Health Care Costs: A Primer

Key Facts

• In 2010, the U.S. spent $2.6 trillion on health care, an average of $8,402 per person.
• The share of economic activity (gross domestic product, or GDP) devoted to health care has increased from 7.2% in 1970 to 17.9% in 2009 and 2010.
• Health care costs per capita have grown an average 2.4 percentage points faster than the GDP since 1970.
• Since 2002, the rate of increase in national health care spending has fallen from 9.5% to 3.9%.
• Half of health care spending is used to treat just 5% of the population.
• Although only 10% of total health expenditures, spending on prescription drugs has received considerable attention because of its rapid growth (114% from 2000 to 2010).
• In 2008, 27% of the nonelderly with 3+ chronic conditions spent more than 10% of their income on health, compared to 11% of the total nonelderly population.
• Many policy experts believe new technologies and the spread of existing ones account for a large portion of medical spending and its growth.

Health care accounts for a remarkably large slice of the U.S. economic pie.  Each year health-related spending grows, virtually always outpacing spending on other goods and services, meaning that the size of that slice increases.  These cost increases have a significant effect on households, businesses, and federal, state, and local governments.  Among other things, rising health care costs make health insurance less affordable for individuals, families, and businesses; put pressure on businesses that offer insurance coverage to their employees; can be a major financial burden to families, even those that have insurance; and can result in individuals not receiving the health care services they need.  For taxpayers, government programs such as Medicare and Medicaid are major parts of federal and state budgets and increasing costs require either additional revenue or reductions in benefits, eligibility, or payment rates.

Concerns about rising health care costs and affordability of health care for families persist despite the enactment of comprehensive health reform legislation in March 2010 (the Affordable Care Act, or ACA).¹  The ACA changed the health care landscape considerably by providing significant financial assistance to help people with low and moderate incomes afford coverage and associated cost sharing.  The law provides new standards for private health insurance, including identifying minimum benefits for health insurance, placing limits on cost sharing for covered benefits, and establishing new rules for private health insurance that assure access to coverage for people with health problems and limit premium and contribution differences based on health-related factors.  Together these provisions will dramatically reduce financial burdens for many people with lower income or significant health care needs.

The ACA also has a number of provisions that address the costs and efficiency of the health care system, including provisions to demonstrate and implement new payment systems for Medicare (e.g., accountable care organizations, or ACOs), provisions to better coordinate care for people dually eligible for Medicare and Medicaid, reductions in Medicare payments, and new rules (e.g., disclosure and transparency) and new institutions (i.e., exchanges) to improve the efficiency of private health insurance.

Despite the many cost-reducing provisions in the ACA, system-wide health care costs are still projected to rise faster than national income for the foreseeable future, and this cost growth has important implications for government and family budgets. Reducing future federal budget deficits is a major focus in national policy debate, and spending on federal health programs is a primary target.  Federal health spending is projected to grow from 5.6% of Gross Domestic Product (GDP) in 2011 to about 9.4% of GDP by 2035.²  Proposals to reduce federal health spending range from modest reforms, such as modifying payment systems to better reward efficiency and effectiveness, to fundamental changes, such as transforming Medicaid into a block grant with capped federal spending and replacing the current Medicare entitlement with a defined set of services to a defined contribution toward purchase of a private or public health plan Recent proposals to reduce future budget deficits include various policies to slow federal health spending, including taking steps to constrain overall federal spending to a proscribed rate of growth, such as one percentage point above GDP or GDP per capita.³ The more far-reaching reforms would limit federal costs and potentially expose program beneficiaries to higher out-of-pocket costs and benefit reductions.  Many states have experienced severe budget problems during the recent recession, leading them to reduce state spending on Medicaid, which is one of the largest components of state budgets.

The federal budget debate in large part revolves around the overall size of the budget and the mix of program cuts and new revenues necessary to bring federal spending into better balance.  Proposals to reduce federal health spending are based on the premise that health programs are growing to unaffordable levels and must be curtailed.  Little of the debate, however, considers the amount of health that is currently provided by these programs and how much health the nation wants to support though federal spending in the future.  Health spending grows faster than national income in part because the health care system continues to innovate and provide new treatment options to people with serious acute and chronic illnesses.  A system that each year can do more of something that people find very valuable – address their health care needs – inevitably will attract a greater share of overall national spending. This does not mean that all current health care spending is necessary or that there are not considerable opportunities to improve the efficiency and quality of care, but even from more efficient levels continuing innovation will push costs higher as the arsenal of health care interventions continues to grow.  The key challenge for policymakers will be finding the best mix of policies so that government, corporate, and private health spending is as efficient as possible and best meets the health care needs and desires of the nation.

The challenge is made more difficult by the highly decentralized nature of health care decision-making in the United States.  Health care investment and spending are influenced by federal and state programs, with differing payment systems, incentives, and reimbursement levels, by numerous private health insurers, each with their own payment policies and practices, and by direct family payments for services that are covered or not covered by public or private insurance.  Decisions by one program may shift costs or affect payment decisions by other payers, usually in an uncoordinated fashion.  Provisions in the ACA provide for some additional coordination across programs, such as coordination of care for those dually eligible for Medicare and Medicaid.  Private payers also may be able to take advantage of Medicare investments in ACOs and medical homes.  Still, the lack of coordination across public and private spending programs makes coordinating efforts to reduce costs and increase efficiency system-wide a challenging proposition.

This primer gives a brief glimpse of available data on health care costs, and summarizes the impact of spending growth on various parts of society.  The National Health Expenditure Accounts (NHEA), the source for several of the analyses shown, present the costs of care by type of health service or product (such as hospital care, physician services, or prescription drugs), sources of funds (such as private insurance, Medicare, Medicaid, or out-of-pocket by the individual patient), and types of sponsors (private business, households, and government).  Results from both the Kaiser Family Foundation/Health Research and Educational Trust Employer Health Benefits Survey and the Medical Expenditures Panel Survey are also shown to help explain how health costs are distributed among families.  Finally, we conclude by discussing some commonly-held explanations for why health care costs grew over time, how they might be addressed, and the effect of the ACA.