For the second year in a row, Rep. Paul Ryan (R-Wis.) has advanced a comprehensive budget plan that would restructure Medicare and Medicaid, repeal the big-spending portions of the Affordable Care Act (ACA), and ultimately resolve the fiscal crisis facing this country.  Critics react that the Ryan plan would dismantle health care as we know it.  They are correct.  The policies underlying the plan would fundamentally change the way decisions are made in the health sector.

The broad outlines of Ryan’s proposals are well known.  Medicare would become a premium support program in 2023, which would provide beneficiaries with a fixed subsidy rather than the open-ended promise of unlimited payment for services.  Similarly, Medicaid would be financed through a block grant instead of open-ended federal matching payments.  The Medicaid expansion under ACA would be repealed, along with subsidies in the insurance exchanges.

Ryan Plan Does Not End Medicare

By shifting from a defined benefit model to defined contribution, the Ryan plan for the first time puts Medicare on a real budget.  Beneficiaries would be given a subsidy that is risk-adjusted and geographically rated, and would be free to choose from a number of competing health plans.  Private plans would be required to cover at a minimum the actuarial equivalent of fee-for-service Medicare’s benefit package.

Total program spending would be limited to GDP growth plus 0.5 percentage points, which is the same spending target proposed in the President’s budget for ACA’s Independent Payment Advisory Board (IPAB).  The IPAB will enforce the target primarily through cuts in provider payment rates, which is likely to result in greater service utilization as providers try to make up the financial shortfall.  Under the premium support model, additional service volume would not add to a health plan’s revenue.

This creates new financial incentives that would alter the way care is delivered.  With a clear budget constraint, the health industry would be put on notice that increasing the number and complexity of services provided to patients is no longer a profitable way to do business.  Instead, health plans will seek more efficient ways to deliver care and beneficiaries will have greater incentives and better information to select the plan that best meets their needs.

There are risks.  The Congressional Budget Office (CBO) points out that restraints on Medicare spending could reduce access to services, diminish quality of care, or reduce investment in new medical technologies.  That is true, but the price controls imposed by ACA and the President’s budget are just as likely to reduce access, quality, and investment — with no incentive to seek greater efficiencies under traditional Medicare’s fee-for-service payment system.  Medicare’s actuary has pointed out that cuts in payment rates that are already legislated would make it impossible for growing numbers of hospitals and other institutional providers to serve Medicare patients and remain profitable.

Unlike last year’s proposal, the current plan offers a safety valve.  Following the Wyden-Ryan proposal, traditional Medicare would remain an option under premium support.  If the private plans fail to provide good value at reasonable prices, beneficiaries will shift back to traditional Medicare.

The potential savings from full competitive bidding are substantial.  A recent analysis by Robert Coulam, Roger Feldman, and Bryan Dowd shows that competition could reduce federal Medicare spending by 5.6 percent a year while maintaining basic benefits and without raising taxes.  Those savings can be achieved without imposing higher costs on seniors, so long as they are willing to enroll in lower-cost plans.  Combined with other near-term savings proposals in Ryan’s plan, I estimate that federal Medicare spending in 2023 could be reduced by as much as 8.9 percent.

Even greater savings are possible if Congress allows health plans more flexibility in organizing care.  In the under-65 market, insurers have successfully negotiated better rates by offering tiered provider networks and modifying the benefit package.  HHS has recently indicated that such plans would not be welcome in Medicare Advantage, eliminating an important potential source of additional savings.

Ryan Plan Does Not Discriminate Against the Poor

Medicaid reform under the Ryan plan would give greater control over the program to the states in exchange for a more predictable federal subsidy paid in the form of a block grant.  States would tailor Medicaid to their individual needs and financial conditions, and would be able to establish their own eligibility standards, cost-sharing requirements, benefits, and provider payment rates. The block grant would be indexed for inflation and population growth.

Under a block grant, states would no longer have an incentive to engage in creative financing schemes solely to increase the federal payment.  The relatively fixed payment would give states a strong incentive to contract with more efficient health plans.  However, as CBO observes, states are likely to need to increase their spending for Medicaid given the sizeable reduction in the federal subsidy.  According to the Ryan plan, total Medicaid spending (including both the federal and state contributions) would decline by $810 billion over the next decade.

The CBO analysis shows federal spending for Medicaid and the Children’s Health Insurance Program (CHIP) falling sharply, from 2 percent of GDP in 2011 to 1 percent by 2040.  In contrast, Medicare spending is estimated as rising over the same period, from 3 1/4 percent of GDP to 4 3/4 percent.

Some observers have mistakenly concluded that the Ryan plan would protect seniors from Medicare cuts but would not extend that protection to the poor.  The decline in CBO’s Medicaid outlay estimate is partly explained by the repeal of the ACA Medicaid expansion, which CBO estimates would swell the Medicaid ranks with 17 million additional enrollees by 2020. Discussion with Budget Committee staff also indicates that all federal health subsidies for dual eligibles, who are enrolled in both Medicare and Medicaid, would be treated as Medicare outlays under the Ryan budget.  Dual eligibles account for about two-thirds of Medicaid spending, so the transfer of those funds to the Medicare account partly explains the dramatic drop in Medicaid spending over that period. In addition, new low-income subsidies would be established in Medicare to help such individuals better afford a high-quality Medicare plan under premium support.

What Happens Next?

In a word, nothing.  At least not right away.  In early February, Senate Majority Leader Harry Reid (D-Nev.) stated that he will not bring a budget to the floor this year.  Any serious attempts to rein in the federal budget will be kicked to next year, when the next President will be faced with much unfinished business and a replay of last August’s debt ceiling debate.

Both the need and the opportunity for decisive action on market-based health reform will coincide next spring.  The pressure for spending cuts as part of a new deal to raise the debt limit will be intense, and the first year of a presidential term offers the least political resistance to major policy change.  If President Obama is re-elected, he will also have to reconsider the timetable for the ACA reform.  Most states are finding it difficult to meet the deadlines imposed by the ACA, and the challenges of implementing functional insurance exchanges by mid-2013 will prove too great for many.  Delaying or scaling back the ACA reform is conceivable under those circumstances.

The Ryan plan is a budget that requires real spending discipline and real change in the business of health.  Congress has rarely exercised such discipline, and the health sector has too often remained comfortable with the status quo.  But our fiscal crisis cannot be denied much longer, and serious negotiations to find a solution are unavoidable.  Regardless of who is President in 2013, the core ideas of Paul Ryan’s budget plan are likely to be the focus of the policy debate next year.