Why U.S. Healthcare Spending Is Rising So Fast

U.S. healthcare expenditures greatly exceed those of other developed countries. They are projected to increase at a substantial rate but produce no better—and indeed sometimes worse—outcomes, according to research sponsored by the Peter G. Peterson Foundation.  

With national healthcare expenditure (NHE) estimated to reach $6.2 trillion by 2028, public policy experts, government officials, healthcare-sector leaders, business executives, and ordinary citizens share mounting concerns about the country’s ability to provide healthcare services that are fiscally responsible and attain acceptable levels of quality, effectiveness, and equity.

Proposals to counter the increasing levels of U.S. healthcare expenditures abound. They include policies intended to achieve price transparency; alternatives to fee-for-service compensation, such as price controls based on Medicare fees or a percentage of negotiated in-network rates, as well as value-based and capitation systems, antitrust enforcement, simplification of administration, and a wholesale restructuring of the sector’s present complex arrangements in favor of a single-payer, governmental system for the entire population.

Efforts to reduce healthcare spending—even if they’re aimed at reducing the future rate of increase in expenditures—are bound to provoke the powerful groups comprising the healthcare sector. Deciding whose revenue would be cut and how reductions would be allocated among different healthcare interests will require widespread agreement on the necessity, urgency, and inevitability of these reductions—coupled with exceptional political leadership.   

Pandemic Reveals Systemic Problems

The COVID-19 pandemic has altered the patterns and distributions of healthcare services and expenditures, at least for 2020 and 2021. It has spotlighted systemic deficiencies and inequities that existed long before the pandemic, continued to exist throughout it, and will probably exist for long after it’s over.

The pandemic and the development of vaccines have confirmed the importance of investment in basic scientific research. It has advanced innovation, particularly in the provision and distribution of services, through telehealth expansion, retail clinic and urgent care utilization, and outreach to rural and underserved communities through mobile health units. Recognizing the widespread acceptance of telehealth, Walmart has purchased a telehealth provider and plans to expand its service nationwide, while Amazon is expanding its Amazon Care from being available only to employees and their families in Washington state to being available in all 50 states.

The pandemic has also revealed substantial weaknesses in crisis preparedness; inadequate and inequitable supply, facility, and professional resources; and insufficient coordination and communication capability.  At the very time that policymakers are compelled to address the rising cost of healthcare, the pandemic is requiring them to face long-latent, systemic inadequacies along with the continuing internal and external causes of increasing healthcare expenditures. 

The necessity of federal financial support and technical assistance for providing free vaccines, various pricing directives for testing, and eventual supply and equipment aid to improve access and affordability for addressing COVID-19 were widely recognized. However, general acceptance of these government interventions seems unlikely to carry forward and expand price regulation and equitable access policies broadly beyond the pandemic. Increasing healthcare costs will continue to challenge individuals, the healthcare sector, and the general U.S. economy.  

Annual U.S. Healthcare Costs

Experts look at healthcare costs both in terms of NHE—which includes costs at every level—and federal-government health spending. Here’s how both are rising.

National Health Costs and the GDP

Healthcare payers, providers, and patients consider the mounting cost of U.S. healthcare and its increasing demands on the American economy unsustainable. The Centers for Medicare & Medicaid Services (CMS) annually produces yearly NHE estimates and 10-year national healthcare expenditure projections reflecting total nationwide costs.

These comprehensive, national statistics pertain to total U.S. spending and thus include spending by federal, state, and local governments, households, and employers. In 2020, NHE grew 9.7% to $4.1 trillion, an amount representing 19.7% of the gross domestic product (GDP). Spending per person was $12,530.

Current levels of U.S. healthcare spending—both on a per-person basis and as a share of GDP—far exceed those of comparable countries. The country with the second-highest expenditure per person was Norway, with a 2020 per capita cost of approximately $6,748 and total healthcare spending constituting an 11.3% share of its GDP. Germany is just behind Norway, spending approximately 12.5% of its GDP, averaging $6,731 per person.

A number of factors contribute to the higher cost of U.S. healthcare. Generally, healthcare prices are higher in the U.S. for professional services, hospitalizations, and medical supplies and drugs. Higher administrative costs in the U.S. account for one-quarter to one-third of all U.S. healthcare spending.

Health Spending by the Federal Government

In addition to reporting NHE, CMS also estimates the subset of expenditures that makes up federal healthcare spending. In 2020 the federal government was responsible for 36.3% of NHE. The rest of NHE was divided among households, which accounted for 26.1%, private business at 16.7%, state and local governments at 14.3%, and other private revenue sources at 6.5%. 

Total federal government expenditures include Medicare, Medicaid, the Children’s Health Insurance Program (CHIP), Affordable Care Act (ACA) Marketplace premium subsidies, the Veterans Administration, U.S. Department of Defense healthcare programs, support for healthcare professionals, and hospitals providing uncompensated care, and other federal programs.

Medicare represented 21% of total NHE in 2019; it accounted for the largest share of federal healthcare spending, a total of $799.4 billion. CMS projects that Medicare spending will grow 7.6% annually between 2019 and 2028. Medicaid accounted for $613.5 billion, 16% of NHE in 2019. That same year, private health insurance spending amounted to $1,195.1 billion, 31% of NHE, and out-of-pocket expenditures were $406.5 billion, 11% of NHE. From 2018 to 2019, spending for hospitals increased 6.2%, while prescription-drug spending rose 5.7%, and spending for physician and clinical services grew 4.6%. CMS has projected the average annual rate of growth for NHE during the period of 2019 to 2028 to be 5.4%.

U.S. Health Outcomes Lag Behind Those of Other Countries

Despite Americans spending significantly more on healthcare compared with the residents of other developed countries, they do not enjoy better outcomes. In fact, the U.S. lags behind other countries when common health metrics are considered. 

Among the wealthier European countries of the current 38 Organisation for Economic Cooperation and Development (OECD) members the life expectancy for individuals born in 2020 is much higher than in the U.S. In Switzerland, it is 83.2 years, while in France it is 82.3 years, and 80.4 years in the United Kingdom. The life expectancy for U.S. residents, at 77.3 years.

National Health Expense: Ever Higher

CMS projects that U.S. healthcare spending will grow at a rate 1.1% faster than that of the annual GDP and is expected to increase from 17.7% of the GDP in 2018 to 19.7% by 2028. Two reasons for this are that health-sector wages are anticipated to increase faster than the GDP will, and the prices for medical goods and services are projected to grow by an average of 2.4% annually by 2028. With the aging baby boom generation greatly increasing Medicare enrollment, Medicare spending is expected to grow 7.6% annually over the decade. Spending for all categories of healthcare expenditures is expected to grow faster between 2019 and 2028 than in earlier years.  

Even with overall growth, some trends with cost-reduction potential were underway before the COVID-19 pandemic. Increasingly, Americans were seeking healthcare services in places other than traditional professional offices, emergency rooms, and hospitals. As health systems diversified their service locations beyond hospital facilities—and insurers directed plan members to lower-cost service—the number and utilization of ambulatory surgery centers, urgent care facilities, and retail clinics grew.

The use of telehealth services, both video and telephonic, which was significant even before the pandemic, became many times greater after social distancing became an imperative. Given telehealth’s convenience for providers and patients—and especially its advantages for remote and underserved communities—its usage likely will expand. Although professional fee schedules for telehealth so far seem unlikely to vary from in-office fees, telehealth may reduce medical-facility costs for providers. Walmart’s and Amazon’s investments to add telehealth operations to their consumer healthcare offerings confirm expectations for this model of care.

Causes of Higher Spending

Studies of healthcare spending tend to focus on factors internal to the healthcare sector that contribute to higher costs—in particular, prices and administrative costs. Even though changes in these areas would be opposed by powerful interests, significant cost savings are imaginable, even if not easy. Less amenable to change are external conditions that increase costs but cannot be avoided, including basic economic principles and demographics.         

External Cost Factors: Basic Economics and Demographics

CMS estimates, as well as other projections of future increases in U.S. health spending, assume that the current structure of the healthcare sector generally will continue. These projections also take into account external developments that impact costs.

Although academic, political, and industry sources are generating many proposals for cost savings—including significant structural changes—the prospect for substantial change is uncertain. Certain externalities, particularly demographics, will challenge cost-containment efforts.

Supply and demand: Healthcare spending is subject to the basic economic principles of supply and demand. As the population grows and more individuals enjoy better access to care because of developments such as the Affordable Care Act, increased Medicare enrollment, and expanded Medicaid and other government programs in some states, expenditures will rise. What’s more, limitations on current and future supply, particularly with respect to the education and licensing of medical professionals, may result in unmet demand that could easily lead to rising prices. 

In addition, the increase in the production of expensive drugs protected by patents will also cause spending increases unless cost-containment measures—much if not all of which will probably require legislation—are adopted.

Baby boomers and the larger insured population: Demographics constitute a significant contributor to the rapid ascent of healthcare costs and will have a substantial, immediate impact. As increasing numbers of the baby boom population born between 1946 and 1964 reach Medicare age, that program is projected to experience its highest-ever rate of spending growth among healthcare payers—7.6%—between 2019 and 2028.

Based on the distribution of births between 1946 and 1964, the peak year for new Medicare enrollment likely will be 2022, 65 years after 1957, the year the greatest number of boomers were born.

As of the 2020 Census, 10,000 baby boomers were aging into the program every day. And as years pass, the Medicare program will have an increasing number of older—and thus more expensive—beneficiaries.

With per-person healthcare expenditures for individuals age 65 and older estimated at five times the spending per child and almost three times the amount per working-age person, the impact of the older cohort is obvious.

In 2019 the average Medicare expenditure per enrollee was $13,276, while overall the national average per-person spending was $11,582. Private insurers, who generally pay higher fees than Medicare does but whose enrollees are typically younger and less expensive than the Medicare population, spent $5,927 per person in 2019. Medicaid, which covers individuals of all ages, spent an average of $8,485 per person.

During periods of increased enrollment in private insurance and public programs, healthcare costs generally can be expected to increase as more people take advantage of their coverage. Assuming enrollees continue their insurance coverage indefinitely and preventive care reduces the severity and cost of later healthcare needs, individual healthcare costs may decline.

However, longer-term savings may not be realized because of terminated insurance coverage (for example, when job loss ends employer coverage or individuals lose government benefits). In addition, high deductibles and copays may discourage the use of covered services by lower-income enrollees and limit their access to long-term and continuing coverage, thereby preventing comprehensive care.

Internal Factors: Prices, Administration, and Anticompetitive Trends

Factors internal to the healthcare system also affect increasing prices.

Prices and administrative costs: Analyses of increasing healthcare spending generally cite prices as the leading cause. In particular, they emphasize trends in pricing for professional and facility services, prescription drugs, and durable medical equipment (DME).

More-detailed studies also acknowledge the significant role of administrative costs, which, like prices, are higher in the U.S. than in other developed countries. These studies often emphasize that the administrative costs for private insurance substantially exceed the costs of Medicare administration.

The comparative complexity of the U.S. health system—with its mix of government programs, private insurance, and uninsured individuals—entails varied and duplicative administrative requirements that significantly add to expenditures. These include expenses incurred by physicians’ practices for billing, obtaining pre-approval for services, and record-keeping required by multiple payers whose enrollment, coverage, patient benefits, authorization, payment, and other standards can vary greatly.

Insurers and plan managers incur their own administrative costs. Employers and other plan sponsors bear consulting, broker, and administrative expenses for their employee health plans. Although government programs generally spend less on administration and pay providers lower fees than private health plans do, the scale of federal and state programs adds significantly to overall national expenditures.

Anticompetitive trends: The impact of greater consolidation in the healthcare sector, both vertically and horizontally, has raised concerns about adverse effects on competition and potential increases in consumer costs, as reported in the New York Times.

Investment funds increasingly see the healthcare sector as an attractive investment opportunity and are viewed as influencing rising prices, according to the Harvard Business Review. Private equity has a growing presence in the health sector, says Institutional Investor. Firms are investing in pharma, biotech, technical equipment, facilities from nursing homes to surgery centers, and professional provider groups, including ER, anesthesiology, and other specialist practices serving hospitals.

Doctors and hospitals view insurer consolidation as anticompetitive and are challenging companies for lowering fee schedules and forcing provider groups and hospitals out of network, according to reports in the New York Times and Kaiser Health News.

HealthLeaders Media reported on a hearing of the House Judiciary Committee at which public officials criticized mergers of provider organizations, insurance company acquisitions of professional provider groups, pharmacy benefit managers, and healthcare-related analytics and consulting organizations.

In Jan. 2021, as litigation and regulatory actions challenged insurer mergers and business practices, government officials reacted. Congress unanimously passed a new law repealing a long-standing federal antitrust exemption for medical and dental insurers, which was then signed by President Trump. Thus, federal authorities, as well as state regulators, can now investigate antitrust issues in the health insurance industry. 

The Bottom Line

Both the Biden administration and the Congress that took office in 2021 recognize the need to address widely held concerns about the cost of healthcare in the U.S. With the COVID-19 pandemic’s exposure of critical weaknesses in the healthcare sector, officials are challenged not only to contain costs but also to develop policies that assure equitable access to quality healthcare.