Chapter 1. The Fiscal Cliff and Future Federal Medicaid Funding

Federal deficit spending reached $1.1 trillion in fiscal year (FY) 2012, marking the fourth year in a row that the deficit has topped a trillion dollars. 3 Total U.S. government debt grew from $5.7 trillion in January 2001 to $16.1 trillion in September 2012. 4 The Congressional Budget Office (CBO), the nonpartisan arbitrator of Congressional fiscal and economic projections, has reported that the federal debt held by the public exceeded 70 percent of the gross domestic product (GDP) on September 30, 2012—the highest level since 1950 and 75 percent higher than the debt-to-GDP percentage in 2008 when the current, prolonged national recession began. 5

Contributing Factors

By far the most prominent factors contributing to continued deficit spending are the structural imbalances in the three largest federal entitlement programs: Social Security, Medicare, and Medicaid. The growing fiscal pressure exerted by these programs can be traced to two interrelated factors: demographics and escalating health care costs. Over the next quarter century, the percentage of the U.S. population over 65 years of age is expected to grow from 13 percent to 20 percent, while the percentage of the population between 20 and 64 years of age declines from 60 percent to 55 percent. As a result of these demographic shifts, the number of active workers per Social Security beneficiary is expected to drop from 3 to 1 to 2 to 1 by 2037. 6

As a growing number of senior citizens enroll in Medicare and Medicaid, demand for increasingly expensive health care services is expected to rise sharply, with federal health care expenditures growing from slightly more than 5 percent of GDP today to 10 percent by 2037. Spending on Social Security benefits is expected to increase at a much slower pace, rising from 5 percent of GDP today to 6 percent of GDP in 2020 and subsequent decades. When the effects of an aging population and rising health care costs are combined, CBO predicts that federal health and Social Security costs will increase from 10 percent to 16 percent of GDP over the next 25 years. Five percentage points of GDP may not sound like much, but they represent more than the nation spent on national defense (4.7% of GDP) in FY 2011—and also more than it spent on all discretionary, nondefense programs and activities (4.3% of GDP) that same year. 7  Viewed from a broader perspective, a five-point increase in the share of the domestic economy would translate into $850 billion in current dollars. By comparison, all federal expenditures, excluding interest payments on the national debt, have averaged 18.5 percent of GDP over the past 40 years. 8

Approaching the Fiscal Cliff

For years, the message from economists has been clear: unless the growth in health care costs and Social Security benefits is curtailed, either federal tax revenues will have to be raised to unprecedented levels or the nation’s ever-expanding debt burden will become economically unsustainable. Yet, despite the development of multiple deficit reduction plans in recent years, attempts to solve the debt crisis have stalled in Congress.

During the summer of 2011, a stopgap plan was approved that called for slightly less than $1 billion in spending reductions over 10 years followed by another $1.3 billion in savings to be recommended by a bipartisan Congressional panel. When this "super committee" failed to reached consensus during the fall of 2011, the legislation authorizing the cuts (the Budget Control Act of 2011) directed the President to institute automatic, across-the-board reductions in both domestic and military spending totaling $1.3 billion over 10 years.

These "sequestration" cuts were scheduled to take effect on January 1, 2013, but Congress intervened at the last minute to avert the "fiscal cliff," a combination of tax and spending increases that economists predicted would stymie the fragile economic recovery and likely lead to another recession. The American Taxpayer Relief Act of 2012 made permanent lower, Bush-era tax rates on income up to $400,000 for individuals and $450,000 for families. The legislation also (1) permanently indexed the threshold of the Alternative Minimum Tax exemption; (2) extended emergency unemployment benefits for one year; (3) postponed a scheduled reduction in Medicare physician payment rates for an additional year; (4) delayed automatic, across-the-board spending cuts for two months; and (5) extended farm policies and programs through September 30, 2013.9

Congress, however, was unable to reach agreement on a long-term plan for reducing the deficit through spending cuts and revenue enhancements. As a result, the 112th Congress will face a new fiscal crisis by the end of February 2013 when the two-month delay in sequestration expires and legislation to raise the debt ceiling will have to be enacted to avoid defaulting on the government’s outstanding obligations. Once again, the debate will focus on approaches to reducing Social Security, Medicare, and Medicaid spending as well as securing increased revenues through reforms in the tax code. The future of the federal-state Medicaid program is integrally tied to the outcome of this and subsequent battles over the proper role of the Federal Government in promoting the best interests of the American public.

The National Debt and Controlling Health Care Outlays

Attempts to reduce deficit spending have been a staple of Washington politics for decades. Yet, despite repeated proposals to bring federal spending and revenues into balance, the nation’s debt has continued to mushroom. The publicly held debt of the United States has increased for 55 straight years, growing from $257 billion to over $16 trillion. 10 Interest payments on the outstanding debt reached $454.4 billion in FY 2011, 11 more than the government expended that year on any program area except national defense, Social Security, and Medicare benefits.

Over approximately the same period (1960–2006), aggregate health care expenditures in the United States grew by an average of 9.9 percent per year, while the GDP increased at an average annual rate of 7.3 percent. After adjusting for inflation, the average annual gap between the growth in health care spending and the growth in GDP was 2.5 percent.12 Average per capita health care expenditures increased by 72 percent between 2000 and 2010, rising from $4,878 to $8,402.13 Per capita spending on health care services is considerably lower in other industrialized nations such as Canada ($4,205), Germany ($4,187), United Kingdom ($3,253), France ($3,835), and Italy ($2,852), all of which, unlike the United States, offer their citizens universal access to health services.14

With 10,000 Baby Boomers retiring each day, the financial pressure on the government’s two principal health programs—Medicare and Medicaid—is going to intensify over the next several decades. According to CBO projections, Medicare expenditures under current law assumptions will increase as a share of GDP from 3.7 percent in 2012 to 4.2 percent in 2022 and to 6.0 percent in 2037. Meanwhile, Medicaid expenditures will increase from 1.7 percent of GDP in 2012 to 3.0 percent of GDP in 2022 and 3.6 percent of GDP in 2037. Health outlays alone, primarily Medicare and Medicaid expenditures, make up about four-fifths of the anticipated growth in the federal deficit over the 25-year period.15 Given these realities, it is clear that curbing excess growth in health care outlays must be a central component of any deficit reduction strategy.

Despite numerous attempts over the past 30 years to control costs, health expenditures have continued to rise at a rate in excess of the general economy. By tying Medicare reimbursements to standardized diagnosis-related groups (DRGs) in the 1980s and expanding the use of managed care techniques throughout the 1980s and into the 1990s, government policymakers were able to slow the rate of growth in health care expenditures. But, growth rates subsequently bounced back to historic levels.

The Affordable Care Act

The 2010 health reform legislation, commonly referred to as the Affordable Care Act (ACA),16 contains many provisions aimed at controlling the rise in near-term and longer-range health care outlays. Among the short-term cost containment strategies included in the law are provisions reducing payments to Medicare providers (e.g., primarily Medicare Advantage plans and hospitals), requiring pharmaceutical firms to pay higher rebates to state Medicaid agencies, eliminating fraud and abuse in the Medicare and Medicaid programs, introducing electronic records to simplify health insurance administration, implementing value-based purchasing programs, and establishing an approval process for purchasing generic biologic agents.17

 At the same time, the ACA includes numerous provisions intended to dampen the long-term growth of health outlays by improving the efficiency and cost-effectiveness of delivering health services. A new Center for Innovation has been established within the Centers for Medicare and Medicaid Services (CMS) to support and evaluate experimental health care delivery models, care coordination methods and payment reforms. Among the center initiatives already under way are (1) a Medicare Shared Savings Program where groups of health care providers, called Accountable Care Organizations, coordinate their services and are allowed to share in any cost savings; (2) projects to test methods of "bundling" payments to different providers so Medicare and Medicaid beneficiaries receive more coordinated and efficient care; (3) patient-centered Medical Homes for patients with chronic illnesses; and (4) coordinated care demonstration projects for individuals dually eligible for Medicare and Medicaid services. The ACA also mandated the establishment of (1) a private, nonprofit Patient-Centered Outcome Research Institute to develop research priorities and conduct and disseminate findings from comparative effectiveness studies of health care interventions, including their risks and benefits; and (2) an Independent Payment Advisory Board to recommend methods of eliminating excess Medicare spending and proposing ways of slowing the growth of private health expenditures while preserving or enhancing service quality.18

 Although the health care reforms currently in the pipeline hold considerable promise, there is scant evidence at present that they will succeed in containing the growth in health spending on a broad scale and in diverse settings. Indeed, it will take years to fully evaluate the impact of the various payment and service delivery reforms presently underway or planned. Federal and state policymakers in the meantime cannot afford to wait until all the evidence is accumulated and conclusions are drawn. They need to act now to curb the growth in deficit spending and thereby preserve the integrity of the nation’s financial system.

Given the importance of controlling federal health care expenditures, changes in Medicaid spending policies are virtually inevitable. All of the major deficit reductions plans advanced in recent years have sought to limit Medicare and Medicaid spending, but they have done so in significantly different ways and to different extents (see Appendix B for an expanded discussion of the major deficit reductions plans and their likely impact on future federal Medicaid spending).

The question is: how will the Medicaid program be changed? Older Americans and people with disabilities would be at special risk should lawmakers choose to convert the Medicaid program into a block grant authority. At present, they constitute about one-quarter of all program beneficiaries but account for almost two-thirds of Medicaid spending because of their elevated need for health services and high reliance on Medicaid to pay for long-term services and supports.19 As pointed out later in this paper, states would face strong pressures to scale back services to low-income seniors and people with disabilities if federal Medicaid funding were to be capped.

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