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Commentary By Charles Blahous

Why the Health Care Law Increases the Gross Federal Debt

Economics, Economics Tax & Budget, Healthcare

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The hottest economic policy issues now facing the White House and Congress include government spending levels, the statutory debt limit extension and efforts to “repeal and replace” last year’s health care law. Largely overlooked in the public debate, however, has been the close relationship between the last two of these issues.

Few have been discussing the fact that last year’s health care law will increase gross federal debt and thus accelerate the speed at which we will approach the statutory debt limit in the future. As elected officials wrestle with these two contentious issues (health care and the debt limit) it seems reasonable to set a minimum policy goal that last year’s health care law be modified so that it at least not worsen the statutory debt outlook.

Note: this is not about whether one believes the Congressional Budget Office (CBO)’s scoring of the health care law. It’s not about whether one believes that assumed reductions in physician reimbursements and other Medicare payments will ever take place. Rather, even if one believes that all of this will occur to reduce unified budget deficits, total government debt subject to statutory limit would still rise significantly because of the law.

This fact is not in dispute. In a January, 2010, letter to Senator Jeff Sessions, CBO substantiated that then-pending health care legislation would increase total government debt by $226 billion through 2019. Obviously, if future Congresses fail to follow through with the cost-cutting provisions envisioned in the law – about which many have voiced skepticism – this increase in the total debt would be hundreds of billions higher. But even with all the assumed cost reductions, we will be bumping up against the statutory debt limit more frequently as a direct result of the new law.

Why? Because of the difference between public debt and the debt subject to statutory limit. The latter is closely related to the government’s gross debt. Before we address the question of which debt measure is more meaningful, let’s just focus on what each means.

Public debt is a function of what happens in the unified federal budget. The unified budget includes all government revenues and all government outlays – on-budget and off-budget. From a unified budget perspective, it doesn’t matter how the government keeps its internal books; it doesn’t matter whether the government keeps track of separate trust funds; and it doesn’t matter how much debt one part of the government issues to another part.

What matters in the unified budget outlook is the total amount of incoming revenue and outgoing spending. The government must finance any unified deficit by borrowing money from the public on the financial markets. Hence the terminology of public debt.

Gross debt by contrast includes all debt issued by the government, including debt exchanged between government accounts. The bonds issued to the Social Security and Medicare Trust Funds, for example, are part of the gross debt. These bonds are backed by the full faith and credit of the government, but they do not have to be borrowed in public markets. The government can issue all the debt between its own internal accounts that it pleases.

The statutory limit on federal debt is very similar to the gross debt. Like gross debt, it also includes debt held by the Social Security and Medicare Trust Funds. This is where the health care law – which would result in substantial additional debt being issued to the Medicare Part A Trust Fund – comes in.

Which debt measure you care about is really a function of whether you regard Social Security and Medicare Trust Fund debt as “real” debt. On the one hand, such debt is clearly “real” in the sense that is backed by the government’s full faith and credit. On the other hand, Trust Fund debt doesn’t have to be raised in the financial markets; the government can issue it virtually by fiat (and sometimes does; see the provision to issue additional debt to the Social Security Trust Fund that accompanied the recent payroll tax cut).

It’s probably fair to say that most analysts regard public debt as the more meaningful metric from a purely economic standpoint. As CBO Director Doug Elmendorf said in the aforementioned letter:

“Debt held by the public is the most meaningful measure for assessing the relationship between federal debt and the economy because it represents the amount that the government has borrowed in the financial markets to pay for its operations and activities; such borrowing competes with other participants in credit markets for financial resources. In contrast, debt held by trust funds and other government accounts represents internal transactions of the government and thus has no effect on credit markets.”

More notably, however, there is a tendency among some policy advocates to be inconsistent in their references to federal debt – that is, to shift from one view to the other and back again as is politically convenient.

I noticed this inconsistency particularly when researching “Social Security; The Unfinished Work.” Opponents of Social Security personal accounts would frequently say things like, “Social Security is fully sound until 2037; and by the way, financing personal accounts would involve a huge transition cost.” From a self-consistent debt perspective, those two statements conflict. Social Security is only sound until 2037 if one believes that debt held by its Trust Fund is economically meaningful (a gross debt perspective). By contrast, funding personal accounts only has a transition cost from a public debt perspective (they would not increase gross debt). This inconsistency is but one that arises from advocates on both sides of the aisle.

For better or worse, the federal debt now subject to statutory limit is very similar to the gross debt. And the reason that the health care law causes us to reach the debt limit more quickly has to do with the law’s double-counting of Medicare savings.

The recently enacted health care law used savings in the Medicare program to finance a new federal health entitlement. But at the same time, the government claimed that the Medicare savings produced an extension of Medicare solvency, in turn reflected in the issuance of more debt to the Medicare Trust Fund. In effect, the savings were double-counted – once as a means of offsetting the costs of the new entitlement, a second time as a means of financing future Medicare benefits.

It’s this double-counting that causes debt subject to limit to rise under the new health care law. New debt will be issued under the law to the Medicare Trust Fund. But the savings from Medicare don’t result in an equivalent reduction in public debt, because most of that savings was used to pay for a new health program. This double-counting means that Trust Fund debt rises more than public debt would fall – and consequently, that the gross debt subject to limit rises.

CBO supplied preliminary numbers in Elmendorf’s 2010 letter:

“(T)he HI trust fund would hold more than $358 billion of additional government debt by the end of 2019 compared with its holdings under current law. At the same time, enacting PPACA would reduce debt held by the public at the end of 2019 by somewhat more than $132 billion . . . Therefore, enacting PPACA would increase debt held by government accounts more than it would decrease debt held by the public, and would thus increase gross federal debt.”

In a December 23, 2009 memorandum, CBO made the double-counting point more explicitly:

“The key point is that the savings to the HI trust fund under the PPACA would be received by the government only once, so they cannot be set aside to pay for future Medicare spending and, at the same time, pay for current spending on other parts of the legislation or on other programs.”

There is a strong case to be made that public debt, not the total debt subject to statutory limit, is the more important measure economically. Nevertheless, the double-counting in the health care law is a significant problem, one that is highlighted by the statutory debt limit debate.

Congress and the White House now face difficult decisions as to how high to raise the statutory debt limit. At the very least, policy makers should correct this flaw of the health care law to ensure that future debt limit decisions are not rendered more difficult.

Charles Blahous is a research fellow with the Hoover Institution and the author of Social Security: The Unfinished Work.