Medicare Reform

In 2003 Congress created a prescription-drug benefit program for persons enrolled in Medicare. It was estimated at the time that the program would cost the government $40 billion a year; a recent re-estimation, adding $30 billion a year, New York Times, has elicited proposals to curtail the benefit.

Given Medicare, I do not think that there is a principled objection to including a prescription-drug benefit in it. Suppose Medicare were limited to hospital treatment. Then critics would say, that's absurd'it will only impel people to get hospital treatment that would cost society (though not the patient) less in a non-hospital setting. It is similarly questionable to exclude prescription drugs from Medicare coverage. Drugs are substitutes for other forms of medical treatment in many situations; therefore excluding them from coverage will induce people to seek other forms of treatment that may cost society more to provide. This means, by the way, that in calculating the net social cost of the prescription-drug benefit, the cost of other treatments for which drugs, with their cost to the patient reduced by the Medicare subsidy, will substitute should be subtracted. Concern has been expressed that increased demand for drugs may increase their price. That is unlikely. The principal cost of drugs is R&D. The manufacturing cost is slight; and therefore an increase in output brought about by increased demand should, if anything, reduce average cost and hence, given competition, price.

The real issue is not the prescription-drug benefit but the overall cost of Medicare; currently (that is, without the prescription-drug benefit) that cost is running at almost $300 billion a year, which is about 3 percent of GDP. As a matter of economic principle (and I think social justice as well), Medicare should be abolished. Then the principal government medical-payment program would be Medicaid, a means-based system of social insurance that is part of the safety net for the indigent. Were Medicare abolished, the nonpoor would finance health care in their old age by buying health insurance when they were young. Insurance companies would sell policies with generous deductible and copayment provisions in order to discourage frivolous expenditures on health care and induce careful shopping among health-care providers. The nonpoor could be required to purchase health insurance in order to prevent them from free riding on family or charitable institutions in the event they needed a medical treatment that they could not afford to pay for. People who had chronic illnesses or other conditions that would deter medical insurers from writing insurance for them at affordable rates might be placed in "assigned risk" pools, as in the case of high-risk drivers, and allowed to buy insurance at rates only moderately higher than those charged healthy people; this would amount to a modest subsidy of the unhealthy by the healthy.

Economists are puzzled by the very low deductibles in Medicare (including the prescription-drug benefit'the annual deductible is only $250). Almost everyone can pay the first few hundred dollars of a medical bill; it is the huge bills that people need insurance against in order to preserve their standard of living in the face of such a bill. But government will not tolerate high deductibles when it is paying for medical care, because the higher the deductible the fewer the claims, and the fewer the claims the less sense people have that they are benefiting from the system. They pay in taxes and premiums but rarely get a return and so rarely are reminded of the government's generosity to them. People are quite happy to pay fire-insurance premiums their whole life without ever filing a claim, but politicians believe that the public will not support a government insurance program'and be grateful to the politicians for it'unless the program produces frequent payouts. If Medicare were abolished, the insurance that replaced it would be cheaper because it probably would feature higher deductibles; it is true that low deductibles are common in many forms of private insurance, such as automobile collision insurance, but I think it would be different in the case of health insurance simply because private health insurance for the elderly, with no Medicare crutch, would be very costly. The premiums would be much lower with high deductibles.

I do not think, however, that total expenditures on medical care would decline markedly if Medicare were abolished. The reason is the enormous value that the vast majority of people place on longevity, good health, and freedom from pain and other physical discomfort. (And, given this value, why shouldn't people who can afford to pay for it be required to do so rather than be subsidized by the taxpayer?) Pursuing a theme in my posting on social security, young people may be unwilling to pay for health insurance that will cover their expenses generously when they are old. But when they reach old age they will demand treatment whether they have insurance or not, and no one who has a serious medical condition is refused treatment in this country although he or she may have to settle for less-than-cutting-edge treatment in a public hospital. To prevent this free riding, a scheme of compulsory health insurance would have to require generous coverage in old age; and so aggregate health costs might not be much lower than under the present system, although with higher deductibles and copayments there would be some reduction.

The explanation usually offered for the fact that a substantial fraction of the population has no health insurance is that these are unfortunate people who cannot afford health insurance. A better explanation is free riding. A person who has no assets lacks a compelling reason to buy medical insurance; he will be able to obtain medical treatment free of charge, as a charity patient. A person who does have assets but is young and healthy may prefer to gamble on not incurring large medical bills, rather than to subsidize the older and less healthy by being placed in the same insurance pool with them. However, these temptations to free ride provide an argument for compulsory health insurance rather than, as often argued, for socialized medicine.

The cost of Medicare (or private substitutes) will continue to rise in relative as well as absolute terms. The reason is that advances in medicine increase longevity and with it the number of years in which a person is likely to require expensive medical treatment. It would thus be desirable from a cost standpoint if medical research could be reoriented from extending the lifespan of the elderly to making the elderly healthier. It would incidentally reduce the cost of social security, because workers who become totally disabled before they reach retirement age become immediately entitled to social security. This will become an increasing problem as the normal age of social security entitlement rises from 65 to 67 pursuant to legislation passed by Congress in 1983.

But of course benefits must be considered as well as costs. If people value additional years of elderly life at more than the cost of the extension, the cost may be worthwhile, though it doesn't follow that it should be subsidized.

Young people find it strange that such a large fraction of overall medical expenses is incurred in the last few months of life'that is, by people who are dying. (Last-year-of-life medical care accounts for 26 percent of Medicare expenditures and 22 percent of all medical expenditures. PubMed. ) Having nothing to look forward to, why are they willing to spend so much on a meager extension of life? There are several reasons. One is that a good deal of end-of-life medical care is devoted to reducing suffering rather than to extending life. Another reason is uncertainty as to whether one is really dying. Another is that the (private) cost of care, however extensive, is negligible for persons who are covered by both Medicare and private "medigap" insurance that pays for the copayments that Medicare requires. Still another reason for the heavy loading of medical expenses at the end of life is that for people who do not have a strong bequest motive, the opportunity cost of money spent in their last period of life is negligible because they will not be able to spend any money saved during that period.

There were, as usual, many very interesting comments. Let me try to respond to a few. One interesting suggestion is that an increase in demand for drugs, brought about by the Medicare prescription-drug benefit, will not, as I suggested, reduce average price by enabling the drug companies' heavy fixed investment in R&D to be spread over a greater output; the companies' patent monopolies will enable them to charge higher prices. This is possible but not certain. If average cost is not rising in output, an increase in demand will not lead to a higher price. If, however, the demand curve facing a monopolist becomes less elastic (meaning that a small increase in price will have a less depressing effect on output), then the monopolist will raise his price (unless, perhaps, his average costs are falling). That is a possible effect of the prescription-drug benefit: the benefit will slow the output reaction to a higher price. However, this effect will be offset to some and perhaps a great extent by the fact that many patented drugs have good substitutes (for example, the different antidepressants and painkillers), since different molecules having the same therapeutic effect are separately patentable. However, I grant that there may indeed be a price effect from the new benefit; one possible (and unlikely!) response would be to shorten the patent term for pharmaceutical drugs.

Some comments suggest that compulsory health insurance and socialized medicine are, contrary to what I argued in my posting, the same thing. That is not so. Compare automobile liability insurance. It is compulsory in most (maybe, by now, in all) states, but since the insurance is written by private companies, it is hardly an example of socialized insurance. Similarly, one could have compulsory education laws but no private schools, and one would then not speak of socialized education.

The analogy of medical to auto insurance was criticized in some of the comments on the ground that there is no upper limit to how much medical treatment one may need. But, similarly, there is no upper limit to the amount of damage you can do driving carelessly, yet it is possible to buy essentially unlimited liability insurance. The real difference is that medical insurance is more expensive--and would be much more expensive were it not for Medicare--than automobile liability insurance is because many more people require expensive medical treatment, especially toward the end of their lives, than cause serious auto accidents. Many comments suggest that medical insurance would be so expensive if it weren't subsidized by the taxpayer through Medicare that it would be unaffordable. But this is obviously wrong. Here the analogy is to life insurance. One can buy a very large life insurance policy cheaply at a young age because the insurance company invests the premiums and earns a return on the investment for many years before it has to pay out. Similarly, medical expenses tend to rise with age. Of course, young people have less disposable income than older--but one implication is that many older people, having high incomes, can afford to buy health insurance even though their premiums will be higher than if they had bought a lifetime policy when they were wrong.

It is true that some, and probably many, people will not be able to afford health insurance, and I agree that, as a practical matter, they cannot be denied treatment just because they can't pay for it. So there will always be medical subsidies, just as there will always be subsidized pensions (social security). But why not make those who can buy health insurance, including health insurance for their old age, do so? One attractive method of subsidy, which I borrow from the automobile insurance example, is to require each insurance company to insure, at premiums only moderately above the market level, the individuals who because of poor health cannot afford to buy health insurance at market rates.

The suggestion that you cannot deny, medical treatment to someone who refuses to buy health insurance is also true, but you can punish him for not buying it, just as we punish people for not paying taxes.

I like the suggestion that low deductibles in health insurance policies are actually cost savers because they encourage people to visit the doctor at the first sign of trouble, when the problem can probably be corrected at less cost than if they delay. However, this reasoning does not justify the low deductibles in the prescription-drug plan. They will just encourage pill popping.