90% in 2020, Health Reform and the State of the Union

When the Disease Management Care Blog views the State of the Union (SOU) this week, it will be keeping the following in mind, courtesy of Mike Chernew et al writing in the New England Journal here:

The accumulated U.S. debt at the end of 2009 was $14 trillion*. While that's a big number, economists use the debt to gross domestic product (GDP) ratio to put things in perspective. The European Union would like to see its members keep it less than 60%. Troubled Greece and Japan - who stepped in to save their banks - have exceeded 100%. Bond markets and economists seem to agree that a sovereign debt ratio up to 90% may be manageable, but not for long. The U.S. was at 53% in 2009 and is on pace, even with the growth of our economy, to exceed 90% by 2020.

Government debt is financed by borrowing, which is accompanied by having to pay interest. About 1.3% of today's U.S. GDP goes to pay that interest, which is likewise manageable. As debt levels increase, the risk to lenders (who fear inflation more than default) also increases, which leads to higher interest rates. So far, the all-important 10 year US Treasury Bond rates haven't notched up, which is good news at two levels. The U.S. government hasn't been forced to pay higher interest rates, which means there is more money for important public programs. In addition, the cost for consumer borrowing hasn't gone up, since consumers are "competing" with our government for loans. That cannot continue forever.

Want to avoid 90% in 2020? Assuming the economy's growth will not appreciably change, you'll have to raise taxes and/or reduce spending.

While increasing taxes seems to be a political bridge too far, the other problem is the tax code equilibrium of "Hauser's Law." Real world tax receipts are remarkably pegged at 20% percent of GDP and always fall short of projected revenues no matter how much they're raised. Economists and politicians are also worried that increasing taxes will harm a fragile economy, which could ironically hamper tax receipts. So that's not a good option right now.

That leaves government spending cuts. In health care, that means the painful prospect of cost sharing, skinnied benefits and higher eligibility thresholds along with reductions in provider payments. While politicians may be tempted to assuage their constituents by pairing cuts with new programs, that will do little to avoid the looming 90% debt to GDP ratio.

The amateur economist DMCB's opinion?

The U.S. is not on the brink of financial crisis, but a day of reckoning is taking shape and there are huge implications for health reform. While the Congressional Budget Office is on record as saying that the Affordable Care Act's tax increases, benefit changes, risk pooling and innovations will reduce the deficit, the inconvenient truths above add up to a good reason to be skeptical.

The lack of any pre-SOU signals about credible spending cuts is lowering the DMCB's expectations. If there is more economic bad news in the coming months, renewed urgency over deficits will mean either a) more posturing with budget gimmicks or b) spending reductions... finally.

The former will increase the risk of rising interest rates, which would hurt consumers and undercut the economy. The latter will mean immediate trouble for two constituencies: 1) the politically marginalized medically indigent and 2) physicians, who have the bad luck of dealing with Medicare (see SGR) and Medicaid payment rates in the middle of a increasingly perfect fiscal storm.

*Not "1.4 trillion." The DMCB appreciates the correction