A deal would be the start, not the end, of an uphill climb to control federal entitlement spending

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The bipartisan budget talks led by Vice President Joe Biden hit a speed bump on Thursday when House Majority Leader Eric Cantor, (R-Va.), declared that it was time for President Obama and House Speaker John Boehner to negotiate directly. But many of the key players remain cautiously optimistic that the effort will eventually produce an agreement to meaningfully reduce Washington's projected deficit over the next decade.

Then the hard work will begin.

Democrats and Republicans in the talks both appear to have accepted the goal of matching any increase in the debt ceiling with a dollar-for-dollar reduction in the next decade's federal deficit. If the negotiators hit that standard, the discussions could produce as much as $2 trillion in deficit reduction over 10 years (as Cantor himself acknowledged). That's not enough to prevent the federal debt from rising, but it is a reasonable first step--and certainly more than seemed possible when the two sides first convened.

Still, insiders believe that the talks are likely to find those savings mostly by squeezing domestic and defense discretionary spending, while moving only modestly to restructure entitlement programs and the tax code. In one sense, that's understandable: Both parties are reluctant to settle those critical choices until they learn whether the 2012 election increases their leverage. But taxes and entitlements are unavoidably the key to stabilizing the long-term debt. That means, whatever happens in the current talks, Washington will need to confront those explosive issues again, probably in 2013.

The two issues present different challenges. On taxes, the dilemma is political, not intellectual. There's not much mystery about how to raise revenue: Washington can increase tax rates, eliminate tax breaks, or impose new levies (such as a carbon or consumption tax). Nor should there be much mystery about the need to do so. Despite the fiscal pressures created by an aging society, federal receipts are now at their lowest level since 1950 when measured as a share of the economy. The problem is building majority support, in Congress and among the populace, for raising more revenue--particularly when so many congressional Republicans have pledged to oppose any tax increase.

On entitlements, the problem is both political and intellectual. The greatest source of pressure on entitlement spending is health care costs, particularly for the elderly. Medicare's trustees recently projected that the number of seniors in the program will grow from about 49 million now to 85 million in 2035, a 75 percent increase. The nonpartisan Congressional Budget Office this week forecast that the growing elderly population, combined with rising health care costs, will increase federal health spending (mostly for Medicare) as a share of the economy by two-thirds through 2035. Nothing else, CBO says, will contribute nearly as much to rising federal outlays.

That suggests Washington can't stabilize the budget unless it also "bends the curve" of increasing health care costs. Yet neither government leaders nor private insurers have shown they can lastingly do that. That intellectual vacuum looms over the political confrontation: Even if the parties could impose their respective agendas to control costs, neither can pledge that it would work.

Republicans have placed their chips on the vision from Rep. Paul Ryan, (R-Wis.), to convert Medicare from a defined-benefit program into a defined-contribution model in which government would provide seniors with a fixed subsidy to purchase private insurance. Supporters of that approach hope to generate substantial savings by both creating competition among insurers and requiring seniors to pay for more of their own care, which should encourage them to consume less of it.

In an important Foreign Affairs article this week, Peter Orszag, President Obama's former budget director, argued that Ryan's approach won't achieve the savings its supporters hope because so little of Medicare spending is discretionary. The most expensive (and sickest) top 25 percent of Medicare recipients account for more than 85 percent of the program's cost, he noted. When CBO analyzed Ryan's plan, it concluded that he would reduce federal spending only by massively shifting costs to seniors, rather than by actually cutting total health care expenditures.

Ryan's proposal bets on decentralized competition and changing incentives for patients. The contrasting Democratic approach to cost control was embodied in last year's health care reform law. It aims to concentrate Medicare's buying power to change incentives for providers, through payment reforms that reward efficiency and coordination and penalize their absence.

Orszag helped formulate that approach and, not surprisingly, argues that it offers a more promising path than Ryan's. But Orszag, now a vice chairman at Citigroup, also strikingly concludes that the reforms included in Obama's health law won't sufficiently change incentives for physicians. "All of these measures," he writes, "will never be enough to substantially constrain the growth of health care costs on their own." Orszag wants to further spur doctors to streamline care by exempting from medical-malpractice suits physicians who treat patients with procedures identified as the most effective through rigorous research.

That might help, but it won't be a silver bullet. In fact, none exists. The gargantuan task of slowing health care spending will require constant innovation and reform that realigns incentives for both patients and providers. That's the mountain that still looms ahead, even if Washington this summer scales the rocky foothill of raising the debt ceiling and avoiding default.


Image Credit: Ho New / Reuters

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