Healthcare Costs and the Looming U.S. Budget Crisis

Reading time: 4 – 7 minutes

The Organization for Economic Cooperation and Development (OECD) released a report last month on the state of the U.S. economy [1]. The report warns that the U.S. is headed for a budget crisis unless it reforms healthcare spending.

Without reform, the report forecasts that healthcare costs will consume approximately 20% of GDP by 2050:

The major entitlement programmes — Social Security, Medicare and Medicaid — are the main reason that government finances are on an unsustainable course. Under current law, public spending on retirement and health programmes is expected to rise toward 20% of GDP by the middle of the century; resulting soaring budget deficits would entail a government debt twice the size of GDP at that time. Raising tax rates to finance such spending would be an expensive and inefficient solution. Entitlement reform is therefore essential to address this longer-term fiscal challenge. The problem facing Social Security is population ageing. As the post-World War II baby boomers retire while increases in life expectancy continue, the ratio of people receiving retirement benefits to the working-age population will rise steadily. Relatively limited changes to programme parameters would suffice to put the scheme on a solid financial footing, but it has been difficult to reach an agreement on the appropriate measures.

With Baby Boomers starting to retire and the lack of new workers to replace them, the government will be collecting less tax revenue while paying increased Social Security and healthcare costs.

Indeed, the National Bureau of Economic Research (NBER), a private, nonprofit, nonpartisan research organization dedicated to promoting a greater understanding of how the economy works, wrote in a working paper almost two years ago [2]:

… the U.S. may well be in the worst long-term fiscal shape of any OECD country even though it is now and will remain very young compared to the majority of its fellow OECD members.

Established in 1961, the OECD brings together governments of countries committed to democracy and the market economy from around the world. Their focus is to support sustainable economic growth, boost employment, raise living standards, maintain financial stability, assist other countries’ economic development and contribute to growth in world trade. The OECD shares expertise and exchanges views with more than 70 other countries around the world and, for more than 40 years, has been one of the world’s largest and most reliable sources of comparable statistics as well as economic and social data.

The OECD report suggests several fixes, including:

• Reducing the high replacement rate of the workforce and tightening screening requirements for disability benefits to ensure that they do not encourage people to stop working unnecessarily.
• Raising the retirement age to not only discourage premature retirement but to make the Social Security system financially more secure.
• Restraining taxation and government spending.
• Expanding trade adjustment assistance programs (including wage insurance and health-care support) to include additional, if not all, dislocated workers, regardless of the cause of dislocation.
• Raising the earned income tax credit.
• Reinstatement of statutory caps on discretionary spending and pay-as-you-go requirements for increases in mandatory spending and tax cuts.
• Broadening of the tax base.
• Reducing or abolishing tax expenditures that are distorting, ill-targeted and ineffective.
• Shifting the tax burden from direct taxes to consumption-based indirect taxes — such as a national sales tax or a value-added tax.
• Higher taxation of carbon-based energy consumption.

The OECD further proposes limited changes to the Social Security program parameters with an acceleration of the already legislated increase in the normal retirement age and indexing benefits for rising longevity, a reduction in replacement rates for higher earners and an increase in the taxable maximum amount of earnings subject to Social Security tax.

With regard to heathcare programs:

… ways should be sought to improve efficiency in Medicare-related health delivery, so as to be able to limit payments to providers without affecting access to and quality of care. At the same time, premiums for higher-income beneficiaries could be raised further. Cost-conscious decisions would be encouraged by expanding individual health savings accounts and eliminating the tax bias towards high-cost insurance. The Administration has proposed to achieve the latter by replacing the unlimited tax exclusion of employer-furnished health insurance plan premiums by a tax deduction available to everyone. Arguably, a tax credit would have a greater effect on health insurance coverage.

For those interested, a policy brief can be downloaded here.

I’ve written about this issue previously. Since September 2005, U.S. Comptroller General David Walker and both Democratic and Republican representatives have been touring the country as part of the Fiscal Wake-Up Tour, lobbying directly to taxpayers and opinion makers for extensive reform to both the Medicare program and the nation’s healthcare system.

This focus on healthcare costs and the U.S. budget is quite troubling. We’ve known for some time that as baby boomers age we’re going to run out of money to pay for the entitlements we’ve promised them. We are the American generation that truly promises enormous debt to those who follow — our children, our grandchildren and ourselves, many of us who will be in the midst of retirement.

Are you concerned?

Does the prospect of the U.S. government having no money available for anything beyond interest payments, Social Security, Medicare and Medicaid in just over 30 years bother you?

How many voices need to echo these warnings before anything is done?

References

1. Economic survey of the United States 2007. The Organization for Economic Cooperation and Development. 2007 May 29.
2. Christian Hagist and Laurence Kotlikoff. Who’s Going Broke? Comparing Growth in Healthcare Costs in Ten OECD Countries. The National Bureau of Economic Research Working Paper, No. 11833. 2005 Dec.