Obamacare Will Balloon Future Budget Deficits

According to the congressional forecasters, Democrats have succeeded in turning water into wine, proposing health care legislation that will simultaneously expand the welfare state with new entitlements while also reducing budget deficits. This is big news, at least from a political perspective, since proponents hope so-called deficit hawks will have an excuse to support bigger government.

Moderate Republicans and Blue Dog Democrats should not be deluded by rosy-scenario estimates. Government-run health care will be a budget buster. First, new subsidies and handouts will cost more than predicted. Second, tax increases won't generate as much money as projected. Third, promises to control other spending - particularly Medicare - are laughably insincere. And fourth, bigger government will hinder growth, reducing tax receipts while triggering more spending.

The Senate plan allegedly will reduce deficits over the next 10 years by $81 billion, while the House proposal will shrink deficits by $104 billion over the same period. But if the Congressional Budget Office (CBO) and Joint Committee on Taxation (JCT) have even tiny errors in their optimistic estimates, the fiscal implications are enormous. If history is any guide, the errors will be significant, especially with regard to the cost of new entitlements. And if revenues and offsets are 25 percent below the forecast and spending is 50 percent higher than estimated (and that almost surely is still too optimistic), the 10-year deficits will be $600 billion to $850 billion higher.

Assuming they actually care about controlling red ink, derailing government-run health care should be the top priority for deficit hawks. The methodology of both CBO and JCT is imperfect, and experience shows that these bureaucracies do a poor job of estimating future spending and revenue.

The budget estimates put together by the CBO are far too low, for instance, because they do not properly measure how people and businesses change their behavior in response to government largesse. Moreover, there are incentives for companies to dump their healthcare plans since workers will be able to obtain government-subsidized insurance. The spending numbers also are far too low because they do not recognize that politicians in the future will be tempted to expand subsidies as part of routine vote-buying behavior, similar to what happened with Medicare and Medicaid.

The federal government's ability to predict healthcare spending leaves much to be desired. When Medicare was created in 1965, the long-run forecasts estimated that the program would cost about $12 billion by 1990. In reality, it cost more than $100 billion that year. And it now costs $500 billion. Medicaid was also created in 1965 and was supposed to be a very small program with annual expenditures of about $1 billion. It has now become a huge $250 billion entitlement.

Medicaid's disproportionate share hospital (DSH) program is a sobering example. Created in 1987, the program was supposed to cost less than $1 billion in 1992, but the actual cost that year was a staggering $17 billion. To cite another example, the Medicare Catastrophic Coverage legislation was adopted in 1988 and repealed less than two years later, in part because some provisions were already projected to cost six times more than originally forecast.

The tax provisions in the healthcare proposals will impose considerable damage without raising much revenue. Higher income tax rates on investors and entrepreneurs in the House legislation will reduce incentives to be productive and also increase incentives for evasion and avoidance. The tax on high-cost insurance plans and medical devices in the Senate plan also will not generate the expected revenue since people and companies will change their behavior.

There also is little reason to expect that politicians in the future will be willing to control Medicare spending, so projected offsets of more than $500 billion are highly unlikely.

Finally, a bigger public sector has negative implications for public finances. Higher levels of government spending will drain resources from the productive sector of the economy, undermining economic vitality. Additionally, the plans result in large implicit marginal tax rates of nearly 70 percent because of the phase-out of insurance subsidies.  So even taxpayers with modest incomes will face a staggering penalty on upward mobility that will hinder overall economic performance.

Fiscal responsibility is achieved by limiting the size of government. The President and his congressional allies, however, claim that big increases in government spending are prudent so long as there are equally large increases in the tax burden. But that's like a doctor trying to fix a broken left leg by breaking the right leg as well.