JAMA Forum: Poised on Edge of the Fiscal Cliff

Gail Wilensky, PhD

Gail Wilensky, PhD

It is the third week of December, and all of Washington is focused on whether the country will fall off the “fiscal cliff” it has built for itself. That metaphor, which is quickly becoming a cliché, refers to the combined effects of the expiration of the Bush-era tax cuts on December 31 and the onset of “sequestration.” The latter peculiar term refers to across-the-board spending cuts built into the Budget Control Act of 2011, to take effect January 2, 2013, if Congress had failed to reduce the deficit by $1.2 trillion.

As of today, Congress had not yet reached an agreement on measures to achieve that goal, so those dramatic wide-ranging spending cuts are poised to go into effect in just 2 weeks. On top of these impending cuts, physicians face their own fiscal cliff when the latest patch on the “doc fix” expires at the end of the calendar year. That means that Medicare payments to physicians will decrease by nearly 30% if Congress does not take action to prevent it.

Tax Changes

Most of the media attention has been on whether everyone’s income tax rates will increase at the end of the month when the existing cuts expire or whether Congress will pass new legislation that raises the rates only for those at a high income level. The line is typically drawn at the top 2%—individuals earning more than $200 000 and families earning more than $250 000. Among the discussion has been a compromise of sorts, to raise the tax rates for these high earners (now at 33% and 35%) to 35% and 37% rather than all the way up to the Clinton-era levels of 35% and 39.6%.

However, marginal tax rate changes are not the only tax changes scheduled to go into effect at the end of this year. Tax rates on capital gains will revert to 20%, dividends will be taxed as ordinary income, and deductions and exemptions for high-income people will be limited to 28% of their taxable income. Although these other changes have received far less attention than changes in the marginal rates, they raise almost as much revenue as the proposed increase in the top marginal rates: $407 billion over 10 years vs $441 billion over 10 years.

In addition, the estate tax rates revert to the Clinton-era rates of 55% on all amounts beyond the first $1 million ($2 million per couple), which would mean another $119 billion over 10 years. Although these other tax issues aren’t likely to be settled until some decision is made about the top marginal rates, there is much more change at stake than most Americans realize.

Sequestration

The use of automatic spending cuts if government spending exceeds specified limits has been in effect since the 1980s and was used as an enforcement tool in the agreement to raise the debt ceiling during the summer of 2011. The legislation specified that if Congress did not pass sufficient deficit reduction legislation by January 15, 2012, automatic spending cuts starting in January 2013 would be required.

Some areas of spending have been exempt from these required reductions, including Social Security, Medicaid, and all services provided by the Department of Veterans Affairs. Other reductions have been limited—most notably reductions in payments for Medicare, which are limited to 2%. Remaining expenditures are classified as either discretionary or as mandatory (depending on how they are treated for budget purposes). Nonexempt discretionary expenditures, such as grant funding for the National Institutes of Health and public health spending by the Centers for Disease Control and Prevention, will be reduced 8.2%; nonexempt mandatory spending, such as the prevention and public health fund established by the Affordable Care Act, will be reduced by 7.6%.

The Doc Fix

As of January 1, physicians’ fees for treating Medicare patients are scheduled for an across-the-board reduction of about 27% in addition to the 2% reduction for all services relating to Medicare under sequestration. The large reduction in unit reimbursements for physicians results from the 1997 Balanced Budget Act legislation that created the sustainable growth rate, a reimbursement formula that ties the growth in physician reimbursements under Medicare to the growth in the economy. Every year since 2003, the Congress has faced the prospect of seeing such fees drop or intervening to prevent that from happening. Every year except for 2003, Congress has acted to keep physician fees for Medicare services approximately flat or to increase them slightly, but the accumulated effect of these one-time interventions has now resulted in a scheduled change of 27%. The estimated cost of another 1-year extension is $25 billion, and as always, the question is how to pay for it. Hospitals and nursing homes are concerned that, like last year, they may be expected to fund the postponement in fee reductions.

At some point, the Congress is going to stop kicking the can down the road and decide how it is going to resolve the sustainable growth rate dilemma it has created for itself—but there is no indication that it is yet ready to do so. I have written so many times about my frustration with the failure of Congress to directly confront this issue, including several times in this forum, that I am beginning to feel like a broken record.

What’s Next?

At the moment, the outlook appears grim, but it usually does before negotiations get serious. Most forecasters believe that if Clinton-era tax rates were to take effect in January along with sequestration-level expenditures, the United States would fall back into a serious recession, with unemployment rates of at least 9%. Even if the tax issues are resolved, it is not clear whether there is much of an appetite to consider entitlement reform or other strategies key to deficit reduction—a quid pro quo that at least some Republicans are claiming as necessary for an agreement on tax increases. Sen Dick Durbin (D, Ill), number 2 in the Senate leadership behind Majority Leader Harry Reid (D, Nev), has indicated that any savings needed on Medicare can only come from payment reductions in the short-term and that more structural changes in entitlements can’t be negotiated quickly. Little has been said thus far about when such structural changes would be seriously considered.

The recommendations from the National Commission on Fiscal Responsibility and Reform (the bipartisan Simpson-Bowles commission), appointed by President Obama in 2010, are being periodically raised as providing a credible path toward getting the nation’s fiscal house in order. Unlike most current discussions, they include a mix of higher taxes, reduced spending, and long-term structural reforms to Medicare and Social Security. Unfortunately, it is not clear who’s listening—yet alone who’s ready to act.

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About the author: Gail Wilensky, PhD, is an economist and Senior Fellow at Project HOPE, an international health foundation. She directed the Medicare and Medicaid programs, served as a senior adviser on health and welfare issues to President George H. W. Bush, and was the first chair of the Medicare Payment Advisory Commission.  She is an elected member of the Institute of Medicine.

About The JAMA Forum:  JAMA has assembled a team of leading scholars, including health economists, health policy experts, and legal scholars, to provide expert commentary and insight into news that involves the intersection of health policy and politics, economics, and the law. Each JAMA Forum entry expresses the opinions of the author but does not necessarily reflect the views or opinions of JAMA, the editorial staff, or the American Medical Association. More information is available here and here.



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