An ACA Provision You’ve Never Heard Of Could End Up Being Very Costly

Published November 23, 2015


One of the most consequential provisions of the Affordable Care Act (ACA) is also one of its most obscure.

The “productivity adjustment factor,” inserted by the ACA into the Medicare program, is a massive spending cut, one of the largest in the program’s history. It was included to make room in the federal budget for the ACA’s expensive new health insurance subsidies.  If Congress follows past practice, the ACA’s higher spending will be with us long after savings from the productivity adjustment factor have been reduced or eliminated altogether.

The productivity adjustment factor is one of four ACA “indexing” provisions we examined in a new research paper published by the Mercatus Center at George Mason University. Indexing refers to adjustments that are made to keep tax and program benefit parameters consistent with policy preferences over time.  The most familiar indexing provision in federal law is the Social Security cost-of-living adjustment, or COLA, which prevents purchasing-power erosion of Social Security checks due to inflation.

In Medicare, the federal government makes a COLA-like adjustment to the payments made to hospitals and other facilities. The cost of running a hospital is measured by examining a “market basket” of goods and services typically purchased by inpatient facilities. The prices of items in the basket are tracked, creating an index used to maintain the inflation-adjusted value of Medicare’s payments for seniors’ hospital stays.

Since 1983, when Congress established this prospective payment system for hospitals, Capitol Hill has frequently made ad hoc adjustments to the increase that otherwise would have applied to hospital payments.  For instance, in 1990, as part of a large budget-cutting effort, Congress reduced the market basket increase for fiscal year 1991 by 2.0 percentage points for hospitals located in urban areas and 0.7 percentage points for facilities located in rural communities.

The new ACA productivity adjustment factor is different from previous adjustments because it isn’t ad hoc (the formula for making the cut is written into the law) and it isn’t temporary (it will occur automatically every year). Under this provision, the annual updates to hospital and other facility payments will be reduced by a measure of economy-wide productivity increases — thus it’s a productivity adjustment factor. The government actuaries who produce Medicare cost projections estimate that this factor will reduce the market basket index by, on average, 1.1 percentage points annually, dropping the average increase from 3.5 percent to 2.4 percent.

The budgetary savings from this cut in payments are substantial — at least on paper. The Congressional Budget Office has estimated it would reduce Medicare spending by $196 billion over 10 years — making it the largest single spending reduction included in the ACA.

But it is over the long run that the purported cost reductions are truly staggering because the annual cut compounds each year. Medicare’s actuaries have compared these cuts to a scenario in which hospital and other facility payment updates more closely track historical rates. That comparison shows the productivity adjustment factor reduces Medicare spending by about $4.0 trillion over seventy-five years, measured in present value terms.

The actuaries are skeptical that the full cuts from the productivity adjustment factor can be sustained. They estimate that by 2040, half of all hospitals, 70 percent of skilled nursing facilities, and 90 percent of home health agencies would be losing money each year because of the deep cuts in their Medicare reimbursement rates.  This would leave Medicare beneficiaries facing substantial barriers to accessing needed care. As the actuaries put it, “in practice, providers could not sustain continuing negative margins and, absent legislative changes, may have to withdraw from providing services to Medicare beneficiaries” or take actions to shift the cost of Medicare patients to other payers.

It’s ironic that Congress enacted the productivity adjustment factor in 2010 because, even then, it was clear that a similar effort to cut Medicare payments to physicians was not working. The so-called “sustainable growth rate,” or SGR, was enacted in 1997 and imposed a cap on total physician fees that was indexed to GDP growth. As health expenses outpaced economic growth, the gap between the amount of spending allowed by the cap and what was necessary to take care of patients grew wider every year. With formula-driven cuts exceeding 20 percent, the SGR became impractical to enforce. It was abandoned altogether earlier this year.

Formulaic cuts are attractive to legislators because they create the illusion of improved solvency in Medicare. The productivity adjustment factor is a blunt instrument that simply lowers what Medicare will pay for services, by trillions of dollars. But if the solution were that easy, it would have been done long ago. The truth is that Medicare is only valuable to the program’s beneficiaries if hospitals and physicians are willing to take Medicare patients.  There’s nothing to stop providers of medical care from catering to patients covered by private insurance and avoiding those on Medicare and Medicaid when the government payments fall too low.

The ACA’s defenders say the law will reduce future federal budget deficits. But that will only be true if Congress sticks with the productivity adjustment factor even when beneficiaries complain of restricted access to care. Based on prior history, that’s an unlikely scenario, to say the least.

Mr. Capretta is a senior fellow at the Ethics and Public Policy Center, a Visiting Fellow at the American Enterprise Institute, and an affiliated scholar at the Mercatus Center at George Mason University. Dr. Antos is the Wilson H. Taylor Scholar in Health Care and Retirement Policy at the American Enterprise Institute. They are the authors of “Indexing in the Affordable Care Act: The Impact on the Federal Budget,” published this month by the Mercatus Center.

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