the prognosis for national health insurance

8/14/2019 The Prognosis for National Health Insurance

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August 2009la erhealthcarereport.org

Prepared or the Texas Public Policy Foundationby Dr. Arthur La er o Arduin, La er & Moore Econometric

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Executive Summary ...................................................

Introduction ................................................................

Diagnosing the Health Care Industry: Strengths ....... 6

The Health Care Wedge ..............................................

Current Health Insurance PlansWorsen the Wedge ......................................................

The Empirical Existence o the Wedge ......................

Studies Demonstrate that Government PoliciesAre the Problem .........................................................

The Consequences o Rising Health Care Costs .......1

Distribution o Health Care Spending .......................

President Obamas Re orms Do Not Address theRoot Causes o the Problem ......................................

Quanti ying the Potential Economic Impacts ...........2

The Economic Impacts o Obama-Style Health Careon the States...............................................................

Concluding Thoughts .................................................

Endnotes ....................................................................

Bibliography ..............................................................

Table o ContentsAugust 2009

Prepared or the Texas Public Policy Foundationby Dr. Arthur La er o Arduin, La er & Moore Econometrics


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August 2009 The Prognosis or National Health Insuran

Texas Public Policy Foundation

Executive Summary

In 1960, the private sector unded over three quarters o thenations health care expenditures. Individuals paid nearlyone-hal o the total national health care expendituresthrough out o pocket expenditures. Beginning in 1967 theway health care is purchased in the U.S. began to completelyreverse itsel :

The private sector has been slowly unding less and lesso the total national health expenditures; as o 2007 lessthan 54 percent o total national health care expendi-tures are paid or by the private sector.

Reciprocally, the public sector has been slowly undingmore and more o the total national health expendi-tures; as o 2007 public expenditures at the ederal andstate levels now und nearly one-hal o the total healthcare expenditures in the U.S.

Total out-o -pocket expenditures have been plummet-

ing as a share o total health expenditures at an evenaster rate; today only a bit more than $1 out o every

$10 spent on health care is being unded by individualsthrough out-o -pocket expenditures.

This has resulted in a large and growing government healthcare wedgean economic separation o e ort rom reward,o consumers (patients) rom producers (health care pro-viders), caused by government policies. Rising governmentexpenditures on health care are the main actor driving the

growth in the wedge. The wedge is a primary driver in risinghealth care costs, i.e., in ation in medical costs.

President Barack Obamas principles to drastically alter U.S.health care policya public health insurance exchange,mandated minimum coverage, mandated coverage o preexisting conditions, required purchase o health insur-ancedo not address the growing wedge and its role asthe undamental driver o health care costs. In act, they will

urther increase the wedge, and can thus be expected toincrease medical price in ation.

Speci cally, the estimated $1.0 trillion increase in ederal gernment health subsidies over 10 years based on PresidentObamas principles will have the ollowing consequences

Overall, total ederal expenditures will be 5.6 percehigher than otherwise by 2019, adding $285.6 billion tthe ederal de cit in 2019.

An increase in national health care expenditures by anadditional 8.9 percent by 2019.

An increase in medical price in ation by 5.2 percenabove what it would have been otherwise by 2019.

Reduce U.S. economic growth in 2019 compared tothe baseline scenario by 4.9 percent or the nation aa whole.

The current net present value o unding health care reorm based on President Obamas priorities would b

$1.3 trillion (due to higher medical in ation and expenditures), or $ 4,354 or every man, woman, and childthe U.S. These gure include:

A net present value o all additional ederal govement expenditures through 2019 o $1.2 trillion, $3,900 per capita, and

A net present value o all state government expen

ditures through 2019 o $138 billion, or $454 pcapita.

Despite these costs, 30 million people would remainuninsured. The cost to reduce the number o uninsuredby 15 million people is $62,500 in subsidy expenditurper person insured.

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The Prognosis or National Health Insurance

4 Texas Public Policy Foundatio

Introduction

In 2009, health care re orm is not a luxury. Its a necessity we cannot de er. Soaring health care costs make our current course unsustainable. It is unsustainable or our amilies It is unsustainable or businesses.

President Barack Obama

President Obama is correct when he says that soaringhealth care costs make our current course unsustainable.Adjusting or the growing U.S. population, the dollar levelo expenditures on health care has exceeded the growthin overall consumer prices in the economy every year ornearly the past 50 years. Such a trend cannot continue

orever.

Americans agree that health care re orm is necessary. Forinstance, 55 percent o respondents to a recent CNN pollthink the U.S. health care system needs a great deal o re-

orm.1 Yet, combining the latest CNN and Census data re-veals that approximately 70 percent o Americans are satis-

ed with their current health care arrangements. 2

Such results are not contradictory. Consumers are satis edwith their current health arrangements because they arereceiving quality medical care at little direct cost to them-selves. Yet they understand that the runaway costs drivenby this arrangement have to be addressed be ore the sys-

tem collapses.Part o the blame alls upon waste, raud, and abuse in thehealth care system itsel . These actors cost the system anestimated $700 billion in 2007, or more than $2,300 per le-gal U.S. resident. Another primary cost driver is a large andgrowing government health care wedgean economicseparation o e ort rom reward, or consumers (patients)

rom producers (health care providers), caused by govern-ment policies.

The health care wedge is one way o thinking about govern-ment involvement in the economy. When the governmentor a third party spends money on health care the patientis not. The patient is then separated rom the transaction inthe sense that the costs are no longer his concern. This sep-arationhow ar the supplier and consumer are separated

rom one anotheris what the economic wedge is mea-suring. The wedge measures the deadweight loss rom thisseparation in higher costs that do not improve e ciency.

In the case o health care, the wedge also separates patientsrom doctors in determining what type o care should be

provided. Decisions are made by government, insurers, and judges deciding medical malpractice liabilities. The govern-ment, lawyer, and third party wedge in our current healthcare system causes higher costs and diminished e ciency.

Health care re orm should be based on policies that dimin-ish, not increase this wedge.

From a macroeconomic perspective, a tax wedge diminish-es incentives to work, save, and produce; consequently lesswork, savings, and production results. Yet at the same time,the wedge increases incentives to consume and spend,since the costs o consumption are not directly borne bythe one making the decisions. Such basic undamentals o economics are not repealed at the entrance to the hospitalor the doctors waiting room. The result: higher costs anddiminished e ciency.

The primary government policy causing the wedge is theever-increasing role o the government in unding healthcare, a actor that corresponds directly with the diminish-ing role o the private sector, particularly the consumers ohealth care.

Since 1967, the private sector has been unding less andless o total national health expenditures less than 54

percent as o 2007. Public outlays (at the ederal and statelevels) now account or nearly one-hal o total U.S. healcare expenditures. Meanwhile total out-o -pocket expendi-tures have been plummeting even aster as a share o totalhealth expenditures.

Taken together, these trends illustrate the complete rever-sal o the way health care is purchased in the U.S. In 1960the private sector unded over three quarters o the na-tional health care expenditures. Individuals paid rom theirown pockets nearly hal o these costs. Today, the private

sector unds slightly more than hal o these expendituresIndividual patients covered just over $1 o every $10 spenton health care.

Although re orm is necessary, ill-advised re orms can makthings much worse. Health care policy re ormers shouldproceed in the same manner that doctors treat patients.Doctors must properly diagnosis the disease or afictionso as to understand the likely e ects o a proposed courseo treatment. Likewise health care re ormers who have the


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public interest in mind will correctly diagnose the problem,showing how re orm will restore a agging health care sys-tem to robust health.

A proper diagnosis begins with the 85 percent o Ameri-cans who say they are satis ed with their current healthcare arrangements and thereby remind us that we are not

acing a crisis in access to health care or in health insurancecoverage. Re ormers must ensure that changes to help theremaining 15 percent o Americans do not make the vastmajority o Americans worse o .

In act, the disease weighing down the health care industryis costs that are spiraling out o control. These care costsare driven to a large extent by the health care wedge. Ris-ing government expenditures on health care are one o themain actors driving the growth in the health care wedge.

The President and his advisors have misdiagnosed theproblems o the health care system. Health care re ormsbased on President Obamas criteria ail to address the

undamental driver o health care coststhe health carewedge.

The likely impact rom the combination o generous eder-al subsidies and a new public insurance option is a signi -cant reduction in peoples incentives to monitor costs anda signi cant increase in the costs o administering the pub-

lic program. In short, these policies will urther increase thewedge. The growing health expenditure wedge is stronglycorrelated with in ation in medical costs.

Re orms based on President Obamas priorities can thus beexpected to weaken the health care system and increasemedical price in ation.

The actual health care re orm proposal under considerationis uid as o this writing. Proposals range rom:

A gross $1.6 trillion expenditures contained in Sena-

tor Edward M. Kennedys health care re orm proposal,and

A $1 trillion expenditures in the House Tri-CommitteeGroup re orm.

A simple expansion o Medicaid eligibility at an estimat-ed cost o $600 billion, much or all o it borne by stategovernments.

The exact impact on the states will vary depending uponwhich route is taken and whether the ederal re orm pro-posal attempts to cover the costs or shi t these costs to thestates.

We assess here the impact o a re orm proposal that signi -cantly expands governments role in the health care mar-ket through 1) providing an additional $1 trillion in ederalsubsidies over 10 years and 2) o ering incentives to movecurrent Medicaid recipients into a new ederal health insur-ance program.

Such a program would:

Increase national health care expenditures by an ad-ditional 8.9 percent by 2019.

Increase medical price in ation by 5.2 percent abovewhat it would have been otherwise due to the highernational expenditures by 2019.

Pressure the ederal and state budgets due to the in-creased expenditure levels and increased medicalin ation:

The current net present value o unding healthcare re orm based on President Obamas pri-orities would be $1.3 trillion, or $4,354 or ever

man, woman, and child in the U.S. These guresinclude:

A net present value o all additional ederagovernment expenditures through 2019 o $1.2 trillion, or $3,900 per capita; and

A net present value o all state governmentexpenditures through 2019 o $138 billion, or$454 per capita.

Reduce economic growth in 2019 compared to the

baseline scenario by 4.9 percent or the nation as awhole.

Sharply higher health care costs would orce people o private insurance and into the government plan. Further,as we know, the government rarely competes on a levelplaying eld with private companies and rms. Always, thegovernment tilts the eld in its avor. A government planembodying the Obama priorities would operate with guar-


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anteed taxpayer subsidies. These would pressure the healthcare industry to price at uneconomical levels in order tomeet political goals regardless o economic merit or viabili-ty. This would urther reduce the number o Americans withprivate health care insurance.

In consequence, the increase in the number o people onthe government plan would not re ect a corresponding de-crease in the number o uninsured individuals. A $1 trillionplan based on President Obamas criteria would still leave30 million people uninsured.3 The cost to reduce the num-ber o uninsured, as estimated by the Congressional BudgetO ce, is $62,500 per person.

Such a negative economic assessment is consistent withthe Massachusetts experience ollowing the states recenthealth care re orms. These share common ground with theObama principles o a government-sponsored health careexchange, an individual mandate, and generous subsidies.

For all the hope ul rhetoric they occasioned, the Massachu-setts re orms have seriously strained the state budget. Al-though supporters claimed that the re orms would reducethe price o individual insurance policies, insurance premi-ums rose by 7.4 percent in 2007, 8-12 percent in 2008, andare expected to rise 9 percent this year.4

The analysis below links the problems in our current health

care system to the rising wedge between patients andmedical providers. From this link it is clear that re ormsbased on President Obamas priorities would only exacer-bate our health care problems. Re orm e orts need to bemore care ully cra ted and considered than have been theplans based on President Obamas priorities.

Congress needs to ocus on re orm that promotes protec-tion o what Americans want and demand most: immedi-ate, measurable ways to make health care more accessibleand a ordable without jeopardizing quality, individual

choice, or personalized care.

Diagnosing the Health CareIndustry: StrengthsBe ore addressing the adverse incentives and outcomes

rom the current U.S. health care system, it is worthwhile toquickly summarize its most important strengths. Accord-ing to the U.S. Census, 45.7 million people in the U.S. didnot have health insurance in 2007 (down rom 47.0 million

in 2006).5 Another way o putting it: 255.6 million people(or 85 percent o the population) had insurance in 2007,up rom 251.4 million in 2006.6 A majority o these peopleare satis ed with their current coverage, which is o ered byone o the approximately 1,300 separate health insurancecompanies that operate in the U.S.7 According to a recentCNN poll:

Most Americans like their health care coverage but arenot happy with the overall cost o health care...

More than eight in 10 Americans questioned in a CNN/ Opinion Research Corp. survey released Thursday said theyre satis ed with the quality o health care they receive.

And nearly three out o our said theyre happy with their overall health care coverage.

But satis action drops to 52 percent when it comes tothe amount people pay or their health care, and morethan three out o our are dissatis ed with the total cost o health care in the United States.8

Such eelings are not new. A 2004 HarrisInteractive poound:

For the th time in six years, Harris Interactive has asked the insured public to rate their own insurance plans.Two thirds o them continue to give their plans an A or a B, with only 10% giving them a D or an F. Substantial but not overwhelming majorities continue to say that they would recommend their own health plans to amily members who are basically healthy (76%) or who have aserious or chronic illness (68%).9

Using the latest CNN and Census data, i 85 percent o Americans have health insurance, and 80 percent o Americans aresatis ed with their current health quality, then more than ap-

proximately 70 percent o Americans are satis ed with theircurrent arrangements. Care must be taken to ensure thatchanges to help 15 percent o Americans do not make thevast majority o Americans worse o .

The act that such large percentages o the population areinsured, and at the same time are satis ed with their insur-ance, is clear evidence that the U.S. health care system doesnot ace a crisis o coverage or quality. Re orms that treaccess to health care or health insurance coverage as i they


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were in crisis undamentally misread the positive aspectso the current health care system and, consequently, risk breaking the parts o the health care system that are cur-rently working.

The Health Care Wedge

The health care system is acing serious problems, howev-er. These problems, which impose signi cant hardships onmany individuals, need correction. Correcting the problemswith the current health care system begins with an under-standing o incentives to invest ones money one way oranother way. Incentives drive all economic behaviorin-cluding behavior in the health care industry. The cost andquality o health care goods and services respond to theinteraction o consumers (patients) and suppliers (doctorsand medical product suppliers).

The health care wedge is one way o thinking about govern-ment involvement in the economy. When the governmentor a third party spends money on health care the patient isnot. The patient is then separated rom the transaction inthe sense that the costs are no longer his concern. This sep-arationhow ar the supplier and consumer are separated

rom one anotheris what the economic wedge is mea-suring. The wedge measures the deadweight loss rom thisseparation in higher costs that do not improve e ciency.

In the case o health care, the wedge also separates patientsrom doctors in determining what type o care should beprovided. Decisions are made by government, insurers, and judges deciding medical malpractice liabilities. The govern-ment, lawyer, and third party wedge in our current healthcare system causes higher costs and diminished e ciency.

One o the most basic axioms o economics examineschanges in behavior when prices change. When the priceo a product increases, consumers have an incentive to con-sume less while suppliers simultaneously have an incentive

to produce more. When prices are obscured by govern-ment inter erence in the marketplace, neither consumersnor suppliers have the necessary knowledge to properly al-locate societys scarce resources.

An economic wedge occurs anytime government policiesseparate e ort rom reward or consumers rom producers.When government, lawyers, or third party insurance is re-sponsible or paying the bills, consumers have no incentiveto control costs. It is intrinsically an economic variable that

operates at the margin where incentives come into play anddecisions are made. Economic wedges inevitably changeeconomic incentives, o tentimes leading to undesirableoutcomes. The burden o government on the growth o theprivate sector economy illustrates the costs associated witheconomic wedges.

Government spending relative to the size o the privatesector economy (the government expenditure wedge) is aproxy or the total burden o government activities on theeconomy. Figure 1 tracks the growth in the governmentexpenditure wedge between 1951 and 2007 (the latest ulldata set available). As o 2007, total government expendi-tures were $4.4 trillion. Net domestic business output (cor-porate and non-corporate income adjusted or deprecia-tion) or 2007 was $9.5 trillion. The resulting governmenexpenditure wedge or 2007 was 46.1 percent.

The vertical black lines in Figure 1 represent the years inwhich changes in the path o the government expenditurewedge are evident. For instance, total government expen-ditures between 1951 and 1965 ranged rom relatively atto more expansive. Beginning in 1966, there is a change inthe rate o expenditure growth that continued until 1983. The growth in government expenditures then slowed un-til 1989. A renewed, but short-lived, pick-up in governmentexpenditures occurred between 1989 and 1993. The trendtoward lower government expenditures then resumed un-

til 2001. Since then, total government expenditures haverisen.

Table 1 illustrates the negative impact that a high and/orgrowing government expenditure wedge has on privatesector activity, as well as the positive impact o a lower

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Figure 1: Total Federal, State, and LocalGovernment Expenditure Wedge, 1951-2007 10


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and/or declining expenditure wedge. Taking each periodseparately:

Between 1950 and 1965, the government expendi-ture wedge was relatively low (32.4 percent) and grewslightly (+5.5 percentage points). Private sector ex-pansion was a robust 3.6 percent per year during thisperiod.

Between 1965 and 1983, the government expenditurewedge grew quickly, rising 16.6 percentage points to49.0 percent. Growth in the private sector slowed to2.5 percent per year.

Between 1983 and 1988, growth in the private sector

accelerated to 5.1 percent per year as the governmentexpenditure wedge ell 3.3 points back down to 45.7percent.

The brie reversal in the government expenditurewedge between 1988 and 1992 led to a 5.2 percent-age point rise in the wedge to 50.9 percent. Growthin the private sector economy slowed again to 1per-cent per year.

Between 1992 and 2000, the government expendi-

ture wedge ell 9.2 percentage points to 41.7 percent.Growth in the private sector economy acceleratedagain to 4.5 percent per year.

Finally, between 2000 and 2007, the growth in thegovernment expenditure wedge started growingagain (by 4.5 percentage points to 46.1 percent) andthe growth rate in the private sector cooled to 2.0percent.

Taken together, Figure 1 and Table 1 illustrate the conse-quences rom the overall government wedge on total eco-nomic growth. By separating e ort rom reward, a large orgrowing government wedge diminishes the incentive towork, save, and produce; less work, savings, and productionresults. Such basic undamentals o economics are not re-pealed at the health care industrys doorstep.

In order to diagnose correctly the current problems in thehealth care industry, one must rst understand the incen-tives driving the people and organizations participating inthe health care market. Understanding the incentives pin-points the current weaknesses o the U.S. health care indus-try, and provides the basis or developing a methodology toassess the impacts rom proposed re orms on the problems

in particular and the health care industry overall.Our current third party payer system creates a wedge thatseparates consumers rom suppliers. Larger wedges createlarger gaps between consumers and suppliers and lead togreater market ine ciencies and a larger number o adverseincentives. Many o the problems with our current healthcare system stem rom the adverse incentives created by thewedge between consumers and suppliers.

On the consumer side o the market, the wedge diminishes

consumers incentives to monitor costs. Consumers bearonly a raction o the costs rom any additional health carservice (see below). On the supplier side, doctors and othermedical providers receive no incentive to provide higherquality services or less cost. No positive bene t accrues tothose who do so.

Costs do, nevertheless. One o the most important disincen-tives or doctors to monitor costs is the tort liability threat.According to the American Medical Association, de ensive

% Change NetBusiness Output (CAGR)

Wedge at Endo Period

Change Wedge(peak to trough,trough to peak)

1950-1965 3.6% 32.4% 5.5%

1965-1983 2.5% 49.0% 16.6%

1983-1988 5.1% 45.7% -3.3%

1988-1992 1.0% 50.9% 5.2%

1992-2000 4.5% 41.7% -9.2%

2000-2007 2.0% 46.1% 4.5%

Table 1: Negative Relationship Between ExpenditureWedge and Private Sector Growth, 1950-2007 11


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medicine in response to rising tort liability costs added $99billion to $179 billion in additional costs in 2005 alone.12

As a result, Medicare, Medicaid, and tax- avored, employer-based coverage blind both patient and doctor to the costo care. Meanwhile litigation risks incentivize doctors to runadditional tests to limit their liability exposure. Govern-ment regulations and the third party payer system are alsodiminishing the market incentives to implement best prac-tices programs that would help eliminate waste, raud, andabuse. Whether the payer is government or an insurancecompany, the process removes competition and patient

eedback that drives innovation.

Take as an example programs to implement best practices,or comparative e ectiveness research. Comparative e ec-tiveness research evaluates di erent medical proceduresand treatments or the purpose o educating doctors andpatients about which treatments are e ective and econom-ical; and which treatments are not. An o t-cited complainto the current U.S. health care system a complaint notwithout meritconcerns the lack o e ective comparativee ectiveness research.

Cannon (2009) illustrates that removing government-cre-ated obstructions is a more e ective policy re orm to cre-ate comparative e ectiveness research than the creation o a new government agencyan important principle sup-

ported by the President. The Presidents principles call or a government agencyto provide comparative e ectiveness research claiming amarket ailure has occurred. According to this theory, oncecomparative e ectiveness research is known, it is di cultto keep out o the public domain. Organizations incentivesto invest in this research are diminished by the prospect o competitors bene ting rom their private research at nocost to themselves. Consequently, organizations will natu-rally under-invest in comparative e ectiveness research, ac-

cording to this theory.

Cannon (2009) illustrates that the current lack o compara-tive e ectiveness research represents the ailure, not o themarket, but o government.13 For instance, prepaid groupplans (PGPs) have a large incentive to provide compara-tive e ectiveness research to their members, because thebene ts o the research can be e ectively captured withintheir networks o doctors and acilities. Government regula-tions and the complex web o state regulations discourage

PGPs, however. On the demand side, the declining amounto out-o -pocket expenditures by consumers reduces theirdemand or comparative e ectiveness research. Becauseconsumers do not bear the costs or reap the bene t o en-suring the most cost- e ective practices, their incentives toseek those bene t are accordingly lessened. Taken together,government interventions have deadened the incentivesto create comparative e ectiveness research.

Cannon explains that, by de nition, government agenciesare subject to political in uence. The record o governmentagencies rom the Federal Reserve Bank, to the Securities& Exchange Commission, to the National Center or HealthCare Technology shows that political in uence has createdperiodic con icts in which the agencies mission and/or in-dependence came under extreme pressure. Because moree ective means exist to create this valuable research, thebest way to create e ective comparative e ectiveness re-search isnt to commission it rom government bur, rather,to remove the government obstructions preventing itscreation.

Current Health InsurancePlans Worsen the WedgeMost Americans do not have health insurance as the termis traditionally understood. Insurance is a tool or managingrisk. In exchange or periodic payments rom a customer, an

insurance company provides protection against a large butuncertain potential cost.

Take disability insurance. A potential risk or many amiliesthe possibility that the primary (or one o the dual-incomeearners) might meet with an accident that prevents him orher rom working or a prolonged period o time. In suca case, a amily could ace potential nancial ruin. To protect against this risk, many primary income earners will pur-chase a disability insurance policy. In return or annual (orquarterly/monthly) payments to the insurance company,

the company will pay a pre-determined amount o moneyto the income earner should an un ortunate accident ordisabling illness occur.

Health insurance does not work this way. As opposed tocovering only true health risks (the costs associated withbroken arms or major surgeries), health insurance paysthe costs or routine health events that are not risks in thetrue sense o the word. An analogous situation would be

or disability insurance plans to pay an individuals disabilit


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claims or missing work due to a cold. The basic principleso risk and insurance have been distorted. The expected re-sult rom this distortion is diminished quality and increasedprices.

Imagine i another orm o insurance, automobile insur-ance, worked like health insurance. As opposed to coveringthe costs rom major automobile accidents, costs o routinemaintenance such as oil changes and tune ups would alsobe covered. Additionally, to ensure that car owners are alltreated equally, insurance companies would be prohibited

rom charging di erent rates or speci c drivers who causemore accidents, or rom charging di erent rates to groupswith di erent driving habitsmarried women in their 50s,

or instance, who might quali y or lower rates than single18 year-old males.

I indeed automobile insurance worked like health insur-ance, sa e drivers would end up paying more or automo-bile insurance to subsidize the costs o unsa e drivers. Carconsumers would also have no incentive to shop or thebest deal when it came to changing the cars oil, gettinga tune up, or per orming any other routine maintenanceservice. The cost or routine maintenance services wouldbe expected to increase. Additionally, because a car ownerwould not bear costs resulting rom improper maintenance,the incentive to properly maintain cars would decline. Thenumber o major car repairs, and the cost o these repairs,

would all be expected to increase as well.Automobile insurance companies, trying to arrest the ris-ing costs o car repairs and car maintenance would beginto increase the amount o rules and regulations. The resultwould be signi cant market distortions in the automobileinsurance market, skyrocketing costs o repairs, and an in-crease in the quantity o major repairs. In short, both theautomobile insurance market and the automobile repairmarket would become much more ine cient to the pointwhere people might even begin to wonder whether the

automobile repair market is special, needing the govern-ment to mandate prices and repair schedules.

The Empirical Existence o the Wedge

The empirical data con rm the expected outcomes romthe wedge in the health care market: health care expendi-tures and costs are rising aster than our economy. Accord-ing to the Centers or Medicare & Medicaid Services, totalnational health expenditures accounted or more than 16

percent o our economy in 2007 (see Figure 2); and are ex-pected to be about 18 percent o GDP in 2009.14

The rise in health care expenditures as a share o the U.Seconomy has not been even. Signi cant growth has ol-lowed years o relative at growth. In particular, health careexpenditure growth was steady relative to overall U.S. eco-nomic growth in the mid-1970s; early 1980s; and throughmost o the 1990s. In between the periods o steady healthexpenditures were years o rapid health expendituregrowth.

Gross Domestic Product (GDP), or total national income, isa measure o peoples ability to pay or goods and services The recent housing bubble vividly demonstrated that ex-

penditures on a good or service cannot consistently out-pace peoples ability to pay orever. The same is true ohealth care. The consistent excessive growth o health careexpenditures, compared to the economys ability to pay, isthe major weakness o the current health care system. Allother problems (e.g., lack o insurance coverage and medi-cal bankruptcy) all nd their genesis in the uncontrolled risein health care expenditures. Consequently, bene cial healthcare re orm must begin with an understanding o the trendsand drivers o health care expenditures.

Part o the health care wedge is created by governmentexpenditures substituting or private expenditures; anoth-er part by the private third-party payment system. Figure3 shows that the government- created wedge has beengrowing signi cantly since 1965.

The rise o government spending has been at the expenseo private spending in the health care market. In 1960, over75 percent o total health expenditures in the U.S. were

unded by private expenditures. Beginning in 1966, with the

Figure 2: National Health Expenditures asPercentage o GDP, 1960-2007 15

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passage o Medicare, the private sectors role in the healthcare market began to change. In 1965, the private sectorwas still unding over 75 percent o total national health ex-penditures. This ell to 70 percent in 1966, and 63 percent in1967. Since 1967, the private sector has been slowly und-ing less and less o the total national health expenditures;and as o 2007 less than 54 percent o total national healthcare expenditures are paid or by the private sector.

Public expenditures (at the ederal and state levels) nowund nearly one-hal o the total health care expenditures

in the U.S. Along with these trends, total out-o -pocket ex-penditures have been plummeting even aster as a share

o total health expenditures (see Figure 4). It is important tonote that while total out-o -pocket expenditures have beendeclining as a share o total national health expenditures,they have grown in total in ation- adjusted terms. Despitethe governments covering a larger and larger share o total health care expenditures, individuals continued to pay morethan ever be ore in total dollar terms.

Taken together, these trends illustrate a complete reversalo the way health care is purchased in the U.S. In 1960, theprivate sector unded over three quarters o national health

care expenditures, with individuals responsible or nearlyone-hal o these costs through out-o -pocket expenditures. Today, the private sector unds just a bit more than one hal o these expenditures, with only a bit more than $1 out o every$10 coming out o the consumers pocket.

Rising government expenditures on health care have beena primary driver o overall government expenditure wedgeillustrated in Figure 2. Figure 5 breaks down the govern-ment expenditure wedge trends broken down by govern-

ment health care expenditures and all other governmentexpenditures. Figure 5 demonstrates two important trends.First, the government expenditure wedge outside o healthcare, although volatile, is currently only 5 percentage pointshigher than the 1960 wedge (35.3 percent compared to30.1 percent). The remaining 9.1 percentage point increasein the government expenditure wedge is due to risinghealth care expenditures.

Second, health care expenditures have been an importantdriving orce in the overall government expenditure wedge. Table 1 identi ed three main periods o a rising governmentexpenditure wedge: 1965-1983, 1988-1992, and 2000-2007.Health care expenditures drove the rising government ex-penditure wedge during each one o these periods, the im-portance o which has been growing over time:

Between 1965 and 1983 the total government ex-penditure wedge rose 16.6 percentage points, 26

Figure 3: National, Private, and Public HealthExpenditures as Percentage o GDP, 1960-2007 16

0.0%

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Pr iv ate % G DP Publ i c % G DP N ati o na l h ealth e xp.

Figure 4: Out-o -Pocket Expenditures as Percentage o Total National Health Expenditures, 1960-2007 17

0.0%

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Figure 5: Total Federal, State, and Local GovernmentExpenditure Wedge Health Care Compared to All

Other Government Expenditures, 1960-2007 18

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percent o which was caused by rising health careexpenditures.

Between 1988 and 1992, the total government expen-diture wedge rose 5.2 percentage points, 41 percent o which was caused by rising health care expenditures

Between 2000 and 2007, the total government expen-diture wedge rose 4.5 percentage points, 51 percent o which was caused by rising health care expenditures.

Government health care expenditures are clearly driving thegovernment expenditure wedge higher. A rising govern-ment expenditure wedge diminishes growth in the privatesector economy, however. This link has important implica-tions with respect to bene cial health care re orms. Healthcare re orms based on President Obamas priorities lead tolarge increases in government expenditures on health carewithout removing the negative consumer and supplier in-centives. The consequences are signi cant increases in gov-ernment expenditures and subsequent decreases in eco-nomic growth.

The adverse incentives created by the growing separationbetween consumers and suppliers are mani ested mostprominently through the skyrocketing health care costs. The relatively larger growth in health care expenditures isoutpacing growth in overall consumer prices in the econo-

my (see Figure 6). Adjusting or the growing U.S. population,the dollar level o expenditures on health care has exceed-ed the growth in prices in the economy each year or nearlythe past 50 years.

The cost o health care on individuals in the economygoes beyond simply the current dollar outlays individualsmust pay themselves. The individual cost o health care in-cludes the loss o monetary income to und health insur-ance plans through employers and the extra tax burdensthat have been levied in order to und the public healthexpenditures.

Health insurance expenditures have been rising as a shareo disposable personal income, with premiums paid, inlarge measure, by employers or other third parties such asthe government. For instance, according to the U.S. CensusBureau, 59 percent o people under the age o 65 receivehealth insurance through work.20 In 2006, the average em-ployer cost or a amily was $11,941 (in 2008 dollars).21

The rising burden rom increasing health insurance costscan be seen as a share o total business costs and in gov-ernment budgets. The Bureau o Economic Analysis trackstotal costs on health care in a category called supplementsto wages. These costs incorporate all o the expenses that

rms pay to employees other than wageshealth insur-ance being a major component o these costs.

In 1960, most o an employees compensation was in theorm o actual cash. O total personal income earned (a g

ure that includes wages, bene ts, interest earnings, capitalgains, dividends, etc.), wages accounted or approximately

two-thirds (66.3 percent) o total personal income. Supple-ments to wages, were a relatively small 5.7 percent. Theshare o income represented by wages ell over this timeperiod to 54.5 percent by 2007, while supplements to wag-es rose steadily to 12.5 percent.

More important, perhaps, the decline in wages as a shareo personal income increases when the growth in healthexpenditures accelerate and moderates when the growthin health expenditures moderates. Supplements to wages(e.g., health insurance) move in the opposite direction as

wages. When growth in health expenditures accelerates, sodoes growth in supplements as a orm o compensation.When growth in health expenditures moderates, growthin supplements as a orm o compensation moderateslikewise.

Figure 7 illustrates this trend visually. The red solid line inFigure 7 is the percentage change in health care expendi-tures. The black dotted line is the di erence between thechanges in wages as a share o personal income and the

Figure 6: Percent Change in Per Capita NationalHealth Expenditures Compared to PercentIncrease in Consumer Prices, 1960-2007 19

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change in supplements to wages as a share o personal in-come. When the black dotted line is positive, the categoryo wages as a share o personal income is growing asterthan supplements to wages. When the black dotted line isnegative, supplements to wages as a share o personal in-come grow aster than wages.

Figure 7 clearly shows that when health care expendi-ture growth accelerates, supplements to wages are grow-ing aster than wages. The reverse happens when health

care expenditure growth slows. This pattern illustrates thedampening impact that out-o -control health expenditureshas been having on monetary wages or American workers.Growing health care expenditure happens at the expenseo growth in monetary wages, limiting workers wel are byreducing their expenditure power outside o health careservices.

The same can be true o the ederal and state governments.Figure 8 traces the growth in health care expenditures asa share o ederal, state, and local expenditures. Whereas

health expenditures made up only 4.5 percent o total gov-ernment expenditures (or less than $1 in $20) in 1960, by2007 they were 20.3 percent o total government expen-ditures (or more than $1 in $5). These expenditures alonerequired the government to take 7.7 percent o all personalincome earned in 2007 just to pay or the countrys publichealth expenditures.

Rising health care expenditures have led to:

Rising tax burdens to und the government portion o health care spending;

Slower relative wage growth to und the rising em-ployer portion o this spending; and

Rising health insurance outlays as a share o individu-als take-home pay.

All o these costs more than overwhelm the reduction indirect out-o -pocket expenditures as a share o take-homepay, creating a larger, and accelerating, health care burdenon individuals.

Studies Demonstrate that GovernmentPolicies Are the ProblemResearch into the causes o the excessive health care priceincreases concludes that government policies are the pri-mary reason why prices are growing excessively and cover-age is so distorted. Consequently, the most e ective meth-od o controlling the excessive price increases is to removethose policies that are causing the excessive price increasesin the rst place.

The real alternative to todays health care system isnt theintrusion o ederal power into the process, as presently pro-posed in Washington, D.C. The real alternative is the remov-al i o government regulation and the consequent encour-agement o robust competition among health care servicesand insurance products.

The impact rom government policies on the health caremarket is o two kindsdirect and indirect. The direct im-

Figure 7: Change in Health Care Expenditures Comparedto Change in Wages as Share o Personal Income andChange in Supplements to Wages (health insurance &pensions) as Share o Personal Income, 1961-2007 22

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% Change in health expenditures

Figure 8: Total Federal, State, and Local Health Expenditures asPercentage o Total Government Expenditures, 1960-2007

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pact re ers to the direct government medical spendingpolicies that are directly increasing health care costs. Theindirect impact results rom government inter erence thateliminate incentives or individuals or medical pro ession-als to engage in economizing behavior that would increasequality and decrease costs in the health care eld.

MIT economics pro essor Amy Finkelstein (2007) and Uni-versity o Illinois economics pro essor Je rey Brown, alongwith Amy Finkelstein (2008), establish a direct link betweengovernment Medicare and Medicaid expenditures and ris-ing health care prices or other distortions that limit the e -

ciency o the health care market.24

Finkelstein (2007) illustrates that o the six- old increase inper capita health care spending that occurred between1950 and 1990, one-hal o this increase could be explainedby the impact o Medicare along with Medicares impact onthe spread o health insurance more generally.

Brown and Finkelstein (2008) show that Medicaid imposes apower ul crowding out e ect on private insurance purchas-es. Speci cally, they nd that the provision o even very in-complete public insurance can crowd -out more compre-hensive private policies by imposing a large implicit tax onprivate insurance bene ts, thus potentially increasing over-all risk exposure or individuals.25 These results show thatthe growing government involvement in the health care

industry has helped drive up health care expenditures. The Presidents Council o Economic Advisors has cited theincentive problem as one o the key drivers o the excessivehealth care in ation, saying:

While health insurance provides valuable nancial protection against high costs associated with medical treatment, current bene t designs o ten blunt consumer sensitivity with respect to prices, quality, and choice o care setting. There is well documented evidence that in-

dividuals respond to lower cost-sharing by using morecare, as well as more expensive care, when they do not ace the ull price o their decisions at the point o utiliza-

tion. Additionally, most insurance bene t designs do not include direct nancial incentives to enrollees or choos-ing physicians, hospitals, and diagnostic testing acilitiesthat are higher quality and lower cost.26

Accordingly, it is necessary to change the adverse incen-tives on consumers so that they become price-sensitive

when purchasing health careand thus help, by their indi-vidual decisions, to contain out-o -control health care costs. The same logic holds or the adverse incentives the currentsystem places on insurance companies, doctors, and otherhealth providers.

The Consequences o RisingHealth Care CostsHigher expenditure growth can arise or three reasons. Ei-ther the price o the service is increasing; the quantity o theservices consumed is increasing; or a combination o both.In the case o health care, it is a combination o both, butespecially o rising prices. Speci cally, the total quantity ogoods in the U.S. economy increased 377 percent between1960 and 2008. The total quantity o medical services in-creased 712 percent or less than twice as much. However,prices in the U.S. economy increased just 490 percent, whileprices o medical services soared 1,239 percentmorethan 2.5 times as much.

Figure 9 compares the rising medical prices and medicalconsumption to total national medical expenditures. Therising national medical expenditures is clearly a combina-tion o both rising costs and rising consumption, but ris-ing costs are clearly the major driver o rising health careexpenditures.

Figure 10 illustrates the excessive growth in health care costscompared to in ation since 1998. Rising prices or medicaland hospital services are driving medical in ation. The actthat the cost o medical and hospital services are driving

Figure 9: Percent Change in Per Capita NationalHealth Expenditures Compared to Percent Increasein Medical Services Prices and the Quantity o

Medical Services Consumed, 1960-2008 27

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price increases or medical care is not unexpected. Theseare the sectors most burdened by regulations and a ectedmost by the insurance market. It is, consequently, expectedthat the areas subject to the largest excessive price pres-sures are the markets most a ected by the insurance issue.In act, those markets least a ected by insurancemedicalservices related to eye glassesare precisely the healthcare costs exhibiting the least amount o price pressures.

Figure 11 relates the medical price in ation back to thewedge and adverse incentives created by the current sys-tem. When expenditures that are covered by either the

insurance company or the government increase relativeto national health expenditures, medical price in ation ac-celerates. When these expenditures all relative to nationalhealth expenditures, medical price in ation slows. Acceler-ating medical in ation, consequently, is strongly correlatedwith a growing separation (wedge) in the medical marketbetween doctors and patients. Re orm policies that increasethis separation, such as those re orms based on PresidentObamas priorities, can be expected to increase pressureson medical price in ation.

Distribution o Health Care SpendingIt is important to note that the distribution o total healthcare spending is not even. According to the Agency orHealthcare Research and Quality (AHRQ):

actual spending [on health care] is distributed un-evenly across individuals, di erent segments o the pop-ulation, speci c diseases, and payers. For example, analysis o health care spending shows that:

Five percent o the population accounts or almost hal (49 percent) o total health care expenses.

The 15 most expensive health conditions account or 44 percent o total health care expenses.

Patients with multiple chronic conditions cost upto seven times as much as patients with only onechronic condition.30

The Kaiser Family Foundation notes that At the other end

o the spectrum, the one-hal o the population with thelowest health spending accounts or just over 3 percento spending.31 Figure 12 (next page) reproduces the data

rom the AHRQ study illustrating how the vast majority othe total health care spending (that is, the consumers o theservice) is created by a small percentage o the U.S. popu-lation. Controlling spending, there ore, requires controllingthe spending by the 5 percent o the population spendingone-hal o all health care expenditures.

Predictably, the elderly represent a large portion o the high

spenders: People 65-79 (9 percent o the total population)represented 29 percent o the top 5 percent o spenders.Similarly, people 80 years and older (about 3 percent o thepopulation) accounted or 14 percent o the top 5 percento spenders32 Alemayehu and Warner (2004) ound (seeFigure 13) that over peoples li etimes 8 percent o healthcare expenses:

occurred during childhood (under age 20), 13 percent during young adulthood (20-39 years), 31 percent dur-

Figure 10: Cumulative Growth in Health CarePrices by Category, 1998-2008 28

93.6%

66.4%61.0%

55.1% 51.6%

39.7% 37.6% 35.3% 34.1%

22.9%

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Figure 11: Growth in Health Expenditures Not Outo Pocket as Share o National Health ExpendituresCompared to Medical Price In ation, 1968-2007 29

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ing middle age (40-64 years), and nearly hal (49 per-cent) occurred a ter 65 years o age. Among people age65 and older, three-quarters o expenses (or 37 percent o the li etime total) occurred among individuals 65-84and the rest (12 percent o the li etime total) among people 85 and over. The total per capita li etime expense wascalculated to be $316,600.34

Age aside, the primary actors or determining the largest-spending consumers o health care depended upon sev-eral actors. First, the type o disease. According to the AHQRstudy, The 15 most costly medical conditions in the UnitedStates accounted or 44 percent o total U.S. health care

spending in 1996; heart disease, cancer, trauma, mentaldisorders, and pulmonary conditions being the ve mostexpensive diseases to manage. 35 Chronic conditions, suchas asthma, are the other major indicators o major expense.

Those who are high spenders in one year, however, are notnecessarily high spenders over the next several years:

Over longer periods o time, a considerable leveling o expenses takes place. In a study o Medicare enrollees,researchers ound that although the top 1 percent o spenders accounted or 20 percent o expenses in a par-ticular year, the top 1 percent o spenders over a 16-year period accounted or only 7 percent o expenses. Theresearchers concluded that there is a substantial level-ing o expenses across a population when looking over several years or more compared to just a single year. Anacute episode o pneumonia or a motor vehicle accident might lead to an expensive hospitalization or an other-wise healthy person, who might be in the top 1 percent

or just that year but have ew expenses in subsequent years. Similarly, many people have chronic conditions,such as diabetes and asthma, which are airly expensiveto treat on an ongoing basis or the rest o their lives, but in most years will not put them at the very top o healthcare spenders. However, each year some o those withchronic conditions will have acute episodes or compli-cations requiring a hospitalization or other more expen-sive treatment.37

The distribution o health expenditures provides impor-tant context rom which to interpret the rising expendituretrendsespecially with respect to which adverse incen-tives are driving the excessive cost increases. Due to the cur-rent demographic trends, the adverse incentives created byMedicareas identi ed by Finkelstein (2007) and espe-

cially the new Medicare prescription drug bene t are keyocus areas or any health care re orm e ort to be e ective

President Obamas Re orms Do NotAddress the Root Causes o the Problem The acts presented above have established that risinghealth care expenditures are limiting income gains andthereby hurting amily budgets, raising tax costs, raisingindividuals dollar costs at a rate that is not sustainable, anddamaging the U.S. economy. The economic costs rom these

ine ciencies are large. One study estimates that the ine -ciencies o the current system alone could account or 30percent o the total health care spending in 2007:

Examining Medicare records, researchers have ound that per-bene ciary spending varies widely rom onearea o the country to the next. In some areas, Medicarespends twice as much per senior as it does in other areas.Researchers have also ound that bene ciaries in highspending areas do not start out sicker, do not end up

Figure 12: Percent o Total Health Care Expendituresby Percent o the Population, 2002 33

22%

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Top 1% >$35,543

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Figure 13: Percent o Total Health CareExpenditures by Age Group, 2002 36

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healthier, and are no happier with the care they receive,than bene ciaries in low-spending areas. That suggeststhat a signi cant amount o Medicare spending pro-vides no discernible bene t to the programs intended bene ciaries. Those researchers estimate that as muchas 30 percent o total U.S. medical spending provides nodiscernible value. I so, then Americans spend more than$700 billion each year, or 5 percent o gross domestic product, on medical services o no discernible value.38

Waste, raud, and abuse created a large health care bill o $700 billion in 2007. On a per capita basis, $700 billion inwaste, raud, and abuse imposes a bill o over $2,300 per le-gal resident in the U.S. The possibility that 30 percent o totalhealth care spending is waste underscores the Presidentscontention that re orm is needed. However, success ul re-

orms will directly address the root causes o the problemsoutlined above. The root cause is the adverse governmentpolicies that have diminished the incentives and ability or ei-ther doctors or patients to control costs and experiment withalternative and more e ective ways to deliver health care.

The Obama Administration reverses this cause-and-e ectrelationship, positing that large numbers o the uninsuredare driving health care costs higher. In reality, rising costsand a distorted health insurance market are limiting the insur-ance opportunities or millions o Americans. Implementingre orms true to President Obamas health care re orm prin-

ciples will create negative economic impacts that will exceedthose negative impacts created by the current system.

As o this writing, neither the President nor the Democrat-ic majority in Congress has settled on a speci c detailedhealth re orm plan. There are general concepts that guidetheir approaches. These concepts include:

A public health insurance option to compete with theprivate sector;

An individual or employer mandate requiring

coverage;

The establishment o health care exchanges where in-dividuals can purchase health insurance, at discount-ed rates or certain individuals;

Prohibition on rate di erentiation based on health sta-tus, although di erentiation by age is allowed (guar-anteed issue); and

Best practices mandates (such as an administrativebody that disseminates comparative e ectiveness in-

ormation or electronic medical records) and the elim-ination o waste, raud and abuse.

None o these approaches addresses the problem at hand. The centerpiece o the Obama plan is the creation o apublic health insurance option that supposedly would en-sure that private insurance companies provide a air prod-uct at a reasonable price. Such a solution is predicated onthe problems being ine ective pricing and services romhealth insurance companies. As shown above, this is notthe problem.

The government rarely competes on a level playing eldwith private industry; instead, it tilts the eld in its avor. Apublic health insurance option, with guaranteed taxpayersubsidies, would pressure the industry to price at uneco-nomical levels in order to meet political goals, regardlesso their economic merit or viability. Private insurers wouldhave no choice but to ollow the governments leaduntil

orced to close up shop.

Floridas experience with storm (e.g., hurricane) insuranceexempli es the ate o health care insurance under theObama plan. As everyone knows, hurricanes requentlybatter Florida. Sometimes a given hurricane is particularlysevere. Storm insurance provides protection or residents

against signi cant or catastrophic wind damage caused bythe occasional strong hurricane.

Originally, storm insurance plans were o ered by both pri-vate insurers and the state government. Under GovernorCharlie Crist, the state lowered its storm insurance rates toan actuarially unsound level. Under any reasonable scenario,the costs rom storm insurance claims rom the next largestorm would overwhelm the insurance premiums collectedand bankrupt any insurance und that extended these rates.When combined with other market restrictions, the state all

but ensured that insurance companies operating in Floridawould lose money. In order to avoid bankruptcy, these com-panies have been leaving Florida. As a result, the state gov-ernment has become the primary storm insurer. The state o Florida is now insuring millions o people and aces a nancial crisis when the next major hurricane comes ashore.

The end result o the Obama plan on the health insurancemarket would be the same as in Floridas storm insurancemarket. The Federal insurance program would drive out the


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private sector and become the primary health insurer in theUnited States. The U.S. health system would e ectively be-come a single-payer, government-run health care system.

Fannie Mae (the Federal National Mortgage Association)and Freddie Mac (the Federal Home Loan Mortgage Corp.)provide an example o how ederal in uence over publiccompanies distorts the market and decreases its e ciency.While academics and researchers are still struggling to allo-cate blame over the housing bubble, it already is clear thattoo many homes were sold to too many individuals whocould not a ord them. In response, Fannie Mae and Fred-die Mac tightened standards on the types o mortgages itwould guarantee and/or purchase. The latest initiative, an-nounced in March 2009, has the e ect o tightening creditstandards or condominium purchasers, especially or pur-chases in developments likely soon to experience nancialdi culties. A ter years o too-lax credit standards, tighten-ing lending standards is the correct economic response,although it comes a bit late. It is the incorrect political re-sponse, however.

Representatives Barney Frank and Anthony Weiner com-plained to the CEOs o Fannie Mae and Freddie Mac thatthese new restrictions may be too onerous.39 Whateverthe congressmens motive, their actions illustrate that whenpublic companies make hard economic decisions the po-litical overseers inevitably intervene and second-guess the

companys decisions. The inter erenceor threat o inter-erencein the daily operations o public companies orc-es these companies to consider the political rami cations o their actions in addition to their economic viability. Havingto incorporate the latest political considerations decreasesthe e ectiveness o Fannie Mae and Freddie Mac, and is an-other real-world example o how public corporations, subject to the whims o politicians, distort the markets in whichthey operate.

Similarly, congressmen and senators will have an incentive

to pressure the CEO o some uture public health insurancecompany whenever premium price increases are viewedby their political constituents as too onerous. Greater eco-nomic ine ciencies will be the result.

Additionally, creating another government insurance planwould not address the problem o rising health care costs,even while it exacerbated other problems by urther dimin-

ishing consumer incentives to monitor health care costs.Brown and Finkelsteins research (2008) suggests that thelikely impact rom a public insurance option is a signi canreduction in peoples incentives to monitor costs and a sig-ni cant increase in the costs o administering the publicprogram.

In addition to the public insurance option, the Presidentshealth care re orm priorities would create public health in-surance exchanges. In theory, health insurance exchangesprovide people with the resources and in ormation to makee cient insurance purchases. When combined with guar-anteed issue* or some orm o individual mandate, suchpolicies are designed to ensure that all Americans have in-surance coverage. Sometimes health insurance exchangesare sold as a ree lunch that will simultaneously increase e

ciency, expand coverage, and lower costsat least overthe next decade.

Senator Edward Kennedy asked the Congressional BudgetO ce (CBO) to evaluate a plan that contains these policiesthe A ordable Health Choices Act. The CBOs reply dispethe myths that health insurance exchanges, combined withan individual mandate, constitute e ective health care re-

orm. Speci cally, the CBO stated:

According to that assessment, enacting the proposal would result in a net increase in ederal budget de cits o about $1.0 trillion over the 2010-2019 period. Once the proposal was ully implemented, about 39 million indi-viduals would obtain coverage through the new insur-ance exchanges. At the same time, the number o peoplewho had coverage through an employer would declineby about 15 million (or roughly 10 percent), and cover-age rom other sources would all by about 8 million,so the net decrease in the number o people uninsured would be about 16 million.40

Since the U.S. Census currently estimates that 45.7 million

people did not have insurance in 2007, the net $1 trillionin additional spending ($1.6 trillion gross spending) wouldreduce the number o insured by only 35 percent. The ini-tiative would leave 30 million people uninsured despitethe governments expenditure o an additional $1 trillionon net.41 The cost to reduce the number o uninsured by15 million people is $62,500 per each additional personinsured.

*Guaranteed issue means that applicants cannot be turned down or coverage based on their health status.


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That assessment is consistent with experience in Massachu-setts ollowing the states recent health care re orms. TheMassachusetts re orm embodied the same main principlespromoted by the Obama administrationthe health ex-change, individual mandate, and generous subsidies. Thestates legislature provided:

Cost control by increasing the number o insuredthrough both an individual and employer mandate;

Generous middle class subsidies to cover insurancecosts; and

The creation o Massachusetts Health Connector, whichis an exchange designed to connect individuals withthe right insurance policy.

The individual mandates o Massachusetts did reduce thenumber o uninsured. A recent summary o the re orms putit this way:

In mid-2008, just 2.6 percent o state residents lacked insurance coverage, down rom 9.8 percent in 2006, ac-cording to a state report:

Overall, 439,000 were newly insured. These included 72,000 added to MassHealth, the states Medicaid pro-gram, which raised eligibility rom 100 percent to 150 percent o the ederal poverty level; and 176,000 in Com-mCare, a new subsidized program or those between150 percent and 300 percent o poverty. Another 18,000obtained insurance through CommChoice, the new state insurance connector o ering standardized plansto individuals and small businesses, while 14,000 morebought individual polices on the open market. Many more obtained employer-sponsored coverage, particu-larly among lower-income workers.42

But, the same report also documents that these same re-

orms are bankrupting the state and creating many unin-tended and unwanted consequences including:

escalating costs, growing concerns about underin-surance or some low- and middle-income groups, and an unintended but severe impact on some sa ety-net providers. I anything, many o these issues will be evenmore pronounced in states with higher uninsured ratesand ewer available Medicaid dollars

Original budget projections or the Massachusetts pro-gram were $160 million in scal year 2007, $400 millionin FY2008 and $725 million in FY2009. At $133 million,actual costs came in lower or 2007, but shot up to $625million in 2008. The state unding request or 2009 was$869 million, with some estimating that actual costscould reach $1.1 billion. Much o the increase results

rom higher than expected enrollment in MassHealthand the subsidized CommCare programs, possibly be-cause o underestimates o how many people would quali y. With the state about $4 billion short o a bal-anced budget this year, sustaining these numbers is ahuge challenge.43

The bene ts rom expanding insurance coverage are alsoquestionable. A recent Cato Institute report ound that un-compensated care provided by hospitals and other medical

acilities has not declined in proportion to the increase inthe number o insured.44 In act, one o the original sellinpoints behind the Massachusetts re orm was that it wouldshi t subsidies or uncompensated care rom hospitals to in-dividuals. Uncompensated care subsidies were supposed to

ade away, with the state using the savings to help low- andmiddle-income residents buy insurance instead. But hospi-tals now say that the rate o uncompensated care contin-ues to be so high that they cannot dispense with their sub-sidies. The taxpayers end up paying twice.45

The resultant pressure isnt on taxpayers and state budgetarchitects alone. Although supporters claimed:

re orms would reduce the price o individual insur-ance policies by 25-40 percent [ i]n reality, insurance premiums rose by 7.4 percent in 2007, 8-12 percent in2008, and are expected to rise 9 percent this year. By comparison, nationwide insurance costs rose by 6.1 per-cent in 2007, just 4.7 percent in 2008, and are projected to increase 6.4 percent this year. On average, health in-surance costs $16,897 or a amily o our in Massachu-

setts, compared to $12,700 nationally.46

The Massachusetts re orm is a case study that demonstratesthe negative economic impact o health re orm based onthe Presidents principles o expanding coverage. Such anapproach not only ails to address the adverse incentivesdriving up costs, it makes these incentives worse. The im-pact rom the worsened economic incentives creates theadditional adverse economic outcomes that will result romthe Presidents re orm concepts.


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The last concept supported by President Obama addressesthe outcomes o the adverse incentives (the symptoms) andnot the actual adverse incentives themselves (the disease). The President discusses the need or best practices (suchas an administrative body that disseminates comparativee ectiveness in ormation or electronic medical records)to be better shared across the medical pro ession. He alsopledges the elimination o waste, raud and abuse. As anindication o his commitment to this cause, the AmericanRecovery and Reinvestment Act (the stimulus package) in-vested $19 billion in health in ormation technology, whichincluded $17 billion in incentives to encourage health careproviders to use electronic medical records and $1.1 billion

or comparative e ectiveness research.

As Cannon (2009) illustrated, the medical pro ession lacksadequate comparative e ective research and other bestpractice sharing initiatives because government programsand price insensitive consumers have eliminated the incen-tive to do so. Throwing money at this problem will not ap-preciably change this incentive. What it will do is create newproblems such as the possibility that the best practices willcome to mean politically, rather than medically, best. Themore e ective policy, which should be apparent by now, isto address the problem directly by correcting the adverseincentives that are causing the ine cient result.

Quanti ying the PotentialEconomic ImpactsBecause the concepts behind the Obama Administrationshealth care re orm plans do not address the incentives inthe current health care systemindeed, they o ten worsenthese incentiveshealth re orms based on these conceptswill have a signi cant negative economic impact. To quan-ti y the impacts rom re orms based on the Obama Admin-istrations concepts we ocus on the impacts rom a re ormproposal that:

Creates another public health care option that will di-

rectly compete with private health insurers;

Establishes an individual mandate that requires all indi-viduals to obtain health insurance coverage; and

Creates a health care exchange.

We base our analysis on the CBOs assessment o the Kennedy health care plan mentioned above.* Because it is un-likely the Kennedy plan as currently written will be the nalhealth care re orm bill, we modi y the CBOs analysis to r

ect the impact on the health care re orm market rom acumulative $1 trillion in health care subsidies spent over thenext 10 years. We assume that the $1 trillion in health caresubsidies will be spent in a similar manner, with similar tim-ing, and will have impacts on the uninsured similar to thosenoted in the CBO analysis.

The purpose o the subsidies is to extend health insurancecoverage to the current uninsured. Some o this money isduplicative, replacing private sector dollars currently beingdevoted toward health insurance coverage. By 2019, ap-proximately $4 out o every $10 in the new subsidies wouldbe devoted toward those individuals who did not have cov-erage previously.

On net, assuming that the subsidies would be e ective in2012, the number o uninsured Americans would be ap-proximately 25 percent smaller than it would have been

otherwise without these subsidies. Thus 13.3 million peoplewho currently lack health insurance would acquire it. But,as demonstrated above, expanding health insurance cov-erage ails to address the undamental adverse incentivesdriving health care cost in ation. Consequently, re orms

*Elmendor , Douglas (2009) Letter to Honorable Edward M. Kennedy Congressional Budget Ofce, June 15. On July 2nd, the CBO analyzed another healthre orm proposal rom the Senate Committee on Health, Environment, Labor and Pensions, Elmendor , Douglas (2009) Letter to Honorable Edward M. KenCongressional Budget Ofce, July 2. While the price tag on this analysis is smaller ($645 billion), it does not include a signi cant expansion o the Med program or other options or subsidizing coverage or those with income below 150 percent o the ederal poverty level Because leaving out lower iindividuals appears to contradict the goals o health insurance re orm in the rst place, our analysis is based on the original Kennedy plan.

Figure 14: Projected Reduction in Uninsured rom$1 Trillion in Federal Subsidies, 2012-2019 47

-30.0%

-25.0%

-20.0%

-15.0%

-10.0%

-5.0%

0.0%

2012 2013 2014 2015 2016 2017 2018 2019


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based on the Presidents priorities would not only provecostly and ine ective at achieving his goals, they would ac-tually aggravate current problems with the health care sys-tem. Expanding coverage in this manner would worsen theincentives by increasing the number o dollars spent thatare insensitive to costs.

Finkelstein (2007) demonstrated that, historically, health careexpenditures increase rapidly when medical consumers areinsulated rom the nancial costs rom using the medicalsystem (connection rate).48 We estimate that the increasedgovernment subsidies would reduce the expected connec-tion rate by approximately one percentage point. See Fig-ure 15 or a year-by-year breakdown o the changes in theconnection rate due to the new government subsidies.

The reduction in the connection rate directly creates incen-tives or additional medical expenditures that are insensitiveto price. Based on the elasticity calculations rom Finkelstein(2007), due to the reduced connection rates (and the addi-tional adverse incentives created by the lower connectionrates), total medical expenditures would actually accelerate.Figure 16 illustrates the estimated additional annual increas-

es in medical expenditures caused by the reduced connec-tion rates, which would be 8.9 percent higher in 2019 thanObama-style re orm would have enabled. Note that suchincreases are the exact opposite o what the proponents o President Obamas health care priorities predict

the prognosis for national health insurance

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