Running the numbers

A major argument presented by Democrats in support of Obamacare, along with extending coverage to uninsured people and preventing unfair treatment from insurance companies has been that we need to reduce the rate of growth of medical costs. Obama cited the statistic that medical expenditures are growing at 6% annually, about 50% more than inflation. The National Health Statistics Group at the Centers for Medicare and Medicaid Services reported in March that expenditures in the United States on health care surpassed $2.2 trillion in 2007, more than three times the $714 billion spent in 1990, and over eight times the $253 billion spent in 1980. With annual population growth over that period running at 1.3% that does represent a 6% growth in per-capita medical costs.

Why would medical costs rise faster than the cost of other things, like bread or cars or clothing? There are several reasons.

One is that the demographics of the nation have changed. The percentage of the population over the age of 65, who account for a large portion of medical expenses, has increased from 9.8% in 1980 to 12.7% today. That number continues to increase as the baby boomers reach retirement.

A more fundamental reason is that the medical services you buy today are not the same as the ones you bought in 1980. The advances in diagnostics, treatments, medications, and surgical procedures are staggering, and those advances are expensive. Bread, on the other hand, has not changed much. Thus it is not an apples-to-apples comparison. In circa 1980 health care was available today, it would certainly cost much less than modern health care, but there is not much call for outdated medical care.

Notice that these two factors are interconnected. As medical care improves, longevity increases and the number of elderly people consuming large amounts of medical services increases.

The cost of malpractice insurance and defensive medicine is another driver of medical cost inflation.

A key argument in Obama's speech on Wednesday was that Obamacare would save money in the long run by reducing the growth rate of medical expenses. Because government currently pays nearly half of the nation's medical costs, controlling those costs is essential to controlling the Federal budget. He said "If we do nothing to slow these skyrocketing costs, we will eventually be spending more on Medicare and Medicaid than every other government program combined. Put simply, our health care problem is our deficit problem. Nothing else even comes close." This is completely true.

Where he gets fuzzy is when he addresses this problem by increasing the portion of medical costs paid by the government in the hope that those very real costs will be offset by nebulous future savings which may or may not materialize.

“And if we are able to slow the growth of health care costs by just one-tenth of 1 percent each year -- one-tenth of 1 percent -- it will actually reduce the deficit by $4 trillion over the long term.”

I wanted to see if this was a reasonable claim, so I ran the numbers.

In 2009, the population of the United States is 307 million and the per-capita cost for medical care is roughly $7996. The total cost for medical care is $2.455 trillion, of which government pays $1.1 trillion.

According to Pelosi's estimates, which are exceedingly rosy, Obamacare would increase the portion of total medical costs paid by government from 45% to 50%. Any time the government has a big pot of money to give away, you can count on there being more takers than projected, so I expect a much larger increase, but we'll just go with her number.

Over time the objective is to see the lower growth rate make up for the immediate cost of the increase in the government-paid portion of medical costs. The only problem is that it doesn't. In the first year, the government spends $122 billion more than it would have spent, and the additional cost increases every year until 2106. Instead of reducing the deficit by $4 trillion, Obamacare increases the deficit by $23 trillion in 2009 dollars. Much more in nominal dollars.

If we have to wait nearly one hundred years for the benefit to outweigh the cost, that's not much of a payback.

If we assume that Obamacare will slow the growth of medical costs by twice as much as Obama suggests, the savings would outweigh the cost in 2065, but it would take another 28 years to recoup the cost from the first 55 years.

In any case, there is no reason to believe that Obamacare will result in any fundamental reduction in the long-term growth rate of medical costs. Obama claims that they will achieve some savings by improving efficiency and eliminating waste, but in the unlikely event that those are actually realized, they are one-time savings, not permanent reductions in the rate of growth which will compound year after year.

One can still argue that the benefits of extending coverage to more people is worth the cost, but Obama's attempt to tie Obamacare to the financial crisis by suggesting that his plan will reduce the deficit is just more misdirection. Obamacare is not fiscally responsible. It is just more runaway government spending.