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     The Congress of the United States
       Congressional Budget Ofice

Cover photo: An operating room at the Center for Ambulatory Surgery in
Washington, D.C. (From the U.S.News & World Report Collection, Prints and
Photographs Division, Library of Congress.)

        pending on health care has grown rapidly in recent decades and has
 S      placed increasing pressure on both private and public budgets. The
        House Committee on Ways and Means has asked the Congressional
Budget Office (CBO) to study the economic and budgetary costs of the rapid
rise in national health care expenditures. CBO1s response is in two parts.
This study reviews the growth in national health spending since 1965and pro-
vides projections through 2000. A companion study, Economic Implications of
Rising Health Care Costs, examines the implications of providing health
insurance through an employment-based system and the effects of the rising
costs of federal health programs on the economy. In keeping with CBO1sman-
date to provide impartial analysis, the studies make no recommendations.

    This report was written by Jeffrey Lemieux of CBO1s Budget Analysis
Division and Christopher Williams of the Fiscal Analysis Division, under the
direction of Robert Dennis, C.G. Nuckols, Charles E. Seagrave, and Paul N.
Van de Water. Mr. Williams was primarily responsible for Chapter 1 and
Appendix B, and Mr. Lemieux was the principal author of Chapters 2 through
4 and Appendix A.

   Valuable comments were provided by Joseph Anderson of Capital Research
Associates; Sally Burner and Katharine Levit of the Health Care Financing
Administration; and Nancy Gordon, Kathryn Langwell, Jack Rodgers, Larry
Ozanne, Eric Toder, Rick Kasten, Murray Ross, Alan Fairbank, and Douglas
Hamilton of CBO. Special thanks to Marion Curry, Rae Roy, and Dorothy
Kornegay for assistance in preparing the tables, and to Mark McMullen,
Patricia Wahl, Daniel Covitz, Michael Simpson, and Blake Mackey for re-
search assistance.

   Sherwood D. Kohn edited the report. Chris Spoor provided editorial sup-
port. With the assistance of Martina Wojak-Piotrow, Kathryn Quattrone pre-
pared the report for publication.

                                        Robert D. Reischauer

October 1992



             Rising National Health Expenditures 1
             Implications of Rising Health Expenditures 2
             Why Are Health Expenditures Rising So Rapidly? 8

             CONCEPTS, AND METHODOLOGY                             13

             Current Policy Assumptions 13
             Economic and Demographic Assumptions 13
             National Health Expenditures: Concept and Trends 15
             Projection Methodology 15

             EXPENDITURES BY TYPE OF SPENDING                      21

             Hospital Expenditure 23
             Physician Services 27
             Drugs and Other Medical Nondurable Products 29
             Nursing Home Care 30
             Other Types of Personal Health Spending 31
             Other National Health Expenditures 33


             Private Payments 37
             Public Funding 43


A            HCFA National Health Expenditure
               Projections Methodology 49

B            Projecting Employer-Paid Health Insurance
                Premiums: Their Impact on Wages
                and Tax Revenues 53


S-1.           Projections of National Health Expenditures,
               by Type of Spending                                       xi

               Projections of National Health Expenditures,
               by Source of Funds                                       xii

               National and Personal Health Spending:
               Demographic and Economic Assumptions                      14

               Factors Accounting for Growth in Personal
               Health Spending

               Projections of National Health Expenditures
               to 2000, by Major Types of Spending

               Factors Accounting for Growth in Inpatient
               Expenditures at Community Hospitals

               Factors Accounting for Growth in Outpatient
               Expenditures a t Community Hospitals

               Factors Accounting for Growth in Expenditures
               for Physician Services

               Average Physician Practice Incomes and Expenses,
               All Specialties

               Factors Accounting for Growth in Nursing
               Home Expenditures

               Projections of National Health Expenditures
               to 2000, by Smaller Types of Spending

               Health Insurance Primary Coverage

               Projections of National Health Expenditures
               to 2000, by Source of Funds

               Private and Public Health Insurance Expenditures

               Projections of National Health Expenditures in
               the Public Sector to 2000, by Source of Funds

               Employer-Paid Health Insurance Premiums
               and Wages and Salaries, 1991-1997,Showing
               Hypothetical Gains from Restraint in the
               Growth of Health Premiums
CONTENTS                                                          vii

B-2.       Estimated Tax Expenditures Related to Health
           Care, Calendar Years 1967-2000                         56


1.         National Health Expenditures as a Share
           of Gross Domestic Product

2.         Health Expenditures a s a Percentage of
           Gross Domestic Product, United States and
           Selected Countries, 1960-1990

3.         Inflation-Adjusted Compensation, Health
           Premiums, and Wages per Full-Time Employee:
           Actual Data and 1973-1989 Trends                        6

           Federal Health Expenditures as a Percentage
           of Gross Federal Outlays Less Interest                  7

           State and Local Spending on Health Care                 9

           Health Spending and Income in Countries of
           the Organization for Economic Cooperation
           and Development, 1989                                  10

           National Health Expenditures vs.
           Gross Domestic Product

           Projected Growth of U.S. Population Aged 65
           or Older, by Age Group and Year                        18

           Percentage Change in Major Health
           Expenditure Categories

           Community Hospital Margins                             24

           Trends in Community Hospital Use and Occupancy         26

           Consumer Price Index                                   30

           Private Health Insurance Administration and Net Cost   34

           Major Sources of Funds for Health Care, by
           Percentage of Total Health Expenditures                39

           Trends in Private Health Insurance
           Premiums, 1981-1992

           Number of Hospital Days, by Age Group and Sex          50

A-2.           Hospital Cost per Day, by Age Group and Sex              51

B-1.           Ratio of Employer-Paid Premiums to
               Total Private Health Insurance

B-2.           Employer-Paid Health Insurance Premiums and
               Wages and Salaries as Shares of Total Compensation       55


               Tax Subsidies to Private Health Spending

               Reporting Health Expenditure Data: Health
               Expenditures and Inflation

               Estimating Community Hospital Expenditures

        ver the last 25 years, the health sec-    nity hospital margins (the net of revenues less
 0      tor's share of the U.S. economy has
        more than doubled. In 1965, national
health spending constituted less than 6 per-
                                                  expenses) reported by the American Hospital
                                                  Association were 5.2 percent in 1991, higher
                                                  than their 20-year average of 4.2 percent.
cent of the gross domestic product (GDP), but
by 1990 it had expanded to more than 12 per-         Health expenditures generally grow more
cent of GDP. Assuming that current govern-        rapidly than spending in most other parts of
ment policies remain in force, and that medi-     the economy, largely because of what econo-
cal practice and private health insurance         mists call market failure. This failure has
trends continue, the Congressional Budget         allowed rapid technological change that tends
Office (CBO) projects that national health        to inflate rather than save costs, a n unrelent-
spending will reach 18 percent of GDP by the      ing expansion of services provided during each
year 2000, or almost $1.7 trillion. As health     doctor visit or hospital stay, and large in-
spending continues to grow, concerns mount        creases in fees paid to health care providers.
about its financial impacts on consumers,         The aging of the U.S. population contributes
businesses, and governments.                      to higher spending on health care because
                                                  older patients use a disproportionate amount
    Despite recent weakness i n the economy,      of health services, but in the next decade the
employment and incomes in the health sector       impact of the aging population will increase
have increased a t striking rates. The total      health spending only modestly. Increases in
number ofjobs in the health sector of the econ-   hospital stays and physician visits that can be
omy increased by 639,000 from May 1990            expected because the population is aging are
through May 1992, while the total number of       likely to account for only a small part of in-
jobs in the economy fell by almost 1.8 million    creased health spending.
and the number of nonhealth jobs fell by 2.4
million. According to the American Medical          Health insurance, t h e nation's primary
Association, t h e average n e t income of        method of financing health care, is one source
physicians (after subtracting office expenses,    of market failure t h a t prevents t h e usual
malpractice insurance premiums, and t h e         workings of competition. It permits the rapid
 like) in 1990 was $164,000, up from $98,000 in   application of new and expensive procedures
 1982--an average annual growth rate of 6.6       and helps insulate providers from price com-
percent. By comparison, the average pay of all    petition. Collective payment through insur-
full-time workers increased from $18,500 to       ance is a natural response to the possibility of
$25,900 during the same period, a growth rate     large and uncertain health care expenses.
of only 4.3 percent a year. Similarly, commu-     When a n insurance company or government
x PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                          October 1992

program pays the bills, however, patients and      Projections by Type of Spending
health providers have less incentive to control
costs carefully.                                   Hospital, physician, drug, and nursing home
                                                   expenditures accounted for almost 75 percent
   Another source of market failure is the dele-   of national health spending in 1990 (see Sum-
gation of much decisionmaking to providers.        mary Table 1for CBO's baseline health spend-
Patients who have little medical expertise are     ing projections classified by major type of
happy to benefit from whatever treatments          spending).
providers recommend when the insurance will
pay the bill. And even if they wish to do bene-      CBO projects that hospital spending will in-
fit-cost calculations, patients are often unable   crease a t a n average rate of 10 percent a year
to judge the appropriateness, quality, or price    in the 1990s, up slightly from 9.5 percent in
of a health service.                               the 1980s (see Summary Table 1). The shift
                                                   toward use of outpatient services is expected
  Because the competitive market has failed,       to continue, with the number of outpatient
health spending cannot be assumed to repre-        hospital visits increasing almost 5 percent a
sent well-informed demands by consumers or         year. The occupancy rate for community hos-
efficient provision of services by providers.      pitals is projected to remain below 65 percent--
                                                   despite reductions in the number of available
   Many of these attributes of U.S. health mar-    beds--as the rate of inpatient admissions per
kets are not unique to this country or even to     person continues t o fall and t h e average
the health industry. Regulatory agencies           length of a hospital stay drifts lower.
oversee other industries where competitive
markets do not function, such as public utili-        Spending on physician services is expected
ties. In other countries, budgets, regulatory      to increase a t a n average annual rate of 9.7
constraints, or other countervailing forces        percent in the 19909, down from 11.6 percent
help prevent health expenditures from spiral-      in the 1980s. Increases in physicians' charges,
ing out of control. In this country, however,      additional procedures per doctor visit, and the
cost-containing pressures operate only on          continual increase in the complexity or inten-
parts of the sector, and their overall impact is   sity of treatments provided in doctors' offices
diluted.                                           account for almost nine-tenths of the total in-
                                                   crease in this spending. Changes in the demo-
                                                   graphic composition of the population and a n
                                                   increasing number of doctor visits per person
                                                   contribute little to the growth of spending for
National Health                                    physician services.
Expenditures                                         Spending on drugs, which is characterized
Total spending on health is projected to reach     by a high proportion of out-of-pocket pay-
almost $1.7 trillion in 2000, compared with        ments, is projected to grow by about 7.5 per-
about $800 billion in 1992. One can look a t       cent a year in the 1990s. Spending on nursing
the projections from two points of view:           home care is projected to grow 10 percent an-
                                                   nually in the 1990s, even as financing con-
  o Type of spending--hospital care, physi-        straints and the reluctance of states to ap-
    cian services, and so forth, and               prove new construction prevent the number of
                                                   beds from keeping up with the demands of the
  o Source of funding--private or public.          aging population.
SUMMARY                                                                                                                    xi

Projections by Source of Funds                                                CBO projects that the number of people cov-
                                                                           ered by private health insurance will increase
The main sources of funds in the health sector,                            slowly, and enrollment in the major govern-
accounting for more than 80 percent of total                               ment health insurance programs, especially
health spending, are out-of-pocket payments                                Medicaid, will grow strongly. Encouraged by
by patients, private health insurance pay-                                 federal tax policy, private health insurance
ments, and Medicare and Medicaid (see Sum-                                 coverage increased steadily until the 1980s.
mary Table 2 for a division of national spend-                             Since the 1981-1982 recession, however, pri-
ing projections into private and government                                vate health insurance benefits have stabilized
funds).                                                                    as a share of health expenditures, and the

Summary Table 1.
Projections of National Health Expenditures, by Type of Spending

                                                                               Selected Calendar Years
Type of Spending                                    1965          1980        1985       1990     1992a    1995a   2OOOa

                                                             Billions of Dollars

Hospital                                               14        102         168            2 56    310     41 6    67 1
Physician                                               8         42          74            126     153     204     31 6
Drugs, Other Nondurables                                6         22          36              55     63      78     111
Nursing Home                                            2         20          34              53     65      87     137
All Other                                              12        -64         110
                                                                             -              177     218     287     444

      Tota I                                           42          250          423         666     808    1,072   1,679

                            Average Annual Growth Rate from Previous Year Shown (Percent)

Drugs, Other Nondurables
Nursing Home
All Other

 National Health Expenditure                                       12.7        11.1          9.5    10.1     9.9     9.4

 Gross Domestic Product
 (Billions of dollars)                                703        2,708       4,039         5,514   5,931   7,104   9,322

Average Annual Growth of
Gross Domestic Product (Percent)                      n.a.          9.4          8.3         6.4     3.7     6.2     5.6

Ratio of National Health Expenditures
t o Gross Domestic Product                             5.9          9.2        10.5         12.1    13.6    15.1    18.0

 SOURCE:        Congressional Budget Office.
 NOTES:        n.a. = not applicable. Details may not add to totals because of rounding.
 a.    Projected.
 b. Economic assumptions reflect the Congressional Budget Office baseline of January 1992.
xii PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                       October 1992

Summary Table 2.
Projections of National Health Expenditures, by Source of Funds

                                                                          Selected Calendar Years
Source of Funds                                 1965         1980        1985       1990     1992a           1995a        2OOOa

                                                        Billions of Dollars

  State and local

      Total, National                              42         2 50        423         666          808       1,072         1,679

                                                     Percentage of Total

  State and local

      Total, National                          100.0        100.0        100.0      100.0        100.0       100.0         100.0

                         Average Annual Growth Rate from Previous Year Shown (Percent)

  State and local

National Health Expenditures                                  12.7        11.1         9.5        10.1          9.9          9.4

Gross Domestic Product
(Billions of dollars)

Average Annual Growth of
Gross Domestic Product (Percent)                 n.a.          9.4         8.3         6.4         3.7          6.2          5.6

Ratio of National Health Expenditures
t o Gross Domestic Product                        5.9          9.2        10.5        12.1        13.6         15.1         18.0

SOURCE:      Congressional Budget Office.
 NOTES: n.a. = not applicable. Details may not add to totals because of rounding.
 a.   Projected.
 b.   Economic and government spending assumptions reflect the Congressional Budge Office baseline of January 1992.
SUMMARY                                                                                       Xlll

continuing pressure of higher health spending      the courts, and t h e weakening of private
is expected to cause a decrease in the propor-     health insurance coverage.
tion of people covered by private health insur-
ance. CBO projects that the other major com-
ponent of private funding--direct out-of-pocket
payments by patients to providers--will con-
tinue to grow a t slower rates, constrained by     Implications
limited growth in patients' incomes.
                                                   If present laws, institutional arrangements,
   CBO expects that in the 1990s private fund-     and trends continue in the 1990s, the high cost
ing of health care will shrink as a share of na-   of private health insurance will shrink the
tional health expenditures. The proportion of      proportion of Americans who a r e privately
people receiving health coverage through gov-      covered and increase the number of people
ernment programs and the share of national         with no insurance. Governments will pay a
health spending by governments will grow.          larger fraction of U.S. h e a l t h spending
                                                   through the Medicare and Medicaid programs.
   These projections of national health expen-     Higher government spending on health care
ditures incorporate CBO's January 1992 base-       has serious implications for the federal bud-
line for spending on the Medicare and Medic-       get; the projected increase i n health care
aid programs. Medicare inpatient hospital          spending outpaces the growth in any other
spending is expected to resume growth rates of     major component of the budget and promises
9 percent to 10 percent a year in the 1990s,       not only to preempt resources from other gov-
after a period of slower growth in the 1980s.      ernment programs, but also to make deficit re-
Active cost containment efforts in the 1980s       duction more difficult.
temporarily reduced the growth in Medicare
hospital spending, but the impact of these            People pay for government health spending
efforts had waned by the end of the decade.        directly, through taxes, or indirectly, through
CBO assumes that the introduction of reforms       the adverse effects of government deficit
in Medicare payments to physicians in 1992         spending on capital formation and economic
will not restrain Medicare payments signifi-       growth. People pay in a different sense when
cantly, although payments in some physician        government health spending preempts other
specialties and regions of the country may be      government expenditures, such a s invest-
noticeably changed. Aside from physician           ments in education and infrastructure or in-
payment reform, current law provides no ma-        come maintenance programs. Similarly, em-
jor cost-containing changes during the 1990s.      ployees pay for employer-sponsored health in-
                                                   surance indirectly, through wages and sala-
    CBO expects the growth of Medicaid to slow     ries they might otherwise have received in the
from its current rapid rate--26 percent pro-       absence of coverage. The increasing cost of
jected for 1992 alone--to a n annual rate of 12    health benefits has contributed to the slow
percent by the year 2000. Medicaid remains         growth in wages and salaries that many U.S.
the fastest growing source of funds for na-        workers have experienced in recent years.
tional health expenditures, and CBO projects       Without significant changes in public policy
t h a t its share of payments will rise from 11    and private behavior, rising spending on
percent in 1990 to almost 19 percent in 2000.      health care will continue to limit wage and
This increase in payments is driven by a com-      salary gains as private employers pour money
bination of recent expansions in eligibility,      into higher health insurance premiums for
rising reimbursement r a t e s mandated by         employees rather than into pay raises.
                                                        Chapter One

                  National Health Expenditures

        ealth care spending, both private and
H       public, has taken a steadily increas-
        ing share of national income for the
last 25 years. Spending on health care has
                                                                 Rising National Health
increased from 6 percent of the national gross
domestic product (GDP) in 1965 to 12 percent                     CBO projects that national health spending
in 1990, and the Congressional Budget Office                     will grow from $666 billion in 1990 to more
(CBO) projects that spending on health will                      than $800 billion in 1992 and almost $1.7 tril-
rise to 18 percent of GDP by the year 2000 if                    lion in 2000. Between 1992 and 2000, CBO
current trends and government policies con-                      expects that spending on health care will grow
tinue (see Figure 1). Such rapidly rising                        a t an average annual rate of 9.6 percent, al-
spending on health would increase the pres-                      most 4 percentage points faster than the pro-
sure on household budgets and on federal,                        jected GDP growth of 5.8 percent.
state, and local government budgets in the
1990s.                                                              The United States spends considerably
                                                                 more on health care than do other countries,
   These projections provide a basis for mea-                    but there seems to be little difference between
suring the impact of policy changes rather                       the health of its population and the popula-
than a forecast of spending on health care.                      tions of other industrialized countries that
They are not a prediction that national health                   spend considerably less.2 Since the mid-
expenditures will inevitably rise to 18 percent                  1970s, U.S. health care expenditures have
of GDP, because government and private poli-                     grown much more rapidly as a share of na-
cies are likely to change, a t least in modest                   tional income than those of other countries
ways. But they are a suitable baseline against                   (see Figure 2). The United States now stands
which the costs of major health financing re-                    out as a n anomaly.
form bills can be estimated. The Health Care
Financing Administration (HCFA) also regu-                         The sheer size and growth rate of the health
larly publishes detailed, long-term projections                  care sector should not cause concern over poli-
of national spending on health. The projec-
tions in this paper differ from the HCFA pro-
jections in their economic, technical, and con-                   2.   Henry Aaron, writing in Serious and Unstable Condi-
                                                                       tion: Financing America's Health Care (Washington
ceptual assumptions; CBO's projections of                              D.C.:                                         is
                                                                             Brookings Institution, 19911,pp. 89-92, skeptical
health expenditures are consistent with its                            of attempts to link health spending and health status in
                                                                       national comparisons. He specifically warns against the
January 1992 baseline economic assumptions                             use of infant mortality and life expectancy as summary
and federal budget projections, which assume                           indicators of health outcomes in the United States.
unchanged current policies and trends.1                                Nevertheless, some evidence is available from within the
                                                                       United States on health spending and health status. The
                                                                       RAND Health Insurance Experiment indicated that,
                                                                       with some minor exceptions, health status outcomes did
 1.   CBO's August 1992 baseline is only slightly different.           not differ significantly among consumers who, faced
      The Health Care Financing Administration's most re-              with different coinsurance rates in their health insur-
      cent projections are reported in Sally Sonnefeld, Daniel         ance plans, chose different levels of health expenditure.
      Waldo, Jeffrey Lemieux, and David McKusick, "Projec-             See Willard Manning and others, "Health Insurance and
      tions of Health Care Spending Through the Year 2000,"            the Demand for Medical Care: Evidence from a Ran-
      Health Care Financing Review (Fall 19911, although               domized Experiment," American Economic Review, vol.
      updated HCFA projections are forthcoming.                        77 (June 1987), 265.
2 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                     October 1992

                                                                ment, and the difficulty t h a t the consumer
 Figure 1.                                                      faces in assessing t h e appropriateness or
 National Health Expenditures as a                              quality of care, make the market for health
 Share of Gross Domestic Product                                care function quite differently from the com-
                                                                petitive markets for other goods and services.
                                                                The system of financing health care, which
                                                                uses third-party payment extensively, encour-
                                                                ages higher levels of expenditure and the use
                                                                of services and procedures that may cost more
                                                                than they are worth. The prevalence of insur-
                                                                ance means that consumers do not consider
                                                                the full price of services when deciding on the
                                                                quantity and quality of services they want--
                                                                decisions they often delegate to physicians

                                                                   The pattern of rapid increases in spending
                                                                is widespread and cannot be attributed to the
                                                                increased incidence of particular illnesses or
 SOURCE:    Congressional Budget Office.                        diseases. The cost of treating people infected
                                                                with human immunodeficiency virus (HIV)
                                                                and patients with full-blown acquired immune
cy if it reflects rational and informed private                 deficiency syndrome (AIDS) illustrates this
and public choices. Policymakers accept, for                    point well. Despite the rapid (and widely pub-
example, that the service sectors of mature                     licized) spread of the disease, treatment of
industrial countries will claim a n increasing                  HIV and AIDS patients is not a major con-
proportion of resources as a result of free-                    tributor to the rapid growth of total health
market choices. But the health market does                      spending.4
not function in the same way as other mar-
kets.3 As a result, decisions on health spend-
ing are distorted in relation to the usual stan-
dards of pure market choice. Moreover, al-
though public policy has shaped many aspects                    Implications of Rising
of health spending, the nation's pattern of
spending on health may not be the result of a
                                                                Health Expenditures
deliberate social choice.
                                                                The high levels and rapid growth of projected
   Decisions about health care in the United                    health care expenditures have several broad
States are made in the context of a compli-                     implications. Some of these result from the
cated system that does not allow much room                      largely employer-sponsored, tax-subsidized
for explicit choices among competing uses of                    system of financing. These implications are
resources. The highly uncertain and individ-                    examined in detail in a companion CBO study,
ual nature of health care diagnosis and treat-

                                                                4.   Spending on HIV and AIDS is growing faster than all
 3.   The workings of the health market are discussed in             other health spending, but the share of total spending on
      greater detail in Chapter 1 of a companion study, Con-         health devoted to HIV and AIDS is still small. The latest
      gressional Budget Office, Economic Implications of Ris-        projections of the Public Health Service's Agency for
      ing Health Care Costs (October 1992). That study also          Health Care Policy and Research indicate that an an-
      analyzes in greater detail the impact of the employ-           nual cost of $10.3 billion in 1992 will rise to $15.2 billion
      ment-based system of health insurance and the feed-            in 1995. Spending on HIV-positive people will therefore
      backs from rising health care costs through the federal        only rise from 1.3 percent of national health spending in
      deficit to the economy as a whole.                             1992 to 1.4 percent in 1995.
CHAPTER ONE                                                                    NATIONAL HEALTH EXPENDITURES 3

Figure 2.
Health Expenditures as a Percentage of Gross Domestic Product,
United States and Selected Countries, 1960-1990
 16 1                                                                                                                       1

     I     I United States
 l4  t      Canada

SOURCE:     Organization for Economic Cooperation and Development, Health Data File, 1991

Economic Implications of Rising Health Care                        rectly--bear a heavy burden of increasing
Costs (October 1992).                                              costs.

   As costs increase, fewer employers offer in-
surance and the number of uninsured people                         Reduced Access to
rises, reducing access. Moreover, the growth                       Health Insurance
of cash wages is limited where employers con-
tinue to offer insurance. Higher state spend-
                                                                   Under current policies and practices, most
ing on health will probably preempt expen-
                                                                   people have access to some form of health in-
ditures on other state and local programs, and,
                                                                   surance, but a substantial minority do not.
given current policies, net saving by the fed-                     The majority of people (57 percent of the total
eral government will be reduced, thereby rais-                     population in 1991) are covered by private
ing interest rates and lowering investment,                        health insurance that they obtain directly
capital formation, and economic growth.5 Al-
                                                                   through their own employers or as dependents
though the quantity and sophistication of
                                                                   through relatives' employer-sponsored health
health care available to most Americans will
continue to rise, many will--directly or indi-

5.   If increased government spending on health entitle-            6.   The companion CBO study, Economic Implicatioas of
     ments were financed by tax increases and reduced pri-               Rising Health Care Costs, presents data for 1990 on the
     vate spending, or by cuts in other government spending,             insurance statue of the nonelderly population in ita dis-
     there may be no adverse effects on net government                   cussion of health coverage provided through employ-
     saving and economic growth. Such an outcome would                   ment. This study describes the pattern of insurance
     require a change in current policies.                               coverage for the total population in 1991.
4 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                      October 1992

   Almost all the elderly have guaranteed ac-     quite slowly during the 1990s. Even allowing
cess to health care through the Medicare pro-     for increases in Medicaid enrollment, CBO
gram, which pays the bulk of hospitalization      projects that the number of uninsured people
costs and offers a heavily subsidized insurance   will rise from 35 million in 1992 to 39 million
program for physician services and other out-     in 2000.
patient care. The Medicaid program provides
medical services to about one-half of the na-        Under the employment-based system of
tion's poor. Medicaid furnished about 6 per-      health insurance, rising health costs will
cent of the population with their primary cov-    make access more difficult for low-wage work-
erage in 1991.                                    ers and those in smaller firms. To obtain fav-
                                                  orable tax treatment for their health plans,
   A relatively small number of people (7 per-    employers must offer all full-time workers
cent in 1991) buy their primary health insur-     equitable coverage.7 But they can exclude
ance independently: these policies can be         part-time workers from their plans. There-
more expensive t h a n employment-based or        fore, rising health costs may increase the in-
government programs. The higher per-person        centive for employers to shift lower-paid work
administrative costs that make health insur-      to part-time employees and deny them health
ance more expensive for smaller firms are still   benefits without running afoul of the law. Al-
higher for individual policies, as a result of    ternatively, employers may choose to subcon-
higher overheads. Thus, even though the           tract the work done by their low-wage workers
benefits offered may be highly restricted, in-    to firms that provide no health benefits to
dividual insurance policies may be prohibi-       their employees. Almost no minimum-wage
tively expensive. Moreover, individual poli-      workers have employer-provided insurance;
cies may not be freely available to some people   one reason for this may be that the legal floor
who have neither employment-based nor gov-        under cash wages inhibits employers from
ernment-provided insurance, especially those      passing on rising health costs to such em-
with a history of health problems.                ployees.

   According to the March 1992 Current Popu-         The costs per person of administering
lation Survey, more than 35 million people--14    health insurance plans are higher for small
percent of the total population--had no health    firms than for large ones. These higher costs
insurance. People in single-parent families       reflect higher administrative and marketing
and in families with a n unemployed worker,       costs and the high turnover of accounts en-
young adults, and black Americans are dispro-     couraged by some underwriting practices.
portionately represented among t h e unin-        Hence, small firms face higher costs for insur-
sured. Some of the uninsured--particularly        ance and are less likely than larger companies
young and healthy people--may choose to go        to offer health benefits.
without health insurance. But many would
wish to obtain insurance if only they could af-      Problems of access have recently intensified
ford it, and some people may not be able to       for employees of small firms because insurers,
obtain health insurance a t any price.            driven by competitive pressures, have shifted
                                                  from community to experience rating. Under
   As health insurance premiums and the cost      community rating the insurance company
of health care rise, a n increasing number of     lumps all the insured into a single pool and
people will find it difficult to afford health    averages the risks among them. Under ex-
insurance. and the number of uninsured will
grow. Despite the nation's employment-based
                                                   7.   Under antidiscrimination statutes, the tax advantage of
system of health insurance, a substantial ma-           employer-sponsored plans is only available to plane that
jority of the uninsured are full-time workers           are judged to be nondiscriminatory. Legally, this re-
                                                        quirement is met if a plan's coverage satisfies one of two
or their dependents. The number of people               alternative formulas or if the Internal Revenue Service
covered by private health insurance will grow           certifies it to be so.
CHAPTER ONE                                                               NATIONAL HEALTH EXPENDITURES 5

perience rating each insured group i n a                      a n extra dollar of health benefits paid by their
geographic area is classified according to its                employer a s much as a dollar of before-tax
history and other observable indicators, mak-                 wages. Otherwise, other firms t h a t offer a
ing coverage for work forces that are a t great-              better mix of benefits and wages should be
er risk for high health spending more expen-                  able to lure the workers away. Workers will
sive--sometimes prohibitively so. Another as-                 choose their employment on the basis of a mix
pect of the shift to experience rating of health              of wages and benefits t h a t best suits their
insurance is that a person with a known                       needs and preferences. But even if workers do
health problem may be unable t o obtain                       not fully value health insurance--because the
health insurance without excluding that con-                  insurance market only provides a limited
dition from treatment. Without changes in                     range of alternative packages and so workers
government policy, rising health costs can                    cannot choose exactly what they would pre-
only make it more difficult for many small                    fer--firms will still be able to pass most of the
firms to obtain health insurance for their em-                increased cost on to workers because rela-
ployees. Such a trend could have wide conse-                  tively few workers drop out of the labor force
quences; if many people feel that they cannot                 when wages fall. Profits may suffer in the
change jobs without losing health coverage,                   short run while adjustments take place. Out-
labor markets may lose both flexibility and                   put, employment, and competitiveness may
efficiency.8                                                  also decline. In the long run, though, i t is
                                                              largely workers who will bear the burden of
                                                              increased health costs.9 (See Appendix B for a
Slower Growth of Wages                                        discussion of the relationships between projec-
                                                              tions of health costs, economic forecasts of the
Because the majority of U.S. workers obtain                   components of total compensation, and projec-
health insurance a t the workplace, as part of                tions of federal revenues.)
employee compensation, rapidly rising health
costs will translate into slower growth in pay                    Increasing health care spending has swal-
and other benefits. Rising health costs will                  lowed up a large part of the increase in real
raise the cost of insurance, and the employees                compensation that employees have garnered
will bear most of the increase in the long run.               from growth in productivity since 1973. From
This conclusion is most valid for competitive                 1973 to 1989, health insurance premiums paid
markets; but even if firms have monopoly                      by employers accounted for more than half of
power, or workers are unionized, there is no                  the increase in real compensation per full-
reason to think that changes in the cost of                   t i m e employee, even t h o u g h t h e y s t i l l
health benefits will alter the balance of forces              amounted to only 5 percent of total compen-
that determine total compensation.                            sation by 1989 (see Figure 3).10 Over this
                                                              period, health benefits per employee more
  As the cost of insurance rises, employers                   than doubled, other fringe benefits (including
can be expected to adjust the other elements of               pensions and employer payroll taxes) rose by
total employee compensation so that real com-
pensation stays in line with productivity and
profits are maintained. At the same time, if
workers value health insurance as much as
wages, they will be content to trade lower pay                 9.   Chapter 3 of CBO's study Economic Implications of
                                                                    Rising Hedth Care Costs contains further discussion of
for the increased health benefits. Over a long                      the incidence of health care costs, including the effects of
enough period, employees are likely to value                        tax policy toward health insurance. It discusses i n
                                                                    greater detail how factors such as labor contracts could
                                                                    produce a wide range of impacts on prices, competitive-
                                                                    ness, profits, and employment in the short run, as well as
                                                                    emphasizing the expected long-run effect on employees.

 8.   See Congressional Budget Ofice. Economic Implications    10. The choice of 1973 and 1989 for the comparison holds
      of Rising Health Care Costs, Chapter 3.                      fluctuations in economic activity roughly constant.
6 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                   October 1992

                                                                   there were a return to the faster growth in
 Figure 3.                                                         productivity of the 1960s.
 Inflation-Adjusted Compensation, Health
 Premiums, and Wages per Full-Time
 Employee: Actual Data and 1973-1989 Trends
                                                                   Implications for Government
     Thousands of 1989 Dollars
                                                                   Federal, state, and local governments a r e
                                                                   heavily involved in funding and providing
                                                                   health care, directly through programs and
                                                                   indirectly through tax expenditures. Hence,
                                   Compensation Less               as the cost of health care rises, the pressures
                                 Employer-Paid Premiums            on government resources increase from both
                                                                   the outlay and revenue sides of the budget. If
                                                                   governments are unable to slow the growth in
                                                                   health spending, they can either cut back
                                                                   their other spending plans, or raise tax reve-
                                                                   nues. The federal government can also fund
                                                                   the increased bill for existing health entitle-
                                                                   ment programs through increased borrowing.

 SOURCE:     Congressional Budget Office based on data                The health entitlement programs, Medicare
             from the Department of Commerce, Bureau of            and Medicaid, are by far the fastest growing
             Economic Analysis.
                                                                   major items in the federal budget. Medicare
 NOTE: Deflated by the consumer price index for all urban          and Medicaid spending together accounted for
                                                                   8 percent of federal outlays in 1980 and 13
                                                                   percent in 1991. According to CBO's projec-
15 percent, and real cash wages and salaries                       tions, they will rise to 23 percent of the budget
grew hardly a t all.11                                             by the year 2000 (see Figure 4). By contrast,
                                                                   all discretionary spending (defense, interna-
   CBO's projections for health spending,                          tional, and domestic programs taken together)
along with projected rates of productivity                         is expected to fall from 40 percent to 31 per-
growth, imply that real cash wages will con-                       cent of the federal budget by the turn of the
tinue to grow slowly during the next decade.                       century.12 By the end of the century, under
The importance of increasing health care costs                     current policy, Medicare and Medicaid will ac-
in the slow growth of wages from 1973 should                       count for more of the budget than either Social
be kept in perspective, however. The primary                       Security or defense spending.
explanation for the slowdown in wages is the
slowdown in productivity growth (and hence                           The Congress controls these entitlements
in the growth of total compensation) after                         indirectly by defining eligibility and payment
1972. Rapidly growing health spending would                        rules. Unless the Congress changes the rules,
be a much easier burden for wage earners if                        federal expenditures on entitlements are driv-
                                                                   en by factors beyond legislative control. Cur-
                                                                   rent law provides no direct limit to these
                                                                   health expenditures.
 11. During the 19808, the pressure on wages and salaries
     from increasing health costa was less than it might have
     been becawe other nonhealth compenaation actually fell
     in real terms, in part because rising asset values buoyed
     up pension funds in the mid-1980s. Wages and salaries
     grew faster between 1979 and 1989 than between 1973            12. Congressional Budget Offlce, An Analysis of the Presi-
     and 1979, but health costs still took more than half of the        dent's Budgetary Proposals for Fiscal Year 1993 (March
     t t l growth in real compensation.
      oa                                                                19921,Appendix A.
CHAPTER ONE                                                               NATIONAL HEALTH EXPENDITURES 7

Figure 4.                                                                          Box 1.
Federal Health Expendituresas a Percentage                                 Tax Subsidies to Private
of Gross Federal Outlays Less Interest                                        Health Spending
                                                                  The federal tax code allows exclusions and de-
                                                                  ductions from taxable income relating to health
 25                                                               care, which added up to a total federal tax ex-
                                                                  penditure of some $45.4 billion in 1991. Tax ex-
                                                                  penditures are not shown in the national health
                                                                  expenditure accounts compiled by the Health Care
                                                                  Financing Administration, but they are very im-
                                                                  portant in understanding the nature of the U.S.
                                                                  health care financing system.

                                                                    The exemption of employer-provided health in-
                                                                  surance from taxable income constitutes the larg-
                                                                  est category of tax expenditure related to health
                                                                  care. Other, smaller categories include the deduc-
                                                                  tibility of out-of-pocket medical expenses in excess
                                                                  of certain thresholds and the exemption of dona-
                                                                  tions to charitable health care institutions.
 SOURCE: Congressional Budget Office.
                                                                    Federal revenues are about 4 percent less than
                                                                  they would be without these exclusions and deduc-
   The rising costs of health care will squeeze                            f
                                                                  tions. I this subsidy to private spending was
                                                                  counted as government spending, the share of
the federal budget from two sides. Expendi-                       spending on health care financed through the fed-
tures on Medicare and Medicaid will rise fast-                    eral government--by the taxpayer--would rise from
er than other federal spending.13 At the same                     30 percent to 36 percent, with private funding re-
time, tax exemptions for private health expen-                    duced by the same amount. Many states follow the
                                                                  federal treatment of health insurance and do not
ditures of various kinds rise as a proportion of                  count it as taxable income. Assuming an average
income, limiting the growth of the federal tax                    marginal income tax rate of 4 percent, the state
base.                                                             and local tax expenditure for health care could be
                                                                  some $6.8 billion in 1991. If the state and local
                                                                  sector is taken into account, the inclusion of tax ex-
  The government forgoes tax revenues be-                         penditures as spending funded through govern-
cause of the special t a x status of certain                      ment, albeit indirectly, raises the share of national
                                                                  health spending funded by government to 5 1 per-
health-related spending, most notably ex-                         cent, compared with 44 percent if only direct
empting from income tax health insurance                          spending is included.
payments sponsored by employers. These tax
exemptions effectively subsidize the demand                         Tax expenditures for health care affect the effi-
                                                                  ciency of the economy. By lowering the after-tax
for health care services. Total federal tax ex-                   price of health care in relation to other kinds of
penditures related to health care are projected                   spending, they amount to subsidies for health
to grow to $128 billion in 2000. (For a dis-                      spending.
cussion of health-related tax expenditures, see                     Tax expenditures also have distributional con-
Box 1.)                                                           sequences. Although the precise implications are
                                                                  complex, the tax deductibility of employer-pro-
                                                                  vided insurance gives the largest absolute subsidy
  The principal health outlay of state and                        to higher-income workers with their higher tax
local governments is state funding for Medic-                     rates, and little or no help to low-income workers,
aid, which is growing very rapidly. On                            many of whose jobs do not provide health insur-
average the states pay for 43 percent of Medic-                   ance.

                                                                    (See Appendix B for a detailed breakdown of
                                                                  historical estimates for the principal federal and
 13. The federal government will also have to cope with ris-      state tax expenditures, along with projections of
      ing health costs as an employer, and as a direct provider   future tax expenditures.)
      of medical services through the Defense Department, the
      Veterans Administration, and the Bureau of Indian
8 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                               October 1992

aid, with the federal government picking up                 spending. Without structural changes in the
the other 57 percent. In addition, states and               delivery and financing of health care services,
localities provide funds for public health ser-             these influences will continue to push health
vices, hospitals, and clinics. Unlike the fed-              spending up through the 1990s.
eral government, however, almost all states
are required by their own laws to balance
their budgets. Therefore, the CBO projections               Rising National Income
imply that state and local governments may
be required to increase revenues and reduce                 Given a growing economy and a rising na-
the growth of nonhealth spending (for exam-                 tional income, national health expenditures
ple, on infrastructure, education, and income-              should also be expected to grow. But growth
maintenance programs) in order to fund their                in income alone cannot explain the strong in-
increasing expenditures on health.                          crease in the share of income that is spent on
                                                            health in the United States. Wealthier coun-
   In 1991, state contributions to spending on              tries typically spend more on health t h a n
health care accounted for about 17 percent of               poorer countries, with per capita health spend-
state and local expenditures less federal                   ing rising approximately in proportion with
grants-in-aid. By 2000, assuming that overall               per capita income (see Figure 6).16 As na-
state and local government revenues and                     tional income rises, people may choose to pur-
spending remain roughly constant as a share                 chase health services that improve their quali-
of gross domestic product, health spending                  ty of life, as well as the basic services that are
could rise to more than 27 percent of state and             essential to good health. In addition, the gov-
local expenditures (see Figure 5, first paneU.14            ernments of wealthier countries may be able
State and local spending on health will rise                to spend more on public health and research.
significantly faster than nonhealth spending,               The growth of national income alone cannot
although the rapid growth of health expendi-                plausibly account for much more than one-
tures still leaves some room for the growth of              third of the dramatic rise in health spending
other expenditures (see Figure 5, second                    that has occurred over the last 25 years in the
panel).                                                     United States.17

Why Are Health
Expenditures Rising                                          15. The characteristics of the health sector are discussed in
                                                                 greater detail in Congressional Budget Office, Rising
So Rapidly?                                                      Health Care Costs: Causes, Zmplications, a n d Strategzes
                                                                 (April 19911,and in Congressional Budget Office, Eco-
                                                                 nomic Implications of Rising Health Care Costs.
Several characteristics of U.S. health care
markets encourage consumers to purchase                      16. Economists' estimates of the relationship between in-
                                                                 come and health spending vary considerably depending
more health care--including more expensive                       on the data and methods used. Joseph P. Newhouse,
new procedures and treatments--and allow                         "Medical Care Costs: How Much Welfare Loss," Journal
                                                                 of Economic Perspectiues, vol. 6 (19921, 7-8,
                                                                                                           pp.     explains
higher-than-average price increases by health                    why estimates of the income elasticity from interna-
care providers.15 When these characteristics                     tional cross sections may be preferred to estimates taken
are combined with rising incomes and the                         from households within one country. An income elas-
                                                                 ticity of one is supported by the evidence in David Parkin
possibility of medical innovation, they help                     and others, "Aggregate Health Expenditures and Na-
explain the pattern of continually rising                        tional Income: Is Health Care a Luxury Good?" Journal
                                                                 of Health Economics, vol. 6 (1987), 109-127.

                                                             17. This estimate of the additional health spending that can
                                                                 be explained by rising income alone could be high be-
 14. There is considerable uncertainty concerning future         cause it may attribute some of the growth resulting from
     state and local government spending, but these esti-        technological progress to rising income. See Newhouse,
     mates are consistent with CBO economic projections.         "Medical Care Costs," p. 8.
CHAPTER ONE                                                                        NATIONAL HEALTH EXPENDITURES 9

Figure 5.
State and Local Spending on Health Care

                                              Health Expenditures as a Percentqge of
                                                     State and Local Budgets
 30                                                                                            I

                                                                                     Actual    I   Projected

 25    -                                                                                       I

 20    -
                               Total State and Local Health Expenditures

 15    -

                                                                 State Medicaid Expenditures

  5    -

      1965              1970             1975             1980             1985               1990             1995         2000

                                          Growth Rate of State and Local Expenditures
 20                                                                                            I

                                                                                     Actual    I Projected
       -                                                                                       I
 16    -

  4    -
      1965              1970             1975             1980             1985               1990             1995         2000

SOURCES:         Department of Commerce, Bureau of Economic Analysis; Health Care Financing Administration; and Congressional Bud-
                 get Office.

NOTE: Total state and local expenditures are assumed t o remain roughly constant as a share of gross domestic product, consistent
      with CBO's economic assumptions.
10 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                       October 1992

                                                                self-medication and treatment. For instance,
 Figure 6.                                                      most drugs are sold only with a doctor's pre-
 Health Spending and Income in Countries
 of the Organization for Economic
 Cooperation and Development, 1989
                                                                   Once consumers delegate decisions to doc-
        Per Capita Health Spending
                                                                tors, they surrender their power to control the
 2500                                                           level and growth of health spending. Profes-
                                      United States.
                                                                sional ethics encourage physicians to provide
                                                                all services that promise medical benefits, and
                                                                patients, knowing little about the medical de-
                                                                tails, may base their satisfaction on how much
                                                                medical care is provided. The inescapable, if
                                                                uncomfortable, reality is that providers have
                                                                a n interest in higher spending. Compared
                                                                with other markets, the delegation of respon-
                                                                sibility to medical providers creates a n inher-
                                                                ent bias in most health care towards higher
                                                                spending and away from cost control.

                            Per Capita GDP                      Third-Party Payment and
 SOURCE:      George Schieber and others, "Health Care Sys-
                                                                Technological Change
              tems in Twenty-Four Countries," Health Affairs,
              vol. 10, no. 3 (Fall 1991), pp. 7-21.             Most health payments are made by a third
 NOTES: Health spending and gross domestic product are          party--an insurance company or government
        converted t o dollars using purchasing power pari-      program--on a fee-for-service basis, and this
        ties. Per capita gross domestic product is ex-          reinforces the bias in health care toward high-
        pressed in thousands of dollars. Per capita health
        spending is expressed in dollars.                       er spending and away from cost control.
                                                                Neither the patient nor the doctor is likely to
                                                                care much about the costs of the treatment at
                                                                the point of service. Fee-for-service arrange-
"DoctorKnows Best"                                              ments with distant third-party reimburse-
                                                                ment ensure that patients have a n incentive
The market for health care is different from                    to accept, a s well as providers have to offer,
most other markets. Patients rarely are well                    any treatment that may possibly have a posi-
informed about the appropriateness, value, or                   tive benefit, with little regard for cost.
quality of medical treatments and thus dele-
gate many decisions to the professional ex-                        These features may encourage spending on
perts--doctors. And, of course, sick or injured                 health care procedures or services t h a t cost
people and their families are in a n especially                 more than the value consumers place on the
poor position to drive a hard bargain with pro-                 benefits. The same features may spur the de-
viders. This situation gives doctors extraordi-                 velopment and use of new, often expensive,
nary authority to determine spending on                         medical technologies and drugs even when
health care. Patients routinely defer to pro-                   their benefits may be small compared with the
viders on questions of care, and often do not                   costs. People who have insurance face a low
know what will ultimately be charged a t the                    out-of-pocket charge for health services at the
time of treatment. Even if consumers think                      point of delivery, and a s a result go to doctors
t h a t they can make appropriate decisions,                    more often and have more tests and elaborate
they are legally or effectively prohibited from                 treatment than people who are faced with the
CHAPTER ONE                                                               NATIONAL HEALTH EXPENDITURES 11
    -        -          -

full prices.18 One hypothesis is t h a t cost-                   their workers traditionally contribute more
increasing technology raises the demand for                      per worker to the more expensive plans--
health insurance and, hence, for health care,                    employees who choose inexpensive plans are
but the development of cost-increasing tech-                     not always rewarded with higher cash wages.
nology is itself encouraged by more extensive                    This practice further discourages price com-
insurance.19 Together, it is argued, the two                     parisons and reduces the incentive for efficient
effects produce an upward spiral of health care                  insurers to offer low prices.21 In principle,
costs.20 Because third-party reimbursement,                      employers could change these arrangements
based on provider charges, dominates the mar-                    to favor cost-conscious behavior, and some
ket, competitive pressures do not encourage                      have begun to do so.
the efficient provision of services. Doctors
compete for patient loyalties, and hospitals
compete for physician referrals, but providers                   Government Tax Policy
do not tend to compete with one another over
fees. Lack of medical knowledge on the part of                   Tax policy reinforces the bias against cost
consumers, difficulties in performing price or                   control in the U.S. system of health care fi-
quality comparisons, and professional links                      nance. The exemption of employer-paid pri-
between providers inhibit price competition in                   vate health insurance from the income tax has
the usual sense.                                                 supported the widespread growth of employ-
                                                                 ment-based private health insurance over the
                                                                 past 40 years and thus contributes to the in-
Employer-Sponsored Insurance                                     creased demand for health care.22 This fea-
                                                                 ture of the tax code is the largest of several tax
Most private health insurance in the United                      expenditures through which, by providing tax
States is organized by employers. Employers                      deductions for certain health care costs, the
who offer more than one insurance option to                      government helps eligible taxpayers to fi-
                                                                 nance their health expenditures.
 18. Martin Feldstein, 'The Welfare L o s ~ Excess Health
     Insurance," Journal of Political Economy, vol. 81 (19731,      Although federal tax policy has achieved its
     pp. 853-72; Martin Feldstein and Bernard Friedman,          major health policy goal--the expansion of
     "Tax Subsidies, the Rational Demand for Insurance, and      private health insurance to most of the popu-
     the Health Care Crisis," Journal of Public Economics,
     vol. 7 (19771, pp. 155-78; Mark Pauly, 'Taxation, Health    lation--it has also encouraged inefficiency be-
     Insurance, and Market Failure in the Medical Econo-         cause of the resulting failure to confront
     my," Journal of Economic Literature vol. 24 (1986), pp.
     629-75; Willard Manning and others, "Health Insurance       choices. Favorable tax treatment of employer-
     and the Demand for Medical Care: Evidence from a Ran-       paid health insurance premiums reduces the
     domized Experiment," American Economic Review, vol.
     77 (June 1987), pp. 251-77.                                 effective price and so increases the amount of
                                                                 health insurance through a hidden subsidy.
 19. See Burton A. Weisbrod, "The Health Care Quadri-
     lemma: An Essay on Technological Change, Insurance,         Such tax breaks cause even higher levels of
     Quality of Care and Cost Containment," Journal of           health expenditure a t the expense of tax reve-
     Economic Literature, vol. 23 (19911,pp. 523-52.             nues that would otherwise be collected.
 20. Not all medical advances increase costs: Burton A.
     Weisbrod in 'The Health Care Quadrilemma," p. 534,
     contraste cost-reducing innovations in medical processes
     such as vaccines with quality-increasing but cost-in-
     creasing innovations in medical products and procedures      21. See, for example, Alain C. Enthoven. "How Employers
     such as artificial organs and organ transplants. Under           Boost Health Costs," Wall Street Journal, January 24,
     retrospective systems of payment, cost-increasing tech-          1992.
     nical advance is not discouraged, and so more cost-
     increasing technologies have probably been developed         22. The tax expenditure for private health insurance in-
     than cost-reducing ones. However, recent moves toward            creases expenditures on health insurance, which
     more prospective systems of payment--Medicare's pro-             strengthens the existing effect of insurance in raising
     spective payment system for hospitals, as well as devel-         health expenditures. See Feldstein and Friedman, "Tax
     opments in the private sector--may have tilted the in-           Subsidies, the Rational Demand for Insurance, and the
     centives for future research and development toward              Health Care Crisis"; and Pauly, "Taxation, Health In-
     cost-saving technologies.                                        surance, and Market Failure in the Medical Economy."
12 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                   October 1992

Health Care as a Public Priority                             A Soft Budget Constraint
Public policy contributes to high and rising                 In relation to the size of the economy, health
health spending in other ways as well. For                   spending per capita in this country is some 35
reasons of equity, the government intervenes                 percent higher than in other industrialized
to ensure that the very poor and the elderly                 nations (see Figure 6 ) . The preceding sections
have access to care. Public values appear to                 have explored reasons for high and rapidly
reinforce the medical ethic that life should be              growing health spending, but many of these
sustained as long a s possible, regardless of                reasons are common to other industrialized
cost, especially a t the beginning and near the              countries and so cannot alone explain why the
end of the lifespan. This strict medical pro-                United States appears as an anomaly. A cru-
tocol makes high spending on health very                     cial additional element is that in the United
hard to avoid in some cases. Government                      States, unlike other countries, the pressures
policy in the entitlement programs has been to               for increased health spending are not counter-
reimburse those procedures that physicians                   balanced by mechanisms that put a lid on
recommend on medical grounds.                                total expenditures.

                                                                Other countries have carried out some form
Defensive Medicine                                           of global budgeting for health expenditures
                                                             that places effective limits on spending by
Some commentators have blamed the mal-                       pressuring providers to supply services more
practice system for increasing health costs.                 cheaply and efficiently, restricting investment
They claim that physicians must pay more for                 in new technology, or rationing the provision
malpractice insurance, and feel that doctors                 of services in some way. By contrast, neither
must practice defensive medicine, using more                 federal entitlement programs nor the private
tests and precautionary procedures t h a n                   system of health insurance in the United
would otherwise seem necessary, in order to                  States responds to rising costs by strongly
remove all but the remotest doubts of mis-                   resisting increases in health expenditures. On
diagnosis or errant treatment. A patient with                the contrary, federal expenditures and private
limited medical knowledge and a weak incen-                  insurance premiums have tended to rise to
tive to worry about costs is not likely to resist            meet the higher costs. In effect, both private
what might be redundant tests or only mar-                   and public financing mechanisms appear to
ginally beneficial procedures. The available                 provide only a soft budget constraint that is
evidence indicates, however, that changing                   ineffective in restraining total health spend-
the medical liability system would have little               ing in the United States.
effect on total health spending. If the system
of medical malpractice law were restructured,
much of the care commonly dubbed "defensive
medicine" would probably still be provided for
reasons other than concerns about malprac-

 23. See testimony of Robert D. Reischauer, Director, Con-
     gressional Budget Office, before the House Committee
     on Ways and Means, March 4,1992, Appendix F.
                                           Chapter Two

                   CBO Baseline Projections:
                    Assumptions, Concepts,
                       and Methodology

        he special characteristics of the health      The most recent recession may provoke new
        care market, especially the relative       cost control efforts in the government and pri-
        absence of price competition and the       vate sectors that are not reflected in these pro-
features of health insurance that encourage        jections. The recession of 1981-1982 high-
the development and use of new technology,         lighted the need for efforts by the government
cause health spending to grow more rapidly         and private sector to control health payments.
than other sectors of the economy. The Con-        During that downturn, the growth in health
gressional Budget Office (CBO) projects rapid      spending continued unabated while govern-
growth in health spending based on a n analy-      ment tax revenues and private incomes--the
sis of a variety of factors--most notably in-      funding resources for health care--were under
creases in the price and intensity or com-         economic pressure.1 Subsequently, both the
plexity of care.                                   federal government and private insurers con-
                                                   centrated on containing health spending.
                                                   While similar types of policy changes may
                                                   well occur over the next decade, the projec-
                                                   tions presented here represent a baseline that
Current Policy                                     assumes continuation of current policies and
CBO's current policy projections assume that
government health programs, laws, and regu-
lations do not change over the period of the       Economic and
projections. The projections also assume that      Demographic
current trends in clinical medical practices
and procedures will continue and that there        Assumptions
will be no major structural change in the pri-
vate sector's primary health- payment institu-     The projections are consistent with CBO's
tion: private health insurance obtained            January 1992 baseline economic assumptions
through employers.                                 and spending projections for Medicare and
   These projections are not predictions--a pro-
jection of current policy may be far from the
best forecast. Federal and state governments
                                                    I.   Cost containment efforts in the private sector are also
may take new actions to try to limit health              stimulated by the peculiar premium cycle of private
spending, and new legislation affecting the              health inaurers. When private health inaurance
private health insurance system is also pos-             premium rise rapidly, businesses may prod insurers for
                                                         coat control. For the private sector. both the buaineas
sible.                                                   and insurance cyclea may lead to cost control efforts.
14 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                          October 1992

Table 1.
National and Personal Health Spending: Demographic and Economic Assumptions

                                                                                      Selected Calendar Years
                                                               1965           1983         1987     1990         1992a      2OOOa

                                            Level of Spending (Billions of dollars)

National Health Expenditures
  Personal health expend ituresb                                  36           315          439      585         71 3
  Other health expendituresc                                       6      -     44         -
                                                                                           55      -
                                                                                                   81           -

      Total                                                       42           3 59         494      666         80 8

Gross Domestic Product (GDP)                                    703           3,405        4,540   5,514        5,931
  Real GDP (Billions of 1987 dollars)                         2,473           3,907        4,540   4,885        4,924
  GDP implicit deflator (1987 = 1)                            0.284           0.871        1.000   1.129        1.204

Total Population (Millions)
  Age 65 and over
  Age 75 and over

                         Average Annual Growth Rate from Previous Year Shown (Percent)

National Health Expenditures
  Personal health expendituresb
  Other health expendituresc

      National Expenditures                                                    12.7          8.3     10.5        10.1

Gross Domestic Product
  Real GDP
  GDP implicit price deflator

Total Population
  Age 65 and over
  Age 75 and over

SOURCES:      Population projections are from the 1991 Social Security Trustees' Report. Economic assumptions reflect the Congres-
              sional Budget Office baseline of January 1992. Health expenditure projections are by the Congressional Budget Office,
              based on historical estimatesfrom the Health Care Financing Administration.
a.   Projected.
b.   Personal health expenditures include all spending directly related to patient care.
c.   Other health expenditures include administrative, research, and construction spending.

Medicaid.2 They use population projections                               low inflation. Under these assumptions, GDP
from the 1991 Social Security Administration                             grows by 5.8 percent a year between 1992 and
Trustees' Report (see Table 1).                                          2000, with real growth averaging 2.6 percent
                                                                         a year and average price growth of 3.2
  CBO projects relatively slow economic                                  percent. Population growth, especially that of
growth in the remainder of the 19909, with                               the elderly segment, will slow somewhat in
                                                                         the 1990s. The number of people over age 65
                                                                         will increase by 1percent a year between 1992
2.   Congressional Budget Oftice, The Economic and Budget
                                                                         and 2000, down from its average growth of
     outlook: Fiscal Years 1993-1997 (January 1992).                     about 2 percent a year in the 1970s and 1980s.

                                                                   Figure 7.
National Health                                                    National Health Expenditures vs.
                                                                   Gross Domestic Product
Concepts and Trends                                                20
                                                                         Percentage Change from Previous Year

                                                                                                   Actual       Projected
                                                                         -                                  I
National health expenditures are reported by                                                                I

the Health Care Financing Administration
(HCFA) in detailed estimates of spending in
the health sector of the economy.3 HCFA es-
timates national health expenditures by ma-
jor types of spending and sources of funds.
HCFA compiles and reports current dollar ex-
penditures from 1960 through 1990. The first
CBO projection year is 1991, although some
preliminary 1991 data a r e available, a n d
these help guide the 1991 figures.4 Figure 7                             -                                  I
shows HCFA's estimate of the percentage                             0          I      I      I      I       I        I
change in national health expenditures from                             1965        1975          1985             1995
 1965 through 1990 (and CBO's projection from
                                                                   SOURCE: Congressional Budget Office.
 1991 through 2000) in relation to the per-
 centage change in GDP.

  National health expenditures are separated                      of health spending (especially for costly inpa-
into personal health spending, which consists                     tient hospital stays) and the number of unin-
of all direct spending for patient care (pri-                     sured people increased significantly; and 1987
marily hospital, physician, drug, and nursing                     to 1990, when more rapid growth of expen-
home expenditures), and other health spend-                       ditures resumed. The projections are divided
ing (including administrative, research, and                      into two periods: 1990 to 1992, a time of re-
investment costs).                                                cession; and 1992 to 2000, assumed to be a
                                                                  period of relatively stable economic growth.
  The growth in national health spending can                      (See Table 1 for a comparison of growth in
be divided into three distinct periods: 1965 to                   national health spending with major economic
1983, when it grew largely unencumbered by                        and population indicators during these peri-
policy or financing constraints; 1983 to 1987,                    ods.)
when government and private cost contain-
ment efforts temporarily reduced the growth

 3.   See Katharine R. Levit, Helen C. Lazenby, Cathy A.
                                                                  Projection Methodology
      Cowan, and Suzanne W. Letach, "National Health Ex-
      penditures, 1990," Health Care Financing Review (Fall       T h e CBO projections follow t h e H C F A
      1991), for the latest historical national health expendi-
      ture data; and Office of National Cost Estimates, 'Wa-      method--a process of separation and analysis
      tional Health Expenditures. 1988" and "Revisioris to the    of trends using the HCFA accounting frame-
      National Health Accounts and Methodology," Health
      Care Financing Review (Summer 1990), for detailed dis-      work for national health expenditures. The
      cussiom of the accounta and their construction.             methodology is actuarial rather than econo-
 4.   For example, American Hospital Association data on          metric, consisting of a series of identities, the
      community hospital revenues and use are available for       elements of which are projected and recon-
      all of 1991.
                                                                  ciled. It explicitly takes into account the effect
1 6 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                        October 1992

of changes in the demographic (age and sex)         population growth, change in demographic
composition of the population on the use of         composition, growth in basic use of services,
health services per person and on the com-          inflation, and the combined contributions of
plexity or intensity of the services provided.      increases in the relative price and of the in-
                                                    tensity of health care services to the projected
    Each type of personal health care spend-        rise in personal health spending.
ing--spending that is directly related to pa-
tient care--is broken down into factors that ac-       One important assumption of the CBO pro-
count for its growth. These factors are pro-        jections is that use of basic health services per
jected into the future based on analysis of cur-    person will return to its previous positive
rent trends, judgments about patients' de-          growth rate, after declining for most of t h e
mands for services, and the consequent de-           1980s under the influence of changes in policy.
mands by providers for payment. Because             CBO does not foresee any significant new con-
some types of health spending may comple-           straints on hospital days or physician contacts
ment or substitute for other types of spending,     in the 1990s from current government or pri-
the projection factors must be reconciled           vate-sector policies, and the resumption of
among themselves to ensure consistent pat-          growth in the use of services boosts the health
terns of use and expenditure among types of         spending projections.
health services. Finally, the projection of ex-
penditures for each service must be matched         Demographics. Shifts in the size and com-
k i t h projected sources of health care financ-    position of the population, including the in-
ing.                                                crease in the proportion of the elderly, will add
                                                    only modestly to the growth of health spend-
  Categories of health spending not directly        ing over the next decade. Population growth
related to patient care--government program         alone accounts for 0.8 percentage points per
administration and the administrative costs of      year of the 9.8 percent average annual growth
private health insurance, public health ad-         in personal health spending between 1992 and
ministration, research, and construction--are       2000. Although older people use a dispropor-
projected using different methods (see Appen-       tionate amount of health care services, the ag-
dix A for a detailed discussion of the projection   ing character of the population adds a n aver-
methods).                                           age increase of only about 0.5 percent per year
                                                    to the growth of personal health spending.6

Growth Factors in                                     The aging of the baby-boom generation will
Personal Health Spending                            probably add upward pressure to h e a l t h
                                                    spending after 2000, but even at its peak just
The factors accounting for t h e growth in
spending on h e a l t h c a r e a r e population
growth, the demographic composition of the           5.   Use in the model refers to very basic numbers of patient-
population, trends in the per capita use of               provider contacts. Intensity can be both extra services
                                                          provided per contact, or more involved, complex, or capi-
basic health care services (for example, hos-             tal-intensive procedures per contact. For example, sup-
pital days and physician visits), overall infla-          pose average prenatal obstetrician visits per person have
                                                          remained constant over the years. But in modern visits,
tion rates, trends in the relative prices of              patients are much more likely to have ultrasound
health services, and a residual factor called             screenings in the doctor's office. The extra billings for
                                                          the screenings are not price or use increases; in the
intensity of service. Intensity of service is un-         model these would be considered intensity increases.
derstood to express the growth in expenditures
                                                     6.   See Daniel R. Waldo and others, "Health Expenditures
associated with additional health services per            by Age Group, 1977 and 1987," Health Care Financing
basic unit of use and with advancing tech-                Review (Summer 1989). Note that the tables on pages
nologies and sophistication of health ser-                115 and 117 of the article are mislabeled; correctly titled,
                                                          they cover the 19-to-64 and 65-and-olderpopulations.
vices.5 Table 2 presents the contributions of

Table 2.
F a c t o r s A c c o u n t i n g for G r o w t h in P e r s o n a l Health S p e n d i n g
(Average annual growth rate by c a l e n d a r year)

T o t a l G r o w t h in Personal
Health E x p e n d i t u r e s
Factors Accounting for G r o w t h b
  P o p u l a t i o n increase                                    1.O                  1.O           1.O          1.O          0.8
  Demographic composition                                         0.5                  0.4           0.4          0.5          0.5
  Use per personc                                                 0.6                 -2.1          -0.5          0.2          0.8
  GDP i m p l i c i t p r i c e deflator                          6.4                  3.5           4.1          3.3          3.2
  O t h e r price and i n t e n s i t y d                         3.9                  5.8           4.7          5.1          4.2

SOURCE:        Congressional Budget Office.

NOTES:       "Use per person" and "Other price and intensity" are net of predicted impacts on use and intensity from changes in
             demographic composition. CBO has no measure of demographic composition effects for some smaller types of health
             spending and no independent use or volume measures for some types of spending. In these cases, CBO has approximated
             the demographic and use contributions to personal health expenditure growth using data from similar types of spending.

             GDP = gross domestic product.

a.    Projected.

b.    Factors are combined multiplicatively t o yield total growth rate.

c.    Use per person consists of basic medical contacts, such as days in the hospital or physician visits.

d.    Other price and intensity includes price increases in excess of the GDP deflator, additional volume of services per unit of use, and
      increases in the complexity of services.

before 2030 changes in demographic composi-                                            ber of people reaching retirement age in this
tion are expected to add less than 1percentage                                         decade. The baby-boom generation, born be-
point to the growth rate of health spending per                                        tween World War I1 and about 1965, will be-
year.7 The share of the population 65 years                                            gin reaching retirement age after 2010, and
old and older has been growing steadily, but                                           the population over age 65 will then increase
this growth will slow during the 1990s. Fewer                                          sharply. Within the over-65 population, the
children were born during the Great Depres-                                            share of people over 85 will continue to in-
sion of the 1930s and the 1940-1945 war years,                                         crease during the 1990s--leadingto pressures
and this accounts for a slowdown in the num-                                           for increased use of nursing homes (see Figure
                                                                                       8 for projections of the number of people older
                                                                                       than 65).
      Because CBO does not have data on costs by age and sex
      for some of the smaller types of personal health care, and                       Use of Basic Services. The number of basic
      because the age and eex distributions of cost can be ex-                         health services used per person, such as the
      pected to change somewhat over long time periods, these
      calculations of overall age and sex impacts, especially for                      number of hospital days or physician visits, is
      the distant future, are highly uncertain. For more in-                           also projected to grow relatively slowly in the
      formation about HCFA's predictions of health expendi-
      ture growth from demographic changes, see Division of                            1990s. Rapid increases in hospital outpatient
      National Cost Estimates, "National Health Expendi-                               visits will be largely offset by declines in in-
      tures, 1986-2000,"Health Care Financing Review (Sum-                             patient (overnight) stays, if current trends
      mer 1987); and Daniel R. Waldo, Sally T. Sonnefeld,
      Jeffrey A. Lemieux, and David R. McKusick, "Health                               continue. The number of times a person visits
      Spending Through 2030: Three Scenarios," Health Af-                              a physician will increase by less than 1 per-
      fairs (Winter 1991).
                                                                                       cent per year, and dental visits are expected to
18 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                       October 1992

Figure 8.
Projected Growth of U.S. Population Aged 65 or Older, by Age Group and Year

     Millions of People


   1965     1970      1975     1980     1985      1990     1995     2000       2005     2010     2015     2020     2025     2030

SOURCE: Social Security Administration: data used in 1991 trustee's report.

increase slowly, especially in the later years of                     for new technologies or discounted fees (see
the projection. Increases in use of basic ser-                        Box 2). Some evidence indicates that, when
vices per person have not driven rapid health                         fees are strictly controlled, providers order
spending growth in the past, and despite the                          more treatments and procedures for their pa-
assumption that modest growth in basic hos-                           tients and change their billing practices in
pital and physician contacts resumes, use per                         ways that increase revenues in order to main-
person is not the key factor accounting for                           tain income levels.9 (Indeed, CBO assumes
rapidly increasing health spending.                                   such behavior in developing cost estimates
                                                                      and baseline projections for Medicare.)
Price a n d Intensity I n c r e a s e s . The pri-
mary factors behind rapid growth of health                              Despite measurement problems, the forces
spending are higher-than-average price in-                            driving increasing health care spending are
creases received by health care providers and                         the combination of increasing prices, expen-
rapid growth in intensity per unit of service,                        sive new services and procedures, and addi-
based on extra services provided per basic unit
of use and on the introduction of technologies
and treatments that increase spending.                                 8.     See Joseph P. Newhouse, "Measuring Medical Prices and
                                                                              Understanding Their Effects: The Baxter Foundation
                                                                              Prize Address," Journal of Health Administration
   Unfortunately, health prices are difficult to                              Education, vol. 7 (Winter 1989), pp. 19-26.
measure and interpret.8 The statistics do not                          9.     For estimates of behavioral responses under Medicare,
allow higher charges resulting from increased                                 see Appendix B of Congressional Budget Office, Physi-
                                                                              cian Payment Reform Under Medicare (April 1990). This
intensity to be disentangled from increases in                                study notes another factor that may contribute to the
prices for identical procedures. Measured                                     observed effects, namely patients demanding more care
                                                                              because of lower out-of-pocket costs under fee con-
price indexes for health care may not account                                 straints.
                                                           Sources of Payment
                  Box 2.
    Reporting Health Expenditure Data:
     Health Expenditures a n d Inflation                   Analysis of these demographic, use, and price
                                                           and intensity factors helps guide the initial
                                                           estimates of the demand for services. Pro-
    In this study, health expenditures are expressed in
    current dollars. Tables showing health expendi-        jected demands must then be reconciled with
    tures are in current dollars, with the growth in       the availability of funds from the sources of
    current dollar gross domestic product (GDP) shown      health care payments. The two largest gov-
    a t the bottom of the table. The GDP growth rate is
    intended to help the reader compare the growth of
                                                           ernment payers are the Medicare and Medic-
    health expenditures with the growth of the econo-      aid programs. The largest private sources are
    my. Several tables report the ratio of total health    health insurance benefits and direct out-of-
    spending to GDP, a good summary measure of             pocket payments by patients.
    health spending in relation to the economy, espe-
    cially over long periods. The tables that show fac-
    tors accounting for growth in the components of        Out-of-Pocket Payments. All health spend-
    personal health spending include a general infla-      ing eventually comes out of the consumer's
    tion measure.
                                                           pocket, some through direct payments, some
     Displaying health estimates in current dollars        through higher taxes, and some through lower
    can confound the role of movements in economic         wages. A major theme of these projections,
    growth and general inflation with changes in the       and a firm historical trend, is that direct pa-
    amount of health care services delivered over time.
    But separating changes i n expenditures into           tient payments tend to grow much more slow-
    changes in quantities and prices is difficult be-      ly than payments made by third-party inter-
    cause of the uncertainties about the measurement       mediaries. Relatively slow growth in out-of-
    and interpretation of health service prices.
                                                           pocket payments is consistent with the basic
      Price indexes for health care suffer from numer-     motivation for health insurance; people want
    ous minor technical problems and from one major        to avoid large and uncertain out-of-pocket ex-
    theoretical problem: price indexes cannot ade-
    quately adjust for improvements in the quality of      penditures. When patients must pay directly,
    medical care. New, more accurate diagnostic tools      they are more likely to resist marginal proced-
    such as magnetic resonance imaging (MRI) a r e         ures; often, uninsured patients are simply not
    now readily available. Ultrasound screening for
    pregnant women is now routine. Less invasive and       offered expensive care options.
    less risky surgical techniques are now the norm.
    Although these improvements have generally             Private Health I n s u r a n c e . CBO projects
    pushed up spending, i t is impossible to distinguish   that private health insurance benefits will
    the portion of those cost increases t h a t reflects
    higher prices without somehow measuring the im-        continue growing rapidly despite a slow in-
    provement in quality that has taken place.             crease in the number of people covered and a
                                                           decline in the proportion of the population cov-
      Some analysts are working to create improved
    measures. For example, the Health Care Financ-         ered by private health insurance. The private
    ing Administration has developed a set of price        health insurance projections are based largely
    indexes for medical services that attempt to over-     on judgments about current trends in cov-
    come some of the technical hurdles, including dis-
    tinguishing between reported prices and the prices     erages and costs per covered person. Al-
    actually paid, and accounting for health spending      though private health insurance costs per per-
    paid through insurance. But the treatment of           son are projected to continue growing rapidly,
    quality change remains a t issue.                      the total number of people covered is expected

tional services and procedures per medical
contact. Assuming current policies and trends
continue, rising prices and more expensive                  10. The GDP deflator is not a measure of pure price inflation
                                                                since it does not hold constant the proportions of items
procedures will also be the rule in the 1990s                   purchased. But, for this application, the deflator is wed
(see Table 2 for price and intensity increases,                 because the differences between the GDP deflator and
after overall inflation, measured with t h e                    more appropriate, fixed-weighted indexes are minor, and
                                                                because the GDP deflator facilitates comparisons with
GDP deflator, is subtracted).10                                 HCFA's projection factors.
20 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                         October 1992

to increase by only 4 million in the 1990~1,and    1990s. Medicare and Medicaid are expected to
will actually fall during the recession years of   cover a n expanding proportion of the popu-
1990 to 1992.                                      lation, and the percentage of people covered by
                                                   private insurance will fall. Medicare a n d
Government P r o g r a m Spending. Under           Medicaid are entitlement programs, and CBO
current policies, CBO projects that the govern-    assumes that under current law spending for
ment's share of financing for national health      these programs will continue to increase
expenditures will grow significantly in the        rapidly on behalf of the entitled populations.
                                         Chapter Three

         Projections of National Health
        Expenditures by Type of Spending

        rowth in health expenditure will vary        Other national health expenditures include
 G      substantially by type of spending in
        the 1990s, following current clinical
and financing trends. Because similar
                                                  construction and research, investments re-
                                                  lated to future health care, and certain ad-
                                                  ministrative costs of government programs,
medical procedures may be performed in vari-      public health services, and private health in-
ous clinical settings, and because proposed       surance. These expenditures do not apply to
reforms of the health financing system might      direct patient care; therefore, they are sepa-
affect categories of spending differently, the    rated from personal health expenditures.
Congressional Budget Office's projections in-     Other national health expenditures accounted
clude details of spending by type of service      for about 12 percent of total national health
and source of funds.                              spending in 1990.

  National health expenditures fall into two         Hospital expenditures, largely funded by
major categories: personal and other health       private insurance benefits and government
expenditures. Personal health expenditures        program payments, are expected to grow more
include all services and goods purchased for      rapidly in the 1990s than in the 1980s, with
direct patient care. They accounted for 88 per-   inpatient expenditures increasing by 8 per-
cent of national health expenditures in 1990.     cent per year. The annual growth of out-
                                                  patient expenditure will average 16 percent in
  The largest personal health spending cate-      the projection period. Technological changes
gories are hospital care, physician services,     are allowing practitioners to perform more
drugs, and nursing homes. These four types of     procedures on an outpatient basis, and CBO
spending accounted for 84 percent of personal     expects pressures from both government and
health expenditure in 1990 (see Table 3 for       private insurers to continue steering care
CBO's baseline projections for national health    away from costly inpatient settings. Spending
expenditures, personal health spending, and       for physician services is projected to grow a t
the major components of personal spending).       slower rates in the 1990s than in the recent
                                                  past. A combination of slower growth in the
   Smaller categories of personal health          number of doctors and in private health in-
spending include dental care, other profes-       surance and out-of-pocket spending should
sional services, home health care, vision prod-   help reduce increases in expenditures, despite
ucts and durable medical equipment, and a         the fact that more high-tech procedures will be
residual category called other personal expen-    performed in doctors' offices.
ditures. All of these smaller varieties ac-
counted for 16 percent of personal health           Health spending categories that carry a
spending in 1990.                                 high proportion of out-of-pocket payments--
22 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                October 1992

Table 3.
Projections of National Health Expenditures t o 2000, by Major Types of Spending

                                                                                  Selected Calendar Years
Type of Spending                                                  1965   1983        1987      1990      1992a    OO

                                                         Billions of Dollars
Personal Health Expenditures
  Hospital expenditures
     Community hospitals, inpatient                                8     104       130        165      194
     Community hospitals, outpatient                               1      17        32         51       71
     Federal hospitals                                             2      11        14         18       20
     Other hospitalsb                                        3           -15       -18        -21      -25
          Subtotal, hospital expenditures                          14    147       194        256      310

      Drugs, other nondurables
      Nursing home
      Smaller types of spending

                    Total, personal expenditures                   36    31 5        439        585    713

Other Health Expenditures                                    6           -
                                                                         44        -
                                                                                   55         -
                                                                                              81       -

Total, National Health Expenditures                                42    359         494        666    808

                           Average Annual Growth Rate from Previous Year Shown (Percent)
Personal Health Expenditures
  Hospital expenditures
     Community hospitals, inpatient
     Community hospitals, outpatient
     Federal hospitals
     Other hospitalsb
          All hospital expenditures

      Drugs, other nondurables
      Nursing home
      Smaller types of spending

                    All personal expenditures                            12.9         8.7       10.0   10.4

Other Health Expenditures                                                11.7         5.8       13.8    8.3

National Health Expenditures                                             12.7         8.3       10.5   10.1

Average Annual Growth of GDP (Percent)

SOURCE:       Congressional Budget Office.
NOTES:       Details may not add to totals because of rounding.
             GDP = gross domestic product.
a.     Projected.
 b.    Includes nonfederal, noncommunity hospitals and nonpatient revenues at community hospitals.

drugs, durable medical goods, dental services,
and so on--are expected to grow a t slower
rates. Nursing home spending, despite being                                     Hospital Expenditure
funded largely by out-of-pocket and Medicaid
payments, has grown rapidly in the past, and                                    There are three major subcategories -of hos-
CBO projects continued strong growth in the                                     pita1 spending: inpatient spending a t com-
1990s (see Figure 9 for trends in each major                                    munity hospitals, outpatient spending a t com-
category of personal health spending).                                          munity hospitals, and total spending a t fed-

 Figure 9.
 Percentage Change in Major Health Expenditure Categories

               Community Hospital Expenditure                                                   Physician Expenditure
         Percentage Change from Previous Year                                         Percentage Change from Previous Year
  30 1                                                 I                  1      30
                                                                                                                Actual   I

                         Drug Expenditure                                                    Nursing Home Expenditure
         Percentage Change from Previous Year
   30                                                   I

                                             Actual         Projected
  25     -                                              I

    0     ' 1 1 ' 1 1 ' 1 1 1 1 1 1 ~ 1 1 1 1 1 1 1 1 ~ 1 1 1 1 1 1 1 1 1 1 1
        1965            1975                1985               1995

 SOURCE: Congressional Budget Office.
24 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                October 1992

era1 hospitals. Community hospital spending
makes up 90 percent of total hospital spend-                  Figure 10.
ing, and federal hospitals account for another                Community Hospital Margins
7 percent. The Health Care Financing Admin-                        Percent
istration's estimates of hospital spending are                 8   1                                                 I
based on hospitals' total receipts and include
the value of drugs and durable goods paid for
through hospital bills and the services of sal-
aried hospital medical personnel. (See Box 3
for additional information on the estimates of
hospital expenditures.)

   Hospital spending makes up almost 40 per-
cent of national health expenditures and is ex-
pected to grow a t 10 percent annually in the
1990s, somewhat faster than in the 1980s. In
CBO's projection, hospital spending grows
from $281 billion in 1991 to $671 billion in
2000, with a continuing shift toward out-                      SOURCE:       American Hospital Association.
patient rather than inpatient treatment.

  Hospitals' financial performance, on aver-
age, remained strong in the 1980s. Com-                       more than 6 percent and have been around 5
munity hospital margins peaked in 1984 a t                    percent through 1991 (see Figure 10). Hospital
                                                              margins, the percentage excess of hospital
                                                              revenues over operating expenses (mostly
                                                              wages and salaries, professional fees, and
                    Box 3.                                    equipment a n d supply expenses), a r e ex-
            Estimating Community                              pected to remain positive in the 1990s.
            Hospital Expenditures

  The Health Care Financing Administration                    Community Hospitals:
  (HCFA) defines community hospitals a s                      Inpatient Care
  "acute care hospitals whose average length of
  stay is less than 30 days and whose facilities
  and services are open to the general public."               Spending for inpatient care a t community hos-
  HCFA measures health expenditures by type                   pitals, which amounts to about 65 percent of
  of spending, using estimates of receipts of the             total hospital expenditures, grows in CBO's
  various providers. Community hospital ex-                   projection a t an annual rate of 8 percent in the
  penditure includes all revenues actually re-                1990s, from $179 billion in 1991 to $364 bil-
  ceived by the hospital--including nonpatient
  operating revenues (gift shop and so on) and                lion in 2000. This growth reflects continuing
  nonoperating revenues (interest income, phil-               reductions in inpatient use per person and
  anthropy, and so on)--but not necessarily                   continued strong growth in hospital prices and
  total charges or billings. This measure is in-              intensity of services provided. Inpatient use,
  dependent of the profits or losses (often called            measured by inpatient days per person, is
  mar-gins) that hospitals incur.1                            projected to decline by 2.7 percent a year be-
                                                              tween 1992 and 2000, while price and inten-
  1.   For more information about definitions and mea-
                                                              sity increases over and above general inflation
       surement in the national health accounts, see Office   grow by 6.4 percent. The aging of the popula-
       of National Cost Estimates, "Revisions to the Na-      tion adds about one-half of one percentage
       tional Health Accounts and Methodology," Health
       Care Financing Review (Summer 1990).                   point to the expected growth of inpatient
                                                              spending each year (see Table 4).

   Since the early 1980s, the number of inpa-                            1980s. As a result, total outpatient spending
tient hospital days per person has fallen in                             a t community hospitals has continued to grow
response to government and private-sector                                rapidly. Outpatient spending will grow a t an
initiatives to reduce costs. Technological and                           average annual rate of 16 percent between
procedural changes t h a t allow outpatient                              1992 and 2000, compared with 18 percent
treatment have made the decrease possible.                               growth in 1991 and 1992. Outpatient visits
The number of inpatient days has decreased                               per capita (the measure of outpatient use) are
consistently since 1982 and is projected to                              expected to continue growing by almost 4 per-
continue declining through 2000, although at                             cent per person in the decade (see Table 5).
slower rates than during the last 10 years.                              Rapid technological change has allowed many
Nationwide, the hospital occupancy rate fell                             procedures that previously required over-
from about 75 percent in 1982 to under 65 per-                           night stays to be accomplished on a n out-
cent in 1985, despite reductions in the number                           patient basis.
of beds available during the period (see Figure
                                                                         Federal Hospitals
Community Hospitals:                                                     CBO projects t h a t direct federal hospital
Outpatient Services                                                      spending, the majority of which takes place a t
                                                                         Veterans Administration (VA) hospitals, will
Substantial increases in the number of out-                              grow slowly in the 1990s. The average growth
patient hospital visits have coincided with de-                          rate is projected to be between 4 percent and 5
clines in inpatient hospital days since the mid-                         percent per year. The number of days of occu-

Table 4.
Factors Accounting for Growth in Inpatient Expenditures at Community Hospitals
(Average annual growth rate by calendar year)

 Growth in lnpatient
 Hospital Expenditures
 Factors Accounting for Growthb
   Population increase                                        1.O            1 .O             1 .O            1 .O           0.8
   Demographic composition                                    0.5            0.4              0.4             0.4            0.5
   Use per personc                                              0           -5.5             -2.4            -3.7           -2.7
   GDP implicit price deflator                                6.4            3.5              4.1             3.3            3.2
   Other price and intensityd                                 6.8            6.5              5.2             7.5            6.4

 SOURCE:    Congressional Budget Office.

 NOTES: "Use per person" and "Other price and intensity" are net of predicted impacts on use and intensity from demographic

           GDP = gross domestic product.

 a.   Projected.

 b.   Factors are combined multiplicativelyto yield total growth rate.

 c.   Use per person is measured by per capita days in the hospital.

 d.   Other price and intensity includes price increases in excess of the GDP deflator, additional volume of services per inpatient day,
      and increases in the complexity of services.
26 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                October 1992

 Figure 11.
 Trends in Community Hospital Use and Occupancy

        Inpatient Days and Outpatient Visits                                                     Beds

                                                                            1965      1975          1985     1995

                        Occupancy Rate                                              Average Length of Stay
                                           Actual          Projected
        -                                              I
        -                                              I
        -                                              I
        -                                              I


        -                                              I
        -                                              I
         I 1 I I I I I I I I I I I I I Ill1 I I I I I I I I I I I I I I L

 SOURCE:     Congressional Budget Office based on data from the American Hospital Association.

Table 5.
Factors Accounting for Growth in Outpatient Expenditures at Community Hospitals
(Average annual growth rate by calendar year)

Growth in Outpatient
Hospital Expenditures

 Factors Accounting for Growthb
   Population increase
   Demographic composition
   Use per personc
   GDP implicit price deflator
   Other price and intensityd

SOURCE:       Congressional Budget Office.

 NOTES:     "Use per person" and "Other price and intensity" are net of predicted impacts on use and intensity from demographic

            GDP = gross domestic Product.

a.    Projected.

 b.   Factors are combined multiplicatively to yield total growth rate.

c.    Use per person is measured by per capita outpatient visits.

 d.   Other price and intensity includes price increases in excess of the GDP deflator, additional volume of services per outpatient visit,
      and increases in the complexity of services.

pancy per person in federal hospitals has fall-                           employed by health maintenance organiza-
en almost continually in the last 20 years, and                           tions.1
2 percent to 3 percent annual declines are pro-
jected in the 1990s. VA hospitals are facing                                 CBO projects that physician spending will
declining occupancy rates and a r e actively                              increase rapidly, both because prices for phy-
converting beds from acute to long-term care.                             sician services increase faster than general
                                                                          inflation and because new, high-technology
                                                                          treatments are available in doctors' offices,
                                                                          thereby increasing the intensity of physician
                                                                          visits. The aging of the population and the
Physician Services                                                        number of physician visits per person are ex-
                                                                          pected to add very little to the growth of
Physician services account for about 20 per-                              spending for physician services. Between
cent of national health spending. CBO esti-                               1992 and 2000, change i n the demographic
mates that these expenditures will grow from                              composition of the population accounts for
$126 billion in 1990 to $153 billion in 1992                              only 0.2 percentage points of the projected 9.5
and to $316 billion in 2000. Physician spend-                             percent average annual spending growth.
ing covers services for which patients a r e                              Use, measured by physician visits per person,
billed by private doctors' offices. Professional
fees paid by hospitals to physicians are re-
ported in hospital spending and are not in-                                 1.   Other spending channeled through health maintenance
cluded under physician services. Physician                                       organizations ie accounted for primarily in the hoepital
spending includes the salaries of physicians                                     and other profeeeionale categoriee.
28 P R O J E C T I O N S OF NATIONAL HEALTH E X P E N D I T U R E S                                                         October 1992

Table 6.
Factors Accounting for Growth in Expenditures for Physician Services
(Average annual growth rate by calendar year)

                                                           1965-1983       1983-1987       1987- 1990      1990-1992a 1992-20003

 G r o w t h in P h y s i c i a n

 F a c t o r s A c c o u n t i n g for G r o w t h b
     P o p u l a t i o n increase                               1.
                                                                 O               1.
                                                                                  O             1 .O             1 .O           0.8
     Demographic composition                                    0.2              0.2            0.2              0.2            0.2
     Use per p e r s o n c                                      0.7              0.4            0.0              0.8            0.5
     G D P i m p l i c i t price deflator                       6.4              3.5            4.1              3.3            3.2
     Other p r i c e and i n t e n s i t y d                    3.1              5.8            5.0              4.8            4.5

 SOURCE:         Congressional Budget Office.

 NOTES:        "Use per person" and "Other price and intensity" are net of predicted impacts on use and intensity from demographic

               GDP = gross domestic product.

 a.    Projected.

 b.    Factors are combined multiplicatively t o yield total growth rate

 c.    Use per person is measured by per capita physician visits.

 d.    Other price and intensity includes price increases i n excess of the GDP delator, additional volume of services per physician visit,
       and increases in the complexity of services.

is expected to grow slowly a t just over one-half                          fast as the general population in the 1990s,
of one percent per year, slightly higher than in                           with the 1990 ratio of one physician per 714
the 1987-1990 period, but in line with longer-                             people rising to one physician per 628 people
term trends in the past (see Table 6).                                     in 2000.

   Trends in the number of practicing phy-                                    Total spending on physician services in the
sicians and their average incomes are impor-                               national health expenditure estimates is
tant indicators of the amount spent on phy-                                roughly equal to the average gross practice in-
sician services. The number of nonfederal                                  come per physician multiplied by the number
doctors who practice out of their own offices                              of self-employed physicians. The average self-
has grown from 275,000 in 1980 to 364,000 in                               employed physician grossed $336,000 in 1990
1990 (an average annual growth rate of 2.8                                 from his or her medical practice, according to a
percent since 1980) and is projected to in-                                recent American Medical Association survey
crease to 450,000 in 2000 (a growth rate of 2.2                            (see Table 7).3 The average net income for all
percent from 1990).2 Slower growth in the                                  doctors increased from $98,000 in 1982 to
number of doctors should help restrain expen-                              $164,000 in 1990, a n average annual increase
ditures on physician services in the 1990s.                                of 6.6 percent, which compares to a 4.3 per-
Nevertheless, the number of practicing doc-                                cent average increase for all full-time em-
tors is expected to grow more than twice as
                                                                            3.    The American Medical Association reports these figures
                                                                                  in an annual report, t h e most recent of which i s A M A
 2.    These projections of numbers of physicians are made by                     Center for Health Policy Research, Socioeconomic Char-
       the Bureau of Health Professions of the Public Health                      acteristics of Medical Practice 1991/1992 (Chicago:
       Service and developed b y HCFA.                                            American Medical Aaeociation, 1992).

Table 7.
Average Physician Practice Incomes and Expenses, All Specialties (In dollars per year)

                                                                               Selected Calendar Years
                                                                1982                     1986                        1990

All Physicians
   Net practice income
Self-Employed Physicians
  Total practice revenue
  Total practice expense
  Liability insurance premiums
  Net practice income
Office-Based Nonfederal
Active Physicians (Total number)
National Health Expenditure
Physician Services (Millions of dollars)
Average Wage and Salary Disbursements
per Full-Time Equivalent Employee (Dollars)                    18,500                     22,000                     25,900

SOURCES:   American Medical Association, Center for Health Policy Research; Health Care Financing Administration; Department of
           Commerce, Bureau of Economic Analysis.

ployees. The average net income of self-                             Total spending on drugs has grown a t a
employed doctors increased from $109,000 in                        fairly steady pace of about 9 percent a year
1982 to $186,000 in 1990, an average growth                        through the entire 1965-1990 period. Almost
rate of 6.9 percent a year.                                        75 percent of drug spending is paid out of pock-
                                                                   et by consumers, which has helped restrain
                                                                   drug spending in relation to other, more
                                                                   heavily insured types of spending.

Drugs and Other Medical                                               The relatively stable growth of spending on
d on durable Products                                              retail drugs since 1965, however, may mask
                                                                   dramatic changes in its composition. In the
                                                                   late 1960s and early 1970s; the consumer
CBO projects that spending on drugs will grow                      price index (CPI) for prescription drugs grew
7.5 percent a year from 1992 to 2000, a con-
                                                                   more slowly than the overall economic in-
tinuation of its recent trend and at the low end
                                                                   flation rate. From about 1975 to 1982, the CPI
of the longer-term average growth rate. Drug
                                                                   for prescription drugs grew a t almost the same
expenditure is defined as.goods purchased
                                                                   rate as overall inflation, and since 1982 the
through retail channels and includes prescrip-
                                                                   prescription drug CPI has grown about 4 per-
tion drugs (about 60 percent of total drug                         centage points faster per year than the overall
spending) and over-the-counter preparations
                                                                   inflation rate (and almost as fast as drug ex-
and nondurable medical products (about 40                          penditures; see Figure l2).4 Although it is
percent of the total). Medicines administered
                                                                   difficult to make firm judgments about pure
in hospitals and nursing homes, which are in-                      health price increases, much of the recent in-
cluded in hospital bills or nursing home finan-
cia1 arrangements, are not included in this
account.                                                            4.   The CPI for over-the-counter drugs shows a similar, but
                                                                         less exaggerated, pattern.
30 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                                                                                October 1992

Figure 12.
Consumer Price Index

      Percentage Change from Previous Year

      -                                                                                      I
                                                                                                 I           \
                                                                                                                 \                           CPI-U Prescription Drugs
      -                                                                              I
                                                                                         I                           \

      -                                                                                                                                           /

                                                                                                                                                  CPI-U All Items
      -                                                                                                                                       Less Food and Energy
      -                                              I

      -                         .   ----I

          1     1   1   1   1   1    1   1               1   1   1   1   1   1   1                   1   1   1               1   1   1   1    1   1               1   1   1    1   1

SOURCE:       Department of Labor, Bureau of Labor Statistics.

 NOTE: CPI-U = consumer price index for all urban consumers.

crease in drug spending may be caused by in-                                                         the major factors accounting for the growth of
creases in prices rather than quantities.5                                                           nursing home spending.

                                                                                                        Projections of nursing home spending de-
                                                                                                     pend heavily on the projected sources of pay-
                                                                                                     ment. In 1990, Medicaid paid for about 45 per-
Nursing Home Care                                                                                    cent of all nursing home care. Consumers paid
                                                                                                     for another 45 percent out of pocket. Private
CBO projects that spending for nursing home                                                          health insurance and Medicare have paid for a
care will grow a t a 10 percent annual rate in                                                       very small portion of nursing home spending.
the 1990s, continuing its recent trend. Nurs-
ing home care includes skilled nursing and                                                              Medicaid funding fell from 50 percent of the
intermediate care facilities.6 Table 8 shows                                                         total from all sources of payment in 1981 to
                                                                                                     less than 45 percent by 1984, and the out-of-
                                                                                                     pocket share rose from 43 percent to 48 per-
                                                                                                     cent in the same period. Growth in nursing
 5.   The analysis of drug expenditure and apparent price in-                                        home spending gradually fell to 8.3 percent
      creases implies that quantity increases must be very                                           per year between 1983 and 1987, substan-
      slight. Unfortunately there is little independent evi-
      dence available to confirm this implication. HCFA has                                          tially slower than the 17 percent average an-
      no independent measure for the use of drugs.                                                   nual growth between 1965 and 1983. By 1989,
 6.   The nursing home estimates include intermediate care
                                                                                                     however, Medicare nursing home payments
      facilities for the mentally retarded financed by the                                           were temporarily boosted by the Medicare
      Medicaid program.                                                                              Catastrophic Coverage Act of 1988, Medicaid

payments resumed stronger growth, the out-                                beds allows. States, which pay for a signifi-
of-pocket share fell, and nursing home ex-                                cant amount of nursing home care through
penditures resumed their historic double-digit                            Medicaid, have been reluctant to issue permits
growth.                                                                   for new nursing home construction, a develop-
                                                                          ment that has helped limit the supply of nurs-
   The aging of the population will have a                                ing home beds.
strong impact on the demand for nursing
home care, adding 1.4 percentage points of
growth to the demand for nursing home days
per person between 1992 and 2000. CBO pro-
jects that actual nursing home days per per-
                                                                          Other Types of Personal
son, however, will increase by only 1percent a                            Health Spending
year, in part because the supply of nursing
home beds is expected to grow less rapidly                                Smaller categories of personal health spend-
than the medical demand prompted by demo-                                 ing include dental services, other professional
graphic changes. In the 1980s, the number of                              services, durable medical products, and home
nursing home days per person increased bare-                              health services. These categories, with the ex-
ly a t all, despite the demographic predictions                           ception of other professional services, are
of 1.4 percent growth a year. The nursing                                 characterized by relatively large proportions
home occupancy rate is projected to continue                              of out-of-pocket payments and lower rates of
a t more than 90 percent of available beds in                             expenditure growth. (See Table 9 for an anal-
the 1990s, and the number of nursing home                                 ysis of the smaller categories of personal
days will increase as fast as the availability of                         health spending, and categories of spending

 T a b l e 8.
                              in N u r s i n g Home E x p e n d i t u r e s
 Factors Accounting for G r o w t h
 (Average annual growth rate by calendar year)

                                                         1965-1983        1983-1987    1987-1990       1990-1992a 1992-2000a

 G r o w t h in N u r s i n g
 H o m e Expenditures

 Factors A c c o u n t i n g for G r o w t h b
   P o p u l a t i o n increase                               1.O            1.O            1.O             1.O            0.8
   Demographic composition                                    2.0            1.4            1.2             1.3            1.4
   Use per personc                                            2.4           -1.1           -1.1            -0.3           -0.5
   GDP i m p l i c i t p r i c e d e f l a t o r              6.4            3.5            4.1             3.3            3.2
   Other p r i c e a n d i n t e n s i t y d                  4.2            3.3            4.7             4.9            4.6

 SOURCE: Congressional Budget Office.

 NOTES: "Use per person" and "Other price and intensity" are net of predicted impacts on use and intensity from demographic

            GDP = gross domestic product.

 a.   Projected.

 b.   Factors are combined multiplicatively to yield total growth rate.

 c.   Use per person is measured by per capita nursing home days.

 d.   Other price and intensity includes price increases in excess of the GDP deflator, additional volume of services per nursing home
      day, and increases in the complexity of services.
32 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                             October 1992

Table 9.
Projections of National Health Expenditures t o 2000, by Smaller Types of Spending

                                                                              Selected Calendar Years
Type of Spending                                                1965   1983      1987      1990      1992a     2OOOa

                                                       Billions of Dollars

Personal Health Expenditures
  Major types of spending
  Other professional
  Home health
  Vision and durables
  Other personal

Other National Health Expenditures
  Administration, net cost of private insurance                   2    19      23        39       47
  Government public health                                        1    10      15        19        22
  Research                                                        2     6       9        12        14
  Construction                                             -2          -9      -8       -10       -12
    Subtotal                                                      6    44      55        81        95

          Total                                                 42     3 59     494       666       808

                        Average Annual Growth Rate from Previous Year Shown (Percent)

Personal Health Expenditures
  Major types of spending
  Other professiona I
  Home health
  Vision and durables
  Other personal
     All personal health expenditures

Other National Health Expenditures
  Administration, net cost of private insurance                        13.6      4.9      19.1      10.5
  Government public health                                             16.8     10.5       9.8       6.6
  Research                                                              8.3      9.3      11.2       6.6
  Construction                                                          8.8     -1.5       8.4       5.5
    All other health expenditures                                      11.8      5.8      13.9       8.3

National Health Expenditures                                           12.7      8.3      10.5      10.1

Average Annual Growth of GDP (Percent)

SOURCE:     Congressional Budget Office.

NOTES:     Details may not add to totals because of rounding.

           GDP = gross domestic product.

a.   Projected.

that make up other national health expendi-                   Durable Medical Products
                                                              CBO projects that spending for durable medi-
                                                              cal products, such a s prescription eyewear,
Dental Services                                               hearing aids, and wheelchairs, will rebound
                                                              from current slow rates of growth as the econo-
Dental care services are the slowest-growing                  my emerges from recession. Durables are one
category of professional services. Spending                   of the few categories of health expenditures
growth is projected to decline from 8 percent                 with a n obvious response to the business cycle;
per year in the 1987-1990 period to 6 percent                 spending on durables increases when t h e
in the 1992-2000 period. The growth of spend-                 economy is strong and falls off during reces-
ing on dental services has slowed over the last               sions. About two-thirds of spending for dur-
20 years a s advances in preventive care have                 ables is financed through direct patient out-of-
allowed a greater proportion of routine, less                 pocket payments, a n d t h u s slower-than-
complicated visits and more care by dental                    average spending growth is projected.
hygienists.7 Improved preventive care in this
sector and low insurance coverage--more than
half of dental spending is paid directly by pa-               Home Health Spending
tients--compared with hospital and physician
services are reasons to expect lower spending                 Home health spending grew more than 20
growth for dental care in the future.                         percent in 1989 and 1990, and a continuation
                                                              of double-digit growth rates is projected in the
                                                              1990s as more patients are shifted from costly
Other Professional Services                                   inpatient stays to home treatment. As the
                                                              home health industry expands and matures,
CBO projects that spending for other profes-                  spending growth is expected to taper off to
sional services will remain strong, although                  about 12 percent annually by the year 2000.
spending growth is expected to slow to about                  CBO projects that home health spending will
13 percent a year between 1992 and 2000,                      exceed $35 billion by 2000. Home health
down from more than 14 percent growth in                      spending includes only spending for services
recent years. The other professional services                 that are medical in nature, not primarily cus-
category covers spending for services of li-                  todial. For example, Meals on Wheels and
censed health professionals, such as private-                 other nonmedical home assistance programs
duty nurses, chiropractors, podiatrists, and op-              are not included. This home health estimate
tometrists, and for services performed in out-                measures spending by home health agencies
patient clinics.                                              that are not based a t hospitals or nursing
                                                              homes. The agencies must provide skilled
   Substantial insurance coverage of these ser-               nursing or medical care in the home, under
vices underlies their continued rapid growth.                 the supervision of a physician.
The proportion of out-of-pocket spending by
patients for other professional services has
fallen dramatically--from 44 percent in 1980
to 28 percent in 1990--as public programs and
private health insurance have accounted for a                 Other National Health
steadily increasing share.                                    Expenditures
                                                              Other national health expenditures that are
 7. This situation is accounted for in the HCFA model as      not directly related to patient care include the
    negative intensity growth, especially since about 1982.
                                                              costs of administering third-party payments
34 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                  October 1992

Figure 13.
Private Health Insurance Administration and Net Cost

     PercentageChange from Previous Year
     I                                                                   I                              I

    1965             1970             1975   1980        1985          1990            1995            2000

SOURCE:    Congressional Budget Office.

and public health efforts, research, and con-             The peculiar underwriting cycle of private
struction.                                             health insurance makes forecasting adminis-
                                                       trative costs for private health insurance, and
                                                       thus total private health insurance premiums,
Administration                                         difficult. State regulatory behavior, competi-
                                                       tive forces, and the way health insurance
This category includes the costs of admin-             companies set premiums have contributed to
istering government programs a s well as prof-         regular wide swings in the growth rates of
its, overhead costs, and additions to the re-          health insurance premiums.8 (See Figure 13
serves of private health insurance companies--         for the percentage change in the adminis-
the annual difference between premiums                 trative costs of private health insurance.) To
collected and benefits paid. The administra-           avoid having to project this cycle, CBO as-
tive cost of private health insurance does not         sumed that the net cost of private health in-
include the cost of filing forms and billing in        surance will grow a t its expected average an-
hospitals and in other providers' offices. (Bill-      nual rate of about 9.5 percent a year from
ing and other administrative costs incurred by         1991 to 2000. Projecting the private health
health providers are included in the specific          insurance underwriting cycle would be too
categories of personal health spending.) These         speculative to add much insight, and elimi-
projections assume fairly stable growth in the
administrative expenses of Medicare, Medic-            8. See Jon Gabel, Roger Formisano, Barbara Lohr, and
aid, and noninsurance private and public pro-             Steven DiCarlo, "Tracing the Cycle of Health Insur-
                                                          ance," Health Affairs (Winter 1991).

nating it reduces distortion in CBO's evalua-      Noncommercial Research
tion of insurance over the longer period.
                                                   Research spending only includes activities of
                                                   nonprofit or government research entities.
Public Health                                      Commercial medical research and develop-
                                                   ment costs are included in the value of the
The public health category encompasses the         drugs or equipment provided i n personal
cost of organizing and delivering health care,     health expenditures. The federal government
including preventive efforts, over and above       funds most noncommercial research.
direct payments on behalf of individuals for
immediate care (which is accounted for in the        CBO projects that research will grow slight-
various personal health expenditure ca te-         ly faster than GDP, averaging 6.2 percent
gories based on the treatment given). State        annual growth in the 19909, in continuation of
and local governments make the most public         recent trends. Between 1965 and 1986, fed-
health expenditures.                               eral research spending was a nearly constant
                                                   7 percent share of federal nondefense pur-
   CBO projects that total public health ex-       chases. Since 1987, federal research spending
penditures will grow slightly faster than gross    has been higher than this long-run trend, in
domestic product in the 1990s, averaging 6.3       part because of additional AIDS research.
percent annual growth in the 1990s. State
and local public health spending has risen con-
tinually since the 1960s as a share of state and   Construction
local government purchases. CBO projects,
however, that budget pressures on the states       Expenditures for construction expresses the
will hold the growth in state and local public     value of new hospitals and nursing home con-
health spending in the 1990s to less than pre-     struction. Construction spending grows slow-
vious rates.                                       ly because inpatient hospital use declines and
                                                   the supply of nursing home beds grows rela-
                                                   tively slowly, restricted by the reluctance of
                                                   the states to approve new facilities.
                                          Chapter Four

          Projections of National Health
         Expenditures by Source of Funds

        he government share of health spend-      services they do receive. (See Figure 14 for a n
 T      ing will increase in the 1990s under
        current policies and the share of pri-
vate payments will decline. CBO expects
                                                  illustration of the share of health spending
                                                  accounted for by government programs, pri-
                                                  vate health insurance, and out-of-pocket pay-
strong growth in Medicare payments despite        ments over the 1965-2000 period.)
slower growth in the elderly population, and
projects that Medicaid payments will con-
tinue growing rapidly because of increases in
enrollments and court decisions requiring
Medicaid programs to increase payments.           Private Payments
   CBO projects that the number of people cov-    Private health payments have been a stable
ered by private health insurance will increase    percentage of health spending since the mid-
slowly and the proportion of the population       1970s. Between 1975 and 1990, private
covered by private health insurance will con-     health insurance payments, out-of-pocket pay-
tinue to decrease. As a result, private health    ments, and other private payments have to-
insurance benefits, which had accounted for a     gether accounted for about 58 percent of
steadily increasing share of health expendi-      health expenditures. In the projections, the
ture until the mid-19809, are expected to pay     out-of-pocket share declines rapidly, t h e
for a slightly smaller share of health spending   private health insurance share declines slight-
by the end of the 1990s. CBO projects that the    ly, and the total share of private payments de-
number of uninsured people will increase from     clines to 52 percent by the year 2000. (See
about 35 million in 1992 to more than 39 mil-     Table 11for the composition of national health
lion in 2000, despite the growth in Medicare      expenditures, w i t h emphasis on private
and Medicaid (see Table 10).                      sources of funds.)

   CBO projects that direct out-of-pocket pay-
ments by patients to providers will continue      Private Health Insurance
declining as a share of total health spending,    Continues to Erode
despite the increase in the number of unin-
sured people. Types of health spending that       The proportion of spending on health care paid
are funded largely by out-of-pocket payments      by private health insurance increased steadily
tend to grow more slowly than hospital or phy-    during the 1970s, although its share has
sician spending, which are heavily insured,       grown more slowly in 1980s. CBO projects
and many of the newly uninsured will choose       that total private health insurance spending
to do without nonessential services and are       will swell from $217 billion in 1990 to $527
not in a position to pay large amounts for the    billion in 2000, an average annual growth
38 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                           October 1992

Table 10.
Health lnsurance Primary Coverage

                                                                                    Selected Calendar Years
Type of Coverage                                               1980       1983         1987         1990         1992a       2OOOa

                                                        Millions of People

Employer-Sponsored lnsurance
Individual lnsurance


     Total Population

                                                   Percentage of Population

Employer-Sponsored lnsurance
Individual lnsurance


     Total Population

SOURCE:       Congressional Budget Office.
NOTES: CHAMPUS = Civilian Health and Medical Program of the Uniformed Services.
          Estimates and projections based on data from the March Current Population Surveys. Note that the Current Population
          Surveys use a more restrictive definition of the population than the Social Security Administration figures used elsewhere in
          this report.
          Details may not add to totals because of rounding.
a.    Projected.

rate of 9.3 percent, slightly less than the in-                           CBO projects t h a t the total number of
crease in total spending on health care. Total                          people covered by employer-sponsored insur-
private insurance spending in the estimates of                          ance will grow slowly in the 1990s. Total
national health expenditure equals total bene-                          employer-sponsored coverage increased from
fits paid to providers by private insurers plus                         about 135 million people in 1980 to about 141
administrative and net underwriting costs,                              million in 1990 and is expected to grow to only
and is identical to total health insurance pre-                         145 million in 2000. The number of people
miums. Private health insurance benefits for                            with individual insurance (including a l l
personal health care will expand from $186                              insurance not organized through employ-
billion in 1990 to $450 billion in 2000,and ad-
ministrative and net underwriting costs will
remain a constant 17 percent of benefits paid
                                                                         1.   This stability is caused, in part, by the fact that the
(see Table 12).1                                                              private insurance underwriting cycle is not projected, as
                                                                              discussed in Chapter 3.

Figure 14.
Major Sources of Funds for Health Care, by Percentage of Total Health Expenditures


                                                                                              Actual        Projected
                                                             Private Health lnsuranc
       -                                                                                                I
       -                                                            Out of Pocket


                                                                     I     I    I     I   I    I   I          1   1   1   l    1     1   1   1   1    .

      1965             1970             1975             1980                  1985                    1990                   1995                   2000

SOURCE:      Congressional Budget Office.

ment) is expected to continue falling in the                                 The public often equates "health care costs"
19908, from about 17 million in 1990 to 15 mil-                           with employer-sponsored insurance premi-
lion in 2000.2                                                            ums. It is not unusual to read that a firm faces
                                                                          dramatic increases in premiums to renew its
   The rise i n private h e a l t h i n s u r a n c e                     current coverage. Obviously such increases
benefits paid, therefore, almost entirely con-                            represent only a portion of total health care
sists of growth in benefits paid per covered                              financing, leaving out government and other
person, with the number of people covered                                 private funding, and do not really represent
increasing slowly. The expanding population                               increases in total national health costs. More-
combined with slow growth in private health                               over, premium increases quoted by particular
insurance coverage leads to an increase in the                            insurance companies do not necessarily corre-
number of uninsured people from 35 million in                             spond to the total premium increases actually
1992 to 39 million in 2000, despite projected                             paid in the system; total premiums reported in
rapid increases in Medicare and Medicaid en-                              the national health accounts frequently grow
rollment .3                                                               more slowly than reported increases i n pre-
                                                                          mium prices, as employers change coverage or
                                                                          offer coverage to fewer workers.

                                                                            The cycle of private health insurance premi-
 2.    For a discussion of trends in individual insurance, see
       Jon Gabel, "On Their Own: A Profile of the Individually            ums also distorts the common view of health
       Insured," Journal of American Health Policy (Novem-                costs. Private health insurance premiums
       beriDecember 1991).
                                                                          tend to rise rapidly as insurance companies
 3.    Figures for insured and uninsured populations are CBO              build reserves, and then grow slowly (or even
       estimates based on data from the Current Population                fall) u n t i l losses require new premium
       Survey and other sources.
40 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                               October 1992

Table 11.
Projections of National Health Expenditures t o 2000, by Source of Funds

                                                                               Selected Calendar Years
Source of Funds                                             1965       1983      1987      1990      1992a       2OOOa

                                                        Billions of Dollars
   Health insurance
   Out of pocket
  State and local
          Total                                                  42     3 59     494       666       80 8
                                                       Percentage of Total
   Health insurance
   Out of pocket
  Federal                                                    11.6      28.8      29.1      29.3      31.3
  State and Local                                            32
                                                            1.        -
                                                                      12.4      13.0
                                                                                -         -
                                                                                          13.1      -
     Subtotal                                                24.7      41.2      42.2      42.4      45.5

          Total                                             100.0     100.0     100.0     100.0     100.0
                         Average Annual Growth Rate from Previous Year Shown (Percent)
   Health insurance
   Out of pocket
     Private health expenditures
  State and local
     Public health expenditures
National Health Expenditures                                            12.7      8.3      10.5      10.1
Average Annual Growth of GDP (Percent)
SOURCE:     Congressional Budget Office.
NOTES:     Details may not add t o totals because of rounding.
           GDP = gross domestic product.
a.   Projected.

Table 12.
Private and Public Health lnsurance Expenditures

                                                                              Selected Calendar Years
                                                               1980    1983     1987      1990      1992a   2000a

                                                        Billions of Dollars

Private lnsurance

      Total premiums


      Total expenditures                                         38      60       83      1 11


      Total expenditures                                         26      35       51       75

                                   Administration Rate as Percentage of Benefits Paid

Private Insurance

                         Average Annual Growth Rate from Previous Year Shown (Percent)

Private lnsurance

        Increase in premiums                                           14.9      8.6      11.9


        Increase in expenditures                                       16.9      8.6      10.1


        Increase in expenditures                                       10.6      9.5      14.0

SOURCE:      Congressional Budget Office.
NOTE:     Details may not add to totals because of rounding.
a.   Projected.
42 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                 October 1992

Figure 15.
Trends in Private Health Insurance Premiums, 1981-1992

        Percentage Change from Previous Year
  30    I                                                                                                              I

SOURCE:     Congressional Research Service.

NOTE: Hay Huggins surveys about 1,000 large and medium-sized employers. FEHBP is the Federal Employees Health Benefits Pro-
      gram, covering about 10 million people.

increases. The cycle has consistently been five                   in 1990, and CBO projects that it will fall
or six years long, with large changes in the                      further to 16 percent in 2000. Direct patient
growth of premium prices from year to year                        payments will nevertheless rise more rapidly
(see Figure 15 for an illustration of the growth                  than gross domestic product--from 2.5 percent
in premiums for the Federal Employees                             of GDP in 1990 to 2.9 percent in 2000--since
Health Benefits plan and the average increase                     health spending is growing faster than GDP.
reported in a private survey of large firms).4
                                                                    Sectors with a high proportion of out-of-
                                                                  pocket payments--drugs, durables, and dental
Out-of-PocketPayments                                             services--have shown slower growth i n
                                                                  spending than sectors financed more heavily
Out-of-pocket or direct patient payments have                     by private health insurance or government
grown much more slowly than national health                       sources. Payments of deductibles and coinsur-
spending as a whole. The proportion of na-                        ance by insured patients are considered out-of-
tional health expenditures paid directly by                       pocket payments.
patients has fallen from 45 percent in 1965
(before Medicare and Medicaid) to 20 percent                        Insurance can allow patients to ignore costs
                                                                  when receiving treatments, but direct patient
                                                                  payments are subject to a stronger cost-benefit
                                                                  calculation. In the estimates of national
 4.    Congressional Research Service, The Federal Employees      health expenditures, consumer payments of
       Health Benefits Program (May 24, 19891, with updated
       figures from Congressional Research Service staff.         private health insurance premiums (including

employee cost sharing of premium payments        Medicaid programs and smaller programs
sponsored by employers) are not classified as    supporting public health, research, and the
direct out-of-pocket payments. Instead, these    needs of particular groups of people, such as
payments are included in the private health      veterans.5 Total federal health payments are
insurance account, and no attempt is made to     expected to rise from 29 percent of national
calculate the burden of private health insur-    health spending in 1990 to 34 percent in 2000.
ance premiums on consumers. CBO assumes
that consumers or workers ultimately bear the    Medicare. CBO projects t h a t Medicare
entire burden of private health insurance pay-   spending will grow a t about 11 percent an-
ments regardless of whether employers or-        nually in the projection period, raising its
ganize the coverage, or the amount of the ap-    share of national health expenditure from 17
parent cost sharing of the premiums by em-       percent in 1990 to 19 percent in 2000.
ployees. Thus, even if employers are asking
employees to pay a greater share of their           The federal Medicare program for the elder-
health insurance premiums, the estimates of      ly has two parts: Hospital Insurance (HI, or
out-of-pocket spending presented here are not    Part A), which covers inpatient hospital care,
affected.                                        and Supplementary Medical Insurance (SMI,
                                                 or Part B), which covers mostly physician and
                                                 outpatient hospital services. Part A is largely
Other Private Payments                           funded by a payroll tax. About 75 percent of
                                                 Part B is funded from general revenues with
Other private payments include hospital non-     the other 25 percent from premiums paid by
patient revenues and philanthropy. As in the     beneficiaries.
past, other private payments are expected to
grow a t 9.1 percent in the 19909, maintaining      Medicare Part A spending for inpatient hos-
about a 4.5 percent share of national health     pital care has grown relatively slowly since
expenditures.                                    the mid-1980s when the prospective payment
                                                 system (PPS) was put into effect. This system
                                                 pays hospitals on the basis of a fixed fee ac-
                                                 cording to the broad diagnosis of the patient,
                                                 or diagnosis-related group (DRG). Peer re-
Public Funding                                   view organizations were created to help pre-
                                                 vent inappropriate admissions of Medicare pa-
The government's share of health care pay-       tients to hospitals. The PPS discourages hos-
ments has been growing faster than the pri-      pitals from providing longer-term or mainte-
vate share. Payments per person partici-         nance care of the elderly in an inpatient set-
pating in government programs are growing        ting, and admissions and lengths of stay for
a t about the same rate as private health in-    Medicare beneficiaries have fallen consider-
surance benefits per covered person, but the     ably since the system was started.
government is becoming the primary payer for
a greater proportion of the population (see         CBO projects that Medicare Part A inpa-
Table 13 for a breakdown of the sources of       tient hospital payments will resume growing
funds for national health expenditures with      a t 9 percent to 10 percent a year in the 1990s,
emphasis on public funding).
                                                 5.   Payments made by government agencies for employee
                                                      health insurance are included under private health
Federal                                               insurance paymenta. Government paymenta exclude
                                                      nutrition, sanitation, and antipollution programs a0
                                                      these are not directly related to the provision of medical
The federal share of national expenditure on          care or treatment of disease. Expenditures assisting the
health care consists of the Medicare and              training of health professionals are also excluded from
                                                      national health expenditures.
44 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                                           October 1992

T a b l e 13.
P r o j e c t i o n s of N a t i o n a l   Health E x p e n d i t u r e s in t h e Public Sector to 2000, by Source of F u n d s

                                                                                                  Selected Calendar Years
Source o f Funds                                                          1965         1983        1987        1990       1992a              2OOOa

                                                                      Billions o f Dollars
Private                                                                      31         21 1         286          384          44 1           869
State and Local
                                                                     Percent Distribution
State and Local
             Total                                                        100.0        100.0        100.0        100.0        100.0          100.0
                                           Average Annual G r o w t h Rate f r o m Previous Year Shown (Percent)
Private                                                                                 11.2          7.9         10.3             7.2         8.9
     A l l federal
State and Local
      A l l state and local
National Health Expenditures                                                            12.7          8.3         10.5         10.1            9.6
Average Annual Growth o f GDP (Percent)                                                  9.2          7.5          6.7             3.7         5.8
SOURCE:    Congressional Budget Office.
NOTES:   Details may not add to totals because of rounding.
         n.a. = not applicable; GDP = gross domestic product.
a. Projected.

after a period of slower growth in the late                try, CBO projects only small reductions in
1980s. Inpatient admissions per enrollee are               total payments to physicians from the new
expected to resume growing, and DRG pay-                   system. Part B payments for physicians,
ment rates are projected to increase more                  which total about two-thirds of Part B spend-
quickly than in the recent past. Inpatient                 ing, are projected to grow a t about 12 percent
admissions of people over age 65 have fallen               a year during the 1990s.
from 404 per thousand in 1983 to 350 per
thousand in 1991, but CBO projects that ad-                   The second largest component of Medicare
missions of elderly patients will grow to 374              Part B is outpatient hospital payments, which
per thousand by 2000. Since 1986, Medicare                 account for about 20 percent of Part B spend-
DRG payment rates have been increased more                 ing. CBO projects that outpatient hospital
slowly than a price index (called the hospital             payments on behalf of Medicare beneficiaries
"market basket" or "input price index") that is            will continue growing about 18 percent a year
used to track hospital operating costs. DRG                in the projection period. Overall Part B ex-
rate increases were held below this price index            penditure stabilizes a t a 13 percent a year rate
during portions of the 1980s, but beginning in             of growth in the 1993-2000period.
1995, according to current law, hospitals are
scheduled to begin receiving DRG rate in-                  Medicaid. Medicaid finances health care for
creases based on the full price index, which               some of the nation's poor and is administered
will add to Medicare costs.                                by the states under broad federal guidelines.
                                                           The states, which pay 43 percent of total
   Medicare Part B has paid for physician ser-             Medicaid costs, can exercise considerable dis-
vices in the past, based on the reasonable and             cretion in deciding whom and what to cover,
customary fees for the services provided in the            and eligibility rules and coverage vary widely.
physician's locality. This system has been                 Federal Medicaid spending has grown very
criticized for making inequitable allocations of           rapidly in recent years--21percent in 1990, 29
payments between primary and specialty                     percent in 1991, and a n estimated 26 percent
services, a n d by region.6 For example,                   in 1992. CBO projects that Medicaid growth
Medicare paid for certain intensive techno-                will slow to about 12 percent a year by 2000,
logical procedures and surgeries much more                 but Medicaid's share of national health ex-
generously than it did for consultative visits.            penditures will rise from 11percent in 1990 to
                                                           more than 19 percent in 2000.
  Medicare began changing its method of pay-
ing physicians in 1992. The new system is                    Population and cost pressures, legislated
based on a fee schedule with set payments for              extensions of eligibility, legal decisions re-
services, adjusted for differences in practice             quiring increased payments, and the fiscal
costs in different parts of the country. The fees          pressures that push state and local govern-
are based on a n outside determination of the              ments to get the most funds from the federal
relative values of each service. A feature of              government all drive rapid growth in Medic-
the new system is that the fees are expected to            aid spending. In the short term, the extra-
grow according to a price index; if overall pay-           ordinary growth between 1990 and 1993
ments grow more rapidly than a predeter-                   stems partly from so-called disproportionate
mined target rate in a year, the growth of fees            share payments and tax and donation pro-
for succeeding years may be reduced. Al-                   grams. Disproportionate share payments are
though the Congressional Budget Office ex-                 supplementary amounts allotted to hospitals
pects some redistribution of payments among                that serve unusually large numbers of in-
physician specialties and regions of the coun-             digent and uninsured patients. Legislation
                                                           enacted in 1990 extended these payments and
                                                           gave states great latitude to designate hos-
 6.   See, for example, Physician Payment Review Commis-   pitals that qualify and placed some limits on
      sion, AnnualReport to Congress (19911, 1.
                                           p.              total payments. Many states, too, have
46 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                         October 1992

discovered a mini-bonanza in tax and dona-         State and Local Government
tion programs since 1990. Such programs in-        Financing
volve raising Medicaid reimbursements and
simultaneously levying special taxes on pro-
                                                   CBO projects that total state and local funding
viders. States have used such arrangements
                                                   for health will grow a t double-digit rates
as a tool to obtain the highest possible federal
                                                   through the mid-1990s, before tapering off to
matching payments. These complicated tac-
                                                   about 9 percent a year in 2000. These growth
tics were curtailed by Public Law 102-345, en-
                                                   rates are considerably higher than the growth
acted in 1991, which requires that any such
                                                   expected in state and local revenues outside of
levies be broad-based and caps the proportion
                                                   federal Medicaid payments. Under current
of state Medicaid spending that states can fi-
                                                   policies, therefore, unless taxes are increased,
nance.                                             states are likely to have very little room to
                                                   expand nonhealth spending.
   But even after these extraordinary growth
rates taper off, longer-run pressures persist.
                                                   Medicaid. CBO assumes that Medicaid costs
Recent expansions in eligibility, particularly
                                                   a t the state and local level will grow a t the
for poor children, will continue to raise the
                                                   same rate as federal payments, and expects
number of people who are eligible. States may
                                                   that the current ratio of state and local Medic-
keep shifting programs that they formerly          aid funding to federal--43 percent to 57 per-
funded for mental health, testing, and so forth
                                                   cent--will remain constant. States' efforts to
into Medicaid to gain t h e federal match.
                                                   increase the effective federal matching rate
Many states now run outreach programs to
                                                   through tax and donation schemes are not ex-
alert potential beneficiaries to their eligi-
                                                   pected to result in any further increase in the
bility. The impacts of provisions for nursing
                                                   federal share.
home reform (enacted in 1987 but only re-
cently effective) remain uncertain. ~ n fi-   d
                                                   Other State a n d Local Health Payments.
nally, a rash of lawsuits has resulted in sharp-   Other expenditures by state and local govern-
ly higher reimbursements under a 1980              ments for health care include workers' com-
amendment requiring t h a t Medicaid pay-
                                                   pensation, direct support of public hospitals
ments to providers be "reasonable and ade-         and school health programs, and public health
quate." Pressures for increased Medicaid pay-      efforts. CBO projects t h a t state and local
ments will continue to inflate the costs of the    spending other than Medicaid will grow less
program.                                           rapidly than national health expenditures as
                                                   a whoie. The other state and local share of na-
Other Federal Funding. The Department of
                                                   tional health expenditures thus declines from
Defense, the Department of Veterans Affairs
                                                   8.2 percent in 1990 to 6.4 percent in 2000.
(VA), and the National Institutes of Health
                                                   Despite the declining share of total spending
spend most of the rest of federal health funds,
                                                   on health, other state and local spending is ex-
which CBO expects will grow a t about the
                                                   pected to grow more rapidly than GDP, aver-
same rate as GDP in the projection period,         aging 7 percent growth a year in the 1990s
from $41 billion in 1990 to $73 billion in 2000.   compared with 5.4 percent average annual
CBO projects that slow growth in VA hospital
                                                   growth in GDP.
spending and declines in health insurance en-
rbllment through the Department of Defense
will help restrain the total cost.
                                                        Appendix A

        HCFA National Health Expenditure
           Projections ~ e t h o d o l o g ~

                                                                for analysis and projection. They are general
        he projections in this study use the
                                                                price inflation measured by the gross domestic
        Congressional Budget Office's (CBO's)
                                                                product (GDP) implicit deflator; specific medi-
        economic and technical estimating as-
                                                                cal price inflation in relation to general infla-
sumptions and the Health Care Financing                         tion; overall population growth; change in use
Administration's (HCFA's) method of project-                    per capita a s a result of the changing age and
ing--a process of trend analysis using the ac-                  sex composition of the population; change in
counting framework for national health ex-                      intensity of service due to the impact of age
penditures.1 This actuarial method employs                      and sex; change in use per capita exclusive of
a series of identities that divide spending for                 age and sex; and change in intensity of service
a particular service into the factors account-                  exclusive of age and sex.
ing for its growth, and by its sources of funds.
Price, demographic, and quantity factors ac-                      Two factors pertain to the amount that price
count for growth in the demand for health                       change contributes to the growth in expendi-
funding, while government financing, private                    tures. The first factor is the rate of growth of
health insurance benefits, and direct out-of-                   the general price level in the economy. HCFA
pocket payments by patients supply most of                      uses the GDP deflator as a proxy for the gen-
the funds.                                                      era1 inflation rate. The second factor reflects
                                                                the increase in the price of individual
   HCFA refers to health service quantities in
                                                                types of health services. Proxies for medical
terms of the use of services and the intensity of
                                                                price inflation are based on input price in-
each service. Use reflects the measured unit                    dexes for hospitals, nursing homes, and home
number of basic services provided: for ex-
                                                                health care and consumer price indexes for
ample, the number of inpatient days, outpa-                     professional care and health goods. The medi-
tient visits, or visits to physician's offices.                 cal price proxy divided by the GDP deflator
Intensity is unmeasured quantity change--the                    yields a relative price measure.2
expenditure, adjusted for price, per unit of use.
                                                                   Three of the seven factors express the in-
                                                                fluence of population growth and changes in
                                                                the age and sex composition of the population.
The HCFA Seven-Factor                                           Trends in the size and composition of t h e
                                                                population are well understood and widely ac-
Model for Personal                                              cepted explanations of variation in health
Health Spending                                                 spending.

HCFA sorts the growth of a particular type of
health spending into seven component factors                     2.   The GDP implicit price deflator is not a measure of pure
                                                                      price change. The Congressional Budget Office gen-
                                                                      erally uses the "core" consumer price index to measure
                                                                      general inflation or the cost of living. CBO uses the GDP
 1.   For HCFA's national health expenditure projections, see         implicit deflator here to facilitate comparisons with the
      Sally T. Sonnefeld and others, "Projections of Health           HCFA projections, and because the differences between
      Care Spending Through the Year 2000,"Health Care Fi-            the price measures are not important for this applica-
      nancing Review (Fall 1991).                                     tion.
50 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                                          October 1992

Figure A-1.
Number of Hospital Days, by Age Group and Sex

8.000   1Days per 1,000 Persons

        I                                                                                                    / ,'     Female                          I

              5-9          15-19          25-29          3539           45-49           5559         65-69          75-79           85-09            95   +
        0-4         1014           2024           3034          4044            50-54          W64           7074           80-84            90-94

                                                                       Age Group
SOURCE: Health Care Financing Administration.

NOTE: Hospital days exclude maternity and newborn use.

   One demographic factor used to explain                                        to calculate the age and sex index for inpatient
growth in expenditures is the growth rate of                                     hospital use), and inpatient hospital cost per
the total population. The HCFA method also                                       day by age and sex (the distribution used to
employs two other factors that predict the                                       calculate the age and sex index for inpatient
spending impacts of changes in the demo-                                         hospital intensity). Hospital days per person
graphic (age and sex) composition. The age                                       increase rapidly for older people, but cost per
and sex factor for use projects additional use                                   day actually decreases somewhat. Thus, a s
per person as the age and sex structure of the                                   the population ages, the age and sex index for
population changes; the age and sex factor for                                   hospital days per person predicts increased
intensity projects changes in real cost per unit                                 use, while the index for hospital cost per day
of use from the changing population structure.                                   predicts slightly reduced intensity.3

   These age and sex factors are based on dis-                                       A sixth factor determining the level of over-
tributions of use per person and cost per unit                                    all health expenditures is per capita use, ex-
of use by sex and five-year age cohort. Popu-
lation projections by age and sex from the
                                                                                   3.   The surveys upon which the age and sex indexes are
Social Security Administration are applied to                                           based are quite old (1977 National Medical Consumer
these distributions to form indexes that pre-                                           Expenditure Survey, 1981 National Hospital Discharge
                                                                                        Survey, and so forth). CBO is currently studying dis-
dict the impact on use or intensity of expected                                         tributions from the newly available 1987 National Medi-
changes in the age and sex composition of pop-                                          cal Expenditure Survey to check for poaaible changes in
                                                                                        the dietributions, but expects that the use of newer dis-
ulation. Figures A-1 and A-2 show inpatient                                             tributions in future projection0 will change the results
hospital days per person (the distribution used

Figure A-2.
Hospital Cost per Day, by Age Group and Sex

                                                              Age Group

SOURCE:    Health Care Financing Administration.

clusive of that which could be expected from                          errors in the other six factors, as well as the
changes in demographic composition. The                               effects of items not identified (or misiden-
specific measure varies by type of service. For                       tified) in the seven-factor scheme.
example, inpatient days per capita, adjusted
for the expected impact of age and sex change,
are used to explain and project hospital inpa-
tient expenditures.
                                                                      Economic and Demo-
  An important part of the experience of in-                          graphic Assumptions
creased health expenditures remains unex-
plained by the factors described above. This
residual factor is called intensity per unit of                       In CBO's projections, the GDP deflator is
service, exclusive of age and sex effects. This                       taken directly from the CBO baseline eco-
residual contains any measurement or other                            nomic assumptions for January 1992. Total
                                                                      population growth and population composi-
                                                                      tion change are based on Social Security Ad-
                                                                      ministration population projections from the
3.   Continued
                                                                      1991 Trustees' Report. Projections of relative
     only slightly. For more information about the HCFA age           health prices, and use and intensity exclusive
     and sex indexes, see Daniel R. Waldo and others,                 of age and sex, are computed on the basis of re-
     "Health Expenditures by Age Group, 1977-1987,"Health
     Care Financing Review (Summer 1989); and Ross H.                 cent trends and judgments about the interac-
     Arnett 111 and others, "Projections of Health Care               tions between factors for various types of ser-
     Spending to 1990," Health Care Financing Review
     (Spring 1986).                                                   vice.
52 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                       October 1992

                                                                     ments are implicitly restricted by the forecast
                                                                     of income growth in the economy as a whole.
Reconciliation with
Sources of Funds
and Other Data
                                                                     Other Types of National
Projections of some services are reconciled
with others that may be clinical complements
                                                                     Health Spending
or substitutes. Projections of professional ser-
                                                                     Projections for research and public health are
vices are checked against forecasts of practi-                       related to CBO baselines for federal govern-
tioner supply. For physicians, projections of                        ment research and public health administra-
expenditure are checked against data on aver-                        tion and to trends in government funding of
age physician incomes from the American
                                                                     these services. Public program administra-
Medical Association.                                                 tion is based on CBO's baseline projections of  "

                                                                     Medicare and Medicaid administrative costs,
   Overall demands for services from t h e                           and the administrative cost of private health
seven-factor model must also be reconciled                           insurance--the overhead costs and net under-
with expectations about sources of funding.                          writing profits of insurance companies--is pro-
Projections of demand for spending on a ser-                         jected using long-term historical averages.4
vice from the seven-factor model must be equi-
                                                                     Construction spending is based on the project-
librated to projections of the supply of funds                       ions of hospital and nursing home use, which
for that service. The sum of projected pay-                          translates to demand for construction of addi-
ments by a particular payer, such a s Medi-                          tional capacity.
care, for all types of spending must correspond
with overall payment and policy trends for
that payer.

   Medicare and Medicaid projections are con-
sistent with the CBO baseline from January
                                                                     Comparison with
1992. Other federal hospital payments, most-                         HCFA's Projections
ly by the Department of Veterans Affairs and
the Department of Defense, also grow in line                         CBO's projections of national health expen-
with CBO baseline assumptions (nonhospital                           ditures are higher than HCFA's baseline;
spending amounts are based on trends). Non-                          CBO projects that health expenditures will
Medicaid state and local government pay-                             reach 18.0 percent of GDP in 2000, HCFA pro-
ments a r e also based primarily on recent                           jects 16.4 percent.5 CBO's projections are
trends.                                                              based on more recent estimates of health ex-
                                                                     penditures, economic forecasts, and govern-
  Private payments are split into private                            ment program assumptions. HCFA expects to
health insurance and out-of-pocket spending                          publish complete updated projections in an up-
based on judgments about trends in insurance                         coming issue of the Health Care Financing
coverage and incomes. Out-of-pocket pay-                             Review.

 4.   The net cost of private health insurance (premiums col-         5.   HCFA's ratio is to gross national product (GNP) based on
      lected less benefits paid) is smoothed in the projections to         the economic assumptions the administration's analysts
      expected trend rates. This approach allows examination               used. Recalculation of HCFA's ratio by constructing an
      of private health insurance premiums without the dis-                appropriate GDP measure would yield a similar, but
      tortions caused by the volatile underwriting or profit               perhaps not identical, result. GDP and GNP are almost
      cycle.                                                               identical in CB0's projections.
                                           Appendix B

      Projecting Employer-Paid Health
    Insurance Premiums: Their Impact on
          Wages and Tax Revenues

        rojections of national health expendi-     paid by employers are also incorporated in the
P       tures feed back into economic and bud-
        getary forecasts through their impact
on wages and tax revenues, in addition to any
                                                   total costs of health care discussed in this
                                                   study. They are part of the total of private
                                                   health insurance premiums, along with t h e
direct impact of government health spending        component of premiums paid by employees
on the economy and the budget. As health           and the total of individual insurance policies.
spending rises, increases in employers' contri-    The Health Care Financing Administration's
butions to private health insurance premiums       framework for the national health accounts
are largely paid for out of wages. As a result,    does not, however, distinguish among insur-
wages are lower than they would be other-          ance premiums paid by employers, employ-
wise. Because premiums for employer-spon-          ees, or private individuals on their own behalf.
sored insurance are not taxable, increases in
the premiums paid by employers tend to re-           Some extra steps are required to arrive a t
duce taxable income and revenues. Increases        the amount of employer-paid premiums from
in health care costs could further increase the
federal deficit through this channel, a s well
as by increasing federal spending on health        Figure 0-1.
                                                   Ratio of Employer-Paid Premiums to
entitlements.                                      Total Private Health Insurance

  This appendix considers only the effect of             Percent
changes in health costs on health insurance
premiums paid by employers, on wages, and
on tax revenues.

Forecasting Employer-
Paid Premiums
Employer-paid premiums for private health
insurance enter the national income and prod-
uct accounts (NIPAs) as a component of a cate-
gory called other labor income, which is part of
total employee compensation. This item in-
                                                    SOURCE:   Congressional Budget Office
cludes payments made on behalf of retirees a s
well as the active labor force. The premiums
54 PROJECTIONS O F NATIONAL HEALTH EXPENDITURES                                                         October 1992

Table 0-1.
Employer-Paid Health lnsurance Premiums and Wages and Salaries,
1991-1997, Showing Hypothetical Gains from Restraint in the Growth
of Health Premiums (In billions of dollars)

Employer-Paid Health
Insurance Premiums                  189       205     225           247            272            300           330

Wages and Salaries                2,808      2,914   3,093        3,280          3,472         3,664          3,859

Wages and Salaries If
Employer-Paid Premiums
Hold Constant at 1991
Share of Compensation             2,808      2,914   3,108        3,305          3,506         3,714          3,924

Federal Revenue Gain                     0      3       4              8             11            16             21

SOURCE:   Congressional Budget Office.

projections for the total amount of private            in the number and total amount of individual
health insurance. The future path of health in-        policies, but also with some rise in the employ-
surance premiums paid by employers will                ee's share of employer-sponsored premiums.
depend on such issues as how the burden of to-
tal premiums will be shared between employ-
ers and employees, the treatment of commit-
ments to retirees, and the extent to which in-
surance coverage in the form of individual              The Impact on Wages
policies will decline.
                                                        and Salaries
   CBO makes its projection of the employers'
share of premiums by assuming that recent               Health insurance premiums paid by employ-
trends will continue in the relationship be-            ers will grow, but largely a t the expense of em-
tween the measure of private insurance in-              ployees' wages and salaries. Some decline in
cluded in the health accounts and the measure           other fringe benefits will probably also occur,
of employer-paid premiums in the national               but the change will be much smaller. This ac-
income accounts. The ratio of the private               count of the impact on wages and salaries
health insurance component of other labor in-           draws on the analysis of employment-based
come (from the NIPA accounts) to total private          health insurance detailed in the companion
health insurance premiums (from the national            CBO study, Economic Implications of Rising
health accounts) is assumed to follow the               Health Care Costs.1
trend of the late 19809, when the ratio of em-
ployer-paid health premiums to total private               Employers' payments to health premiums
health insurance was rising a t around 0.4 per-         have consumed, and are expected to take, a n
cent per year (see Figure B-1). The resulting           increasing proportion of total compensation.
projections of the ratio fall well within the           The share of wages and salaries is projected to
range of past experience.                               fall over time (see Figure B-2 and Table B-1
                                                        for the projected path of wages and salaries).
  As illustrated in Table B-1, CBO's esti-
mates of the employer-paid component of
health insurance are consistent with a decline           1.   Congressional Budget O f i c e , Economic Implications of
                                                              Rising Hedth Care Costs (October 1992).

 Figure 0-2.
 Employer-Paid Health Insurance Premiums and Wages and Salaries as Shares of Total Compensation

           Employer-Paid Health Premiums                                   Wages and Salaries

 20   Percent
                                    Actual Projected

 SOURCE:    Congressional Budget Office.

If the share of total compensation accounted                  the same proportion, the vast majority (96 per-
for by health premiums paid by employers did                  cent) of the increase in employer contributions
not rise as predicted in this study, but were to              would still come out of the largest component,
remain constant, then wages and salaries                      wages and salaries. Conversely, if health
would be about 3 percent higher in 1997.                      premiums were to grow more slowly, most of
                                                              the gains would accrue to wages and salaries
   CBO assumes that in the long run real total                (see Table B-1).
compensation increases in line with produc-
tivity growth, and that total compensation is
not affected by its division into parts. Hence,
increases in employer-paid premiums must
come a t the expense either of wages and sal-                 The Impact on
aries or of other fringe benefits, such as pen-
sions. Empirical studies and the economic
                                                              Tax Revenues
theory of consumer behavior offer little guid-                A change in wages and salaries amounts to a
ance, however, on the subsequent question of                  change in taxable income, and CBO uses a n
how the incidence of increased health premi-                  average marginal tax rate of 32 percent in
ums is likely to fall between wages and sal-                  1992 (rising to 32.6 percent in 1997) to derive
aries and other fringe benefits.                              the change in federal tax revenues. This re-
                                                              flects both the loss of individual income tax
  CBO currently assumes that the projected                    revenues and payroll taxes. If health premi-
growth in employer-paid premiums will result                  ums paid by employers were held to a constant
in an approximately proportionate squeeze on                  share of total compensation after 1991, the
wages and salaries and in t h e nonwagel                      gain in federal revenue would be $3 billion in
nonhealth component of total compensation.                    1992 and would rise to $21 billion in 1997 (see
Nontaxable fringe benefits other than health                  Table B-1).
insurance constitute only about 3 percent of
total compensation. Hence, if all nonhealth                     Tax expenditures are another measure of
components of compensation were reduced by                    the impact of health costs on tax revenues. As
56 PROJECTIONS OF NATIONAL HEALTH EXPENDITURES                                                                         October 1992

explained in Chapter 1,certain kinds of health                         penditures indicate the tax revenues t h a t
expenditures are exempt from tax, or can be                            would otherwise be collected if these tax ex-
deducted from taxable income. Historical esti-                         emptions were not available (see Table B-2).
mates of the principal federal and state tax ex-                       The revenue gains from eliminating a l l
penditures and projections of future tax ex-                           health-related tax expenditures would prob-

Table 0-2.
Estimated Tax Expenditures Related to Health Care,
Calendar Years 1967-2000 (In billions of dollars)

                                                                         Principal Federal Tax Expenditures
                                                                                                                     Interest o n
                                                      Exemption         Deducti-     Untaxed    Deducti-              State a n d
                                                     o f Employer-      bility o f   Medicare   bility o f          Local Bonds
                                                     Paid Insurance     Medical       (HI.)    Charitable          for N o n p r o f i t
                 Total       Federal       State       Premiums         Expenses     Benefits Contributions           Hospitals

 SOURCES:   Joint Committeeon Taxation; Officeof Management and Budget; and Congressional Budget Office.
 NOTE:   The Congressional Budget Office uses tax expenditure estimates based on projections of the Joint Committee on Taxation
         (JCT) published annually in "Tax Expenditure Estimates By Budget Function." CBO converts these to a calendar-year basis
         and extrapolates them through 2000 based on CBO's projections of health spending. Until the mid-1980s, JCT estimates were
         identical t o those of the Office of Management and Budget (OMB) as published in The Budget o f the United States. The
         OM0 estimates provide an additional year o f revision and therefore are used for historical data where appropriate. The sum
         of the estimates reported here may differ from the actual revenue gain by eliminating all the individual tax expenditures
         because of interaction effects.
         n.a. = not applicable; HI = Hospital Insurance (Part A of Medicare).

ably differ slightly from the sum of the esti-    one of the options in its studies of deficit re-
mates of individual revenue gains.                duction.2 Because lower contributions reduce
                                                  enrollees' entitlements to benefits from the
   The base for Social Security payroll taxes     Social Security system, however, estimates of
excludes employer-paid health insurance pre-      the Social Security payroll tax expenditure
miums. Conceptually, this could be taken as       are not reckoned into the estimates of tax ex-
part of the tax subsidy to health insurance and   penditures prepared by the Joint Committee
in order of magnitude would rank second only      on Taxation (see Table B-2).
to the income tax exemption for employer-paid
insurance. CBO has considered the inclusion       2.   See Congressional Budget Office, Reducing the Deficit:
of such premiums in the payroll tax base as            SpendingandRevenue Options (February 1992).
                      RELATED CBO STUDIES

Economic Implications of Rising Health Care Costs, October 1992.

Rural Hospitals and Medicare's Prospective Payment System, January

Universal Health Insurance Coverage Using Medicare's Payment Rates,
December 1991.

Restructuring Health Insurance for Medicare Enrollees, August 199 1.

Selected Options for Expanding Health Insurance Coverage, July 199 1.

Policy Choices for Long-Term Care, June 1991.

Rising Health Care Costs: Causes, Implications, and Strategies, April

Medicare's Disproportionate Share Acljustment for Hospitals, May 1990

Physician Payment Reform Under Medicare, April 1990.

Questions about these studies should be directed to CBO's Human
Resources and Community Development Division at (202) 226-2653.
The Office of Intergovernmental Relations is CBO's Congressional
liaison office and can be reached at 226-2600. Copies of the studies may
be obtained by calling CBO's Publications Office at 226-2809.
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