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A percentage point here and a percentage point there and soon you're talking real money

Technological Change and the Growth of Health Care Spending - Powered by Google Docs_1263497344696.jpeg

The news that Americans have stopped getting fatter -- but are still pretty fat -- is a nice opportunity to distinguish things that change how much we spend next year from how much we spend 10 years from now.

There are two things going on with health-care costs. The first is that we spend a lot right now. In 2008, we clocked in at $2.3 trillion. That's a lot of money. But the other problem is that that sum is growing by quite a bit every year. A normal year sees 8% or so growth.

We can afford $2.3 trillion. We can't afford $2.3 trillion after 20 years at 8% growth (which would be $10.7 trillion, if my calculations are correct).

To get costs under control, we have to change the 8%, not the 2.3 trillion. To make this clearer, let's say we do some serious cost control and cut $200 billion from the system next year. That's heavy work that will hurt a lot of people. It's more than we've ever done before. But if we're still growing at 8%, then 20 years from now, it leaves us with $9.8 trillion in spending. That's $900 billion less than the original projection, which is something, but not enough.

Conversely, let's say we don't cut a dollar next year, but we lower the growth rate to a (still fast!) 6.5%. In 20 years, we're spending $8.1 trillion. That's $2.6 trillion less than the projections. Which would you prefer?

That's not to deride the worth of things that cut the $2.3 trillion. Saving money is good, and it buys us time. But if we just cut payment rates by enough to save, say, $200 billion, all we're doing is buying some time. Things that attack the growth of health-care spending -- reversing the rise in obesity, for instance, would mean that demand for health care grows more slowly than we project -- change the 8%, and are thus much more important.

Graph credit: Congressional Budget Office

By Ezra Klein  |  January 14, 2010; 3:04 PM ET
Categories:  Health Economics  
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That analysis is not really correct.

The best way to evaluate the two options is to integrate the two curves over the period in question.

Totaling the yearly payments, not compounding interest continually, and not counting the first 2.3 trillion from this year which contributes to each estimate equally.

After 20 years, I get $89.6 Trillion paid if you drop growth by 2% and $103.7 Trillion paid if you decrease expenditures by $200 billion.

If you don't do the integral you don't really account for the accrued savings at the beginning of the period leading to counter-intuitive results. For example, if we saved $500 Billion now rather than $200 Billion, we would only pay $88.9 Trillion over 20 years even though our total payment at year 20 would be higher $8.3 Trillion rather than $8.1 Trillion for 2% growth reduction.

Of course, if you are integrating savings for an arbitrarily long interval, slowing growth is always better, even if it is a trivially small change. But I think this fact more serves as a reductio ad absurdum; demonstrating that our assumptions about growth extrapolation are unsound at a certain distance into the future.

An additional complication that favors initial savings is recognition of the fact that money has an opportunity cost. Savings can earn at least modest interest. If we save earlier, we start earning interest sooner.

Posted by: zosima | January 14, 2010 3:58 PM | Report abuse

Extending on my point on opportunity cost. If we assume the 200 Billion that we save each year earns us 5% interest for every year AFTER the savings are accrued.

Then saving $200 Billion next year has an aggregate cost of $97.2 Trillion over 20 years, whereas saving 2% next year has the same cost $89.6 Trillion. So we'd only need to save $300 Billion next year to save more over 20 years than growth reduction of 2%.

Incidentally, I only calculated opportunity cost on dollars saved and not on expected cost versus baseline. This might be a better way of analyzing the problem.

My take home message: It is not that simple, unfortunately.

Posted by: zosima | January 14, 2010 4:07 PM | Report abuse

I like how when its health care spending its all about growth, not the short run. But when its GDP its all about the short run, not growth.

Posted by: steve10c | January 14, 2010 4:18 PM | Report abuse

I ran the numbers comparing both options to baseline with 5% interest as opportunity cost and it strongly favors growth reduction. This analysis assumes dollars saved aren't just put under the mattress. The assumption is loosely that the saved dollars versus baseline are invested in some endeavor that earns value at 5% APR.(paying off debt, building infrastructure, buying stocks, whatever). Money saved next year has longer to accrue interest, so it is more valuable than money saved 20 years from now.

Decrease Growth by 2%, 20 year cost: $56.9 Trillion.
Decrease Cost by $200 Billion next year, 20 year cost: $88.6 Trillion
Decrease Cost by $300 Billion next year, 20 year cost: $76.0 Trillion

Posted by: zosima | January 14, 2010 6:14 PM | Report abuse

Ezra, it's easy for us outside of Washington to see how the Village pollutes your thinking.

In talking about obesity in your post, you are saying that our health care costs are because of our "unhealthy choices," repeating an untrue and misleading Republican meme (one that is yet another echo of Reagan's untrue and misleading attacks on overweight black welfare queens, BTW)

The obesity of the US population is a very small component in the ridiculously high cost of US healthcare. How can I say that? Because we pay our providers 1.5-2X what European providers are paid, we pay pharma 2x-3x what pharma is paid in Europe and we pay insurance companies 2x-8x what they are paid in Europe, based on our 80% medical loss ratio compared to 90-93% in Switzerland, Germany and France or 97% in the UK.

What we need is a chart that shows the impact of those 3 costs (inflated cost of insurance, overpaying providers, overpaying pharma) as components of the difference between Germany's per capita health costs and ours, and then adding in our "poor health choices." It would be pretty clear that "choices" are a smokescreen, and that the real goal should be immediate cuts in pharma and insurance, along with a 10 year freeze in reimbursements to allow providers to fall in line with the rest of the developed world.

So why, Ezra? Why help people obscure the real issues with the "Fat Americans" meme?

Posted by: Dollared | January 14, 2010 7:41 PM | Report abuse

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