Order Code RL32545
CRS Report for Congress
Received through the CRS Web
Health Care Spending: Context and Policy
Updated September 6, 2005
Jennifer Jenson
Specialist in Health Economics
Domestic Social Policy Division
Congressional Research Service ˜ The Library of Congress

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Health Care Spending: Context and Policy
Summary
The United States spends a large and growing share of national income on
health care. In 2005, health spending is expected to be about $1.9 trillion, more than
15% of gross domestic product (GDP). We spend substantially more than other
developed countries, both per capita and as a share of GDP. However, given our
wealth, such spending is not necessarily a problem. On the one hand, depending on
our preference for health care compared with other things, we may wish to spend
even more. On the other hand, regardless of the preferred level for national spending,
our nation might use available resources more efficiently and equitably.
Health care costs put significant pressure on the federal budget — both directly,
through spending on Medicare, Medicaid, and other federal benefits, and indirectly,
through tax expenditures for health insurance and expenses. The Congressional
Budget Office projects spending for Medicare, Medicaid, and the State Children’s
Health Insurance Program will total $521 billion and account for about 21% of
federal spending in 2005. Federal tax expenditures for health benefits; health
coverage for military personnel, veterans, and federal employees; and spending by
Public Health Service agencies are expected to add $231 billion in costs. Given
competing constituent interests and the complex interdependence of public and
private benefits and actors, policymakers face difficult challenges in helping to
ensure access to health care and health insurance without exacerbating federal budget
pressures or contributing to marketwide inflation.
Three broad policy directions have both promise and limitations for addressing
health spending: (1) changing health care, (2) changing federal programs, and (3)
using tax policy to make health care more affordable for individuals and families.
The first, changing health care, focuses on what government might do to help
improve the production and delivery of health services. This direction focuses on
innovations that could improve quality and potentially reduce costs throughout the
health care system. A key limitation comes from uncertainty about whether any
particular innovation will reduce or increase health spending.
The second direction, changing federal programs, focuses more narrowly on
federal spending for federal benefits. To influence federal spending, policymakers
can set budgets for programs, services, or beneficiaries. They can change eligibility
rules or program benefits. And they can change other program features, including
payment methods and amounts, and how beneficiaries obtain coverage. In this
category, the primary challenge is balancing explicit tradeoffs between competing
goals regarding access and spending.
The final direction, using tax policy to make health care more affordable for
individuals and families, focuses on helping consumers pay for health insurance and
health care. Tax exclusions, credits, and deductions, and tax-advantaged accounts
are examples of subsidies in this category. The promise of these tools relates to
flexibility: In general, they help consumers buy the health insurance and health care
they prefer. An important limitation is that tax subsidies drive up consumer demand,
health care prices, and both public and private spending. This report will be updated.

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Contents
Health Spending: The Big Picture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
International Perspective . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Valuing Spending on Health Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Economics and Valuing Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Distribution Matters . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Key Issue for the Congress . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Federal Spending . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Constituents and Complexity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Three Policy Directions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Changing Health Care . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Changing Federal Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Program Budgets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Eligibility and Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Other Program Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Using Tax Policy to Make Health Care More Affordable . . . . . . . . . . . . . . 11
Insurance Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Other Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
List of Tables
Table 1. National Health Expenditures
and Gross Domestic Product . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Table 2. U.S. Spending on Health Care and Other Items . . . . . . . . . . . . . . . . . . . 5

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Health Care Spending: Context and Policy
Health care costs and spending are persistent concerns for the Congress. On one
hand, policymakers worry about access to care and the burden of health costs on
household and employer budgets. On the other hand, rising costs put growing
pressure on the federal budget from Medicare, Medicaid, and tax expenditures for
private health insurance. This report seeks to put health spending in context. How
much does this nation spend, and is it too much? Why is policy action so difficult?
And what types of policies can the Congress pursue in seeking to balance concerns
regarding spending and access?
Given the breadth of the topic, this report is not intended to be comprehensive.
Instead, it introduces selected issues and policy strategies, using examples from a
variety of federal programs and policies to make ideas more concrete.
Health Spending: The Big Picture

Health spending in the United States is expected to be about $1.9 trillion in
2005, an estimated $6,423 per capita, according to the Centers for Medicare and
Medicaid Services (CMS). As Table 1 shows, although growth in spending has been
slowing, the rate continues to outpace change in gross domestic product (GDP) by
a healthy margin.
Table 1. National Health Expenditures
and Gross Domestic Product

2002
2003
2004a
2005a
National Health Expenditures
(NHE, in billions)b
$1,559
$1,679
$1,805
$1,937
NHE per capitab
$5,317
$5,671
$6,040
$6,423
NHE growth from prior year
9.3%
7.7%
7.5%
7.3%
GDP growth from prior year
3.5%
4.9%
6.5%
5.6%
NHE as percent of GDP
14.9%
15.3%
15.4%
15.6%
Sources: Stephen Heffler et al., “U.S. Health Spending Projections for 2004-2014,” Health Affairs
— Web Exclusive, Feb. 23, 2005, at [http://content.healthaffairs.org/webexclusives
/index.dtl?year=2005], pp. W5-75 and W5-76. Cynthia Smith et al., “Health Spending Growth Slows
in 2003,” Health Affairs, vol. 24, no. 1 (Jan./Feb. 2005), pp. 186 and 188.
a. Projected.
b. Amounts include spending for health services and supplies, and investment (research and
construction).

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Much like national spending, growth in spending for individuals with private
health insurance is slower than a few years ago, but still rapid compared with changes
in personal income. In 2004, spending on health care services — including hospital
inpatient and outpatient services, physician services, and prescription drugs — rose
by 8.2% per capita. This rate compares with spending growth of 8.4% in 2003,
10.7% in 2002 and 11.3% in 2001.1 By contrast, personal income grew 4.9% during
2004 and at an average annual rate of 1.8% over the 2001-2003 period.2
Is the U.S. spending level a problem? What about the rate of growth?3
International Perspective
Compared with other developed countries, the United States spends both more
per capita and a greater share of its national income on health care. According to
data from the Organization for Economic Cooperation and Development (OECD),
in 2003, per capita health spending in the United States was about two-and-one-half
times the OECD median.4
Also based on OECD data, U.S. health spending consumed 15.0% of GDP in
2003, compared with median spending of 8.3% of GDP for OECD countries.5 After
1 Center for Studying Health System Change, Tracking Health Care Costs: Spending
Growth Stabilizes at High Rate in 2004, Data Bulletin no. 29, Jun. 2005. Growth in
spending for outpatient hospital care continues to outpace growth in spending for other
services. Rates of growth by service for 2004 are: hospital outpatient (11.3%), prescription
drugs (7.2%), physician (6.4%), and hospital inpatient (6.2%).
2 Bureau of Economic Analysis, “National Income and Product Accounts, Table 7.1 —
Selected Per Capita Product and Income Series in Current and Chained Dollars,” last revised
Aug. 31, 2005, at [http://www.bea.gov/bea/dn/nipaweb/SelectTable.asp?Selected=Y].
Annual growth rates for personal income were: 2.2% in 2003, 0.8% in 2002, and 2.4% in
2001.
3 For additional information on health spending, see CRS Report RL31374, Health
Expenditures in 2003, and CRS Report RL31094, Health Care Spending: Past Trends and
Projections, both by Paulette C. Morgan.
4 Organization for Economic Cooperation and Development, “OECD Health Data 2005 —
Frequently Requested Data, Table 7: Total health expenditure per capita, US$ PPP,” at
[http://www.oecd.org/document/16/0,2340,en_2649_37407_2085200_1_1_1_37407,00.h
tml], visited Sep. 2, 2005. U.S. spending in purchasing-power-parity international dollars
was $5,635, compared with median spending in OECD countries of $2,269. OECD
countries include Australia, Austria, Belgium, Canada, Czech Republic, Denmark, Finland,
France, Germany, Greece, Hungary, Iceland, Ireland, Italy, Japan, Korea, Luxembourg,
Mexico, the Netherlands, New Zealand, Norway, Poland, Portugal, Slovak Republic, Spain,
Sweden, Switzerland, Turkey, and the United Kingdom.
5 Organization for Economic Cooperation and Development, “OECD Health Data 2005 —
Frequently Requested Data, Table 6: Total expenditure on health, % of gross domestic
product,” at [http://www.oecd.org/document/16/0,2340,en_2649_37407_2085200_1_1_1
_37407,00.html], visited Sep. 2, 2005. OECD and CMS report slightly different estimates
of health spending as a share of GDP in 2003 (15.0% vs. 15.3%). Given uncertainty in
(continued...)

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America, countries spending the highest shares of GDP were: Switzerland (11.5%),
Germany (11.1%), Iceland (10.5%), Norway (10.3%), France (10.1%), Canada
(9.9%), Greece (9.9%), and the Netherlands (9.8%). The U.S. spending level is not
necessarily too high. Most of the variation in health spending across OECD
countries can be explained by differences in GDP per capita, suggesting that
countries with higher national income are able and willing to spend this income on
more health care.6
Valuing Spending on Health Care
Criticism of U.S. spending levels generally boils down to the argument that
Americans benefit little from the additional money they spend on health care.
Despite paying more than twice as much per capita as other OECD countries, basic
health statistics for the United States are worse than OECD averages.7 In 2003, the
U.S. infant mortality rate of 7.0 deaths/1000 live births was higher than the mean rate
of 6.1 deaths/1,000 live births for all OECD countries. In the same year, U.S. life
expectancy at birth also was below OECD averages. U.S. females were expected to
live 79.9 years, compared with 80.7 years for females in all OECD countries; for
males, the U.S. and OECD numbers were 74.5 and 74.9 years, respectively.
Another argument regarding the uncertain value of health spending points to
variation within the United States itself that cannot be explained fully by differences
in health status or prices, and that is not correlated with better outcomes or
satisfaction with care.8 For example, according to the Medicare Payment Advisory
Commission (MedPAC), in 2000, Medicare spending per beneficiary varied from
about $3,500 in Santa Fe, New Mexico, to almost $9,200 in Miami, Florida.9 Many
factors contribute to such differences in spending, including variation in the supply
5 (...continued)
estimating both health spending and GDP, this difference is not meaningful.
6 Uwe E. Reinhardt, Peter S. Hussey, and Gerard F. Anderson, “U.S. Health Care Spending
in an International Context,” Health Affairs, vol. 23, no. 3 (May/June 2004), p. 12. Using
2001 OECD data, Reinhardt and colleagues estimate that about 90% of cross-national
variation in health spending can be explained by differences in GDP. Said another way, as
income increases, spending on health care increases both absolutely and as a proportion of
income. This characteristic implies, in economic jargon, that health care is a luxury good.
7 Organization for Economic Cooperation and Development, “OECD Health Data 2005 —
Frequently Requested Data, Table 1: Life expectancy (in years)” and “Table 2: Infant
mortality rate, deaths per 1000 live births,” data released Jun. 5, 2005, at
[http://www.oecd.org/document/16/0,2340,en_2649_37407_2085200_1_1_1_
37407,00.html], visited Sep. 2, 2005.
8 See, for example, Fisher et al., “The Implications of Regional Variations in Medicare
Spending, part 2: Health Outcomes and Satisfaction with Care,” Annals of Internal
Medicine, vol. 138, no. 4 (Feb. 18, 2003), pp. 288-298.
9 Medicare Payment Advisory Commission, “Geographic Variation in Per Beneficiary
Medicare Expenditures,” Report to the Congress: Variation and Innovation in Medicare,
(Washington: MedPAC, June 2003), p. 4.

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of medical resources; in how physicians practice medicine; and in the economic,
social, and cultural characteristics of communities.10
Unfortunately, variation in measures of health on the one hand and spending on
the other are difficult to interpret. In the former case, many things besides health care
affect mortality and life expectancy, including nutrition, sanitation and hygiene,
housing, and the prevention and control of infectious disease. In the latter case,
although more spending on health care is not necessarily better,11 it also is not
necessarily worse. Some differences in spending may be the appropriate result of
differences across markets in the cost of inputs for producing health services. In
addition, although overuse of health care may be wasteful, underuse of services also
can be a problem. It may not be clear whether any given spending level is too high,
too low, or about right.
Economics and Valuing Spending
Economics offers additional concepts for thinking about whether U.S. spending
levels are desirable or affordable. Despite high spending, we may conclude as a
society that it is worthwhile to devote the same, or even more, resources to health
care. This conclusion depends on preferences for health care, relative to other things.
If we value health care more than what we would otherwise produce with the same
resources, diverting resources to health care from other uses will increase social
welfare.
We also may conclude that spending levels are affordable based on the
observation that it is possible, in a growing economy, to spend more both on health
care and on other goods and services. As Table 2 shows, over the 1960-1999 period,
increasing national income was sufficient to support both rapid growth in per capita
spending for health care and growth in spending for items other than health care.
Whether our economy will be able to support a similar trend in the future depends
on the extent to which increases in health spending continue to outpace change in
GDP.12
10 Victor R. Fuchs, “More Variation in Use of Care, More Flat-of-the-Curve Medicine,”
Variations Revisited, Web-Exclusive Collection 2004, A Supplement to Health Affairs,
(2004), p. VAR-104. (Article originally published as a Web-Exclusive on Oct. 7, 2004.)
11 More spending on health care is not better if it fails to improve health or otherwise offer
benefits that exceed costs. In “More Variation in Use of Care, More Flat-of-the-Curve
Medicine,” Fuchs asserts that a “considerable” amount of the care in the U.S. provides “no
incremental health benefit.”
12 Michael E. Chernew, Richard A. Hirth, and David M. Cutler, “Increased Spending on
Health Care: How Much Can the United States Afford?” Health Affairs, vol. 22, no. 4
(July/Aug. 2003), pp. 15-25. Based on simulation analysis, the authors conclude health
spending will continue to be affordable through 2075 if real per capita growth in health care
costs exceeds real growth in GDP by 1%. If the gap is instead 2%, spending would be
affordable only through 2039.

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Table 2. U.S. Spending on Health Care and Other Items
(in 1996 dollars)
1960
1970
1980
1990
1999
Per capita GDP (sum of
spending on health care and
items other than health care)
$12,764
$17,022
$21,271
$26,388
$31,962
Per capita spending on health
care
646
1,197
1,870
3,165
4,192
Per capita spending on items
other than health care
12,118
15,825
19,401
23,223
27,770
Source: Chernew et al., “Increased Spending on Health Care: How Much Can the United States
Afford?” Health Affairs, vol. 22, no. 4 (July/Aug. 2003), p. 19.
Distribution Matters
Even if health spending is generally affordable for society, the cost of health
insurance and health care may be too much for certain individuals and families. For
example, in 2004 about 17.8% of Americans under age 65 went without health
insurance for the entire year. Low income individuals were more likely to be
uninsured: about one-third of those earning less than 150% of the poverty level, and
more than one-quarter of those with income between 150 and 199% were uninsured,
compared with just over one in ten people earning at least 200% of poverty.13
Given the cost of health insurance, these rates are not surprising. In 2004, the
average annual premium for individual coverage under an employer-sponsored plan
was $3,695, with the workers’ share of this amount averaging $558. For a family of
four, the average premium and workers’ share were $9,950 and $2,661,
respectively.14 For comparison, in 2004 the average poverty threshold was $9,645
for an individual and $19,307 for a family of four.15
Having insurance may not guarantee ready access to health care. For example,
according to MedPAC, although Medicare beneficiaries enjoy good access overall,
population subgroups report delaying care because of cost. Even after controlling for
13 CRS Report 96-891, Health Insurance Coverage: Characteristics of the Insured and
Uninsured Populations in 2004, by Chris L. Peterson. Based on data from the Mar.
Supplement to the Current Population Survey, 33.7% of those earning less than 100% of the
poverty level were uninsured in 2004. Rates for other income groups were: 30.9% (100-
149% of poverty), 28.0% (150-199%), and 11.9% (200% or more).
14 The Kaiser Family Foundation and Health Research and Educational Trust, Employer
Health Benefits, 2004 Annual Survey, Henry J. Kaiser Family Foundation, 2004, pp. 28 and
76.
15 U.S. Census Bureau, Income, Poverty, and Health Insurance Coverage in the United
States: 2004, Current Population Report No. P60-229, Aug. 2005, p. 45. For information
on poverty rates and distribution, see CRS Report RL33069, Poverty in the United States:
2004, by Thomas Gabe.

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income, health status, and other demographic variables, beneficiaries with only
Medicare are more likely to delay care than those with Medicare and supplemental
coverage of some sort. This finding is statistically significant for all reported sources
of supplemental coverage, including Medicaid, Medigap, employer-sponsored, and
health maintenance organization (HMO).16
Key Issue for the Congress
Regardless of whether America can afford to spend more of its national income
on health care, health spending is a key issue for the Congress both because it
constitutes a substantial share of federal spending and because it affects all
constituents in one way or another.
Federal Spending
Medicare and Medicaid generally top the list of concerns about federal health
spending. According to the Congressional Budget Office, Medicare spending is
projected to be $332 billion in 2005, and the federal shares of spending for Medicaid
and the State Children’s Health Insurance Program are expected to be $184 billion
and $5 billion, respectively. The sum of these amounts, $521 billion, represents
about 21% of estimated federal outlays ($2.5 trillion) for 2005.17 Costs for Medicare
and Medicaid are expected to grow significantly as the population ages.
Federal tax expenditures for health benefits are also substantial. Although
difficult to measure, estimates by the Joint Committee on Taxation suggest personal
income tax expenditures for health benefits will be about $90 billion in 2005.18 Most
of this amount represents forgone revenue because employer-provided health benefits
are excluded from federal income and employment taxes. Other tax expenditures
include: the itemized deduction for unreimbursed medical and dental expenses above
7.5% of adjusted gross income, the deduction for health insurance for the self-
employed, and the deduction and exclusion for health savings accounts.
Federal spending on health benefits for military personnel, veterans, and federal
employees is expected to total $89 billion in 2005. This amount comprises outlays
16 Medicare Payment Advisory Commission, “Access to Care in the Medicare Program,”
Report to the Congress: Medicare Payment Policy, (Washington: MedPAC, Mar. 2003), p.
167. For significance testing, MedPAC calculated adjusted odds ratios using pooled data
(1996-1999) from the Medicare Current Beneficiary Survey. The Commission also reported
the unadjusted proportion of beneficiaries delaying care because of cost, noted here for a
sense of magnitude. Of beneficiaries with only Medicare, 16.1% reported delaying care
because of cost, compared with 7.9% of beneficiaries with both Medicare and Medicaid.
Rates of delay for those with other sources of supplemental coverage were: 3.8% (Medicare
and Medigap), 2.9% (Medicare and employer-sponsored insurance), and 2.7% (HMO).
17 U.S. Congressional Budget Office, The Budget and Economic Outlook: An Update, Aug.
2005, pp. 4 and 6-7, at [http://cbo.gov/ftpdocs/66xx/doc6609/08-15-OutlookUpdate.pdf].
18 Joint Committee on Taxation (JCT), Estimates of Federal Tax Expenditures for Fiscal
Years 2005-2009, Joint Committee Print #JCS-1-05, Jan. 12, 2005, pp. 37-38.

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of $31.5 billion for defense health benefits, $26.6 billion for veterans medical care,
and $30.7 billion for federal employees health benefits.19
In addition to the health and tax benefits noted already, program budgets for
Public Health Service agencies sum to $52 billion in FY2005. This amount includes
$28.7 billion for the National Institutes of Health, $7.4 billion for the Health
Resources and Services Administration, $6.3 billion for the Centers for Disease
Control and Prevention, $3.8 billion for the Indian Health Service, $3.4 billion for
the Substance Abuse and Mental Health Services Administration, $1.8 billion for the
Food and Drug Administration, and $0.3 billion for the Agency for Healthcare
Research and Quality.20
Constituents and Complexity
Influencing health spending is complicated. Broadly, the Congress faces the
challenge of balancing fiscal constraints against the desire to help constituents.
Beyond this general challenge, the details can be mind-numbing: constituent groups
often have competing objectives, or at least different priorities; public and private
actions are highly interdependent; and policy actions inevitably have both intended
and unintended consequences.
For example, health spending and cost trends affect:
! Taxpayers, who pay for public benefits and tax subsidies;
! Individuals and families, who may receive coverage through public
programs, benefit from tax subsidies for health insurance, or find
themselves uninsured or underinsured because of the high cost of
health care;
! Employers, who must balance providing an attractive compensation
package, including health insurance, for employees against the need
to keep labor costs under control;
! States, who share responsibility with the federal government to
provide coverage for certain vulnerable populations;
! Insurers and health plans, who must balance offering attractive
products at reasonable prices against profit goals and the risk of
financial loss; and
! Health care providers, whose income depends on insurance
coverage and a functioning market for health care.
19 Executive Office of the President, Office of Management and Budget, Historical Tables,
Budget of the United States Government, Fiscal Year 2006 (Washington: U.S. Government
Printing Office, 2005), p. 308.
20 Executive Office of the President, Office of Management and Budget, Budget of the
United States Government, Fiscal Year 2006 (Washington: U.S. Government Printing
Office, 2005), p. 148. For this accounting, program budgets include both agency
appropriations and funding from other sources, including user fees, transfers between Public
Health Service agencies, and transfers both from the Department-level budget for Health and
Human Services, and from other federal Departments.

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Together, these actors make up a complex market in which it is hard to discern
the beginning or end of public and private influences. Public programs depend on
private providers to deliver health care services; and they depend on private entities
to administer benefits, whether by processing claims or by providing private health
plan options for beneficiaries. The private insurance market in turn depends on
substantial tax subsidies to increase demand for coverage and make the price of
insurance more affordable for purchasers. Public subsidies — such as Medicare and
Medicaid payment add-ons for hospitals that train physicians or treat low-income
people — help ensure access to care not only for beneficiaries of public programs,
but also for uninsured and privately insured individuals. Ultimately, all policies
affecting public benefits influence the private market, and vice versa.
Given the complicated interdependence of actors, unintended consequences are
inevitable. For example, although Medicare and Medicaid have provided both
financial protection and access to care for millions of beneficiaries, the programs also
contribute to health care inflation because insured consumers are less price sensitive.
Similarly, expanding public benefits, as the Congress has done in enacting drug
coverage under Medicare and creating the State Children’s Health Insurance
Program, inevitably crowds out private spending, regardless of efforts by
policymakers to prevent this substitution. Maximizing the benefits while minimizing
the costs of any policy action is a difficult challenge.
Three Policy Directions
Rapid growth in health spending makes considering policy strategy both more
difficult, and more important. Accordingly, the following pages introduce three
broad approaches for using policy to influence health costs and spending: changing
health care, changing federal programs, and using tax policy to make health care
more affordable.
These broad directions are neither mutually exclusive nor exhaustive. In
addition, controlling spending — whether national spending or federal spending —
is not assumed to be their only objective. As discussed above, devoting a high share
of national income to health care is not necessarily a problem. Nevertheless,
policymakers generally are concerned about whether health services are worth their
cost, as well as about how benefits and subsidies are distributed.
Changing Health Care
This broad direction — changing health care to increase its value and potentially
reduce its underlying cost — focuses on the health system. The basic idea is that
policy might help improve quality and efficiency in the production and delivery of
health care, and in so doing lower the cost of health services. If realized, lower costs
would affect both public and private health spending.
If health care were a car, policy goals might be building a better car for the same
cost, building the same car at a lower cost, or getting the car from factory to customer
more efficiently. For cars, the “invisible hand” of the market helps make these things

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happen; but health care is different, its market complicated by insurance coverage,
poor information, and other problems.
Two hot policy topics: evidence-based medicine21 and health information
technology, are examples of promising tools for helping produce better health care
at the same cost, the same health care at a lower cost, and a more efficient delivery
system. Both offer the potential to improve quality by providing information,
including general information about effective treatment strategies, and specific
information about patients. Both also might help reduce spending by encouraging
cost-effective care and more efficient administrative systems.
However, given America’s fragmented and competitive health care system,
private entities generally have been unwilling or unable to invest sufficient capital
to realize the potential of these tools. Government might help by subsidizing
research and the development of systems, by disseminating information, and by
establishing standards to facilitate coordination.
This policy direction offers both promise and risk. Investment in the tools
described above and in other types of information, technology, and systems is likely
to improve quality, but its potential impact on costs is uncertain. On one hand,
although technological change tends to lower the cost of most products, new
discoveries in health care tend to have the opposite effect. On the other hand,
inefficiency and waste in the U.S. health care system (like that implied by relatively
poor health statistics and regional variation in health spending) suggest opportunities
for improvement relative to multiple objectives, including: enhancing value, slowing
growth in spending, and possibly also rationalizing the distribution of resources.
Changing Federal Programs
Whereas strategies to change health care focus on the health system generally,
a second broad direction — changing federal programs — focuses on federal
spending for federal benefits.
Given growing costs and limited resources, many policymakers note the need
to control spending on federal programs. But other goals, such as improving program
benefits and ensuring adequate payments for health care providers, are also
important. Medicare illustrates the tension from competing objectives. Over the past
decade, repeated legislative efforts alternately have emphasized limiting spending or
increasing spending, with most bills including provisions for doing both.
Whether the Congress seeks to reduce spending or not, policymakers have
different types of options for changing federal programs, including specifying
21 According to the Oxford Centre for Evidence-Based Medicine, “evidence-based medicine
is the conscientious, explicit and judicious use of current best evidence in making decisions
about the care of individual patients. The practice of evidence-based medicine means
integrating individual clinical expertise with the best available external clinical evidence
from systematic research.”

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budgets, changing eligibility and/or benefits, and changing features that define how
programs work.
Program Budgets. In a way, the simplest tool for influencing federal
spending on health care is to set a budget. For example, the Congress limits outlays
on health benefits for veterans by specifying a budget through the appropriations
process. By changing the appropriation, Congress can reduce or increase spending
for this population.
The appropriation for veterans’ health care is an example of a program-level
budget, but other possibilities include budgets for certain services or beneficiaries.
For example, the Congress has attempted to control spending for physician services
under Medicare through the sustainable growth rate system, which more or less sets
a budget for Medicare spending on physician services. Policymakers also could limit
federal spending for individuals in entitlement programs through capitation
payments. Two examples of this type of approach include: converting Medicare to
a “premium support” system, under which beneficiaries would purchase coverage
much like federal employees do today; and changing Medicaid from a program with
federal matching payments for services to a program in which states receive fixed
payments for enrollees.
The details matter. Setting a budget can restrict spending, but if set too high, it
also can lead to higher spending than would occur otherwise. In addition, a
mismatch between funding, demand, and supply can lead to access problems. In the
veterans case, some argue that queuing for services is the result of appropriations that
have failed to grow in tandem with rising enrollment and health care costs. In the
Medicare case, some physicians threatened to stop seeing beneficiaries when the
sustainable growth rate system recently led to payment cuts.
Eligibility and Benefits. Another tool for influencing federal spending is
changing eligibility and benefits under entitlement programs. The Congress can use
this tool to reduce spending, but usually it has done the opposite. For example, over
the years, policymakers have expanded eligibility for Medicare and Medicaid,
notably in the former case to certain disabled persons and individuals with end-stage
renal disease, and in the latter case to successive subgroups of pregnant women and
children.
The Congress also has expanded benefits. Examples in Medicare include
coverage for hospice services and, more recently, for various clinical preventive
services and outpatient prescription drugs. In Medicaid, most new benefits have been
optional for states. Mandatory additions have included: limited coverage for
professional services by non-physician providers (dentists, nurse midwives, and nurse
practitioners), coverage for care provided in rural health clinics and federally
qualified health centers, and coverage for family planning and pregnancy-related
services.
Changing cost sharing is another way policymakers can modify benefits. For
example, under the Balanced Budget Act of 1997 (P.L. 105-33, BBA), policymakers
in effect increased coverage for hospital outpatient services under Medicare by
reducing beneficiaries’ liability for coinsurance. In contrast, the Congress slightly

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reduced Medicare benefits when it required future increases in the Part B deductible
under the Medicare Prescription Drug, Improvement, and Modernization Act of
2003.
Changes to eligibility and benefits have fairly straightforward tradeoffs. In
general, expansions increase access, but also spending. Restrictions reduce spending,
but may limit access. Distribution and incentives matter. While a policy change to
reduce covered services or increase cost sharing requirements might seriously limit
access for some beneficiaries, the same cutback likely would encourage others to be
appropriately prudent in seeking health services.
Other Program Features. The Congress can influence spending under
entitlement programs by changing program features other than eligibility or benefits.
Key tools include changing payment methods and amounts, and changing how
beneficiaries obtain coverage.
For example, over the years policymakers have changed payment methods for
most Medicare services. Beginning in 1983 and accelerating with the BBA, cost-
based payment has been abandoned in favor of prospectively determined rates for
hospital, physician, skilled nursing facility, home health, and other services. Under
prospective payment, providers have a greater incentive to be efficient because they
are at risk for costs above payments amounts, and can profit if costs are below
payment amounts.
In addition to encouraging efficiency through payment methods, policymakers
can influence spending by changing payment updates. For example, under the BBA,
Congress restricted payment updates for most Medicare services to control rapid
growth in spending. Since the BBA, Congress has increased updates on multiple
occasions to ensure adequate payments for providers.
Increasingly, policymakers have looked to private health plans to provide
benefits under public programs, including Medicare, Medicaid, and the State
Children’s Health Insurance Program. Some people emphasize the inherent value of
offering different coverage options for beneficiaries. Others argue that greater
reliance on private plans will reduce program spending because the plans can provide
benefits more efficiently. That outcome depends, among other things, on how much
private plans are paid.
Like changes in eligibility and benefits, changes in other program features must
balance competing goals regarding spending and access to care. Payment amounts,
whether for particular services or for all services under a health plan, must cover the
cost of efficiently caring for beneficiaries; and payment methods should encourage
the provision of adequate, but not wasteful, care.
Using Tax Policy to Make Health Care More Affordable
A third broad direction — using tax policy to make health care more affordable
for individuals and families — focuses more on consumers, compared with strategies
to change health care or federal programs. In this area, limiting tax expenditures

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generally has not been a policy priority; instead, tax policies emphasize helping
consumers pay for health insurance and health care.
Insurance Subsidies. The subsidy for employer-provided health benefits
is by far the largest tax expenditure for private insurance. Payments for health
insurance are excluded from the income and employment tax base, effectively
lowering the price of insurance for those obtaining coverage under employer-
sponsored plans.22 With the annual cost of such plans averaging $3,695 for
individuals and $9,950 for a family of four in 2004,23 and with most households
facing marginal income tax rates of 15 or 25%, savings can be substantial.
Although tax savings make insurance more affordable, the subsidy encourages
people to purchase more insurance than they would otherwise. Having more
insurance drives up demand for health care, which in turn drives up health care prices
and spending. In addition, the exclusion for employer-provided benefits
disproportionately helps those who least need assistance: high-income workers who
face high marginal tax rates.
Increasingly, policymakers have shown interest in another type of subsidy for
purchasing insurance — tax credits. Depending on the details, tax credits offer
potential advantages compared with the exclusion for employer-provided benefits.
First, credits are less regressive because subsidies are not a function of marginal
income tax rates. Second, because tax credits need not be tied to employment, they
provide a tool for expanding insurance coverage that can reach a larger population.
Key disadvantages relate to access and complexity. Even credits of $1000 or
more may not be enough to make insurance affordable for the unemployed or lower-
income workers, especially if they must purchase insurance in the nongroup market,
which generally is more expensive than employment-based coverage. In addition,
unless tax credits are carefully targeted, subsidies may crowd out private spending
without expanding coverage. Finally, ensuring that low-income individuals receive
subsidies when premiums are due (as opposed to as much as a year later, when they
file their taxes) is complicated. Tax credits can be paid in advance, but doing so
requires both more administrative resources and sufficient knowledge and
sophistication among potential beneficiaries.
Other Subsidies. In addition to helping consumers purchase insurance, tax
subsidies — including the itemized deduction for unreimbursed medical and dental
expenses, and several tax-advantaged accounts — help consumers pay for health
expenses not covered by insurance. Like insurance subsidies, these subsidies reduce
the apparent cost of health care, and have the same unintended impact: increasing
demand, prices, and spending. They also provide larger benefits to taxpayers in the
highest brackets.
22 For more information on this tax subsidy and others, see CRS Issue Brief IB98037, Tax
Benefits for Health Insurance and Expenses: Current Legislation, by Bob Lyke.
23 The Kaiser Family Foundation and Health Research and Educational Trust, Employer
Health Benefits, 2004 Annual Survey. Annual premium costs include both employer and
worker contributions.

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The deduction for unreimbursed medical and dental expenses is less regressive
than the subsidy for employer-provided insurance because eligibility is related to
income (taxpayers who itemize deductions can deduct expenses exceeding 7.5% of
adjusted gross income). In addition, because the deduction covers catastrophic costs,
some might regard it a higher-priority use of limited public dollars.
The policy trend favors tax-advantaged accounts to help consumers pay for
unreimbursed expenses. These accounts — health care Flexible Spending Accounts
(FSAs), Health Reimbursement Accounts (HRAs), Archer Medical Savings Accounts
(Archer MSAs), and Health Savings Accounts (HSAs) — differ on various
dimensions.24 But they are more similar than different, offering account holders
significant flexibility in using balances to cover health care expenses.
Two of the accounts, HSAs and Archer MSAs, were crafted with an eye to
limiting the impact of insurance coverage on demand. Because the accounts must be
used in conjunction with high-deductible health insurance plans, some believe the
combination will encourage consumers to be more prudent in seeking health services.
The underlying assumption — that consumers with savings accounts and high-
deductible plans will think twice before seeking discretionary health services — is
worth evaluation, although incentives under this arrangement are not completely
obvious. If consumers accrue large account balances over time, will they continue
to be price sensitive, or will they instead act as if they have first-dollar coverage?
And will high-deductible plans affect spending at all among consumers with health
care expenses that easily exceed even high deductibles?
Few consumers established MSAs, but interest in HSAs appears to be greater.
Regardless of how HSAs play out, the idea of influencing consumer demand by
favoring certain types of insurance coverage merits further analysis. Next steps
might include evaluating consumer behavior under different types of arrangements,
and developing strategies that target subsidies according to need.
Conclusion
The good news is that policymakers have a full toolbox for pursuing goals
regarding health care costs and spending. They can use government resources and
leadership to help improve health care. They can change federal programs to
influence both access to care and federal spending. And they can use tax policy to
support and shape the market for health insurance and health care.
The bad news is that both problems and solutions are complicated. Does the
United States spend too much on health care, or not? How should society allocate
its resources among members? And how should policymakers set priorities among
competing goals and interests? Even assuming agreement on these questions, the
Congress faces difficult challenges in choosing the best combination of policy tools
for achieving whatever objective is adopted
24 For more information, see CRS Report RS21573, Tax-Advantaged Accounts for Health
Care Expenses: Side-by-Side Comparison, by Bob Lyke and Chris L. Peterson.

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