Hogging the Pie: Inflation in Healthcare Costs

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One of the catchphrases frequently heard in discussions about the cost of health care is “bending the curve.”  This refers to efforts to try to reduce “excess cost growth” (as the Congressional Budget Office delicately puts it) in health spending, relative to the rate of growth in the nation’s gross domestic product. Today, health care spending is growing faster than the economy (after accounting for population growth and aging), and this means that the further one plots this curve into the future, the larger the share of U.S. national output is consumed by health care.  According to CBO, if health spending continues growing at historical rates, total health care spending would reach 29% of GDP by 2030, 48% of GDP by 2050, and by the mid-2080s the entire economy would consist almost solely of the production and consumption of health care services.

The obsession over “bending the curve” is misplaced: there is nothing intrinsically bad or harmful about faster growth for the health sector than for the rest of the U.S. economy.  Indeed, it is quite natural for health spending to grow faster than national income.  Studies of income elasticity of demand for health care have generally found positive values that are greater than 1: this means that as income rises, the amount of health care consumed rises more than what would be considered proportional.  The process of becoming “richer”  – as an individual or a nation – involves more incremental income being devoted to health consumption than non-health consumption.  Put another way, the economic pie gets larger, but most of the growth is in health care’s slice of it.  

This suggests that CBO’s forecast for health spending is reasonable, but only to a point. The increase in health care spending from 16% of GDP to 29% of GDP over the next twenty years would allow non-health consumption to rise in real terms by nearly 50%.  There’s no reason right now to assume this can’t or won’t happen.  However, as health care’s “slice of the pie” continues to grow, eventually all of the incremental increase in the size of the pie will be attributed to health care.  And to get to 100% of GDP in the 2080s, the growth of the health care slice would come not only from incremental additions to the size of the pie, but also from the other component slices of spending.  It’s foolish to believe health care would ever squeeze out all other spending.  Health care inflation is destined to slow well before we reach that point, but no one knows precisely when.  Will it come only when consumption of non-health items like consumer electronics, computers, appliances, and transportation declines in real terms?  Or will it occur sooner, when health care already occupies such a large share of incremental income that consumption of these other non-health items fails to grow in proportion to our preferences?  “Growth” here not only means greater amounts of non-health consumption but also improvements in its quality.  Well before crowding out other spending, current rates of health care inflation would retard non-health technological advances and constrain the amount of discretionary risk capital available for anything other than investment in medical technology.

The decision to intervene today to reduce excess cost growth by limiting reimbursements for health care experimentation and costly but unproven therapies should not be made lightly.  In the long run, the “curve” will be “bent” when free people operating in a market economy decide that too much of their finite resources are being devoted to health care.  Instead of making judgments about what pace of medical technological advancement is optimal, the government should reduce its contribution to health care inflation by limiting the excludability of employer-provided health insurance and increasing the copayments and deductibles for existing government health insurance programs.  Such action would also dramatically reduce the currently unsustainable budgetary pressures imposed by health care – the rationale for intervening in the first place.