My own education on the problems with healthcare began about a decade ago when I heard Grace-Marie Turner of the Galen Institute explain the fiscal origins of the problem. It all started in the early 1950s when the government decided to allow companies to deduct the cost of the healthcare insurance they bought on behalf of their employees. That decision, in turn, was made in order to circumvent wage and price controls that had been put in place after the start of WW II, in an effort to keep inflation at bay. Since only employers could deduct healthcare costs, it quickly became apparent that the optimal, tax-efficient solution for everyone was to work for an employer that offered to pay for the most complete health insurance policy possible. We're now seeing the unintended consequence of this change to the tax code, since consumers now pay less than 12% of their healthcare costs out of pocket. Between employer-paid health insurance and government programs (e.g., Medicare, Medicaid), almost 90% of healthcare spending is paid for by a third party. The result: the healthcare industry in the U.S. has become totally separated from the discipline of free markets. No wonder things aren't working well.
My education was greatly advanced today, thanks to reading a transcript of a recent NPR "All Things Considered" program. (HT: Don Boudreaux and Glenn Reynolds) I learned that when the Medicare program was being designed 45 years ago, the government originally decided to pay doctors whatever they wanted to charge, because they needed the doctors' support. When this blew up because costs escalated beyond control, the government hired an economist to figure out what the value of thousands of procedures was. Now we know that the economist's calculations were wrong. To this day, the government is still searching for a method for determining how much to pay physicians. Nobody in the government has ever thought about letting the market figure out the right price. That's the fundamental problem of healthcare today: the government is not giving free markets a chance. No wonder everything is screwed up.
I'm going to reprint the entire transcript of the NPR show, because it needs to be spread far and wide, and it's not very long:
How Should Medicare Pay Doctors?
February 26, 2010 - MELISSA BLOCK, host:
After yesterday's summit there appears to be no more bipartisan consensus on health care today than there was before the summit. Part of the problem is, of course, political, but not all of the problem. With health care, even questions that seem simple just aren't. Take, for instance, the question of how to pay doctors.
David Kestenbaum and Chana Joffe-Walt from our Planet Money team report that doctor pay has confounded policy wonks, economists and presidents for decades.
CHANA JOFFE-WALT: In 1965, Joe Califano had to answer a question. He didn't know it was such a big question, or a question that would change the course of health care in American for the next five decades. It just seemed simple: How should the government pay doctors?
DAVID KESTENBAUM: Califano was President Lyndon Johnson's adviser for domestic affairs. And the government was about to get into the health insurance business in a huge way - about to launch the largest health insurance plan we've ever had: Medicare. But the idea made doctors nervous, so LBJ, Califano and lawmakers made what seemed like a small concession. The government told doctors: We will pay you for every procedure you do. How much will we pay you? Whatever you think is right.
JOFFE-WALT: Califano shakes his head describing that call now. But he says, look, the government needed doctors to participate. If doctors didn't accept Medicare, wouldn't see patients covered by Medicare, the whole thing would fail.
Mr. JOSEPH CALIFANO (Former Adviser, Domestic Affairs): We were on edge. We were on edge.
Mr. CALIFANO: About whether doctors would agree to take Medicare patients.
KESTENBAUM: Why were you worried they wouldn't participate? You were going to pay them whatever they wanted.
Mr. CALIFANO: They were so opposed to it. I mean, they reluctantly - believe me, within two years, they love it. But they really didn't understand what a bonanza this was going to be for them.
KESTENBAUM: Turns out, doctors had been giving out a lot of free care to old people and now they were going to get paid for that, and within limits, whatever they asked for.
Dr. Lucian Leape was a practicing surgeon at the time.
Dr. LUCIAN LEAPE (Surgeon): We found out what the general fee for our service was and charged that or maybe added 10 percent, 'cause of course I'm better than average. And so it was an incentive for doctors to charge what they thought was reasonable for them, and then of course to increase it every year by, say, 5 or 10 percent.
KESTENBAUM: Medicare solution for how to pay doctors put into cement this idea of fee for service, paying doctors per procedure for every test, every scan. That sounds reasonable, but it served as a nudge to err on the safe side - to do more tests, to do that exploratory surgery.
JOFFE-WALT: LBJ and Califano, all their people, all realized they created something of a monster right away. I mean, two years after Medicare passed, LBJ is pleading with Congress to let him change the way Medicare pays physicians.
Califano remembers it well.
Mr. CALIFANO: By late '67, the budget data was just stunning. I mean 1968, we knew that system should be changed. We asked Congress for authority to change it.
JOFFE-WALT: But you just created it.
Mr. CALIFANO: I know it. But we saw what was happening with costs so fast. So fast.
KESTENBAUM: But they couldn't change it. Doctors now like the system. They were getting paid for work they'd previously done for free. And that was that. This system, with all its problems, stayed in place for almost 30 years. Meanwhile, medicine got more expensive.
JOFFE-WALT: Figuring out prices for health services is really hard. We have an idea of what we should pay for toothpaste. Back surgery, no idea.
KESTENBAUM: And yet, in 1986, one man was convinced he could calculate the prices. An economist at Harvard by the name of William Hsiao; an economist with a small voice and a big, kind of weird idea.
Professor WILLIAM HSIAO (Harvard University): So the question is: Can we find a rational method that could be used to set physicians' fees?
JOFFE-WALT: Professor Hsiao decided, okay, the market does not work for health care services. So I will calculate the right prices for each and everything a doctor does.
KESTENBAUM: Hsiao brought in groups of doctors and asked them some pretty crazy sounding, almost philosophical questions like: How much mental work does a regular checkup require? He had them compare everything they did to one reference point. For surgeons, it might be a hernia repair: How technically hard is it, how stressful, how many supplies? Hsiao had doctors do this for thousands of procedures.
JOFFE-WALT: Congress loved this idea: An economist, a rational way of answering this annoying question. And Congress said if you can really do this, we will adopt your method. We will make it law.
KESTENBAUM: Now, if someone was talking about changing how you got paid, you'd pay attention - and doctors did.
JOFFE-WALT: While Hsiao was creating his Relative Value Scale, he'd invite groups of doctors in to advise him. And the doctors would bring their own advisors, consultants - lobbyists, really. Hsiao wouldn't let them in the room, so they'd sit outside. And then those consultants started coming out with their own relative value studies that were more favorable to whatever group of doctors they represented.
Prof. HSIAO: So then they were trying to trump us. And so it took tremendous amount of work, took years out of my life and my hair turned gray.
(Soundbite of laughter)
JOFFE-WALT: During that time?
Prof. HSIAO: Mm-hmm.
JOFFE-WALT: In 1992, Congress adopted Hsiao's Relative Value Scale, that enormous spreadsheet. And it worked for a while until just a few years later, it didn't anymore.
KESTENBAUM: There are different explanations for what happened. Hsiao blames lobbyists. Lobbyists and doctors say, sorry, health care just is expensive, and most of the time, Medicare actually underpays us.
JOFFE-WALT: Congress did try one more thing. It tried to slow growth of doctor pay by saying payments could not grow faster than the overall economy grows. But when the economy slowed, that would mean cutting doctor pay.
KESTENBAUM: When that happened, Congress balked and put off making the cut one year, then the next year and the next. Those delayed cuts added up and now this coming Monday morning, doctors are facing a 21 percent pay cut. Unless, of course, Congress puts it off again.
JOFFE-WALT: So that question about paying doctors, we're still working on it.
I'm Chana Joffe-Walt.
KESTENBAUM: And I'm David Kestenbaum, NPR News.
It's clear from all this that the solution to our healthcare crisis must start with any and all measures that restore free market forces to the healthcare industry. For starters, that means changing the tax code to eliminate the third-party payer problem—allow everyone or no one to deduct healthcare costs. That would ultimately put consumers in charge of spending their own money on healthcare, instead of their employers'. That would also solve the portability problem, since healthcare wouldn't be tied to one's job. It would also go a long way to solving the pre-existing condition problem, since people could buy a policy when they were young and keep it for life. Next, breaking down interstate barriers to selling healthcare insurance would greatly increase competition, by allowing consumers to discover that buying a policy that provides first-dollar coverage for just about everything doesn't make sense for everyone, and that high-deductible policies can be very attractive for most consumers.
Mitch Daniels, Governor of Indiana, has a great op-ed in today's WSJ that describes in detail how introducing market forces to the healthcare equation can improve results for everyone. The secret is to use Health Savings Accounts. Key takeaway: "Americans can make sound, thrifty decisions about their own health. If national policy trusted and encouraged them to do so, our skyrocketing health-care costs would decelerate." What a novel concept: trust the people!