A Dose of Reality for Energy Policy

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Bruce Everett  of the Fletcher School at Tufts University offers a healthy double-helping of reality in his essay entitled "Back to Basics on Energy Policy: For the past 40 years, political leaders have promised that government can plan and engineer a fundamental transformation of our energy industry They were wrong." It appears in the Fall 2012 edition of Issues in Science and Technology. He begins:

"In June 1973, President Richard Nixon addressed the emerging energy crisis, saying that “the answer to our long-term needs lies in developing new forms of energy.” He asked Congress for a five-year, $10 billion budget to “ensure the development of technologies vital to meeting our future energy needs.” With this speech, the federal government set out to engineer a fundamental transformation of our energy supply. All seven subsequent presidents have endorsed Nixon’s goal, and during the past 40 years, the federal government has spent about $150 billion (in 2012 dollars) on energy R&D, offered $35 billion in loan guarantees, and imposed numerous expensive energy mandates in an effort to develop new energy sources. During this time, many talented and dedicated people have worked hard, done some excellent science, and learned a great deal. Yet federal energy technology policy has failed to reshape the U.S. energy market in any meaningful way."

For example, about 30% of that energy R&D spending went to nuclear power, with President Nixon forecasting 40 years ago that nuclear would provide half of the nation's electricity supply by 2000. But nuclear power plateaued at 20% of the electricity supply in 1991, and given the lack of new plants and the gradual retirement of older ones, it seems certain to be a declining contributor in the next few decades. 
Over the last 40 years, the U.S. government has backed a number of renewable energy technologies: hydro-power, solar, wind, solar, geothermal, synthetic fuels including ethanol, burning municipal  waste, and others. Over that time, the share of all these renewables in energy consumption went from 6% in 1973 to 8% at present. Hydropower and corn ethanol comprise more than half that total. Current projections from the Energy Information Administration hold that solar power will quadruple by 2035--at which point it will still be less than 0.5% of U.S. energy consumption.
The fundamental problem, Everett argues, is that showing something is possible at high cost is one thing, but commercializing it at low costs is quite another. He writes: "The mantra of the energy R&D program has always been, “If we can put a man on the Moon, we can do anything,” but this comparison is wrong. Apollo was a conceptual and technical triumph with no commercial aspirations. Between 1969 and 1972, the United States landed 12 astronauts on the Moon at a cost of $12.5 billion (in 2012 dollars) per astronaut. The purpose of the program was to accomplish a technically difficult feat a few times despite the enormous cost. Civilian technology requires the exact opposite: the ability to do something on a large scale at a low cost."
 As a matter of public policy, Everett argues, the government has shown a pattern of trying to force-feed commercialization before it is actually ready to happen, through subsidies to nuclear power, or synthetic fuels, or wind, or battery-powered cars. It's always politically enticing to promise that a few temporary subsidies will jump-start large industries with many new jobs, but the record in energy is that the subsidies are often long-lasting and large, while the subsidized companies are short-lived. Managers get their bonuses, but sustainable jobs aren't created. (And for those who argue that fossil fuels are subsidized as well, Everett points out that the taxes collected on oil use are vastly higher than any public support received by the oil industry.)
Everett doesn't emphasize the point, but the newfound ability of U.S. energy producers to access vast reserves of natural gas will reshape energy markets in manifold ways. I've posted in the past about "Unconventional Natural Gas and Environmental Issues" and also about my own preference for "The Drill-Baby Carbon Tax," which would be a policy of moving ahead with all deliberate speed in developing U.S. fossil fuel resources while also imposing a carbon tax and addressing the costs of other environment issues as well.
But after 40 years of watching the U.S. government try to force energy markets on to a different path, it's time for an alternative approach. The U.S. government should stop subsidizing commercial energy firms, and instead put that money into a dramatic increase in energy research and development.

Head Start is Failing Its Test

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I'll just admit up front that the vast inequities that exist even before children start school bother me, and that I am predisposed to favor programs that would help disadvantaged children early in life. Thus, I was delighted when Head Start announced some years back that it was going to carry out a randomized control trial--that is, to assign some preschool children randomly to Head Start and others not--so that it would be possible to do a statistically meaningful test of how well Head Start worked.  I presumed that the test would provide ammunition for my pre-existing views.

But as the evidence has built up, Head Start is failing its test. The latest evidence appears in the "Third Grade Follow-up to the Head Start Impact Study: Final Report," which was released in December. The report was carried out by a company called Westat and published by the Office of Planning, Research and Evaluation, Administration for Children and Families, U.S. Department of Health and Human Services. Basically, the report shows that Head Start provides short-term gains to preschool children, but those gains have faded to essentially nothing by third grade.

To appreciate how depressing this conclusion is, you need to appreciate the high quality of the study. It's based on a nationally representative sample of more than 5,000 3 and 4 year-olds from low-income families who were eligible for Head Start. These children were randomly either assigned to Head Start, or not. Data collection started in 2002, and so by 2008, data was available on how the children were performing in third grade. The study didn't just look at test scores: it considered a range of data on how Head Start might affect aspects of cognitive development, social-emotional development, health status and services, and even parenting practices.

The findings are summarized in this way:  "In summary, there were initial positive impacts from having access to Head Start, but by the end of 3rd grade there were very few impacts found for either cohort in any of the four domains of cognitive, social-emotional, health and parenting practices. The few impacts that were found did not show a clear pattern of favorable or unfavorable impacts for children."

Of course, because I am predisposed to favor these kinds of programs, I look for silver linings. Perhaps for certain specific subgroups such preschool programs can be useful? Perhaps certain kinds of curriculum are more likely to make a lasting difference?  Perhaps helping children from low-income families catch up before they start school is insufficient, but a sustained set of interventions continuing through elementary school would show lasting results? Sometimes studies of early preschool interventions have found little gain in measured outcomes a few years into school, but later gains like greater rates of high school completion or reductions in certain risky behaviors in adolescence. Maybe as the Head Start study continues, these sorts of longer-term gains will emerge?

I don't have an answer  here. Some years ago, I edited a paper in a special issue of the  Future of Children about the enormous gaps in school readiness for preschool children. Equal opportunity is an important goal of public policy, and as a society, we are clearly not providing equal opportunity to many children--who are already well behind before their first day of school. If the Head Start study had positive results about the long-run efficacy of preschool programs, I'd trumpet it to the hills. But the unfolding evidence isn't backing up the conclusion I would prefer. 

Checkerboard Puzzle, Moore's Law, and Growth Prospects

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My father the mathematician first posed the checkerboard puzzle to me back in grade-school, perhaps on some rainy Saturday. His version of the story went something like this:

The jester performs a great deed, and the king asks him how he would like to be rewarded. The jester is aware that the king is a highly volatile individual, and if the jester asks for too much, the king might just kill him then and there. The jester also knows that the king views his promise as sacred, so if the king says "yes" to the jester's proposal, then the king will honor that promise. So in a way, the jester's problem is how to ask for a lot, but have the king at least initially think it's not very much, so that the king will give his consent.

So the jester clowns around a bit and then says: "Here's all I want. Take this checkerboard. On the first square, but one piece of gold. On the second square, two pieces. On the third square, four pieces, and on the fourth square, 8 pieces. Double the amount on each square until you reach the end of the checkerboard."

In the story, the king laughs at this comic proposal and says,  "Your great deed was so wonderful, I would have happily done much more than this! I grant your request!"

But of course, when the king starts hauling up gold pieces from the treasury, he will discover that 2 raised to the 63rd power, the final spot on the checkerboard requires about 9 quintillion gold pieces (that is, 9 followed by 18 zeros). 

I've had some sense of the power of exponential growth ever since.  But what I hadn't thought about is the interaction of Moore's Law and economic growth. Moore's Law is of course named for Gordon Moore, one of the founders of Intel, who noticed this pattern back in 1965. Back in the 1970s, he wrote a paper that contained the following graph showing how much it cost to produce a computer chip with a certain number of components. Here's his figure. Notice that the numbers of component on the horizontal axis and the cost figures on the vertical axis are both graphed as logarithm (specifically, each step up the axis is a change by a factor of 10). The key takeaway was that the number of transistors ("components") on an integrated circuit was doubling about every two years, making computing power much cheaper and faster.


Ever since I started reading up on Moore's law in the early 1980s, there have been predictions in the trade press that it will soon reach technological limits and come to and end. But Moore's law marches on: indeed, the research and innovation targets at Intel and other chip-makers are defined in terms of making sure that Moore's law continues to hold for at least awhile longer. Stephen Shankland offers a nice accessible overview of the current situation in an October 15, 2012, essay on CNET: ""Moore's Law: The rule that really matters in tech"  (The Gordon Moore graph above is copied from Shankland's essay.)

As Shankland writes: "To keep up with Moore's Law, engineers must keep shrinking the size of transistors. Intel, the leader in the race, currently uses a manufacturing process with 22-nanometer features. That's 22 billionths of a meter, or roughly a 4,000th the width of a human hair." He cites a variety of industry and research experts to the effect that Moore's law has at least another decade to run--and remember, a decade of doubling every two years means five more doublings!

It's hard to wrap one's mind around what it means to say that the power of microchipo technology will increase by a factor of 32 (doubling five times) in the next 10 years. A characteristically intriguing survey essay  from the January 10 issue of the Economist on the future of innovation uses the checkerboard analogy to think about the potential effects of Moore's law. Here's a comment from the Economist essay:

Ray Kurzweil, a pioneer of computer science and a devotee of exponential technological extrapolation, likes to talk of “the second half of the chess board”. There is an old fable in which a gullible king is tricked into paying an obligation in grains of rice, one on the first square of a chessboard, two on the second, four on the third, the payment doubling with every square. Along the first row, the obligation is minuscule. With half the chessboard covered, the king is out only about 100 tonnes of rice. But a square before reaching the end of the seventh row he has laid out 500m tonnes in total—the whole world’s annual rice production. He will have to put more or less the same amount again on the next square. And there will still be a row to go.

Erik Brynjolfsson and Andrew McAfee of MIT make use of this image in their e-book “Race Against the Machine”. By the measure known as Moore’s law, the ability to get calculations out of a piece of silicon doubles every 18 months. That growth rate will not last for ever; but other aspects of computation, such as the capacity of algorithms to handle data, are also growing exponentially. When such a capacity is low, that doubling does not matter. As soon as it matters at all, though, it can quickly start to matter a lot. On the second half of the chessboard not only has the cumulative effect of innovations become large, but each new iteration of innovation delivers a technological jolt as powerful as all previous rounds combined."

Now, it's of course true that doubling the capacity of computer chips doesn't translate in a direct way into a higher standard of living: there are many steps from one to the other. But my point here is to note that many of us (myself included) have been thinking about the changes in electronics technology a little too much like the king in the checkerboard story: that is, we think of something doubling a few times, even 10 or 20 times, and we know it's a big change, but it somehow seems within our range of comprehension.

But when something has already been doubling every 18 months or two years for a half-century--it is continuing to double!--the absolute size of each additional doubling is starting to get very large. I lack the imagination to conceive of what will be done with all this cheap computing power in terms of health care, education, industrial process, communication, transportation, entertainment, food, travel, design, and more. But I suspect that these enormous repeated doublings, as Moore's law marches forward in the next decade and drives computing speeds up and prices down, will transform lives and industries in ways that we are only just starting to imagine.

Economic Bounceback by 2014, Says CBO

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After recessions, the U.S. economy has typically had a period of bounce-back growth, which then catches the economy up to the path of "potential GDP" it would have been on prior to the recession. One of the imponderable questions in the aftermath of the Great Recession that lasted from 2007-2009 was when--or if--this bounceback growth would arrive. The nonpartisan Congressional Budget Office offers a prediction in its just-released "The Budget and Economic Outlook: Fiscal Years 2013 to 2023" that "economic activity will expand slowly in 2013 but will
increase more rapidly in 2014." In other words, the long-delayed period of bounceback growth is now at least visible on the horizon. Here's the forecast in pictures.

"Potential GDP" refers to how much an economy could produce with full employment of workers and productive capacity. The blue line shows growth in potential GDP; the gray line shows the actual course of the economy during the recession and its aftermath. Notice the catch-up growth, bringing the economy back to potential GDP.

You can also see the catch-up growth in the CBO predictions for the annual growth rate of GDP.

As the catch-up growth arrives, the CBO is also predicting that the unemployment rate will drop briskly.

In addition, some measures of the grim economy will start to reverse themselves. For example, real investment in residential housing (that is, in building and remodeling houses), after several years of negative growth, has moved back to positive territory.

The underlying story here is that when a recession is accompanied by a financial crisis, the economic bounceback can be painfully slow. When households and firms across the economy are all feeling that they have borrowed too much, and need to get their financial houses back in order, it takes time. The depth of the U.S. recession has actually been somewhat shallower and less prolonged than the experience in many other countries when they experienced the double-whammy of financial crisis and recession, as I discussed here. But by fits and starts, the economic bounceback process does eventually work its way forward.

Winter 2013 Journal of Economic Perspectives

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The Winter 2013 issue of my own Journal of Economic Perspectives is now available on-line. Like all issues of JEP back to the first issue in 1987, it is freely available here, courtesy of the American Economic Association. I will probably put put some posts about individual articles in the next week or so, but here is an overview. The issue has two symposia of four papers each: one on the economics of patents and the other on tradeable pollution allowances. There are a couple of individual papers, one on the empirical work about prospect theory 30 years after that theory was formulated, and the other a look back at the famous RAND health insurance experiment. My own "Recommendations for Further Reading" rounds out the issue. Here are abstracts for the papers, with links to the text.

Symposium on Patents

"The Case against Patents," by Michele Boldrin and David K. Levine

The case against patents can be summarized briefly: there is no empirical evidence that they serve to increase innovation and productivity, unless productivity is identified with the numberof patents awarded—which, as evidence shows, has no correlation with measured productivity. Both theory and evidence suggest that while patents can have a partial equilibrium effect ofimproving incentives to invent, the general equilibrium effect on innovation can be negative. A properly designed patent system might serve to increase innovation at a certain time and place. Unfortunately, the political economy of government-operated patent systems indicates that such systems are susceptible to pressures that cause the ill effects of patents to grow over time. Our preferred policy solution is to abolish patents entirely and to find other legislative instruments, less open to lobbying and rent seeking, to foster innovation when there is clear evidence that laissez-faire undersupplies it. However, if that policy change seems too large to swallow, we discuss in the conclusion a set of partial reforms that could be implemented.
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"Patents and Innovation: Evidence from Economic History," by Petra Moser

What is the optimal system of intellectual property rights to encourage innovation? Empirical evidence from economic history can help to inform important policy questions that have been difficult to answer with modern data: For example, does the existence of strong patent laws encourage innovation? What proportion of innovations is patented? Is this share constant across industries and over time? How does patenting affect the diffusion of knowledge? How effective are prominent mechanisms, such as patent pools and compulsory licensing, that have been proposed to address problems with the patent system? This essay summarizes results of existing research and highlights promising areas for future research.
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"The New Patent Intermediaries: Platforms, Defensive Aggregators, and Super-Aggregators," by Andrei Hagiu and David B. Yoffie

The patent market consists mainly of privately negotiated, bilateral transactions, either sales or cross-licenses, between large companies. There is no eBay, Amazon, New York StockExchange, or Kelley's Blue Book equivalent for patents, and when buyers and sellers do manage to find each other, they usually negotiate under enormous uncertainty: prices of similar patentsvary widely from transaction to transaction and the terms of the transactions (including prices) are often secret and confidential. Inefficient and illiquid markets, such as the one for patents,generally create profit opportunities for intermediaries. We begin with an overview of the problems that arise in patent markets, and how traditional institutions like patent brokers, patent pools, and standard-setting organizations have sought to address them. During the last decade, a variety of novel patent intermediaries has emerged. We discuss how several online platforms have started services for buying and selling patents but have failed to gain meaningful traction. And new intermediaries that we call defensive patent aggregators and superaggregators have become quite influential and controversial in the technology industries they touch. The goal ofthis paper is to shed light on the role and efficiency tradeoffs of these new patent intermediaries. Finally, we offer a provisional assessment of how the new patent intermediary institutions affecteconomic welfare.
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"Of Smart Phone Wars and Software Patents," by Stuart Graham and Saurabh Vishnubhakat

Among the main criticisms currently confronting the US Patent and Trademark Office are concerns about software patents and what role they play in the web of litigation now proceeding in the smart phone industry. We will examine the evidence on the litigation and the treatment by the Patent Office of patents that include software elements. We present specific empirical evidence regarding the examination by the Patent Office of software patents, their validity, and their role in the smart phone wars. More broadly, this article discusses the competing values at work in the patent system and how the system has dealt with disputes that, like the smart phone wars, routinely erupt over time, in fact dating back to the very founding of the United States. The article concludes with an outlook for systematic policymaking within the patent system in the wake of major recent legislative and administrative reforms. Principally, the article highlights how the US Patent Office acts responsibly when it engages constructively with principled criticisms and calls for reform, as it has during the passage and now implementation of the landmark Leahy-Smith America Invents Act of 2011.
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Symposium on Tradeable Pollution Allowances

"Markets for Pollution Allowances: What Are the (New) Lessons?" by Lawrence H. Goulder

About 45 years ago a few economists offered the novel idea of trading pollution rights as a way of meeting environmental goals. Such trading was touted as a more cost-effective alternative totraditional forms of regulation, such as specific technology requirements or performance standards. The principal form of trading in pollution rights is a cap-and-trade system, whose essential elements are few and simple: first, the regulatory authority specifies the cap—the total pollution allowed by all of the facilities covered by the regulatory program; second, the regulatory authority distributes the allowances, either by auction or through free provision; third, the system provides for trading of allowances. Since the 1980s the use of cap and trade has grown substantially. In this overview article, I consider some key lessons about when cap-and-trade programs work well, when they perform less effectively, how they work compared with other policy options, and how they might need to be modified to address issues that had not been anticipated.
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"The SO₂ Allowance Trading System: The Ironic History of a Grand Policy Experiment," by Richard Schmalensee and Robert N. Stavins 

Two decades have passed since the Clean Air Act Amendments of 1990 launched a grand experiment in market-based environmental policy: the SO₂ cap-and-trade system. That system performed well but created four striking ironies: First, by creating this system to reduce SO₂ emissions to curb acid rain, the government did the right thing for the wrong reason. Second, a substantial source of this system's cost-effectiveness was an unanticipated consequence of earlier railroad deregulation. Third, it is ironic that cap-and-trade has come to be demonized by conservative politicians in recent years, as this market-based, cost-effective policy innovation was initially championed and implemented by Republican administrations. Fourth, court decisions and subsequent regulatory responses have led to the collapse of the SO₂ market, demonstrating that what the government gives, the government can take away.
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"Carbon Markets 15 Years after Kyoto: Lessons Learned, New Challenges," by Richard G. Newell, William A. Pizer and Daniel Raimi

Carbon markets are substantial and they are expanding. There are many lessons from market experiences over the past eight years: there should be fewer free allowances, better management of market-sensitive information, and a recognition that trading systems require adjustments that have consequences for market participants and market confidence. Moreover, the emergingmarket architecture features separate emissions trading systems serving distinct jurisdictions and a variety of other types of policies exist alongside the carbon markets.This situation is in sharpcontrast to the top-down, integrated global trading architecture envisioned 15 years ago by the designers of the Kyoto Protocol and raises a suite of new questions. In this new architecture, jurisdictions with emissions trading have to decide how, whether, and when to link with one another. Stakeholders and policymakers must confront how to measure the comparability of efforts among markets as well as relative to a variety of other policy approaches. Internationalnegotiators must in turn work out a global agreement that can accommodate and support increasingly bottom-up approaches to carbon markets and climate change mitigation.
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"Moving Pollution Trading from Air to Water: Potential, Problems, and Prognosis," by Karen Fisher-Vanden and Sheila Olmstead

This paper seeks to assess the current status of water quality trading and to identify possible problems and solutions. Water pollution permit trading programs have rarely been comprehensively described and analyzed in the peer-reviewed literature. Including activeprograms and completed or otherwise inactive programs, we identify approximately three dozen initiatives. We describe six criteria for successful pollution trading programs and consider how these apply to standard water quality problems, as compared to air quality. We then highlight some important issues to be resolved if current water quality trading programs are to function as the "leading edge" of a new frontier in cost-effective pollution permit trading in the UnitedStates.
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Individual articles

"Thirty Years of Prospect Theory in Economics: A Review and Assessment," by Nicholas C. Barberis

In 1979, Daniel Kahneman and Amos Tversky, published a paper in Econometrica titled "Prospect Theory: An Analysis of Decision under Risk." The paper presented a new model ofrisk attitudes called "prospect theory," which elegantly captured the experimental evidence on risk taking, including the documented violations of expected utility. More than 30 years later,prospect theory is still widely viewed as the best available description of how people evaluate risk in experimental settings. However, there are still relatively few well-known and broadlyaccepted applications of prospect theory in economics. One might be tempted to conclude that, even if prospect theory is an excellent description of behavior in experimental settings, it is less relevant outside the laboratory. In my view, this lesson would be incorrect. Over the past decade, researchers in the field of behavioral economics have put a lot of thought into how prospect theory should be applied in economic settings. This effort is bearing fruit. A significant body of theoretical work now incorporates the ideas in prospect theory into more traditional models of economic behavior, and a growing body of empirical work tests the predictions of these new theories. I am optimistic that some insights of prospect theory will eventually find a permanent and significant place in mainstream economic analysis.
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"The RAND Health Insurance Experiment, Three Decades Later," by Aviva Aron-Dine, Liran Einav and Amy Finkelstein 

Between 1974 and 1981, the RAND health insurance experiment provided health insurance to more than 5,800 individuals from about 2,000 households in six different locations across theUnited States, a sample designed to be representative of families with adults under the age of 62. More than three decades later, the RAND results are still widely held to be the "gold standard" ofevidence for predicting the likely impact of health insurance reforms on medical spending, as well as for designing actual insurance policies. On cost grounds alone, we are unlikely to seesomething like the RAND experiment again. In this essay, we reexamine the core findings of the RAND health insurance experiment in light of the subsequent three decades of work on theanalysis of randomized experiments and the economics of moral hazard. First, we re-present the main findings of the RAND experiment in a manner more similar to the way they would bepresented today. Second, we reexamine the validity of the experimental treatment effects. Finally, we reconsider the famous RAND estimate that the elasticity of medical spending withrespect to its out-of pocket price is -0.2. We draw a contrast between how this elasticity was originally estimated and how it has been subsequently applied, and more generally we cautionagainst trying to summarize the experimental treatment effects from nonlinear health insurance contracts using a single price elasticity.
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"Recommendations for Further Reading," by Timothy Taylor
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Economics of Ideas: Paul Romer and Thomas Jefferson

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Here's Paul Romer on the power of ideas, from his article the Fall 2012 Issues in Science and Technology:
"What makes ideas so remarkable is their capacity for shared use. A bottle of valuable medicine can heal one person, but the formula that is used to make the medicine is as valuable as the total number of people on Earth. Economists call this concept “non-rivalry.”... There is a saying that you all know that we use to capture this character of non-rivalry: If you give someone a fish, you feed them for a day, but if you teach someone to fish, you destroy another aquatic ecosystem."
For me, the classic statement about the economic power of ideas and their relation to the patent system comes from Thomas Jefferson, in a letter  he wrote in 1813: 
"If nature has made any one thing less susceptible than allothers of exclusive property, it is the action of the thinking power called anidea, which an individual may exclusively possess as long as he keeps it tohimself; but the moment it is divulged, it forces itself into the possession ofevery one, and the receiver cannot dispossess himself of it. Its peculiarcharacter, too, is that no one possesses the less, because every otherpossesses the whole of it. He who receives an idea from me, receives instructionhimself without lessening mine; as he who lights his taper at mine, receiveslight without darkening me. That ideas should freely spread from one to anotherover the globe, for the moral and mutual instruction of man, and improvement ofhis condition, seems to have been peculiarly and benevolently designed bynature, when she made them, like fire, expansible over all space, withoutlessening their density in any point, and like the air in which we breathe,move, and have our physical being, incapable of confinement or exclusiveappropriation. 
"Inventions then cannot, in nature, be a subject of property.Society may give an exclusive right to the profits arising from them, as anencouragement to men to pursue ideas which may produce utility, but this may ormay not be done, according to the will and convenience of the society, withoutclaim or complaint from anybody. Accordingly, it is a fact, as far as I aminformed, that Englandwas, until we copied her, the only country on earth which ever, by a generallaw, gave a legal right to the exclusive use of an idea. In some othercountries it is sometimes done, in a great case, and by a special and personalact, but, generally speaking, other nations have thought that these monopoliesproduce more embarrassment than advantage to society; and it may be observedthat the nations which refuse monopolies of invention, are as fruitful asEngland in new and useful devices."

An Agenda for Medicare Reforms

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What's to be done about Medicare? The Kaiser Family Foundation has usefully pulled together a list of possible "Policy Options to Sustain Medicare for the Future." I especially liked that the report is fairly exhaustive in listing about 130 options (depending on how one counts options, suboptions, and sub-suboptions), and fairly honest in admitting that no realistic cost estimates for many of those options. Here, I'll start with a quick reminder of where Medicare is currently headed, and then list just 12 of the choices--those that in the KFF tally would reduce Medicare costs or raise Medicare taxes by at least $4 billion per year over the next  few years.





Medicare spending is taking off for two reasons: as the baby boomer retire, a rising proportion of Americans will become eligible, and continually rising health care costs will push up costs still further. The first figure shows projections for the rising number of Medicare enrollees and Medicare spending as a share of GDP. The second figure shows Medicare spending projected as a rising share of the overall federal budget.

Discussions of how to fix Medicare often head for happy talk about how, if we all just provide patients and doctors with the right information and incentives, and link them together with the right network of health information technology and thoughtful counselors, we can save billions while improving everyone's health. For a recent example, see this report from the United Health UnitedHealth Center for Health Reform & Modernization, which suggests that steps along these lines could save up to $542 billion in Medicare and Medicaid spending over the next decade. It's a cheerful story, and I'm certainly fine with pursuing these kinds of win-win possibilities. But the U.S. health care system has been facing ever-rising costs and talking about win-win solutions for several decades. While we're waiting for the cost savings from these kinds of more enlightened and efficient practices to arrive, we need to start thinking about some less pleasant options.

 Here's the list of 12 possibilities from the KFF report that would involve Medicare cost savings or revenue increases of at least $4 billion per year. In that report, all the proposals for better information sharing and quality control and improved decision making by patients and providers have the effect on costs and revenues listed as "Not available," which seems fair to me, given historical experience with attempts along these lines as overall health care costs have continues to rise. What's left are choices that sting (with the effect on costs or revenues in parentheses). The KFF Report gives a couple of pages of more detailed explanation for each of these, along with the other 100+ choices.

1) Raise the age of Medicare eligibility from 65 to 67 ($113 billion over 10 years)

2) 10% coinsurance payment on all home health episodes ($40 billion over 10 years)

3) Restrict first-dollar Medigap coverage ($53 billion over 10 years)

4) Increasing premiums for Part B and Part D: for example, raise Part B premiums by 2% per year until they cover 35% of total Part B expenses ($231 billion over 10 years)

5)  Increase Medicare payroll tax by 1 percentage point for all workers ($651 billion over 10 years)

6) Require manufacturers to pay a minimum rebate on drugs covered under Medicare Part D for
beneficiaries receiving low-income subsidies ($137 billion over 10 years).

7) Repeal provisions in the Affordable Care Act that would close the Part D coverage gap by
2020 ($51 billion over 10 years)

8) Reduce and restructure graduate medical education payments to hospitals ($69 billion over 10 years)

9) Rebase SNF and home health payment rates: for example, reducing payment updates for post-acute care by 1.1 percentage points ($45 billion over 10 years)

10) Adopt traditional tort reforms at the Federal level ($40 billion to $57 billion over 10 years)

11) Establish a combined deductible, uniform coinsurance rate, and a limit on out-of-pocket
spending, along with Medigap reforms ($93 billion over 10 years)

12) Set Federal contributions per beneficiary at the average plan bid in a given area, including
traditional Medicare as a plan, weighted by enrollment ($161 billion over 10 years)

A few thoughts:

1) One of the policy changes would dramatically increase costs. Congress has been playing a game for years now in which it lowballs the future costs of Medicare by proposing very large cuts  in payments to health care providiers that will take place a few years in the future. Then Congress perpetually pushes back those cuts. To their credit, the official Medicare actuaries have been quite blunt in pointing out "Why Official Medicare Costs are Understated." But if, for example, the currently legislated future cuts in payments to health care providers were replaced with a 10-year freeze on fees and a "only" a 5.9% cut in fees for non-primary care services each year for the first three years, Medicare costs would be $200 billion higher over 10 years than the current legislative estimates. If fees for health care providers rise at the rate of GDP growth, or a percentage point or two faster, then Medicare costs will be $300 billion or more higher over the next 10 years. Thus, take your first few hundred billion in cost savings or revenue increases above, and assume that it's going to go to sidestepping the huge future cuts to health care providers in current legislation.

2) I did leave out a few proposals on the KFF list for increasing taxes on other items and earmarking the funds for Medicare. For example, one could raise taxes on alcohol, tobacco, soft drinks, or employer-provided health insurance and earmark the funds for Medicare. But one could also raise those taxes and spend the money on deficit reduction or some other program, so at least to me, these are not specifically "Medicare" reforms.

3) Just for the record, you can't just add up the cost estimates several of these proposals with, because they interact in various ways. For example, option #3 on restricting first-dollar Medigap coverage overlaps heavily with option #11  on Medigap reforms. If the Medicare age was raised to 67, it would alter the cost changes from all of the other proposals.

My bottom line is that too many of the arguments over Medicare spending are magically nonspecific. Sometimes they describe innovations in health care delivery that would improve health and save money and leave everyone with a big rosy smile. I'm all for such changes, and I'll believe in their effectiveness as soon as they are actually effective in reducing costs--but not before. Other time, politicians talk tough about how they will just put a cap on Medicare spending, or just not let it rise at faster than some certain rate. Again, I'll believe in the workability of such caps when I've seen them operate for a few years.

In contrast, the list above is not a pleasant one. Some of these proposals reduce coverage for the elderly or require them to pay more. Some reduce payments to health care providers. One raises taxes on current workers. I am fully aware that none of these are popular options! Which options are more palatable is an argument for another day. But these are real choices, and the inexorable arithmetic of Medicare's rising costs is likely to force choices among these sorts of options.