Congressional Budget Office
Director’s Blog

This evening, CBO released a preliminary analysis of a substitute amendment to H.R. 3962, the Affordable Health Care for America Act, proposed by Representative John Boehner, the Republican Leader in the House of Representatives. CBO and the staff of the Joint Committee on Taxation (JCT) estimate that the amendment would reduce federal deficits by $68 billion over the 2010-2019 period; it would also slightly reduce federal budget deficits in the following decade, relative to those projected under current law, with a total effect during that decade that is in a broad range between zero and one-quarter percent of gross domestic product.

That amendment contains several provisions that are intended to increase rates of insurance coverage by reducing its costs or subsidizing its purchase, including:

• Regulatory reforms in the small group and non-group markets, including establishing association health plans (insurance coverage that is offered to members of an association) and individual membership associations, and allowing states to establish interstate compacts with a unified regulatory structure;
• A State Innovations grant program to provide federal payments to states that achieve specified reductions in the number of uninsured individuals or in the premiums for small group or individually purchased policies;
• Federal funding for states to use for high-risk pools in the individual insurance market and reinsurance programs in the small group market; and
• Changes to health savings accounts (HSAs) to allow funds in such accounts to be used to pay premiums under certain circumstances, to make net contributions to HSAs eligible for the saver’s tax credit, and to provide a 60-day grace period for medical expenses incurred prior to the establishment of an HSA.

CBO and JCT estimate that those provisions would increase federal budget deficits by about $8 billion over the 2010-2019 period, reducing the number of nonelderly people without health insurance by about 3 million in 2019 and leaving about 52 million nonelderly residents uninsured. The share of legal nonelderly residents with insurance coverage in 2019—83 percent—would be roughly in line with the current share.

Other provisions of the amendment would alter federal spending and revenues in significant ways. The key provisions include:

• Limits on costs related to medical malpractice (“tort reform”), including capping noneconomic and punitive damages and making changes in the allocation of liability;
• Requirements that the Secretary of Health and Human Services adopt and regularly update standards for electronic administrative transactions that enable electronic funds transfers, claims management processes, and verification of eligibility, among other administrative tasks;
• Establishment of an abbreviated approval pathway for follow-on biologics (biological products that are highly similar to or interchangeable with their brand-name counterparts); and
• An increase in funding for HHS investigations into fraud and abuses.

CBO anticipates that the combination of provisions in the amendment would reduce average private health insurance premiums per enrollee in the United States, relative to what they would be under current law-by 7 percent to 10 percent in the small group market, by 5 percent to 8 percent for individually purchased insurance, and by zero to 3 percent in the large group market.  Those are averages, however, and they are subject to a great deal of uncertainty; some individuals and families in each market would see different results.

In 2005, the National Flood Insurance Program (NFIP), administered by the Federal Emergency Management Agency (FEMA), experienced an unprecedented volume of claims resulting from hurricanes Katrina, Rita, and Wilma. Total payments on those claims were greater than the total for all of the program’s previous years combined and led the NFIP to borrow about $17 billion from the Treasury. The 2005 losses highlighted a number of factual and policy questions—discussed in a CBO paper released today—about the NFIP’s financial health, including the actuarial soundness of the premium rates charged on policies that are not explicitly subsidized and the cost of paying claims for properties that have suffered multiple flood losses.

As of July 31, 2009, the NFIP had 5.6 million policies, with a total insured value of $1.2 trillion and total premiums of $3.1 billion. For most of those policies, about 80 percent, FEMA charges “full-risk” premium rates, which it considers to be actuarially sound (that is, sufficient to cover the expected value of flood claims and administrative costs). About 20 percent of the premium rates are explicitly subsidized under current law; those explicit subsidies give the NFIP a built-in actuarial deficit of about $1.3 billion per year, by CBO’s estimate. Those policies mainly cover older structures in areas at high risk of flooding.

Are FEMA’s full-risk premium rates actuarially sound?

Historically, the NFIP’s full-risk premiums have been too low to cover the flood claims and administrative costs of the policies insured at those rates. Between 1978 and 2004, premiums for such policies totaled $10.2 billion in nominal dollars, while claims and expenses totaled $10.7 billion. The result was a loss of $0.5 billion over that period on policies with full-risk rates. Taking into account the large losses of 2005, income was about half of costs over the 1978-2006 period—total premiums were $12.6 billion while claims and expenses were $24.2 billion.

Previous experience does not necessarily imply that current premium rates are too low, however, because rates have risen over time and because the frequency of future catastrophic years like 2005 is highly uncertain. In part because of that uncertainty, CBO does not have enough information about the current distribution of flood risks to calculate whether the present full-risk premiums are actuarially adequate.

Further, analyzing the methods that FEMA uses to set the full-risk rates also does not provide definitive answers. Some aspects of those methods tend to contribute to an actuarial surplus—the primary one being the additional 10 percent that FEMA includes in the rates in high-risk areas (20 percent in high-risk coastal areas) as a safety margin for uncertainty. Other aspects of the agency’s rate-setting methods tend to contribute to an actuarial deficit. FEMA is not reviewing its flood maps every five years as required by law, and some older maps do not reflect significant changes in local conditions, such as coastal erosion, which can increase the probability of flooding. In addition, evidence suggests that climate change has increased the risk of flooding from rivers and perhaps also from coastal storms, making FEMA’s models of flood frequencies out of date. Those issues may warrant attention regardless of the overall adequacy of the program’s full-risk rates.

To what extent are the NFIP’s losses attributable to properties that have experienced multiple floods?

Currently insured repetitive-loss properties (RLPs)—defined by FEMA as those that have been the subject of at least two flood-claims payments of more than $1,000 apiece in any 10-year period—account for 2 percent of current policies and 3 percent of current premiums but about 12 percent of total claims since 1978. Including formerly insured RLPs, such properties accounted for almost one-quarter of claims payments since 1978. About 23,000 RLPs nationwide have been the subject of at least four claims payments while insured, and 10,000 of those have prompted six or more payments. FEMA’s approach to reducing the cost of repetitive-loss properties focuses more on measures to mitigate the worst flood risks—such as elevating, relocating, flood-proofing, or demolishing properties—than on charging higher premiums for flood insurance. More than half of the policies covering RLPs in high-risk areas have subsidized rates.

This paper was prepared by Perry Beider of CBO’s Microeconomic Studies Division.

The federal government commits substantial budgetary resources to support housing and mortgage markets through a combination of spending programs and tax provisions. During the crisis of the past two years, the commitment expanded—to about $300 billion in 2009—from the placement into conservatorship in September 2008 of the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) and the creation of new housing programs. Today CBO released a brief describing, in broad terms, the array of federal activities that support housing and the recent expansion of particular programs.

As shown in the figure below, most of the federal government’s spending for housing supports homeownership. In fiscal year 2009, the federal government devoted almost four times the amount of budgetary resources to supporting homeownership (about $230 billion) as it devoted to improving rental affordability ($60 billion).

Federal Spending for Housing, 2009

(In Billions of Dollars)

The government supports homeownership by subsidizing the costs of owning a home (reducing down payments, mortgage insurance costs, and tax liability) and increasing the availability of mortgage loans. Until recently, the bulk of federal support for homeownership took the form of tax expenditures (that is, subsidies conveyed through reductions in taxes), which make it less expensive to own a home by reducing taxes for homeowners and investors.

As a result of recent actions to address the crisis, the government now provides roughly  equivalent amounts of support for homeownership through tax expenditures and spending programs. About 80 percent of the federal support for renters is provided by spending programs; the remainder is provided through tax expenditures. The federal government also shapes the housing and mortgage markets through regulation—as provided, for example, in the Truth in Lending Act and the Home Mortgage Disclosure Act.

This brief categorizes 28 federal housing activities by type of support (homeownership or rental), mechanism (spending or taxation), and budgetary cost in 2009. The largest single budgetary cost is associated with the tax deduction for mortgage interest, which resulted in an estimated revenue loss of $80 billion in 2009. On the spending side, in 2009 the Treasury Department initiated the Making Home Affordable program, which provides incentive payments to mortgage servicers and homeowners to facilitate the process of refinancing or modifying loans so that homeowners can move into lower-cost or fixed rate mortgages. The Treasury has committed up to $50 billion to that program, and Fannie Mae and Freddie Mac are expected to spend up to $25 billion—though only a very small portion of the $75 billion was spent in 2009.   

This brief was prepared by Elizabeth Cove Delisle of CBO’s Budget Analysis Division. 

In February 2009, CBO issued its estimate of spending from the American Recovery and Reinvestment Act (ARRA)—commonly referred to as the stimulus package. At that time, CBO expected that federal agencies would spend about $120 billion over the remaining months of fiscal year 2009. That figure included $14 billion in payments for health insurance premiums of unemployed workers, but those payments were ultimately recorded as a reduction to federal revenues (instead of as federal outlays, as CBO initially assumed) because the payments were conveyed by reducing the amount of withholding taxes that businesses remit, and requiring them to pass those savings on to their employees by charging lower premiums. Setting aside those payments, the estimate of roughly $106 billion in outlays proved to be quite accurate: At the close of fiscal year 2009, agencies reported spending a little under $108 billion in ARRA funds—about 1 percent higher than CBO’s initial estimate (see the table below). In a few cases, agencies that received stimulus funds for certain programs spent less than CBO expected from their regular appropriations for those programs, so the net change in outlays that can be attributed to the stimulus package was actually a bit less that CBO initially estimated.

ARRA also included provisions that reduced taxes, and the Joint Committee on Taxation estimated that the legislation would reduce federal revenues by about $65 billion in 2009. Adjusting for the reclassification of payments for health insurance premiums, that total would be $79 billion. It is not possible to determine how closely the 2009 revenue effects of ARRA were to the initial estimates because detailed data on 2009 tax collections are not yet available.

Half of the 2009 stimulus spending is attributable to two programs: $32 billion for Medicaid and $22 billion for unemployment insurance. A one-time payment to Social Security beneficiaries added another $13 billion; spending for financial assistance to states (from the new State Stabilization Fund) added $12 billion; and direct assistance to college students (mostly for Pell grants) added $7 billion. Together, those five programs account for almost 80 percent of stimulus spending in fiscal year 2009.

As shown in the following table, outlays by individual agencies differed from CBO’s estimates in both size and direction.  Here are a few key points:

• Outlays for Medicaid, in the form of increased federal payments to states, were within $0.5 billion of CBO’s estimate. Outlays for other activities of the Department of Health and Human Services (such as health research) came in several billion dollars lower than CBO’s estimate.
• A few agencies spent more than CBO expected from amounts authorized in the stimulus package for some programs and less than CBO expected from regular appropriations for those same programs. For example, stimulus spending by the Department of Education for Pell grants was about $6 billion more than CBO’s original estimate—but those higher-than-expected outlays were partially offset by lower-than-expected spending from funds provided through the annual appropriation process.
• CBO underestimated the costs of providing additional unemployment benefits under ARRA. The agency’s original estimate of such benefits was about $17 billion for 2009, but the total for the year came in about $6 billion higher.
• Infrastructure-related spending fell short of CBO estimates. For example, spending by the Departments of Transportation, Energy, and Commerce totaled just over $5 billion, compared with CBO’s original estimates of about $8 billion for those three agencies.
• Funding for a broad range of other federal agencies has been spent considerably more slowly than originally estimated. The last line in the following table shows outlays of about $6 billion in 2009 for a group of agencies that received over $60 billion in stimulus funding.

Notes

1. CBO’s March baseline estimates, which were identical to those provided in the February 13, 2009, cost estimate for the conference agreement for H.R. 1, the American Recovery and Reinvestment Act of 2009.
2. Actual outlays are based on agency reports posted on www.recovery.gov, through September 30, 2009.  CBO made adjustments for some of the loan-related cash flows that were reported as outlays of the Small Business Administration ($3.4 billion) and the Department of Agriculture ($0.2 billion), because the federal budget records as outlays the estimated subsidy costs of such loans rather than the annual cash flows for loan disbursements and repayments. CBO also adjusted the reported outlays of the Department of Labor to reflect transfers between federal government funds that were recorded as outlays but not spent ($2.8 billion).
3. CBO’s original estimate of outlays for the Department of Labor included $13.8 billion for payments of health insurance premiums for unemployed workers under COBRA (the Consolidated Omnibus Budget Reconciliation Act of 1985). Those payments ended up being classified as reductions in revenues as opposed to outlays (as CBO initially expected). The numbers shown in the table for the Department of Labor reflect an adjustment for that change in classification.

Today CBO released a letter responding to questions about the subsidies that enrollees would receive for premiums and cost sharing, and the amounts that they would have to pay, on average, if they purchased a relatively low cost plan in the new insurance exchanges to be established under H.R. 3962 as introduced in the House of Representatives on October 29. The analysis reflects the preliminary analysis of that bill that CBO, in conjunction with the staff of the Joint Committee on Taxation, released last week.

The table accompanying the letter focuses on enrollees who purchase a “reference” plan (the premiums equal the average of the three lowest-cost “basic” plans, as defined in the bill), because federal subsidies would be tied to that average. Such a plan would have an actuarial value of 70 percent, which represents the average share of costs for covered benefits that would be paid by the plan. Although premiums would vary by geographic area to reflect differences in average spending for health care and would also vary by age, the table shows the approximate national average for the reference plan—about $5,300 for single policies and about $15,000 for family policies in 2016. Enrollees could purchase a more expensive plan or more extensive coverage for an additional, unsubsidized premium—and CBO anticipates that many enrollees would do that, so the average premiums actually paid in the exchanges would be higher (although average cost-sharing amounts could be lower than those shown in the table). The figures are presented for 2016 in order to illustrate the likely situation after the proposed changes in insurance markets were fully implemented. (A downside of that approach is that the figures are harder to compare with those observed in 2009.)

Under the House bill, the maximum share of income that enrollees would have to pay for the reference plan in 2013 would range from 1.5 percent for those with income less than or equal to 133 percent of the federal poverty level (FPL) to 12 percent for those with income equal to 400 percent of the FPL. (People with income below 150 percent of the FPL, however, would generally be eligible for Medicaid and thus ineligible for subsidies within the exchanges.) After 2013, those income-based caps would all be indexed so that the share of the premiums that enrollees (in each income band) paid would be maintained over time. As a result, the income-based caps would gradually become higher over time; for example, they are estimated to range from about 1.6 percent to about 12.8 percent in 2016. Enrollees with income below 350 percent of the FPL would also be given cost-sharing subsidies to raise the actuarial value of their coverage to specified levels—ranging from 97 percent for those with income below 150 percent of the FPL to 72 percent for those with income between 300 percent and 350 percent of the FPL.

To illustrate the effects of those features, the table shows the amounts of income that would correspond to the midpoint of each FPL band, the resulting premiums that single individuals and families of four would have to pay for a reference plan if their income equaled that midpoint, and the share of their income that would be represented by the sum of the enrollee premiums and the average cost-sharing amount at that midpoint. For instance, a single person with income of $26,500 in 2016 (225 percent of the FPL) would pay a premium of about $1,900 (after getting a premium subsidy of 64 percent) and could expect to pay another $900 in cost sharing (net of federal subsidies); thus, the average payment by such a person for the premium and cost sharing combined is projected to be $2,800, or about 11 percent of income. A family of four with income of about $54,000 (also 225 percent of the FPL in 2016) could expect to pay about the same share of its income for premiums and cost sharing. (Because use of health care in a given year varies widely, many people would pay less in cost sharing than the average, but some would pay more—subject to the limits on out-of-pocket costs that are specified in the bill.)

The estimated average premiums and average cost-sharing amounts for the reference plan shown at the top of the table—before any subsidies are applied—are slightly higher than the premiums for the comparable plan shown in a similar table that CBO released on October 9 for the health care reform proposal introduced by the Chairman of the Senate Committee on Finance, as amended by the committee. (That table represented an update to a table enclosed in a letter to Chairman Baucus on September 22 that addressed the earlier Chairman’s mark.). Because the reference plans in both proposals would cover the same range of benefits and have the same extent of coverage (actuarial value), the difference in premiums cannot be attributed to a difference in coverage. Instead, the difference is the net result of a number of other provisions of each proposal and primarily reflects higher average health care costs projected for enrollees in the exchanges under the House bill than for enrollees in the exchanges under the Finance Committee’s proposal. That difference in average health costs would arise because exchange enrollees under the House bill would be slightly less healthy, on average, than exchange enrollees under the Finance Committee’s proposal—a difference that itself reflects a number of opposing factors described in the letter.

Current proposals to reform the health care and health insurance systems would affect the federal budget and the nation’s spending for health care in many ways, and those effects can be summarized using a variety of different measures. Today CBO released a letter to clarify the measures being used by CBO in its analysis of such proposals—in particular, the effects of proposals on federal budget deficits and on the magnitude of the federal budgetary commitment to health care. As concrete examples, the letter discusses the preliminary analysis recently completed by CBO and the staff of the Joint Committee on Taxation (JCT) of the proposal put forward by the Chairman of the Senate Committee on Finance, as amended by the committee, and of the preliminary analysis by CBO and JCT of H.R. 3962, the Affordable Health Care for America Act, which was introduced yesterday in the House of Representatives.

Effect on Federal Budget Deficits

CBO and JCT’s analysis of a health care reform proposal focuses on its net impact on federal budget deficits during the 10 year budget window from 2010 through 2019. This “bottom line” reflects all of the effects of a proposal on spending and revenues, regardless of whether or how they are related to the provision of health care. CBO and JCT estimated that the proposal approved by the Committee on Finance would result in a net reduction in federal budget deficits of $81 billion over the 2010–2019 period, and that H.R. 3962 would result in a net reduction in federal budget deficits of $104 billion over the same period.

Effect on the Federal Budgetary Commitment to Health Care

CBO’s letters providing preliminary analyses of the proposal approved by the Senate Committee on Finance and H.R. 3962 also addressed the effects of the proposals on “the federal budgetary commitment to health care.” CBO used that phrase in a letter earlier this year to describe the sum of net federal outlays for health programs and tax preferences for health care. CBO has used this measure because some Members have expressed interest in the federal government’s overall role in the financing of health care—both under current law and under alternative reform proposals. (Whether the federal role should be expanded, contracted, or held the same is a policy choice, and CBO, as always, makes no policy recommendations.)

Federal outlays for health programs are not an adequate gauge of that overall role because tax expenditures for health care are substantial under current law and because new tax credits to help purchase health insurance are a significant part of some reform proposals. Similarly, federal tax expenditures for health care do not, by themselves, capture this overall role because federal spending on health care is also substantial under current law and because such spending would increase significantly under some reform proposals. By including both the federal government’s spending for health care and the subsidies for health care that are conveyed through reductions in federal taxes, the “federal budgetary commitment to health care” represents a broad measure of the resources allocated by the federal government in this area—and a measure that is independent of the extent to which outlays or tax provisions are used to channel those resources.

For example, how would the proposal approved by the Senate Finance Committee affect the budgetary commitment to health care? CBO and JCT’s estimates imply that the proposal would increase the federal budgetary commitment to health care by about $85 billion over the 2010-2019 period. (Again, we estimate that the proposal would result in a net reduction in federal budget deficits of $81 billion over the same time period.)

Bending the Cost Curve

Major proposals to reform health care would affect not only the federal budget but also spending for health care by individuals, firms, and other levels of government. A broad measure encompassing those effects would be the impact on total national health expenditures. However, CBO does not analyze national health expenditures as closely as it does the federal budget, and at this point CBO has not assessed the net effect of health care reform proposals on those expenditures, either within the 10-year budget window or for the subsequent decade. That is, CBO has not evaluated whether reform proposals would lower or raise—or bend down or up—the “curve” of national health expenditures.

CBO and the Joint Committee on Taxation (JCT) have just issued a preliminary analysis of H.R. 3962, the Affordable Health Care for America Act, as introduced on October 29, 2009. Among other things, H.R. 3962 would establish a mandate for most legal residents of the United States to obtain health insurance; set up insurance “exchanges” through which certain individuals and families could receive federal subsidies to substantially reduce the cost of purchasing that coverage; significantly expand eligibility for Medicaid; substantially reduce the growth of Medicare’s payment rates for most services (relative to the growth rates projected under current law); impose an income tax surcharge on high-income individuals; and make various other changes to the federal tax code, Medicaid, Medicare, and other programs.

According to CBO and JCT’s assessment, enacting H.R. 3962 would result in a net reduction in federal budget deficits of $104 billion over the 2010–2019 period. In the subsequent decade, the collective effect of its provisions would probably be slight reductions in federal budget deficits. Those estimates are all subject to substantial uncertainty.

The estimate includes a projected net cost of $894 billion over 10 years for the proposed expansions in insurance coverage. That net cost itself reflects a gross total of $1,055 billion in subsidies provided through the exchanges (and related spending), increased net outlays for Medicaid and the Children’s Health Insurance Program (CHIP), and tax credits for small employers; those costs are partly offset by $167 billion in collections of penalties paid by individuals and employers. On balance, other effects on revenues and outlays associated with the coverage provisions add $6 billion to their total cost.

Over the 2010–2019 period, the net cost of the coverage expansions would be more than offset by the combination of other spending changes, which CBO estimates would save $426 billion, and receipts resulting from the income tax surcharge on high-income individuals and other provisions, which JCT and CBO estimate would increase federal revenues by $572 billion over that period.

By 2019, CBO and JCT estimate, the number of nonelderly people who are uninsured would be reduced by about 36 million, leaving about 18 million nonelderly residents uninsured (about one-third of whom would be unauthorized immigrants). Under H.R. 3962, the share of legal nonelderly residents with insurance coverage would rise from about 83 percent currently to about 96 percent. Roughly 21 million people would purchase their own coverage through the new insurance exchanges, and there would be roughly 15 million more enrollees in Medicaid than the total number projected for Medicaid and CHIP combined under current law. (Under the bill, CHIP would no longer exist in 2019.) Relative to currently projected levels, the number of people purchasing individual coverage outside of the exchanges would decrease by about 6 million, and the number obtaining coverage through employers would increase by about 6 million.

Although CBO does not generally provide cost estimates beyond the 10 year budget projection period (2010 through 2019 currently), many Members have requested CBO analyses of the long-term budgetary impact of broad changes in the nation’s health care and health insurance systems. However, a detailed year-by-year projection, like those that CBO prepares for the 10-year budget window, would not be meaningful because the uncertainties involved are simply too great. Among other factors, a wide range of changes could occur—in people’s health, in the sources and extent of their insurance coverage, and in the delivery of medical care (such as advances in medical research, technological developments, and changes in physicians’ practice patterns)—that are likely to be significant but are very difficult to predict, both under current law and under any proposal.

All told, H.R. 3962 would reduce the federal deficit by $9 billion in 2019, CBO and JCT estimate. After that, the added revenues and cost savings are projected to grow slightly more rapidly than the cost of the coverage expansions. In the decade after 2019, the gross cost of the coverage expansions would probably exceed 1 percent of gross domestic product (GDP), but the added revenues and cost savings would probably be greater. Consequently, CBO expects that the legislation would slightly reduce federal budget deficits in that decade relative to those projected under current law—with a total effect during that decade that is in a broad range between zero and one-quarter percent of GDP. The imprecision of that calculation reflects the even greater degree of uncertainty that attends to it, compared with CBO’s 10 year budget estimates, and the effects of the bill could fall outside of that range.

Those longer-term projections assume that the provisions of H.R. 3962 are enacted and remain unchanged throughout the next two decades, which is often not the case for major legislation. For example, the “sustainable growth rate” mechanism governing Medicare’s payments to physicians has frequently been modified to avoid reductions in those payments, and legislation to do so again is currently under consideration in the Congress. The bill would put into effect (or leave in effect) a number of procedures that might be difficult to maintain over a long period of time. It would leave in place the 21 percent reduction in the payment rates for physicians currently scheduled for 2010. At the same time, the bill includes a number of provisions that would constrain payment rates for other providers of Medicare services. In particular, increases in payment rates for many providers would be held below the rate of inflation (in expectation of ongoing productivity improvements in the delivery of health care). Based on the extrapolation described above, CBO expects that Medicare spending under the bill would increase at an average annual rate of roughly 6 percent during the next two decades—well below the roughly 8 percent annual growth rate of the past two decades, despite a growing number of Medicare beneficiaries as the baby-boom generation retires. Based on the same extrapolation, Medicare spending per beneficiary under the bill would increase by roughly 4 percent per year, on average, during the next two decades—compared with a 7 percent average growth rate (excluding the effect of establishing Part D) during the past two decades.

Investment in research and development (R&D) over the past several decades has produced a wealth of valuable new drug therapies. Current and future pharmaceutical R&D will determine what drug therapies will become available, and thus will influence future health-care costs. Yesterday CBO released a brief that describes the state of investment in drug R&D and the factors that influence it. It also examines how various policy options to control the growth in health care costs or to expand insurance coverage could affect spending on R&D.

Rate of New-Drug Development

Spending on prescription drugs rose rapidly between 1994 and 2004, but has grown more slowly since then. The rising-then-slowing pattern of growth in prescription drug spending, as shown in the figure below, is related to the evolving pace of new-drug introductions and patent expirations over the past two decades. Specifically, drug introductions spiked in the mid- to late 1990s but have declined since 2000—in most years, back to levels not seen since the 1980s.  The introduction of priority drugs (those that, according to the Food and Drug Administration, provide a significant therapeutic or public health advance) has also subsided.

Slower revenue growth for drugmakers does not mean that consumers are using fewer prescription drugs. In fact, the total number of prescriptions continues to increase, albeit more slowly since 2004. But generic drugs, which cost less than their brand-name counterparts, comprise a greater share of prescriptions, having risen from 42 percent in 2000 to 58 percent in 2007.

Investment in R&D

According to Pharmaceutical Research and Manufacturers of America (PhRMA), the industry’s trade association, member firms spent $50 billion on pharmaceutical R&D in 2008, a 2.6 percent real increase over the previous year. That increase is unusually small; over the past 30 years, PhRMA has seldom reported less than a 5 percent real annual increase in R&D spending, and the average has been almost 9 percent. Generally, pharmaceutical R&D in the private sector is complemented by health-related research funded by the public sector, mostly through the National Institutes of Health. Analysts have found that increased public spending on basic (health-related) research stimulates additional private drug R&D.

Real R&D spending per successful new drug has been rising for many years, largely because of growth in the size and length of clinical trials and an increased rate of failure. Those changes generally reflect drug companies’ strategic choices about which kinds of drugs to pursue—choices that depend on anticipated demand and scientific opportunities. In particular, drug companies are devoting more resources to developing drugs for chronic illnesses, which generally require longer clinical trials.

The Role of Health Insurance in the Demand for Prescription Drugs and Drug R&D

Insurance plays a significant role in determining the demand for prescription drugs and, ultimately, drug R&D. By shielding individuals from the full costs of the drugs they use, insurance encourages higher spending on drugs. Further, the scope of health insurance coverage of prescription drugs has been expanding for many years, as has the number of prescriptions being filled. From 1997 to 2007, the share of consumers’ total drug expenses paid for by third parties (private health insurance plans and public programs) rose from 67 percent to 79 percent. At least partly as a consequence, the number of prescriptions increased by 72 percent over that same period.

Prospective Policy Options and Their Implications for R&D

The federal government finances a large and growing share of prescription drug sales, and it faces severe long-term budgetary pressures, with rising health care costs playing a key role. CBO’s brief discusses a number of policy options for reducing those costs or for expanding insurance coverage that would affect the market for prescription drugs. Those options—some of them detailed in the Congressional Budget Office’s December 2008 report, Budget Options, Volume 1: Health Care—include:

• Expand prescription drug coverage
• Expand the Medicaid rebate paid by manufacturers of brand-name drugs
• Require drugmakers to pay a minimum rebate on drugs covered by Medicare Part D
• Increase the availability and use of follow-on biologic drug products
• Incorporate findings on comparative effectiveness into decisions about insurance coverage

This brief was prepared by David Austin of CBO’s Microeconomic Studies Division and Colin Baker of CBO’s Health and Human Resources Division. 

Today CBO released a letter responding to a request from the Ranking Members of the House and Senate Budget Committees for information on the effects of S. 1776, the Medicare Physicians Fairness Act of 2009. Under current law, CBO estimates that Medicare’s payment rates for physicians’ services will be reduced by about 21 percent in January 2010 and by about 6 percent annually for several subsequent years. S. 1776 would repeal the Sustainable Growth Rate (SGR) formula, which determines the updates to those payment rates, and permanently freeze those rates. CBO estimates that enacting S. 1776 would increase net direct spending by $247 billion over the 2010-2019 period, relative to CBO’s current baseline projections, which assume the reductions in payment rates outlined above. Enacting the legislation would increase net federal spending by about $40 billion in 2019, which is equivalent to about a 5 percent increase in net Medicare spending projected for that year.

CBO’s estimate consists of three major components. First, repealing the SGR formula and replacing it with a freeze of payment rates would increase the fees paid to physicians under Medicare by about $236 billion over the 10-year budget projection window. Second, that increase in Medicare spending for physicians’ services would also result in higher spending for both the Medicare Advantage program and the Department of Defense’s TRICARE program. CBO estimates those changes would sum to about $80 billion over the budget window.

Third, over the 2011-2019 period, CBO estimates that aggregate Part B premiums would increase by about $70 billion. Premium collections are recorded as offsetting receipts (a credit against direct spending). Beneficiaries enrolled in Part B of Medicare pay premiums that offset about 25 percent of the costs of those benefits. (All of the changes in Medicare spending that would result from enacting S. 1776 would be for Part B benefits.) Therefore, about one-quarter of the increase in Medicare spending would be offset by changes in those premium receipts. The premium for 2010 has already been set and will not be changed, so S. 1776 would have no effect on Part B premium receipts until 2011.

On July 13, 2009, the Department of Health and Human Services issued a proposed rule that would remove physician-administered (P-A) drugs from the calculation of the SGR retroactively and prospectively. If the rule becomes final, baseline physician spending would be higher over the next 10 years. Because the rule is proposed, CBO has incorporated 50 percent of the effect into its scorekeeping baseline; it will incorporate the entire effect if the rule becomes final in early November. The estimate of S. 1776’s impact on direct spending would be about $40 billion lower over the 2010-2019 period if the rule, as proposed, becomes final.

The public and private sectors in the United States together spend over $500 billion a year on infrastructure projects, including highways and airports, water and energy utilities, dams, waste disposal sites and other environmental facilities, schools, and hospitals. The federal government makes a significant contribution to that investment through its direct expenditures and the subsidies it provides indirectly through the tax system, which are sometimes referred to as tax expenditures. Today CBO and the Joint Committee on Taxation (JCT) released a study on the importance of tax preferences, the types of tax-preferred bonds used in financing infrastructure, and the economic efficiency of such bonds.

That study concludes that the amount that the federal government forgoes through tax-exempt bond financing is greater than the associated reduction in borrowing costs for state and local governments. Some analysts have estimated the magnitude of that differential and conclude that several billion dollars each year may simply accrue to bondholders in higher income-tax brackets without providing any cost savings to borrowers.

The Importance of Tax Preferences in Financing Infrastructure

Most federal tax expenditures for infrastructure are the result of tax preferences granted for bonds that state and local governments issue to finance capital spending on infrastructure. Those tax preferences reduce borrowing costs. The amount of tax-preferred debt issued to finance new infrastructure projects undertaken by the public and private sectors totaled $1.7 trillion from 1991 to 2007. About three-quarters of those bond proceeds, or roughly $1.3 trillion, was for capital spending on infrastructure by states and localities, and the remainder was used to fund private capital investment for projects that serve a public purpose, such as schools and hospitals. That $1.3 trillion amounted to over one-half of the $2.3 trillion in capital spending on infrastructure by state and local governments (that is, net of federal grants and loan subsidies).

Tax preferences for debt are attractive to states and localities because they generally allow those governments to exercise broad discretion over the types of projects they finance and the amount of debt they issue. But unlike direct expenditures, tax expenditures—including tax preferences for state and local bonds—are not subject to the annual appropriation process that determines federal outlays for infrastructure and other discretionary programs. As a result, the cost of tax subsidies for infrastructure is not readily apparent, making the design of cost-effective tax preferences all the more important. For fiscal years 2008 to 2012, federal revenues forgone through the tax-exemot bond financing of infrastructure—both for new investments and for the financing of existing debt—are estimated to exceed $26 billion annually.

The Types of Tax-Preferred Bonds and Their Characteristics

The Internal Revenue Code provides for three forms of tax-preferred state and local bonds:

• Tax-exempt bonds pay interest to the bondholder that is not subject to federal income tax.  They are the most well established type of tax-preferred debt (tax exemption dates to the beginning of the federal income tax in 1913) and are issued to finance either the general functions of state and local governments or selected projects undertaken by the private sector. Tax-exempt bonds reduce the issuer’s borrowing costs because purchasers of such debt are willing to accept a lower rate of interest than that of taxable debt of comparable risk and maturity.
• Tax-credit bonds, by contrast, generally provide a credit against the bondholder’s overall federal income tax liability. They are much more recent in origin, and the outstanding amount of tax-credit bonds currently is minuscule in comparison with that of tax-exempt bonds.
• Direct-pay tax-credit bonds, in effect, require the federal government to make cash payments to the issuer of the bond in an amount equal to a portion of each of the interest payments the issuer makes to the bondholder. Such bonds, which were created by the American Recovery and Reinvestment Act of 2009 (ARRA, Public Law 111- 5), in part because the direct payment to the issuer represents a “deeper” subsidy to the issuer than the provision of a tax credit represents to the bondholder.

Increasing the Economic Efficiency of Tax-Preferred Bond Financing

Replacing tax-exempt interest with tax credits could, in principle, increase the efficiency of financing infrastructure with tax-preferred debt. Tax-credit bonds transfer to issuers all of the federal revenues forgone through the tax preference; in addition, the amount of the tax credit can be varied across types of infrastructure projects, thus bringing the federal revenue loss in line with the benefits expected from the investment.

Nevertheless, tax-credit bond programs have not been particularly well received by the market for a number of reasons, including the limited size and temporary nature of tax-credit bond programs and the absence of rules for stripping and selling credits. That situation is likely to change, however, as a result of the ARRA, which greatly expanded the size and range of tax-credit bond programs. As those new programs are implemented, it will be possible to gauge more accurately the practical advantages and disadvantages of tax-credit bonds.

This study was prepared by Nathan Musick of CBO’s Microeconomic Studies Division and the staff of JCT.