The empirical data confirm the expected outcomes from the wedge in the health care market: health care expenditures and costs are rising faster than our economy. According to the Centers for Medicare & Medicaid Services, total national health expenditures accounted for more than 16 percent of our economy in 2007 (see Figure 2); and are expected to be about 18 percent of GDP in 2009.¹⁴

The rise in health care expenditures as a share of the U.S. economy has not been even. Significant growth has followed years of relative flat growth. In particular, health care expenditure growth was steady relative to overall U.S. economic growth in the mid-1970s, early 1980s, and through most of the 1990s. In between the periods of steady health expenditures were years of rapid health expenditure growth.

Gross Domestic Product (GDP), or total national income, is a measure of people's ability to pay for goods and services. The recent housing bubble vividly demonstrated that expenditures on a good or service cannot consistently outpace people's ability to pay forever. The same is true for health care. The consistent excessive growth of health care expenditures, compared to the economy's ability to pay, is the major weakness of the current health care system. All other problems (e.g., lack of insurance coverage and medical bankruptcy) find their genesis in the uncontrolled rise in health care expenditures. Consequently, beneficial health care reform must begin with an understanding of the trends and drivers of health care expenditures.

Part of the health care wedge is created by government expenditures substituting for private expenditures; another part by the private third party payment system. Figure 3 shows that the government-created wedge has been growing significantly since 1965.

The rise of government spending has been at the expense of private spending in the health care market. In 1960, over 75 percent of total health expenditures in the U.S. were funded by private expenditures. Beginning in 1966, with the passage of Medicare, the private sector's role in the health care market began to change. In 1965, the private sector was still funding over 75 percent of total national health expenditures. This fell to 70 percent in 1966, and 63 percent in 1967. Since 1967, the private sector has been slowly funding less and less of the total national health expenditures; and as of 2007, less than 54 percent of total national health care expenditures are paid for by the private sector.

Public expenditures (at the federal and state levels) now fund nearly one-half of the total health care expenditures in the U.S. Along with these trends, total out-of-pocket expenditures have been plummeting even faster as a share of total health expenditures (see Figure 4). It is important to note that while total out-of-pocket expenditures have been declining as a share of total national health expenditures, they have grown in total inflation-adjusted terms. Despite the government covering a growing share of total health care expenditures, individuals continued to pay more than ever before in total dollar terms.

Taken together, these trends illustrate a complete reversal of the way health care is purchased in the U.S. In 1960, the private sector funded over three-quarters of national health care expenditures, with individuals responsible for nearly one-half of these costs through out-of-pocket expenditures. Today, the private sector funds just a bit more than one-half of these expenditures, with only a bit more than $1 out of every $10 coming out of the consumer's pocket.

Rising government expenditures on health care have been a primary driver of the overall government expenditure wedge illustrated in Figure 2. Figure 5 breaks down the government expenditure wedge trends broken down by government health care expenditures and all other government expenditures. Figure 5 demonstrates two important trends. First, the government expenditure wedge outside of health care, although volatile, is currently only 5 percentage points higher than the 1960 wedge (35.3 percent compared to 30.1 percent). The remaining 9.1 percentage point increase in the government expenditure wedge is due to rising health care expenditures.

Second, health care expenditures have been an important driving force in the overall government expenditure wedge. Table 1 identified three main periods of a rising government expenditure wedge: 1965-1983, 1988-1992, and 2000-2007. Health care expenditures drove the rising government expenditure wedge during each one of these periods, the importance of which has been growing over time.

• Between 1965 and 1983, the total government expenditure wedge rose 16.6 percentage points, 26 percent of which was caused by rising health care expenditures.

 

• Between 1988 and 1992, the total government expenditure wedge rose 5.2 percentage points, 41 percent of which was caused by rising health care expenditures.

 

• Between 2000 and 2007, the total government expenditure wedge rose 4.5 percentage points, 51 percent of which was caused by rising health care expenditures.
  

Government health care expenditures are clearly driving the government expenditure wedge higher. A rising government expenditure wedge diminishes growth in the private sector economy, however. This link has important implications with respect to beneficial health care reforms. Health care reforms based on President Obama's priorities lead to large increases in government expenditures on health care without removing the negative consumer and supplier incentives. The consequences are significant increases in government expenditures and subsequent decreases in economic growth.

The adverse incentives created by the growing separation between consumers and suppliers are manifested most prominently through the skyrocketing health care costs. The relatively larger growth in health care expenditures is outpacing growth in overall consumer prices in the economy (see Figure 6). Adjusting for the growing U.S. population, the dollar level of expenditures on health care has exceeded the growth in prices in the economy each year for nearly the past 50 years.

The cost of health care on individuals in the economy goes beyond simply the current dollar outlays individuals must pay themselves. The individual cost of health care includes the loss of monetary income to fund health insurance plans through employers and the extra tax burdens that have been levied in order to fund the public health expenditures. 

Health insurance expenditures have been rising as a share of disposable personal income, with premiums paid, in large measure, by employers or other third parties such as the government. For instance, according to the U.S. Census Bureau, 59 percent of people under the age of 65 receive health insurance through work.²⁰ In 2006, the average employer cost for a family was $11,941 (in 2008 dollars).²¹

The rising burden from increasing health insurance costs can be seen as a share of total business costs and in government budgets. The Bureau of Economic Analysis tracks total costs on health care in a category called supplements to wages.  These costs incorporate all of the expenses that firms pay to employees other than wages-health insurance being a major component of these costs.

In 1960, most of an employee's compensation was in the form of actual cash. Of total personal income earned (a figure that includes wages, benefits, interest earnings, capital gains, dividends, etc.), wages accounted for approximately two-thirds (66.3 percent) of total personal income. Supplements to wages were a relatively small 5.7 percent. The share of income represented by wages fell over this time period to 54.5 percent by 2007, while supplements to wages rose steadily to 12.5 percent.

More important, perhaps, the decline in wages as a share of personal income increases when the growth in health expenditures accelerate, and moderates when the growth in health expenditures moderates. Supplements to wages (e.g., health insurance) move in the opposite direction as wages. When growth in health expenditures accelerates, so does growth in supplements as a form of compensation. When growth in health expenditures moderates, growth in supplements as a form of compensation moderates likewise.

Figure 7 illustrates this trend. The red solid line in Figure 7 is the percentage change in health care expenditures. The black dotted line is the difference between the changes in wages as a share of personal income and the change in supplements to wages as a share of personal income. When the black dotted line is positive, the category of wages as a share of personal income is growing faster than supplements to wages. When the black dotted line is negative, supplements to wages as a share of personal income grow faster than wages.

Figure 7 clearly shows that when health care expenditure growth accelerates, supplements to wages are growing faster than wages. The reverse happens when health care expenditure growth slows. This pattern illustrates the dampening impact that out-of-control health expenditures has been having on monetary wages for American workers. Growing health care expenditure happens at the expense of growth in monetary wages, limiting workers' welfare by reducing their expenditure power outside of health care services. 

The same can be true of the federal and state governments. Figure 8 traces the growth in health care expenditures as a share of federal, state, and local expenditures. Whereas health expenditures made up only 4.5 percent of total government expenditures (or less than $1 in $20) in 1960, by 2007 they were 20.3 percent of total government expenditures (or more than $1 in $5). These expenditures alone required the government to take 7.7 percent of all personal income earned in 2007 just to pay for the country's public health expenditures.

Rising health care expenditures have led to:

• Rising tax burdens to fund the government portion of health care spending;
• Slower relative wage growth to fund the rising employer portion of this spending; and
• Rising health insurance outlays as a share of individuals' take-home pay.

All of these costs more than overwhelm the reduction in direct out-of-pocket expenditures as a share of take-home pay, creating a larger, and accelerating, health care burden on individuals.

¹⁴ Executive Office of The President, Council of Economic Advisors (2009) The Economic Case for Health Care Reform, June 2009.

¹⁵ Centers for Medicare & Medicaid Services, Office of the Actuary: Data from the National Health Statistics Group.

¹⁶ Ibid.

¹⁷ Ibid.

¹⁸ Author calculations based on Bureau of Economic Analysis data.

¹⁹ Bureau of Economic Analysis, National Income and Product Accounts, Tables 1.5.3 and 1.5.4, www.bea.gov; Bureau of Labor Statistics, http://www.bls.gov/cpi/.

²⁰ U.S. Census Bureau. Income, Poverty, and Health Insurance Coverage in the United States: 2007.

²¹ U.S. Department of Health and Human Services, Medical Expenditures Panel Survey-Insurance Component: 2006.

²² Bureau of Economic Analysis, National Income and Product Accounts, Table 2.1 www.bea.gov; Centers for Medicare & Medicaid Services, Office of the Actuary: Data from the National Health Statistics Group.

²³ Bureau of Economic Analysis, National Income and Product Accounts, Table 3.16 www.bea.gov.