Diagnosing America’s Health Care Mess: Part 3

In Part 1, we learned that real per capita health spending saw a 25-fold increase the 8 decades starting in 1929 even as real per capita GDP grew only 5-fold during the same period.

In Part 2, we learned that annual excess growth in inflation-adjusted health spending above and beyond general economic growth has been a persistent phenomenon: from 1929 to 2015, the average rate of growth in real per capita health spending (4.1%) was slightly more than double the rate experienced in the rest of the economy (2%).

Today we will examine the consequences of this outsized growth in health spending: health care spending absorbs an ever-growing fraction of the economy and government spending. This is a mathematical inevitability of the excess growth of health spending relative to the economy. But readers may be surprised to see just how quickly the health share of the economy and government spending is growing, especially in recent years when health costs purportedly have slowed down.

Health Share of GDP

The percentage of GDP devoted to health care has more than quadrupled during the past 80 years to more than one-sixth of the entire U.S. economy. Indeed, health spending has grown faster than almost all other major components of GDP.

Many readers are aware that health spending has been approaching 20% of GDP for some years. The latest official government projections show that by 2025, we will have crossed that threshold assuming current law remains in effect. If Republicans ever succeed in repealing and replacing the Affordable Care Act, then all bets are off about where we’ll be in 2025. But that is a bridge to cross in a future post only if such a bill is signed into law.

Health Share of Government Spending

Fig. 3 demonstrates conclusively that a growing share of health care is financed by government at all levels. Consequently, the percentage of public sector spending having to do with health care has risen even faster than in the general economy. However, viewing aggregate health spending across all levels of government would mask a sizable difference in trends at the federal government level compared with state and local governments—especially since the introduction of Medicare and Medicaid in 1966. Therefore, I have shown two separate sets of bars to illustrate this divergence.

By 2025, health spending will make up more than 30 percent of all federal spending compared with less than 22% of total spending by state and local governments. As of 1969, the health share of non-federal government spending (8.4%) still slightly exceeded the share of government spending at the federal level (6.9%). But this quickly changed as Medicare and Medicaid (whose spending began in 1966) mushroomed in size over subsequent decades.

Here are some caveats and takeaways from Fig. 3.

The Health Share of the Economy is Higher Than it Appears

My charts only measure direct spending on health care. Consequently, all of the figures understate the true impact of tax-financed healthcare on the economy. As I explained in a previous installment, every dollar of taxes imposes hidden costs on the economy in the form of lower output (also called “deadweight losses”). That is, we get less of whatever we tax, be it labor, commodities, or even health services.

At the margin, each incremental dollar of federal taxes is likely generating deadweight losses amounting to 44 cents on the dollar. Thus, unless one can make the case that tax-financed healthcare is 44 percent more efficient than the same dollar raised and spent privately, every dollar we shift away from the private sector onto the books of government is a losing proposition.

I’ll devote a later post to discussing just how much of the health economy is tax-financed, but for purposes of discussion, suffice it to say that it’s at least 50 percent. With hidden deadweight losses amounting to 44%, this implies that the total burden on the economy arising from health spending is 22% higher than my chart shows. That would make the health share of GDP in 2025 exceed 37% rather than just 30%.

Government Spending is Higher Than it Appears

The situation is compounded by the fact that my figures leave out 2 important components of tax-financed health spending: the amounts that governments at all levels spend on health benefits for government employees and their dependents and the hundreds of billions of dollars in annual tax expenditures related to the tax exclusion and similar health-related tax benefits such as the medical expense deduction.

The reason I have left these out is that the official CMS figures that separately track spending on government employee health benefits only go back to 1987 and readily-available estimates of tax expenditures begin only in the mid-1960’s. So at this juncture it is not possible to provide a reliable historical time series going back to 1929.

But to give readers a rough idea of what’s excluded, my figures for 2017 show $1.187 trillion in health spending financed by federal taxes. Excluded from that total is $36 billion in federal payments for the Federal Employees Health Benefits Program (FEHBP) plus another $317 billion in health-related tax expenditures (this includes both income and payroll tax revenue losses related to the tax exclusion and other tax benefits related to health). In short, the federal figures are understated by $353 billion or about 30%! Assuming the same were true in 2025, it would imply that the health share of federal spending that year actually would be just under 40%.

The situation is actually worse on the state and local government side of the street. Total health-related spending financed through state and local government taxes in 2017 amounts to $429 billion. Left out are $199 billion in public employee health benefits plus an additional $42 billion in health-related tax expenditures. So a total of $241 billion in tax-financed spending is missing, amounting to 56% of what is reported in Fig. 3. If the same were true in 2025, the correctly-measured health share of state and local government spending will be just over one-third .

Bottom line, my charts are missing nearly $600 billion in tax-financed health spending in 2017 alone, so all the figures should be viewed as an extremely conservative estimate of the true impact of health care on government spending.

There is No Intrinsic Optimal Level of GDP That “Should” Be Devoted to Health

The fact that health is absorbing a growing share of the economy is not intrinsically a bad thing. In any market economy, people can and will spend more on things they value and less on things they value less. Every purchase has an opportunity cost: namely, what Consumer X did not buy as a consequence of using X’s limited resources to instead purchase something that consumer thought would provide greater satisfaction.

So long as there are no distortions in the market or Consumer X’s ability to make rational decisions, we should not be alarmed if that consumer opts to devote a growing share of available income to health care. Because real GDP per capita has also grown quite rapidly in recent decades, we have been able to allocate a growing share of GDP to health care while also enjoying a rising standard of living in non-health consumption. So we have not reached the point where growth in health spending literally reduces our standard of living. As best we can tell, such a time–if it ever comes–is still decades off [1].

Moreover, there are health economists who have argued that Americans spend too little on health care and that in value-for-the-money terms, “we believe it likely that maximizing social welfare in the United States will require the development of institutions that are consistent with spending 30 percent or more of GDP on health by the middle of the century” [2].

On the flip side, there are plenty of reasons to believe that much of U.S. health spending currently is wasted as a consequence of all manner of distortions created by the pervasive use of third party payers. That is something we will explore further as this series goes on.

Health Care Matters for Those Concerned About the Size of Government

The rise in government-funded healthcare has been extraordinary by any measure, especially at the federal level. Between 1949 and 1969, the health share of federal government more than tripled (from 2.1% to 6.7%) at a time when the health share of GDP grew by “merely” 50% (from 4.3% to 6.5%). But over the next two decades, the growth in shares was much more similar, with the federal share rising 5.5 percentage points to 12.2% and the health share of GDP growing by 4.9 percentage points (to 11.4%).

In contrast, the 2 decades that ended with President Obama’s first year in office saw much sharper growth in the health share of federal spending (9.5 percentage points) than in the health share of GDP (5.9 percentage points). And the subsequent two decades have been even worse. The growth in the health share of federal spending (8.7 percentage points) has been more than double the growth in the health share of the economy (3.5 percentage points).

The health share of state and local spending historically has been slightly higher than the health share of GDP [3]. An exception is 2009, but that is a somewhat distorted slice in time since the recession ended that year and the health share of spending was at its lowest level since 2001 in part because the federal government increased the matching rate for Medicaid [4]. It quickly rebounded so that by 2011, the health share already had again reached its highest level ever. By 2025, this share will be less than one percentage point higher than the health share of GDP.

So long as health absorbs an ever-growing share of the economy, it will be quite challenging for either Uncle Sam or governors to prevent health care from absorbing a growing share of government budgets as well. Again, if health care is providing good value for the money relative to spending on national defense, criminal justice and infrastructure, all is well and good. However:

  • The fact that the U.S. has been getting progressively worse grades on its infrastructure over time (coupled with corresponding growth in the dollar magnitude of unmet infrastructure needs) suggests at least the possibility that health care may be crowding out more than just fat in the federal, state and local government budgets.
  • Similarly, I earlier have shown that the amount of federal health spending per dollar of defense increased nearly 50-fold in the half century starting in 1967.
  • Health spending accounts for more than half of the $205 trillion in unfunded liabilities facing Uncle Sam [5]. If our societal health spending decisions are distorted by the presumption that we can simply pass these costs along to our children and grandchildren, we should be ashamed of ourselves.

In the next installment we’ll look at just how much of the growth in government over the past 50 years can be chalked up to health spending.

READ CHRIS’ BOOK, The American Health Economy Illustrated (AEI Press, 2012), available at Amazon and other major retailers or as a pdf at AEI. With generous support from the National Research Initiative at the American Enterprise Institute, an online version complete with downloadable Powerpoint slides and companion spreadsheets has been made available through the Medical Industry Institute’s Open Education Hub at the University of Minnesota.