November 2012, Week 2


Options: Use Monospaced Font
Show Text Part by Default
Show All Mail Headers

Message: [<< First] [< Prev] [Next >] [Last >>]
Topic: [<< First] [< Prev] [Next >] [Last >>]
Author: [<< First] [< Prev] [Next >] [Last >>]

Print Reply
Portside Moderator <[log in to unmask]>
Reply To:
Mon, 12 Nov 2012 00:41:57 -0500
text/plain (445 lines)
Fed Budgetary Experts Demolish CBO Health Cost Model,
the Lynchpin of Budget Hysteria
Yves Smith
Naked Capitalism
November 4, 2012

A remarkably important and persuasive paper that calls
into question the need for "reforming" Medicare has not
gotten the attention it warrants. "An Examination of
Health-Spending Growth In The United States: Past Trends
And Future Prospects" (hat tip nathan) by Glenn Follette
and Louise Sheiner looks at the model used by the
Congressional Budgetary Office to estimate long term
health care cost increases. Bear in mind that this model
is THE driver of virtually all forecasts of future
budget deficits.

This paper, although written in typically anodyne
economese, is devastating in the range and nature of its
criticisms. And the reason this assessment should be
taken seriously, independent of the importance of the
issues it raises, is that the authors are uniquely
qualified to make this critique. Follette is chief of
the Fed's fiscal analysis section. Sheiner, a fellow
member of that group, has worked for both the Treasury
and the Council of Economic Advisers previously. In
other words, the sort of analysis they have made here is
the core of what they do on a daily basis.

The argument made by the opponents of the plans to cut
Social Security and Medicare generally take this form:
concerns about Social Security are greatly exaggerated.
They are based on long-term forecasts, which are
notoriously inaccurate in outlying years. The most
commonly cited, by the Trustees of the Social Security
system, projects the exahustion of the famous trust fund
in 2033. As several analysts have observed, if Social
Security really has a problem, we'll know it in plenty
of time; there's no need to do anything immediately.

By contrast, conventional wisdom is that Medicare does
have a long term cost predicament, but the problem is
not demographic, but that of the steep rise of health
care costs in general.

The fundamental beef of Follette and Sheiner with the
CBO model is that it naively assumes past growth in
health care spending as the basis for its long-term
projections. The result is that it shows that trees will
grow to the sky. One of the things anyone who has build
forecasting models will tell you is you come up with
assumptions that look reasonable and then sanity check
the output (for instance, does your model say in year 10
that your revenues will be 3x what you can produce given
your forecast level in plant and investment? If so, you
need to make some revisions). The Fed economists point
out numerous ways that the model output flies in the
face of what amounts to common sense in the world of
long term budget forecasting. From the opening of the
paper (emphasis ours):

    Long-run projections of the U.S. federal budget have
    played a prominent role in discussions about fiscal
    policy and the design of major transfer programs for
    several decades. The projections typically show
    large fiscal imbalances owing to ramping up of
    retirement and health care costs relative to GDP.
    Health care costs are the key factor in these
    projections for two reasons. First, in current
    projections they are the prime source of growth of
    spending as a share of GDP. Second, they are the
    most uncertain part of the forecast. For example,
    the Congressional Budget Office's most recent long
    run outlook shows spending on Medicare and Medicaid,
    the governments health programs for the old and
    poor, respectively, rising from 4.1 per cent of GDP
    in 2007 to 19.1 per cent of GDP in 2082.1 By
    contrast, Social Security benefits (the government's
    main old-age pension program) increase only 2
    percentage points, from 4.3 per cent of GDP in 2007
    to 6.4 per cent in 2082. Another analysis by CBO
    suggests that an 80 per cent confidence band around
    the Social Security projection would be from 51/2 to
    91/2 per cent of GDP.2 CBO did not present similar
    calculations for health spending; instead, they
    projected health spending under three different
    assumptions about the rate of growth of age-adjusted
    health care spending in excess of per capita income.
    Their projections show health spending ranging from
    7 to nearly 40 per cent of GDP by 2082.

By comparison, defense spending as a percent of GDP
peaked at 42% of GDP in World War II. A model that
presents as a possible outcome that the US will devote
nearly 40% of GDP to health care spending a long-term,
sustained outcome, is ludicrous on its face. The CBO
assuming public health care spending will sustain its
growth rate of the last 50 years for as long as they do
(see further discussion below) with no policy changes is
like budget analysts in 1946 assuming that military
spending will grow at the same rate it did during World
War II without any policy changes. Yet they further
assume that, having reached this crushing level,
Medicare costs in 2082 will still be growing faster than

The underlying issue is that nothing that is a large
portion of GDP can exceed the growth rate of GDP
forever, or even for all that long; that's how we've
gotten in the insane position of having health care
reach 16% of GDP. The term of art is "excess health care
spending growth" which as noted above, they define in
relationship to per capita incomes. The Fed economists
make the following observations in their paper:

1. Given the concern about health care cost escalation,
and the pressure being exerted now by employers to
contain these costs, as well as the fact that other
advanced economies have shown declines in excess costs,
the growth assumptions look very aggressive. Moreover,
the excess growth took place during a period when
government and private health care insurance expanded
greatly. In 1960, out-of-pocket spending was 52% of
medical spending; by 2006, it had fallen to only 13% by

Follette and Shiener also looked at the composition of
cost drivers and argued that certain key ones will

    Accordingly, 1.1 percentage points of the
    [historical] 2.2 percentage points of age-adjusted
    excess growth over the period resulted from
    technological change and other factors and 1.1
    percentage points reflected the effects increased
    insurance coverage and administrative costs.16 The
    historical data therefore support excess growth of
    1.1 per cent per year if we assume that out-of-
    pocket costs do not decline further and that
    administrative costs (as a share of expenditures) do
    not rise further. However, demand should fall short
    of this as consumers respond to rising health bills.

The Fed economists separately find that excess growth
has averaged 2% over the last 40 years but has been
slowing and argue that 1% excess growth is a likely
upper bound for the long term average. They posit that
excess growth of 2% can be maintained for only a few
years at most because consumption as a percentage of GDP
is anticipated to fall (this is in the CBO's own models;
it's mainly the result of the trade deficit falling). By
contrast, the CBO assumes 2.4% excess growth for
Medicare and 2.2% for Medicaid over the next decade,
falling monotonically to 1.1% for Medicare and 0% for
Medicare by 2082. If you've ever run financial models,
you'll know that goosing the growth rates in the early
years has an impressive impact on the final result.

2. The CBO model produces the peculiar result that
government funded plans will show faster cost growth
than private plans. From the article:

    Our chief concern with their projection is their
    assumption that per capita spending by Medicare
    grows much more rapidly than that of the private
    sector. The projected divergence seems inconsistent
    with the underlying assumption that policies are
    unchanged because Medicare and private sector
    insurance plans have had similar payment rates

3. The Fed budget experts note that the CBO analysis
violates the requirements for CBO budget projections.
The CBO is tasked to forecast assuming no policy
changes. But in simply relying on historical trends,
which as noted above include considerable expansion of
government-funded health coverage, they have effectively
incorporated the hidden assumption of continued
expansion. Put it another way, the forecasts should have
explicitly backed out the impact of historical increases
in health insurance coverage to arrive at a true
baseline growth rate. Per Follette and Sheiner:

    The lack of distinction between policy and other
    factors is a particular problem because CBO uses
    different excess cost growth assumptions for
    Medicare, Medicaid, and other health spending, and
    the CBO projection is supposed to be under the
    assumption of no policy changes. Past Medicare
    spending growth includes factors that are not
    assumed to continue in the future. For example, the
    Medicare Part B premium was not previously indexed
    to Medicare spending; thus Medicare spending growth
    grew faster than overall health spending, as
    Medicare picked up a higher share of spending.
    Similarly, Medicare policies changed to include
    renal dialysis, HMOs, coverage of the SSI
    population, and more broadened coverage of home
    health care. As CBO is not assuming further
    expansion of Medicare, it does not seem reasonable
    to forecast future growth based on historical growth
    rates that include such expansions. Similar issues
    arise with Medicaid.

4. Follette and Sheiner find that, contrary to
conventional wisdom, that more realistic health care
cost assumptions allow for some improvements in coverage
to low income groups, provided government coverage to
the better off is not increased further:

    We find that a narrow expansion of assistance to the
    lowest quintile would have only minor consequences
    to government finances but more broad-based programs
    would have materially deleterious effects.

* * *

The CBO's performance on this front looks like
malpractice. The Fed economists note telling
irregularities, such as the substitution of scenarios,
as opposed to the use of confidence band analysis, as
the CBO employed in its Social Security forecasts. And
this would not the first time that CBO has apparently
allowed political considerations to interfere with its
pretense of objectivity. First we have the case of CBO
analyst Lan Pham, who was fired for attempting to
incorporate the impact of foreclosures and chain of
title issues on home price and property tax forecasts.
Second, we have the instance of Tom Ferguson and Rob
Johnson of alerting the CBO to a significant omission in
their deficit analysis, that of failing to include
financial assets in their debt-to-GDP ratio calculation.
CBO staffers have not disputed the accuracy of the
Ferguson/Johnson research but nevertheless will not
change their projections. Now we have what is
demonstrably an overly aggressive set of assumptions
driving health policy debate, with two Federal Reserve
analysts sufficiently taken aback by the model as to
publish a serious takedown of it.

The CBO's independence is, like its output, treated as
above question. It's time to subject both to harsh

The Lady Doth Protest Too Much: CBO Director Asks for 
a Chat Regarding Our Post on Their Questionable Health 
Cost Increase Model
Yves Smith
Naked Capitalism
November 11, 2012

As regular readers may recall, last Monday, we put up a
post titled "Fed Budgetary Experts Demolish CBO Health
Cost Model, the Lynchpin of Budget Hysteria." We
received a voicemail and a related e-mail Wednesday
morning. This is the text of the e-mail:

    Greetings, Susan.

    I am following up on my voicemail to see if we can
    arrange a time either today or sometime this week
    for you to speak with our director, Doug Elmendorf.
    He wanted to speak with you about your blog post
    that appeared Sunday on Naked Capitalism regarding

    I am copying Brianne Hutchinson, Doug's executive
    assistant, who will work with you to find a
    convenient time for the call. You can reach Brianne
    by e-mail or directly at:[xxx].

    We look forward to hearing back from you at your

    Kind regards,


    Deborah Kilroe Associate Director for Communications
    Congressional Budget Office 2nd and D Streets, SW
    Washington, DC 20515 [phone number and e-mail
    address omitted]

This was our reply, which went out in the wee hours of
Thursday morning:

    Dear Deborah,

    Thanks for your messages yesterday and sincere
    apologies for the delay in replying.

    While I am flattered that Director Elmendorf is
    interested in discussing my post, I must confess to
    being puzzled by the request. The piece is a write-
    up of a journal article by two economists working
    for the Federal Reserve Board. If the CBO objects to
    their analysis, those issues should be raised first
    with the authors. I would of course be willing to
    issue a new post if they were to modify their
    analysis after speaking with members of your staff

    The post also mentioned other matters relating to
    CBO which are in the public domain. One is Lan
    Pham's claim that she was directed to exclude
    information such as foreclosure trends and chain of
    title issues from her analysis of the outlook for
    the banking sector and the mortgage market and that
    her efforts to include this and other "negative"
    data led to her being fired. That is a very
    troubling charge, given that every private sector
    housing analyst has used trends in foreclosures as a
    significant input in their housing price forecasts
    since the crisis.

    The post also cited a paper by Thomas Ferguson and
    Robert Johnson on the CBO's forecasts of debt levels
    relative to GDP and the CBO's curious failure to
    present net, as opposed to gross, debt levels. I
    cited their Roosevelt Institute Working Paper; their
    paper was later published in the International
    Journal of Political Economy. I have been advised by
    an academic in my readership that the paper was
    brought to the attention of staffers at the CBO, who
    did not dispute the Ferguson/Johnson analysis but
    also indicated that the CBO would not correct its
    public reports. These three instances, taken
    together, point to a pattern of CBO acceding to
    Administration interests, so it is hardly far-
    fetched to question its independence.

    I have a policy of not entering into private
    conversations on published posts. If you feel a
    correction is warranted, please tell me why in
    writing. If you can substantiate factual
    inaccuracies, I will of course make either a
    correction of the existing post or issue an update,
    depending on the severity of any error.

    Thanks for your interest.



In other words, the CBO asked to have a conversation for
unspecified reasons, presumably because they were
unhappy about the post they mentioned. That's fine, but
they should make an argument, not try for private chats.
Yet after my request for them to present any objections
in writing so as to prevent misunderstanding and keep
personalities out of the mix, they've gone silent.

In addition, if they were confident in their analysis
and their lack of outside influence, why would they
bother dealing with noise from the peanut gallery? If
you are an analyst, you submit your presumed objective
view, and your client does whatever he does with it.

But to get a sense of what is at stake, if you read the
newest CBO document on the deficit, it is not a
dispassionate analysis of budget math alternatives. This
is an advocacy document. It has the tone, the use of
overly simplified language (below 8th grade level, which
is the level used to spoon feed journalists, as opposed
to higher reading levels that you see in other types of
reports. Contrast both the look and the writing style
with this FHFA Inspector General report, as an example:
text paragraphs, no nice bullet points and generous use
of white space, not much coddling of the reader).

A simple illustration: look at how this paragraph on the
first page is not an analysis of budgetary options,
which is the CBO's role. This shows the CBO pushing for
a particular set of outcomes (taking immediate steps to
reduce the deficit) rather than simply providing
analysis of the budgetary outcomes of specific
legislative actions (click to enlarge):

[moderator: please use the link above to view the 
referenced quote]

And to add insult to injury, it does not take much in
the way of investigation to debunk these unsubstantiated
arguments. Paul Krugman has already, in terse form,
shown how the usual economic models suggest than the
outcome of running continuing large fiscal deficits is a
weakening of the dollar rather than a rise in interest
rates. The CBO needs to explain their theory of monetary
policy and primary dealer behavior to explain how the
prices of Treasury bonds could collapse and cause a
fiscal crisis.

The evidence from the closest comparable to the US,
which is Japan in its post crisis era, in fact suggests
the exact reverse of the CBO fearmongering, namely, that
fiscal tightening in a post crisis economy is likely to
precipitate financial firm failures. The collapse of
Japan's real estate and stock market bubbles caused a
severe contraction in household consumption and private
investment spending which culminated in a brief real
contraction in 1994. Once the stimulus from the
expanding budget deficit began to work, real GDP growth
regained momentum.

By 1996, the same calls for austerity that we hear in
the US now led to increases in taxes. The contraction in
public spending on top of very fragile private sector
spending - akin to the situation that most nations face
today - caused a massive contraction in 1997 and 1998 -
which increased the budget deficit (via the automatic
stabilisers) and added to the public debt ratio (given
both debt was rising and GDP was falling). Most
importantly, it also led to a second wave of financial
firm failure, including one of the four biggest
securities firms in Japan, Yamaichi, as well as some of
its long term credit banks.

So if I had to guess, this would be the reason for the
CBO's peculiar anxiety. It knows it is going out on thin
ice and wants to rein in any inspection of its choice to
insert itself in the budget debate on the side of the


Portside aims to provide material of interest to people
on the left that will help them to interpret the world
and to change it.

Submit via email: [log in to unmask]

Submit via the Web: http://portside.org/submittous3

Frequently asked questions: http://portside.org/faq

Sub/Unsub: http://portside.org/subscribe-and-unsubscribe

Search Portside archives: http://portside.org/archive

Contribute to Portside: https://portside.org/donate