Let's hypothesize that all the engineers working in SV get an AIDS-like illness caused by spending too much time on news.yc.
If there was a health care solution that would make sure that all the employees of Google, Intel, HP, etc. continued to function as usual by caring for those engineers, then even an extremely high up-front cost for that care would result in a net-win for the budget/economy/country.
Of course, that's silly as it won't happen to that extreme. But, I don't think the downward-spiral of more-cuts-here-and-there that you describe is the only possible outcome. A positive virtuous-cycle of increased wealth production is also possible.