Among mandatory spending programs—and indeed tax expenditures—the health area is especially important because the long-term fiscal challenge is largely a health care challenge. Contrary to public perceptions, health care is the biggest driver of the long-term fiscal challenge. While Social Security is important because of its size, health care spending is both large and projected to grow much more rapidly. Our most recent simulation results illustrate the importance of health care in the long-term fiscal outlook as well as the imperative to take action. Simply put, our nation’s fiscal policy is on an imprudent and unsustainable course. These long-term budget simulations show, as do those published last December by the Congressional Budget Office (CBO), that over the long term we face a large and growing structural deficit due primarily to known demographic trends and rising health care costs and lower federal revenues as a percentage of the economy. Continuing on this unsustainable fiscal path will gradually erode, if not suddenly damage, our economy, our standard of living, and ultimately our national security. Our current path also will increasingly constrain our ability to address emerging and unexpected budgetary needs and increase the burdens that will be faced by future generations. Figures 3 and 4 present our long-term simulations under two different sets of assumptions. In figure 3, we start with CBO’s 10-year baseline— constructed according to the statutory requirements for that baseline. Consistent with these requirements, discretionary spending is assumed to grow with inflation for the first 10 years and tax cuts scheduled to expire are assumed to expire. After 2016, discretionary spending is assumed to grow with the economy, and revenue is held constant as a share of GDP at the 2016 level. In figure 4, two assumptions are changed: (1) discretionary spending is assumed to grow with the economy after 2006 rather than merely with inflation, and (2) all expiring tax provisions are extended. For both simulations, Social Security and Medicare spending is based on the 2005 Trustees’ intermediate projections, and we assume that benefits continue to be paid in full after the trust funds are exhausted. Medicaid spending is based on CBO’s December 2005 long-term projections under mid-range assumptions. As these simulations illustrate, absent significant policy changes on the spending and/or revenue side of the budget, the growth in mandatory spending on federal retirement and especially health entitlements will encumber an escalating share of the government’s resources. Indeed, when we assume that all the temporary tax reductions are made permanent and discretionary spending keeps pace with the economy, our long-term simulations suggest that by 2040 federal revenues may be adequate to pay only some Social Security benefits and interest on the federal debt. Neither slowing the growth in discretionary spending nor allowing the tax provisions to expire—nor both together—would eliminate the imbalance. Although revenues will be part of the debate about our fiscal future, assuming no changes to Social Security, Medicare, Medicaid, and other drivers of the long-term fiscal gap would require at least a doubling of taxes—and that seems highly implausible. Economic growth is essential, but we will not be able to simply grow our way out of the problem. The numbers speak loudly: our projected fiscal gap is simply too great. Closing the current long-term fiscal gap would require sustained economic growth far beyond that experienced in U.S. economic history since World War II. Tough choices are inevitable, and the sooner we act the better. Accordingly, substantive reform of the major health programs and Social Security is critical to recapturing our future fiscal flexibility. Ultimately, the nation will have to decide what level of federal benefits and spending it wants and how it will pay for these benefits. Our current fiscal path will increasingly constrain our ability to address emerging and unexpected budgetary needs and increase the burdens that will be faced by future generations. Continuing on this path will mean escalating and ultimately unsustainable federal deficits and debt that will serve to threaten our future national security as well as the standard of living for the American people. The aging population and rising health care spending will have significant implications not only for the budget, but also the economy as a whole. Figure 5 shows the total future draw on the economy represented by Social Security, Medicare, and Medicaid. Under the 2005 Trustees’ intermediate estimates and CBO’s 2005 long-term Medicaid estimates under mid-range assumptions, spending for these entitlement programs combined will grow to 15.7 percent of gross domestic product (GDP) in 2030 from today’s 8.4 percent. It is clear that, taken together, Social Security, Medicare, and Medicaid represent an unsustainable burden on future generations. Furthermore, most of the long-term growth is in health care. While Social Security in its current form will grow from 4.3 percent of GDP today to 6.4 percent in 2080, Medicare’s burden on the economy will quintuple—from 2.7 percent to 13.8 percent of the economy—and these projections assume a growth rate for Medicare spending that is below historical experience! As figure 5 shows, unlike Social Security which grows larger as a share of the economy and then levels off, within this projection period we do not see Medicare growth abating. Whether or not the President’s Budget proposals on Medicare are adopted, they should serve to raise public awareness of the importance of health care costs to both today’s budget and tomorrow’s. This could serve to jump start a discussion about appropriate ways to control the major driver of our long-term fiscal outlook—health care spending. As noted, unlike Social Security, Medicare spending growth rates reflect not only a burgeoning beneficiary population, but also the escalation of health care costs at rates well exceeding general rates of inflation. The growth of medical technology has contributed to increases in the number and quality of health care services. Moreover, the actual costs of health care consumption are not transparent. Consumers are largely insulated by third-party payers from the cost of health care decisions. The health care spending problem is particularly vexing for the federal budget, affecting not only Medicare and Medicaid but also other important federal health programs, such as for our military personnel and veterans. For example, Department of Defense health care spending rose from about $12 billion in 1990 to about $30.4 billion in 2004—in part, to meet additional demand resulting from program eligibility expansions for military retirees, reservists, and the dependents of those two groups and for the increased needs of active duty personnel involved in conflicts in Iraq, Bosnia, and Afghanistan. Expenditures by the Department of Veterans Affairs have also grown—from about $12 billion in 1990 to about $26.8 billion in 2004—as an increasing number of veterans look to federal programs to supply their health care needs. The challenge to rein in health care spending is not limited to public payers, however, as the phenomenon of rising health care costs associated with new technology exists system-wide. This means that addressing the unsustainability of health care costs is also a major competitiveness and societal challenge that calls for us as a nation to fundamentally rethink how we define, deliver, and finance health care in both the public and the private sectors. A major difficulty is that our current system does little to encourage informed discussions and decisions about the costs and value of various health care services. These decisions are very important when it comes to cutting-edge drugs and medical technologies, which can be incredibly expensive but only marginally better than other alternatives. As a nation, we are going to need to weigh unlimited individual wants against broader societal needs and decide how responsibility for financing health care should be divided among employers, individuals, and government. Ultimately, we may need to define a set of basic and essential health care services to which every American is ensured access. Individuals wanting additional services, and insurance coverage to pay for them, might be required to allocate their own resources. Clearly, such a dramatic change would require a long transition period—all the more reason to act sooner rather than later. In recent years, policy analysts have discussed a number of incremental reforms that take aim at moderating health care spending, in part by unmasking health care’s true costs. (See fig. 6 for a list of selected reforms.) Among these reforms is to devise additional cost-sharing provisions to make health care costs more transparent to patients. Currently, many insured individuals pay relatively little out of pocket for care at the point of delivery because of comprehensive health care coverage—precluding the opportunity to sensitize these patients to the cost of their care. Develop a set of national practice standards to help avoid unnecessary care, improve outcomes, and reduce litigation. Encourage case management approaches for people with expensive acute and chronic conditions to improve the quality and efficiency of care delivered and avoid inappropriate care. Foster the use of information technology to increase consistency, transparency, and accountability in health care. Emphasize prevention and wellness care, including nutrition. Leverage the government’s purchasing power to control costs for prescription drugs and other health care services. Revise certain federal tax preferences for health care to encourage the more efficient use of appropriate care. Create an insurance market that adequately pools risk and offers alternative levels of coverage. Develop a core set of basic and essential services with supplemental coverage being available as an option but at a cost. Use the Federal Employees Health Benefits Program (FEHBP) model as a possible means to experiment and see the way forward. Limit spending growth for government-sponsored health care programs (e.g., percentage of the budget and/or the economy). Other steps include reforming the policies that give tax preferences to insured individuals and their employers. These policies permit the value of employees’ health insurance premiums to be excluded from the calculation of their taxable earnings and exclude the value of the premium from the employers’ calculation of payroll taxes for both themselves and employees. Tax preferences also exist for health savings accounts and other consumer-directed plans.