In about an hour, the US Supreme Court, three years after Chrysler, is about to have a profound impact on Wall Street one more time. As Goldman explains, the court is expected to release some of the final opinions of the current session, which ends this week. Rulings on the Affordable Care Act (ACA) as well as the Arizona immigration law are likely to capture the greatest amount of attention. With a number of opinions to get out, it is possible the court could wait until later this week (possibly Thursday, June 28) to release some of the remaining rulings for this term, though the court has not yet announced any additional dates for the release of opinions. Trading in the online prediction market intrade.com implies a 74% probability that the court will find the mandate unconstitutional; prior to the oral arguments in March, it implied only around a 35% probability the court would rule against the mandate. Goldman believes that the outcome is fairly unpredictable and that many market participants probably are relying too heavily on the oral arguments in trying to predict the outcome of the case.
For those curious what the long-term implications of today's ruling are, here is a complete Q&A from Goldman:
Q&A on the Upcoming Supreme Court Health Reform Decision
- The US Supreme Court appears poised to rule on the health reform legislation enacted in 2010, the Affordable Care Act (ACA). The court has three basic options: (1) uphold the entire law; (2) strike only the aspects of the law that were under review--the individual coverage mandate or the Medicaid expansion, or (3) strike the entire law.
- If the court strikes the key components of the law that are under review, it is unlikely that Congress will act quickly to "repair" the court's action. Such a ruling would reduce net federal spending by more than $300bn over the next ten years, and in the current fiscal environment lawmakers are less likely to want to allocate those funds to coverage expansion than they were when the law was originally enacted.
- The court's decision, whatever it may be, should have a fairly modest effect on fiscal policy for 2013. Of the $600bn or so in policy changes that comprise the fiscal cliff, less than $50bn (0.3% of GDP) were enacted under the ACA and this fiscal restraint would only be removed if the entire law were struck down, which in our view seems less likely than the other outcomes.
Q: What does the health reform law do?
A: It provides new insurance subsidies, financed by Medicare spending cuts and tax increases. The Affordable Care Act (ACA) expands insurance coverage mainly through (1) an expansion of the existing Medicaid program for the low-income population and (2) new subsidies available through insurance "exchanges" that the law would establish in each state to facilitate enrollment in plans offered by insurance companies. To cover the cost of this expansion, the law established new taxes on individuals and several sectors of the health care industry, limited health-related tax preferences, and reduced Medicare payments to health care providers and insurers. The law also included several regulatory reforms meant to increase coverage and/or health system efficiency. The chart below shows the main components of the law, organized by the average fiscal effect from 2014 to 2019, as a share of GDP.
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Q: What is the Supreme Court ruling on?
A: The court heard arguments on four questions:
- The individual mandate. The court is considering whether Congress exceeded its powers in mandating that virtually every individual obtain health insurance. The ACA requires most individuals to obtain insurance that meets minimum standards. Beginning in 2014, individuals who fail to obtain insurance must pay a monetary penalty (set at the greater of roughly $700 or 2.5% of income, once fully phased in). The mandate was enacted to expand the insurance risk pool to include individuals who receive uncompensated health care and, in particular, healthy individuals who might otherwise intentionally decline coverage. Several other aspects of the law either directly or indirectly relate to the coverage mandate, including a "guaranteed issue" requirement, which compels insurers to provide coverage to any eligible applicant regardless of health status and "community rating," which limits insurers' ability to price premiums based on the health risk of the applicant.
- Medicaid expansion. A group of states has asked the Supreme Court to invalidate the expansion of the Medicaid program on grounds that Congress has unconstitutionally coerced States into accepting conditions of the new law by threatening to withhold all federal funding for Medicaid (the largest source of federal funding for states) if they do not.
- Severability. If the court finds parts of the law unconstitutional, it must then also decide whether those aspects can be severed from the rest of the law, which would remain intact, or whether the entire law should be struck down. The most obvious provisions that are linked to the areas under review are the guaranteed issue and community rating requirements described above, which many view as inextricably linked to the individual coverage mandate.
- Whether the challenge to the mandate is barred by the Anti-Injunction Act. This is a technical question dealing with whether the court may hear a case related to a tax before the tax has actually been levied, but it could serve as a basis to delay a ruling until 2014, when the coverage mandate takes effect.
Q: When will it make its decision?
A: Most observers expect a decision the week of June 25. The ruling could come at any point, but there are two constraints on the timing. First, the court normally issues opinions on Mondays and Thursdays. Second, the court's session is scheduled to end the week of June 25. Some opinions are expected to be released this Thursday, June 21, but most observers expect the court to wait until the very end of its session, with June 25 or June 28 the most likely dates for the court to rule on the ACA.
Q: How will the court rule?
A: Anything is possible, but it looks like a close call between upholding the entire law and striking parts of it. Market participants appear to have more conviction in the likely outcome than one would expect in light of the fact that (1) most of the commentary over the last two months has been based on a few hours of oral arguments, (2) the consensus view shifted dramatically following the arguments, implying that the market has a limited ability to handicap judicial outcomes, and (3) the court is known for an absence of leaks prior to rulings so no new information has come to light since the arguments were held in late March. Despite this seemingly uncertain situation, trading in the online prediction market intrade.com implies roughly a 75% probability that the individual mandate will be struck down, up from 35% or so prior to the oral arguments and 55% about a month ago.
The ruling is likely to take one of three directions:
- Uphold the law in its entirety. The court could opt to leave the law unchanged. Questioning from the justices during oral arguments suggests that four of the nine justices--Breyer, Ginsburg, Kagan, and Sotomayor--might lean in this direction. Chief Justice Roberts and Justice Kennedy are seen as swing votes, while the remaining justices--Alito, Scalia, and Thomas--are generally expected to support striking down at least some parts of the law.
- Strike parts of the law while leaving the rest intact. It is possible that the court could decide to strike the mandate on individuals to obtain insurance and the expansion of the Medicaid program while leaving the broader law in place. A ruling against the Medicaid expansion could strike that provision from law entirely, but during oral arguments the possibility was raised of making participation in the Medicaid expansion voluntary for states as a constitutional remedy, which would stop short of completely striking the expansion. While some justices appeared to question the constitutionality of the Medicaid expansion, it seems more likely that the expansion will be upheld. The outcome regarding the individual coverage mandate is much less certain. As noted above, Justices Kennedy and Roberts appear likely to be the swing votes, but how they will rule on this issue is difficult to predict. In our view, the likelihood that the mandate will be struck down is lower than the 75% probability implied by prediction markets and is essentially a 50/50 proposition. If the mandate is struck down, the court must also decide whether to strike down the related insurance underwriting rules as well. This seems fairly likely, since several justices acknowledged the important linkage among them, and opponents of the law as well as the Obama Administration have asked that the court strike those related rules if they strike down the mandate.
- Strike the entire law. While certainly possible, this appears to be a less likely outcome than upholding the mandate or striking only part of the law. Some justices who appear likely to find parts of the law unconstitutional still appear to have doubts about striking the entire statute. For instance, Justice Scalia noted that "it can't be right" that the various provisions unrelated to the mandate had to fall with it, though at one point he nevertheless noted the possibility that they might have to be. Although Congress could in theory revisit the law following a court decision, justices across the ideological spectrum appeared to hold little hope that they would be able to do so.
While most commentary on the court's upcoming ruling presents these decisions as binary questions, it is also important to note that the court could split its ruling in several different ways, and while it seems unlikely following the oral arguments, it is even possible that the court could delay a decision until 2014, citing the Anti-Injunction Act noted above.
Q: If the mandate alone is struck down, how would this affect the financing of health benefits?
A: Public costs would decrease in the medium term but would also become more uncertain. If the mandate is struck down but the related insurance underwriting rules are left standing, fewer healthier individuals would purchase coverage than if the mandate were implemented. Private-sector insurance plans would be unable to turn applicants away despite pre-existing health conditions and could not price premiums according to health risk. This would be very likely to lead to an increase in health insurance premiums, which would make it even less likely that healthy individuals would enroll, thereby increasing premiums again and further reducing demand for insurance among the healthy. While there is general agreement that insurance premiums would rise under such a scenario, there is much more uncertainty regarding where this process would find equilibrium. The Congressional Budget Office estimates that non-group policies (i.e., policies purchased through newly created insurance "exchanges" or in the traditional non-group market) would increase by 15% to 20% compared with a scenario in which the mandate were fully implemented. Per-capita costs in Medicaid might also rise, though net spending in that program would also fall due to lower enrollment.
The upshot, according to CBO, is that lower enrollment at a higher per-enrollee cost would reduce net federal spending by roughly 0.16pp of GDP from 2014 (when the mandate and related provisions are scheduled to take effect), or over $300bn over the 2014 to 2022 period. If the mandate and the related underwriting rules were struck down, the reduction in net federal spending might be slightly greater, since without guaranteed access to insurance, even fewer individuals would take up the new federal subsidies.
Q: If the law is partly or entirely struck down, will a new law be enacted to replace it?
A: Not quickly and quite possibly not at all. Congress seems unlikely to quickly intervene to "repair" whatever changes the Supreme Court might order. The most important obstacle is political--the original law was passed when Democrats held the White House and both chambers of Congress, including a 60-seat majority in the Senate for most of the time the legislation was considered. This allowed them to make policy changes beyond the scope of what appears likely in the foreseeable future, when neither party appears likely to have much more than a slim majority in either chamber of Congress and a divided government is very possible. A second obstacle is fiscal--if the court strikes the mandate or even the entire law, it seems likely that lawmakers will be more interested in deficit reduction and less focused on coverage expansion than they were when the legislation was first drafted in 2009.
Q: If the court's decision reduces estimated spending, can Congress "spend" those funds on something else?
A: Not officially. Lawmakers have struggled since last year to find budgetary savings to offset the cost of new legislation and to match deficit reduction with increases in the debt limit, as was done in last year's Budget Control Act (BCA) and which House Speaker Boehner has recently proposed for the next debt limit increase. The pressure to find savings will become more intense later this year, as the debt limit approaches and Congress works to avoid, or at least reduce, the "fiscal cliff" at year end. Although the court's decision could reduce the deficit by more than $300bn over the next ten years (if it strikes the mandate or the Medicaid expansion but leaves in place the spending cuts and taxes used to finance them) Congress is unlikely to be able to use those savings to offset new spending or tax relief. Unofficially, however, it would not be surprising to see some lawmakers attempt to use a budgetary windfall created by the Supreme Court to justify delay of the scheduled spending cuts at year end (i.e., the "sequester").
Q: Is there a scenario in which a ruling would increase the projected deficit?
A: Yes, if the entire law were struck. However, the increase in the projected budget deficit would probably be fairly modest. In the next decade (i.e., from 2020), CBO has estimated the law would reduce the federal budget deficit by about 0.5pp of GDP, so repealing it would add a similar amount to long-term deficit projections. In the current decade, the fiscal effect of the legislation is close to neutral, so while repeal could increase or decrease the projected deficit in a given year, over several years there would be little effect on the projected budget balance. But it is also worth noting that while many of the provisions enacted in the ACA were extraordinary, some of the savings provisions enacted were fairly routine. For example, Congress enacts changes (usually reductions) in Medicare payments to health care providers once every few years. Were the entire law to be repealed, it seems likely that at some point in the next several years Congress would recapture the savings from at least those Medicare-related policies if they were struck by the court along with the rest of the law.
Q: If the court strikes some or all of the law, would it change the size of the "fiscal cliff" at year end?
A: It would reduce it slightly. The ACA was estimated to reduce spending and increase tax revenue by $46bn in 2013. This is mainly the result of new taxes on income over $250,000 and the implementation of Medicare payment cuts. If the court opts to strike down the entire law (scenario three above), this fiscal restraint would not occur and the deficit would rise. However, in the other scenarios in which the law is upheld in part or in whole, it is unlikely that any of the items in the ACA that affect the fiscal stance in 2013 would be affected by the decision.
Q: If the law is upheld, are changes to the law still possible?
A: Yes, either as a result of the election, a fiscal agreement in 2013, or both. If Republican presidential candidate Mitt Romney wins the White House in November, changes to the health care law--and broader entitlement programs--are possible regardless of what the court decides this month. If Republicans hold at least 50 seats in the Senate following the election and maintain control of the US House, they could pass legislation to limit or repeal the coverage expansion enacted under the ACA (the Vice President would in that case cast the tie-breaking vote), since most of those provisions could be modified using the "reconciliation" procedure that is available through the congressional budget process. That said, not all of the provisions could be dealt with using a simple majority in the Senate. The coverage mandate and other regulatory issues would most likely require 60 votes in the Senate to repeal under congressional rules and thus would be more difficult to change.
In addition to the election, there is also a possibility that the health law could be reopened during the fiscal debate that is likely to take place in 2013, assuming that the "fiscal cliff" is temporarily extended past the end of the year into the spring or summer of 2013. At that stage, Congress looks likely to debate tax reform and potentially entitlement reforms, in an effort to reach a broad-based fiscal agreement, similar to Bowles-Simpson. While this is far from guaranteed, any such agreement would almost certainly include health reform among its components, and if so it would be very difficult to meaningfully address health spending without at least indirectly reopening a few of the provisions of the ACA.