CBO

TESTIMONY

Statement of

Peter R. Orszag

Director

Health Care and the Budget:

Issues and Challenges for Reform

before the

Committee on the Budget

United States Senate

June 21, 2007

CONGRESSIONAL BUDGET OFFICE

SECOND AND D STREETS, S.W.

WASHINGTON, D.C. 20515

This document is embargoed until it is delivered

at 10:00 a.m. (EDT), Thursday, June 21, 2007.

The contents may not be published, transmitted,

or otherwise communicated by any print, broadcast, or electronic media before that time.

Chairman Conrad, Ranking Member Gregg, and other Members of the Committee,

thank you for inviting me to testify this morning on the U.S. health care system

and the major budgetary and policy issues associated with that system. Rising

health care costs and their consequences for federal health insurance programs

constitute the nation’s central fiscal challenge. Rising costs also represent a critical

issue for employers—who sponsor most private health insurance coverage—and

for the enrollees and patients who ultimately bear the costs of health insurance and

health care. At the same time, substantial concerns exist about the number of individuals who lack health insurance, about the quality of care that is provided both to

the uninsured and to the insured, and about trends in health such as the growing

prevalence of obesity.

In light of those challenges, my testimony today makes four main points:

B Health Care Costs. The nation’s long-term fiscal balance will be determined

primarily by the future rate of health care cost growth. If health care costs continued growing at the same rate over the next four decades as they did over the

past four decades, federal spending on Medicare and Medicaid alone would rise

to about 20 percent of gross domestic product (GDP) by 2050—roughly the

share of the economy now accounted for by the entire federal budget. Furthermore, controlling those federal costs over the long term will be very difficult

without addressing the underlying forces that are also causing private costs for

health care to rise. A variety of evidence, however, suggests that opportunities

exist to constrain health care costs both in the public programs and in the rest of

the health care system without adverse health consequences. Capturing those

opportunities to reduce costs without harming health outcomes involves many

challenges, including the time that may be necessary to generate significant savings—but even if reforms take time to generate savings, acting sooner rather

than later can ultimately make a substantial difference.

B Employer-Sponsored Insurance. Most Americans get their primary health

insurance through an employer—either their own or that of a family member.

Many employers have expressed serious concerns about rising health care costs;

to date, however, aggregate data indicate that any reductions in employers’

offers of insurance or the scope of coverage they provide have been modest. An

employer-based system has both advantages (for example, workers’ risks are

pooled together) and disadvantages (for example, workers often have to change

their health plan when they change jobs). A key issue for broad health reform

proposals is whether they are based upon an employer-sponsored system: if so,

whether they retain the significant existing tax incentives for employer-based

insurance, and if not, how they create the pooling mechanisms essential for

effective health insurance markets.
2

B Lack of Insurance. The most recent estimates indicate that about 45 million

people were uninsured at any given point in 2005. Both the high cost of health

care and the evolution of employer-based health insurance affect the number of

people who have coverage. Higher premiums discourage people—especially

those who have lower income and who perceive themselves as healthy—from

purchasing insurance. People who are not employed or who choose to work at a

firm not offering insurance may have to seek coverage in the individual market,

where policy terms and tax benefits are generally much less attractive than

those for employer-sponsored plans. Federal and state expansions of coverage

over the past 25 years—particularly through Medicaid and the State Children’s

Health Insurance Program (SCHIP)—have significantly reduced uninsurance

rates among eligible populations. Many proposals aim to reduce the number of

uninsured further, through either direct spending or tax credits, but such proposals typically generate budgetary costs that must ultimately be financed by

higher revenues or offset by lower spending elsewhere—and almost invariably

cause at least some substitution of public funds for private funds.

B Prevention and Healthy Living. The ultimate objective of the health care

system is to improve health. Despite the resources that the nation devotes to

treating diseases, the results in terms of health gains are mixed, and many

investments that can foster better health—such as preventive medicine—

are underused. At the same time, various types of unhealthy behavior—such as

smoking, poor diets, and a lack of regular exercise—remain relatively common.

Although proposals that encourage more prevention and healthy living can help

to promote better health outcomes, their effects on federal and total health

spending are uncertain.

Rising Health Care Costs

Over the past four decades, Medicare’s and Medicaid’s costs per beneficiary have

increased about 2.5 percentage points faster per year than has per capita gross

domestic product (GDP).1 If those costs continued growing at the same rate over

the next four decades, federal spending on those two programs alone would rise

from 4.5 percent of GDP today to about 20 percent by 2050 (see Figure 1); that

amount would represent roughly the same share of the economy as the entire federal budget does today. If, instead, those costs grew at the same rate as income—a

scenario that illustrates the pure effect of demographic changes on the two programs—then the change in spending by 2050 would be much smaller. Indeed, that

change would be substantially smaller than the difference between the two scenarios. That observation underscores that the rate at which health care costs grow relative to income is the most important determinant of the long-term fiscal balance;

1. See Congressional Budget Office, The Long-Term Budget Outlook (December 2005), pp. 6–7

and 31–32.
3

Figure 1.

Total Federal Spending for Medicare and Medicaid

Under Assumptions About the Health Cost

Growth Differential

(Percentage of gross domestic product)

Source: Congressional Budget Office.

Note: The health cost growth differential refers to the number of percentage points by which the 

growth of annual health care spending per beneficiary is assumed to exceed the growth of 

nominal gross domestic product per capita, after an adjustment for the growth and aging of 

the Medicare and Medicaid populations.

it exerts a significantly larger influence on the budget over the long term than other

commonly cited factors, such as the aging of the population.

Rising health care costs represent a challenge not only for the federal government

but also for private payers. Indeed, the trends for both largely reflect the same

underlying forces—the spread of costly new medical technologies, limited costsharing requirements, and other factors—and cost growth per beneficiary in Medicare and Medicaid has tracked that in the rest of the health system over long periods of time (see Figure 2). Total health care spending, which consumed about

8 percent of the U.S. economy in 1975, currently accounts for about 16 percent of

GDP, and that share is projected to reach nearly 20 percent by 2016. About half of

that spending is now publicly financed, and half is privately financed.

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4

Figure 2.

Annual Growth Rates of Private and Public Health

Care Spending

(Change in total nominal spending from previous year)

Source: Congressional Budget Office based on Centers for Medicare and Medicaid Services’ data on 

national health expenditures.

Reasons for Cost Growth and the Relationship Between

Cost and Quality

In order to see what options may exist to limit future cost growth, it is useful to

review the main factors contributing to that growth—as well as past efforts at cost

control. Many analysts attribute the bulk of the growth in health care spending to

the development and diffusion of new medical technology, or, as one leading

observer has described it, “the increased capabilities of medicine.”2 Recent medical advances have made a wealth of new medical therapies available to physicians

and patients. Some advances permit the treatment of previously untreatable conditions, which can confer substantial benefits but also introduces new categories of

spending. Others advances may improve medical outcomes (compared with those

provided by older treatments) but at added costs. Some studies have found that the

spread of new medical technology has yielded benefits that clearly justify the

added costs on average, but other evidence also strongly suggests that additional

2. Joseph P. Newhouse, “An Iconoclastic View of Health Cost Containment,” Health Affairs, vol.

12, Supplement (1993), pp. 152–171.

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Figure 3.

Medicare Spending per Capita in the United States, by

Hospital Referral Region, 2003

Source: The Dartmouth Atlas of Health Care.

Note: Numbers in parentheses refer to the number of hospital referral regions with per capita 

spending in each interval.

treatments and services are being provided broadly to patients who could do just as

well with less-expensive care.3

Significant evidence exists that more-expensive care need not mean higher-quality

care—suggesting an opportunity to reduce costs without impairing health outcomes. Perhaps the most compelling evidence of that opportunity comes from the

substantial geographic differences in spending on health care within the United

States—and the fact that they do not translate into higher life expectancy or measured advantages in other health statistics in the higher-spending regions.4 For

example, Medicare’s costs per enrollee vary significantly from regions to region:

from as low as $4,000 to more than $11,000 in 2003 (see Figure 3). Research has

3. See David M. Cutler, Your Money or Your Life: Strong Medicine for America’s Health Care

System (New York: Oxford University Press, 2004).

4. Comparisons among countries also support that conclusion. For a recent comparison of health

spending and outcomes in the United States and other countries, see McKinsey Global Institute,

Accounting for the Cost of Health Care in the United States (San Francisco: McKinsey & Company, January 2007).

$7,000 to $11,352 (64)

$6,500 to <$7,000 (53)

$6,000 to <$6,500 (56) 

$5,500 to <$6,000 (64)

$4,272 to <$5,500 (70)

Not Populated
6

Figure 4.

The Relationship Between Quality and Medicare

Spending, by State, 2004

(Composite measure of quality of care)

Source: Congressional Budget Office based on data from Agency for Healthcare Research and 

Quality, National Healthcare Quality Report, 2005, Appendix: Data Tables, available at 

www.ahrq.gov/qual/nhqr05/index.html, and data from the Centers for Medicare and 

Medicaid Services' Continuous Medicare History Sample.

Note: The composite measure of the quality of care, based on Medicare beneficiaries in the 

fee-for-service program who were hospitalized in 2004, conveys the percentage who 

received recommended care for myocardial infarction, heart failure, and pneumonia. 

Spending figures convey average amounts by state.

shown that much of that variation in spending cannot be explained by differences

in the population or medical prices and that the higher-spending regions do not

generate better health outcomes than the lower-spending regions.5 Furthermore,

differences in spending are not correlated with measures of the quality of care that

enrollees receive (see Figure 4). Concerns about that regional variation are buttressed by the fact that hard evidence is often unavailable about which treatments

work best for which patients or whether the added benefits of more-effective but

more-expensive services are sufficient to warrant their added costs—and in many

5. See John E. Wennberg, Elliot S. Fisher, and Jonathan S. Skinner, “Geography and the Debate

Over Medicare Reform,” Health Affairs, Web Exclusive (February 13, 2002), pp. w96–w114;

and Elliot S. Fisher and others, “The Implications of Regional Variations in Medicare Spending, Part 1: The Content, Quality, and Accessibility of Care,” Annals of Internal Medicine, vol.

38, no. 4 (February 18, 2003), pp. 273–287.

73

78

83

88

4,000 5,000 6,000 7,000 8,000

Spending per Beneficiary (Dollars)
7

cases, the variation in treatments is greatest for those types of care for which evidence about relative effectiveness is lacking.

Another important factor affecting the level and potentially the growth rate of

health care costs is the manner in which insurers reimburse and oversee the delivery of health care. Up through the 1980s, private health insurance coverage in the

United States typically took the form of an “indemnity” policy, which reimbursed

enrollees for their incurred costs, left it to them and their doctors to determine what

care to provide, and largely allowed doctors and hospitals to set prices for those

services. Rapidly rising health costs and concerns about the incentives that those

arrangements provided led to increased enrollment in managed care plans, such as

health maintenance organizations. Those plans used various methods to reduce

both the prices and the quantity or intensity of health care services, including limited networks of providers and requirements to obtain a referral from a primary

care physician in order to see a specialist. Their adoption played an important role

in controlling U.S. health care costs during the 1990s. Private payments for health

care grew at the same rate as the overall economy between 1992 and 2000, and

total spending for health care as a share of GDP remained constant at about 14 percent between 1993 and 2000. By the end of the 1990s, however, the increasing

objections of enrollees and providers to the constraints of managed care—which

often included restrictions on treatments that were not based on medical evidence—led health plans to adopt less aggressive forms of management and produced shifts in enrollment toward more loosely managed plans. Fee-for-service

reimbursement remains the predominant form of payment in private health insurance as well as Medicare.

Spending is the product of prices and quantities, so concerns about rising health

care costs also raise questions about the prices that are paid for services. Measuring prices in the health sector can be difficult, however, both because it can be hard

to control for changes over time in the quality of the products being compared

(which makes historical price comparisons misleading) and because discounts

negotiated by private insurers are typically confidential. Despite those challenges,

some observers have suggested that, properly measured, many prices for health

care have actually grown at rates comparable to general inflation and that prices

have not played a substantial role in the growth of U.S. health costs over time. 6

Even so, price levels affect total spending, and in some cases private insurers may

have difficulty negotiating low prices for health care items and services—whereas

public purchasers have sometimes intervened to obtain relatively low prices. In the

case of doctors and hospitals, limited competition in some parts of the country acts

6. See David M. Cutler and others, “Are Medical Prices Falling? Evidence from Heart Attack

Treatments,” Quarterly Journal of Economics, vol. 113, no. 4 (November 1998), pp. 991-1024;

and Joseph P. Newhouse, “Medical Care Costs: How Much Welfare Loss?” Journal of Economic Perspectives vol. 6, no. 3 (Summer 1992), pp. 3–21.
8

Figure 5.

Share of Personal Health Care Expenditures Paid

Out of Pocket

(Percentage)

Source: Congressional Budget Office based on the Centers for Medicare and Medicaid Services’ 

data on national health expenditures.

Note: Spending on personal health care excludes administrative costs for health insurance, public 

and private spending for medical research and construction of facilities, and government 

spending for public health agencies, such as the Centers for Disease Control and Prevention 

and state health departments.

as a constraint on private negotiations; in the case of prescription drugs, public

policy (through patents) gives manufacturers monopoly power—which leads to

higher drug prices but also encourages the development of new drugs that can be

patented. Federal and state purchasers have established mechanisms that yield

prices that are below private-sector levels for drugs (under Medicaid and the

health program for military veterans) and for doctors and hospitals (under Medicare and particularly Medicaid), but such approaches can also raise various concerns (including concerns about access to providers).

Another important factor that both reflects and has contributed to rising health

costs is the declining proportion of those costs that are paid out of pocket. Out-ofpocket payments accounted for 33 percent of all personal health care expenditures

in 1975, but by 2005, that share had fallen to 15 percent (see Figure 5). It is projected to decline a little more in the future, reaching 13 percent in 2015. Consumers facing lower out-of-pocket costs tend to demand more health care services than

consumers facing higher out-of-pocket costs. At the same time, rising health care

costs (as a share of income) have probably led individuals to seek more extensive

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insurance in order to keep the variability of their out-of-pocket expenses from

increasing.

Options for Controlling Health Care Costs

A number of programmatic changes within Medicare and Medicaid, including

changes in payments to providers and eligibility rules, could be implemented to

reduce federal spending.7 Those options have different implications for overall

health spending, however. Some would simply result in a reallocation of total costs

among different sectors (the federal government, the corporate sector, households,

and state and local governments) rather than a reduction in overall costs; others

would involve some combination of shifting among sectors and reduction in total

costs; and still others would reduce both federal and total health spending in parallel. Many analysts believe that significantly constraining the growth of costs for

Medicare and Medicaid over long periods of time, while maintaining broad access

to health providers under those programs, can occur only in conjunction with

slowing cost growth in the health care sector as a whole.

Ultimately, therefore, restraining costs in Medicare and Medicaid requires restraining overall health care costs. Two potentially complementary approaches to reducing total health spending—rather than simply reallocating spending among different sectors of the economy—involve generating more information about the

relative effectiveness of medical treatments and changing the incentives for

providers and consumers in the supply and demand of health care.

The current financial incentives facing both providers and patients tend to encourage or at least facilitate the adoption of expensive treatments and procedures, even

if evidence about their effectiveness relative to existing therapies is limited. For

doctors and hospitals, those incentives stem from fee-for-service reimbursement.

Such payments can encourage health care providers to deliver a given service in an

efficient manner but also provide an incentive to supply additional services—as

long as the payment exceeds the costs of the services. For their part, insured individuals generally face only a portion of the costs of their care and, consequently,

have only limited financial incentives to seek a lower-cost treatment—a trade-off

inherent in having insurance protection. Private health insurers have incentives to

limit the use of ineffective care but are also constrained by a lack of information

about what treatments work best for which patients.

7. See Congressional Budget Office, Budget Options (February 2007); and Statement of Donald

B. Marron, Acting Director, Congressional Budget Office, Medicaid Spending Growth and

Options for Controlling Costs, before the Senate Special Committee on Aging (July 13, 2006).
10

Many analysts believe that expanded research on “comparative effectiveness”

offers a promising mechanism to address some of those concerns.8 Analysis of

comparative effectiveness is simply a comparison of the impact of different

options that are available for treating a given medical condition for a particular set

of patients. Such studies may compare similar treatments, such as competing

drugs, or they may analyze very different approaches, such as surgery and drug

therapy. The analysis may focus only on the relative medical benefits and risks of

each option, or it may go on to weigh both the costs and the benefits of those

options. In some cases, a given treatment may be found more effective for all types

of patients, but more commonly a key issue is determining which specific types

would benefit most from it. An expanded research effort could be organized in

various different ways. In response to a request from the Senate Budget and

Finance Committees, the Congressional Budget Office (CBO) will issue a report

on those options in the near future.

Comparative effectiveness research could be facilitated by having more health

records available in electronic form, assuming privacy concerns were appropriately addressed.9 That format makes it easier to collect detailed data on the health

status and the clinical characteristics of patients, which in some cases could be

used to compare treatments in a rigorous way without having to conduct full-scale

clinical trials. Indeed, despite somewhat exaggerated claims about direct cost savings from investments in health information technology, one reason those investments might have a long-term impact on health costs is because of their potential

to expand and improve comparative effectiveness research.

To affect medical treatment and reduce health care spending, the results of comparative effectiveness analyses would ultimately have to change the behavior of

doctors and patients—that is, to get them to use fewer services or less intensive

and less expensive services than are currently projected. Bringing about those

changes would probably require action by public and private insurers to incorporate the results into their coverage and payment policies in order to affect the

incentives facing doctors and patients.

Although private insurers could choose not to cover drugs, devices, or procedures

that were found to be less effective or less cost-effective, the insurers would have a

number of additional options as well. They could simply provide more information

to patients and doctors, which could improve compliance with treatment guidelines. Alternatively, insurers could adjust payments to doctors and hospitals to

8. For an analysis of the issue, see Statement of Peter R. Orszag, Director, Congressional Budget

Office, Research on the Comparative Effectiveness of Medical Treatments: Options for an

Expanded Federal Role, before the Subcommittee on Health, House Committee on Ways and

Means (June 12, 2007).

9. See Jean R. Slutsky, “Moving Closer to a Rapid-Learning Health Care System,” Health Affairs,

Web Exclusive (January 26, 2007), pp. w122-w124; and related articles in that issue on rapid

learning and electronic medical records.
11

encourage the use of more-effective care. Or insurers could require enrollees to

pay some or all of the additional costs of more-expensive treatments that were

shown to be less effective or less cost-effective (in which case enrollees would

have to decide whether the added benefits were worth the added costs). Indeed,

some recent proposals call for “value-based” insurance design that encourages the

use of services when the clinical benefits exceed the costs and likewise discourages the use of services when the benefits do not justify the costs.10 Although

insurance plans generally vary cost sharing by the type of service provided—

with lower cost-sharing requirements for hospital care and higher obligations for

outpatient services—that new approach would be tailored to the patient and the

treatment.

The Medicare program has not taken costs into account in determining what services are covered and has made only limited use of comparative effectiveness data

in its payment policies—but if statutory changes permitted it, Medicare could use

information about comparative effectiveness to promote higher-value care. For

example, Medicare could tie its payments to providers to the cost of the most

effective or most efficient treatment. If that payment was less than the cost of providing a more expensive service, then doctors and hospitals would probably elect

not to provide it—so the change in Medicare’s payment policy would have the

same practical effect as a coverage decision. Alternatively, enrollees could be

required to pay for the additional costs of less effective procedures (although the

impact on incentives for patients and their use of care would depend on whether

and to what extent they had supplemental insurance coverage that paid some or all

of Medicare’s cost-sharing requirements).

More modest steps that Medicare could be authorized to take would include

smaller-scale financial inducements to doctors and patients to encourage the use of

cost-effective care. Doctors and hospitals could receive modest bonuses for practicing effective care or modest cuts in their payments for using less effective treatments. Likewise, enrollees could be asked to pay a portion of the additional costs

of less efficient procedures (rather than the full difference in costs). Or Medicare

could provide information to doctors and their patients about doctors’ treatment

patterns, which would create some pressure for doctors to use more-efficient

approaches. Adopting more modest measures to incorporate the findings of comparative effectiveness research, however, is likely to yield smaller savings for the

program.

Even in the absence of more information about comparative effectiveness, changes

in incentives could help to control health care costs—but such measures would be

more likely to maximize the health gains obtained for a given level of spending if

they were combined with improved information. On the provider side, greater

10. Michael E. Chernew, Allison B. Rosen, and A. Mark Fendrick, “Value-Based Insurance

Design,” Health Affairs, Web Exclusive (January 30, 2007), pp. w195–w203.
12

bundling of payments to cover all of the services associated with a treatment, disease, or patient could reduce or eliminate incentives to provide additional services

that might be of low value. Such approaches, however, can raise concerns about

the financial risk that providers face and about their incentives to provide too little

care. On the consumer side, a landmark health insurance experiment by RAND

showed that higher cost sharing reduces spending—particularly when compared to

a plan offering free care—with little or no adverse effects on health.11 However,

compared with more typical health insurance plans (which do not offer free care),

high-deductible designs have more modest effects on health care spending; such

approaches also raise concerns about the financial burden on individuals with

more health problems (again reflecting trade-offs between providing insurance

protection and maintaining incentives to control costs).12

The broad options of generating more information and of changing incentives do

not represent an exhaustive list of proposals intended to reduce health costs. Some

analysts have advocated significant expansions of disease management and care

coordination as mechanisms for reducing costs—proposals that reflect the increasing prevalence of many chronic conditions, the large share of health care spending

that is incurred by individuals with those conditions, and lack of care coordination

systems in many public and private health insurance plans. The top 25 percent of

Medicare beneficiaries, for example, account for 85 percent of Medicare costs (see

Figure 6), and more than three-quarters of those expensive beneficiaries had one

or more of seven prominent chronic conditions (including coronary artery disease,

diabetes, and congestive heart failure).13 However, the evidence to date—including the findings of several demonstration projects conducted under Medicare—

suggests that disease management and care coordination may raise the quality of

health care provided but do not significantly reduce costs among a broad array of

patients.14 As more empirical evidence on the approaches develops, identifying

specific ways to reduce costs, especially for targeted subsets of beneficiaries, may

become possible; for now, the possibility and scope of savings remain unclear. In

11. See Willard G. Manning and others, “Health Insurance and the Demand for Medical Care: Evidence from a Randomized Experiment,” American Economic Review, vol. 77, no. 3 (June

1987), pp. 251–277.

12. See Congressional Budget Office, Consumer-Directed Health Plans: Potential Effects on

Health Care Spending and Outcomes (December 2006).

13. See Congressional Budget Office, High-Cost Medicare Beneficiaries (May 2005).

14. See Congressional Budget Office, An Analysis of the Literature on Disease Management Programs (October 13, 2004); Randall Brown and others, “The Evaluation of the Medicare Coordinated Care Demonstration: Findings for the First Two Years,” (Mathematica Policy Research,

Inc., March 21, 2007), available at www.mathematica-mpr.com/publications; and Statement of

Stuart Guterman, Senior Program Director, Program on Medicare’s Future, The Commonwealth Fund, Enhancing Value in Medicare: Chronic Care Initiatives to Improve the Program,

before the Senate Special Committee on Aging (May 9, 2007).
13

Figure 6.

Concentration of Total Annual Medicare Expenditures

Among Beneficiaries, 2001

(Percent)

Source: Congressional Budget Office based on data from the Centers for Medicare and Medicaid 

Services.

future months and years, CBO will be expanding its work to provide the Congress

with more analysis of various options for controlling health care costs.

Whichever approaches are taken, the overall impact of steps to control costs will

be greater the sooner that they are taken—particularly if they reduce the growth

rate of health care costs and not just the level of those costs. For example, if costs

per beneficiary in Medicare and Medicaid grew 1 percentage point faster than per

capita GDP starting in 2025—rather than growing at the long-term historical rate

of 2.5 percentage points faster—then the share of the economy devoted to those

two programs in 2050 would shrink by nearly 7 percent of GDP, from 21 percent

to about 14 percent (see Figure 7). If that slower growth rate were instead obtained

starting in 2015, the projected spending for those programs in 2050 would be

reduced by nearly 9 percent of GDP (from 21 percent to about 13 percent).15

15. Similarly, if costs per enrollee continued to grow 2.5 percentage points faster than per capita

GDP, the present value of Medicare and Medicaid spending over the next 50 years would equal

almost 11 percent of the present value of GDP over that period. If that difference in growth

rates were reduced to 1 percentage point starting in 2025, the present value of outlays would

decline to about 9 percent of GDP. And if the slower growth rate were obtained starting in 2015,

the present value of outlays would fall to about 8 percent of GDP.

Beneficiaries Expenditures

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Figure 7.

Effects of Slowing the Growth of Spending for

Medicare and Medicaid

(Percentage of gross domestic product)

Source: Congressional Budget Office.

Note: The health cost growth differential refers to the number of percentage points by which the 

growth of annual health care spending per beneficiary is assumed to exceed the growth of 

nominal gross domestic product per capita, after an adjustment for the growth and aging of 

the Medicare and Medicaid populations.

In considering those potential savings, it is important to note that they are merely

illustrative and do not represent CBO’s estimates of the effects that any specific

proposal or combination of options would have. As the challenges touched on in

the preceding discussion suggest, reducing the growth rate of health costs over an

extended period of time will be a complicated endeavor.

Employer-Sponsored Insurance

Concerns about the operation of private insurance markets have given rise to various proposals that seek to improve the efficiency of those markets and that could

also affect health care spending. Because of the central role that employer-sponsored coverage currently plays, a key issue for broad health reform proposals is

whether they are based upon an employer-sponsored system, and if not, how they

create the pooling mechanisms essential for effective health insurance markets.

Other key budgetary and policy issues include any requirements for employers’

contributions and the treatment of existing tax subsidies for employer-sponsored

insurance.

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Issues with Current System

Most Americans get their primary health insurance through an employer—either

their own or that of a family member. By CBO’s estimates, 165 million nonelderly

individuals are currently covered by employer-based insurance, with 140 million

obtaining that coverage through a large or medium-sized employer (one with 50 or

more workers) and 25 million obtaining that coverage through a small employer.

Although employer-based insurance has advantages, particularly when provided

through a larger employer, that arrangement also has limitations, and many

employers have expressed serious concerns about the rising costs of providing

coverage. Employers’ concerns are presumably a proxy for the underlying issue,

which is how well the employer-based system functions for the American public:

Ultimately, workers pay for their coverage directly or through reduced wages, and

the advantages and disadvantages of that system accrue to them.

One advantage of employer-based insurance is that it can facilitate the pooling of

risks. Although employees will vary in their use of health services from year to

year, the average health costs of a large group of employees tend to be quite stable—because higher-than-expected costs for some workers are offset by lowerthan-expected costs for others. As a result, employees can be offered insurance

that reduces their exposure to high medical costs without posing substantial financial risks for their employer (and, indeed, many large employers choose to assume

those risks themselves rather than contracting with an insurance company to bear

them). Employers typically foster risk pooling by offering to cover a majority of

the total premiums; even though a firm’s workers (as a group) ultimately pay for

that subsidy, employers’ contributions lower the price of insurance that individual

workers see and thus encourage broad participation. Another advantage of

employer-based coverage is its reduced administrative costs—compared with

those that would be incurred if employees purchased their own policies in the individual insurance market—which in turn lower the premiums.

At the same time, several concerns about employer-based coverage have been

raised. For one, the advantages related to risk pooling and administrative costs are

less evident for smaller firms, which employ about one-fourth of all workers. As a

result, premiums for small employers are typically higher (for the same level of

coverage) and can also be more volatile—factors which contribute to the lower

likelihood that small employers offer insurance. In addition, the link between

employment and insurance coverage typically means that when workers change

jobs, they also have to change their insurance plan. Over time, the resulting turnover of enrollees may discourage insurers from subsidizing health investments that

take a long time to pay off, because the initial insurers may not be the ones to realize the benefits from them. Finally, other observers object to the limited range of

choices provided by many employers—at least a third of workers have no choice

of health plan—and to the role that employers play in selecting which types of

coverage are made available (even though over the long term, employers’ offerings presumably evolve to reflect the collective preferences of their workers).
16

Another key feature of the U.S. health care system is that insurance purchased

through employers receives favorable treatment under the tax code—which

encourages enrollment in such coverage but also tends to drive up health costs.

Employers may deduct the costs of providing that coverage as a business expense

(just as they deduct employees’ wages and other forms of compensation), and thus

those payments avoid corporate taxes on profits. But unlike wages, the costs that

employers pay for health insurance are excluded from the taxable income of the

policyholders (and most employee contributions are similarly excluded). As a

result, that portion of employees’ compensation avoids individual income and payroll taxes as well. For a typical worker, those tax preferences amount to a subsidy

from the government of more than 30 percent toward the costs of health care services covered by employer-sponsored insurance. By reducing the price of that

insurance, the tax subsidy also encourages workers to secure more extensive policies through their employers, increasing the share of costs that is covered and

decreasing the share that is paid out of pocket. In turn, that more extensive coverage puts upward pressure on total health spending.

Rising health costs in recent years have generated concerns that employers will

cease offering coverage or make their coverage less comprehensive. However,

aggregate data indicate that such effects have been modest to date. The share of

workers who have employer-sponsored health insurance has decreased somewhat

since 2000, but according to surveys of employers, that development largely

reflects a decline in the percentage of smaller firms that are offering insurance;

coverage rates at larger firms have fluctuated over time but were comparable in

2000 and 2006.16 There is also some evidence that in recent years, employment

has shifted somewhat to smaller firms and to industries that are less likely to offer

coverage. Even with the recent decline in smaller firms’ rates of offering insurance, their overall “offer rate” remains comparable to that in 1996.

Amounts that enrollees have to pay out of pocket in premiums and cost-sharing

have risen significantly in absolute terms, but for the most part those increases are

in line with rising health costs overall. On average, the share of health costs that

enrollees pay directly has not changed much (and the longer-term trend in the

share of health care paid out of pocket, as indicated above, has been a substantial

decline). Between 2000 and 2006, employees’ average contributions to health

insurance premiums—the amount they pay directly, net of any employers’ contributions—rose about 85 percent. The overall costs of their insurance plans rose

about 75 percent over that same period, yielding only slight changes in the share of

premiums paid directly by enrollees.

16. Kaiser Family Foundation and Health Research and Educational Trust, Employer Health Benefits: 2006 Annual Survey (Washington, D.C., September 2006).
17

Options for Reforming Employer-Sponsored Insurance

Proposals to replace or significantly modify the current system of employer-sponsored insurance vary widely in their design. Some would establish a single-payer

system in which all workers and dependents would participate, as under proposals

to allow or require all individuals to enroll in Medicare. Others would move in

essentially the opposite direction, shifting to a system in which insurance was typically purchased in the individual market (perhaps accompanied by additional regulation of that market). Still others would build on the existing employment-based

system but use subsidies or mandates to increase the number of workers and

dependents who had insurance, such as “pay or play” proposals that would require

most employers either to offer health insurance or to contribute to a fund that

would subsidize insurance purchases.

A full analysis of those options is beyond the scope of my testimony today, but a

few key considerations can be highlighted. One is the impact each option might

have on the pooling of risks. By their nature, single-payer systems pool all participants together. By contrast, options that emphasize the individual insurance market may require further regulation—such as limits on the degree to which premiums may vary and on the factors (such as age) that may affect premiums—to

maintain current levels of pooling, as most supporters of such options recognize.

In principle, all enrollees in a given insurer’s policy are pooled together even

though they purchased their coverage individually. In practice, however, those

who have health problems will generally find changing insurers or plans more difficult, so, over time, as healthier enrollees gravitate toward less expensive policies,

the degree of pooling that occurs will tend to decline.

Another significant issue involved in any reform of the employer-provided system

is the short- and medium-term impact on employers’ contributions to health insurance. Over time, any changes in those contributions, which are substantial, should

be reflected in workers’ wages or other benefits, but the speed of that adjustment

could vary. Alternative systems for employers’ payments—including new taxes or

other mandatory contributions—could also have significant macroeconomic

effects on incentives to work and on the formation and organization of businesses

(if, for example, contributions were tied to the size of firms). The specific effects

of any proposal, however, would depend importantly on the details of the new system that would be established.

A closely related question is whether proposals modify or repeal the tax exclusion

for employer-sponsored insurance. Replacing the tax exclusion for employmentbased health plans with a deduction or tax credit that could be used in either the

employment-based or individual market would make employment-based plans

less attractive (relative to individually purchased plans) than they are now. As a

result, the number of people insured through employment-based plans would

decline. Although some of the people losing coverage in the employment-based

market would become uninsured, the bulk of them would be insured through the
18

individual market instead. Moving from the current system—in which the tax

exclusion creates a bigger tax subsidy for larger health insurance expenditures—

to a fixed deduction or credit independent of the cost of a health plan would cause

people to buy plans with less extensive benefits, on average.17

Lack of Insurance

The most recent estimates available indicate that about 45 million individuals

lacked health insurance at any given point in 2005; a larger number were uninsured at some point during that year.18 In some respects, the uninsured are a heterogeneous group: Some are young and healthy and may not perceive a need to purchase health insurance, while others are older and have health problems that make

insurance expensive to obtain. Many of the uninsured lack coverage for a relatively short time, but others are chronically uninsured.

Even so, a common characteristic of the uninsured is that they tend to have low

income. Depending on whether the analysis looks at all uninsured or is weighted

toward those with longer spells, the share of the uninsured who live in families

with income below 200 percent of the poverty level is between two-thirds and

three-quarters. Studies also indicate that about 80 percent of the uninsured live in

families with at least one worker (usually with a full-time job). In most cases,

however, those workers are either employed by firms that do not offer health insurance, or they are not eligible to enroll in the health insurance plans that their

employer offers.

Factors Affecting the Number of Uninsured

Both the high cost of health care and the evolution of employer-based health insurance affect the number of people who have coverage. Higher premiums discourage

people from purchasing insurance—especially those who have lower income or

who perceive little risk of incurring a costly illness. (Rising health care costs can

also make insurance protection more valuable, but that consideration may not substantially affect the behavior of lower-income or younger and healthier people.)

Those who are not employed or who choose to work at a firm not offering insurance—and who do not have coverage through a spouse’s policy—have to seek

insurance in the individual market, where policy terms and tax benefits are generally much less attractive than they are for employer-sponsored plans. As a result,

many such people (and their family members) are uninsured.

17. For an analysis of the President’s proposal to create a standard tax deduction for health insurance, see Congressional Budget Office, An Analysis of the President’s Budgetary Proposals for

Fiscal Year 2008 (March 2007), pp. 57–62.

18. For a discussion of different measures of the uninsured population, see Congressional Budget

Office, How Many People Lack Health Insurance and For How Long? (May 2003).
19

Federal programs have reduced significantly the number of people who would otherwise be uninsured. The Medicare program provides nearly universal coverage to

the elderly, a substantial share of whom lacked health insurance (or had very limited coverage) at the time of its enactment. Medicaid offers health insurance coverage to a variety of low-income individuals—primarily poor children and their

mothers, pregnant women, the disabled, and the elderly. In 2006, about 30 million

nondisabled children in low-income families were enrolled in Medicaid. At the

same time, surveys indicate that several million people are eligible for Medicaid

and otherwise uninsured but not enrolled in the program. Such individuals may

simply be unaware of Medicaid or their eligibility for it, or they may be dissuaded

from enrolling by various factors, including the stigma that is sometimes associated with means-tested programs. In many cases, individuals may be enrolled into

Medicaid when they need expensive services; thus, those who are eligible for but

not enrolled in the program have some protection against financial loss but do not

obtain the full benefits of participation.

The State Children’s Health Insurance Program (SCHIP), enacted in 1997, also

provides health insurance coverage to uninsured children living in families with

income that is relatively low—but too high to qualify for Medicaid. During 2006,

nearly 7 million children were enrolled in SCHIP at a total cost to the federal government of about $5 billion.19

SCHIP has significantly reduced the number of low-income children who are

uninsured. CBO estimates that, among children living in families with income

between 100 percent and 200 percent of the poverty threshold, the uninsurance

rate fell from 22.5 percent in 1996 (the year before SCHIP was enacted) to

16.9 percent in 2005, a reduction of 25 percent. In contrast, the uninsurance rate

among children in higher-income families remained relatively stable during that

period (see Figure 8). As with Medicaid, estimates indicate that a substantial number of children are eligible for SCHIP but not enrolled in it. Although SCHIP and

Medicaid have significantly reduced the number of uninsured children in lowincome families, the net effect on the extent of coverage is smaller than the number of children who have been enrolled in public coverage because the increase in

public coverage has been partially offset by a reduction in private coverage.

Concerns about the uninsured include the financial risk they face and the prospect

that their health will be adversely affected. According to one recent study, people

who are uninsured for a full year receive about half as much care as continuously

insured individuals—partly reflecting the fact that many uninsured individuals are

relatively young and healthy but also a result of the higher costs they face for

19. See Congressional Budget Office, The State Children’s Health Insurance Program (May 2007).

The figure for the number of people enrolled in 2006 reflects enrollment at any time during the

year. The number of people enrolled in an average month would be about 60 percent of that

total.
20

Figure 8.

Percentage of Children Who Were Uninsured, by

Family Income as a Percentage of the Federal Poverty

Level

(Percent)

Source: Congressional Budget Office based on data from the Current Population Survey for 1996 to 

2005.

Note FPL = federal poverty level.

services.20 Several studies have found that, when they have a serious disease, the

uninsured are less likely to have received a prompt diagnosis of their condition and

are less likely to receive expensive treatments.21 The majority of the care that the

uninsured do receive is provided free of charge or at a substantially reduced cost,

either because they receive services from clinics or other sources that are subsidized by the government or because private providers are unable to collect

payment.

To address such concerns, several states have taken or are contemplating their own

initiatives targeting the uninsured. For example, Massachusetts enacted a program

in 2006 aimed at providing nearly universal health insurance coverage for its residents. The legislation generally requires individuals to purchase insurance and

includes increasing penalties for those who do not obtain coverage (in 2008, they

20. Jack Hadley and John Holahan, “How Much Medical Care Do the Uninsured Use, and Who

Pays for It?” Health Affairs, Web Exclusive (February 12, 2003), pp. W3-66–W3-81.

21. For a review of those studies, see Institute of Medicine, Care Without Coverage: Too Little, Too

Late (Washington, D.C.: National Academy Press, 2002), available at www.iom.edu/

Object.File/Master/4/160/Uninsured2FINAL.pdf.

1996 1999 2002 2005

0

5

10

15

20

25

30

Less Than FPL

100% to 199% of FPL

200% to 299% of FPL

300% of FPL or More
21

will have to pay roughly half of the cost of the least expensive health plan offered

in their region); additional penalties apply to employers who do not offer coverage. To make it easier for individuals without access to employer-based plans to

obtain coverage, an insurance exchange (known as the Connector) has been established. To help lower-income individuals obtain coverage, the state will fully subsidize insurance for those with income below 150 percent of the poverty level and

will offer smaller subsidies to those with somewhat higher income. Even so, some

individuals have been exempted from the coverage mandate because they have

been deemed unable to find low-cost sources of coverage. Other states, including

California (which has a much larger uninsured population), are considering similar

approaches.

Options for Expanding Insurance Coverage

Although reductions in overall health costs would tend to lower health insurance

premiums—and thus could reduce the number of people without insurance—a

substantial number of people were uninsured even when health care costs were

lower. Substantially reducing the number of uninsured individuals would therefore

probably require a mandate to purchase insurance (or similar penalties for not having coverage), a set of subsidies for low-income people, or some combination of

those approaches. The share of people who are uninsured tends to decline as their

income rises, so subsidies of premiums could be set on a sliding scale. A tradeoff

exists in the size of the subsidy: larger subsidies would increase voluntary purchases of insurance but would also be more costly to provide. A mandate to purchase insurance combined with a penalty for not doing so also provides an impetus

to obtain coverage, but in the form of a stick rather than a carrot.

Subsidies could take the form of tax rebates or credits or direct support through a

government program like Medicaid (in which the enrollee’s premiums cover less

than the average cost of the policy). Because the uninsured tend to have lower

income and therefore face lower marginal income tax rates, tax credits tend to be a

more effective means of providing subsidies than tax deductions (whose value

increases with the marginal tax rate). For the same reason, tax credits are even

more valuable to low- and moderate-income recipients if they are refundable,

because that feature makes the full value of the credit available even if it exceeds

recipients’ income tax liability. An inevitable trade-off is that providing new government subsidies to expand insurance coverage will displace some private spending—because it is difficult to prevent people with low-income who already have

health insurance from qualifying for the newly offered subsidies.

Here too a full consideration of the advantages and disadvantages of those options

would require much more extensive analysis than can be presented in this testimony, but a few key points can be covered regarding administrative costs and

overall health care costs. Administrative costs could be affected if options for

expanding insurance coverage also included reforms of the individual insurance

market (as discussed above in connection with changes to the employer-sponsored
22

insurance system) as well as mechanisms to oversee the insurance policies offered

and to facilitate enrollment in a plan (as under the Massachusetts initiative). Insurance market reforms have the potential to reduce or eliminate some administrative

costs now incurred by private insurers. For example, community rating requirements—under which all enrollees pay the same premium, at least within an age

range—or limits on the factors that can be used to adjust premiums could reduce

costs that insurers now incur to enroll beneficiaries and underwrite their policies.

At the same time, providing information and conducting outreach to individuals

involves administrative costs that may be difficult to avoid under any system that

provides a choice of insurance plans. Administrative costs could be reduced further under a single-payer system, but trade-offs would arise between achieving

those savings, running the plan efficiently, and limiting choices for enrollees.

Several factors would affect the overall impact that expanding insurance coverage

would have on total health care spending—first and foremost being the net

increase in coverage and the type and extent of insurance provided. Health spending associated with individuals who were newly covered would be expected to

increase because coverage would encourage greater use of services (indeed, that

would be one of the objectives of expanding coverage). A shift in measured spending would also occur, because the services used by newly covered beneficiaries

would be paid for by their insurer rather than becoming uncompensated care.

Some of that increase would be offset by reductions in government spending that

now goes to provide free or subsidized care, and it is also possible that reductions

in uncompensated care could reduce costs for other private payers (if doctors and

hospitals lowered their fees to private insurers as a result of receiving higher payments on behalf of formerly uninsured individuals). The extent of such effects is

highly uncertain, however.

Prevention and Healthy Living

The ultimate objective of any health care system is to promote health, whether by

treating diseases that arise or by preventing them from occurring in the first place.

Despite the cost of the nation’s health care system, many concerns exist about the

degree to which it is attaining that objective. Indeed, concerns about rising health

care costs might not be so prominent if more evidence showed that those expenditures were yielding commensurate gains in health. In part, those shortcomings in

the system’s performance relate to the questions noted above about whether

patients are receiving the most effective or most cost-effective treatments—

reflecting a lack of information, among other factors. Concerns also exist, though,

about steps that are not being taken today to prevent the onset of disease, even

when clear evidence is available about their benefits. In that context, proposals

that encourage more prevention and healthy living can help to promote better

health outcomes, although their net effects on federal and total health spending are

uncertain. Moreover, bringing about substantial changes in behavior could require
23

actions outside the formal health care sector, and even then might be very difficult

to achieve.

Issues Regarding Preventive Care and People’s Behavior

The health of the American public, on average, is lower than it could be because

steps that can foster better health—such as preventive medicine—appear to be

underused, and various types of unhealthy behavior—in particular, those contributing to recent increases in obesity—remain relatively common.

Preventive services encompass several distinct types of care: immunizations and

other interventions that actually prevent diseases from arising; screening tests that

can determine the presence of a disease; and counseling to encourage healthy

behavior or discourage unhealthy habits. The U.S. Preventive Services Task Force,

an arm of the Department of Health and Human Services, has analyzed the costeffectiveness of many preventive services and has developed a recommended list

of interventions that should be routinely provided. (In some cases, the evidence

necessary to make a recommendation is not available—a situation analogous to

the uncertainties about which treatments work best.) According to one study, however, adults receive only about half of the recommended preventive services.22

Various reasons have been cited for the low use of preventive services, including a

lack of awareness about their benefits among consumers and a focus on treatment

rather than prevention among doctors. Another source of concern has been the

extent to which insurance plans cover preventive care and the cost-sharing requirements for that care. The majority of private insurers appear to cover immunizations and various screening tests—and about half of the plans that require a

deductible exempt at least some preventive services from it—but coverage of

counseling services is much more limited; low reimbursements to physicians for

counseling services also discourage their provision.23 Coverage of preventive care

under Medicare requires specific legislative authority, and thus varies from services to service. Medicaid covers childhood immunizations on a consistent basis,

but coverage for screening and diagnostic services for children and adults varies

from state to state. To address that situation, some health researchers have recently

put forward proposals to expand the use of preventive care using federal subsidies.24

22. See Elizabeth A. McGlynn and others, “The Quality of Health Care Delivered to Adults in the

United States,” New England Journal of Medicine, vol. 348, no. 26 (June 26, 2003), pp. 2635–

2645. That study also found that adults receive about half of the recommended services for

acute and chronic health problems.

23. See Eileen Salinsky, Clinical Preventive Services: When Is the Juice Worth the Squeeze? Issue

Brief No. 806 (Washington, D.C.: National Health Policy Forum, August 24, 2005); and Kaiser

Family Foundation, Employer Health Benefits: 2006 Annual Survey.

24. See, for example, Jeanne M. Lambrew, A Wellness Trust to Prioritize Disease Prevention,

Hamilton Project Discussion Paper 2007-04 (Washington, D.C.: Brookings Institution, April

2007).
24

Such steps could improve health, but the net effect of greater use of preventive

care on health spending is uncertain. In some cases, preventive care can help avoid

more costly treatments that may be required after a disease has developed further.

In other cases, though, increased use of preventive care could increase other health

care spending—to treat newly discovered diseases or to address complications

arising from testing, for example. Additional costs are associated with treating

people who have received “false positives”—that is, who are incorrectly identified

as having a given disease. Furthermore, screening tests are typically performed on

people with no symptoms, so the number of people tested may be quite large compared with the number who will have a disease discovered. As a result, one older

study found, the use of preventive care usually adds to overall medical spending,

once the cumulative costs of screening individuals who are found not to have the

disease in question are included.25 A more recent review of the evidence concluded that, “with the exception of some immunizations, most preventive services

do not ‘save’ money.”26 The extent to which electronic health records and other

information technology advances could allow more precise targeting of screening

tests remains unclear.

Perhaps an even more important determinant of health than the health care system

is an individual’s behavior. In particular, obesity and smoking have substantial

health consequences.

Obesity. The share of Americans who are overweight or obese has risen dramatically over the past three decades, from about one-half to roughly two-thirds—with

the share who are obese accounting for the entire increase (see Figure 9). According to one recent study, the rise in obesity rates in the United States is related

mostly to an increase in caloric intake—and in particular, an increase in calories

from snacks—rather than a decline in caloric expenditures—that is, reduced

activity.27

Obesity is associated with many serious medical conditions, including diabetes,

heart disease, and high blood pressure. According to another recent study, obese

people incurred medical costs in 2001 that were 37 percent higher than those for

people of normal weight—a difference of about $1,000 per person.28 That study

also found that the increased prevalence of obesity between 1987 and 2001

accounted for 12 percent of the overall growth in real (inflation-adjusted) medical

spending per capita that occurred over that period. Another study found even more

25. Louise B. Russell, Is Prevention Better Than Cure? (Washington, D.C.: Brookings Institution,

1986).

26. Salinsky, Clinical Preventive Services, p. 7.

27. David M. Cutler, Edward L. Glaeser, and Jesse M. Shapiro, “Why Have Americans Become

More Obese?” Journal of Economic Perspectives, vol. 17, no. 33 (Summer 2003), pp. 93–118.

28. Kenneth E. Thorpe and others, “The Impact of Obesity on Rising Medical Spending,” Health

Affairs, Web Exclusive (October 20, 2004), pp. W4-480–W4-486.
25

Figure 9.

Percentage of Individuals Ages 20 to 74 Who Are

Overweight or Obese

Source: Congressional Budget Office based on Department of Health and Human Services, Centers 

for Disease Control and Prevention, National Center for Health Statistics, Health, United 

States, 2006.

Note: Individuals who are overweight are defined as having a body mass index (BMI) of 25 or more 

but less than 30; obese, a BMI of 30 or more. By comparison, people with a healthy weight 

have a BMI of 18.5 to less than 25.

significant implications for Medicare: The share of spending attributable to obese

enrollees increased from about 9 percent in 1987 to about 25 percent in 2002, a

substantially larger increase than was seen in the obesity rate for the Medicare

population.29

Smoking. Smoking rates have declined in the United States, but roughly one-fifth

of the population still smokes. Smoking rates among pregnant women have also

shown a steady decline, but about 10 percent of expectant mothers still smoke

despite the substantial health risks that smoking poses to their babies (see

Figure 10).

Smoking rates began to fall following the Surgeon General’s 1964 report on smoking, which stated definitively that smoking causes cancer. Since that time, additional information about the adverse health effects of smoking has been developed

and disseminated—which has probably contributed to the steady decline in smok29. Medicare Payment Advisory Commission, Report to the Congress: Promoting Greater Efficiency in Medicare (June 2007), p. 9.

1960–1962 1971–1974 1976–1980 1988–1994 1999–2002

0

10

20

30

40

50

60

70

Overweight

Obese
26

Figure 10.

Cigarette Smoking by Various Groups

(Percentage)

Source: Congressional Budget Office based on Department of Health and Human Services, Centers 

for Disease Control and Prevention, National Center for Health Statistics, Health, United 

States, 2006.

ing rates. (For example, smoking is associated with a significantly increased risk

of developing heart disease and emphysema and of having a stroke) Other factors

affecting smoking rates are regulations such as bans on smoking in certain areas

and limits on how cigarettes can be sold and, more importantly, the rise in the real

price of cigarettes. Federal excise taxes and most state taxes on tobacco have been

raised periodically over the years, and those increases are passed on to consumers,

boosting the retail price of cigarettes. Each 10 percent increase in price, research

has shown, causes the use of cigarettes to fall by 2.5 percent to 5 percent.

In general, the fact that taxing an item can cause consumers to buy less of it than

they might otherwise can result in a less efficient allocation of society’s resources

(unless some of the costs associated with the taxed item are not reflected in its

price). But the use of cigarettes creates “external costs” for society that are not

paid by smokers or tobacco producers, such as higher costs for health insurance (to

cover the higher medical expenses incurred by smokers) and the damaging effects

of cigarette smoke on the health of nonsmokers. Furthermore, people may underestimate the harm they do to themselves by smoking or the addictive power of nicotine. Teenagers in particular may not be capable of evaluating the long-term

effects of beginning to smoke. For reasons that are not entirely clear, the smoking

rate for teens (which had been comparable to the rate for adult men) increased in

the early 1990s. But that rate fell substantially following the significant increases

1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005

0

5

10

15

20

25

30

35

40

Adults

Pregnant Women

High School Seniors
27

in cigarette prices that accompanied a multibillion-dollar settlement agreement

between major tobacco companies and the states.

Options Regarding Prevention and Healthy Living

Reform proposals could encompass preventive measures and efforts to encourage

healthier lifestyles. Broadly speaking, three basic policy approaches could be

adopted. First, more information about the consequences of unhealthy behavior or

the factors contributing to it could be made available, in forms that could affect

individual behavior or even social norms. (Nutritional information, for example, is

readily available for packaged foods but more difficult to come by for other

sources—such as restaurant meals). Second, financial incentives could be modified to encourage healthier living and to discourage unhealthy activities. For

example, cigarette taxes could be increased, which would discourage smoking,

especially among teenagers. In addition, an increase in the federal tax on cigarettes

of 50 cents per pack would raise about $5 billion per year, according to the Joint

Committee on Taxation. Third, regulatory steps could be taken to encourage

healthy behavior and discourage poor health habits. For example, recent efforts

have been aimed at improving the nutrition and reducing the calories of school

lunches and snacks available in schools. Some research suggests that changing the

presentation of food choices can encourage healthy eating.30

In considering those options, it is important to recognize that there are costs to

imposing regulations and levying taxes and that in many cases the benefits of specific options to promote healthy living are uncertain. For example, no consensus

exists about the size of smoking’s external costs, which makes determining the

appropriate level of tobacco taxes difficult. Some analysts estimate that those costs

are significantly lower than the taxes and settlement fees now levied. Others maintain that the external costs are greater or that the failure of people to anticipate the

future effects on themselves (rather than on other people) justifies a higher tax rate

on cigarettes. Technical issues complicate the debate; for example, the effects of

secondhand smoke are uncertain. An argument against raising cigarette taxes is

their regressivity: Such taxes take up a larger percentage of the earnings of lowincome families than of middle- and upper-income families. Similarly, providing

additional information about the caloric content of restaurant meals could be

expensive, and it is not clear how much that information would change people’s

behavior or whether the benefits of those changes would exceed the costs of producing them.

More broadly, information about the benefits of eating right, exercising, and not

smoking is widely available, and bringing about changes in people’s behavior represents a substantial challenge. The growing field of behavioral economics is

beginning to examine how the combination of information, incentives, and regula30. See Brian Wansink, Mindless Eating: Why We Eat More Than We Think (New York: Bantam

Dell, 2006).
28

tions—as well as people’s inertia and biases—affects their behavior. That research

may ultimately help inform efforts to make various policy changes to promote

health. As the nation struggles to address the cost, quality, and access to its health

care system, developments and policy changes outside the system itself will continue to exert an important influence on Americans’ health, which in turn will

affect the system.