On to EROP

Let’s begin with Chapter 4 on Medicare. The chapter focuses on the increasing costs of Medicare (and Medicaid) and ways to control them. At the outset it rejects raising taxes to cover the rising costs:

“Controlling cost growth while preserving the vital financial and health protections offered by the program is particularly important in light of the large negative consequences of raising taxes. An increase in the payroll tax rate would decrease incentives to work, increase efforts to receive compensation in forms not subject to taxation, and be a drag on economic growth.”

All true enough in general (though how important these disincentive effects are in practice is an open question), but this reluctance to spend more on health care is telling. Our population is getting older and richer; exciting new medical technologies are making it possible for us to live longer, healthier lives. Why shouldn’t we spend more on health care in the future? What is more important?

To prepare the groundwork for the Administration’s proposals the report lays out the economic theory behind the existence of a program like Medicare:

“Economists generally attempt to justify government intervention into private market outcomes by suggesting potential market failures that may exist in the absence of any government intervention. Many economists would justify the existence of Medicare (and its government provision of health insurance for the elderly and disabled) with three potential explanations. The first potential explanation is that many people may lack sufficient information to plan properly for the financial hardships that would otherwise arise from expensive medical treatment when they age or become disabled... But this reason alone is insufficient to explain the provision of health insurance as opposed to additional income. A second potential explanation for government intervention in the provision of health insurance for seniors is to avoid having seniors in poor health pay considerably more toward their health care… This suggests that there may be efficiency gains from providing future insurance coverage with pooled contributions. (Private health insurance markets handle this intertemporal uncertainty of developing a chronic health condition with “guaranteed renewal at class average rates” provisions that ensure that premiums do not vary with the onset of illness for those with coverage.) A third potential explanation for government intervention in the provision of health insurance is related to the redistribution of resources toward lowincome people… This economic argument, however, justifies the subsidization of, or requirement for, insurance but does not justify a government-run plan.”

They’re showing quite a blindside here. There are many other good reasons to have a government-run program, the most widely-accepted of which is the “lemons problem.” Suppose an insurance company offers a comprehensive plan costing $10,000. Individuals have a choice between buying the plan and self-insuring by putting money in the bank for unforeseen medical expenditures. Assuming people are not too risk-averse, the people who want to buy the $10,000 plan will be those whose expected expenditures are close to or above $10,000, while those who chose to self-insure are relatively healthy people who expect to spend considerably less than $10,000. But the insurance company can’t make a profit insuring unhealthy people for $10,000, so it raises rates to $15,000. But now of those who were buying insurance previously, the healthiest people drop out and self-insure, leaving the insurance company with a smaller group of less healthy customers, paying more but not making profit for the company. So rates rise again, more people drop out, and so on. Eventually, the insurance policy is prohibitively expensive and no one buys it. This is market failure on a grand scale driven by “adverse selection” (George Akerlof originally described this problem as it pertains to the market for used cars; hence the term “lemons problem”). The “market” solution is to keep rates something less than prohibitively high, but screen the unhealthiest people out and ruthlessly challenging claims. This adds to administrative costs and reduces the number of people who are insured (and the people who are unable to get insurance are those who need it most). Another solution is to have large employers buy group insurance for their employees, essentially prohibiting the company from screening out high-cost customers. But the Administration’s key reform proposal – reducing the tax deductions for employer-paid insurance benefits – would reduce the subsidies that make this insurance affordable and push more workers into the individual insurance pool, where the adverse selection problem is more severe.

The report then makes its diagnosis of what’s wrong with America’s health care system: we have too much health care! To whit:

“It is likely that there is significant overconsumption of health care that provides little marginal benefit. Consider a costly new technology that provides very large health benefits to specific patients in need. Suppose, however, that it is also consumed by patients who benefit very little from the treatment. If the benefits to “appropriate” patients are very large, the increase in spending over time on both “appropriate” and “inappropriate” patients combined can still imply that the new technology is cost effective. However, because some “inappropriate” patients also receive the treatment, some of the variation in spending is due to inefficiency. If this characterization is accurate, the technology is not as cost effective as it should be. This overconsumption of health care is frequently thought of as being caused by poor incentives such as overly generous health insurance coverage. That is, patients often face marginal prices for costly treatments that, due to insurance coverage, are lower than the true marginal costs of treatment… The presence of generous health insurance may also influence the research and development of certain technologies with questionable cost effectiveness.”

Ok everyone, raise your hand if you think the main problem with the American health care system is that we have overly generous health insurance. You in the back, why aren’t you raising your hand? You say the main problem is that 50 million of us have no coverage whatsoever? That the coverage that millions more of us have is lousy? That rates are high because administrative costs eat up a quarter of total costs? Commie.

The report then lists some proposals that are probably sensible, including pay-for-performance schemes (insurers and hospitals are paid more the more healthy they make their patients) as opposed to the current system of paying per procedure. But while these proposals may produce benefits at the margin, they don’t address what most of us would regard as the most fundamental flaws of our health care system. And why should they – the people writing the report, and the people they’re writing it for, and the people who write the checks that finance their campaigns – they’re all quite satisfied with their own health insurance, thank you very much.