Why Health Care Reform is Critical for the U.S. Economy


Article below is from Fidelity's Website


BY Dirk Hofschire, Fidelity's Vice President of Market Analysis, Fidelity
Viewpoints — 08/17/09

Editors' note: The editors of Fidelity Interactive Content Services (FICS) chose this article for its detailed insights into how health care spending could affect U.S. investments over the long term.

The current debate on health care proposals in Washington, D.C. has generated a myriad of opinions on the scope of health insurance coverage and the role of government versus private sector providers. The one issue most sides of the debate agree on is that health care costs are too high and rising too quickly.

Rate of health care spending is unsustainable

Health care expenditures have risen at more than twice the pace of overall inflation since 1970, more than doubling their share of the economy during that period.1  Even adjusting for the size of its economy and population, the United States spends far and away more money on health care each year than any other country in the world. In fact, health care spending makes up 15.3% of the U.S. economy (Gross Domestic Product) compared to an average 8.8% for developed countries (see Exhibit 1).

Many critics of the U.S. health care system point to data that show aggregate health statistics, such as life expectancy or infant mortality, are worse in the United States than other developed countries despite the extra expenditure. However the quality of care is evaluated, the fact that the United States spends 35%-50% more on health care than other advanced countries—with U.S. costs rising more rapidly—means some entity must pay for those increasingly burdensome expenses.

This is the essence of the problem: health care costs are rising more quickly than GDP, tax revenues, business sales, employee wages or any other measure of national, public, or private incomes. At this pace, health care will continue to consume an ever larger share of public and private sector resources. Whether the burden ultimately falls on the government, private businesses, or individuals, it represents a large expense with inflation rates that are unsustainable.

Who will shoulder the burden?

Consider the government budget. At current rates of health care inflation, spending on Medicare and other programs would overwhelm the government budget in the years to come. Under current policies, government spending on health care is projected by the Congressional Budget Office to rise to more than 18% of GDP per year over the next 75 years. To put this into perspective, 18% of GDP is the average annual amount the government has collected in tax revenue since World War II to finance its entire budget.3  While the aging of the baby boomer population does exacerbate the spending crunch over the next couple of decades, runaway health care cost inflation is a much bigger contributor to putting health care spending on an unsustainable path (see Exhibit 2, below).
Exhibit 2

Moreover, as health care inflation continues to outpace the growth in incomes, Medicare taxes will become insufficient to support the increased spending levels. Almost all of the increase in Medicare spending over the next several decades is an unfunded liability, meaning if current policies are to be maintained an increasing amount of revenue would have to come from other sources (i.e., higher taxes or diverted spending from other federal programs). However, the runaway numbers are simply too large to plug, with Medicare's unfunded component rising to an estimated 5% of GDP by 2050 (see Exhibit 3, below). To fund this amount, overall government tax revenues would have to increase by nearly one-third (which could be devastating to economic growth) or spending cuts equivalent to the entire defense department budget (itself the largest non-entitlement government spending program) would have to be enacted.

Exhibit 3
Businesses are in no better position to absorb this cost inflation than the government. The Detroit automakers lost their cost competitiveness due more to the rising cost of supporting retirees—and particularly their health benefits—than to current wages. Large domestic-based firms facing competition from foreign companies, which in many cases do not provide health benefits, suffer from this cost disadvantage. Small business surveys routinely cite the high cost of providing health care as a major impediment to expanding employment.

Individuals will also find it difficult to shoulder more of the health care burden. Many studies show wage gains for U.S. workers have been slowing due to employers spending an increasingly large proportion of compensation on rising health care costs. Personal income growth had not kept pace with inflation this decade even before the latest rise in unemployment, and health issues remain a leading cause of personal bankruptcy.

Some type of reform is necessary

The only way out of this unsustainable path is to reduce the rate of health care cost inflation. Overall, the system needs to provide more information about the quality and cost of care, particularly to patients who rarely experience the actual cost of procedures and as a result have no incentive to be cost-efficient. Some experimentation may well be necessary to determine effective solutions, and 2009 health care reform may only be the first step in an ongoing process.

However, there are several ideas broadly supported by economists and independent experts to help contain costs. For example, one idea is to institute methods to pay providers for positive outcomes as opposed to the current fee-for-service model (that pays providers on the number of procedures). Limiting the open-ended tax exclusion to employment-based health care is another. Other ideas range from allowing the government to negotiate lower pharmaceutical prices for Medicare to placing ceilings on malpractice awards. What is clear is that changing nothing now will merely mean the inevitable future changes will be more wrenching.

Investment implications

Americans have strong opinions about health care policy, and the ongoing political debate traverses a multitude of practical, ethical and ideological considerations. For investors, however, there is one clear issue to follow—cost inflation. The current unsustainable growth in health care spending and its burgeoning share of the government budget could negatively impact the economy through higher interest rate and tax rate pressures. Rising health cost burdens on American businesses could place them is an increasingly disadvantageous position versus many of their foreign competitors. Investors should be rooting for policy solutions that limit health care inflation to provide a better economic backdrop for U.S. securities in the years to come.

© 2009 Fidelity Investor's Publications

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