Obama Misdiagnoses ‘Real Deficit Threat’

In Saturday’s Wall Street Journal President Obama’s budget chief Peter Orszag described rising healthcare costs as “the real deficit threat” and outlined the administration’s solution. Peter is very bright and always well prepared, but his argument—while compelling—is remarkably flimsy when subjected to pressure. In sum, the Obama administration appears to have misdiagnosed what is driving rising entitlement costs, and as a result would mistreat them.

It is broadly agreed that rising Social Security, Medicare, and Medicaid costs have the potential to bankrupt the budget and crush the economy. As I argued here, the foreign borrowing needed to finance these programs risks destroying the value of the dollar. Likewise, even before the financial crisis, Standard & Poor’s projected that by 2017 rising debt levels could cause Treasury bonds to lose their triple-A rating, falling to junk status by the late 2020s.

The controversy comes over what is driving these rising costs. Two factors account for rising entitlement costs: population aging, which pushes more seniors onto benefit rolls, and rising per capita healthcare prices, which boost costs even if the population weren’t getting older.

The Obama administration sees rising per capita health prices as “the real deficit” threat and aims its policies solely at reducing medical cost growth. As Orszag wrote:

The Medicare and Social Security trustees’ reports released this week show that health-care costs drive our long-term entitlement problem. An example illustrates the point: If costs per enrollee in Medicare and Medicaid grow at the same rate over the next four decades as they have over the past four, those two programs will increase from 5% of GDP today to 20% by 2050. Despite the attention often paid to Social Security, spending on that program rises much more modestly—from 5% to 6% of GDP—over the same time period. Over the long run, the deficit impact of every other fiscal policy variable is swamped by the impact of health-care costs.

This passage overstates the role of rising healthcare prices in two ways.

First, it implies that cost increases in Medicare and Medicaid are due to rising healthcare prices while rising costs in Social Security are due to aging. That’s false. Social Security’s costs are entirely aging-driven, but much of Medicare and Medicaid’s costs increases are due to aging as well. In fact, if you add together all aging-driven entitlement costs, as I did in this paper and as the OMB helpfully did in this chart, aging is clearly the predominant driver of entitlement costs over the short and medium term. Obama’s own budget office projects that it is not until around 2050 that per capita healthcare inflation outweighs simple population aging as the main driver of entitlement costs. If we include accumulated interest costs from rising deficits, aging is the main cost driver over the next 75 years.

Second, Orszag’s focus on the long term ignores that short- and medium-term deficits, which will be principally driven by aging, are more than enough to bankrupt the nation. Over the next two decades more than two-thirds of entitlement deficits will be driven by aging, not healthcare inflation. Recall Standard and Poor’s warnings—the bond downgrade happens in 2017, not 2050. Put simply, if we don’t fix entitlements in the short term, there won’t be a long term.

The fact that aging, not healthcare inflation, will drive entitlement deficits over the next several decades undercuts President Obama’s claim that imposing new federal controls over private sector healthcare could cut costs for Medicare and Medicaid—that, in short, “healthcare reform is entitlement reform,” as Obama says. Even if Obama’s reforms succeed we could still face a budget crisis because the reforms don’t address the real cost driver over the next decade or two.

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