Friday, July 6, 2007

The Health Care Crisis: Who is to Blame and How to Fix It

The accepted wisdom today is that the private marketplace cannot be relied upon to provide health care. At the heart of most critques of our existing system is the belief that the problem lies with the private market and its greedy health insurers, drug companies and providers.

Senator Ted Kennedy (D-Massachusetts) has been an opponent of every market-oriented reform, despite the fact that the track record of his preferred, government-centric policies has been so poor. Medicare costs, for example, have evolved to be four times the 1965 estimates. Presidential aspirant Congressman Dennis Kucinich (D-Ohio) goes further, asserting baldly that profit making enterprise have no place in the health care system. Finally, the subtext of Michael Moore's muckumentary "Sicko" is that the current system is heartless, cruel and ineffective.

In reality, the problem with the US health care system is that there is too little, rather than too much, private marketplace involvement. This situation, in turn, can be traced to the clumsy interventions by government over the past sixty years. These interventions have marginalized the role of the consumer in the health care market. In fact, the role of the consumer has been so marginalized that it bears little resemblence to the paradigm of the private market in economics. In that paradigm, the consumer, having a personal stake in the outcome, exercises discipline over the sellers of services. Without this discipline, the price and quality of service is indeterminate.

The Clumsy Hand of Government

The first government intervention that hastened the exit of consumer sovereignty occurred as a side effect of other economic interventions in World War II. Specifically, price and wage controls handicapped firms' ability to compete for labor. Firms found a loophole in these controls. The regulators had neglected to include the value of labor benefits, such as insurance, in the regulated wage. Moreover, the Internal Revenue Service had neglected to include the value of such benefits in the definition of taxable income.

Firms began offering health insurance as a workaround to wage controls. By the time that the IRS woke up to what was happening, employer provision of this benefit was widespread and the inadvertent exemption from taxation was memorialized in law. The effect on consumer behavior was profound. The consumer no longer perceived the cost of health insurance directly as a personal cost. The illusion was created that health insurance was a cost to the employer, not the worker. And because it enjoyed special tax treatment, the package of compensation was tilted away from wages toward health insurance benefits.

The second government intervention was to compel, over the years, ever-greater comprehensiveness of the coverage offered by employers. The result was that coverage was expanded to procedures that have little actuarial justification for being insured. Instead of being a mechanism for protecting the consumer against financial and physical catastrophe (like fire insurance, by analogy), health insurance also became a payment mechanism for routine services. By analogy, the fire insurance policy was extended to insuring for the cost of common home repairs and maintenance.

The Loss of Consumer Discipline

The separation of the consumer from the purchase of health services was now nearly complete. The price of service was now of little interest to the consumer who enjoyed the price illusion of insurance coverage. Without the consumer to restrain them, provider costs grew more rapidly. This lead directly to the death spiral of private market health care: consumer indifference led to higher provider costs, which led to higher insurance premium until, finally, employers could not justify providing insurance.

The uninsured and elderly now faced health care costs that had been ballooned by decades of insured consumers' indifference to price. Undaunted by its own culpability for this state of affairs, government vainly sought for more governmental solutions: Medicare, Medicaid, and subsidies for those whom they (government) had put in this pickle in the first place.

Fixing It

What should be done? There are several, simple elements to restoring sanity in the health care system. All, in one way or another, re-insert the consumer into the marketplace:

1. Eliminate the employer as the provider of health insurance. The illusion continues today that, somehow, emplyer-provided health insurance is costless to the worker. The employer could be removed from the process by removing employer-coverage mandates where they exist and eliminating the special tax treatment of employer-provided insurance.

2. Mandate the consumer to acquire a standard, catastrophic care policy. Insurers would compete to provide catastrophic policies based on price and features, with risk rating differentiated only by sex and age, not by pre-existing condition. Consumers be offered favored tax treatment for policy premium expenses for catastrophic plans only. Poor consumers would be offered premium assistance for the basic policy.

3. Encourage the consumer to husband funds for non-catastrophic costs of care. The existing Health Savings Account (HSA) could be the basis for this encouragement.

Adoption of these policies would enhance price competition in insurance and in health care provision. Unlike most other proposals, it reduces, rather than increases, government's involvedment in the marketpalce. Government's role would be limited to defining the method for ensuring that consumers obtained the basic policy, and for devising the assistance scheme for the poor. Government, ever the clumsy mischief maker, will be tempted to compel a definition of the basic policy that re-introduces the problems of comprehensive coverage. To pander to some constituencies, politicians will press to broaden uselessly the definition of who obtains premium assistance. These tendencies, too can be contained:

1. The funds for providing premium assistance to the poor could be raised from an pro-rata excise tax on the insurance plan premiums. This would give consumers a stake in establishing reasonable limitations on the amount of and eligibility for assistance.

2. Politicians' temptation to morph the catastrophic plan into a comprehensive plan by limiting the amount and the growth rate of the policy premium qualifying for tax favored treatment. This, too, would give consumers a stake in having access to affordable plans.

Not a Radical Proposal

Some of the basic features of this proposal are already in place in Switzerland. The State of Massachusetts passed (under former Republican governor and current presidential candidate, Mitt Romney) a related, though flawed proposal. Finally, here in Oregon, the legislature passed Senate Bill 329, The Healthy Oregon Act. It is scheduled to convene an expert panel to determine how to best provide universal access to insurance. Oregon's track record of micro-management of the health care sector does not bode well, but it is conceivable that a market-oriented proposal like that offered here could emerge.

For more detail on my proposal, you can look on the Cascade Policy Institute website.