Aging and Health Costs

Recently, CBO released its Long-Term Budget Outlook, projecting deficits will hit 7.5 percent of GDP by 2020, almost 15 percent by 2035, and well over 40 percent by the end of the 75-year budget window if we continue current policies. Driving these deficits is the rapid growth of Medicare, Medicaid, and to a lesser extent Social Security, along with the subsequent interest payments that result from high levels of debt sustained through continued borrowing.
 
A debate exists among experts, though, over the source of growth over these programs. OMB Director (and former CBO Director) Peter Orszag has been among those arguing that health care cost growth is the primary driver of projected entitlement costs, and that there has been an overemphasis among experts on population aging.
 
In its 2007 release, The Long-Term Outlook for Health Care Spending, CBO displayed the following graph, showing that for Medicare and Medicaid, the growth of health care (beyond GDP growth) is a significantly larger factor than population aging -- and in fact population aging explains only around 15 percent of the growth by 2080.
 

 
This chart attributes all of the "interaction effect," which explains nearly one third of the growth, to the light blue section. In its newest release, CBO allocates the interaction effect between the two effects, and finds that population aging contributes closer to 30 percent of the growth in Medicare and Medicaid. When they look at a less distant year, 2035, they find population aging accounts for about 44 percent of the growth.
 

 
And all of this excludes the role of Social Security. Adding this program to the mix, population aging is responsible for around 44 percent of entitlement growth in 2080, and 64 percent in 2035.
 

 
The extent to which health care cost growth versus population aging drives entitlement growth has important policy implications. To the extent the problem is health care, we should be devoting considerable efforts toward designing and implementing policies to slow health care cost growth.
 
To the extent population aging is a driver, some changes to encourage greater and longer lasting labor force participation, as well as higher birth rates and immigration may be possible, but the focus will have to be more on the traditional options of cutting spending and/or increasing taxes.
 
Of course, with a long-term outlook like this, we're going to have to do both.