Tuesday, October 30, 2012

Politico reported that Simpson-Bowles was the most popular Google search during the October 3rd presidential debate. Given the renewed attention to this deficit reduction plan, it is interesting to examine its implications for sustainable health spending and also to “map it” on the Triangle of Painful Choices that I developed previously.

I have argued that under the Patient Protection and Affordable Care Act (ACA), long-run sustainability in health spending is largely determined by the federal government’s ability to meet its Medicare, Medicaid, exchange subsidy, and other health obligations under a balanced budget. Cost growth beyond what the government can afford will not be sustainable. Moreover, sustainable cost growth for the government will be affordable to individuals as long as the ACA subsidies are adequate. I have developed a model that computes the growth rate that is affordable by the government (hence sustainable) under alternative assumptions about what the public is willing to provide in tax revenues, and the share of revenues going to non-health spending.

Tax Revenues and Non-Health Spending Under Simpson-Bowles

Simpson-Bowles caps federal tax revenues at 21 percent of Gross Domestic Product (GDP). Under their reforms, spending on Social Security in 2035 is projected to be 5.8 percent of GDP, slightly below the 6.1 percent projected by the Congressional Budget Office (CBO). Simpson-Bowles does not provide an estimate of federal spending on national defense and other non-health items for 2035.[1]  Instead, I extrapolated an estimate of 6.5 percent of GDP, just below the value for 2021 implied in their recent report.[2]

The first two charts place these revenue and outlay recommendations in historical context. The first shows federal tax revenues as a share of GDP from 1972 through 2011. The average over the entire period is slightly under 18, percent but is dragged down by the abnormally low recent percentages. CBO uses 18.5 percent under their Alternative Fiscal Scenario which is based on continuing current policies (as opposed to current law). For every year except 2000, revenues were less than 20 percent of GDP. Thus the Simpson-Bowles proposal of 21 percent is nearly 3 percentage points above the long run historical average and 1 percentage point above the historical high.[3]

The second chart plots federal spending on defense and other non-health items (not counting Social Security and interest) as a percent of GDP. The average over the entire period is 10.9 percent with a high of nearly 14 percent and a low of about 8 percent.[4]  As noted above, my extrapolation of the Simpson-Bowles policy would set this figure to 6.5 percent of GDP – 1.3 percentage points under the historic low, and 4.5 percentage points under the 39-year average.

Graph of the federal tax revenues by fiscal year

Source:  CBO Long Term Budget Outlook, June 2012

Graph of defense and other non-health spending by fiscal year

Source:  CBO Long Term Budget Outlook, June 2012 with author’s adjustments


As I interpret their projections, the 6.5 percent would include 2.5 percent for defense and 4 percent for other non-health spending. These figures are about half of their historical averages and 10 to 20 percent below the minimum levels for the 1972 to 2011 period. Thus, under Simpson-Bowles, defense spending and other non-health spending share are treated similarly when measured against their previous average and minimum amounts.

Implications for Sustainable Health Spending

Simpson-Bowles includes numerous recommendations for reducing the rate of growth in federal health spending through 2020 and suggests a target of GDP+1 thereafter, though there is some ambiguity.[5] It is possible to derive the rate of increase that would be consistent with their proposed tax revenues and federal spending on Social Security, defense, other non-health items. I have done this by imposing two restrictions:  federal outlays must equal tax revenues in 2035, and the underlying health cost trend, public and private, is the same throughout the health system.[6] The answer I derive is health spending growth just under PGDP+1 where PGDP represents potential GDP.[7] The next chart provides historical context. While PGDP+1 is well below the long run average, it is roughly in line with the rate experienced since 2005.[8]

Graph of health spending growth in excess of potential GDP since 1966

Source:  Altarum Center for Sustainable Health Spending


Simpson-Bowles and the Triangle of Painful Choices

The final chart locates Simpson-Bowles on my Triangle of Painful Choices.[9] The triangle portrays the tradeoffs between tax revenues, federal spending on items other than health, and the resulting rate of increase in health spending that would be sustainable (consistent with a balanced budget in 2035). I label the smaller brown triangle the Region of Tri-Shared Pain because all points in it correspond to:

  1. Historically high tax revenues; and
  2. Historically low spending on defense and other non-health items; and
  3. Historically low rates of growth in health spending.[10]

That is, within this smaller triangle, the outcome would be outside of (in a painful way!) historical precedence along all three dimensions. With tax revenues at 21 percent, and defense and other non-health spending at 6.5 percent, the sustainable rate of growth in health spending is somewhat less than PGDP+1, thus Simpson-Bowles is in this triply painful region.[11]

Image of the Triangle of Painful Choices, policy options for a balanced budget in 2035 

Does Simpson-Bowles Strike the Right Balance? 

The answer to this question is clearly a matter of taste. The Politico article cited above notes that:

Simpson and Bowles are looking to retool their deficit reduction package to decrease the amount of revenue it raises — to address those concerns from the right regarding tax increases. And they’re zoning in on increased tweaks to health care programs and want to bolster social safety net protections for low-income Americans — to address concerns from the left.

Simultaneously reducing revenues and bolstering social safety net protections will be a good trick! Nevertheless, this could be accomplished if the growth rate in health spending could be reduced. For example, if the nation adopted, and achieved, a Massachusetts-like health spending target of PGDP+0, one could reduce revenues to 20 percent of GDP, and increase defense and other non-health spending to 7 percent of GDP (point A). Alternatively, a move to the center of the shared-pain region would hold revenues at around 21 percent, increase spending on defense and other non-health programs to 7 percent, and target health spending growth of PGDP+.5.

For my taste, it is hard to imagine living with less than 8 percent of GDP available for defense and other non-health spending. The nation achieved 8 percent only during a brief period characterized by no war (defense needs low) and an economy at greater than full employment (social safety net needs very low). We could afford 8 percent at Simpson-Bowles revenues of 21 percent and PGDP+0 health spending growth – but not at all easy (point B). Good grief!  How about moving to point C?


[1] Other non-health spending in this context does not include spending on Social Security or interest on the national debt.

[2] Their report uses different data definitions from those in the CBO Long Term Budget Outlook as it shifts the Medicare premium offset from the non-health category to the health category. My model includes an additional adjustment to account for other “health” spending that CBO includes in the defense and other non-health spending category. Items that I shift into the “health spending” category are derived from the National Health Expenditure Accounts and include federal spending on defense health, VA health, public health, and National Institutes of Health. Applying these adjustments to the Simpson-Bowles figure yielded 6.6 percent of GDP going to defense and other non-health in 2021. Since there was a slow downward trend, I extrapolated this to 6.5 percent in 2035.

[3] I am defining the historical high in terms of a three-year moving average, and this was 20 percent of GDP over the 1999-2001 time period.

[4] Over the 1999-2001 period, the average was 7.9 percent. Fiscally speaking, this period was exceptional, with the highest tax revenues and the lowest defense and other non-health spending in history!

[5] GDP+1 is suggested both as a global federal health spending target and as a per-beneficiary target when applied to particular programs. These can be quite different as described here.

[6] More specifically, I require a balanced primary budget plus some partial interest payments which, in this instance, I have specified at 0.5 percent of GDP. The partial interest payment was based upon feedback received at our July 24 Symposium on Sustainable Health Spending.

[7] The growth in PGDP, calculated by the Congressional Budget Office, captures the long-term trend in GDP driven by labor-force growth and trends in labor productivity. See here for why I favor using PGDP.

[8] I use PGDP+1 as the historical minimum because of the volatility of this figure and the effects of the recent recession.

[9] Careful readers will notice that the triangle has slightly shifted from what was shown in my previous blog. That is due primarily to a reduction in the 2035 Social Security spending share of GDP from 6.1 percent to 5.8 percent. It also reflects a revised definition of defense and other non-health spending and some updates to the model used in developing the sustainable health spending estimates.

[10] There is some rounding in the construction of the historical boundaries.

[11] “Triply” painful does not mean “most” painful, of course. It is indicative of a balanced solution where each of the three dimensions shares in the pain. Interestingly, it is health spending that seems to be sharing the least.

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