April 15, 2007
Health Care Reform
Some Priorities in Reforming Health Care-BECKER
I will make three points: the United States system of health care may not be the most efficient but people here get good value for their large spending on health care, employer-based health insurance has the frequently overlooked major advantage of providing long term insurance, and catastrophic health coverage probably should be made compulsory.
Americans spend the largest amount of any country on health care, both in terms of dollar spending, and as a percent of income-the health sector in the United States takes about 1/7 of GDP, which is a far larger percent than any other country. Although this share of income has grown rapidly during the past 25 years, the benefits are also very large. Using the economists concept of how much people are willing to pay for improvements in their life expectancy- called the "statistical value of life"- Kevin Murphy and Robert Topel (see their ""he Value of Life and Longevity", Journal of Political Economy, 2006, pp. 871-904) estimate that improvements in life expectancy in the United States from 1970-2000 is worth over $95 trillion (yes, trillion!). Even after netting out the $35 trillion dollar increase in medical spending over the same period, the net gain exceeds $60 trillion.
Of course, not all the increase in life expectancy is attributable to medical spending, as declines in smoking and other behavior changes made major contributions to longer life. On the other hand, the large improvements in the quality of life due to medical spending, including hip replacements, pacemakers, organ transplants, Viagra, and other advances should be added to the benefits of the increased medical spending. Other OECD countries, such as Europe and Japan, had comparable improvements in life expectancy with much smaller increases in medical spending. Perhaps that means they have more efficient health care delivery systems than the United States has, but these nations generally ration care, and are less generous in providing quality of life improvements, such as hip replacements and breast reconstruction after breast cancer. The United States is also the world's leader in medical research, and residents of other countries come to this country for advanced medical treatment of serious diseases and ailments.
I have argued in a previous post (January 29, 2007) that the tax advantage currently enjoyed by employer-provided health plans should be extended to individual and other group based plans in order to level the playing field among competing plans. All tax advantages should have a cap, however, so that "Cadillac" coverage is not deductible, and any extension to individuals and that other group plans of the tax advantage of employer plans would not raise the overall tax burden. Even with such changes, employer-based plans would continue to be important in competition against other group-based plans. A drawback of employer-based health coverage is that workers with existing medical conditions who are covered by such plans would be discouraged from changing jobs because their condition may discourage companies from taking them on. However, most job changes are by younger workers who have few serious medical conditions.
Employees who have been with the same company for a few years or longer are not likely to change jobs, although the propensity of senior workers to lose their jobs has risen a little in recent years. The advantage of employer-based medical insurance to employees who remain with the same employer for many years is that they effectively have long-term medical coverage against serious health problems that could arise in the future. The big problem in individual health insurance coverage is that it is on a year-by-year basis. Anyone who develops a serious health problem can lose his coverage or be forced to pay much higher rates, especially if he wants to change plans or insurance companies.
Long-term health insurance with individual plans is uncommon mainly because health insurance companies cannot force customers to make a long-term commitment. If a person has experienced good health, he may seek a cheaper plan with another company that would reward his additional years of good health, an experience that his original plan could not fully anticipate. Given such "adverse selection", health insurance companies are discouraged from offering long-term insurance.
Most individuals and families need a combination of health savings accounts that give them incentives to conserve on normal health spending, and protection against major health problems. President Bush's State of the Union address proposed an excellent extension of health saving accounts that would help handle more normal health spending (see my post on this on January 29, 2007). To avoid the risk that individuals and families would attempt to free ride on taxpayers and others by not contracting for catastrophic medical coverage, one can make such coverage compulsory for everyone, either through group plans, such as from employment, or through individual plans. As Posner indicates, poorer individuals and families are already covered through Medicaid, so no additional subsidy for lower income persons is needed to implement compulsory coverage of catastrophic health problems.
The Reform of Health Care--Posner
The early Presidential campaigning season is replete with complaints, discussions, and proposals concerning the health care system, widely regarded as broken. Democratic candidate John Edwards has proposed a comprehensive reform that he calls "Universal Health Care through Shared Responsibility," http://johnedwards.com/about/issues/health-care-overview.pdf.
Although the Edwards plan is commendable for its detail and clarity, there is an element of fantasy in Presidential candidates' proposing detailed, specific reforms, on any complex issue, so far before the election; for the feasibility of reform depends on economic and political conditions, including the political makeup of Congress, when the President takes office.
But, passing that point, the current concern about the health system, which generates plans such as the Edwards plan, may be misplaced. It is true that health costs are rising faster than the inflation rate. But rising costs, even of "essential" products and services, such as food, health care, and national defense, do not necessarily demonstrate the existence of a problem. Costs may be rising because quality is rising, which is true of health care (new and better therapies and diagnostic tools), or because demand is rising (and average cost is not flat or declining), which is also true; as people live longer, their demand for health care rises because more health care is required to keep people alive and healthy the older they are. In addition, much health care is in fact discretionary (cosmetic surgery is only one example; others are treatment for mild depression and other mild emotional or cognitive problems and treatments designed to enhance athletic ability), and demand for it can be expected to rise if quality rises relative to price.
It is also true that Americans spend much more on health care on average than the people in other wealthy countries do, without greater longevity to show for these expenditures. But health care does much more than extend life; it alleviates pain, discomfort, disfigurement, limited mobility, visual and hearing impairments, and mental suffering, and it is not clear that foreign health systems, which also involve considerable costs in queuing, do these things as well. In addition, the better a nation's health care is, the riskier the population's life style is likely to be, because the cost of obesity and other risk factors for disease is less.
Also misplaced is concern that the United States is becoming less competitive because employers pay for their employees' health insurance, rather than the government. Employers do not really pay for their employees' health insurance; employees (and the taxpayer, who subsidizes employee health insurance) do, because by raising labor costs employee health insurance reduces the wages that employers are willing to pay. Employers who committed themselves to assuming open-ended obligations for employees' (including retired employees') health costs have only themselves to blame for having assumed a risk that has materialized because of the rapid growth in those costs.
Nor is it a scandal, or even a serious inefficiency, that many millions of workers do not have health insurance. Their health care is paid for my Medicaid if they cannot afford to buy health insurance whether directly or as part of an employee group health insurance plan. Those that can afford health insurance but forgo it either are young and healthy or are risk preferrers, gambling that they will avoid illnesses requiring expensive treatment. If their gamble fails, they will have to pay out of their pockets, and when their pockets are empty (their assets depleted) go onto Medicaid, where their care will be subsidized. Although there is no reason why people who can afford health insurance should be treated at the taxpayer's expense, the effect on the aggregate cost of health care may be neutral or even negative, because Medicaid patients receive less pricey treatment on average than patients who have health insurance. If the young and healthy who today choose to go without health insurance were forced to buy health insurance, there would be two potentially offsetting effects: the average cost of health insurance would fall because the insurance pool was getting an influx of people with below-average expected health costs (though this assumes that the insurance companies wouldn't be permitted to charge lower rates on the basis of age and health, in which event the influx of young and healthy would not affect the rates charged the existing members of the insurance pool); at the same time the average cost of insurance would be rising because aggregate demand was rising, since being forced to have health insurance the newly insured would consume more health care in order to get their money's worth.
Some people are uninsured because of lack of "portability." Suppose a person insured under his employer's group policy leaves the job, and cannot find another one; or suppose that while working for that employer he had contracted a serious chronic illness. In either case, he may find it impossible to buy health insurance at a rate that he can afford. But the idea that such experiences demonstrate a market failure comes from a misunderstanding of the economic function of insurance. The economic basis of insurance is declining marginal utility of income: the more money we have, the less utility (pleasure, happiness) an additional dollar would confer. Suppose your life savings is $2 million, and you are asked to flip a coin: heads you win $3 million, tails you lose your $2 million. The expected value of the bet is $500,000 ($3 million x.5 – $2 million x.5), and thus is positive; but most people would refuse the bet, because the pain of losing their entire savings of $2 million would exceed the pleasure of winning $3 million. The implication for health insurance is that such insurance should be limited to catastrophic long-term illnesses that would drain an individual's or a family's resources and thus be equivalent in the example to losing $2 million. Such cases are rare, and therefore such insurance would be cheap, especially for young people, who would be unlikely to encounter such a catastrophe for many years, during which the insurance company would be earning interest on the premiums paid by the insured; so the premiums would be low. Someone who purchased such insurance at the outset of adulthood would not have to worry much about the lack of portability of an employer's group health insurance because he would have his catastrophic coverage even if he switched jobs or had no job.
Nor finally should we think it a scandal that such a large percentage of the Gross Domestic Product (about $2 trillion out of a total of $14 trillion) goes for health care. One reason it is so large is that other expenses of living, such as food and clothing, have become such a small fraction of overall spending. The question should be not whether the percentage of spending that goes to health is increasing but whether there are better things to spend some of the $2 trillion on than health care. Notice that liberals' concern with the increasing percentage of expenditures on health parallels conservatives' concern with the increasing percentage of GDP that is spent on government services. In both cases the proper concern is not the percentage of overall spending that goes for a particular class of services but whether there are better uses for some of the money being spent for those services.
There are two ways to reduce the aggregate cost of health care, if this is considered a worthy objective, as I am inclined to doubt. One would be to ration demand. If the supply curve for health care is upward sloping, as undoubtedly it is, then capping demand would result in lower prices by forcing the market down the supply curve. But rationing demand would be fiercely resisted by patients, for obvious reasons. The second way to reduce aggregate health costs would be to force down the price of treatment by exercise of the government's potential monopsony power. Suppose all doctors were employed by the government. Then their wages would be low because if you wanted to be a doctor, as many people do, you would not have any alternative to accepting the government's wage. Of course the quality of care would decline. Or suppose (and this the tendency toward which some of the current proposals are tending) that the government bought all the drugs that are produced, having forbidden the drug companies to sell to any other purchaser. Then the price of drugs would be much lower than it is today, but so would be the quality, since the incentives for innovation would be diminished by the lower price.
We should be wary of proposals that if adopted would not reduce (and might increase) aggregate costs, but instead would shift the costs to another class of payees, such as taxpayers (the Edwards plan contemplates additional federal subsidies for health care, which are paid for out of taxes) or future consumers of drugs.