How Reform Law Funds Itself, Strengthens Medicare, and Cuts the Deficit: Part 1

The Mainstream Media Rarely Tries to Explain the Congressional Budget Office’s nearly unbelievable claims that the Patient Protect and Affordable Care Act can:

1)  Pay for itself

2)  Provide coverage for 32 million uninsured Americans

3) Trim this nation’s deficit by some $143 billion over the next ten years

And, that’s not all. Medicare’s Trustees say that the reform legislation puts Medicare on the road to financial solvency–while limiting co-pays and beefing up benefits.

You might well ask: How can this be? How can we provide insurance for an additional 32 million people, improve Medicare, and simultaneously save money?

The media has not been a great help in answering these questions. This is, in large part, because the good news lies in the details—dozens and dozens of details. Fleshing out the myriad ways that the ACA generates new revenues while reining in health care spending would take up far too much time on a cable television show—and way too much space in most newspapers.

This is why the media so often settles for those one-liners that conservatives excel at:  “CBO’s Score: Cloudy with a Chance of Bankruptcy,” declares one pundit.  “The health-care bill does nothing to lower costs, and in fact, is going to raise costs dramatically,” says a Libertarian candidate running for the Senate from Indiana. This just isn’t true, but reform’s opponents get away with the sound-bites because reporters like pithy quotes—and an adequate rebuttal would require more than two or three sentences.

At this point, I am very tired of people who talk in bumper-stickers. Concise may be nice, but not when brevity serves only to package lies.

In this three-part post, my goal is to get my arms around all of the facts about new revenues and savings, and lay them down, in one place, so that readers can judge CBO’s claims.

Exactly where is the money coming from? Will you be paying? Who is contributing—and how much? Most importantly, are the contributions justified?  Is it fair to ask high-income households to contribute so much? Just how high are the penalties for those who decide not to buy insurance? What do they get in return? Are seniors giving up benefits to fund care for younger Americans?

To find the answers to these questions, you have to delve into the details. But first, for the sake of total disclosure, a disclaimer.

Granted, These Are Projections: Savings Could be Less—or Greater

CBO Director Doug Elmensdorf acknowledges that the agency’s estimates of the cost of reform—as well as the savings and new money that the legislation will generate—are just that, estimates. As he told the World Health Organization in April:

“We have concerns in different directions: Subsidies will be more expensive than we project. Medicare reforms will save more money than we project. Our estimates reflect the middle of the distribution of possible outcomes, based on our professional judgment (including consultation with outside experts).”

The CBO estimate is, in fact, “middle of the road. At one end of the spectrum, a Commonwealth Fund report authored by health care economist David Cutler and Commonwealth President Karen Davis is significantly more optimistic than the CBO, forecasting that reform would lead to federal savings of $400 billion over 10 years. “Cutler et. al. believe that the use of Exchanges will reduce average insurer administrative costs by three percent, compared with the CBO’s estimate of just 0.4 percent,” Roger Collier, editor of the Health Reform Update, recently explained. They also are convinced that “system modernization” (i.e., structural reforms that will make care more efficient) “will trim medical costs by one percent a year.”  The CBO does not attempt to include these savings in its estimates.

At the other end of the spectrum, Medicare’s Office of the Actuary (OA) predicts that savings and new revenues will fail to cover the full cost of reform, estimating that over the course of a decade, the ACA will cost the federal government $289 billion. This is in part because the OA scores how many Americans will be signed up for insurance by counting  people who are eligible for both Medicare and Medicaid– as if they will be covered by both programs–“leading to total insured enrollment appearing to exceed the entire US population,” Collier notes on The Health Care Blog.

Moreover, “OA diverges most from the CBO numbers—by some $330 billion—in projected revenue from drug manufacturer fees, hospital insurance taxes, and other provisions, which might be more within CBO’s budgetary forecasting capabilities,” Collier writes.  “Inserting the CBO estimates into the OA forecast would give a net reduction of federal spending of $40 billion—reasonably close to the CBO savings of $89 billion.”

Collier suggests that the Commonwealth Fund may be overly optimistic. But CBO and the Office of the Actuary are not so far apart.  In the end, Chief Actuary Richard S. Foster, like CBO’s Elmensdorf, stresses the uncertainty of any estimate that tries to assess total savings:  “Many of the provisions, particularly the coverage expansions, are unprecedented  . . . Consequently little historical experience is available with which to estimate the potential impacts.”  Moreover, “The behavioral responses to changes introduced by national health reform legislation are impossible to predict with certainty. In particular, the responses of individuals, employers, insurance companies, and Exchange administrators to the new coverage mandates  . . .”

Laying out the Numbers: Cutting Costs and Raising New Revenues

That said, CBO can project revenues and savings from fees and taxes with a fair amount of certainty. These are not just “hoped-for” savings.   Under the Affordable Care Act:

  • Medicare will be cutting overpayment to Medicare Advantage insurers by some $132 billion over the next four years. In Congress, both conservatives and progressives agree that these “windfall” payments to insurers are unwarranted. (See discussion of Advantage below.)
  • Drug-makers, device-makers, and insurers already have agreed to kick in $107 billion in new fees. Drug companies begin making their contribution next year.
  • Because more than 30 million formerly uninsured Americans will have coverage, Medicare will be able to trim subsidies to hospitals that care for the uninsured by $36 billion, or 75%. (The subsidies cannot be totally eliminated because some patients will remain uninsured.)
  • Beginning in 2014, individuals who choose not to purchase “minimal essential insurance” will pay penalties that CBO projects will total $17 billion. (Libertarians and others who object to both the individual mandate and the fines should note that households that ignore the mandate are expected to contribute less than one-third of the $60 billion that the insurance industry will be kicking in. In return, those individuals will enjoy the security of knowing that, if, at some point in the future, they or their families become sick and decide to purchase coverage, insurers cannot turn them away, or gouge them by charging them more than healthier customers. This is why those who reject the mandate are asked to help fund reform. They, too, will benefit.)
  • Employers with at least 50 full-time employees who do not offer coverage to their workers will pay roughly $52 billion in fees, beginning in 2014.
  • The government will take in as much as $32 billion in taxes on pricey health plans that fetch $27,600 to cover a family, or $10,200 for an individual, beginning in 2018. Admittedly, this is a soft number—no one knows how many plans will cost that much in 2018. In fact, reformers hope that insurers will do their best to make sure that premiums come in under that line. This, in turn, would reduce national expenditures on health care. In its own way, the “Cadillac tax” creates a global budget for health care spending—without cutting benefits or shifting costs to patients. (Under the legislation, all plans must offer comprehensive benefits and there is a cap on how much families can be asked to pay out-of-pocket.)
  • Beginning in 2013, reform will raise another  $210.2 billion in new Medicare taxes on wages and self-employment income (0.9 percent) and on investment income (3.8 percent) from taxpayers with an adjusted gross income over $200,000 ($250,000 for couples).

(Source:  Deloitte., “Prescription for Change Filled,”  March 30, 2010. The report relies on estimates from the Joint Committee on Taxation (JCT) and the Congressional Budget Office (CBO)]

And this is a just a short list. For a complete inventory of the ways the legislation generates savings and new money, see the shaded box at end of part 2 of this post. It includes more esoteric sources of funding including $23 billion that results from cancelling an energy tax credit  for “black liquor” (a by-product of paper production), as well as smaller amounts that will flow from dozens of places ($3 billion here, $500 million there.)

These are revenues that reformers can count on, flowing from specific taxes and fees that are now part the law of the land. Could some of these be repealed? Perhaps, but as Collier notes, this “seems close to absurd, given both political parties’ promises to cut the deficit. Almost certainly, there will be some yielding to lobbyists, but a more likely effect will be modest shortfalls in savings . . .”

Should We Expect High-Income Tax-Payers to Contribute So Much?

The biggest item on the list above is the $210 billion that wealthy taxpayers will be contributing. To some, it may seem terribly unfair to force those in the top two percent to take on such a large share of the cost of reform.

But consider this: in recent decades, the wealthiest 10 percent of households saw their share of the nation’s total income climb from 34.6 percent in 1980 to 48.2 percent in 2008.  More importantly, the richest one percent (earning over $368,000 in 2008), watched their slice of the income pie more than double, rising from 10 percent 1980 to 21 percent in ’08.

Meanwhile, as the middle line in the chart below illustrates, middle-class incomes remained relatively flat.

One might argue that the rich became richer because they were working hard to innovate, creating businesses that benefit all of us. In many cases this is true. But these households weren’t just earning more; they were paying out a smaller share of their income in the form of taxes. Over the past 30 years, the average marginal income tax rates for those perched on the highest step of the income ladder plunged—from an average of 48.2% during the eight years of the Reagan administration in the early 1980s, to 39% during President Bush Sr.’s administration in the early 1990s.

Today, the top marginal rate stands at 35%–the lowest in 80 years. Even if the Bush tax cuts for wealthier Americans were eliminated, the top marginal rate would revert to just 39.5%. High income households would be laying out roughly what they did in the early 1990s when Bush Sr.  was president–and nearly 9% less than they shelled out during the Reagan years.

Granted, if progressives win the current tax debate, the taxes that high-income households pay on  long-term capital gains could climb to 20% , up from 15% today—but still well below 28%, the rate they paid on those gains in the late 1980s and early 1990s when income at the top was significantly lower.

To put tax rates for high-income households in a larger historical context, keep in mind that during the Eisenhower and Kennedy administrations of the 1950s and early 1960s, the top marginal rate was 91%. This is one reason why the gaps between the rich and the middle class were so much lower in those decades.

Today, taxes on dividends and capital gains also stand at historic low, and this represents another break for wealthy families because their investment income often exceeds their earned income. As a result, as the Tax Foundation table below reveals, when you combine earned income and investment income, the effective federal tax rate for this group (the percent of total adjusted gross income that the top 1% actually paid) fell from nearly 35% in 1980 to 23% in 1998. (See the fourth column in the table, headlined “Top 1%”)

(Click Table to enlarge)
**** Notes from the Tax Foundation:
(1) All tax returns that have a positive AGI are included, even those that do not have a positive income tax liability.
(2) The only tax analyzed here is the federal individual income tax, which is responsible for about 25 percent of the nation’s taxes paid (at all levels of government). Federal income taxes are much more progressive than payroll taxes, which are responsible for about 20 percent of all taxes paid (at all levels of government), and are more progressive than most state and local taxes (depending upon the economic assumption made about property taxes and corporate income taxes).  Thus, if one looked at all taxes, one would find greater inequality

The bottom line: Over the past 30 years, the top 2% have been taking in a far larger share of the nation’s income while paying out a much smaller percentage of their income in taxes. The chart and table above make a compelling argument that high-income Americans are in a position to extend a hand to those who cannot afford health care insurance.

Those earning six figures can do this without changing their lifestyles: According to Deloitte, a single person earning $250,000 annually would owe an extra $450 in taxes, while an individual reporting $500,000 would pay extra taxes of just $2,700. A couple with $250,000 in joint income would pay no additional tax.

Trimming Over-Payments to Medicare Advantage Insurers

Cuts in what many call unwarranted subsidies for private sector Medicare Advantage insurers represent the second-largest source of funding in the Affordable Care Act. Those  critics who like to sum up reform in a sentence or two describe the change in headlines like these: “The Healthcare Hatchet is Coming to Medicare Advantage” (Washington Examiner)  or “Millions  to Lose Advantage Coverage; Benefits Cut in Half” (AHIP press release).

No surprise, the story is far more complicated than that.

As I have explained in the past, when Congress passed the Medicare Modernization Act in 2003, it agreed to pay private sector Medicare Advantage insurers an average of 13% more than it would cost Medicare to cover the same patients.

In a recent phone interview the Urban Institute’s Robert Berenson (a former Medicare official and astute, long-time observer of Washington politics)  explained such Congressional largesse: “Newt Gingrich wanted to privatize Medicare, by turning it over to the insurers.” If legislators could make the program sufficiently lucrative, insurers would advertise broadly, promising seniors “extras” such as free eye-glass frames, lower co-pays, or gym memberships.

And that is just what insurers did. Today, roughly one quarter of Medicare beneficiaries are enrolled in Advantage plans. But more than 75 percent of seniors have stuck with the original Medicare program, and they, along with tax-payers, are footing the bill for the over-payments to insurers. This hardly seems fair.

Moreover, as Martha Gold, a Senior Fellow at Mathematic Policy Research, noted in Health Affairs, while “individual enrollees may gain” [from Medicare Advantage], beneficiaries as a whole may be harmed if higher payments add to the fiscal stress on Medicare  making the program less viable in the long run.”

If Medicare continues to spend at the current rate, in seven years its hospital fund will begin to run out of money. At that point, it would have to make deeper cuts in the payments to Advantage insurers. In response, probably most insurers would flee the business just as they did in the late 1990s when insurrers decided that an earlier attempt to outsource Medicare to the private sector just wasn’t adding enough to their bottom lines. Seniors bumped from Advantage plans could return to traditional Medicare, but they would find that they, along with all other Medicare beneficiaries, would have to pay substantially higher co-pays and deductibles as Medicare struggled to stay afloat.

Medicare Advantage seniors need to understand that they are still part of Medicare. Their fate depends on Medicare’s solvency. It’s not worth risking that safety net for a “Silver Sneakers” gym membership that, in fact, many seniors rarely use. Even lower co-pays and annual eye exams do not justify the 13% premium that Medicare is doling out to insurers.

Indeed, even Advantage customers acknowledge that the “extras” that Advantage plans offer just aren’t worth that much to them. A 2009 study published in the International Journal of Health Care Finance and Economics reveals that when Advantage beneficiaries were asked how much they would pay, out of their own pocket, for the benefits provided by their insurer, they estimated the value of those benefits at 14 cents for every extra dollar that Medicare was ponying up. As economist Austin Frakt, a co-author of the report, explains: This relatively poor return of value on taxpayer dollars is why I support reductions in Advantage payments. The administration and congressional Democrats have chosen the right path for Advantage payment policy.”

In part 2 of this post, I will talk about the ultimate effect of Advantage cuts on seniors. Despite shrill predictions (more sound-bites) 99% of those on Advantage will still have access to an Advantage Plan. And thanks to the new authority that the Affordable Care Act grants to the Secretary of the Department of Health and Human Services (HHS), HHS Secretary Kathleen Sebellius has succeeded in protecting Medicare beneficiaries from excessive increases in cost-sharing and premiums in 2011. Next year, the premium on the average Advantage plan will fall by 1 percent. Under the ACA, seniors on traditional Medicare also will enjoy lower co-pays and better benefits.

Part 2 will conclude by explaining how Medicare aims to improve productivity and reduce waste, by trimming annual increases in payments to hospitals, nursing homes and home health agencies while improving care for patients. Ask hospital CEOs, and some will tell you that productivity cannot be improved—hospital systems are as good as they possibly could be. Then ask a hospital nurse about waste, errors, and whether better system support would give her more time with patients. Or talk to a hospital executive like Paul Levy.

In Part 3, I’ll discuss the savings that can flow from deep structural changes in how we pay for care, and how it is delivered. These are the savings that cannot easily be counted, but, in the long run, may well count most.

Maggie Mahar is an award winning journalist and author. A frequent contributor to THCB, her work has appeared in the New York Times, Barron’s and Institutional Investor. She is the author of  “Money-Driven Medicine: The Real Reason Why Healthcare Costs So Much,” an examination of the economic forces driving the health care system. A fellow at the Century Foundation, Maggie is also the author the increasingly influential HealthBeat blog, one of our favorite health care reads, where this piece first appeared.