The ACA reminded us how little we know about long-run Medicare spending

Editor’s note: This post is part of a Health360 special series that provides a look back at the impact of the Affordable Care Act since it was signed in March 2010. To view additional posts, click here.

Official projections of long-term Medicare spending were lowered sharply in response to the ACA. In 2009, the Medicare Trustees projected that Medicare spending would reach 10 percent of GDP in 2065. In 2010, following the ACA’s enactment, the Trustees projected that Medicare spending in 2065 would account for just 6.2 percent of GDP. It seemed like the ACA had made a major dent in addressing our long-term fiscal challenges. But had it? That turns out to be very hard to know.

The main reason for the improved projections was a change in the formula used to calculate the annual updates for Medicare payments to hospitals and other non-physician providers. Prior to the ACA, provider payments increased over time at the same rate as input costs. For example, if wages and the costs of non-labor inputs increased 3 percent in one year, then reimbursements would increase 3 percent as well. But the ACA recognized that when productivity increases over time, reimbursements don’t have to rise as much as input costs: When each input is more productive, the health sector can provide the same services with fewer inputs. So, under the ACA, Medicare reimbursements are updated by input cost growth less economy-wide productivity growth: if input costs increase 3 percent and productivity increases 1 percent, Medicare reimbursements increase 2 percent. Over time, the difference between an annual update of 2 percent vs 3 percent adds up, resulting in sharp markdowns of future Medicare spending.

This math seems right. So why the skepticism?  Basically, because this math puts a lot more weight on the pre-ACA projections than is warranted.

Historically, Medicare spending has increased faster than GDP growth, as has overall health spending. Projecting this to continue into the infinite future creates a nonsensical projection: eventually, health spending consumes all of GDP. Thus, spending has to slow eventually, and the Trustees’ projections have always assumed that it will. But, exactly when and how Medicare growth will slow, and whether it will require a change in legislation to do so, is something forecasters have almost no ability to predict.

Thus, most projections have taken a formulaic approach. For example, the pre-ACA baseline used by the Trustees in 2009 assumed that per-beneficiary Medicare spending growth would slow to the rate of per capita GDP growth gradually over 75 years. Why 75 years? Because that’s the length of their projection period.

Given the necessity of using a formulaic approach to long-run projections, it is hard to know how to assess the effects of the ACA, which permanently changed the annual payment updates to Medicare providers. The initial approach taken by the Trustees, quite naturally, was to assume that if, before the ACA, Medicare spending growth slowed to GDP growth, then after the ACA, Medicare spending growth would fall below GDP growth.

The necessity of projecting the effects of the ACA on long-run Medicare spending exposed the fuzziness of the long-run projections and raised a lot of questions. Were the pre-ACA projections really current law projections that reflected statutory Medicare payment policies? Should those projections be used as a baseline to assess policy changes?  Does it even make sense to think about current Medicare policy over 75 years, given that medicine as we know it is not likely to exist in 75 years?

Forecasters have responded in different ways to these questions. The actuaries at CMS have been trying to come up with a better, more detailed and more economics-based model of long-run Medicare spending. In contrast, the Congressional Budget Office, which also does long-run projections, has decided to stop trying to model specific Medicare policies over the long run, and instead has decided to take a mechanical approach to projections after the ten-year budget window.  

From the perspective of a budget wonk (like myself), one of the interesting legacies of the ACA is the questions it raised about how and whether we should be projecting and preparing for Medicare spending over the long run.