Finding a Way to Pay for Health Reform

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Expanding health insurance coverage to over 90% of residents is anything but cheap—the price tag on the House bill is $1.1 trillion while the cost of the Senate bill is only twelve digits --$848 billion. Legislators in the House and Senate have zeroed in on three basic ways to cover these enormous costs: (1) cutting health care expenditures, (2) reducing health care tax breaks, and (3) raising revenue with new taxes. The House and Senate largely agree on how to cut health care expenditures and reduce tax subsidies but take fundamentally different approaches to raising revenue. If the revenue provisions of the Senate bill do not significantly change before the final floor vote, a battle royale between the House and Senate over their differing revenue-raising philosophies may unfold in the days ahead.

Cutting Expenditures

Ideally health reform would be financed through measures to make the delivery system more efficient—by “bending the cost curve” (see the related article, "Delivery System Reform: Do the House and Senate Bills Deliver?"). But those measures are not projected to yield anywhere near the necessary savings in the crucial ten-year budget window in which legislation is scored, because most are gradually phased in through pilot programs and studies. As a result, in order to extract substantial health system savings, both the House and Senate are relying on straight cuts in Medicare and Medicaid payments. The most significant of these are: (1) adjusting “market basket” indices, (2) cutting Medicare Advantage payments, and (3) cutting disproportionate share hospital payments.

Productivity Adjustments. Both bills contain significant “productivity adjustments” to market basket indices that are used to update Medicare payment rates each year to keep pace with providers’ costs of providing services. The Senate bill achieves ten-year savings of $150 billion through a downward “productivity” adjustment (to account for economy-wide productivity gains) in the annual market basket increase in payments for nearly all providers other than professional providers. Included in this formula reduction would be payments for hospital inpatient and outpatient services, skilled nursing facilities, long term care hospitals, inpatient rehabilitation facilities, home health agencies, hospice care, dialysis, ambulance, ambulatory surgical centers, laboratory services, durable medical equipment, and prosthetics and orthotics. In addition, inpatient hospital services and home health services are subject to further market basket reductions on top of these productivity adjustments. The market basket adjustments in the House bill save slightly less, $131 billion, by making productivity-related cuts in many of the same service areas as the Senate bill, in addition to freezing updates in earlier years for skilled nursing and long term care facilities.
Medicare Advantage Payments. The largest health care spending cuts in the House bill are made to Medicare Advantage payments, saving $170 billion over ten years. The majority of these savings are derived from basing Medicare Advantage payments on comparable fee-for-service costs with bonus payments for quality. Although the Senate bill does not cut Medicare Advantage quite as deeply as the House bill, it does achieve $118 billion in savings over ten years by using the average Medicare Advantage plan bid rates in each market to set Medicare Advantage payment rates. In the first days of floor debate, the Senate rejected a Republican amendment that would have stripped a significant portion of these cuts from the bill.
Disproportionate Share Hospital Payments. Both bills extract savings through cuts to Medicare and Medicaid disproportionate share hospital (DSH) payments that are intended to support hospitals with the highest burdens of uncompensated care. On the theory that this burden will be reduced under health reform, the bills phase down DSH payments after coverage expands, although the Senate’s cuts are quicker and deeper than the House’s. The Senate bill cuts nearly $43 billion from DSH payments over ten years (about $22 billion in Medicaid cuts and $20 billion in Medicare), which is more than double the $20 billion over ten years (equally split between Medicaid and Medicare) cut by the House bill.

Reducing Tax Breaks

Even though health care represents one of the largest federal tax expenditures, the changes being proposed in this favorable treatment are both small in comparison to other cuts and a far cry from the proposals to eliminate the tax exclusion for employer-provided coverage that were once prominent in discussions of reform. Two of the larger cuts in health-related tax benefits are made to (1) health flexible spending arrangements and (2) the deductibility of medical expenses over 7.5% adjusted gross income (AGI). Both bills limit annual salary contributions to health flexible spending arrangements to $2,500, with scored savings of $13-$14 billion over ten years. Although the House bill does not change the deductibility of medical expenses over 7.5% of AGI, the Senate would increase the threshold to 10% of AGI (for individuals under 65 years of age), saving $15 billion over ten years.

Raising Revenue

The most fundamental difference between the financing provisions of the two health reform bills lies in their approaches to raising revenue. The Senate looks primarily to the health care system as the source of new revenue, while the House levies tax increases on the wealthiest Americans. Because of its higher price tag, the House bill must, and does, raise more revenue than the Senate bill: $561 billion over ten years as compared to $372 billion in the Senate. The House achieves this result primarily through a 5.4% surcharge on individuals with income in excess of $500,000 ($1 million for joint returns), which is expected to yield $461 billion over ten years.

In contrast, the Senate bill draws the majority of its revenue from a controversial 40% excise tax on the value of health plan coverage in excess of $8,500 for an individual ($23,000 for a family). This excise tax on so-called “gold-plated health plans" would raise $149 billion over ten years and, according to its supporters, would steer employers away from extravagant health plans that drive up health care spending, thereby redirecting those resources into higher salaries. (As an interesting side note, the excise tax is projected to raise the majority of its revenue from income taxes paid on increased salaries, not from revenue directly collected by taxing gold-plated health plans.) But opponents—most notably union groups that over the years have bargained for increased benefits at the expense of increased wages—fear that although the excise tax would be imposed on insurers, workers will ultimately absorb the cost in the form of decreased salaries or benefits.

The bills include a few other noteworthy revenue provisions, although of smaller magnitude. Both bills would impose a per-enrollee fee on insurers to finance comparative effectiveness research. The Senate would impose a $6.7 billion annual fee on health insurance plans, based on an insurer’s net premiums and third party administration fees. Both the House and Senate would impose new excise taxes on medical devices, although the Senate’s version would begin with 2009 sales rather than 2013 sales as in the House. The Senate would also tax sales of branded pharmaceuticals to certain government programs beginning after December 31, 2008. Finally, expect to hear rumblings about the so-called “Botax” in the Senate bill, which would impose a 5% tax on elective cosmetic surgery performed on or after January 1, 2010.

Given the Congressional leadership’s oft-repeated commitment to financing reform without increasing the deficit, tough choices on financing lie ahead, with few painless options on the table and the support of important constituencies hanging in the balance. While the Democratic caucuses in both houses struggle to reach consensus on this make-or-break legislation, the leadership faces a daunting challenge in finding the right mix of financing measures to pay for the bill. Stay tuned.