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What is Next for Health Care Spending in the US?

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What is Next for Health Care Spending in the US?

December 21, 2016

President-elect Trump has promised to repeal and replace the Affordable Care Act (ACA). He outlined broad reform principles during the campaign, but has offered few specifics on the replacement of the new insurance provided under the ACA. The election hype diverted attention from recent news that premiums for insurance sold on the exchanges are rising, options have declined, and that health care spending is again rising faster than the rest of the economy. The big question is: If the ACA is repealed, how will its replacement be constructed?

The ACA left little of the health sector unaffected and repealing and replacing it will do likewise. Since the passage of the ACA, many previously uninsured Americans now have health insurance through the exchanges or through the expansion of Medicaid. Given the breadth of the ACA, any alternative must deal with all aspects of the health insurance market.

The ultimate goal of reform should be to give all access to health insurance without requiring that they obtain it. That said, however, the reason that some would not opt to be insured should not be because they are not on an equal playing field with all others. As a result any replacement of the ACA must address employer-based insurance vis-à- vis self-employed insurance, and the main government programs: Medicare and Medicaid.

The proponents of the ACA also promised to “bend the cost curve” by constraining the health sector’s faster growth when compared to the rest of the economy. The ACA’s lofty goals of expanding coverage while at the same time reducing health sector’s faster growth are fundamentally at odds. Is it possible to reconcile the tension between these two goals and to make progress toward achieving both? The answer is a qualified yes, but we have to be upfront about the give and take that must occur to achieve both.

Let’s consider the goal of limiting the health care sector’s growth as a share of the economy. We care about this growth because much of health care spending is paid through tax revenues or tax preferences. Medicare, Medicaid and CHIP, and other public programs pay for 45% of all health care spending. Further, the Congressional Budget Office estimates that the cost of tax preferences will top $260 billion this year. Constraining the growth in the health sector’s share of the economy probably should not be a policy objective – consumers should decide. Constraining how much is paid through taxes and tax preferences, however, is definitely within the realm of public policy.

A natural starting point for health care reform is employer-provided health insurance. The fact that most Americans’ health insurance is employer-provided is the result of its preferential tax treatment. Employer-provided health insurance typically includes all employees and their eligible family members regardless of health status. Thus, it forms an insurance pool that avoids the adverse selection problem that is faced by independent health insurance providers. However, the tax exclusion of employer-provided health insurance premiums raises a range of issues.

The tax exclusion is essentially a health insurance price subsidy favoring consumption of health insurance (and hence healthcare spending) over other consumption. It does this by encouraging both firms and their employees to expand what is covered in the tax exempt health insurance package. Employer-based insurance can be reformed by limiting the tax exclusion to a prescribed level. Retaining employer-based health insurance preserves the risk pools that address the adverse selection problems that exist in individualized markets. The limit on the tax exclusion could be set equal to the premium necessary to purchase higher cost-sharing plans so that the reform reduces tax expenditures.

Because employer-provided health insurance is the standard to which all publically-provided health insurance programs are compared, a limit on the tax exclusion will also help control the expense of public insurance. And moving health care consumers away from first dollar coverage insurance to insurance that requires them to be more cost conscious will go a long way toward bringing more price competition to the health care market.

The ACA promised to limit the growth in Medicare spending per capita to the growth in per capita GDP. Interestingly, that is also the implicit goal of most Republican proposals that have come after the ACA. So both parties agree on the same budgetary goal for Medicare, but the ACA relied on a new provision to control total spending. The new provision, known as the productivity adjustment, was designed to constrain spending in the Part A of the program by constraining provider payments. The new provision was to be combined with the oft overridden and now rescinded sustainable growth rate that was supposed to constrain the growth in Part B of the program by the same provider payment method. Even if effective, such spending caps would, in time, severely limit access to health care for seniors.

In contrast to the ACA’s spending caps, the growth in taxpayer spending on Medicare can be reduced through reforms that give all beneficiaries more freedom while at the same time requiring higher cost sharing for higher income beneficiaries. In exchange for shouldering a greater share of their health care costs, affected beneficiaries would be free to use their means-tested Medicare benefit payments in conjunction with their own funds to buy into a Medicare Advantage plan or to opt into other insurance products like a health savings account coupled with a higher deductible plan.

The other major government health program, Medicaid, has grown considerably after the passage of the ACA. Many of the newly insured are covered by Medicaid either through the extension of coverage to adults whose income is less than 138% of the poverty level or through additional enrollment under the rules that existed before the passages of the ACA. Medicaid is a joint state/federal program, but since its inception states have responded quite differently to the program. States have flexibility in establishing eligibility requirements. Spending per enrollee and per person under the poverty threshold varies considerably across the states. Since the passage of the ACA, 32 states including the District of Columbia have expanded Medicaid coverage to the newly eligible adults.

The large differences in the states’ responses to the past and current incentives in Medicaid can be reduced by adjusting the federal commitment. To contain the growth in the federal component of Medicaid states could initially receive a block grant in the amount they receive currently. However, the block grant could gradually adjust to address the disparities in current Medicaid payments per individual below the poverty threshold. Basing the total amount of the block grant on the number and composition of a state’s residents at or below poverty, the price of health insurance in the state and the average income in the state can reduce the current state differences in federal payments per person at or below the poverty level.

The ACA has induced previously uninsured individuals to acquire health insurance through the exchanges, by taking part in the Medicaid expansion as a newly eligible enrollee, or by enrolling in Medicaid under the pre-ACA eligibility requirements. Any successful replacement of ACA must adequately and fairly deal with these newly insured. Anything done to help these individuals transition to the new system must be made available to all. The costs saved on the government subsidies on exchanges and Medicaid expansion, if the ACA is repealed, could be used for those directly affected. However, whatever method is taken to make the transition less costly for some, must ultimately apply to all. Risk-adjusted tax credits for the purchase of health insurance offers a way to take care of those losing their previous subsidy while at the same time contribute to leveling the field for all. These tax credits would encourage all to purchase health insurance in the marketplace.

As a result of the limited risk-adjustment allowed by the ACA, the exchanges failed to attract enough low cost (generally young) participants into the state pools that would cover the groups’ cost. The legal restriction on the range of age-adjusted premiums resulted in premiums that were significantly below cost for high risk subscribers and significantly above cost for low risk subscribers. As a result the exchanges suffered from extreme adverse selection.

To alleviate this problem requires at least two changes to the requirements that were imposed by the ACA. First, insurance providers must be allowed to more fully risk-adjust premiums. Second, higher cost enrollees must be equipped to pay the real cost of their insurance. In this case, tax credits based on health care status would ensure that the high cost enrollees have the resources necessary to buy insurance in the general marketplace.

As long as we pay for much of health care spending through government programs and tax preferences it will remain one of the top policy issues. The ACA expanded insurance coverage through Medicaid expansion, subsidies, and mandates. It also specified stringent spending constraints on the Medicare program. Alternatives to the ACA include limiting tax expenditures on employer provided health insurance, and in the case of Medicare, increasing means-testing. Risk-adjusted tax credits for the newly insured and state innovation in Medicaid are also necessary in replacing the ACA. The ACA and the alternatives outlined here each provoke opposition, but the latter path brings more market forces to bear on limiting taxpayer funded health care spending growth and on allocating resources more efficiently.

Read full study here.

Liqun Liu is a Research Scientist at the Private Enterprise Research Center (PERC) at Texas A&M University, Andrew J. Rettenmaier is the Executive Associate Director of PERC, and Thomas R. Saving is the Director of PERC.

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