Order Code RL32545
CRS Report for Congress
Received through the CRS Web
Health Care Spending: Context and Policy
Updated March 31, 2006
Jennifer Jenson
Specialist in Health Economics
Domestic Social Policy Division
Congressional Research Service ˜ The Library of Congress

---

Health Care Spending: Context and Policy
Summary
The United States spends a large and growing share of national income on
health care. In 2006, health spending is expected to approach $2.2 trillion and
account for more than 16% 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 that spending for Medicare, Medicaid, and the State
Children’s Health Insurance Program will total $578 billion and account for about
22% of federal outlays in 2006. 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 $247 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)
changing tax policy. The first, changing health care, considers the potential for
influencing spending by improving the quality and delivery of health care services.
A key limitation of this direction is uncertainty about whether any particular change
will reduce or increase health spending.
The second direction, changing federal programs, focuses more narrowly on
federal spending for federal benefits. To influence 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, changing tax policy, focuses both on making health care
more affordable for individuals and families, and on influencing consumers’ choices
as they purchase health insurance and health care. A key benefit of tax subsidies —
including exclusions, credits, deductions, and tax-advantaged accounts — relates to
flexibility. In general, these tools help consumers buy the health insurance and health
care they prefer. A drawback is that tax subsidies may drive up consumer demand
and spending on the one hand, while failing to help ensure access to health coverage
on the other. This report will be updated.

---

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
Research . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Information Technology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Leadership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Changing Federal Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Program Budgets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Eligibility and Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Other Program Features . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
Changing Tax Policy . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Insurance Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
Other Subsidies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
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

---

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 projected to be nearly $2.2 trillion in
2006, an estimated $7,110 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
2004
2005a
2006a
National Health Expenditures
(NHE, in billions)b
$1,608
$1,741
$1,878
$2,016
$2,164
NHE per capitab
$5,485
$5879
$6,280
$6,683
$7,110
NHE growth from prior year
9.1%
8.2%
7.9%
7.4%
7.3%
GDP growth from prior year
3.4%
4.8%
7.0%
6.1%
5.5%
NHE as percent of GDP
15.4%
15.9%
16.0%
16.2%
16.5%
Source: Christine Borger et al., “Health Spending Projections Through 2015: Changes on the
Horizon,” Health Affairs — Web Exclusive, Feb. 22, 2006, at [http://content.healthaffairs.org/
webexclusives/index.dtl?year=2006], pp. W62 and W63.
a. Projected.
b. Amounts include spending for health services and supplies, and investment (research and
construction).

---

CRS-2
Much like national spending, growth in spending for individuals with private
health insurance has slowed but is 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 8.4% 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
Feb. 28, 2006, at [http://www.bea.gov/bea/dn/nipaweb/SelectTable.asp?Selected=N].
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 2004, 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, Total health expenditure per capita, US$ PPP,” at
[http://www.oecd.org/document/16/0,2340,en_2649_34631_2085200_1_1_1_1,00.html],
visited Mar. 21, 2006. U.S. spending in purchasing-power-parity international dollars was
$5,635, compared with median spending in OECD countries of $2,280. 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, Total expenditure on health, % of gross domestic product,” at
[http://www.oecd.org/document/16/0,2340,en_2649_34631_2085200_1_1_1_1,00.html],
visited Mar. 21, 2006. OECD and CMS report different estimates of health spending as a
share of GDP in 2003 (15.0% vs. 15.9%). Given uncertainty in estimating both health
(continued...)

---

CRS-3
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)
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, Life expectancy at birth” and “Infant mortality rate, deaths per
1000 live births,” at [http://www.oecd.org/document/16/0,2340,en_2649_34631_2085200
_1_1_1_1,00.html], visited Mar. 21, 2006.
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.

---

CRS-4
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 infant 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.

---

CRS-5
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 18% 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 2005, the
average annual premium for individual coverage under an employer-sponsored plan
was $4,024, with the workers’ share of this amount averaging $610. For a family of
four, the average premium and workers’ share were $10,880 and $2,713,
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 coverage does 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
income, health status, and other demographic variables, beneficiaries with only
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 March
Supplement to the Current Population Survey, 34% of those earning less than 100% of the
poverty level were uninsured in 2004. Rates for other income groups were: 31% (100-
149% of poverty), 28% (150-199%), and 12% (200% or more).
14 The Kaiser Family Foundation and Health Research and Educational Trust, Employer
Health Benefits, 2005 Annual Survey, Henry J. Kaiser Family Foundation, 2005, p. 62.
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.

---

CRS-6
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
Having coverage also does not guarantee low out-of-pocket costs. In 2003, 9%
of people with private health insurance — almost one in ten — reported spending
more than 5% of family income on health care, not including health insurance
premiums. The burden was predictably higher for people without health benefits:
21% of the uninsured spent more than 5% of family income on health care.17
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 $382 billion in 2006, and the federal shares of spending for Medicaid
and the State Children’s Health Insurance Program are expected to be $192 billion
and $6 billion, respectively. The sum of these amounts, $578 billion, represents
about 22% of estimated federal outlays ($2.7 trillion) for 2006.18 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
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 Center for Studying Health System Change, Rising Health Costs, Medical Debt, and
Chronic Conditions, Issue Brief no. 88, Sept. 2004.
18 U.S. Congressional Budget Office, “Fact Sheet for CBO’s March 2006 Baseline:
Medicare,” at [http://cbo.gov/budget/factsheets/2006b/medicare.pdf], and “Fact Sheet for
CBO’s March 2006 Baseline: Medicaid and the State Children’s Health Insurance
Program,” at [http://cbo.gov/budget/factsheets/2006b/medicaid.pdf]. U.S. Congressional
Budget Office, An Analysis of the President’s Budgetary Proposals for Fiscal Year 2007,
Mar. 2006, p. 46, at [http://cbo.gov/ftpdocs/70xx/doc7069/03-14-PresidentsBudget.pdf].

---

CRS-7
income tax expenditures for health benefits will exceed $100 billion in 2006.19 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 $96 billion in 2005. This amount comprises outlays
of $34.3 billion for defense health benefits, $30.1 billion for veterans’ medical care,
and $32.0 billion for federal employees health benefits.20
In addition to the health and tax benefits noted already, program budgets for
Public Health Service agencies sum to $51 billion for FY2006. This amount includes
$28.6 billion for the National Institutes of Health, $6.6 billion for the Health
Resources and Services Administration, $6.2 billion for the Centers for Disease
Control and Prevention, $3.9 billion for the Indian Health Service, $3.3 billion for
the Substance Abuse and Mental Health Services Administration, $1.9 billion for the
Food and Drug Administration, and $0.3 billion for the Agency for Healthcare
Research and Quality.21
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;
19 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.
20 Executive Office of the President, Office of Management and Budget, Historical Tables,
Budget of the United States Government, Fiscal Year 2007 (Washington: U.S. Government
Printing Office, 2006), p. 317.
21 Executive Office of the President, Office of Management and Budget, Budget of the
United States Government, Fiscal Year 2007 (Washington: U.S. Government Printing
Office, 2006), p. 129. 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.

---

CRS-8
! 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.
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
The following sections introduce three broad approaches for using policy to
influence health costs and spending: changing health care, changing federal
programs, and changing tax policy. These approaches 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

---

CRS-9
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.
Research. High-quality health care depends on information: about health and
illness, about medical treatments, and about patients. Federal policy has long
influenced health care delivery by supporting the development and dissemination of
information. For example, the National Institutes of Health supports basic science
and clinical research, the Agency for Healthcare Research and Quality analyzes the
effectiveness of different treatments and clinical practices, and the Centers for
Disease Control and Prevention monitors the incidence and prevalence of health risk
factors and illness in communities. Government support of these research functions
benefits both private actors, who use the information, and society more broadly
(because absent government support, the private market would produce and share
less information).
Information Technology. Beyond supporting research and surveillance, the
government can facilitate the use of information in health care by developing data
and communication standards, and by creating incentives for adopting information
tools. For example, policymakers have moved to support the use of health
information technology (IT) by establishing standards for data exchange among the
Departments of Health and Human Services, Defense, and Veterans Affairs. In
addition to promoting information sharing across these federal departments that
deliver health care, the initiative is meant to serve as a model for the private sector.22
Policymakers also have supported financial incentives for implementing health
IT. For example, the Medicare Prescription Drug, Improvement, and Modernization
Act of 2003 (MMA, P.L. 108-173) authorized grants to physicians to help defray the
cost of purchasing, installing, and using computer systems for electronic
prescriptions.
Health IT offers the potential to improve health care quality by providing both
specific information about patients, and general information about effective treatment
strategies. Electronic health records and clinical decision support systems can help
physicians and other clinicians provide integrated, evidence-based care;
computerized physician order entry systems can help prevent medical errors; and
interconnected systems can facilitate the exchange of information about patients and
populations. Over time, these tools might help reduce health care spending by
encouraging cost-effective care and streamlining administrative processes, but
current evidence is inconclusive.23
Leadership. More generally, government influences the health care system
by sometimes leading and sometimes reinforcing change. Policy support of research
22 For more information about this initiative specifically and health IT more generally, see
CRS Report RL32858, Health Information Technology: Promoting Electronic Connectivity
in Health Care, by C. Stephen Redhead.
23 See the thematic issue of Health Affairs, vol. 24, no. 5 (September/October 2005), which
includes a series of articles on the economics of health IT.

---

CRS-10
and health IT are just two examples of this influence. During the past decade, both
public and private efforts to rein in health care spending have shifted from focusing
on managed care and integrated delivery systems to focusing on changing incentives
for health care consumers (through so-called consumer-directed strategies) and
providers (through pay-for-performance). This evolution reflects a mix of public and
private initiative. For example, federal policy supported a broader trend toward
managed care by making it easier for states to provide Medicaid benefits through
health plans and primary care case management arrangements. Similarly, tax
subsidies for health savings accounts and policy interest in tying Medicare payments
to providers’ performance are examples of federal efforts that both reflect and shape
ongoing change in the market for private health insurance.
Efforts to change the health care system offer both promise and risk. Investment
in research, policies to support health information technology, and other efforts may
improve the quality of care, but their potential impact on spending is uncertain. On
one hand, although new discoveries and technology tend to lower the cost of most
products, innovation in health care tends 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, whether this means slowing growth in health care
spending or at least getting a better value for what we spend.
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
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 attempted to control spending for physician services
under Medicare through the sustainable growth rate system, which more or less sets

---

CRS-11
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 have threatened to stop seeing beneficiaries in
response to recent and expected future payment cuts.
Eligibility and Benefits. Another tool for influencing federal spending is
changing eligibility and benefits under entitlement programs. The Congress could
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 (BBA, P.L. 105-33), policymakers
in effect increased coverage for hospital outpatient services under Medicare by
reducing beneficiaries’ liability for coinsurance. In contrast, the Congress slightly
reduced Medicare benefits when it required future increases in the Part B deductible
under the MMA.
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.

---

CRS-12
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. Over several years following passage of the BBA, Congress
essentially reversed course, increasing Medicare payments on multiple occasions to
ensure adequate reimbursement for health care providers — under the Balanced
Budget Refinement Act of 1999 (BBRA, P.L. 106-113); the Medicare, Medicaid, and
SCHIP Benefits Improvement and Protection Act of 2000 (BIPA, P.L. 106-554); and
the MMA. More recently, the Congress cut payments for various Medicare services
under the Deficit Reduction Act of 2005 (DRA, P.L. 109-171).
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.
Changing Tax Policy
A third broad direction — changing tax policy — focuses more on consumers,
compared with strategies to change health care or federal programs. The tax code
currently includes a variety of subsidies to help individuals and families pay for
health insurance and health care. Limiting tax expenditures generally has not been
a policy priority, although recent debate has emphasized policy approaches that seek
to influence consumers’ use of health care by making them more price-sensitive.
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-

---

CRS-13
sponsored plans.24 With the annual cost of such plans averaging $4,024 for
individuals and $10,880 for a family of four in 2005,25 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 tax exclusion for employer health benefits provides
the largest savings to those who least need assistance: high-income workers who
face high marginal tax rates.
To address issues regarding demand and equity, policymakers and analysts have
proposed various changes to tax subsidies for insurance, including limiting the
exclusion for employer-provided benefits, increasing tax benefits for high-deductible
health plans, and offering tax credits for the purchase of nongroup health coverage.
Two of these approaches might influence health care spending by changing
demand for health insurance and health care. Limiting the exclusion for employer-
provided benefits could affect the type of coverage employers provide, and it could
reduce employees’ demand for policies that are generous compared with the tax
threshold. Similarly, increasing tax benefits for high-deductible plans (and
associated savings accounts) may change consumer preferences regarding health
coverage. In both cases, the assumption is that people with less generous coverage
will use less health care.
The third approach, offering tax credits for the purchase of nongroup coverage,
is more about making insurance affordable than it is about influencing health
spending. Depending on the details, such 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
subsidizing insurance coverage that can reach a larger population.
Potential disadvantages of tax credits relate to affordability and access. Even
healthy people may find that credits of $1,000 or more are not enough to make
insurance affordable. In addition, because of their health or risk profile, some people
may not be able to purchase nongroup coverage at any price.
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
24 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.
25 The Kaiser Family Foundation and Health Research and Educational Trust, Employer
Health Benefits, 2005 Annual Survey. Annual premium costs include both employer and
worker contributions.

---

CRS-14
demand, prices, and spending. They also provide larger benefits to taxpayers in the
highest brackets.
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.26 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?
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.
26 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.

---