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Spending Wisely? Key Drivers of National Health Expenditure Increases and Policy Solutions

August 27, 2017

American healthcare has been a recent focus in both politics and the media, with much fanfare around the future of health reform. Woven into these discussions are questions about the rise in national health expenditures – if spending growth is significantly faster than economic growth, it may pose risks for consumers and for the nation as a whole. Here, an overview is provided of some principal drivers of growth in national healthcare expenditures, along with their impacts and policy proposals aimed at management.

A Macro-Level Look

Health expenditures in the United States amounted to $3.2 trillion in 2015 [4], and upwards of $3.4 trillion in 2016, with per capita expenditures breaching $10,000 in the same year. [1] Expenditures have steadily increased in their share of the US economy, from 5.0% of GDP in 1960 to 17.8% in 2015, and they are projected to approach 20% by 2025. In the same 2016-2025 period, health expenditure growth is predicted to outpace GDP growth by an average 1.2% per year. [2] [3] [4]

Additionally, healthcare spending is heavily skewed, with the top 1% of spenders accounting for over a fifth of total expenditures, and the top 5% accounting for nearly half. [5]

Images (clockwise from top left): Medical CPI, percent increase in NHE, health expenditures per capita, and healthcare as share of GDP. Sources: Wikimedia Commons.Images (clockwise from top left): Medical CPI, percent increase in NHE, health expenditures per capita, and healthcare as share of GDP. Sources: Wikimedia Commons.

Image: National Health Expenditures breakdown by service. Source: Kaiser Family Foundation.Image: National Health Expenditures breakdown by service. Source: Kaiser Family Foundation.

Associated with this increase in health expenditures’ share of the economy are concerns about affordability, both on the individual and national levels. On the individual level, premium growth (partially a response to healthcare cost increases) has outpaced wage growth. [6] This threatens the ability of individuals and households to pay for other goods and services, and can erode savings. On the national level, increased costs can reduce companies’ investments, raise prices, and depress employment. Additionally, increases in public spending can lead to increased government borrowing, which drives inflation; a reduction in government spending on other areas such as infrastructure and education; and an increase in taxes, which depresses growth and reduces income for households and companies. [7] As such, policies that encourage sustainable growth should be examined.

Key Spending Drivers and Associated Policies and Proposals

Medical Price Inflation

Increases in the cost of “input factors” are predicted to drive expenditure increases through 2025. [8] Examples of (hospital) input factors might include variable costs such as provider salaries and medical supplies, and fixed costs such as utilities and land. [9]

Perhaps an easy phenomenon to overlook, economy-wide inflation partially contributes to increases in input costs, and tracks well with medical inflation. According to the Kaiser Family Foundation, the economy explained over 85% of the variation in year-to-year health spending from 1965-2011. [10]

As such, monetary policy, controlled by the Federal Reserve Bank, will be instrumental in curbing future inflation (and by extension input cost increases) during this expansionary period. [11]

Fingers are often pointed by politicians toward the pharmaceutical industry, particularly at the high list prices of certain drugs, for rising medical prices. However, insurers and pharmacy benefit managers have succeeded in recent years in negotiating lower prices with pharmaceutical companies, and the chief driver of pharmaceutical spending increases is in fact the increased spending on specialty drugs. [12] Additionally, pharmaceutical spending’s share of national health expenditures is not predicted to increase drastically, projected to rise steadily to 10.8% in 2025 from 10.1% in 2015. [13]

Yet there are savings to be made in pharma still, with pharmaceutical expenditures increasing yearly: policy proposals targeting pharmaceutical expenditures include expansion of Medicare’s negotiation power, value-based pricing, increasing generic presence, and slowing utilization of specialty medicines. [14]

Hospital Market Structure and Hospital Charging Practices

Hospital merger activity has been high in the past decade: hospital systems claim these mergers increase synergies, efficiencies, and quality, though this claim is disputed by some. [15] It is also possible that mergers and hospital charge increases are a response to the aforementioned increases in input costs, as a measure to ensure the hospital remains operational.

Less controversial is the notion that hospital consolidation increases their leverage over also-merging insurers (who hope to negotiate lower prices), and allows for hospital systems to create regional mon- or oligopolies. This enables hospitals to charge higher list prices for the services they provide, and thus extract higher prices from (private) insurers, putting upward pressure on hospitalization costs and having downstream effects on premiums. Hospital chargemasters, which list prices of all hospital services, also demonstrate high levels of regional variation, with high opaqueness and little oversight. [16]

To combat the current, consolidating market, legislators can look to apply regulations and antitrust laws [17] [18], which would serve to ensure patients have choice in healthcare providers, and to prevent monopolistic price hikes. The move could also be a more effective method of slowing or reversing deficit growth, as it could lessen a phenomenon in which hospitals respond to cuts in Medicare/Medicaid by shifting costs to non-Medicare patients. This cost shift can actually increase government outlays, because it drives up insurance premiums and thus ACA subsidies. [19]

One proposal aimed at tackling charging practices concerns closing the information gap between patients and providers, by making prices more transparent to patients [20] and to the government, ostensibly as an attempt to introduce rationality. The proposal is popular among patient advocates, employers, and health plans; however, some evidence exists to demonstrate that the effect of this initiative may be limited, as patients can tend to equate price with quality, and they rarely bear the full cost of treatment. [21]

Hospital charges could also be targeted by the government. Proponents of single payer purport that national price regulation by an expanded Medicaid would have immense leverage over hospitals and would be able to negotiate low prices. [22] However, critics cite several issues with this practice, as it eliminates incentives for quality, leads to shortages in resources and in care, and harms competition and innovation among providers. [23]

Reimbursement Models

The fee-for-service (FFS) physician reimbursement model, in which providers charge fees for specific treatments and procedures, dominates in the United States. As payment is per-service, the model incentivizes providers to increase the volume and cost of services, but does not contain any incentives for coordination among doctors, leading to duplicative treatments and other inefficiencies that serve to drive up spending. [24] In addition to over-treatment, this duplication can lead to costly medical errors.

Broadly, policy hopes to move from promoting volume-based care to promoting value-based care, which can be accomplished through a number of coordinated care models. These include accountable care organizations (ACOs), where a network of health providers work together to coordinate care; or bundled payment initiatives like BPCI, where hospital payment is tied to a “bundle” or target price for an entire episode of care, rather than having each provider bill for his services. [25]

Employer-Sponsored Insurance

Employer-sponsored insurance, which covers approximately half of Americans [26], is treated as tax deductible for employers and is excluded for employees. Yet this tax deduction allows employers to offer generous plans, and encourages high utilization by employees. Additionally, the tax exclusion works regressively, with top income earners seeing the most benefits. In all, the exclusion costs the government $260 billion annually in lost revenues; imposing taxes would depress employer spending (and thus NHE), but at the cost of employee coverage levels. [27]

The “Cadillac tax”, a 40% excise tax on especially generous plans, was part of the ACA’s plan to combat these generous plans, but faced immense political opposition and will likely be delayed for years to come. [28]

Population Health

The United States’ population is aging (i.e. the share of individuals 65 and older is increasing relative to the number of individuals of working age), which will have implications on health spending in future years. An aging population will increase mandatory outlays for healthcare, and be responsible for over 52 percent of the growth in outlays for Medicare and other national health programs through 2027. [29]

In addition, chronic diseases account for 84% of national health expenditures and 99% of Medicare expenditures, and the number of Americans with chronic diseases is rapidly increasing. [30] Many of these conditions are preventable or behavior-based, so public health and education programs will be vital in the coming decades.

Student Blog Disclaimer
  • The views expressed on the Student Blog are the author’s opinions and don’t necessarily represent the Penn Wharton Public Policy Initiative’s strategies, recommendations, or opinions.



  [1] http://www.pbs.org/newshour/rundown/new-peak-us-health-care-spending-10345-per-person/

  [2] https://www.cms.gov/Newsroom/MediaReleaseDatabase/Press-releases/2017-Press-releases-items/2017-02-15-2.html

  [3] http://healthaffairs.org/blog/2015/11/23/national-health-spending-1960-2013/

  [4] https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/Downloads/highlights.pdf

  [5] http://www.kff.org/health-costs/slide/concentration-of-health-care-spending-in-the-u-s-population-2010/

  [6] https://www.pwc.com/us/en/health-industries/health-research-institute/behind-the-numbers/reports/hri-behind-the-numbers-2018.pdf

  [7] https://aspe.hhs.gov/system/files/pdf/75441/report.pdf

  [8] http://content.healthaffairs.org/content/36/3/553.full

  [9] https://www.advisory.com/research/financial-leadership-council/at-the-margins/2013/06/difference-between-cost-and-cost#lightbox/0/

  [10] http://www.kff.org/health-costs/issue-brief/assessing-the-effects-of-the-economy-on-the-recent-slowdown-in-health-spending-2/

  [11] http://www.businessinsider.com/federal-reserve-inflation-pce-cpi-healthcare-obamacare-epipen-problem-2016-9

  [12] http://www.reuters.com/article/us-health-usa-drugspending-idUSKCN0XB08Q

  [13] http://www.healthsystemtracker.org/chart-collection/recent-forecasted-trends-prescription-drug-spending/?_sf_s=recent+trends#item-start

  [14] https://publicpolicy.wharton.upenn.edu/live/news/1784-the-pharma-conundrum-pharmaceutical-spending

  [15] http://www.latimes.com/business/hiltzik/la-fi-hiltzik-healthcare-mergers-20160527-snap-story.html

  [16] http://www.healthcarepricingproject.org/sites/default/files/pricing_variation_manuscript_0.pdf

  [17] http://content.healthaffairs.org/content/23/2/25.full.html

  [18] http://insights.som.yale.edu/insights/why-is-healthcare-so-expensive

  [19] http://content.time.com/time/subscriber/article/0,33009,2136864-11,00.html

  [20] http://thehill.com/blogs/pundits-blog/healthcare/344523-we-need-to-treat-the-causes-of-high-health-costs-not-the

  [21] http://www.commonwealthfund.org/publications/newsletters/quality-matters/2012/april-may/in-focus

  [22] https://jacobinmag.com/2017/06/trumpcare-obamacare-repeal-ahca-single-payer

  [23] http://www.heritage.org/health-care-reform/report/legislating-low-prices-cutting-costs-or-care#_ftnref1

  [24] http://www.nejm.org/doi/full/10.1056/NEJMsb1302322#t=article

  [25] https://innovation.cms.gov/initiatives/bundled-payments/

  [26] http://www.kff.org/other/state-indicator/total-population/?currentTimeframe=0&sortModel=%7B%22colId%22:%22Location%22,%22sort%22:%22asc%22%7D

  [27] http://www.nber.org/aginghealth/2010no1/w15766.html

  [28] https://www.nytimes.com/2017/07/07/health/health-insurance-tax-deduction.html

  [29] http://cbo.gov/publication/43288

  [30] https://kaiserhealthnews.files.wordpress.com/2012/10/bpc_health_care_cost_drivers_brief_sept_2012.pdf


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