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The Political Economy of Health Care

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Trouble begins the moment health care becomes a matter of government spending. From then on, unless the policy is reversed, society is on the road to state intervention in peoples most personal decisions.

Its easy to see why. If government starts picking up the tab for some peoples medical services, those people will not face the full costs of those services. As a result, they will overconsume and others will be stuck with the expense, setting off a clamor for government controls and even socialized medicine.

Its supply and demand, and, as the economists say, demand curves slope downward. The lower the price, the more will be consumed.

The demand for much health care (in truth a very broad category of services), like many things, is responsive to price. If services appear cheap or free, people can find many reasons to consume them. At a high price a person might ignore a minor pain or a sneeze or take an over-the-counter remedy. But at a very low price or no price at all, that person might run to the doctor every time he has a pain or discomfort. He would have no incentive to be cost-conscious. Most medical service is not emergency care, so there is a great range for discretionary consumption.

This would not be a problem if medical services were found superabundant in nature. But in our world medical services are scarce. They consist of people who have limited time and energy and who face opportunity costs and resources, which, when used for one purpose, are unavailable for another purpose.

In a world of scarcity, wants are unlimited while resources are finite. Even if all resources and people were directed to the production of medical services, there would not be enough to satisfy a populations entire demand if the explicit price were free or nearly so.

Thus, when medical care is an item in the governments budget and the states objective is to make that care universal, which means apparently cheap or free, the result is fiscally unviable. The medical part of the budget could easily overwhelm the rest if government officials dont impose limits.

Look at Medicare, the medical program for people over 65. It began with modest cost projections. At its inception in 1965, expenditures for 1990 were projected to be $9 billion. In fact, they were $66 billion (adjusted for inflation). Today Medicare has a 75-year $37 trillion unfunded liability. That is, the discounted present value of outstanding promises exceeds the discounted present value of expected revenues by that amount. Medicare dwarfs Social Security in this regard. Medicaid, the governments medical program for people below the poverty line, has also exceeded cost projections. Medicare and Medicaid combined will cost $742 billion in the current fiscal year, about a quarter of the total budget. Thats more than President Obama proposed separately for total military spending and for discretionary nonmilitary spending. When the baby-boom generation goes on Medicare en masse, the budget will grow.

With government (that is, taxpayers) picking up the tab, the consumption of medical services at once becomes a public matter. Politicians, always with an eye on the next election, will find advantage in expanding the governments medical budget especially for the elderly, who vote and have a strong lobby but they have other constituencies to please also. They cant let medical programs swallow up all the governments revenues. Meanwhile, the taxpayers have a natural, if unrealized, interest in limiting the medical consumption of people on the dole: the taxation and government borrowing that would be required to finance ever higher levels of consumption of medical services are harmful to economic growth, not to mention personal liberty.
Rationing

This tension is inherent in any third-party payment system. Buyers disconnected from the full cost have a conflict of interest with payers who are disconnected from the benefits. The former have an incentive to get as much service as possible, while the latter have an incentive to limit the choices of the buyers.

Thus government is inevitably drawn toward rationing medical care as soon as it takes on the job of financing such services to any part of the population. Rationing does not need to be explicit, as occurred during World War II, when Americans were issued ration tickets for specific quantities of consumer products. It may be implicit. For example, to keep its budget under control, the government could underpay doctors and hospitals, discouraging the provision of services and lengthening the wait times for what is provided. Consumers wouldnt be told directly that they cannot go to the doctor whenever they want, but restricted hours and queues would accomplish the same objective, which would be to reduce the taxpayer cost by reducing consumption indirectly. Note that longer wait times and degraded service represent costs to consumers, illustrating the principle that when government lowers money costs, it causes nonmonetary costs to rise. Costs may also get shifted to the unsubsidized population, creating a new constituency for relief through further government intervention.

Another form of rationing occurs when government simply refuses to pay for certain products and services. For example, Medicare does not pay for noninvasive virtual colonoscopies on the grounds that if doctors find polyps in a patient, they must do a follow-up standard colonoscopy. In an effort to keep some control over Medicares budget, virtual colonoscopies were ruled wasteful and unnecessary. As budgets become tighter, more services could be excluded for the same reasons. Government funding leads to government, rather than patient, decision-making.

Note the insidiousness of government entry into the financing of medical care. In the name of protecting the taxpayers, government officers must insinuate themselves between patients and doctors. The Medicare legislation included a pledge that that would not happen, but that was a pledge that could not be kept. He who pays the piper calls the tune. When a society starts down this road, no one should be surprised where it leads.

We find empirical verification of this in Europe and Canada. Where medical services appear virtually free, rationing of one form or another ensues, as in Great Britain and Canada. Where egregious rationing does not occur, for example in France, Germany, and Switzerland, high co-pays and other market-style devices are used to curb consumption. Nevertheless, those systems face strains, and more controls can be expected.

Direct financing is not the only means of intervention. Much distortion of the U.S. medical market is the result of the rigging of the tax code and regulation of the insurance industry. During World War II wage and price controls prohibited employers from increasing pay to keep or attract workers. So someone hit on the idea of using noncash medical benefits as a method of compensation. What made this method especially attractive was its exemption from income taxation. If an employer spends $5,000 to buy a policy for a worker, the beneficiary pays no tax on its value. (Of course, he pays for the policy with lower cash wages, though that fact is obscured.) But if the employer pays the worker in cash, the amount will be reduced by how much the federal and state governments take in income taxation. Under those circumstances, it makes sense to shift from cash to medical coverage.
Perverse consequences

But there are perverse unintended consequences in this system. First, since medical benefits are worth more than cash at the margin, workers have an incentive to bargain for ever more comprehensive coverage. Second, employers, not employees, select the policies, taking the consumer out of the process. Today most employees have no more than two choices and many have just one. Third, employer-based insurance creates an unfortunate dependence of workers on bosses. Concern about being without medical coverage creates one more reason to tolerate a job rather than search for something new. That reduces workers bargaining power.

These three results have important ramifications for the medical and insurance industries. When workers have comprehensive low-deductible coverage that appears to be paid for by someone else, they will overconsume medical services, creating the problems discussed above and driving up prices for those without insurance. Furthermore, these circumstances all but guarantee that much of the coverage will not be true insurance but, rather, prepayment for future consumption of services. Why is that so?

The push to expand tax-free compensation will lead to coverage of events that are not insurable at all as well as government mandates requiring such coverage. Insurance is a way for people to pool their risk against a rare but catastrophic event that will wipe them out financially. The key to viable insurance is what is called class risk; that is, in a group of a certain size and risk profile, a predictably small number of members will suffer the covered misfortune. For this to work, the event being insured against must not be caused by the policyholder. You wont find a homeowners policy that covers arson by the owner. Life insurance policies dont pay off on suicides. Similarly, home and auto policies dont cover routine maintenance.

But under the perverse insurance the employer-based system spawns, many things are insured against that are self-caused or largely volitional. How could true insurance cover annual physical examinations? Or well-baby care? Or contraceptives? Or even pregnancy and abortion? It is only the tax system and the hidden cost of coverage that makes such policies appear worthwhile. In a free market, prepayment plans would not be worthwhile because the price would include not only the services to be consumed but also the administrative overhead.

The upshot is that in a free market, without government intervention, people would most likely buy coverage only for catastrophic illnesses the treatment of which would wipe them out financially. They would pay for routine and elective services out of savings, the same way they pay for oil changes and new furnace filters. It should be mentioned, however, that truly free-market medical insurance might be far less extensive than we think. Since many ailments are the result of bad diet, lack of exercise, smoking, and so on, it might be impossible to buy actual insurance for many diseases that are covered today. At the very least, insurance premiums, unlike those we pay today, would reflect actual risk. (Government regulation often requires that insurers charge people with different risk profiles the same premiums.)

Government involvement in the financing of medical services and the provision of coverage has had wide-ranging negative consequences for most people. By stimulating demand and disconnecting it from cost, the state has created serious problems, which in turn have prompted calls for more government intervention to fix what the earlier intervention caused. (There has not been space to discuss how government constricts the supply of services through licensing and other measures, aggravating the problems even more.)

Moreover, the politicization of medicine encourages the belief that no one should have to pay for his own medical care. Even employment-based insurance, under the current system, appears to be a way to get something for nothing. Needless to say, the reforms being implemented will make all those problems worse.

There is only one way to maximize accessibility and affordability in medical care without those distortions and without third parties intruding on our privacy and freedom: the free market.

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    Sheldon Richman is vice president of The Future of Freedom Foundation and editor of FFF's monthly journal, Future of Freedom. For 15 years he was editor of The Freeman, published by the Foundation for Economic Education in Irvington, New York. He is the author of FFF's award-winning book Separating School & State: How to Liberate America's Families; Your Money or Your Life: Why We Must Abolish the Income Tax; and Tethered Citizens: Time to Repeal the Welfare State. Calling for the abolition, not the reform, of public schooling. Separating School & State has become a landmark book in both libertarian and educational circles. In his column in the Financial Times, Michael Prowse wrote: "I recommend a subversive tract, Separating School & State by Sheldon Richman of the Cato Institute, a Washington think tank... . I also think that Mr. Richman is right to fear that state education undermines personal responsibility..." Sheldon's articles on economic policy, education, civil liberties, American history, foreign policy, and the Middle East have appeared in the Washington Post, Wall Street Journal, American Scholar, Chicago Tribune, USA Today, Washington Times, The American Conservative, Insight, Cato Policy Report, Journal of Economic Development, The Freeman, The World & I, Reason, Washington Report on Middle East Affairs, Middle East Policy, Liberty magazine, and other publications. He is a contributor to the The Concise Encyclopedia of Economics. A former newspaper reporter and senior editor at the Cato Institute and the Institute for Humane Studies, Sheldon is a graduate of Temple University in Philadelphia. He blogs at Free Association. Send him e-mail.