Home > Health Care Policy, Obamacare > An Analysis of Obamacare Part IV: Obamacare and the Government Deficit

An Analysis of Obamacare Part IV: Obamacare and the Government Deficit

I previously argued that the newly-passed health care bill, dubbed Obamacare, will likely raise health care expenditures faster than they would have otherwise grown.  Here I discuss the question of the impact of Obamacare on the federal government deficit.

Is Obamacare Deficit-Neutral?

One of the defenses of Obamacare by its advocates is that the program will not raise the government deficit or may even lower the deficit.  This is almost certainly incorrect for the following reasons.

One of the more remarkable aspects of the computation used to gauge the impact upon the deficit is what is left out of the computation.  As observed by Douglas Holz-Eakin, a former director of the Congressional Budget Office (CBO) in a New York Times blog post, the deficit computation does not include the cost of administering the program by the government. Note that this is not a criticism of the CBO.  Their job is to play by the rules created by Congress.  If the rules lead to an exercise in fiction, the CBO carries out an exercise in the writing of fiction.  So from this point of view, a more sensible measure of the effects of Obamacare is that it will raise the federal government’s deficit.  But it is actually worse than this.

One additional source of “funding” for the program is the so-called “doctor fix” that is associated with Medicare.  Medicare has built-in reductions in payments to doctors who treat Medicare patients.  These reductions may cause doctors to refuse to treat Medicare patients so Congress passes legislation to stop the payment reductions.  If the spending reductions are made, that is, if the “doctor fix” does not occur, this frees up resources to be used to pay for the new health bill.  However, it is well understood that the “doctor fix” is likely to be passed again, removing this source of financing for Obamacare.

Further, an additional source of funding for Obamacare is the assertion that there will be $500 billion dollars in savings that can be generated from the existing Medicare program.  It has been noted by many individuals that the administration has “double-counted” these alleged savings, suggesting that the savings would help with the solvency of Medicare, and that the savings would also help to pay for his new health plan. Obviously one cannot have it both ways.

Finally, the health care bill starts tax increases sooner than it starts most of the payments that the government will make.  Roughly speaking, there are ten years of tax increases and about six years of spending.  Measure taxes and spending each over a ten year period, and one suspects that the deficit will grow.

The bottom line is simply that Obamacare almost certainly raises the government deficit.  By how much?  Estimates vary but there are estimates in the range of $100 Billion to $250 Billion per year but these predictions are unlikely to be very precise.

The Government Budget Constraint

The federal government does indeed have a budget constraint and it is given below.

Spending + Interest Payments + Net Transfer Payments = Tax Revenue + Government Bond Issue

The left-hand side of the expression records the uses of government funds while the right-hand side measures the sources of government funds.  The federal government buys goods and services, it pays interest to bondholders who purchased government debt, and it makes transfer payments to individuals.  The government receives income tax revenues from households and corporations (there are other minor tax sources as well), and, if it is running a deficit where spending exceeds its tax revenues, the government will borrow, selling bonds to the public.  With few exceptions, in the last 40 years, the government has run deficits of varying sizes.

Payments to Social Security and Medicare recipients are in net transfer payments.  Spending on Social Security and Medicare will rise significantly due to the changing demographics of U.S. society.  The 2009 estimate of the unfunded liabilities by the trustees for these two programs is $45.8 Trillion!  That is about three years of U.S. GDP in current dollars. This number is an estimate of the dollar value today of future payments (the time span is 75 years) that Social Security and Medicare must make that have no existing funding source.  All else the same, this number gives you some idea of how much borrowing is implied by this calculation.  For comparison with this number, total federal government receipts in 2007, the year before the latest U.S. recession began, were $2.66 Trillion and the latest U.S. spending figure is about $3.6 trillion dollars for the most recently completed fiscal year.  With these numbers in mind, how would you feel about lending to the U.S.?  Does it strike you that the U.S. can keep the promises that it has made to Social Security and Medicare recipients?  It is hard to believe that those promises can be kept without substantial tax increases levied on the working population.

A more revealing way to describe the government budget constraint is in a form equivalent to what was written above.  This alternative form simply states that sooner or later, government spending must be paid out of tax revenues.  Equivalently, deficits today must be matched by surpluses tomorrow.  How will those surpluses arise?

One way is through economic growth.  As the economy grows, real incomes rise and so do tax payments.  Most economic observers do not expect economic growth to be large enough to cover all of the future liabilities of Social Security and Medicare.  Ultimately, U.S. taxpayers, present and future, must therefore foot the bill.  And given the size of the unfunded liabilities that we have, those increases in tax payments must be substantial, say a doubling of tax revenues or more.  Will taxpayers agree to this?  Your guess is a good as mine on that score.

How Much Borrowing Can the U.S. Do?

The public should now be well-aware of the size of the U.S. deficit because of media reports.  It is larger, as a share of GDP, than it has ever been in the post World War II period.  When we talked about the deficit today being financed by surpluses tomorrow, we implicitly assumed that the government could find lenders willing to lend whatever amounts the government wishes to borrow.  In fact, no economist can tell you just how much borrowing can be done or, equivalently, at what point lenders will lend no more.

It has been reported in the media that the Chinese are holding dollar-denominated financial assets of over $2 trillion.  The Chinese government has already expressed their concerns about U.S. government spending, receiving assurances from various U.S. government officials (the Treasury Secretary and the President among others) that U.S. spending was not out of control.  Are those assurances credible?  The recent passage of Obamacare suggests that they are not.  The credit rating of U.S. government debt has recently declined, implying that higher interest rates will need to be offered to induce people to lend to the U.S. government.  Higher interest payments imply even more debt issue to come up with the additional funds to make those additional interest payments.  Ultimately, insolvency may result if politicians are unwilling or unable to raise taxes sufficiently or reduce spending to generate a decline in government borrowing.  What exactly is insolvency?

It is simply a situation where the government runs out of money and grinds to a halt.  And if this does occur, there will be a temptation to pressure the Federal Reserve System to print money to cover or monetize the deficit.  Doing so will just create even more trouble for the U.S. since printing money will cause inflation.  Ben Bernanke, the current chairman of the Federal Reserve System, is well aware of the economic implications of money creation and has urged the Congress to reduce its deficit.

Final Thoughts

Obamacare will almost certainly cause a substantial increase in the government deficit.  A deficit-reduction committee has been created to make recommendations about how the deficit can and should be reduced.  Watch for their recommendations.  If Obamacare is really deficit-neutral, there will be no mention of Obamacare in their report but I am expecting that it will be prominently discussed.  That report will be very good empirical evidence indeed about Obamacare’s impact on the federal government deficit.

Next Up: Obamacare and the Structure of the U.S. Economy

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