Editor’s note: In addition to Kenneth Kaufman and Charles Roehrig (photos and linked bios above), this post is coauthored by Paul Hughes-Cromwick, a health economist and Senior Analyst at Altarum Institute, and Charles Kim, a Senior Vice President at Kaufman Hall.

Health care costs are a major focus of the nation and individual states. This summer, Massachusetts legislated to bend its health care cost curve. While Massachusetts residents benefit from near-universal coverage via 2006 legislation, the State’s health spending per capita has long been well above the national average. In an effort to rein-in costs and achieve a sustainable spending growth rate, the State passed Senate No. 2400—“an Act improving the quality of healthcare and reducing costs through increased transparency, efficiency, and innovation.”

The Act establishes limits on health care spending growth—defined as not to exceed overall growth in Gross State Product (GSP) in 2013-2017 and GSP growth minus 0.5 percent for 2018-2022. Linking health care spending growth to GSP growth aims to cap health care’s share of GSP. (More precisely, the Act ties spending to the growth of potential GSP, which subtracts the influence of business cycle fluctuations. Since this is roughly equivalent to the long-term average growth in GSP, for simplicity’s sake we use the terms GSP and GDP, or gross domestic product, in the remainder of this post.)

What if Massachusetts-like spending restraints were imposed nationally? National health care expenditures (NHE), which constitute about 18 percent of the nation’s GDP, have been growing about 2 percent faster than the growth of U.S. GDP for most of the past 22 years, though this excess declined in certain years. The blue line in Figure 1 (click to enlarge) shows the change in NHE growth since 1990; the red line represents GDP change during the same period. Economists and health policy experts have started to analyze the fiscal implications of applying Massachusetts’ GSP+0 growth limits to NHE. This post builds on such analysis, looking specifically at the effects on the federal deficit and the Medicare HI Trust fund.

Figure 1. Year-over-Year Percentage Change in National Health Expenditures and GDP
Source: Altarum Institute Center for Sustainable Health Spending, Health Sector Economic IndicatorsSM: October 2012.

The Fiscal Deficit And Trust Fund Solvency Under A GDP+0 Regime

How would bending the health care spending curve to GDP+0 impact the future size of the federal deficit and the solvency of the Medicare Hospital Insurance (HI) Trust Fund? In 2011, the federal deficit was $1.3 trillion; the Trust Fund 2011 balance of $246 billion is declining sharply and is expected to be “exhausted” by the mid-2020s.

We used two sets of estimates from the Congressional Budget Office’s (CBO’s) 2012 Long-Term Budget Outlook to gauge federal deficit estimates (Figure 2, click to enlarge):

  • Under baseline projections that assume that current-law spending cuts occur and Bush-era tax cuts expire at year’s end, the projected deficit in 2037 is $792 billion.
  • Under alternative projections, which assume that scheduled spending reductions do not occur and that Bush-era tax cuts remain, the projected deficit explodes to more than $8.0 trillion in 2037.

Figure 2: The Projected Federal Deficit under CBO’s Baseline and Alternative Scenarios
Source: Congressional Budget Office: The 2012 Long-Term Budget Outlook, June 2012.

Recent CBO projections show the HI Trust Fund balance declining from $246 billion in 2011 to $68 billion by 2022, and depleted by the mid-2020s, as baby boomers continue to enter the Medicare program. The HI Trust Fund covers the cost of Medicare Part A hospital insurance benefits for Medicare beneficiaries, including inpatient hospital care, skilled nursing care, home health, hospice, and Medicare program administration. It is funded primarily through payroll taxes paid by employees, employers, and the self-employed.

Figures 3-5 (click to enlarge) show the effect on the federal deficit and HI Trust Fund solvency of bending the cost curve to GDP+0. Applying the modeling described below (and in Note 1): 

  • Under CBO’s baseline scenario, Figure 3 shows that with NHE held at GDP+0, the projected deficit of $792 billion for 2037 instead becomes a $510 billion surplus.
  • Under CBO’s alternative scenario, Figure 4 shows that a GDP+0 constraint reduces the 2037 deficit by $1.62 trillion, lowering it from $8.0 trillion to about $6.4 trillion.

Figure 3. Effect on the Federal Deficit of GDP+0: Baseline Scenario
Sources: Congressional Budget Office: The 2012 Long-Term Budget Outlook, June 2012; and Kaufman, Hall and Associates and Altarum Institute analyses.

Figure 4. Effect on the Federal Deficit: Alternative Scenario
Sources: Congressional Budget Office: The 2012 Long-Term Budget Outlook, June 2012; and Kaufman, Hall and Associates and Altarum Institute analyses.

For Medicare’s Trust Fund, keeping NHE at GDP+0 reverses the diminishing fund balance, increasing it from $68 billion to $140 billion by 2022. The blue GDP+0 line in Figure 5 shows that the Trust Fund’s balance starts to curve upward in 2019.

Figure 5. Effect on Medicare HI Trust Fund
Source: Congressional Budget Office: March 2012 Medicare Baseline; and Kaufman, Hall and Associates and Altarum Institute analyses.

Overall, our analysis indicates that holding national health care spending growth to GDP+0 would have a significant positive impact on both the federal deficit and the solvency of the HI Trust Fund. But what would it take to achieve this target?

The Cost-Trend Components Behind A GDP+0 Target

To constrain health spending to GDP+0, the nation would need to control the underlying healthcare cost trend. What reduction is required in the underlying cost trend and what does this mean for the growth in the components of health spending?

Per Capita cost trend. The cost trend is defined here as the annual rate of growth in the per capita cost of treating a population whose needs and insurance coverage do not change over time. It is driven by factors such as price inflation, technologies, and treatment intensity. Our analysis indicates that in order to hold overall health spending to GDP+0, the underlying cost trend must be held 0.6 percentage points under the growth rate in per capita GDP. (A key assumption in this analysis is described in Note 2.) This is due to two factors:

  • The aging population drives per capita health needs upward by about 0.5 percent per year. Figure 6 (click to enlarge) indicates the relative annual growth rates of the Medicare and non-Medicare populations due to population aging.
  • The Affordable Care Act expands health care coverage to 30 million previously uninsured people and their improved access to care drives spending above the cost trend. This contributes about .01 of the 0.6 percentage-point differential. (Expanded coverage pushes total health spending up by about 3 percent. This is offset by reducing the cost trend by about 0.1 percentage points over the 24-year period of analysis.)

The major finding here is that a cost trend of per capita GDP+0 isn’t low enough. To hold overall NHE growth to GDP+0, the underlying cost trend must be per capita GDP minus 0.6 percent.

Figure 6. Population Growth Rates
Source:  Altarum Center for Sustainable Health Spending

Health Spending Growth Trends. What are the implications for federal and non-federal spending when overall health spending grows at GDP+0? Figure 7 (click to enlarge) illustrates these results:

  • Due to rapid growth in the eligible population, Medicare spending will grow a full percentage point faster than GDP.
  • Federal spending on Medicaid and the exchanges will grow 1.1 percent more rapidly than GDP due to the federal costs of expanded coverage under the ACA and, to a lesser extent, the rapid growth in the dual-eligible Medicare population. (See Note 3.)
  • Other federal health spending (e.g., public health, military health, medical research) will follow the underlying cost trend and grow by 0.6 percentage points less than GDP.
  • Non-federal health spending (state, private insurance, out-of-pocket) will shrink relative to GDP growth by -0.5 percent.

Figure 7. Attaining GDP+0
Source:  Altarum Center for Sustainable Health Spending

Achieving GDP+0

The above analysis shows that attaining GDP+0 for NHE actually requires holding the underlying cost trend to a level lower than GDP+0. The policy implications of this reality for providers, insurers, and patients would be transformative for the industry, involving lower utilization, less use of technology and expensive drugs, and reduced payments, among other changes.

Many initiatives coupled with market forces are already bending the U.S. health care cost curve and many more will be needed to achieve sustainable spending. Proactive providers are taking steps to fundamentally restructure their costs, recognizing that the normal cost-management approaches will not bring the required level of reductions. Initiatives include redesigning care processes, eliminating inappropriate tests and procedures, removing service duplication within health systems and across systems within communities, managing population health risk for provision of value rather than volume, and reorganizing chronic and end-of-life care. Whether occurring singly or in combination, these initiatives will eliminate utilization from the healthcare system, thereby reducing national health care expenditures.

Our analysis also indicates that health care providers, payers, and other stakeholders can make a significant contribution to solving the country’s macroeconomic challenges by limiting spending growth in their institutions and communities to GDP+0 or lower. Massachusetts has legislated GSP+0 for the next five years, holding all hospitals, physician groups, and payers that exceed this cost benchmark to additional reporting requirements, execution of plans to address the cause of the excess cost growth, and civil penalties for noncompliance. After 2017, the mandate becomes GSP minus 0.5.

The question nationally is whether GDP+0 or better can be accomplished voluntarily through the many initiatives already underway and those still to be developed in the near future. Solving the nation’s fiscal challenges will not be simple; the situation is extraordinarily complex. All participants, including the federal government, state governments, providers, and payers, must do their share.


Note 1. We started with the numbers provided by CBO in the 2012 Long-Term Budget Outlook and applied growth rates as identified later, namely 1 percent for Medicare spending; 1.1 percent for federal spending for Medicaid and exchange subsidies; -0.6 percent for other federal health spending; and -0.5 percent for non-federal health spending (percentages represent deviation from GDP growth).

Note 2. We assume that the cost trend is the same across different beneficiary populations. Thus, for example, the cost trend for Medicare beneficiaries will be the same as the cost trend for those covered by private insurance.

Note 3. It is important to recognize that about 40 percent of Medicaid spending is on the rapidly increasing Medicare population (“dual eligibles”). The remainder of Medicaid spending, and all of the exchange spending, is tied to the more slowly growing non-Medicare population.