Fed Budgetary Experts Demolish CBO Health Cost Model, the Lynchpin of Budget Hysteria

Published on naked capitalism, by blog owner, NOVEMBER 4, 2012.

A remarkably important and persuasive paper that calls into question the need for “reforming” Medicare has not gotten the attention it warrants. An Examination of Health-Spending Growth In The United States: Past Trends And Future Prospects (hat tip nathan) by Glenn Follette and Louise Sheiner looks at the model used by the Congressional Budgetary Office to estimate long term health care cost increases. Bear in mind that this model is THE driver of virtually all forecasts of future budget deficits.  

This paper, although written in typically anodyne economese, is devastating in the range and nature of its criticisms. And the reason this assessment should be taken seriously, independent of the importance of the issues it raises, is that the authors are uniquely qualified to make this critique. Follette is chief of the Fed’s fiscal analysis section. Sheiner, a fellow member of that group, has worked for both the Treasury and the Council of Economic Advisers previously. In other words, the sort of analysis they have made here is the core of what they do on a daily basis.

The argument made by the opponents of the plans to cut Social Security and Medicare generally take this form: concerns about Social Security are greatly exaggerated. They are based on long-term forecasts, which are notoriously inaccurate in outlying years. The most commonly cited, by the Trustees of the Social Security system, projects the exahustion of the famous trust fund in 2033. As several analysts have observed, if Social Security really has a problem, we’ll know it in plenty of time; there’s no need to do anything immediately.

By contrast, conventional wisdom is that Medicare does have a long term cost predicament, but the problem is not demographic, but that of the steep rise of health care costs in general … //

… The underlying issue is that nothing that is a large portion of GDP can exceed the growth rate of GDP forever, or even for all that long; that’s how we’ve gotten in the insane position of having health care reach 16% of GDP. The term of art is “excess health care spending growth” which as noted above, they define in relationship to per capita incomes. The Fed economists make the following observations in their paper:

1. Given the concern about health care cost escalation, and the pressure being exerted now by employers to contain these costs, as well as the fact that other advanced economies have shown declines in excess costs, the growth assumptions look very aggressive. Moreover, the excess growth took place during a period when government and private health care insurance expanded greatly. In 1960, out-of-pocket spending was 52% of medical spending; by 2006, it had fallen to only 13% by 2006.

Follette and Shiener also looked at the composition of cost drivers and argued that certain key ones will moderate:

Accordingly, 1.1 percentage points of the [historical] 2.2 percentage points of age-adjusted excess growth over the period resulted from technological change and other factors and 1.1 percentage points reflected the effects increased insurance coverage and administrative costs.16 The historical data therefore support excess growth of 1.1 per cent per year if we assume that out-of-pocket costs do not decline further and that administrative costs (as a share of expenditures) do not rise further. However, demand should fall short of this as consumers respond to rising health bills.

The Fed economists separately find that excess growth has averaged 2% over the last 40 years but has been slowing and argue that 1% excess growth is a likely upper bound for the long term average. They posit that excess growth of 2% can be maintained for only a few years at most because consumption as a percentage of GDP is anticipated to fall (this is in the CBO’s own models; it’s mainly the result of the trade deficit falling). By contrast, the CBO assumes 2.4% excess growth for Medicare and 2.2% for Medicaid over the next decade, falling monotonically to 1.1% for Medicare and 0% for Medicare by 2082. If you’ve ever run financial models, you’ll know that goosing the growth rates in the early years has an impressive impact on the final result.

2. The CBO model produces the peculiar result that government funded plans will show faster cost growth than private plans. From the article:

Our chief concern with their projection is their assumption that per capita spending by Medicare grows much more rapidly than that of the private sector. The projected divergence seems inconsistent with the underlying assumption that policies are unchanged because Medicare and private sector insurance plans have had similar payment rates historically.

3. The Fed budget experts note that the CBO analysis violates the requirements for CBO budget projections. The CBO is tasked to forecast assuming no policy changes. But in simply relying on historical trends, which as noted above include considerable expansion of government-funded health coverage, they have effectively incorporated the hidden assumption of continued expansion. Put it another way, the forecasts should have explicitly backed out the impact of historical increases in health insurance coverage to arrive at a true baseline growth rate. Per Follette and Sheiner:

The lack of distinction between policy and other factors is a particular problem because CBO uses different excess cost growth assumptions for Medicare, Medicaid, and other health spending, and the CBO projection is supposed to be under the assumption of no policy changes. Past Medicare spending growth includes factors that are not assumed to continue in the future. For example, the Medicare Part B premium was not previously indexed to Medicare spending; thus Medicare spending growth grew faster than overall health spending, as Medicare picked up a higher share of spending. Similarly, Medicare policies changed to include renal dialysis, HMOs, coverage of the SSI population, and more broadened coverage of home health care. As CBO is not assuming further expansion of Medicare, it does not seem reasonable to forecast future growth based on historical growth rates that include such expansions. Similar issues arise with Medicaid.

4. Follette and Sheiner find that, contrary to conventional wisdom, that more realistic health care cost assumptions allow for some improvements in coverage to low income groups, provided government coverage to the better off is not increased further:

We find that a narrow expansion of assistance to the lowest quintile would have only minor consequences to government finances but more broad-based programs would have materially deleterious effects.


The CBO’s performance on this front looks like malpractice. The Fed economists note telling irregularities, such as the substitution of scenarios, as opposed to the use of confidence band analysis, as the CBO employed in its Social Security forecasts. And this would not the first time that CBO has apparently allowed political considerations to interfere with its pretense of objectivity. First we have the case of CBO analyst Lan Pham, who was fired for attempting to incorporate the impact of foreclosures and chain of title issues on home price and property tax forecasts. Second, we have the instance of Tom Ferguson and Rob Johnson of alerting the CBO to a significant omission in their deficit analysis, that of failing to include financial assets in their debt-to-GDP ratio calculation. CBO staffers have not disputed the accuracy of the
Ferguson/Johnson research but nevertheless will not change their projections. Now we have what is demonstrably an overly aggressive set of assumptions driving health policy debate, with two Federal Reserve analysts sufficiently taken aback by the model as to publish a serious takedown of it.

The CBO’s independence is, like its output, treated as above question. It’s time to subject both to harsh scrutiny.
(full text and many comments and replies).


US Government Spending History from 1900, by WeThePeople082, am 25. Okt 2011;

China Is Quietly Becoming Gold Superpower, on Global Research.ca, Washington’s Blog, November 04, 2012;

Pete Peterson and the Deficit Hawks Teach Lawmakers Deep Fiscal Irresponsibility, on naked capitalism, by Michael Hoexter, November 5, 2012;

BNP mark II: Brons leads split from Griffin to form new far-right party, on Left Foot Forward, by Anddrew Brons MEP, November 4, 2012;

New York City faces post-storm housing crisis: Mayor estimates superstorm Sandy severely damaged up to 40,000 homes, just as winter weather sets in, on Al Jazeera, November 5, 2012;

Soll ich mein Kind impfen lassen? Nein!, 30,45 min, uploaded by MainstreamSmasherTV, July 21, 2012 (Original upload on YouTube Channel WeThePeople082 am 19. Nov 2011).

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