Until recently, the conventional wisdom among economists was that the cost of medical care always outpaces growth in the general price level. That’s the main reason why healthcare as a percentage of total federal spending (excluding interest) is expected to grow from 24 percent now to 38 percent 25 years from now. Along with an aging population, skyrocketing medical costs are behind the Congressional Budget Office forecast of unsustainable federal deficits. Some scholars believe that the heavy burden of healthcare costs on the U.S. treasury will result in “financial Armageddon.”
But as the figure below shows, recent developments give us some reason to be less pessimistic. Medical inflation has slowed considerably in the last decade compared with prior decades. It has also slowed in the last year compared with recent years. In 2013 the rate of medical inflation was 2 percent, down from 3.2 percent in 2012. The Bureau of Labor Statistics reports that the 2013 increase was the smallest since 1949.
Source: Bureau of Labor Statistics http://data.bls.gov/timeseries/CUUR0000SAM?output_view=pct_12mths.
The CBO's projection of future medical inflation is based on a weighted average of prior inflation rates, with greater weight placed on the most recent data. If the CBO maintains this approach and medical inflation continues at a snail’s pace, the CBO’s projections of future Medicaid and Medicare spending will decline gradually. Because the decline is gradual, these changes may not grab a lot of press attention. Nevertheless, a small but lasting change in medical inflation can have huge implications. In its latest report on long-term deficits, the CBO estimates that if the cost of healthcare grows at an annual rate just 0.5 percent below the rate it is now assuming, federal debt in 2038 will be 94 percent of GDP—14 percentage points below the 108 percent of GDP estimate in its baseline projection.
So the big question is, will medical inflation at historic lows persist?
Economists are more than a little uncertain. At a September 17, 2013, press briefing, CBO Director Doug Elmendorf provided three reasons why the slow growth in medical costs could continue, saying that (1) the recent decline in costs has occurred across all geographic regions and all types of medical care; (2) the low rate of growth has persisted for more than five years; and (3) the decline does not appear to be related to the recession, because the decline in spending growth has occurred even in Medicare, which is considered to be well insulated from economic conditions.
On the other hand, Elmendorf noted that there were three reasons why medical inflation may be temporary. He said that (1) prior slowdowns in medical inflation have not been harbingers of a permanent decline; (2) innovation of medical technology is still vibrant, and technological advances in the past have added significantly to medical inflation; and (3) Medicare remains a fee-for-service program in which providers have incentive to increase costs.
Outside the government, many experts believe there could be a permanent slowdown in healthcare inflation. In a May 2013 article, four Harvard Medical School researchers expressed “cautious optimism that the slowdown in the growth of health spending may persist—-a change that, if borne out, could have a major impact on U.S. health spending projections and fiscal challenges facing the country.”
Of course, such hopeful forecasts may never be realized. The current slowdown we are experiencing may just be the eye of a storm of exploding healthcare costs for an aging, high-tech society. But maybe—just maybe—as when oil prices unexpectedly declined in the 1980s, or as when the unforeseen dot-com boom of the late 1990s catapulted stock market wealth to unprecedented levels, America’s politicians may have their deficit problems solved for them--this time by moderating growth in medical spending.