An Empirical Analysis of the Relationship Between Government Spending and Healthcare Service Prices

Abstract

This paper analyzes how government spending on healthcare has been related to changes in healthcare service costs in the United States. Data for producer price indexes of healthcare services, including outpatient and inpatient services, home health costs, and other major categories of healthcare expenditure were collected from the Federal Reserve of Economic Data. Government spending on healthcare for Medicare and Medicaid was also collected and regressed on the price indexes of healthcare services. The statistical analysis determined there was no significant relationship between any form of government healthcare spending and the inflation of healthcare service prices. There are numerous implications of this result for both government policy and healthcare economics. This confirms the significance of many factors in healthcare inflation, not just government spending. Market competition, innovation, and pharmaceutical research costs may be important alternative areas to look for as causes of healthcare service inflation. All in all, this result shows the multitude of factors of healthcare service inflation that policymakers can use to determine how to tackle the rising costs of healthcare in the United States.

Introduction

This paper investigates the relationship between US government healthcare spending and the inflation of healthcare service prices, which has become increasingly relevant given the fluctuations in healthcare spending due to the COVID-19 pandemic. Government spending has long been looked at as a source of inflation in the US economy but the specific relationship between government healthcare spending and healthcare service inflation remains underexplored. Dupor claims in a study that government spending has little to no determination on inflation (Dupor, 2016), while Cutsinger claims that government spending drives inflation by increasing the supply of money and reducing the growth rate of money demand (Cutsinger, 2022). However, these ideas for the general economy are more complex for specific sectors, especially healthcare. Healthcare holds a more nuanced relationship between government spending and inflation than what is traditionally accepted. The many components of government spending on healthcare give it an interesting relationship with the inflation of both healthcare services and prescription drug costs.

The COVID-19 pandemic presented serious changes in both the amount of money the government spent on healthcare and the areas they spent it. Traditional Medicare spending was around $31 billion per month from 2019 through the beginning of 2020, but during the initial lockdown, it plummeted to as little as $22 billion per month in April 2020. Spending on Medicare was 7% lower in 2020 due to a number of factors, including the reduction of elective surgeries and co-morbidities. Mortality due to COVID-19 significantly reduced the number of Medicare beneficiaries, which in turn, had meaningful effects on reducing the overall costs of the program.

Nonetheless, the reduction in Medicare spending due to increased mortality during this period was substantially offset by increased government healthcare expenditures in other areas. Following the declaration of a public health emergency by the World Health Organization in 2020, Medicaid implemented a ‘continuous enrollment’ policy. This meant that once an individual became eligible for Medicaid — a scenario that became increasingly common during the economic downturn — their income was not subject to revaluation. This led to an unprecedented surge in Medicaid enrollees and, consequently, a significant financial burden on the government. Moreover, at the onset of the pandemic, the US government ramped up its investment in public health initiatives and vaccine research. This additional expenditure on COVID-19-related programs contributed to a 36% surge in healthcare-related government spending in 2020.

Although analysis of the different spending areas for the government on healthcare is important, the differences between the government spending on healthcare versus other sectors of the economy are also key factors in analyzing the relationship with inflation. It is important to consider that the majority of government healthcare spending is put on Medicare or Medicaid, the government’s own version of health insurance. The health insurance industry sets its prices for the coming year around November of the previous one. For example, an individual’s deductible, premium, and copay percentages for the year 2024 would normally be determined in November of 2023. For government-sponsored programs, this is no different, so in theory, the costs are priced-in. This fixed-price contracting prevents surprises in spending from factoring into price changes over the year. From June 2022 to June 2023, medical prices rose by around 0.1%, while prices for the rest of the economy rose nearly 3% (Rakshit, Wager, Hughes-Cromwick, Cox, & Amin, 2023). This is different from historical trends since 2000, wherein medical inflation rates have been higher than those for the rest of the economy.

Despite the fact that government spending holds an ever-increasing share of GDP, there remains a lack of research regarding its effect on healthcare inflation. The COVID-19 pandemic significantly altered both the amount of money spent on healthcare and the areas it was spent in, so the changes in spending patterns make it an opportune time period to study its effect on prices. Thus, this study aims to fill this gap in research by empirically analyzing the relationship between government healthcare spending and healthcare price inflation. Time-series data on government healthcare expenditures and healthcare service costs were collected, and linear regression models were used to analyze the relationship. The coming section will present a literature review of inflation theories and healthcare inflation, while Section 3 describes the methodology of the study. Section 4 shares the results of the study followed by Section 5, which discusses the implications of the results. Finally, Section 6 concludes the paper, and Section 7 shows the references to this paper and Section 8 finishes with an extended appendix of the study results.

Literature Review

The subject of government spending’s relationship with the economy has long been an intriguing one, and many studies hold various perspectives on the topic. Many studies have explored the idea that government spending has a direct relationship with inflation rates. A common reason for this has been the idea that government spending increases the supply of money and demand for services. This is shown in a study by Cutsinger, which asserts that a rise in inflation can be caused by government spending because it reduces the growth rate of money demand (Cutsinger, 2022). Benson shares a similar base theory, showing that the stimulus packages have increased inflation by boosting household income which was also accompanied by tax increases (Benson, 2021).

However, these views are contradicted by other studies, e.g. that of Dupor (2016). After performing statistical analysis, Dupor claims that there is little statistical significance in the relationship between government spending and economic inflation. The analysis further concludes that a 10% increase in government spending has led to an 8-point basis decline in inflation (ibid). Despite their contradictory viewpoints, however, all three authors relied heavily on empirical data to back up their research claims.

Many studies regarding inflation theories use statistical analysis to lead their research. This is shown in Cutsinger’s article when he says that, “90% of money is held in bank deposits,” (Cutsinger, 2022). However, this analysis also uses qualitative methods and focuses on an explanation of an occurrence. This contradicts the studies done by Benson and Dupor, who both rely heavily on empirical data they collected to show their claims. Like Cutsinger, Benson uses data from the Federal Reserve of Economic Data in St. Louis and statistics for inflation rates to illustrate the claim that government spending and inflation are related. Dupor also relies heavily on data and analyzes the effects of different government spending levels on inflation rates to conclude the lack of a relationship between the two.

Other studies explore the relationship between federal policies and inflation. One study by Hodge discusses the actions of the Federal Reserve to combat inflation. This analysis uses data collected from the International Monetary Fund to claim that the Federal Reserve’s actions will cause a short-term price hike in goods, but will ultimately lead to a more stable economy and lower unemployment rate (Hodge, 2022). However, Miran says that the partisan gridlock of the federal government will ultimately prevent fiscal measures to combat inflation (Miran, 2023). These studies both analyze how the federal government will react to increased inflation rates. The focus of this study is to extend this to healthcare research. There is significant research on the reactions of the government to healthcare inflation, i.e. causality in the opposite direction as studied here (c.f. Morgan et. al, 2023).

There is limited research, however, on how government policy could be the cause of healthcare inflation, which presents a stark contrast to studies on the rest of the economy. For example, many studies analyze how government spending on Medicare and Medicaid, its two biggest categories, changed during the COVID-19 pandemic. One primary example of this is a study done on Medicare funds by Berdine (2023). This study analyzed the changes in Medicare spending during the lockdown and recession of 2020 to prove that money from the Affordable Care Act would last an extra two years for Medicare Part D (ibid). The Commonwealth Fund also performed a study that showed that Medicare spending dropped dramatically in 2020, going from around $31 billion per month in January 2020 all the way down to $23 billion in April 2020 (Shah, et al., 2021). There is also significant research into how the changes in Medicaid enrollment caused spending increases during the COVID-19 pandemic. A study by Khorrami and Sommers (2021) compiled Medicaid enrollment data to show how the record-setting Medicaid expenses were the result of increases in Medicaid enrollment.

Like this study, most others analyze government spending and healthcare inflation separately. One other example is a study done by Rakshit et al. (2023) looked at the historical trends of medical inflation compared to that of the rest of the economy. These authors concluded that traditionally the inflation of healthcare services occurred at a higher rate than that of the rest of the economy, but this was flipped during the COVID-19 pandemic. However, the study fails to discuss possible reasons for that flip, raising even more questions as to how government spending could be a driver of healthcare sector inflation.

There are very extensive studies about inflation in the general economy as well as the changes in government spending during the COVID-19 pandemic. (c.f. American Medical Association, 2023) These studies analyze changes in every aspect, as well as the underlying reasons such as changes in enrollment to Medicaid due to the continuous enrollment policy.(c.f. Khorrami & Sommers, 2021) Many studies even analyze healthcare inflation by itself.(c.f. Rakshit et. al 2023) While there is a large body of research on both government healthcare spending and healthcare inflation separately, this research paper aims to fill the gap by analyzing connections between government spending and healthcare service inflation.

Methodology

All of the data taken into the statistical analysis was used from the Federal Reserve of Economic Data. The Producer Price Index data for healthcare services, notably outpatient, inpatient, home health, and physician care were taken in monthly time series. The government spending on areas like Medicare and Medicaid was also taken at monthly intervals. When comparing government spending categories versus the PPIs of healthcare services, they were broken up into a pre-COVID pandemic time period and a post-COVID pandemic time period. The ‘pre-COVID’ time was a monthly series from as far back as the time series was recorded through February 2020. However, the series began at varying time points. The ‘post-COVID’ time was included in the data series of March 2020 through June 2023. There were also lags added to the data. These lags accounted for the idea of a cause and effect within the spending and inflation, making sure that a correlation could also be seen if it occurred months later than the government spending.

Results

This section includes the results of the time-series linear regressions, which examine the relationships between healthcare spending and healthcare inflation. Specifically, they examine the relationship between government spending on Medicare and Medicaid (and their respective lags) and various PPI indexes of healthcare service costs. The common finding across the regression models is that the relationship between government healthcare expenditure and healthcare service relationships is not statistically significant. The key results from the models are summarized below.

The above table shows a summarized view of the results of the linear regression. It shows the R squared and F Significance values when comparing the PPI indexes of various healthcare services against current and lagged government spending on Medicare and Medicaid. As seen in the table, the numbers of both correlation and causation show no statistical significance in any category, which shows that changes in Medicare and Medicaid spending do not have a statistically significant effect on healthcare price inflation. Further specified tables can be found in the Appendix.

Across the board, the analysis shows no statistical significance between government spending on Medicare and Medicaid, as well as some other spending categories and healthcare price inflation, which was measured by the PPI indexes for the costs of various healthcare services. This result holds across different model specifications and stays consistent across changes in the lag length and other methods of healthcare price inflation measurement.

Discussion

There are many interesting pieces that can be taken out of the result that there is no significant correlation between government spending on healthcare and healthcare service inflation. This study is one of the first to empirically investigate the relationship between government healthcare spending and healthcare service price inflation, and due to its limited attention in existing literature, the conclusions that can be drawn are significant in both the real world and within other literature on the topic.

From a perspective of further research, it is clear that a deeper dive into the root causes of healthcare inflation is necessary, as while overall government spending may not cause an increase, basic components of it or other factors such as innovation, pharmaceutical costs, and supply chain or market dynamics may be drivers of inflation of the industry. This could once again be a result of the fact that – unlike a stimulus check – the government’s spending on healthcare does not often put money into the hands of a consumer. Future research into spending on healthcare services that directly give money to consumers could reveal new information. While there may not be a correlation from the initial analysis, refined measurements may show smaller direct relationships between components of government healthcare spending and healthcare service inflation. This study has reached a conclusion similar to Dupor, who asserted that there was no significant correlation between government spending and inflation. However, this study answered something that was not previously explored; government spending causing healthcare inflation, not vice-versa. Additionally, the results here are significant for policymakers and for people to make decisions for their health. As this analysis confirms that government spending has not been a driver of inflation, the federal government can look to spend more directly on healthcare or turn to other areas with the goal of reducing inflation in mind.

Conclusion

In conclusion, this study collected data on areas of government spending related to healthcare and the inflation of healthcare services during the same time period. It sheds light on a topic extremely relevant to America today, as increasingly important debates regarding the future of healthcare structure and policy occur across the nation. As a whole, this underscores the healthcare system’s complexity, showing the depth of factors that can contribute to service costs. This has far-reaching implications in both future research as well as for policymakers and the healthcare community, as by ruling out government spending as a catalyst of inflation it is now apparent that there are other factors driving it.

For policymakers, the results could allow them to increase spending to improve the structure of Medicare and Medicaid even more because it does not seem to be a driver of healthcare inflation. They now have the confidence to invest in healthcare initiatives without amplifying the inflation of healthcare service prices. This could lead to better infrastructure in government-sponsored healthcare systems for better quality of care for Americans. Future research is undoubtedly needed to discover the real factors driving healthcare inflation.

Although there is no correlation between government spending and healthcare service inflation, numerous other areas of spending on healthcare remain unexplored. Some that could be explored are the investment and costs of pharmaceuticals, the effect of the COVID-19 pandemic on the production of goods and supply chain dynamics, and the administrative expenses of running primary care practices and hospitals. Also, private sector spending is yet to be investigated, and increases in those costs could be a driver of healthcare service cost inflation. In terms of the healthcare community, the findings underscore the multifaceted nature of the US healthcare system. Because price inflation for this sector is not tied to just government spending, it is implicit that the drivers come from many different areas. This is critical insight for healthcare providers, insurance companies, and patient advocacy groups.

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Appendix

The Relation of Govt. Spending and Health Prices 21

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