The Encroaching Fiscal Cliff: Health Care Edition

Newspapers and airways are chock full of warnings about the fiscal cliff the country is getting ready to topple over when scheduled tax increases and spending cuts kick in on January 1, 2013. Standard macroeconomic models, such as those employed by the Congressional Budget Office, predict a contraction in GDP in the first half of 2013 if Congress does not act. But the impact will not be delayed until then. It has started already.

The large and increasing uncertainty about the future of federal fiscal policy is causing the economy to slow even before we reach the edge of the fiscal cliff. Last week's weak jobs report is one broad-based indicator of this trend, but a clearer example of the economic impact of policy uncertainty lies in the health care sector.

Apart from the future effects of health care legislation on health care spending and costs, near-term fiscal policies are stunting the sector. Physician reimbursement in Medicare is scheduled to be cut 27 percent on January 1, 2013, when the current "doc fix" expires. Congress has almost always intervened to avoid these recurring cuts, but the uncertainty still looms, and if Congress does act, other health care providers may be forced to endure cuts to offset the budget impact.

In addition, sequestration provisions in the Budget Control Act will further reduce all Medicare payments-to physicians, hospitals, nursing homes, and others-another 2 percent, $11 billion in 2013. Those cuts will recur every year. On the tax side, physician-owned practices, private clinics, and other privately owned hospital and facilities will face significant tax increases as well-to-do doctors and investors see their marginal tax rates rise five percentage points.

On top of these large-scale changes, Medicare is reconfiguring how much to pay various physician specialties in ways that will unintentionally hurt doctors, medical personnel, and patients and create even more uncertainty for the profession. For example, in early July, Medicare proposed reducing reimbursement to radiation oncologists by 15 percent next year, or roughly $300 million. Radiation oncologists and their staffs won't know until November if these cuts are definite, but just the threat has an immediate economic "chilling effect." If the cuts are, in fact, instituted next year, they will hit these cancer care providers particularly hard, and on top of all the other components of the fiscal cliff.

Why would lawmakers and regulators in Washington impose this kind of damage on the health care sector? For lawmakers, the budget process encourages temporary gimmicks instead of constructive reforms. Lawmakers should be making decisions based on the long-term consequences of policy changes, but they are incentivized to focus on the short term.

But there is another force at work here as well. Politicians are not the only ones interfering with the private sector; regulators in Washington are hard at work steering the health care system toward their own vision of "right" and "fair."

In the case of the radiation oncology cuts in Medicare, the $300 million that CMS is proposing to cut from reimbursement to radiation oncology would not reduce the federal deficit one dollar. Instead, those funds would simply be taken from one specialty and given to others, all under the broad, often unsupervised regulatory authority CMS enjoys. The net impact of this proposal is a regulatory induced raise for family care physicians while cancer care doctors receive a whopping cut.

While standard macroeconomic models would predict that this reassigning of health care dollars from cancer treatment to general practice medicine would have no impact on the overall economy, the reality is quite different. Reimbursement cuts, or even proposed cuts, of this magnitude force affected physicians to cancel plans to upgrade equipment, expand services, or hire new staff. In addition, the seemingly arbitrary rationale for the changes may also leave physicians who are unaffected by this year's cuts nervous about what might happen to them if regulators again pick winners and losers by restructuring Medicare payment rates. This year's attack on radiation oncology may be next year's attack on nursing or cardiology or surgery centers or hospitals.

There is no question that the U.S. health care system must be altered so that aggregate spending growth is brought in line with the overall economy, and that will mean major changes. But those needed reforms should be decided by market forces, not Washington. And they will certainly look nothing like the upcoming fiscal cliff or the bureaucratic rearranging of deck chairs currently underway in Washington.