Republicans were handed a convincing defeat at the polls, not only losing the race for the presidency but also losing ground in the Senate.  The good news for the country is that Republican leadership is not in denial.  The day after the election, Speaker of the House John Boehner outlined a balanced approach for easing federal policy off the fiscal cliff.  He offered a combination of revenue increases and spending cuts, with an emphasis on “real changes to the structure of entitlement programs.”

Two days later, President Barack Obama responded by offering his own balanced approach—more federal spending, lower taxes for everyone but the wealthy, and the certainty of much higher budget deficits for years to come unless the savings proposed by the president last February actually materialize.  This draws the line where it was before the election, with no sign that this will lead to meaningful policy negotiations.

This seeming recalcitrance is likely the result of the irrational exuberance that often strikes newly elected officials.  To paraphrase Alan Greenspan, irrational exuberance has unduly escalated the president’s political asset value.  Contrary to his current stance, President Obama does not have a strong hand in the upcoming fiscal debate.  If he wants to avoid a double-dip recession and leave a positive legacy, he will have to accept compromises and sell them to his Democratic colleagues in the Senate.  That inevitably means health policy, including the Affordable Care Act (ACA), will be on the negotiating table.

In one sense the Administration is already negotiating with itself over provisions of the ACA.  On November 9, the Department of Health and Human Services (HHS) extended the deadline for states to submit plans for setting up their own health insurance exchanges by a month.  It has been clear for some time that many states have struggled with the decision to operate their own exchanges or leave it to the federal government. As of October, only 16 states and the District of Columbia (including Massachusetts and Utah, whose efforts predate the ACA) have established a legal basis for an exchange, and even some of the states that made the commitment would not have had specific plans ready for HHS scrutiny in time to meet the original schedule. The ongoing failure to publish many of the regulations required to implement the ACA, opting instead for informal (but legally unenforceable) “guidance” is another admission that legislative requirements are, in fact, malleable and subject to negotiation.

What, then, can we expect from the fiscal deal that will be hammered out over the next year?  For health programs, it will certainly not be a “grand bargain.”

Medicare.  All sides agree that Medicare is a major contributor to our growing federal deficit.  The sequester called for by the failure of the “super committee” reduces Medicare spending by 2 percent.  The president’s 2013 budget doubles the cuts, with $248 billion in savings through 2022.  That hardly qualifies as an opening bid, in terms of both money and policy.

That savings amount does not even cover the $271 billion ten-year cost of replacing the scheduled cuts in physicians’ fees with a freeze.  Policymakers on both sides of the aisle prefer successive brief (one year or less) “fixes” because the budget optics look better even when the full consequences remain the same.

It will be business as usual in this regard next year.  The lame duck session of Congress is likely to grant a 3-month reprieve, which keeps physician payment a part of the fiscal cliff negotiations.  Short extensions are likely through the year, adding $18.5 billion to the Medicare savings that must be found.

Filling the larger budget hole will force Congress to accept a mix of fee reductions (other than for physicians) and increases in beneficiary costs.  Rather than inventing new ways to cut provider payments, the fiscal compromise will probably accelerate implementation of the “productivity adjustments” and other fee-reduction provisions imposed by the ACA. Medicare premiums are likely to rise (perhaps to an average of 35 percent of the cost of Part B and Part D), with more of the cost paid by higher-income beneficiaries.

Other initiatives are more speculative but possible.  Medicare could shed its historical division into Part A and Part B, which no longer has any usefulness (if it ever did).  Combining Medicare’s parts into a single comprehensive health benefit would allow restructuring the complex cost-sharing requirements that currently exist, and which make no sense.  A single all-encompassing deductible, a simple uniform copayment or coinsurance structure across all services, and the addition of a cap on catastrophic expenses would convert the program into modern insurance.  The Part B premium would become a premium for the entire benefit with appropriate adjustment to the rate to avoid overburdening beneficiaries.  A surcharge could be imposed on supplemental coverage (Medigap and retiree plans) to recoup some of the extra cost imposed on the program when cost-sharing requirements are largely paid by the additional insurance.

These are stop-gap measures at best.  Structural reforms that shift Medicare from an open-ended entitlement to a budgeted approach are needed.  Financial incentives must shift from fee-for-service to more sophisticated payment methods that promote innovative approaches to health care delivery.  Such reforms could reduce the total cost of care, not just the federal government’s share.

The ACA places an overall cap on the growth of federal Medicare spending that is enforced by the Independent Payment Advisory Board (IPAB)—ironically, a likely casualty of the fiscal deal that will be struck next year.  The IPAB is unpopular with anyone who is or who might be chair of the key congressional committees that traditionally set Medicare policy.  Failure to advance any nominations to IPAB reflects a bipartisan dislike of this board.

The alternative approach supported by Republicans is premium support, which remains a viable but dormant political idea.  Scare stories about “vouchers” during the campaign did not create a wave of senior backlash against Republicans, but there is also no wave of senior support for major program reforms.  For the time being, Congress is likely to adopt more modest reforms intended to improve the competitive bidding process for Medicare Advantage and to give accountable care organizations more control over and accountability for the delivery and cost of their services.  Unless President Obama’s successor is extraordinarily fortunate, he or she will revisit these issues four plus years from now.

Medicaid.  The Medicaid expansion envisioned by the ACA has been short-circuited by the Supreme Court ruling that makes it possible for the states to decide for themselves whether to expand eligibility.  Even with more modest take-up by the states, the Medicaid expansion is likely to increase federal spending by $642 billion through 2022.

A fiscal deal would seek to reduce the spending without limiting states’ ability to expand Medicaid eligibility.  The likely target is the enhanced federal match rate authorized by the ACA, which provides states with full funding for the expansion population for three years.  By 2020 the enhanced match tapers down to 90 percent of the cost, which is well above the average amount paid by the federal government for the current Medicaid population.  Reducing the enhanced match rates by 10 percentage points would yield about $65 billion in savings over ten years, and perhaps more if the cut induced additional states to refrain from expanding eligibility.

To make the reduction in federal payments more acceptable, Congress might grant broader waiver authority to the Department of Health and Human Services that could allow the states more discretion in how they operate their programs.  This would address a central issue in the Republican proposal to provide states with block grants for Medicaid rather than continuing to require them to seek federal permission for even modest changes in states’ policies and management procedures.

Private Insurance and Exchanges.  The largest category of new spending created by the ACA is the subsidy for insurance offered on the exchanges, totaling $1 trillion through 2022.  The administration would be reluctant to modify the subsidy structure, particularly if they believe that the Supreme Court’s decision to make the insurance mandate a tax significantly weakens the pressure on individuals to purchase coverage.  They might reason that a generous subsidy is needed under that circumstance to maintain a stable insurance market.

Nonetheless, reducing the subsidy (perhaps by cutting its generosity and limiting its availability to individuals with incomes below 250 percent of poverty rather than the current 400 percent) offers substantial budget savings.  Those savings may be easier for the public to accept than cuts in existing programs that already have well-established and politically vocal constituents.

An alternative would be to delay implementing the exchanges and the subsidy.  That is likely to be unavoidable in some states, and a fiscal deal could get credit for what might be inevitable.  Numerous states are unlikely to have insurance exchanges running by October 2013, and there is some question about the ability of the federal government to create a functioning replacement.  Important regulations defining how the exchanges are expected to operate have not been issued, and the political and technical challenges of creating a complex insurance market based on almost no experience are sufficient to create significant delays in many states—including states headed by Democrats.

A less likely alternative but one with greater leverage on the health system is a reform of the tax subsidy for employer-sponsored insurance.  The ACA includes a “Cadillac tax” on employer coverage deemed too expensive.  The administration has agreed that our current tax subsidy is inefficient even though they endorsed an inefficient way to address this problem.  The tax is imposed on insurers, but obviously most of it will be passed on to workers in the form of higher premiums who will receive a tax subsidy on the higher amount.  The political objective was to avoid admitting that the tax would be paid by those who will, in fact, pay it.  Broad tax reform could make sense out of this by directly limiting the amount of insurance premium that can be excluded from personal income tax.

Health Care Has Its Own Cliff.  We can be confident that Congress and the president will find a way to bridge their differences enough to ease the country off of the fiscal cliff.   Some combination of policies that slow the growth of federal spending and increase the flow of federal revenue will be agreed to by the end of next year, although not likely much before that.

Health programs, which account for about 25 percent of the federal budget, will figure prominently in resolving the immediate fiscal problem.  The legislation will depend heavily on reductions in Medicare fees, which yield scoreable budget savings but do little to change the financial incentives driving program spending and growth in national health spending.  Without structural reform, federal health programs—particularly Medicare—will remain on the precipice.