June 2012

MedPAC's Prescriptions for Medicare

The Medicare Payment Advisory Commission (MedPAC) has released its June 2012 report, detailing ways in which Congress can improve Medicare to better control costs and improve care.

For budgeteers, the first chapter is a particularly helpful portion of the report, discussing Medicare's cost-sharing strucuture. MedPAC finds a number of issues with the structure that could be changed for the better. They note that there is no out-of-pocket maximum for cost-sharing, there are two separate and very different deductibles for Parts A and B, and the benefit design utilizes coinsurance more frequently than copayments despite the fact that copayments provide more predictable cost-sharing for beneficiaries. In addition, many beneficiaries have supplemental "first-dollar" coverage, which often shields them from the effects of cost-sharing, leading them to use perhaps unnecessary care (at least more than they would otherwise). As a result, they say:

In summary, the Commission believes that a new FFS benefit design should include:

  • an OOP maximum (measured in cost-sharing liability incurred by the beneficiary) to protect beneficiaries from the financial risk of very high Medicare costs;
  • deductible(s) for Part A and Part B services that may be combined or separate;
  • copayments, rather than coinsurance, that may vary by type of service and provider;
  • secretarial authority to alter or eliminate cost sharing based on the evidence of the value of services;
  • no change in beneficiaries’ aggregate cost-sharing liability; and
  • an additional charge on supplemental insurance to recoup at least some of the added costs imposed on Medicare.

They do not make specific recommendations, but they design an illustrative cost-sharing plan that would be deficit-neutral in terms of primary effects. However, the secondary effect of the cost-sharing on Medicare spending could have lowered spending by between 0.5 and 4 percent in 2009, based on how many people kept their supplemental coverage. In terms of distribution of the proposal, 70 percent of beneficiaries would see only a minor change, but about 20 percent of beneficiaries would see a greater than $250 annual increase in cost-sharing while 9 percent would see a greater than $250 decrease.

Obviously, adjustments could be made to make it a deficit-reducing package in terms of primary effects, as some major budget plans have done. For example, the Simpson-Bowles plan followed the MedPAC illustrative plan in having an out-of-pocket maximum (although it was higher) and restricting the amoun of cost-sharing that Medigap plans could cover, but it relied more on coinsurance than copayments varying by service. (For more on the Simpson-Bowles cost-sharing reforms, click here.)

Other chapters of the report deal more with health care delivery. The second chapter details the lack of care coordination within fee-for-service Medicare, while the third chapter deals with lack of coordination between Medicaid and Medicare with regards to "dual eligibles" (people who are eligible for both programs). Two other chapters deal with how to improve risk adjustments for payments in Medicare Advantage (Part C) and how to improve Medicare for rural beneficiaries.

Considering the importance of health care spending, especially Medicare, in our budget future, improving Medicare's cost-sharing structure and delivery system will be crucial. The full MedPAC report is well worth the read.

Note to Congress: Pay for the Extenders, or Let Them Expire

A POLITICO article reports on an effort underway at the Senate Finance Committee to negotiate an extension of the "tax extenders," narrow temporary tax provisions that are routinely extended. The article states that an agreement on an extension "could send a signal to financial markets that the two parties can find some common ground ahead of the looming fiscal cliff facing Washington at year’s end." Here's POLITICO's description of what happened:

At a closed-door Senate Finance Committee meeting this week, Chairman Max Baucus (D-Mont.) implored members on both sides of his tax-writing panel to help advance a pre-Election Day package covering an array of business tax breaks known as “tax extenders,” which could cost up to $35 billion depending on the scope of the plan. But Baucus’s pitch came with a catch: Lawmakers need to keep the expiring Bush tax cuts, the so-called Buffett rule and other politically charged issues out of the debate. 

We're not convinced this would be such a breakthrough. If the "clean" extension in the article simply refers to the idea that the extenders will be dealt with separately from the rest of the fiscal cliff, that's one thing (though better to address them as part of comprehensive tax reform!). But if it means there won't be a review of the extenders or consideration of offsetting revenues or spending cuts, then that's a problem. Given the nation's current fiscal state, adding to the national debt and kicking the can down the road with no plan ahead is simply unacceptable. Lawmakers must review the provisions in the "extenders" package and, more importantly, pay for them.

A review has already begun on a Ways and Means Subcommittee (we detailed one of the hearings here), but it needs to be done on a broader basis in both Houses. Surely, lawmakers can find some policies that are not worth extending instead of falling back on the horsetrading that created this package of tax breaks in the first place. In order to avoid the "herd-like" process in which all the extenders are extended in a single package with no oversight, former acting CBO director Donald Marron recently suggested breaking the provisions up into categories for review.

The Five Largest Tax Extenders (billions)
Policy 2012-2013 Cost 2012-2022 Cost
Subpart F Exemption for Active Financing Income $7 $82
R&E Tax Credit $6 $70
Alcohol Fuel Tax Credit $10 $62
Depreciation of Leasehold and Restaurant Equipment $1 $26
Education Expenses Deduction $2 $18
     
Memorandum: Total Tax Extenders (Excluding Expensing Provisions) $40 $456

Source: Joint Committee on Taxation

The extenders shouldn't get a free pass. They should be scrutinized and then enacted only if they are worth the cost. And if they are worth the cost, they are worth paying for--after all, budgeting is supposed to be about tradeoffs.

Targeting Tobacco: The Budgetary Effects of a Cigarette Tax Increase

CBO's latest report details the full effects on the federal budget of raising the federal excise tax on cigarettes. As they would when analyzing any tax policy, CBO estimates the revenue effect of this tax increase by looking both at how an increase in taxes would increase revenue, and how the subsequent reduction in cigarette purchases would reduce revenue. This report goes further, however, looking at the secondary microdynamic effects when accounting for changes in people's health. In reading through the report, one gets a thorough understanding of how many different factors interact with each other within the budget.

CBO analyzes the effect of a 50 cent increase in the cigarette tax, one which raises $38 billion of revenue through 2021 before accounting for health effects. To the extent that the tax causes cigarette consumption to decline, CBO finds that this will result in an improvement in people's health. The effects that this improvement has on the budget are numerous and include:

  • Effects of lower per capita health spending on outlays
  • Effects of increased longevity on both revenue and outlays
  • Effects of increased earnings on revenue
  • Effects of lower health insurance premiums on revenue

Through 2021, these effects reduce the deficit by an additional $4 billion through 2021. Most of this comes from increased earnings that lead to higher revenue, but also from lower outlays in health programs. Over the long term, the magnitude and even direction of the secondary effects change somewhat. 

Budgetary Effects of Cigarette Tax Increase (billions)
  Nominal Dollars Percent of GDP
  2013-2021 Savings 2025 Savings 2035 Savings 2085 Savings
Cigarette Tax Receipts $37.8 0.018% 0.017% 0.018%
Medicare Effects $0.3 *** -0.001% -0.007%
Other Health Program Effects $0.7 +0.001% +0.001% +0.001%
Social Security Effects $0.1 -0.001% -0.002% -0.005%
Other Outlay Effects  * *** -0.001% -0.002%
Secondary Revenue Effects $3.2 +0.005% +0.007% +0.009%
Total Savings $41.7 0.023% 0.023% 0.015%

Source: CBO
Note: Numbers may not add up due to rounding.
*Number is less than $100 million
***Number is smaller than 0.0005 percent of GDP and thus not presented by CBO

One would think that improvements in health would reduce spending in federal health care programs, and indeed this is true for Medicaid and the exchange subsidies. But importantly, better health actually has two offsetting effects – it reduces per-capita health care costs each year while at the same time increasing the number of years people live and therefore collect government benefits (including Medicare). This means that even as Medicaid and other non-Medicare health costs go down, Social Security costs go up. Medicare is more ambiguous, but CBO finds that over the long-term increased longevity pushes up costs for Medicare over the long term by more than improved health reduces them. In addition, increased longevity pushes up costs in Social Security, since the program would not "benefit" from reductions in per capita health spending.

At the same time, improved health and longevity increases the time that people are in the labor force and how much they earn when they are. CBO attributes some degree of higher earnings to not smoking or quitting and obviously the longer someone is in the labor force, the longer they are paying taxes. Also, improved health would marginally lower health insurance premiums overall, making the value of employer-sponsored health insurance go down and encouraging employees to take more compensation in the form of taxable income.

In terms of the comprehensive budgetary effects, the tax itself raises about 0.02 percent of GDP annually over the long term, but the secondary effects vary. The revenue enhancing aspects kick in faster than the outlays, so through sometime in the 2060s, the tax's overall deficit reduction is greater than the revenue brought in. By the 2060s, the outlay-increasing effects of longevity surpass the revenue effects, making the tax's overall deficit reduction less than the tax's revenue.

The graph below from CBO shows how these secondary effects change over time.

Source: CBO

Of course, increased longevity is great for the country, and only harms the budgetary bottom line if we allow it. One way to mitigate the effect of increased life expectancy on old-age programs is to index the Social Security and Medicare retirement ages for changes in life expectancy. Taking an approach that maintains the ratio of years in retirement to years worked, for example, would allow retirees and taxpayers to share in the gains of longevity; more aggressive indexing could still serve as a “win-win.” And increasing the retirement ages would have its own deficit-reducing secondary fiscal effects, which we detailed here.

If anything, the report is an interesting example of how policies can affect so many different parts of the budget, and how CBO's scoring can account for important microdynamic effects. It is certainly worth a read.

Deficit On Track to Shrink Compared to Last Year

Although budget projections had already been showing this, we now have more definitive numbers from the Treasury Department that this year's deficit will be smaller than last year's. At this time last year, the deficit through the first eight months equaled $927.4 billion compared to $844.5 billion this year.

Individual and corporate income tax revenue is on the rise, driving much of the lower deficit. Individual income tax receipts are up 4 percent over last year through a comparable period and corporate tax receipts are up 40 percent--perhaps reflecting unusually low corporate revenue last year due to the ability of businesses to fully expense equipment investments. Meanwhile, outlays have actually fallen slightly due to lower discretionary spending and spending on countercylical programs.

Comparing FY 2012 and FY 2011 Through Eight Months (billions)
  FY 2012 FY 2011
Outlays $2,408 $2,412
Revenue $1,564 $1,484
Deficits -$844 -$927

Source: Treasury Department

Last year's deficit was $1.3 trillion and according to the Congressional Budget Office's latest projections, it will equal $1.17 trillion this year.

Good News for Health Spending?

Actuaries at the Center for Medicare and Medicaid Services have published a new report detailing their projections for health care spending growth from 2011 to 2021. The growth rates they project may be good news for the economy and the budget as well if they pan out.

In recent years, health care spending growth has been much more modest, at least in part because of the recession. After averaging seven percent growth in the previous decade, growth has been around four percent in recent years and is projected to stay around there through 2013. A big debate in the health policy world has been taking place over whether this slowdown represents solely the effects of the recession or structural changes in the health care system that will permanently slow growth.

According to CMS's projection, it's somewhere in between. As the economy recovers and the Affordable Care Act's major coverage expansions kick in, spending growth will jump to about seven percent but settle in around six percent for the rest of the projection period. Overall, from 2011-2021, health care spending grows on average at 5.7 percent annually, only about 0.9 percentage points faster than GDP (note that the Independent Payment Advisory Board's goal is to limit Medicare spending growth per beneficiary to GDP plus one percent).

The Affordable Care Act's effect on overall health spending is actually somewhat small on net, according to CMS. The report very helpfully shows their projections for national health expenditures with and without the ACA. There is a large bump up in growth in 2014 when the coverage expansions kick in, but it quickly converges to non-ACA growth rates and in fact slows growth for some years later in the decade. Cumulatively, the ACA will add $478 billion to health spending through 2021 (for context, total health spending in 2021 will be $4.8 trillion).

Of course, it's no time to break out the champagne even if these projections do pan out. Notice that excess cost growth--the amount by which health spending growth exceeds GDP growth--gets larger later out in the decade. In addition, these calculations take into account the 27 percent Medicare physician payment cut and the sequester's hit on Medicare starting in 2013, both of which are unlikely to occur (especially the former).

Still, the amount of excess cost growth is very important to the budget, so this projection is a bit of good news. CBO's Long Term Budget Outlook shows that having no excess cost growth after 2022 would lower their current law projections of federal health care spending by two percentage points of GDP in 2037. Although this would by no means put our debt on a sustainable path by itself--assuming policymakers continue spending and taxing like they have--it would still go a long way. As we said last week, policymakers should continue to be vigilant on health care cost growth and emphasize policies that can reduce it.

Line Items: Zombie Edition

Undead Ends – Recent reports of disturbing behavior have raised the specter of a zombie apocalypse, where the undead overrun civilization. Flesh/brain-eating creatures aren’t the only things that don’t want to die. Political gridlock also keeps coming back and threatens to make a wasteland out of the political system. Policymakers cannot agree on a budget blueprint at a time when we most need a fiscal plan that shows the way out of the depths of debt. The appropriations process lingers on; a slowly moving, virtually-lifeless corpse. Maybe the zombies have already taken over DC, though the most cynical among us would argue that there are no brains to be had there.

Appropriations: Plight of the Living Dead – The fiscal year 2013 spending bills continue their slow march to an uncertain fate. The House approved of FY 2013 appropriations bills for Energy & Water Development, Homeland Security, and the Legislative Branch last week before leaving for another week-long break. Due up when the House returns are spending bills for Transportation, Housing & Urban Development and Financial Services. The Senate has yet to pass any appropriations bills. Senate Appropriations subcommittees will mark-up the bills for Financial Services and Labor, Health & Human Services and Education this week. Because the House and Senate disagree on spending levels, no one believes that we will have appropriations in place when the fiscal year begins on October 1. The best case scenario appears to be a stopgap measure that provides temporary funding (and avoids a government shutdown) into the next calendar year. We need budget process reform.

Highway to Zombieland – Congressional negotiators appear to be at an impasse on the multi-year reauthorization of highway and transit programs as they face a deadline at the end of the month. The Hill newspaper quotes a source saying the talks are on “life support” and House Speaker John Boehner (R-OH) is suggesting that a six-month extension (the tenth temporary extension) may be needed. A six-month extension would add highway funding to a long list of issues Congress will have to deal with in a post-election lame duck session and a depleted Highway Trust Fund would be added to the fiscal cliff that is already full of peril.

Farm Bill Withering on the Vine? – Congress is considering changes to agricultural programs that could help reduce the deficit, but disagreements could derail the package. The Senate is poised to begin debate on a farm bill that would scrap controversial subsidies and replace them with a form of insurance. We previously noted that this approach would achieve some savings and moves in the right direction, but the way the insurance program is constructed could result in higher than expected costs down the road. But Senators must come to an agreement on what amendments will be considered before serious consideration on the Senate floor begins.

Sequester Quest – Speaking of the farm bill, Sen. John McCain (R-AZ) has offered an amendment to the bill calling on the Department of Defense to provide a detailed report to Congress by August 15, 2012 on the impact to national security of the defense sequester under the Budget Control Act. And many lawmakers are trying to figure out how to replace the defense cuts under the sequester. This comes as a report from the Bipartisan Policy Center says the defense sequester will result in over 1 million jobs being lost. As we have stated in the past, the sequester should be replaced with a comprehensive fiscal plan.

Moving Away from the Fiscal Cliff – The sequester is a part of the “fiscal cliff” that we face at the end of the year, along with the expiration of the 2001/2003/2010 tax cuts, the “doc fix,” the AMT patch and several other tax extensions. A bipartisan group of Senators is quietly meeting to develop an alternative that achieves the debt reduction goals of the fiscal cliff, but in a smarter manner that is more comprehensive and phased in. The latest Long-Term Budget Outlook from the Congressional Budget Office (CBO) illustrates what is at stake. The report highlights two baselines: the Alternative Fiscal Scenario which shows debt skyrocketing to unprecedented and unimaginable levels if action isn’t taken, while the Extended Baseline Scenario shows that public debt is reduced to a much more manageable level if the policies of the fiscal cliff take effect. But, the CBO previously warned that the fiscal cliff could do significant harm to the economy in the short term. CRFB updated its own long-term Realistic Baseline that also paints a not-so-pretty picture. CRFB has been vocal in advocating for a comprehensive debt reduction plan to replace the fiscal cliff.

Moving Towards Tax Reform – Fundamental tax reform should be a part of a comprehensive fiscal plan. On Monday, Senate Finance Committee Chair Max Baucus (D-MT) laid out his vision for tax reform. Baucus said tax reform should contribute to debt reduction and said his committee would hold hearings on the reform proposals from the Simpson-Bowles and Domenici-Rivlin commissions.

Key Upcoming Dates (all times ET)

June 12

  • Senate Appropriations Subcommittee on Financial Service and General Government meeting to markup proposed budget estimates for fiscal year 2013 at 3:30 p.m.

June 13

  • Senate Appropriations Subcommittee on Department of Defense hearing to examine proposed budget estimates for fiscal year 2013 at 10:30 a.m.

June 14

  • Dept. of Labor's Bureau of Labor Statistics releases May 2012 Consumer Price Index (CPI) data.

June 26

  • Presidential primary in Utah

June 28

  • US Dept. of Commerce's Bureau of Economic Analysis releases its third estimate of 2012 first quarter GDP growth.

July 6

  • Dept. of Labor's Bureau of Labor Statistics releases June 2012 employment data.

July 17

  • Dept. of Labor's Bureau of Labor Statistics releases June 2012 Consumer Price Index (CPI) data.

July 27

  • US Dept. of Commerce's Bureau of Economic Analysis releases its advance estimate of 2012 second quarter GDP growth and revised estimates of 2009 through 2012 first quarter GDP growth.

Deloitte Releases Report on the Federal Debt

Today, the consulting firm Deloitte released a report on the scope and consequences of our federal debt. Deloitte, like the majority of researchers, has found that our debt is not sustainable and on its current path, will cause economic harm. Deloitte has five different arguments in the paper, all with their own implications for both the public and private sectors of the economy.

  1. The debt crisis is likely bigger than you think
  2. The magnitude of the debt is highly sensitive to economic fluctuations.
  3. Debt could adversely impact American competitiveness.
  4. Rising debt could impact the independence of monetary policy
  5. Demand for and composition of America's debt isn't just America's decision.

Deloitte also correctly points out "the silent cost of interest" when they explain that increases in interest payments will likely crowd out other spending in the budget. They quantify examples of foregone spending on different areas of the budget due to growing spending on interest on the debt.

Overall, this report is well worth the read, and it is yet another reminder that we need to enact a comprehensive, bipartisan fiscal plan soon because the consequences of our current path are real.

Introducing CRFB's Latest Long Term Realistic Baseline

With the release of CBO's Long-Term Budget Outlook last week, CRFB has updated the Realistic Baseline to incorporate elements of CBO's long-term budget and economic projections. Our baseline's results are little changed from last year, once again showing that a reasonable projection of current policy puts us on a dangerous fiscal path.

Compared to CBO's projections of current law (the Extended Baseline) and current policy (the Alternative Fiscal Scenario), the CRFB Realistic Baseline adheres more closely to debt projections under CBO's AFS in the near-term but roughly splits the difference between CBO's AFS and Extended Baseline over the longer-term. Under the Realistic Baseline, debt as a percent of GDP rises from 73 percent in 2012 to 85 percent by 2022, 134 percent by 2037, and 428 percent by 2087. This is in contrast to current law, where debt falls throughout the projection window until it is paid off in 2070, and CBO's AFS where the debt rises even faster to more than 900 percent of GDP by 2087. 

Source: CBO, CRFB

Spending as a percent of GDP rises significantly over the longer-term, mainly due to increasing interest payments on the debt and rising health care spending. Total federal spending under the CRFB Realistic Baseline falls from the 2012 level of 23.4 percent of GDP to 22.3 percent by 2018, but then rises to about 30 percent by 2037, 38.2 percent by 2060, and 50.4 percent by 2087. Revenue rises throughout the projection window but fails to keep up with spending, increasing from 15.8 percent of GDP in 2012 to 18.8 percent in 2022, 20.1 percent in 2037, and 25.1 percent in 2087.

As you could imagine, the Realistic Baseline's policy assumptions are closer to the Alternative Fiscal Scenario than the Extended Baseline, although there are some key differences that cause divergence over the long-term. The differences in assumptions are presented below.

In addition, we have calculated exactly what is responsible for the differences between current law and the Realistic Baseline. The 2001/2003 tax cuts, the patches to the Alternative Minimum Tax, the repeal of the sequester, the doc fix, and the partial repeal of the Affordable Care Act's cost controls comprise the differences, with the main sources of increased debt being in the first two policies.

Source: CBO, CRFB
Note: 2001/2003 tax cuts include interaction with AMT patch

The CRFB Realistic Baseline represents what we believe is a more realistic projection of where we're heading based on an extension of the path we're on today -- and that path is not promising. Of course, Congress could ultimately take a policy approach that results in even worse debt (like something more in line with CBO's current policy), but either way we won't be able to sustain ever-increasing debt levels for very long. We need to stick more closely to current law debt levels over the long term while avoiding the short term economic damage and poor policies that come with current law.

A Good Way to Limit Tax Expenditures

The Tax Policy Center has released a new table showing the revenue impact of options to reform the mortgage interest deduction. The options shown all involve some form of converting the deduction into a credit.

For example, converting the deduction into a 15 percent credit while limiting the size of the mortgage on which interest could be deducted to $500,000 (currently at $1.1 million) could raise $378 billion from 2012-2021, assuming current tax policies are extended (and the policy being in effect retroactive to the beginning of this year). Shifting the budget window to the current 2013-2022 period would most likely result in revenue of over $400 billion. A more gradual option would phase down the deduction over ten years while allowing taxpayers to choose between the deduction and the 15 percent credit while the deduction still existed. This option could raise $266 billion.

Converting itemized deductions into credits can be an effective way of limiting tax expenditures without necessarily eliminating them. Itemized deductions are poorly designed in that they only confer benefits to people who itemize their tax returns rather than take the standard deduction (generally higher-income earners), and they are more valuable to people in higher-income tax brackets. Even as subsidies, the deductions by their nature have low bang for the buck, often going to people who would engage in these activities anyway.

To see TPC's revenue table and the distributional tables related to it, click here.

Things to Consider When Evaluating Tax Extenders

It is encouraging to see the House Ways and Means Subcommittee on Select Revenue Measures hold a series of hearings on the many temporary tax preferences known as the "tax extenders." Far too often Congress intentionally waits until the eleventh hour so that they can extend them as a wholesale package without any review of the policies involved. The latest hearing came earlier today on methods for dealing with and evaluating tax extenders. In it, there were some interesting comments.

In his testimony, Tax Policy Center director Donald Marron suggested breaking down tax extenders into categories for review and, for timeliness sake, reviewing them in waves to spread out the expiration of tax extenders that are in fact allowed to expire. He also proposed changing budget rules for temporary tax cuts (in a way that could be applied to other temporary provisions as well). In particular, he mentioned that CBO could construct its baseline such that no tax provision could be in effect for less than five years, regardless of what the law said. This would force proponents to immediately budget for the provision's longer-term existence. He also mentioned forcing offsets to happen over the same time period as extensions to prevent the practice of offsetting a year of cost with ten years of offsets (which is technically "deficit-neutral" but deficit-increasing relative to the cost not existing).

Outside of the pure budgetary effects, two of the other witnesses discussed further considerations for tax extenders. Alex Brill of the American Enterprise Institute said that extenders should not simply be evaluated based on the activity they are subsidizing or for the level of activity they generate, but rather the level of activity they generate that would not have happened otherwise--in other words, its marginal effect. He used the R&E tax credit as an example: while subsidizing research and development is generally considered a good idea because the overall returns to society are greater than a private company would benefit from, this does not necessarily mean the R&E tax credit is a good policy; in fact, it would be poor policy if it simply provided windfalls to companies who would do R&D anyways.

Jim White from the Government Accountability Office agreed that policymakers should be focused on the marginal benefit of policies, pointing, for example, to a GAO report that showed that much of the R&E tax credit subsidized research and development that would have happened anyway. He also emphasized that each individual tax extender should be evaluated within the context of the goal it is working towards and the other policies involved in reaching that goal. Coordination would be needed among these policies, and policymakers should also watch out for tax extenders that duplicate other benefits.

Lawmakers would be wise to take these insights into account in the tax extender debate. Ultimately, we will see if these hearings bear any tax code-improving fruit.

The full video of the hearing is below.

The Drivers: Health Care Cost Growth and Population Aging

In our recent analysis of CBO's Long-Term Budget Outlook, we elaborated on how the overall federal debt is on an unsustainable path. Just twelve years from now, under CBO’s Alternative Fiscal Scenario (AFS), debt will surpass 100 percent of GDP, and by 2038, it will exceed 200 percent. Driving this debt growth are the increasing costs of Social Security and especially Medicare and Medicaid. Even under the lower costs of the Extended Baseline scenario, from 2012 to 2037, Social Security spending will rise from 5 to 6 percent of GDP while total federal health care spending will rise from 5 to 10 percent of GDP. What drives the growth of these programs? Two main dynamics are at work.

First, the aging of the U.S. population expands the rolls of Social Security and Medicare (and Medicaid for long-term care) and increases beneficiaries’ average age, with all the increases in costs related to age. Second, health care cost growth raises costs per beneficiary, and those increases in health care costs have grown on an average of 1.6 percent faster than the overall economy on average over the last 25 years according to CBO -- a phenomenon known as “excess cost growth.” CBO assumes that health care cost growth will slow down over time, but excess growth will remain.

Through 2037, aging will be the dominant force in spending increases not only on Social Security and health care programs, but also in the overall non-interest budget. In its Extended Baseline Scenario, where Medicare provider payments are cut by 27 percent next January, CBO projects that aging will account for 75 percent of the growth from 2012 to 2037 in the combined spending on Social Security and health care programs. In CBO’s Alternative Fiscal Scenario, with continued "doc fixes" maintaining Medicare physician reimbursements and various health care cost-controls being overridden after 2022, aging accounts for 68 percent of combined growth on Social Security and health care programs.

Surprisingly, even when you look at just the major health care programs, aging accounts for the majority of the spending growth through 2037 in both scenarios.

After 2037, declining numbers of Baby Boomers will stabilize the age distribution, while health care costs are projected to continue growing faster than the economy. Over the longer term, then, excess cost growth in health care will eventually account for the majority of spending growth for Social Security and federal health care spending.

The fact that aging and health care play such a central role in the growth of Social Security and the health care programs -- which would actually decline in their absence -- suggests that these factors need to be taken seriously. This is especially true given that both factors will also reduce federal revenue -- by reducing the proportion of the population in the labor force and by increasing the amount of tax-exempt compensation received in the form of health insurance -- and could slow economic growth.

As policymakers work toward replacing the fiscal cliff with more targeted deficit reduction measures in the year ahead, they should pay special attention to those measures which can slow health care cost growth or mitigate the effects of population aging. As CBO said:

The aging of the U.S. population and the rising costs for health care mean that the combination of budget policies that worked in the past cannot be maintained in the future.

Senators Meet To Discuss Fiscal Cliff

Earlier this week, about a third of the Senate met to open a bipartisan discussion about comprehensive fiscal reform and the impending fiscal cliff according to coverage from both the National Journal (subscription required), Politico, and Bloomberg. The briefing, according to "Gang of Six" cofounder Sen. Saxby Chambliss (R-GA), was intended to educate the senators on the fiscal cliff, the consequences of inaction, and the need for a comprehensive solution.

Attendees discussed efforts to develop a bipartisan solution based on the Simpson-Bowles framework. Also adding to the discussion were World Bank President Robert Zoellick and New York Federal Reserve Bank President William Dudley, who briefed the senators on the European crisis. The European debt crisis combined with the looming fiscal cliff have created a great deal of uncertainty. Sen. Dick Durbin (D-Ill.) believes that timely action would be the best approach for the economy:

"There's a genuine concern that a downturn in Europe or another place will force our hand: It's far better for us to start working on this earlier rather than later, and there's a lot of work to be done. If we can present something immediately after the election that is a good solid starting point, I think it's going to restore confidence in the business community."

The stakes of the fiscal cliff are well known, but policymakers must be determined to make the tough decisions if we are to avoid the unpleasant affects of the fiscal cliff and the economic consequences from continuing to pile on more and more debt. Sen. Ben Nelson (D-NE) describes the situation well: “Talk is important, but it has to be more than just talk.”

We applaud the Senate’s meeting and hope that lawmakers continue to discuss fiscal responsibility. CRFB encourages all other policymakers -- in the House, Senate, and White House -- to join in their efforts. Only with real leadership will a debt deal get done, and the benefits could be significant. As Sen. Mark Warner (D-VA) sees it, there is danger but also opportunity from the fiscal cliff: “If we don’t do our job, [there will be] really dire consequences. But if we can reach a really comprehensive deal, the positive impact it would have on not only our economy would be remarkable.”