Jan. 23 (Bloomberg) -- When you look at the problems facing America, the cost of health care is at the top of the list. It will soon hit the crisis stage, if it hasn't already.

A number of reports suggest the issue will be featured prominently in President George W. Bush's State of the Union address on Jan. 31. What might he do?

If the size of a problem is any indication of its likely priority on the president's agenda, reforming health care will be front and center. According to the most recent Medicare trustees report, the present value of the program's obligations -- what Medicare will have to pay over an infinite time period in today's dollars -- totals $68.1 trillion.

The future looks so bleak for two reasons. First, the U.S. health-care system is the most expensive in the world. According to the most recent comparisons by the Organization for Economic Cooperation and Development, Americans spent $5,635 per person on health care in 2003, $1,828 more than Norway, the country with the second-highest per-capita spending. Second, we have a rapidly aging society.

When Boomers Retire

When the baby boomers retire, they will almost all join Medicare, so the government will have to pick up the tab for providing the world's best health care to a huge elderly population.

The scale of the problem is almost unfathomable. By 2060, Medicare is expected to cost 10.5 percent of gross domestic product, compared with 2.6 percent in 2004. Our kids won't enter the workforce with balls and chains tied around their necks; they'll have Grandma and Granddad instead.

In principle, policy responses could address both sides of the equation. Liberalizing immigration rules, for example, would lower the percentage of the population that is elderly, because immigrants tend to be young. If the liberalization focuses especially on individuals with scientific expertise, then we will make our workforce more productive as well.

Any solution, however, will have to address the cost side as well.

A recent report suggested that Al Hubbard, the president's top economic adviser, favors an approach spelled out by R. Glenn Hubbard, former chairman of the President's Council of Economic Advisers.

The Hubbard Approach

In a new book, written for the American Enterprise Institute with John Cogan of the Hoover Institution and Daniel Kessler of Stanford University, Glenn Hubbard proposes a number of measures that could significantly improve the health-care system.

One of the authors' key insights is that health-care costs are so high today because few people actually pay the sticker price for the services they purchase. Imagine how it might change your diet if you could eat anywhere you want for free. The health-care system allows folks to do almost the same thing.

The book's first suggestion is to reduce the tax preference for employer-provided insurance. This would be terrific policy. Because employer contributions to employee health plans aren't taxed, employers have a strong incentive to avoid taxes by granting compensation in the form of benefits.

This creates gold-plated health plans that use expensive, low-deductible, low-co-payment insurance. Those luxury plans drive costs up for everyone else, including Uncle Sam, and it's crazy for the federal government to subsidize them.

Shifting Incentives

Cogan, Hubbard and Kessler recommend shifting the incentives towards greater cost-consciousness by allowing individuals to deduct all direct payments for health care if they buy high-deductible catastrophic insurance.

They calculate that full tax deductibility would decrease wasteful health-care spending by roughly $40 billion and reduce the ranks of the uninsured by 2 million to 6 million people, all at a revenue cost of only $6 billion per year. And the extra attention consumers will pay to cost will help make the whole system more efficient.

With government spending this year predicted to hit $2.6 trillion, that seems a small price to pay for more fiscally and medically responsible health-care spending.

It seems quite plausible that the White House is fond of this proposal. After all, the two Hubbards (who aren't related) have worked closely together ever since the president began seeking the White House.

But if phones in a hotel have buttons labeled ``room service,'' phones in the White House should have a button labeled ``lip service.'' Lots of great ideas make it into the State of the Union address. Few of them become law.

The concern is that this proposal might head down the same path as tax reform. The president's panel devised an excellent plan, but Republicans dropped the ball faster than a New England Patriot in Denver. Will they do so again?

If they want to demonstrate that they can govern responsibly, they can begin by attempting to address America's biggest problem in an intelligent and manageably incremental way.

To contact the writer of this column: Kevin Hassett at khassett@aei.org.

Last Updated: January 23, 2006 00:14 EST