The New Abnormal: How Health Costs Derail Our Return to Historic Notions of Fiscal Balance

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Sector & Sovereign, LLC

212.531.6100 Healthcare

Richard Evans


October 6, 2009

The New Abnormal: How Health Costs Derail Our Return to Historic Notions of Fiscal Balance

Research Highlights:

  • We argue that pending health legislation creates a larger and more inflationary health system, that health economic pressures may reach crisis levels before any subsequent attempts at reform; and, that pressures build most rapidly in the fiscal (as opposed to consumer and industrial) setting.
  • We model fiscal health cost pressures; whether or not coverage is expanded to a broader population hardly matters – the system already is large and inflationary enough to soon reach crisis proportions.
  • The crucial macroeconomic question is not whether pending legislation expands coverage, but whether effective provisions exist to reduce, dismantle, or ring-fence the health system’s underlying inflationary gearing. They do not.
  • CBO’s current-law (no reform effects) 10-year budget forecast calls for tax rates (as a % of GDP) to be above historical (’68 – ’08) average (17.6%) by 2012, and 1 s.d. beyond this average by 2016. Current deficit levels already are well above our historic average of 2.4% (of GDP), and the industrialized country norm of 3%.
  • Accepting CBO’s baseline as a given, if we hold taxes and deficits at these (already high) levels and simply grow per-beneficiary health costs at historic rates, our only means of paying for health cost growth is to reduce real growth in non-health spending – exponentially — beginning in 2020.
  • It follows that resolution of mortgage crisis effects does not return the federal budget to familiar, stable norms; rather, (globally shared, large, but falling) mortgage pressures unwind to be replaced by (US-only, large, and growing) health cost effects.
  • We rate the Senate Finance bill’s proposed Medicare Commission as ineffective with regards to reducing health cost growth (e.g. it cannot reduce eligibility or benefits, and cannot change hospital payments). Nevertheless we see the Commission having the power to propose – and subsequently bring about – lower prices for Medicare providers’ inputs; which is potentially devastating to innovators’ margins beginning in 2015.
  • Closer in, we sense a classic setting for further acceleration of pharmaceuticals pricing beginning as early as 1Q/’10 – manufacturers’ earnings expectations and particularly gross margins are under pressure; and, in the wake of reform efforts – pass or fail – the likelihood of political focus on drug pricing is low. We compare this setting to ’98 / ’99 which saw 12 months of 12 percent real pricing gains. Drug wholesalers, and branded drug manufacturers with patent exposures that are relatively smaller and/or further off (e.g. MRK/SGP, NVS, ABT, Roche) are principal beneficiaries.
  • Insurers continue to strike us as a trade on reform-related volatility. The core earnings engine of employer-sponsored insurance is largely beyond the reach of reforms. We recognize the threat of Cadillac plan excise taxes, but see supplemental (vision, dental) coverage being cut first to make room for growing medical coverage, and also see an opportunity for benefit structures to move to indemnity coverage on the margin, reducing excise tax effects. Despite certain adverse selection in the HIEs, we see the first two years’ risk sharing corridors giving insurers reasonable entre’ to what eventually becomes a volatile but relatively high margin risk pool.

How Health Cost Growth Can De-Rail Economic (Particularly Fiscal) Recovery

Previously we asserted that current reform efforts likely will result in a larger health system having (even) greater inflationary gearing; and, that such a system could well produce a health-cost related macro-economic crisis before the federal government can or will make another attempt at reform. The politics of healthcare are singularly bruising; for this reason alone we would not expect another reform attempt from this administration, leaving at least three and in some likelihood 7 years until another politically driven reform attempt is even remotely likely. Even then, we do not have a history of electing presidents on health reform mandates, and so have little reason to expect that the ’16 election is dominated by health reform. All in, this suggests a decade or more until subsequent reform attempts might be made in response to political imperatives. As it turns out, this appears to be sufficient time for underlying economic pressures to build to critical levels.

With all five relevant Congressional committees having reported legislation, the building blocks of any final reform package arguably are in plain view. The Senate Finance bill is unique in having both White House advocacy and a favorable Congressional Budget Office (CBO) score, and so arguably is the most predictive of where present legislative efforts might lead.

As regards our assertion of a larger / more inflationary post-reform health system, the Senate Finance bill obviously would make the health system larger; CBO estimates the bill would result in a gain of 29 million insured lives. And, the bill adds to the broader health system’s inflationary gearing simply by decreasing the number of un-insured. Recall that the American health consumer lives at either of two elasticity extremes (Exh 1); those with insurance consume care with little or no concern for marginal costs, whereas those without insurance often cannot afford even the most essential care. In other words Americans with relatively generous coverage are price inelastic consumers of healthcare; in that such consumers are in the majority, the ‘system average’ price elasticity of demand is about -0.17. By changing the status of 29 million consumers from un-insured to better insured, i.e. from highly elastic to at least somewhat inelastic, the system’s average price elasticity certainly falls further. Inelastic demand invites real price growth; the more inelastic the system, the greater its inflationary gearing.

We’ve further argued that the consequences of health cost inflation build most rapidly in the fiscal setting (as compared to consumer and industrial settings); and, by extension, that straining the federal budget to its breaking point(s) is the most likely form of a health-cost related macroeconomic crisis. Increasingly, we’re asked to be more specific with regards to timing; this call is an attempt to do that.

We start by adopting CBO’s most recent budget projections[1], which extend from 2009 to 2019. We adopt these 10 year projections without change, though we’d note that the budget’s assumptions regarding per-beneficiary Medicare cost growth are remarkably low. The average rate of real per-beneficiary health cost growth in Medicare was 4.5 percent from 1973 to 2008; the current budget assumes per-beneficiary real cost growth of only 2 percent (Exh 2). Recall that these projections are for current law, i.e. they make no provisions for passage of reform legislation. We do not see any means by which Medicare cost trend will be so meaningfully reduced; nevertheless we keep the lower assumption in our baseline.

From 2019 forward, we model fiscal health cost effects using two basic scenarios: legislation passes, providing coverage to 29 million un- and under-insured; or, legislation fails, and coverage does not expand.

In either case, we assume that per-capita real health cost growth for Medicare and Medicaid beneficiaries continues at historic (’68 – ’08) rates (4.5 percent and 2.8 percent for Medicare and Medicaid, respectively) beyond 2019. In that we see little in the way of effective means by which current bills address rates of health cost growth (please see Appendix I), we do not give the ‘reform legislation passes’ scenario the benefit of lower per-beneficiary rates of health cost growth. Also in the ‘reform legislation passes’ scenario, we add 11 million lives to Medicaid in precisely the same manner as CBO does in their preliminary score of the Senate Finance bill, and add newly covered lives to the health insurance exchanges (HIEs) in exactly the same manner as is done in this same preliminary score. We assume that per-beneficiary Medicaid costs for new members are the same as for existing Medicaid beneficiaries, and further assume that per-enrollee subsidies in the HIEs are the same as those used in the preliminary score.[2] Over time, we grow the number of beneficiaries at the rate of population growth in relevant age groups (>= 65 y.o. for Medicare, < 65 y.o. for Medicaid and the HIEs). We use CBO’s default long-range forecasts for CPI and GDP; in effect our only assumption is that per-beneficiary health costs grow at historic rates.

As federal health cost obligations (continue to) grow more rapidly than GDP, we have two basic options for financing this growth – spend less in other programs, or raise more money (raise taxes and/or run a larger deficit). We model each choice separately.

We model the ‘spend less in other programs’ scenario by holding 2019 (the last year of the current budget projection) tax and deficit levels (both as a % of GDP) constant, and pay for the growth in federal health cost obligations by reducing non-health spending. The result (Exh 3) is that federal non-health spending ceases to grow in real terms in 2020, and from there begins an exponential decline. Unless health cost growth is reduced, either taxes and/or deficits must be raised, or spending on non-health items cannot be maintained. After we layer in the effects of benefit expansion under the Senate Finance bill – without adjusting the health cost growth rate higher to account for the system’s greater inflationary gearing – at present tax and deficit levels by 2050 the federal government becomes nothing more than a health plan for 42 percent of the population.

Of course this can’t (be allowed to) happen; federal non-health spending can’t erode to zero. Holding health cost growth constant, the only alternative to reduced non-health spending is to raise taxes and/or deficit levels. We model this by holding federal non-health spending constant in real terms following 2019, and by raising taxes and debt to finance health cost growth. Taxes and deficit levels are raised at relative rates such that they share more or less proportionately in the cost growth burden; this continues until tax rates hit our arbitrary definition of an extreme level (the historic average tax rate + 2 s.d.), at which point additional borrowing becomes the sole means of paying for federal obligations. Accelerated deficit expansion is the obvious result; deficit levels quickly grow through our arbitrarily defined crisis point of 5 percent of GDP (Exh 4). Five percent is indeed an extreme number; note that in the 17 years preceding the ’08 financial crisis, the average deficit level as a percent of GDP for the OECD’s 26 member countries was 2.9 percent. Only one member – Hungary – carried a deficit that averaged above 5 percent.

Exhibits 5 and 6 show how far and how rapidly tax (Exh 5) and deficits (Exh 6) would have to rise to maintain both health benefit obligations and real levels of federal non-health spending in the face of continued health cost inflation.

Assuming for argument’s sake that deficits were held constant and only rising taxes were used, tax rates would exceed historic averages by 2 s.d. in 2026 under current law, and by 2025 if present legislation passes. Alternatively, if both rising taxes and (proportionally) rising deficits are used, then tax rates are 2 s.d. beyond historic averages in 2030 under current law, and 2028 assuming benefits expand under pending legislation.

Assuming tax rates were held constant and only debt was used, we would reach near-Hungarian deficit levels of 5 percent of GDP in 2033 under current law, 2031 under proposed reforms. If we use both tax and deficits, we hit our ‘combined’ arbitrary crisis definitions for both tax and deficits in 2037 under current law, and 2035 under reforms.

Our estimates assume no increased rates of medical inflation, despite greater inflationary gearing of the health system overall; and, we assume no negative effects on economic growth from higher tax rates and deficit levels, and no adverse effects on borrowing costs from either slower rates of economic growth or higher deficit levels. All in, this suggests our estimates of fiscal breakpoints are conservative; if anything we would expect these limits to be reached more quickly.

Note that, as modeled, the question of whether or not benefits are expanded under present reforms is relatively inconsequential. Health costs are already a large enough share of federal spending that continued health cost growth in excess of GDP is sufficient to hit our arbitrary fiscal breakpoints fairly quickly, even without adding additional beneficiaries.

Also note the extreme nature of our endpoints – we’ve been careful to choose fiscal ‘boundaries’ beyond which we can faithfully argue a crisis would exist. By 2030 or thereabouts, federal tax rates would be at 2 s.d. beyond normal, deficit levels would almost certainly be among the few worst in the OECD, and from that point real non-health federal spending could do nothing other than decline – exponentially.

Arguably we’d be in fiscal crisis well before this point. Note in Exhibits 5 and 6 that tax rates and deficit levels are already assumed to be somewhat remarkable in CBO’s current baseline forecast. Tax rates break through historic averages in 2012, and are 1 s.d. beyond averages only four years later in 2016 (Exhibit 5). Deficit levels are already well above both historic averages and industrialized country norms (Exhibit 6). Unless we either reduce health inflation or press these tax and deficit levels further beyond normal boundaries, we cannot maintain real rates of federal non-health spending.

In other words: In roughly five years, without true health economic reforms, we cannot expect to maintain real non-health spending levels and have familiar (or even internationally competitive) tax and deficit levels at any point in the future.

Stepping back, this frames a transition from one crisis to another — as the fiscal effects of the mortgage crisis unwind, tax, deficit, and / or spending levels cannot return to normal until and unless health cost growth is reduced relative to GDP growth. The conventional wisdom that the mortgage crisis unwinds, returning our fiscal health to a stable and familiar equilibrium is simply incorrect. It bears emphasizing that this is a US-specific trap; other OECD nations’ fiscal health arguably returns in the wake of the mortgage crisis.

Effectiveness and Consequences of the Proposed Medicare Commission

To be fair, the Senate Finance bill calls for a Medicare Commission, whose purpose is to keep Medicare per-beneficiary health cost growth within certain boundaries. From 2015 through 2018, the Commission has to reduce the amount by which per-beneficiary costs are expected to exceed inflation; the amount by which the Commission has to reduce this gap rises from 0.5% in 2015 to 1.5% in 2018. Beginning in 2019 and in each year thereafter, the Commission has to keep per-beneficiary Medicare cost growth to within 1% of GDP growth. The Commission makes recommendations to Congress on how these savings can be achieved, but is not allowed to reduce eligibility or benefits, or to raise revenues. Critically, it emerged this past week that the Commission also may not recommend reduced payments to hospitals. Congress must either pass the Commission’s recommendations into law, or come up with the same savings via alternative means.

We see three major problems with the Commission. First, being unable to reduce either eligibility or benefit levels, or raise revenues, the Commission can only reduce price[3]. Second, for reasons of increasing population age-mix alone, we believe the Commission faces an impossible economic challenge – in our estimates real spending per beneficiary would have to fall by nearly 70% over 30 years for the Commission to meet its mandate. Third, at half of total Medicare spending hospitals are far and away the largest recipient of Medicare payments – but the Commission is not allowed to reduce hospital payment levels.

Thus the Commission faces an economically impossible task with both arms tied; accordingly, we chose not to give the Commission significant cost-savings credit in our broader macro-economic framing. That said, more narrowly we see the Commission posing a rather dramatic threat to innovators’ margins. Unlike CMS, the Commission is not limited to recommending changes in payment rates to doctors and hospitals, in fact as we’ve just argued the Commission is in fact enjoined from changing hospital payment rates. Thus presumably the Commission is free to recommend price changes for inputs into the ‘production’ of care for Medicare beneficiaries, making innovators’ (Branded Drugs, Biotech, Medical Devices) margins an obvious target for the Commission.

Consumers’ Non-Health Standard of Living Begins Falling in a Decade

Stepping beyond the fiscal setting, even if federal health cost pressures are reduced by the Commission or some other means, by no means does this eliminate the under-pinnings of a health cost related macro-economic crisis. The purchasing power of consumers’ take-home pay is being steadily reduced by health costs, and this reaches an important inflection point within a decade. We consider consumers’ health cost exposure to be the sum of employers’ contributions to health premiums (which we consider a reduction of cash wages), employees’ contribution to health premiums, and employees’ out-of-pocket costs for care. Assuming these costs continue to inflate at historic rates – i.e. conservatively ignoring the greater inflationary gearing of a post-reform health care system health cost growth will eliminate real gains in take home wages by 2019 (Exhibit 7), after which consumers’ real non-health standards of living would begin to decline. Such an economic transition point would almost certainly mark a political transition as well: For the moment the employed / insured are happy with their health economic circumstances and so tend to oppose reforms; once real non-health standards of living stall or even begin to decline, an electoral consensus in favor of health reforms is practically guaranteed.

More on CBO’s Preliminary Scoring of the Senate Finance Bill

For the preceding macro-economic arguments we adopt CBO’s assumptions regarding number of HIE enrollees and per-enrollee subsidies as a given, though we continue to believe that the HIEs may be a much larger drain on federal revenues than is forecast. Premiums for eligible households are limited as a percent of income, and penalties may be applied if coverage is not purchased. During last week’s mark-ups subsidies were increased, reducing maximum premiums as a percent of income (the highest limit fell from 13 to 12 percent of income); penalties were eliminated for households unable to find creditable coverage for 8 percent of income or less (down from 10 percent in the original mark); and, maximum penalties for not being insured fell from $1900 per household to $800.

Recall that individuals and households are free to jump in an out of coverage, as coverage cannot be denied on the basis of pre-existing conditions. Similarly, individuals and households with modest coverage can upgrade irrespective of health status. Thus the option exists to purchase (or upgrade) coverage when needed, and avoid (or downgrade) coverage when it’s not needed.

The gap between the penalty (if any) for not being insured and the cost of purchasing coverage is the true cost of choosing to be insured. We show this cost as a percent of income for households (average 3.19 persons per) between 133% and 400% of Federal Poverty Level (FPL) in Exhibit 8; this is the diamond-marked line running from 0 percent at left to a maximum of 12 percent at right. For comparison, we show the cost of purchasing a mid-range Toyota Camry (America’s most popular car), assuming the car is financed for 48 months, zero down, at prevailing rates. This too is expressed as a percent of income, and is shown in Exhibit 8 as the smooth line running from 26 percent at left to 9 percent at right. The point is obvious; for nearly half of the households in these income brackets, the incremental cost of purchasing health insurance is comparable to the cost of purchasing a new car. Given the option to jump in and out of coverage – or to upgrade and downgrade coverage – we think a substantial proportion of households opt for the car.

Plainly choosing the car isn’t a good decision if medical costs exceed (or have a reasonable probability of exceeding) premium costs. We examined the probability of health costs exceeding premium costs for each income bracket; the results are shown in Exhibit 9. Between 30 and 40 percent of households in the higher income ranges shown here (from about 260% to 400% of FPL) will see health costs that are higher than premium costs, making subsidized coverage a very good deal; conversely 60 to 70 percent will see medical costs below premium costs in a given year. The difference between premium and medical costs is of course the household’s cost of reducing its medical cost risk, but this has to be considered against the family’s right to purchase or upgrade coverage at the next (six week) open enrollment period, as well as the family’s (reasonably likely but by no means assured) ability to receive compassionate care in the event of an un-insured catastrophic illness.

All in, we continue to see a substantial number of households staying out of coverage until coverage is needed, creating enormous adverse selection pressures. In that coverage is bought preferentially by those with high claims, premiums rise rapidly. Since premiums are limited to a percent of income by federal subsidies, the gap between true premium costs and the income limits becomes, in our view, a larger-than-expected claim on general revenues – i.e. a larger-than-expected source of fiscal health cost pressure.

Investment Conclusion

The broader health system is made larger and more inflationary by proposed reforms. Surprisingly, this isn’t the issue – the system is already large and inflationary enough to be a pending source of unbearable fiscal (and consumer) economic pressure, irrespective of whether present reform attempts result in expanded coverage. By failing to reduce the system’s inflationary gearing, we’ve missed a rare political window, and it’s very likely that health costs will grow to crisis levels before another political window opens. Specifically, we believe that until the underpinnings of health cost inflation are mitigated or even dismantled (see Appendix), that the federal budget cannot return to historically normal, much less internationally competitive, tax and deficit levels.

We continue to see the odds of legislation passing as only slightly better than even, and we believe these odds decline every day. The Democratic Party remains split, and the Senate Finance bill is a poor basis for consensus either within the Democrat party, or between Democrats and Republican moderates. An interesting alternative emerged in last week’s mark-up, namely that of State-level public options. This may prove to have relatively broad appeal. Such a framework might satisfy Progressive’s demands for a public option, but we believe such plans (50 separate plans with little or no means of deficit spending) would have dramatically less negotiating and financial leverage than a single national plan having access to deficit financing, and so do not see State level public options as a substantial threat to any specific healthcare sub-sector, including insurers.

Within the healthcare industry, our broad preferences for sub-sectors remain largely unchanged from our prior (September 21) note, with two subtle changes (see below). We continue to believe that the employer-sponsored insurance market is largely beyond the legislative reach of Congress and the Administration, and so believe that this core earnings engine of the larger capitalization insurers is largely insulated from reform pressures. Moreover, despite our belief that HIEs quickly see premiums rise on adverse selection, we note that federal subsidies protect subscribers from these costs, so the subscribers continue to buy insurance. Much of this adverse selection should unfold during the HIEs’ first two years, during which insurers share underwriting risks with the Secretary of Health, much as occurred with the roll-out of Medicare prescription drug coverage. In our view the HIEs ultimately stabilize as very high-premium markets for beneficiaries with high claims, thus informed underwriters can expect fairly high per-beneficiary margins in exchange for these risks – i.e. we anticipate a volatile but profitable line of business for insurers. Further out, we acknowledge the likely existence of excise taxes on premium expenses above certain (a.k.a. ‘Cadillac’) levels. However we note that supplement insurance is included in the calculation of premiums subject to the threshold limit, and so would expect these ancillary (vision, dental) lines to be trimmed back or dropped before more traditional medical coverage levels are reduced. Moreover, we note that beneficiaries’ after-tax payments for indemnity plans are exempt from the threshold as well, and so would further expect plans to incorporate indemnity features on the margin in order to delay or avoid the impact of above-threshold penalties. Thus all in, we continue to favor buying insurers as reform-related news flow pressures share prices.

We also continue with our simple rule of thumb for finding beneficiaries of reform related health benefit expansion, namely sub-sectors with stable (preferably competitively determined) pricing and leverage to volume. Drug wholesalers and generic drug manufacturers fit this bill almost perfectly, and pharmacy benefit managers fit nearly as well.

As regards shifts in our investment view from the last note, we have two: First, we are even more concerned about the threat the proposed Medicare Commission bears to innovators’ margins, particularly in that it appears the Commission may be enjoined from changing hospital payment rates. Accordingly, we see large cap pharmaceuticals, biotech, and medical device manufacturers carrying a fairly high degree of reform-related investment risk.

Second, we believe that the relationship between pharmaceuticals pricing and politics bears very close attention; specifically, we see substantial odds that already rapid real pricing gains in branded drugs accelerate further. We note the pending gross profit pressures of a raft of patent expirations in the branded drug sector, and the possibility of having to prepare for and live with the effects of a Medicare Commission within as little as 5 years. Broadly this argues that the sector’s interest in accelerating real pricing is even greater than normal. More narrowly, we’d note that to the extent PFE/WYE operating synergy expectations tie to the tendency of drug mergers to produce gross margin gains through consolidation of manufacturing, that these expectations may be hard to fulfill due to both the relatively high asset utilization levels at PFE pre-merger, and the fact that manufacturing synergies typically cannot be found in large-molecule products, which are a substantial portion of WYE’s portfolio. This at least infers that PFE/WYE might have an even greater appetite for real price gains than its sector peers. Our experience with pharmaceuticals pricing is that sector-wide accelerated real-pricing runs often can be ignited by a single large company.

The sector plainly faces reform-related product pricing risks, and so has much to lose if its immediate rates of real pricing draw legislative attention — nevertheless the industry’s producer price index has shown an average real gain of 7 percent over the last 10 months. Despite this fairly aggressive pace, we can’t help but expect pricing to accelerate further once the present reform effort comes to an end – at which point the odds of political focus returning immediately to drug pricing are practically zero, and the odds of adverse policy resulting from a further acceleration of drug pricing in the wake of reform efforts are correspondingly low. We note that even the present considerable real pricing gains are relatively modest against the backdrop of 1998 / 1999, wherein real drug prices grew at an average rate of 12% during a 12 month period of substantial political air cover — beginning with the emergence of the Lewinsky scandal in January of 1998, continuing through the Kosovo conflict that winter, the Asian, Russian, and LTCM crises that spring, and ending with the Rose Garden apology in January of 1999 (Exhibit 10). We further note the ’98/’99 v. ’09 similarity of declining earnings expectations (Exhibit 11).

Principal beneficiaries of real-price acceleration would include drug wholesalers, despite some normalization of price leverage by inventory management agreements (IMAs) which have become standard since the ’98 / ’99 pricing acceleration. Secondarily, branded drug manufacturers with relatively little immediate patent exposure (e.g. MRK/SGP, NVS, ABT, Roche) arguably benefit more than their peers with larger and/or more immediate patent-related gross margin pressures. We would expect drug wholesalers’ earnings to see the benefit of real pricing well before drug manufacturers’, as manufacturers’ commitments to limit effective price growth to certain large commercial buyers means pricing effects may flow through manufacturers’ revenues and earnings only after contracts renew.Appendix I: Our View on the Underlying Mechanics of Health Cost Inflation


Our US health economic thesis holds that nothing links costs and value, so costs grow faster than value for a very simple reason: Because they can. Market forces fail to link price and value for both classic and health system specific reasons. Classically, necessary conditions for market function are weak, if present at all – key among these are information symmetry, and transparency of price and quality. More specific to the US health system, consumers exist at either of two elasticity extremes (Exhibit 1); either indifferent to the marginal cost of care, or unable to afford even basic / essential care. Thus demand is on average hugely inelastic, inviting inflation. Centrally administered prices fail to link cost and value because of the simple human reality that planners cannot match the health system’s pace and complexity; prices are either too high or too low; move too slowly to take account of productivity gains; refuse to move lower and so negate price competition; and, are the same irrespective of quality, thus negating quality competition. Moreover, administered healthcare prices have historically grown at an inflationary pace; CMS’ largest single payment – those made to hospitals for operating costs – are a poignant example (Exh A1).

We further argue that the system is not self-righting, i.e. health cost inflation is the equilibrium state of American health economic affairs, and that the system will continue to consume resources more rapidly than it creates value. This continues until price and value are linked via structural reforms, average prices are arbitrarily reset to much lower levels, and/or hard percent of GDP limits are set on health costs. Absent such reforms, we see no convincing reason to model lower rates of health cost inflation.

The failure of either market forces or central power to link price and value is broadly evident. Prices for virtually everything in US healthcare (Exh A2) are inflationary, practically all of the time (Exh A3). And, cost bears little relation to quality – cost / quality relationships are random (Exh A4, commercial example) or even negative (Exh A5, public example). Exhibits A2 thru A5 are presented on the following page.


  1. Congressional Budget Office – The Budget and Economic Outlook: An Update. August, 2009.
  2. Note that these will rise further in the final score, as the subsidies have been raised in mark-up.
  3. Technically, the Commission could reform price structures to create provider competition and associated operating efficiencies, but this is effectively off of the table if the Commission cannot change hospital payments.
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