Why Government Health Care Spending is a Problem Now
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In the past month, analysts, pundits, bloggers, journalists, economists, politicians and everyone in between has had a chance to voice their opinions on the CBO's latest budget outlook. For wonks, these updates are like scripture - but of course, as all other mere mortals, even policy wonks fall prey to confirmation bias. That means that we often choose to ignore the parts of these reports that make our preferred policies seem less appealing or we try to rationalize them away.

And it turns out that one critical part of the budget outlook has been ignored by those on the left.

A favored argument against deficit reduction is that we can't cut our way to growth - indeed, President Obama said as much in his State of the Union address. Some on the left have taken this argument further - Paul Krugman, the Nobel prize-winning economist often launches into diatribes against the conservatives' push for austerity and in favor of more government spending - as long as we have near zero percent interest rates, the argument goes, we should be borrowing like mad. (Almost) free money is a tempting mistress.

On the surface, this would appear to be a solid argument. But what does the CBO say about it?

At current projections, net interest costs will rise from 1.5 percent of GDP in 2014, to 3.3 percent of GDP by 2023. This assumes that CBO's current projected interest rates remain on track - 4 percent for 3-month t-bills and 5.2 percent for 10-year notes. This alone should be a cause for concern - rising interest rates keep domestic investment down as more borrowing happens from abroad and more of the federal budget is devoted to paying down interest. A vicious cycle ensues as interest rates go up because of growing federal debt. Under normal economic circumstances, this may not be a problem - when interest rates are low, inflation and GDP grows; interest rates are then driven up in order to keep the growth stable and moderate the eventual downturn. But we are now at a point with near-zero interest rates and near-zero inflation - far from ideal, which means that interest rates are certainly something to be worried about.

But the CBO offers one piece of advice that seemingly, no one on the left chooses to heed:

If interest rates on all types of Treasury securities were 1 percentage point higher or lower each year from 2014 through 2023...for the 10-year period would be about $1.1 trillion  higher or lower (excluding the additional costs of servicing the federal debt).

This means that if interest rates on 3-month bills hit 5 percent while hitting 6.2 percent for 10-year notes, non-interest spending would be over a trillion dollars greater over 10 years - an extra $100 billion in spending annually! 

Krugman's "don't worry, be happy" attitude towards interest rates might be defensible if current U.S. borrowing was being used to fund innovation or growth. But the money we're borrowing now isn't being invested in areas that are likely to spur higher productivity or GDP growth later - it's being invested in health care, a sector notoriously resistant to productivity gains.   In fact,  cumulative spending on government health care programs by 2023 will be the single largest source of federal spending.

Cumulative Spending (2014-2023) in $trillions 

Social Security

$11.1

Health Care

$13.9

Income Security

$3.3

Federal Civilian & Military Retirement

$1.8

Veterans

$0.96

Other Programs

$0.56

 Source: CBO 2013 Budget and Economic Outlook; Table 1-3

Even when accounting for offsetting receipts in health care programs (like Medicare premiums), the cumulative total comes to $12.2 trillion.

Health care programs are largely what drive the national debt - this has been acknowledged by CBO and other analysts time after time.

If the cost of borrowing rises even a smidge above CBO's expectations (1 percentage point) - these programs can wreak even more havoc with the federal budget. Stemming the growth of major health care programs is even more critical now, when interest rates are low, and national health care spending has slowed somewhat. Addressing the cost of the "doc fix" for instance, now stands at $138 billion plus $29 billion in debt service. An increase in the interest rate of one percentage point above CBO's projections (between a 19 and 25 percent increase in borrowing costs) would increase the debt service portion to between $34.5 billion and $36.25 billion over 10 years - and this is just for one relatively inexpensive fix to Medicare.   

Capping federal health spending would also free up more money on the kinds of investments that Professor Krugman likes - and that Republicans might find more palatable. 

In the meantime, President Obama and supporters want to shield health programs from additional cuts.  It's a $1 trillion gamble.  Who would take that bet?

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