The ACA’s ‘Indexing’ Charade

Published October 28, 2015


To view or download a PDF of the full study authored by Mr. Capretta and Mr. Antos, click here.

The Obama administration was able to push the Affordable Care Act — Obamacare — through Congress in part because the Congressional Budget Office said it would modestly reduce future federal budget deficits.

The claim of deficit reduction rests on a shaky foundation. It depends entirely on the uninterrupted implementation of four carefully constructed “indexing” provisions. These provisions, which make annual adjustments to key spending and tax parameters of the law (or specify that such adjustments will not be made), were written with the clear intention of making the ACA look better financially as time passed. Our new study, published by the Mercatus Center at George Mason University, shows that these budgetary manipulations are no more likely to survive mounting political pressure than did income-tax “bracket creep” in the 1970s or across-the-board cuts in Medicare physician fees over the past 15 years.

Each of the four provisions has an impact on consumers, who will face higher insurance costs, shrinking access to essential services, and higher tax payments. They are:


1. The productivity adjustment factor.

Medicare payments to hospitals and other facilities are increased annually to account for inflation. The ACA permanently lowered those annual increases based on a “productivity adjustment” — an estimate of productivity improvement in the overall economy. The reduction, expected to average 1.1 percentage points annually, is taken regardless of whether a facility is able to achieve such productivity growth.

The cumulative effect of the adjustment is a massive cut: a 56 percent reduction in what Medicare pays for services at the end of 75 years, and a reduction in overall payments to hospital and other facilities of at least $4 trillion over the same period, in present-value terms.

Such cuts have real consequences. The Medicare actuaries estimate that, without changes to the law, by 2040 half of all hospitals, 70 percent of skilled nursing facilities, and 90 percent of home health agencies will be losing money every year due to the cumulative effect of the productivity adjustment factor. The actuaries believe that “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.

2. Taxes on “high-income” households.

The ACA instituted taxes designed to look as if they will be paid only by those with high incomes. MIT professor Jonathan Gruber asserts that a new Medicare payroll tax in the ACA is “a tax increase on the wealthiest Americans.” The Medicare Hospital Insurance (HI) tax rate is increased from 1.45 percent to 2.35 percent on earnings over $200,000 for individual taxpayers and $250,000 for married couples. In addition, a new 3.8 percent tax is imposed on net investment income for those with incomes exceeding those levels.

The income thresholds for assessing these taxes are not indexed to inflation or wage growth. Consequently, many Americans not considered rich will eventually be required to pay them. The $200,000 threshold will move down to about $140,000 in today’s dollars by 2030 — and will continue to drop — because of the failure to account for inflation.

3. The “Cadillac tax

Job-based health insurance has long received a special tax break. Employer and employee contributions are excluded, without limit, from both income and payroll taxes. While this open-ended tax break has made workplace health insurance affordable, it has promoted overly generous insurance (dubbed Cadillac coverage) and fueled the rapid growth of health spending.

The ACA imposed a 40 percent excise tax on high-cost, job-based insurance starting in 2018. Health benefits costing more than $10,200 for individuals and $27,500 for family coverage will be subject to the tax. These thresholds are to be increased by the consumer price index (CPI) plus 1 percentage point in 2019 and just with the CPI thereafter. The tax will be levied on the employer, who will pass the cost along to employees in the form of higher employee premiums, higher deductibles, and less generous benefits.

Health-care costs and insurance premiums are expected to rise much more rapidly than the CPI, pushing more health plans over the Cadillac thresholds. By 2025 the average-cost plan, indexed to historical spending trends, will exceed the Cadillac-tax threshold.

4. Premium credits.

The foundation of the ACA is the premium credit provided to low-income families purchasing insurance on the exchanges. The credit is available to families with incomes between one and four times the federal poverty level (FPL), unless they are eligible for Medicaid. A cap that depends on the household’s income and the cost of the insurance limits the amount they must pay for coverage. In 2014, for example, a family with income equal to 300 percent of the FPL was required to pay as much as 9.5 percent of its income toward coverage. A family of four with an income of $71,550 (three times the 2014 FPL) was liable for as much as $566 in monthly premium payments last year. Those buying cheaper coverage paid less.

Because total premiums are expected to rise faster than incomes, an adjustment was made in the ACA’s premium-credit calculation to avoid rapid increases in federal cost. A complicated indexing arrangement holds the federal share of the credit constant, which pushes up the percentages of income that households must pay each year. As a result, households with incomes at 300 percent of the FPL are expected to pay as much as 9.56 percent of their incomes towards coverage in 2015. That percentage will keep rising in the future.

The ACA also put a cap on the total amount of exchange subsidies (including premium credits and cost-sharing subsidies) that the federal government would pay out each year, beginning in 2019. The cap is set at 0.504 percent of GDP. If officials expect the cap to be exceeded, the amounts families must pay are further increased to make up the difference.

The unusual and complex indexing provisions for exchange subsidies are designed to limit the federal government’s financial risk. The result is that lower-income households will face ever-increasing costs for their health insurance.

Political pressure will surely increase to ease up on these provisions. If Congress were to allow payments to hospitals and other facilities to follow historical trends, and to limit the revenue from the “high-income” and Cadillac taxes at fixed, rather than rising, levels of GDP, we estimate that, by 2040, the law would increase the federal budget deficit by 0.4 percent of GDP rather than reduce it. The added deficits from the law would then grow rapidly in the following years.

The ACA’s new entitlements may eventually become politically untouchable, like other federal benefit programs. But the same is not likely to be true for the law’s key indexing provisions, which impose ever-increasing burdens on taxpayers and beneficiaries. It would not take much backtracking on these provisions to turn the ACA into a massive, permanent drain on the federal treasury.

James C. Capretta is a senior fellow at the Ethics and Public Policy Center and a visiting fellow at the American Enterprise Institute. Joseph R. 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 at George Mason University.

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