The "Crowding Out" Theory of Health Spending

Is spending on health care "crowding out" other important public spending, or are tax cuts to blame? Several prominent political columnists and commentators in BC appear to have accepted the crowding out argument, and since they influence far more people than all the health economists in Canada, it is important to understand their case.

Surprisingly, it is not possible to find a simple, complete statement of the crowding out theory. The presentation made by Minister of Finance Carole Taylor captured its essence when as part of the background for the release of her First Quarterly Financial Report 2006-07, she presented a slide suggesting that, if health spending grew by 8% while education spending and revenue grew by 3%, then health care would reach 71% of provincial government spending by 2017.

Some insist on making the crowding out argument without reference to growth in revenue, but that is misleading. If health spending grows more rapidly than all other spending, it will increase as a percentage of total spending, but it will not crowd out other spending as long as total spending increases at a sufficient rate. Crowding out occurs when a cap is put on total spending by the requirement that its average long term growth be no greater than the average long term growth in revenue. Virtually everyone would agree that in the long term spending cannot consistently outpace revenue, but that gets us back to looking at health spending as a proportion of revenue rather than as a proportion of total spending.

Notwithstanding the reasons for not using the measure, it is necessary to humour those who insist on ignoring changes in revenue and take a moment to look at the historical pattern of health spending relative to total government spending. That's not as easy as many may think because government constantly changes how it does its accounting, and it only "restates" its books for the year immediately preceding a change. The biggest change in public accounting in BC in recent years was the full adoption in 2004-05 of "generally accepted accounting principles" (GAAP) and the corresponding inclusion of the "SUCH" sector (primarily school districts, universities, colleges and health authorities) as part of the government reporting entity. Public Accounts for the year ending March 31, 2004 included a statement showing how things would change once there was full compliance with GAAP. For the summary accounts (excluding crown corporations), the accounting change would have increased health spending from $10.945 billion to $11.322 billion, and total spending from $27.891 billion to $29.853 billion. So had the accounting change been made in fiscal year 2003-04, rather than in 2004-05, health spending would have declined as a proportion of total spending from 39.2% to 37.9% of total spending, primarily because including the SUCH sector increased reported education spending by $1.6 billion. The most recent Public Accounts are for the fiscal year ended March 31, 2006. They show health spending as $12.822 billion, and total spending as $32.887 billion, making health 39.0% of total spending. In its February 2007 budget, the Campbell government projected spending through to fiscal year 2009-10 when, according to Table 1.4 (page 17) health spending is expected to be $13.798 billion and total spending $37.875 billion, making health 36.4% of the total. Oops! That is backwards and suggests that health spending is being crowded out by other spending; of course we can't believe the 2009-10 numbers because the Campbell government didn't do an accurate projection of health, as explained in the covering note from the Deputy Minister.

Statistics Canada publishes CANSIM Table 385-0001 which includes health spending, total spending and total revenue by province. Looking at 1989 through 2006, those data show health spending as a percentage of total spending as 32.1% in 1989, and rising to 36.1% in 2003 before falling back to 35.5% in 2006. As a percentage of revenue, those data show health spending as 29.7% in 1989, and rising to 38.2% in 2003 before falling to 34.6% in 2006.

Health economists prefer to look at health spending as a proportion of the gross domestic product (GDP). GDP is a measure of the total value added in the economy. You can think of the health to GDP ratio as indicating what proportion of our total productive capacity is used for health care. The growth in GDP might be affected by government policies but it isn't subject to sudden changes because of changes in tax policy. Some might find it difficult to understand how health care can be unaffordable or unsustainable at the same time that taxes are being cut. Defenders of tax cuts argue that they pay for themselves and stimulate the economy; detractors argue that increasing demand by cutting taxes simply results in "leakages" (more spending on goods produced elsewhere) with little direct impact on the provincial economy. According to the Public Accounts, personal income tax raised $5.839 billion in 1999-2000, prior to tax cuts; in 2005-2006, it raised $5.838 billion. It took six years to get back to its pre-cut level. Is that because tax cuts paid for themselves, or because of economic growth and inflation? You would expect income tax revenue to grow by the amount of inflation plus the growth in employment. Between 2000 and 2006, the Consumer Price Index for BC increased by 13.2%; employment increased by 13.7% (it increased by 10.8% between 1994 and 2000). It looks like inflation and customary employment growth fully account for the recovery of personal income tax revenue; most importantly, income tax revenues did not grow faster than would be expected solely as a result of inflation plus normal job growth. We have not yet heard the Campbell government say that spending on health care should be reduced so as to pay for tax cuts, although some may argue that is what has happened to social services.

Economists compare health spending to GDP, not because they believe health spending should be directly tied to GDP and therefore reduced during times of recessions, but because it gives an indication over the long term of the proportion of an economy's resources that are allocated to health care. Canada's agency for health information, supported by the governments of all provinces, is the Canadian Institute for Health Information (CIHI). On its website you will find tables that show health spending relative to GDP by province, but you will not find any table that shows health spending as a proportion of provincial total spending or revenue. Perhaps that is because one measure is more credible than another. The same is true if you look at international comparisons of health spending such as is found on the World Health Organization's website.

Health spending is estimated to represent 10.8% of GDP in BC in 2006. It was 11.3% in 2002, and 9.9% in 1991. (In 2003 it was 15.2% for the U.S.) While showing a slight upward trend, health costs as a proportion of GDP has been amazingly steady since the inception of Medicare. That shouldn't be surprising if you consider what it takes to maintain the current level of health care: enough funding to cover increases in wages and prices (less than 3.0% in 2007), enough to cover population growth (about 1.0%), something to cover increased use from an aging population (about 1.0%) and a little to fund improvements due to technological change or to shorten waits. In other words, at current rates of inflation, between 5% and 6% per year is needed. According to BC's Ministry of Finance, the GDP is expected to grow, before inflation is considered, by between 3.0% and 3.3% over the next five years. When inflation is added, that means that GDP and what is required to maintain health care, should show similar growth rates. If the Campbell government, or anyone else, can't accept that, they will have to admit that they want to limit health care to fund tax cuts despite having an economy that should make it possible to improve care. Of course, with a big system it is always possible to waste money; no one is saying that it is easy to manage our health system, just that it is far from impossible to manage.