Loss of Control: The Proliferation of Constraints

The Outlook for Budgetary Constraints Part 2

Miscellaneous mandated expenditures are quite stylish

Medicaid

With Medicaid, the focus is on a program where the payout is mandated by a formula, but, unlike Social Security and Medicare, there is no dedicated funding source. Medicaid is jointly funded by the federal government and the states. The federal government pays the states for a specified percentage of program expenditures. The financing structure guarantees federal matching dollars for qualifying expenditures with no limit on the level of the federal payment. 

The federal government does not match a one-to-one basis, but even so, the partial match provides an incentive to the states to provide Medicaid services. The percentage the federal government pays is called the Federal Medical Assistance Percentage (FMAP). It varies by state based on criteria such as per capita income. The regular average state FMAP is 57%, but it ranges from 50% up to 75%. The FMAP limits the portion of the expenditures the federal government matches, but not the total magnitude of the expenditures.

The only limits on the federal expenditures are the definition of who is eligible for Medicaid and each state’s ability to match. The disabled, the aged, adults, and children can be Medicaid eligible. Medicaid eligibility is grounded on a needs-based measure, but that measure varies by eligible groups.

Increases in Medicaid expenditures come from aging, growth in healthcare costs and expanded eligibility under the Affordable Care Act. The demographics will drive increasing expenditures associated with the elderly. Healthcare costs are their own story, but expanded access to healthcare that is covered by insurance will increase costs. It's basic supply and demand; as more people are able to afford healthcare because of public subsidies, they will increase the demand for health services. Without a commensurate increase in supply, that will increase costs. So, both the increase in the age of the population and the greater access to subsidized healthcare will tend to drive up the federal government's cost of Medicaid.

As mentioned, federal expenditures are not capped; states receive more matching funds the more they grow Medicaid expenditures. Is it any wonder then that Medicaid is the third largest domestic program in the federal budget? We are basically paying the states to grow the program.

A perfect example of the impact of the Medicaid incentives for states is illustrated by the Affordable Care Act (ACA). The implementation of ACA coverage expansions in 2014 led to higher enrollment and higher spending growth for Medicaid: add a new eligible population and not surprisingly, state governments will find them and bring them into the program. This, of course, increases the amount of money they receive from the federal government as a match. The incentive to find ways to spend 

Medicaid money is particularly strong when the federal government identifies a new eligible group and attaches a high priority to getting them onto Medicaid. For example, Medicaid provides a higher matching rate for some services or populations, the most notable being the ACA Medicaid expansion’s enhanced match rate.

To illustrate the impact, consider that the federal government’s Medicaid expenditures had been relatively stable for the five years ending in 2013. They had fluctuated between $243 and $266 billion with no apparent trend. With the expanded coverage under the ACA, the Federal government’s expenditures grew by about 35% between 2013 and 2015. Total Medicaid spending (state and federal) grew 9.7% to about $545 billion in 2015 with the federal share coming to about $344 billion.

While the ACA impact sounds like history, the important issue is the outlook. The newly eligible group was just used to illustrate the incentive because the states already have every incentive to monitor every potentially eligible group for the possibility of increasing the federal government match. Further, states have some flexibility to target specific groups for inclusion in Medicaid.

With respect to ACA, despite the enhanced incentives provided by the ACA, there are still a significant number of states to be brought into the program, and thus, it will expand coverage and the federal government's expenditure on Medicaid. Plus, even in states that fully implemented ACA, there is a belief, reflected in federally-subsidized outreach programs, that there are still many more eligible participants who haven't been brought into the program. It is quite likely that those nonparticipants are disproportionately represented by individuals who will need Medicaid assistance in order to participate.

In summary, the demographics, healthcare costs, and the likely increase in enrollment all imply higher future Medicaid expenditures. The only potentially offsetting aspect of Medicaid is that it is needs-based. Thus, rapid economic growth that includes increases in income of low income individuals would reduce expenditures. The economic assumptions used to forecast Medicaid expenditures are important. But, it would require an economic forecast of growth far above the estimates of most forecasters for the growth to offset the other forces that will increase Medicaid expenses. It's reasonable to assume that Medicaid, like Medicare and Social Security, will continue to grow as a constraint on budgetary flexibility.

Veterans’ benefits

Veterans’ benefits are the next most important program where expenditures are determined by a formula rather than the budget process. They are in many respects a weird duck; which is another way to say that they have a very unusual way of determining eligibility. There are aspects to the benefits that are an earned right, yet, at the same time, there are aspects to them that resemble other needs-based programs.

Fortunately, from the perspective of the outlook for expenditures, and thus the degree to which the budget process has been made irrelevant, important issues can be ignored. But, the issues remain, for example: whether they should be needs-based at all, whether criteria should resemble those used in other programs even with different thresholds, what form the benefit should take, and whether the benefits are adequate to reflect the benefit to society from the service represented by veteran status. 

But, from the perspective of the outlook, judgment regarding those issues and speculation about how they will be resolved is unnecessary. The important thing about veterans’ benefits from an outlook perspective is that they are based upon three criteria: status as a veteran, need for the service, and criteria for whether the government will pay for a particular service (i.e., a needs-based threshold).

Veterans’ benefits can take a variety of forms. The most broadly-used services are related to healthcare. But, there are also benefits related to pensions, loan guarantees, life insurance, education, housing, and a variety of other services. But, it is largely the health benefits that drive the outlook for expenditures for veterans’ benefits. Further, some of the same factors that will affect expenditures for health care also affect other categories of benefits, especially pensions.

Health services loom large in the outlook for a variety of reasons. Almost every factor that affects the outlook will tend to drive up health care expenditures. Starting with veteran status, the composition of the veteran population is important. Veteran status is a function of the historical size of the military over time. Not surprisingly, the largest cohort of veterans served during the Vietnam Era.

Veterans, on average, are older than non-Veterans, and the difference is dramatic, with major implications. For example, in 2015, half of the male veterans were 65 or older. By contrast, the median age of non-Veteran men was 41. The 65 to 74-year-old cohort is the largest cohort of veterans, but right behind it is the 55 to 64-year-old cohort. Consequently, for quite a while the veteran population will be older. Further, the absolute size of the veteran population will not decrease for many years. So, the first factor to consider, status as a veteran, points to higher healthcare costs over the outlook.

However, age is not the only factor that affects the use of healthcare benefits by veterans. Partially it's a matter of what services veterans are most inclined to use, and partially it's a matter of the degree of need. Veterans have lower uninsured rates than non-veterans. In other words, they're more inclined to choose to be insured. However, one should never lose sight of the fact that many veterans take advantage of the availability of the veteran benefit for health because of injuries they sustained while serving.

In order to maintain coverage, veterans are far more likely to have a combination of public and private health insurance coverage than the population in general.  That’s partially due to Medicare and the use of VA health care by veterans over 65, and it's partially due to the VA’s expertise in treating medical conditions that are associated with military service. So, the second factor, need, reinforces the likelihood that expenditures for healthcare costs as a veterans’ benefit will increase.

The final factor to consider is the needs-based criteria. Here there is some good news. Veterans are less likely to live below poverty, and have higher personal incomes than non-veterans.  But, remember veterans’ benefits aren’t welfare; they are benefits earned through service. There may be needs-based criteria, but the criteria reflect the fact that veterans earned the benefits. The very design of the program and the range of services available are intended to protect veterans from extreme need. From the perspective of the outlook for expenditures on programs, it is highly unlikely that the criteria for accessing services will inhibit the growth of expenditures. If anything, it seems reasonable to assume that the criteria will be made more generous.

Up until this point, the discussion of veterans' benefits has not made any reference to defense expenditures or the size of the military. That was done intentionally in order to show that expenditures will grow regardless of current decisions about the size of the military. But, the size of the military and whether it is involved in active conflicts also affects veterans’ benefits. With respect to the issue of active conflicts, veterans’ benefits are a minor consideration. There are far more important considerations. However, it should be noted that among the costs of conflicts is increased health benefits for those injured in combat.

The size of the military is clearly an issue under the control of currently-elected officials. Without judging the wisdom of their decisions, it is still possible to see the likely impact on the outlook for expenses. Between 2011 and 2016, the portion of the federal budget allocated to defense fell from 19.6% to 15.2%. In some years it actually fell in constant dollars. Currently-elected officials plan to expand defense expenditures which will increase the number of veterans. Even if the next administration reverses any growth in the military, those who served will be veterans for the rest of their lives.

In summary, the composition of the population of veterans guarantees that expenditures on veterans programs will increase. Further, it points to healthcare costs as a primary driver of that increase in expenditures. The factors driving this entitlement are the same factors driving the increase in Medicare expenses, but in the case of veterans, it's far more acute because they are generally older than the non-veteran population. Realistically, the likely growth in veterans’ healthcare benefits looks like the growth in Medicare expenditures on steroids.

Civilian federal retirement

I don't think civilian federal retirement costs really need much comment. Anyone who thinks the civilian federal workforce will shrink or that their retirement benefits will be cut should know I have a bridge in Brooklyn I'd like to sell. As discussed in this posting, there are just too many mandated programs where growth is inevitable without major changes in the laws. Those programs will require more employees to manage the expansion, and those employees will qualify for civilian federal retirement benefits.

Refundable tax credits

When we talk about refundable tax credits, we are not talking about deductions. With a refundable tax credit, individuals calculate their taxes and also calculate whether they qualify for the refundable tax credit. The refundable tax credit is a payment from the government to the individual.

A refundable tax credit is an amount the IRS will pay the individual if he or she qualifies. The payment can be used to pay taxes; that is, it can be credited against their taxes, thus the name. But, if the individual does not have enough taxes to use the credit, the IRS sends the person the money. With refundable tax credits, we are talking about money actually spent rather than taxes that are being foregone.

For example, the Earned-Income Credit is the largest refundable tax credit. It is paid to millions of households. The amount paid can be up to $6,269. If the credit completely pays the individual’s tax bill, any remaining credit is paid to the individual as a cash refund. The Earned-Income Credit isn't the only program that works that way.

Other programs include, the American Opportunities Credit for college. It is a tax credit of up to $2,500 of the cost of tuition, fees and course materials paid during the taxable year. 40% of the credit (up to $1,000) is refundable. This means people can get it even if they owe no tax.

The Child Tax Credit is nonrefundable; if the credit exceeds the tax liability, no tax is due and any remaining unused credit may be lost. However, the individual who couldn't use all their Child Tax Credit may be able to get the money anyway by claiming a refundable Additional Child Tax Credit for the unused balance. It is the same result but with an additional tax form.

So, there are refundable tax credits related to a variety of different conditions, but experience under all these programs would seem to indicate that they will grow. Further, the IRS's assessment is that although millions of households already claim these special breaks, many more are eligible for the credits but fail to take them. While the IRS was primarily referring to the Earned-Income Credit, they’re clearly indicating that all the programs have room to grow.

Further, their comments include the rather telling statement when referring to the Earned-Income Credit that “the rules were recently liberalized, so more households are eligible.” The comment is particularly telling because it points out the tendency to liberalize the rules in order to allow more people to qualify. Thus, not only are there already potential claimants who can be expected to cause expenditures to grow, but the eligible population is being expanded.

In summary, it would be incredibly naïve to believe that refundable tax credits that already exist won't become more expensive. Further, it is likely that new credits will be invented, and the eligibility for the existing credits will be expanded.

Other programmatic expenditures and mandates

There are other programmatic expenditures and mandates, often needs-based. However, none of them individually accounts for as much is 2% of government expenditures. Their growth, stability, or decline has very little impact upon the degree to which elected officials can control government expenditures. Their impact is swamped by the impact of the factors discussed in this and the other postings in this series.

Conclusion

Currently-mandated federal expenditures are going to grow over the foreseeable future. Consequently, regardless of the intent of elected officials during budgetary considerations, the cost of the federal government is going to increase. In some cases, that growth of the federal government feeds back into the growth of the mandated expenditures, for example into increased federal civilian retirement benefits. Unless programs are changed, either taxes will have to go up or the debt will have to be increased. Further, without programmatic changes, the budgetary process as conducted by elected officials will become less and less relevant. Budget decisions won't matter to priorities for government programs or to tax levels. They would be driven by the mandates imposed by previously-elected officials.