Also see our Economic Commentary which supplements the Laufenberg Economic Quarterly and primarily focuses on more recent economic developments.

This page is designed to offer you my perspective on economic fundamentals, ranging from business cycles to yield curves. It will provide more detailed economic analysis than is generally available in the Quarterly. For the most part, the essays provided here will attempt to discuss timely fundamental issues related to the forecast but are expected to have a longer shelf life than the content on either the Quarterly or Commentary pages. I hope that over time you will consider the information on this page as a source of reference when debating economic issues in the future.

Daniel E. Laufenberg, Ph.D.

Health Care Legislation: Essay No. 2-Revenue provisions of the new legislation

[April 13, 2010. This is the second in a series of four essays discussing various aspects of the health care legislation enacted recently. The first discusses the expanded benefits and their impact on the future cost of health care, both in terms of price and quantity. The second essay will discuss the revenue provisions in the legislation and their impact on economic activity. The third essay will discuss the impact of the new legislation on federal deficits and debt, and what it implies for the long-run health of the economy. The final essay will try to summary the various features of the legislation and assess their net impact on the economy in the short-term, as well as in the longer-term.]

According to the markup of the Patient Protection and Affordability Care Act (H.R. 3590) and the Health Care and Education Affordability Reconciliation Act of 2010 by the Congressional Budget Office, the revenue provisions of the legislation would more than offset the added cost. In the first essay, I argued that the cost estimates were probably too low. In this essay, I argue that the revenue estimates are too high. Note that for the purpose of this essay, revenue refers to the items that would be considered offsets to the cost of the new health programs as defined by the pay-as-you-go rules. This would include any cost savings that are expected from the government's increased involvement in health care (including any savings from improved enforcement of fraud and abuse), the new fees that will be assessed pharmaceutical firms, the health insurance industry, and medical device producers and any new or expanded Medicare taxes on upper-income households.

Found money

According to the Congressional Budget Office (CBO), the estimated savings from existing government health care programs (roughly $480 billion) over the next decade is expected to pay for nearly half of the gross cost of proposed expansions in insurance coverage (about $875 billion) included in the recent legislation. There are several aspects of the anticipated cost savings, including lowering the volume of health care used per beneficiary, requiring discounts and rebates on many drugs, reducing emergency room use by the uninsured, and reining in fraud, waste and abuse in Medicare, Medicaid, and the Children’s Health Insurance Program.

In a recent blog, CBO Director Douglas Elmendorf noted that "the legislation maintains and puts into effect a number of policies that might be difficult to sustain over a long period of time."1 The example he offered was the assumption in the legislation that the growth rate of Medicare spending (per beneficiary, adjusting for overall inflation) would slow to 2 percent over the next two decades from 4 percent for the last two decades. It is unclear how such a reduction would be achieved; that is, "whether it would be through greater efficiencies in the delivery of health care or through reductions in access to care or the quality of care."2 The legislation also indexes the subsidies paid through the yet to be established health insurance exchange at a lower rate after 2018. I doubt, given the other provisions in the legislation mandating more demand for health care, that such savings can be as extensive as estimated by the CBO. Ironically, the CBO seems to agree.

Another aspect of the savings from existing programs is that the federal government, operating as a monopsony (the only buyer of health care) will be able to negotiate price reductions for services and drugs. There is some evidence in the data that the government has paid a lower price for health care than others, which has helped fuel the argument that the government-sponsored programs are more efficient than the private-sector insurance programs. For example, the price index for health care reflecting the out-of-pocket expenses of consumers rose at an annual rate of 3.9 percent over the last decade, while the price index for all spending on health care provided to consumers, regardless of who paid for it, increased 2.9 percent a year over the same period. Apparently, the government, and to a lesser extent the health insurance companies, were able to negotiate a lower price for health care than individuals or employers could on their own. Regardless of who paid, however, the medical care providers still saw their revenue increase 2.9 percent per year.

With the new health legislation, the government’s share of all health care expenditures would increase dramatically. At first blush, this would seem to imply lower prices paid for health care. In fact, it may not. What may happen is that the government may realize that it has lost some of its negotiating power on price because the share of the market that paid higher prices to the medical care industry has shrunk. On balance, health care providers most likely will still see their revenue increase at a rate about 30 percent faster than overall inflation (for example, 2.9 percent for health care versus 2.2 percent for overall inflation). On balance, the government will face somewhat higher medical care inflation than they would have otherwise, while the other buyers will likely experience the same medical care inflation they would have otherwise.

Another example of how the government is expected to reduce health care costs was already law before the health care legislation was enacted. In particular, payment rates for physician’s services in Medicare will be reduced by 21 percent in 2010 and then decline further in subsequent years. The legislation includes a number of provisions that would constrain payment rates for other providers of Medicare services. As a result, increases in payment rates for many providers would be held below the rate of inflation. The assumption is that the Independent Payment Advisory Board established by the legislation would be effective in reducing costs.

Finally, reining in fraud, waste and abuse in the various government health care programs—mostly in Medicare—is a key source of estimated savings. If fraud and abuse were so obvious, why were they not dealt with earlier? I suspect that it is waste that is the major issue here. Based on anecdotal evidence that I gathered talking to physicians, much of the waste is that doctors duplicate tests on their patients. The problem is that doctors are reluctant to accept the test results of other doctors that they do not know or trust because of the potential lawsuit they could face if the results were incorrect. Unfortunately, the only realistic way to eliminate this waste is to invest in a massive national health information system, which would probably cost hundreds of billions. It also would revive the usual privacy issues. As such, it seems unlikely to happen.

Tell me again how government fees encourage innovation and lower prices

The federal government anticipates that the expanded drug coverage in Medicare, as well as mandatory health insurance coverage scheduled to go into effect in 2014, will generate excess profits for pharmaceutical firms and health insurance companies. In anticipation of these “windfall” profits, the federal government will assess fees on drug companies and health insurance firms, in addition to the income taxes that these corporations will pay on their profits. Also, starting in 2013, the legislation imposes an excise tax on certain medical devices that is expected to raise $20 billion over the next decade.

The government’s fee on the pharmaceutical industry is estimated at $27 billion over the next decade, starting in 2011. This fee will be administered by the Internal Revenue Service. From an economist’s perspective, this fee effectively guarantees that any economies of scale realized by pharmaceutical companies will not lead to lower prices. As a result, this is one of the provisions of the legislation that make it less likely that health care inflation will be lower over the next two decades than it was over the last two.

Another provision that probably will make health care inflation “sticky downward” is the assessment on the health insurance industry scheduled to begin in 2014. In other words, instead of allowing any possible cost reductions from economies of scale to flow through to consumers in the form of lower health insurance premiums, they will be used to pay the government’s assessment. This fee is estimated to raise $60 billion over 10 years.

In addition, the fees paid to the government could reduce the industry’s incentive to invest in research and development. It is unclear that the pharmaceutical firms will be rewarded for developing new drugs and the health insurance industry will have any incentive to be more efficient. After all, the government will be looking at the health care industry in general for more opportunities to assess even larger fees if they succeed. Indeed, the unintended consequences of these provisions may be increased consolidation in the pharmaceutical and health insurance industries, with little incentive to be innovative. This is not a recipe for lower health care inflation.

Medicare tax changes—making it progressive and expanding the base

The legislation imposes new Medicare Hospital Insurance (HI) taxes on single taxpayers with incomes above $200,000 and married couples filing jointly with incomes above $250,000. The current Medicare HI payroll tax is 2.9 percent of all wages, with the worker and the employer each paying half. Starting in 2013, high income taxpayers will pay an additional 0.9 percentage point HI tax on earned income above the high-income limit of $200,000 or $250,000. In addition, starting in 2013, high income taxpayers will be subject to a new 3.8 percent tax on unearned income, including interest, dividends, annuities, royalties, and rents. It excludes income from active participation in S corporations and, as far as I can tell, capital gains.

According to CBO Director Douglas Elmendorf, these new taxes will improve the cash flow in the HI trust fund by more than $400 billion over the next decade. "Higher balances in the fund will give the government legal authority to pay Medicare benefits longer, but most of the money will pay for new programs rather than reduce future budget deficits." 3 As such, the higher balances will not enhance the government’s economic ability to pay Medicare benefits. In other words, the legislation may make Medicare legally better off but not necessarily economically better off to honor future obligations.

On the White House website, they argue it is unfair that those who have substantial unearned income do not pay the Medicare (HI) tax. What is fair? This is an argument that cannot be won. The people who benefit—or know someone who might—will say it is only fair and those who pay will say it is not. This is the way progressive tax systems work—the more you have, the more you pay in absolute as well as in relative terms. If the purpose of the new tax is to transfer wealth from one group to another, which the White House suggests it is, then use the already progressive income tax rather than trying to make the Medicare HI tax more progressive. The former is far more efficient than the latter. After all, the new taxes will be administered by the Internal Revenue Service anyway, which means they will complicate further an already very complicated income tax return. What happened to tax simplification?

Moreover, the extension of the White House’s definition of fairness suggests that the ability to pay (means tests) will increasingly become part of the government entitlement programs. That is, higher income households will be required not only to pay more taxes on their income, they will be asked to pay the full fare for their health care. Under such circumstances, the programs are no longer entitlements but welfare. For the most part, means tests are already being used to determine the premium paid for Part B of Medicare and the new Medicare taxes on higher income households represent an extensive of this trend. For 2010, the monthly Part B premium ranges from $96.40 to $353.60, depending on the level of modified adjusted gross income (MAGI), which by the way is adjusted gross income plus your tax-exempt interest income. This could, and probably will, change every year depending on any cost adjustments to the premium by Medicare and updated MAGI information from the Internal Revenue Service.

The bottom line is that the revenue estimates, especially the cost savings from existing programs, offered by CBO are much larger than I think possible. If that is the case, Medicare taxes are likely to go even higher and the availability of government-sponsored health care insurance programs will increasingly be on a means-tested basis rather than an entitlement basis. In other words, these programs become wealth transfer (welfare) programs. As such, they should be funded out of general revenues rather than by a special payroll tax. It may be “unfair” to do otherwise.

1 See Douglas Elmendorf, “The Effects of Health Reform on the Federal Budget,” Congressional Budget Office Director’s Blog, Monday, April 12th, 2010.

2 Ibid

3 Ibid

Go Here for Health Care Legislation: Essay No. 3-Budget deficits will continue and they do matter!

The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.

Special Report: Health Care Legislation
Essay No.1 - Costs
Essay No.2 - Revenue
arrow Essay No.3 - Budget Deficits
Essay No.4 - Things to Watch

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