, not to an aging population.
• The rise in health care spending is the largest contributor to the growth projected for federal spending over the long term.
• All of these projections raise fundamental questions of economic sustainability. If outlays increased as projected and revenues did not grow at a corresponding rate, deficits would climb and federal debt would grow significantly.
  • The resultant economic damage could be averted by putting the nation on a sustainable fiscal course, which would require some combination of less spending and more revenues than the amounts now projected. Making such changes sooner rather than later would lessen the risk that an unsustainable fiscal path poses to the economy.
• So what can be done? Given that future health care spending is the single most important factor determining the nation’s long-term fiscal condition, the Congressional Budget Office is devoting increasing resources to assessing options for reducing such spending in the future.
  • Straightforward changes to the Medicare and Medicaid programs-such as more stringent eligibility criteria, greater cost sharing, or changes in provider payments-could reduce federal spending in part by shifting costs from the federal government to households. Ultimately, however, such cost-shifting approaches are unlikely to be sustainable, and controlling federal spending on health care while maintaining broad access to care under these programs will therefore almost certainly need to be associated with slower cost growth in the health care sector as a whole.
• Two potentially complementary approaches to reducing total health care spending-rather than simply reallocating spending among different sectors of the economy-involve generating more information about the relative effectiveness of medical treatments and changing the incentives for providers and consumers of health care. In addition to those changes, a variety of approaches to changing health-related behavior could improve health outcomes at a given level of costs.
• Costs appear to vary across the health sector for reasons that are not highly correlated with quality differences.
• Costly services that are known to be highly effective in some types of patients are sometimes provided to other patients for whom clinical benefits have not been rigorously demonstrated. More information on the “comparative effectiveness” of alternative medical treatments could offer a basis for ensuring that future technologies and existing costly services are used only in cases in which they confer clinical benefits that are superior to those of other, cheaper services.
  • To affect medical treatment and reduce health care spending, though, the results of comparative effectiveness analyses would ultimately have to change the behavior of doctors and patients-that is, to get them to use fewer services or less intensive and less expensive services than are currently projected. Bringing about those changes would probably require action by public and private insurers to incorporate the results into their coverage and payment policies in order to affect the incentives facing doctors and patients.
  • For example, Medicare could tie its payments to providers to the cost of the most effective or most efficient treatment. If that payment was less than the cost of providing a more expensive service, then doctors and hospitals would probably elect not to provide it. Alternatively, enrollees could be required to pay for the additional costs of less effective procedures (although the impact on incentives for patients and their use of care would depend on whether and to what extent they had supplemental insurance coverage that paid some or all of Medicare’s cost-sharing requirements).
• Finally, the ultimate objective of any health care system is to promote health, whether by treating diseases that arise or by preventing them from occurring in the first place. In that context, proposals that encourage more prevention and healthy living can help promote better health outcomes, although their net effects on federal and total health spending are uncertain. Nonetheless, reform proposals could encompass preventive measures and efforts to encourage healthier lifestyles.

CBO released its budget and economic outlook this morning, and the House Budget Committee held a hearing on the topic. I am pasting below the notes for my oral remarks at that hearing. (For video of the hearing, click webcast.)

The outlook report is put together by a large team of analysts and editors at CBO. It is deeply impressive to see how well the team works together in producing a document of this complexity!

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NOTES FOR ORAL REMARKS

First, the economy has been buffeted by several inter-linked shocks, and the risk of recession is significantly elevated relative to normal economic conditions.

• After a dramatic runup in housing prices during the first half of this decade, housing prices have started to decline and many forecasters expect further drops this year.
• The weakening of the housing sector directly affects the economy through a reduction in residential investment, and indirectly affects the economy through reduced consumer spending as a result of lower housing wealth
• Problems in the mortgage markets have spilled over into broader turmoil in financial markets, which poses the risk of impeding the flow of credit essential to a modern economy
• Energy prices have also increased substantially. Although the effect of increases in the price of oil on the macroeconomy is smaller than in the 1970s and 1980s, the rise in oil prices is still a drag on the economy
• The combination of these forces has not yet fully manifested themselves, although the unemployment rate has ticked up. Indeed, the three-month moving average unemployment has now risen by 0.4 percentage points relative to the same period last year, which has only and always occurred in conjunction with a recession over the past three decades.
• On the other hand, other measures that typically have accompanied that large an increase in the unemployment rate at the onset of a recession – such as a steep rise in unemployment insurance claims – have not as yet occurred. Indeed, initial UI claims have recently ticked down just a bit.
• Especially with the most recent and notable action by the Federal Reserve yesterday, many professional forecasters are projecting continued — albeit sluggish — economic growth in 2008, rather than an outright recession.
• One bright spot to date, reinforcing the view of continued but slow growth rather than recession, has been net exports. Thus far, the depreciation of the dollar that is a necessary component of correcting our nation’s external imbalance has been gradual. And that has helped to stabilize and then even slightly improve the current account deficit, as net export growth has improved with the depreciation of the currency and continued growth abroad.
• The bottom line that the risk of recession is substantially elevated, but CBO expects, along with most professional forecasters, a period of unusually weak growth rather than outright recession.
• In particular, CBO expects growth for the year as a whole of under 2 percent and an increase in the unemployment rate to an average of 5.1 percent.
• A reflection of this slowing economic activity is that job growth fell by half between 2005, when it averaged 220,000 per month, and 2007, when it averaged 110,000. We expect it to fall in half again – to 55,000 per month – during the first half of 2008.

Let me now turn to the budget outlook.

• We have already seen some slowing of revenue growth, especially in corporate income taxes, and CBO expects further slowing this year.
• Our baseline suggests that among other factors, the slowing economy will boost the deficit to $219 billion, or 1.5 percent of GDP, this year.
• If Congress provides the additional funding for operations in Iraq and Afghanistan requested by the Administration, the deficit would rise to $250 billion. And if a fiscal stimulus package is enacted, the 2008 deficit could be substantially higher – and at least from a ST stimulus perspective, that could be desirable.
• Thereafter, under the baseline, the budget moves toward balance in 2012. However, as many people have noted, that baseline excludes various policy changes that are widely viewed as likely to occur.
• For example, the baseline assumes no further AMT relief, and so the AMT substantially expands its reach.
• If one instead continued AMT relief, extended the 2001 and 2003 tax legislation past the scheduled 2010 expiration, adopted an alternative scenario for the future global war on terrorism, and increased the rest of discretionary spending in line with GDP, the outcome is substantially different than the baseline. Instead of a small cumulative surplus between 2009 and 2018, the result would be a deficit of about 3.5 percent of GDP.

Even over the next 10 years, the nation’s longer-term budget pressures begin to manifest themselves.

• Caseloads on both Medicare and Social Security are projected to rise. SS beneficiaries rise from 50 million in 2008 to 64 million in 2018. Projected increases in caseloads account for about 30 percent of the growth in mandatory spending between 2008 and 2018.
• More fundamentally, the cost per beneficiary in Medicare is projected to continue rising significantly faster than income. As a result, Medicare and Medicaid spending rises from 4.6 percent of GDP to 5.9 percent; Social Security from 4.3 to 4.9.
• Thereafter, under the long-term budget outlook we released in December, health care costs increasingly dominate the federal budget.
• Under the alternative fiscal scenario embodied in our long-term budget outlook, the nation’s fiscal gap over the next 75 years amounts to 6.9 percent of GDP.
• Most of that is not due to an aging population

Given the ST economic environment and LT fiscal imbalance, let me end by briefly discussing a report that CBO wrote for this committee and the Senate Budget Committee on fiscal stimulus options.

• In particular, when the economy is particularly weak, the key constraint on short-term economic growth is demand for the goods and services that firms could produce with existing resources.
• In most circumstances, by contrast, and certainly over the long term, the key constraint on economic growth is the rate at which firms’ capacity to produce is expanded, through forces like increases in capital and labor and improvements in productivity.
• When the constraint on short-term growth is aggregate demand, as appears to be the case today, both monetary and fiscal policy can help by boosting spending.
• On the fiscal policy side, the automatic stabilizers built into the budget will help to attenuate any economic downturn by providing a cushion to after-tax income.
• The question is whether additional fiscal action is necessary. One way to think about it is that fiscal stimulus can help provide insurance against the risk and severity of a possible recession.
• Our estimates suggest that stimulus of between ½ and 1 percent of GDP or so would reduce the elevated risk of recession to more normal levels, as long as the stimulus is well-designed.
• The stimulus need not be targeted at what caused the economic weakness. Instead, the key is that it bolsters aggregate demand and thereby helps to jump start a positive cycle of increased demand leading to increased production, until the constraint once again becomes how much we can produce rather than how much we are willing to spend.
• So what would work? A well-designed fiscal stimulus would have several central principles:

• First, it would be delivered rapidly. A problem with some efforts at fiscal stimulus in the past is that they took too long to take effect — in a matter of months, not years. If the purpose of fiscal stimulus is to reduce the risk and severity of a recession, it would need to take effect quickly. Stimulus delayed is stimulus denied, and could even prove unnecessary and potentially counterproductive if delayed so long that it takes effect after the period of economic weakness has passed.
• Second, it would be temporary. As just mentioned, the nation faces a severe long-term fiscal gap. Stimulus that exacerbates that long-term budget imbalance could impose greater economic costs than benefits.
• Finally, it would be cost-effective, in the sense of boosting aggregate demand as much as possible at a given budgetary cost.