The Long-Term Outlook for Health Care Spending

Introduction and Summary

Spending on health care in the United States has been growing faster than the economy for many years, representing a challenge not only for the government’s two major health insurance programs—Medicare and Medicaid—but also for the private sector. As health care spending consumes a greater and greater share of the nation’s economic output in the future, Americans will be faced with increasingly difficult choices between health care and other priorities. However, a variety of evidence suggests that opportunities exist to constrain health care costs without adverse health consequences.¹

In December 2007, the Congressional Budget Office (CBO) will release new long-term budget projections, and spending on health care will play a central role in the fiscal outlook to be described in that report. This study presents CBO’s projections of federal spending on Medicare and Medicaid and health care spending generally over the next 75 years. Despite the substantial uncertainties surrounding projections over that long a period, particularly ones involving the growth of health care costs, such a horizon is useful for illustrating the long-term fiscal challenges that this country faces.

The goal of the projections in this study is to examine the implications of a continuation of current federal law, rather than to make a prediction of the future. Under that assumption, however, federal spending on health care would eventually reach unsustainable levels. In reality, federal law will change in the future, ensuring that the basis for the projections will not turn out to be correct, but the projections nevertheless provide a useful measure of the scope of the problem facing the nation.

A simple extrapolation of historical growth rates in Medicare and Medicaid expenditures can illustrate paths for future spending on those programs.² That approach, however, implicitly allows the economic impossibility of having health care spending eventually exceed total national income and fails to allow the nonfederal components of the health system to respond to rising costs (as they probably would do even without a change in federal law). Those shortcomings are magnified as the projection period lengthens. This study describes an alternative approach in which the rising share of national income devoted to health care creates pressure on households and employers to take potentially painful steps to reduce the growth in health care spending.

Various plausible paths exist for how spending in the rest of the health care system would evolve over time in the absence of changes in federal law, and one innovation in the methodology presented here is to incorporate a specific metric for determining how that spending will grow. Many such metrics could be applied; the premise that CBO chose was that Americans will ultimately demand changes to the system to prevent their consumption of other goods and services from declining in real (inflation-adjusted) terms. In other words, CBO’s projections assume that to avoid a reduction in real consumption of items besides health care, employers, households, and insurance firms will change their behavior in a variety of ways (potentially including higher cost sharing, increased utilization management, reduced insurance coverage by employers, and greater scrutiny of new technologies based on evidence of their comparative effectiveness) to slow the rate of growth of spending in the nonfederal part of the health system. The projections also assume that, even in the absence of changes in federal law, some of the measures adopted to slow growth in the rest of the health care system will moderate spending growth in Medicare and Medicaid and that regulatory changes at the federal level and policy changes at the state level will help to slow cost growth in those programs.³

The results of CBO’s projections suggest that in the absence of changes in federal law:

Those results show significantly higher federal spending on Medicare and Medicaid under current law than other official projections do, which typically assume that spending on those programs grows much more slowly in the future than it has in the past. For example, although the projections by CBO and by the trustees of the Medicare program (under their intermediate assumptions) track each other relatively closely for the next two or three decades, by the end of 75 years, Medicare spending under CBO’s projections is about 50 percent higher.

To be sure, significant uncertainty surrounds such projections, and the growth of spending on health care could turn out to be substantially higher or lower over the next 75 years than projected here. Like overall budget projections that show an exploding ratio of federal debt to GDP over the long term (which could not in all likelihood actually occur because, at some point, the government would not be able to sell additional debt to investors), the projections here of significant increases in health care spending and a sustained differential in the growth rates of Medicare and Medicaid relative to that of the rest of the health care system will almost certainly not occur, because current law will be changed to help prevent such outcomes. Nonetheless, the projections are useful in illustrating the implications of current law. The main message of this study is that, without changes in federal law, federal spending on Medicare and Medicaid is on a path that cannot be sustained.

In itself, higher spending on health care is not necessarily a "problem." Indeed, there might be less concern about increasing costs if they yielded commensurate gains in health. But the degree to which the system promotes the population’s health remains unclear. Indeed, substantial evidence exists that more expensive care does not always mean higher-quality care. Consequently, embedded in the country’s fiscal challenge is the opportunity to reduce costs without impairing health outcomes overall (see Box 1).

Overview of the U.S. Health Care System

Spending on health care in the United States is financed through a combination of private and public sources. Most Americans under the age of 65 have private health insurance obtained through an employer. According to CBO’s estimates, about 63 percent of that population (161 million people) had employment-based coverage in 2006, while about 4 percent (10 million people) purchased private coverage directly from an insurer.⁴ The two main sources of public financing for health care are Medicare and Medicaid. Nearly 43 million elderly or disabled individuals were enrolled in Medicare in 2006, and nearly 61 million low-income individuals were enrolled in Medicaid for at least part of the year.⁵ About 43 million people (constituting 17 percent of the nonelderly population) were uninsured. (For more details on the Medicare and Medicaid programs, see Appendix A.)

In 2005, the most recent year for which data are available, national spending on health care totaled nearly $1.9 trillion, or 14.9 percent of the nation’s GDP.⁶ Some 55 percent of the total was financed privately, and the rest came from public sources (see Table 1). Payments by private health insurers were the largest component of private spending, accounting for 37 percent of national health expenditures. Consumers’ out-of-pocket expenses, which include payments for deductibles and copayments for services covered by insurance as well as payments for services not covered by insurance, accounted for 13 percent of national health expenditures.⁷ Other sources of private funds, from philanthropy and on-site clinics that some employers maintain for their workers, accounted for 4 percent of the total.

Table 1. 

National Spending on Health Care by Source of Funds, 2005

Source: Congressional Budget Office based on data on spending on health services and supplies, as defined in the national health expenditure accounts, maintained by the Centers for Medicare and Medicaid Services.

a. Spending on Medicaid includes amounts spent by the federal government as well as by the states.

Federal spending on Medicare accounted for 18 percent of national health expenditures in 2005, while federal and state spending on Medicaid accounted for 17 percent. A variety of other public programs accounted for 10 percent of national health expenditures, including ones by state and local health departments, the Department of Veterans Affairs, and the Department of Defense; workers’ compensation programs; and the State Children’s Health Insurance Program.

The American health care system also consists of a broad array of health care providers, manufacturers, and suppliers. Although 45 percent of the spending on medical care is financed publicly, most services are furnished by private providers. For example, Medicare and Medicaid beneficiaries receive most of their care from physicians, hospitals, and other providers that deliver services to the general population.

From 1975 to 2005, the share of national health expenditures that was financed privately fell slightly, from 59 percent to 55 percent, while the share that was financed publicly rose correspondingly, from 41 percent to 45 percent (see Figure 1). During that period, out-of-pocket payments fell from 31 percent of national health expenditures to 13 percent, while payments by private insurers rose from 25 percent to 37 percent. Although the share of national health expenditures that is financed by out-of-pocket payments has fallen substantially, such payments are still a significant burden for many families. According to one study, 4.3 percent of the nonelderly population (nearly 11 million people) lived in families that spent more than 20 percent of their after-tax income on out-of-pocket payments for medical care in 2003.⁸

Figure 1. 

National Spending on Health Care by Source of Funds, 1975 to 2005

(Percent)

Source: Congressional Budget Office based on data on spending on health services and supplies, as defined in the national health expenditure accounts, maintained by the Centers for Medicare and Medicaid Services.

Historical Growth of Health Care Spending

Total spending on health care in the United States, including both private and public spending, increased from 4.7 percent of GDP in 1960 to 14.9 percent in 2005, the most recent year for which data are available, rising steadily throughout most of that period (see Figure 2). A notable exception was the period from 1993 to 2000, when the share remained relatively stable. Many analysts have attributed that lull to a substantial increase in the number of people who were enrolled in managed care plans as well as to excess capacity among some types of providers, which increased health plans’ negotiating leverage.⁹

Figure 2. 

Spending on Health Care as a Percentage of Gross Domestic Product,
1960 to 2005

(Percent)

Source: Congressional Budget Office based on data on spending on health services and supplies, as defined in the national health expenditure accounts, maintained by the Centers for Medicare and Medicaid Services.

Note: Amounts for Medicare are gross federal spending on the program. Amounts for Medicaid include spending by the federal government and the states.

Factors Underlying the Historical Growth in Health Care Spending

Most analysts agree that the most important factor contributing to the growth in health care spending in recent decades has been the emergence, adoption, and widespread diffusion of new medical technologies and services.¹⁰ Major advances in medical science allow providers to diagnose and treat illnesses in ways that were previously impossible. Many of those innovations rely on costly new drugs, equipment, and skills. Other innovations are relatively inexpensive but add up quickly as growing numbers of patients make use of them. Although technological innovation can sometimes reduce spending, in medicine such advances and the resulting changes in clinical practice have generally increased it.

Other factors that have contributed to the growth of health care spending include increases in personal income and the growth of insurance coverage. Demand for medical care tends to rise as real family income increases. Moreover, the growth of insurance coverage in recent decades, as evidenced by the substantial reduction in the percentage of health care spending that is paid out of pocket, has also increased the demand for medical care, because coverage reduces consumers’ cost of care. However, according to the best available evidence, increasing income and insurance coverage cannot explain much of the growth in health care spending in recent decades.¹¹

Another source of spending growth has been the aging of the population. Among adults, average medical spending generally increases with age, so as the population becomes older, health care spending per capita rises. However, over the past three decades, the effect of aging on health care spending has been relatively modest. The demographic effect will become more pronounced with the aging of the baby-boom generation, but it will continue to have a modest effect not only on national health care spending but also on federal spending on Medicare and Medicaid.¹²

Historical Trends

When analyzing historical trends in the growth of health care spending, it is useful to disaggregate the various components. Factors that affect spending on health care include general inflation; growth in the size of the population; and, to a lesser extent, changes in the age distribution of the population. Removing their effects reveals the amount of spending growth that is attributable to factors beyond inflation and demographics. There are at least two ways to measure such additional spending growth: as the increase in real annual health care spending for an average individual ("real per capita cost growth") or as the increase in health care spending for an average individual relative to the growth of per capita GDP.¹³ The latter measure is commonly referred to as "excess cost growth,"

signifying that it measures the extent to which growth in per capita spending on health care exceeds the growth in per capita GDP, after adjustments for changes in the age distribution of the population. (The phrase is not intended to imply that growth in per capita spending on health care is necessarily excessive. It simply measures that growth relative to the growth of the economy.) If per capita health care spending grows faster than per capita GDP, the share of the economy devoted to health care will rise.

Although real per capita cost growth is useful for short-term projections, excess cost growth is a more useful concept for long-term projections. From one year to the next, real per capita cost growth is the more reliable measure, because health care spending does not closely track annual economic trends. (Per capita health care spending does not usually fall in a recession or sharply accelerate during years of strong economic growth.) As a result, excess cost growth is often unusually low during periods of strong economic growth and unusually high during periods of slow growth. Over longer periods, though, growth in per capita health care spending is likely to reflect changes in overall economic growth. As the baby-boom generation retires and the growth of the labor force slows, per capita GDP growth will probably slow from the rate experienced over the past 30 years, and growth in per capita spending on health care will probably slow as well. Because the projections contained in this study are long term, they are based on assumptions about future excess cost growth rather than real per capita cost growth.

In part, the projections are based on historical trends since 1975. The purpose of beginning in 1975 is to exclude the start-up period for Medicare and Medicaid; by that year, both programs had been in effect for nearly 10 years, and Medicare benefits had been available to nonelderly disabled people for two years.

The historical rates of cost growth that CBO used for Medicare and Medicaid remove the effect of growth in the number of beneficiaries. The calculation for Medicare also removes the effect of changes in the age composition of the population. For Medicaid, the computation removes the effect of changes in the composition of the caseload: the portion of beneficiaries who are children, disabled people, elderly people, and other adults.¹⁴

From 1975 to 2005, real per capita spending on health care grew an average of 4.2 percent annually (see Table 2). During that period, per capita GDP grew at 2.2 percent, and excess cost growth amounted to 2.1 percentage points (see Table 3).¹⁵ Those measures capture the growth in total spending on health care, including payments from all private and public sources. Excess cost growth was somewhat higher during that period for Medicare (2.4 percentage points) and Medicaid (2.2 percentage points) and somewhat lower for all other health care spending (2.0 percentage points). Included in other health care spending are payments by private insurers, payments by people who lacked health insurance coverage, all other out-of-pocket payments by consumers, and health care spending by government programs other than Medicare and Medicaid. Consequently, the differences in excess cost growth between Medicare, Medicaid, and other health care spending should not be interpreted as meaning that Medicare or Medicaid is less able to control spending than private insurers.

Table 2. 

Real per Capita Cost Growth in Medicare, Medicaid, and All Other Spending on Health Care

(Percent)

Source: Congressional Budget Office.

Note: Figures are annual averages.

a. For Medicaid, data are available through 2004.

Table 3. 

Excess Cost Growth in Medicare, Medicaid, and All Other Spending on Health Care

(Percentage points)

Source: Congressional Budget Office.

Note: Excess cost growth refers to the number of percentage points by which the growth of spending on Medicare,
Medicaid, or health care generally (per beneficiary or per capita) exceeded the growth of nominal gross domestic product (per capita). Figures are annual averages.

a. For Medicaid, data are available through 2004.

Excess cost growth was higher during the earlier part of that period and slower during the second half. The slower growth in overall spending during the 1990s, though, may have reflected one-time changes (for instance, the spread of managed care) rather than a change in the underlying trend. In addition, rates of excess cost growth in Medicare and Medicaid are partly driven by changes in law and policy. Changes have included expansions of the programs as well as efforts to limit cost growth. Most notably, in 1983, Medicare introduced a prospective payment system, under which hospitals are paid a predetermined rate for each admission. The system reduced costs. Whether such changes will ultimately constitute one-time shifts or more permanent changes in cost growth rates is uncertain. As with other spending on health care, the rates of real per capita cost growth and excess cost growth for Medicare and Medicaid were lower from 1990 to 2005 than they were in the preceding 15 years. Because it is unclear whether the experience from the 1990s represented a one-time shift in the level of costs or a change in the underlying trend and because the entire 30-year period was marked by substantial year-to-year volatility without any apparent trend (as shown in Figure 3), CBO uses the average from 1975 onward as the starting point for the projections of the future.

Figure 3. 

Excess Cost Growth in Medicare, Medicaid, and All OtherSpending on Health Care

(Percentage points)

Source: Congressional Budget Office based on data on spending on health services and supplies, as defined in the national health expenditure accounts, maintained by the Centers for Medicare and Medicaid Services.

Note: Excess cost growth refers to the number of percentage points by which the growth of annual spending on Medicare, Medicaid, or all other health care (per beneficiary or per capita) exceeded the growth of nominal gross domestic product (per capita).

a. For Medicaid, data are available through 2004.

Projections of Health Care Spending

In the absence of an unprecedented change in the long-term trends, national spending on health care will grow substantially over the coming decades. The magnitude of that growth is highly uncertain, even over short periods, let alone a period as long as 75 years. CBO’s projections show health care spending assuming no change in federal law affecting Medicare or Medicaid.¹⁶ Thus, they provide a measure of the scope of the potential problem posed by the rising costs but are not a forecast of future developments because the magnitude of the problem will ultimately necessitate changes in the government’s programs. They are also subject to the inherent uncertainty surrounding any long-term predictions, especially regarding health care.¹⁷ Nevertheless, they provide a useful reference in showing the consequences of current law and assessing the impact of changes in law.

CBO’s Assumptions About Future Spending on Health Care

In CBO’s projections, spending for Medicare and Medicaid over the next 10 years is based on the agency’s March 2007 budget outlook.¹⁸ The projections for those programs in 2018 and later, as well as the projections for other health care spending, are based on the growth and aging of the population, growth in per capita GDP, and assumed rates of excess cost growth.

Short-Term Projections. For federal spending on Medicare and Medicaid, this study uses CBO’s baseline budget projections for 2008 to 2017, which assume no change in current federal law.¹⁹ CBO’s baseline budget projections do not include projections of total national spending on health care. Therefore, short-term projections of all other (non-Medicare and non-Medicaid) health care spending were made using the same methods as those used for the long-term projections, as described below.

The Structure of Long-Term Projections. In its long-term projections, CBO combines an assumption about excess cost growth in the spending on health care with projections of the growth and aging of the population and of the growth in per capita GDP.

The agency develops separate projections for three categories:

CBO constrained Medicare premiums and cost sharing to grow at the same rate as federal spending on Medicare and constrained state Medicaid spending to grow at the same rate as federal Medicaid spending.²⁰

Assumptions About Initial Rates of Excess Cost Growth. Although all long-term economic and demographic trends are difficult to forecast, future excess cost growth in health spending during the next century may be particularly uncertain. Systems of health care and health care financing have existed in their current forms for only a few decades, and medical technology continues to evolve rapidly.

One simple projection methodology is to base excess cost growth in the future on the average rate in the past. CBO adopts that approach when selecting initial rates of excess cost growth. Specifically, the excess cost growth rate for each of the three categories (Medicare spending, Medicaid spending, and all other spending on health care) in 2018 is assumed to equal the average of the rates from 1975 to 2005 (as presented in Table 3). (As mentioned, for all other spending on health care, the same rate is also used for 2008 through 2017.)

Assumptions About Long-Term Rates of Excess Cost Growth. For later years, one option would be to adopt the historical averages indefinitely. Although that approach is attractive for its simplicity (the results from such an extrapolation are presented in Appendix D), it has significant shortcomings. For example, simply extrapolating prior growth rates would result in total spending on health care eventually exceeding 100 percent of GDP. Furthermore, even in the absence of changes in federal law, spending growth would probably slow eventually as health care expenditures continued to rise and displaced increasing amounts of consumption of goods and services besides health care. In other words, pressure to slow cost growth will mount as health care accounts for a larger share of the American economy.

In response to rising health care costs, various policy changes in the private sector and by state governments would be likely. Employers would probably intensify their efforts to reduce their own costs, by, for example, working with insurers to make health care more efficient or by reducing insurance coverage. They would also probably raise premiums and out-of-pocket charges. Employees would then react to the higher charges either by shifting to plans with lower premiums—and more restrictive coverage—or by limiting their consumption directly in response to the higher out-of-pocket charges.²¹

It is impossible to predict with certainty precisely how such a process would unfold and how much cost growth could slow. Among various plausible approaches, a simple and transparent one is to assume that within the projection period, households would not be willing to spend so much more on health care that, from one year to the next, the increase in such spending alone was greater than the total increase in productivity. Therefore, under the assumption that the consumption of items besides health care does not decline, at the end point of CBO’s projection period, in 2082, per capita consumption would continue to grow because of increased productivity, but the additional economic resources would be devoted entirely to health care. That assumption, to be sure, is not the only reasonable one, and other assumptions could generate higher or lower amounts of spending on health care in the long term. The approach, though, has the virtue of considering future levels of spending on both health care and other goods and services.²²

Under the scenario that CBO presents, the slowdown in excess cost growth would not be painless and would not occur simply through improved efficiencies given the current structure of the health sector. Households would probably face increased cost sharing; new and potentially useful health technologies would be introduced more slowly or utilized at lower levels than would occur without a slowdown in excess cost growth; and more treatments or interventions might simply not be covered by insurance. Nevertheless, Americans would still face steadily increasing health costs. In other words, even though the growth rate might decline, the real level of health care costs would continue to rise—to the point of accounting for all of the increase in productivity. Therefore, real average consumption of goods and services other than health care would stagnate.

Such a slowdown in non-Medicare, non-Medicaid spending on health care may be particularly difficult to achieve in the absence of changes in federal law (as assumed in the projections). But at some point, the pressure on that portion of the system would probably become so severe that measures to slow growth would be taken. State governments and the private sector would almost certainly have more flexibility to respond to that pressure than the federal government would have without a change in federal law. The steps taken to slow growth in the non-Medicare, non-Medicaid sectors of the health system, in turn, would probably exert some downward pressure on growth rates in the public programs because they are integrated to a significant degree with the rest of the health care system. To the extent that actions by individuals and businesses resulted in lower-cost "practice patterns" by physicians, slower development and diffusion of new technologies, and cost-reducing changes to the structure of the health care system, Medicare and Medicaid would experience some reduction in their own growth—but the extent of that spillover is uncertain.

Moreover, CBO assumes that under current law, the federal government would make regulatory changes aimed at slowing spending growth on federal health programs and that Medicare beneficiaries’ demand for health care services would decline as Medicare premiums and cost-sharing amounts consumed a growing share of their income. On the basis of discussions with health and policy experts, CBO assumes that—without changes in law—the combined effects of those factors would be to reduce Medicare’s excess cost growth by one-fourth of the reduction in the growth of non-Medicare, non-Medicaid spending on health care. In other words, in a scenario in which the growth rate of spending on health care outside Medicare and Medicaid declined from 2 percent to 1 percent per year, Medicare spending growth would decline from 2 percent to 1.75 percent per year. (As discussed below, it is perhaps unlikely that Medicare and Medicaid would actually experience a significantly higher growth rate than the rest of the health sector over an extended period of time, but changes in federal law would be necessary to avoid that outcome.)

CBO assumes that excess cost growth will decline more rapidly for Medicaid, which is a joint federal–state program, than for Medicare. In addition to the spillover effects and possible federal regulatory changes noted above, states are likely to take actions to reduce the growth of Medicaid spending even without changes in federal law. State governments would probably respond to growing fiscal pressures by limiting the services they chose to cover or by reducing their number of beneficiaries by tightening eligibility. In its projections, CBO assumes that the rate of decline in Medicaid’s excess cost growth will be 75 percent of the reduction in the growth of non-Medicare, non-Medicaid spending on health care. CBO’s projection methodology for excess cost growth from 2019 through 2082 is thus based on the following set of assumptions:

Under those assumptions, the excess cost growth rate for non-Medicare, non-Medicaid spending on health care declines by 4.6 percent annually (see Table 4).²³ By 2082, that rate drops to 0.1 percentage point. For Medicare, excess cost growth declines to 1.1 percentage points that year, and for Medicaid, to 0.2 percentage points. The average rates for excess cost growth between 2018 and 2082 are 0.6 percentage points for non-Medicare, non-Medicaid spending, 1.7 percentage points for Medicare, and 0.9 percentage points for Medicaid.

Table 4. 

Assumptions About Excess Cost Growth Over the Long Term

(Percentage points)

Source: Congressional Budget Office.

Note: Excess cost growth refers to the number of percentage points by which the growth of spending on Medicare, Medicaid, or health care generally (per beneficiary or per capita) is assumed to exceed the growth of nominal gross domestic product (per capita).

It may be difficult to envision how per capita Medicare and Medicaid spending could continue to grow more rapidly than other health care spending over such a long period, but changes in federal law are probably necessary to avoid that outcome. Furthermore, actions to reduce spending growth in the private sector could attenuate the incentives for the development and diffusion of new medical technologies for nonelderly people while having little effect on new technologies focused on diseases principally affecting the elderly.

That aspect of the projections may appear unrealistic, but it highlights the core problem—the unsustainability of current federal law. (The inherent tension in making long-term projections for a federal health care system that cannot be sustained in its current form must manifest itself in some way.) In reality, it is likely that changes in federal law as well as in practices in the private sector will slow the growth of health care spending such that growth in per capita Medicare and Medicaid spending does not diverge greatly from other spending on health care.

Projections of Health Spending

Over the past 30 years, total national spending on health care has more than doubled as a share of GDP. Under the assumptions described above, according to CBO’s projections, that share will double again by 2035, to 31 percent of GDP. Thereafter, health care costs continue to account for a steadily growing share of GDP, reaching 41 percent by 2060 and 49 percent by the end of the 75-year projection period (see Figure 4).

Figure 4. 

Projected Spending on Health Care as a Percentage of Gross Domestic Product

(Percent)

Source: Congressional Budget Office.

Note: Amounts for Medicare are net of beneficiaries’ premiums. Amounts for Medicaid are federal spending only.

Although the rate of cost growth slows over the projection period, the annual increase in the level would remain high. For example, for the five years beginning in 2007, CBO projects health care spending, measured as a share of GDP, to grow by 12 percent—from 15.5 percent of GDP to 17.4 percent. From 2070 to 2075, CBO projects, it will grow by only 4 percent, from 44.4 percent of GDP to 46.2 percent. From one perspective, the growth during the latter period is much slower. But in both periods, health care spending rises by about 2 percent of GDP.

Spending on Medicare and Medicaid is projected to grow as a share of total spending on health care—as
the assumed rates of excess cost growth for those programs under current federal law slow less quickly than does the rate for other spending on health care and as

the population ages. Net federal spending on those programs now accounts for about 4 percent of GDP, or 26 percent of total spending on health care. By 2035, those figures grow to 9 percent of GDP, or 30 percent of total spending on health care, and by 2082, to 19 percent of GDP, or 38 percent of total spending.

Excess cost growth is the main factor responsible for the projected increase in both national spending on health care and federal spending on Medicare and Medicaid. By itself, the projected change in the age composition of the population has a modest effect on the future path of health care spending (see Box 2).

Consumption of Health Care and of Other Goods and Services

Historically, economic growth has been driven primarily by improved productivity. As the average worker is able to produce more, the average citizen can consume more. As the population ages and a smaller portion is employed, per capita GDP is likely to grow more slowly, but, on average, future generations will be substantially richer than Americans are today. In 2007, total per capita consumption averages about $27,000, of which about $6,000 is for health care. Under CBO’s projections, by 2035, per capita consumption would grow by over $15,000 (in 2007 dollars), but more than three-quarters of that extra money would be spent on health care. While the consumption of other goods and services would grow by just 12 percent, the consumption of health care would triple.

In addition, although the consumption of goods and services besides health care would, on average, be stable at the end of the projection period, the effect would vary for different individuals. Lower-income people tend to spend fewer dollars on health care than average, but that spending represents a larger portion of their earnings than it does for others. Also, people generally have less flexibility about their spending on health care than on other things. For example, even in companies that offer multiple options for health insurance, premiums do not vary substantially. As a result, as costs for health care increased, higher-income people would generally still be able to increase their consumption of other goods and services, whereas poorer people would probably see their consumption of those items decline.²⁴

Projections Under Alternative Assumptions

Analysts working 75 years ago, in 1932, would have been extremely unlikely to correctly project the current share of the economy devoted to health care, and the projections in this study will undoubtedly prove to be inaccurate in one direction or another. It will be difficult to judge their accuracy even after the fact, because they assume no changes in federal law, and such changes are virtually certain to occur.

Even without those changes, though, actual spending on health care could be much lower or much higher. Past technological developments have generally resulted in expanded treatment and higher total spending. Future innovations could accelerate that trend. Alternatively, if future research results in the development of inexpensive curative therapies, growth could slow.

Among simple alternative scenarios for excess cost growth, one in which it is held constant at zero, while implausible, is useful because it isolates the effect of the aging of the population (see Figure 5). Aging alone is projected to increase federal spending on Medicare and Medicaid. Under that scenario, projected net federal outlays on the two programs would increase from 4 percent of GDP in 2007 to 6 percent of GDP by 2040 and then rise gradually to 7 percent by 2082.

Figure 5. 

Federal Spending for Medicare and Medicaid as a Percentage of Gross Domestic Product Under Different Assumptions About Excess Cost Growth

(Percent)

Source: Congressional Budget Office.

Note: Excess cost growth refers to the number of percentage points by which the growth of annual health care spending per beneficiary is assumed to exceed the growth of nominal gross domestic product per capita.

Under a scenario in which excess cost growth for Medicare and Medicaid is 2.5 percentage points, which could be roughly interpreted as what would occur with no slowing of growth rates whatsoever, net federal spending on the two programs would grow to 13 percent of GDP in 2040 and 38 percent of GDP by 2082. (Appendix D shows a set of projections in which spending on Medicare, Medicaid, and other health care grows at their historical average excess growth rates from 1975 through 2005.)

The projections presented in this study can also be compared to the Medicare trustees’ projections of spending on the program.²⁵ For that comparison, CBO adjusted its projections to measure Medicare spending gross of the premiums paid by beneficiaries, which is the measure used by the trustees. (All of CBO’s other projections of Medicare spending in this study are net of beneficiaries’ premiums.) Both CBO and the trustees project that gross Medicare outlays will more than double from their current level of 3 percent of GDP to more than 7 percent of GDP in 2035 (see Figure 6). Under their intermediate scenario, the trustees assume that excess cost growth will decline gradually from the 25th to the 75th year of the projection period but constrain total spending over the 75-year period to the result obtained by assuming excess cost growth to be a constant 1 percentage point in the 25th year and later. CBO’s methodology does not impose that type of constraint. Consequently, the two sets of projections track each other relatively closely over the next two to three decades but then diverge significantly; the trustees project gross Medicare outlays to reach 11 percent of GDP by the end of the projection period, compared with CBO’s 17 percent. In both sets of projections, however, the main message is that health care spending is projected to rise significantly and that changes in federal law will be necessary to avoid or mitigate a substantial increase in federal spending on Medicare and Medicaid.

Figure 6. 

CBO’s and the Trustees’ Projections of Spending on Medicare as a Percentage of Gross Domestic Product

(Percent)

Source: Congressional Budget Office.

Note: Projections are of gross federal spending.

Statement of Peter R. Orszag, Director, Congressional Budget Office, Health Care and the Budget: Issues and Challenges for Reform, before the Senate Committee on the Budget (June 21, 2007).

Ibid.

Such changes that would also affect federal programs could include less rapid development and adoption of costly new technologies and changes in physicians’ practice patterns.

Those estimates are from CBO’s health insurance simulation model. For a description of the model, see Congressional Budget Office, CBO’s Health Insurance Simulation Model: A Technical Description (October 2007).

Sixteen percent of Medicare beneficiaries were also enrolled in Medicaid.

This study defines national spending on health care as total spending on health services and supplies, as defined in the national health expenditure accounts, maintained by the Centers for Medicare and Medicaid Services. The figure cited is equal to total national health expenditures minus spending on research and development and construction.

Out-of-pocket payments do not include the premiums that people pay for health insurance. Premiums fund the payments by insurers, which are already included in the measure of private spending.

Jessica S. Banthin and Didem M. Bernard, "Changes in Financial Burdens for Health Care: National Estimates for the Population Younger Than 65 Years, 1996 to 2003," Journal of the American Medical Association, vol. 296, no. 22 (December 13, 2006), pp. 2712–2719.

See, for example, Katharine Levit and others, "National Health Expenditures in 1997: More Slow Growth," Health Affairs, vol. 17, no. 6 (1998), pp. 99–110.

See Joseph P. Newhouse, "Medical Care Costs: How Much Welfare Loss?" Journal of Economic Perspectives, vol. 6, no. 2 (Summer 1992), pp. 3–21; David M. Cutler, "Technology, Health Costs, and the NIH" (paper presented at the National Institutes of Health Economics Roundtable on Biomedical Research, Cambridge, Mass., September 1995); and Technical Review Panel on the Medicare Trustees’ Reports, Review of Assumptions and Methods of the Medicare Trustees’ Financial Projections (December 2000).

Ibid.

For the effect on Medicare, see Micah Hartman and others, "U.S. Health Spending By Age, Selected Years Through 2004," Health Affairs, Web Exclusive (November 6, 2007), available at www.healthaffairs.org.

The effect of general inflation is removed from the second measure because growth in spending on health care is measured relative to growth in per capita GDP, both of which are affected by general inflation.

That methodology is consistent with CBO’s projections of future spending, which separately account for projected changes in the composition of the caseload.

Excess cost growth is not computed simply by subtracting per capita growth in GDP from per capita growth in health care spending but involves a more complex formula (see Appendix B).

The projections for Medicare assume that the program will continue to pay for benefits as currently scheduled, notwithstanding the projected insolvency of the Medicare Hospital Insurance trust fund. Moreover, CBO assumes that future Medicare spending will not be affected by the provision of current law that requires the Medicare trustees to issue a "Medicare funding warning" if projected outlays for the program exceed 45 percent of "dedicated financing sources," because the law does not require the Congress to respond to such a warning by enacting legislation that would reduce Medicare spending.

For simplicity, the projections assume that the projected growth in health care spending has no effect on the future growth of GDP.

Congressional Budget Office, An Analysis of the President’s Budgetary Proposals for Fiscal Year 2008 (March 2007) and Detailed Projections for Medicare, Medicaid, and State Children’s Health Insurance Program (March 2007).

Appendix C presents projections under an alternative scenario that assumes a change in federal law to prevent the reductions that would otherwise occur in the fees that Medicare allows for physicians’ services. That scenario assumes that those fees will be updated to account for inflation in the inputs used for physicians’ services. In both that scenario and the one presented in the main text, projected outlays for Medicare over the next 75 years are similar because the assumption that Medicare’s physician fees will be updated to account for inflation has a minor effect over the long term.

To apply those constraints, CBO initially projected total Medicare spending, gross of beneficiaries’ premiums and including cost sharing by beneficiaries, and total Medicaid spending, including both state and federal spending. To separate out federal spending on Medicare and Medicaid, CBO then reclassified the projected Medicare premiums and cost sharing and state spending on Medicaid into the category that includes all other spending on health care.

In its projections, CBO assumes that the share of health care spending that will be in the form of premiums in employment-based plans—and thus is tax preferred—will remain at approximately 58 percent of non-Medicare, non-Medicaid spending on health care.

For related discussions, see Michael E. Chernew, Richard A. Hirth, and David M. Cutler, "Increased Spending on Health Care: How Much Can the United States Afford?" Health Affairs, vol. 22, no. 4 (2003), pp. 15–25; and Glenn Follette and Louise Sheiner, "The Sustainability of Health Spending Growth," Finance and Economics Discussion Series No. 2005-60 (Washington, D.C.: Board of Governors of the Federal Reserve System, 2005).

Specifically, ECGy = ECGy-1 * 0.954.

For example, consider the simplified example of two coworkers with incomes of $20,000 and $80,000 who both get a 10 percent salary increase and devote their extra income to an increase of $5,000 in health insurance premiums. The lower earner’s income would increase by $2,000, but his or her health care costs would be $3,000 higher than that, forcing a real reduction in his or her consumption of other goods and services. The higher earner’s income would increase by $8,000, more than enough to cover the additional $5,000 in health care expenses.

See Department of Health and Human Services, Centers for Medicare and Medicaid Services, Office of the Actuary, 2007 Annual Report of the Board of Trustees of the Federal Hospital Insurance and Federal Supplementary Medical Insurance Trust Funds (April 23, 2007), pp. 160–162.