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Brooks Wilson's Economics Blog: Rationing Health Care

Wednesday, August 19, 2009

Rationing Health Care

Economics is the study of how individuals through markets or acting collectively through government ration scarce resources to meet unlimited wants.  A point that is seemingly missed in the current health care debate is that it is a product like any other and must be rationed.  The demand for health care can be divided into two components: the demand for routine, relatively low cost health maintenance and for extreme, low probability, high cost events such as care for cancer or strokes.  The two demand components are similar to other goods we insure like our homes or cars.  Consumers generally opt to pay for routine costs out of pocket and insure the high cost, low probability events.  Over time and largely because of government policy, the purchase of health care maintenance has been conflated with the purchase of insurance for extreme health care events.  The result has been a quirky, expensive health care system inherently subject to rising cost.

As part of its effort to manage the economy during World War II the government passed the Stabilization Act of 1942 that imposed price and wage controls but authorized employers to offer health insurance as a fringe benefit exempt from wage controls.  Employee provided health insurance was granted tax preferences in 1943 by an administrative tax court ruling, and in 1954 by changes to the Internal Revenue Code; health insurance payments were made tax deductible for the employer and tax exempt for the employee.  Copayments remained fully taxable creating an economic incentive to have as many dollars of health care services paid through the employer provided plan.  To avoid taxes, routine health payments and insurance against catastrophic health events were covered by the same policy.  Health care users no longer observed nor cared to observe the full cost of medical treatment because it had little to do with their out of pocket cost.  Price became less important as a rationing mechanism and the health care subject to rising cost.

I would like to begin with a thought experiment involving cars rather than health care to lose some of the emotional responses that the health care debate engenders.  What type of car do you currently drive?  Because we must pay for all costs of the vehicle, we shop carefully for price, not just of purchase but of use, including insurance.  Automakers are attuned to our demand and supply a number of models to meet our demand and make cars ranging from the Ford Focus to the BMW M5.

Let's change reality a little to create an insurance plan for cars that is similar to employee provided health insurance.  You are joining an employee group auto plan that has a fixed fee of $250 per month and $20 every time that you have maintenance performed.  The fixed fee also covers insurance.  There are 300 people in your group and each drives a Honda Civic prior to joining.  The cost of the plan is based on the average cost the group has experienced driving a Civic.  After joining the group you decide to replace your car.  What type of car would you buy?  I'll bet that with a little consideration that it is a lot nicer than the Civic.  Say that you bought the BMW M5 costing $85,000.  You would only pay 1/300th of the purchase price; other group members would pick up the other 299/300th.  The same goes with the gas.  You are only paying $20 plus 1/300th of the cost of the fill up.  And when the wash car option on the gas pump is offered, you select it.  The cost of the plan would increase by $65,000, the increase in purchase price over the price of the Civic plus the increase in routine costs.  Of course, all members in the group are likely to respond the same way and cost of the group plan will grow.  A rational person would soon drop out of the group, but suppose they couldn't.

Automakers and service providers would respond to the change in market conditions.  Honda will drop the Civic, Toyota the Corolla, Ford the Focus, etc.  All makers will specialize in high end models loaded with standard equipment like GPS systems, radar that finds blind spots, self filling tires, etc.  Rather than have a clean car option, gas stations will have a detail clean option.  Jiffy Lube will not only provide coffee, but full meals as well.  We will have the best car sector in the world for those who could afford it.

This is the mess the government unintentionally created when they gave tax benefits for employee provided health care and we can't easily drop out.  We would pay more because our income used for health care payments would be taxable and we would be buying into a health care system specializing in the production of high end medical care.  In fact, most states regulate individual purchases of insurance to make it more like employee provided insurance.  It just cost more. 

Some people have dropped out or been forced out.  Advocates of universal coverage claim that there are 47 million uninsured and believe that all should be provided access to the system and that taxpayers should cover the bill.  Of course, the 47 million are likely to choose BMW M5 health care, and the cost would explode as it has with employee provided plans, Medicare and Medicaid.  The Obama administration has proposed eliminating unnecessary procedures that don't benefit anyone to help contain the cost.  Even if perfectly done, that is rationing and still won't solve the basic problem.  It does the equivalent of eliminating meals at Jiffy Lube.  People are still accessing BMW M5 health care because the buyers do not face the true cost of either ordinary health care maintenance or health insurance for high cost, low probability events.

The government could ration care by trying to emulate a market outcome with taxpayers picking up the tab for those priced out of the market, but governments are bad at emulating markets.  They produce inferior goods at a higher price.

Effective reform begins by separating the market for routine health care from the insurance market for extreme medical events.  This means that the tax break given to employee provided plans must be eliminated or extended to private purchasers of health insurance.  Given that a recession is a bad time to raise taxes, I would start by extending tax benefits to all and eliminating them over time as the economy recovered. 

Over time, insurance companies would offer more varied insurance options including low cost-high deductible health plans in which consumers would pay for routine health care out of pocket.  The lower cost would make health insurance more affordable and the number of uninsured would decrease.

Problems would remain.  Many would still be uninsured and insurance companies would still try to drop people with preexisting conditions to name two.  Perhaps taxpayers would be more willing to pay for universal access into a cheaper health care system, and health care markets might spontaneously deal with other problems.  But it would be a good start and inexpensive. 

1 comment:

  1. Great post, Brooks. State-of-the-art technology and the moral hazard problem involved with HMO's covered services rather than a fee-for-service program also have been cited for fueling the problem of high costs. So many are accustomed to their $20 co-pay may take some convincing that a low-cost/high-deductible health plan would be better.