Veronique de Rugy: The Facts about the Government's Medicare Cost Projections

Editor's Note: Reason columnist and Mercatus Center economist Veronique de Rugy appears weekly on Bloomberg TV to separate economic fact from economic myth.

Myth: The government's cost projections are reliable.

Fact: They are not. No matter what governmental body does the scoring, it is almost invariably unreliable.

In 1967 long-run forecasts estimated that Medicare would cost about $12 billion by 1990. In reality, it cost more than $98 billion that year. Today it costs $500 billion.

When it comes to the federal government, massive cost overruns are the rule, not the exception. The $800 billion cost of the war in Iraq dwarfs the $50-60 billion that Mitch Daniels, then director of the Office of Management and Budget, predicted at the outset. In light of these numbers it's interesting to remember that Larry Lindsey, President George W. Bush's economic advisor, was fired for projecting that the war could cost between 1 and 2 percent of GDP back in 2002 (roughly between $100 and $200 billion).

Strangely, lawmakers seem to never expect these extra costs even when the excesses take place under their own noses. The Capitol Hill Visitor Center, an ambitious three-floor underground facility, originally scheduled to open at the end of 2005, was delayed until 2008. The price tag exploded from an original estimate of $265 million in 2000 to a final cost of $621 million.

At the heart of the problem is the massive amount of budget gimmicks, the abuse of rosy scenarios, the emergency spending loopholes, and a lack of fiscal discipline by lawmakers who just can't stop spending the taxpayers' money.

This chart compares Congressional Budget Office long-term projections of the debt held by the public from 2010 with long-term projections calculated in 2007. In 2007, the CBO projected that the debt held by the public would surpass 60 percent in 2023. Note that this long-term projection incorporated policy changes that were deemed likely at the time. Using the same methodology last year, the CBO projected that the debt will exceed 60 percent of GDP by the end of 2010. In the three years between projections, the debt milestone has accelerated by 13 years. This unforeseen acceleration is worth careful consideration; as the government consumes more credit, less will be available to the private sector.

In other words, even even short-term economic projections are frequently unreliable-especially when the projections are done by the government.

The above chart shows what a more realistic path for Medicare spending may look like. It compares the long-term projections of Medicare costs under the current law (the 2011 Trustees Report) with the Centers for Medicare and Medicaid Services' Office of the Actuary's alternative projections (2011 Trustees Report Alternative). The latter projections were released as a "best estimate" of future Medicare expenditures to address the "likely understatement of current-law projections."

These projections primarily differ in their assumptions about the plausibility of drastic payment-rate cuts. If such cuts do not materialize, Medicare will cost tens of billions more each year than current law projects.

Furthermore, under the Patient Protection and Affordable Care Act, physician payments are tied to a sustainable growth rate mechanism (SGR), which adjusts repayment rates in order to cap physician-related spending. Since 2001, physicians have been scheduled to receive at least a 5 percent reimbursement cut each year under SGR; and this cut has been overridden by Congress every year except 2002.

In 2012, physician payments are scheduled to decrease by 29.4 percent-an update which is extremely unlikely to occur. So while the Board of Trustees is legally bound to incorporate these cost savings into its projections, the Office of the Actuary has formed a more realistic baseline which incorporates increasing physician repayments into the total cost of Medicare.

Under the current-law baseline, Medicare spending is projected to grow from 3.99 percent of GDP in 2020 to 6.25 percent of GDP in 2080; under the alternative scenario, Medicare spending is projected to grow from 4.31 percent of GDP in 2020 to 10.36 percent of GDP in 2080. In nominal terms, this is a cost underestimation of $2.7 trillion dollars by the year 2080.

Contributing Editor Veronique de Rugy is a senior research fellow at the Mercatus Center at George Mason University.