EVENTS

Date:	Friday, April 16, 2004
Time:	9:00 AM -- 10:30 AM
Location:	Wohlstetter Conference Center, Twelfth Floor, AEI 1150 Seventeenth Street, N.W., Washington, D.C. 20036

April 2004
Health Care System Crisis

Almost everyone seems to agree that our health care system is in crisis and needs to be reformed.  But after that, there is little consensus about the causes of the crisis and how to change the system.  What are the fundamental challenges that we face in both the public and private sectors? What are the obstacles to reform? What can government agencies like the General Accounting Office, Congressional Budget Office, and private think tanks do to help policymakers confront this crisis and take effective action?

At an April 16 AEI conference, David M. Walker, comptroller general and head of the General Accounting Office, presented the GAO's plan to help congressional policymakers systematically evaluate proposed health care reforms. The plan develops criteria to assess issues relating to cost, access, quality, and implementation-the greatest challenges to building an effective health care system.

David M. Walker
Comptroller General of the United States

As the chief executive officer of the GAO and the de facto chief accountability officer of the United States government, I have an obligation to be concerned with our nation's financial condition and fiscal outlook. Our current fiscal challenges can be best understood in the context of our changing federal budget. Forty years ago, 46 percent of the budget was devoted to defense spending. Since then, entitlement programs have absorbed an increasing share of the federal budget, and defense spending has fallen to only 20 percent of federal outlays. Discretionary spending, which Congress annually appropriates, has decreased from 67 percent in 1964 to only 38 percent in 2004. Since 1789, the United States has accrued negative results of operation totaling $7 trillion. In fact, this debt is even larger because the bonds in the Social Security and Medicare trust funds are not counted as liabilities. In Washington, trust funds are treated as merely accounting devices and have no economic significance. Other items, such as promised Social Security benefits in excess of committed funding, are also left off the balance sheet. In order to close the actual deficit the United States faces, the government would need to invest $42 trillion at current treasury rates.

If we compare revenue and discretionary spending projections by simply extending the current baseline and assuming that the tax cuts expire, the fiscal situation begins to look troublesome only in 2020 or 2030. With deficits looming so distantly, people are tempted to believe that we can grow our way out of the problem. However, these assumptions are unrealistic and misleading. It is more plausible that discretionary spending will grow with the economy, widening the revenue-spending gap sooner. If the tax cuts are extended permanently, the picture becomes even bleaker. We must understand that we face a huge structural imbalance driven by demographic pressures and rising health care costs. Economic growth will not be enough to close the gap. Instead, we must reform the entitlement programs to ensure their solvency, reconsider the base of government spending and reassign priorities, and revise our tax policy.

Health care costs will continue to consume an increasing share of our economy in the next decade. Compared to other industrialized countries, the United States spends considerably more on health care as a percentage of GDP. The composition of our health care budget has also changed dramatically. As a share of personal health care spending, hospital care has fallen, and prescription drugs have increased.

In the 1990s, managed care and other tools effectively contained health spending growth, but current growth rates are again unsustainable. The federal commitment to health care is not captured totally by government outlays. Tax preferences for some portions of health care are the largest tax expenditure, valued at $116 billion. Tax-free fringe benefits impact government revenues and individual incentives to use health care. While health care absorbs an increasing share of an individual's personal budget, out-of-pocket spending as a share of total health spending has declined substantially.

The United States' demographic profile is changing dramatically and permanently. As labor force growth continues to slow, we must encourage individuals to participate longer in our knowledge-based economy where they are able. The retirement of the baby boom generation can be represented by a giant tidal wave that will never recede.

Seventeen percent of the non-elderly population was uninsured in 2002. The primary gap in health care coverage is for poor and near-poor adults, ages eighteen to sixty-four. Among Medicare, Medicaid, and private insurance, Medicaid appears to offer the most comprehensive services, but the program still faces many practical challenges.

Even though the United States leads the world in health care spending and arguably has the best health care system anywhere, it does not have the same advantage in health outcomes. The United States lags other nations in certain health indicators and medical error rates; and standards of care vary widely across the country.

Ultimately, we will need to fundamentally reform our entire health care system, and this will be best achieved in installments. These efforts will need to overcome insurance-related challenges, including inadequate protection against catastrophic illness, insufficient risk pooling, and rapidly rising malpractice costs. Despite our tremendous investment in health care, we continue to lack adequate and timely data to monitor our progress and improve our system. Comparative information about providers, services, and treatments is insufficient, hampering consumer choice and competition. Other challenges stem from the functioning of health care markets. Providers and health plans often use monopoly power to influence prices in individual markets, and price schedules set by public programs also distort market prices. Moreover, tax incentives disassociate individuals from the true cost of health care, which drives utilization and increases costs. Finally, administrative burdens decrease efficiency in health care markets and reduce the value to consumers.

Efforts to reform our health care system must begin by distinguishing our society's most critical needs from individual wants, which are unlimited and unaffordable. Societal priorities should include inoculation against infectious diseases, protection against catastrophic health care costs, and access to group insurance rates. Next, we must evaluate who should pay for these needs and assign appropriate roles to individuals, employers, associations, and governments. Reforms must also consider where the greatest challenges exist geographically and when we will begin to confront the mounting problems. While reforms to our health care system must be comprehensive, they must be undertaken incrementally to minimize disruptions and garner political support.

A framework to evaluate all proposals for reform will be valuable in this process. The four layers considered by the GAO framework are cost, access, quality, and implementation. Ultimately, workable reform proposals must align incentives for providers and consumers, promote transparency on the value and costs of care, and ensure accountability for adhering to standards of appropriate use and quality. Our current health care crisis stems from the absence of all three. We must confront this growing challenge, and the time to act is now.

Rudolph G. Penner
Urban Institute

Our health care system is highly inefficient, and Medicare and Medicaid are especially so. While these programs are projected to consume an increasing share of our economy, their cost growth is not a function of mounting inefficiencies but rather of new medical technologies that will be expensive to exploit. In other words, amid bleak projections, there is some optimism. Medical advances will continue, though at a cost. If Medicare, Medicaid, and Social Security paid only the current baseline to future beneficiaries, the program budgets would appear far more sustainable. However, the government has promised far richer benefits to beneficiaries in the future. Seniors in Medicare will essentially have access to all life-saving technologies in the future, regardless of their cost. To make these benefits affordable, we must increase the efficiency of the programs.

To improve program efficiency, the 2003 Medicare law encourages competition among private insurers, but policymakers can rarely resist the temptation to regulate government programs. The tax treatment of private insurance is also highly inefficient and creates incentives to purchase first dollar coverage as a substitute for taxable wages. Reversing this situation, however, seems politically implausible. A better model for insurance-one that would force consumers to purchase prudently-would have higher deductibles and co-payments, and provide greater protection for the poor. Safety nets, however, must be designed carefully to ensure that people continue to save for their own retirement. Medigap insurance could conceivably thwart efforts to instill cost-sensitivity in consumers through higher deductibles and cost sharing. If Medicare provided better catastrophic coverage, perhaps Medigap would no longer be necessary.

Market solutions to correct inefficiencies in our health system have proved unpopular. In general, the public has preferred bureaucratic rationing, which has so far not been severe. However, if costs continue to escalate, price controls may be tightened and become more binding. Americans are not likely to tolerate well the shortages and delays that would develop.

A budget and economic crisis may be necessary to seriously initiate sweeping reforms of our health care system. Assuming that discretionary spending grows with GDP and that the tax cuts are extended, GAO projects the debt to GDP ratio passing 100 percent in 2022 and growing rapidly thereafter. By 2032, the value of the U.S. debt will be twice the size of its economy. Despite these grim projections, financial markets are still not agitating for reform. They should be, however.

AEI research assistant Ximena Pinell prepared this summary.