Wednesday, April 5, 2017

The two major sources of our healthcare problem

As I noted two weeks ago, the problem with Obamacare is that "it attempted to rejigger a huge fraction of the U.S. economy, and that is something that is virtually impossible to accomplish in a successful fashion by government diktat. Only a freely functioning market economy can make something so huge and so complex work in an efficient manner." So the solution is to restore a freely functioning market to the healthcare industry. That sounds easy, but the complexities involved with undoing Obamacare are nearly intractable, and that is what has bogged down Congress' attempts to repeal and replace.

When faced with very complex problems, the best solution involves simplifying things as much as possible. Fortunately, John Cochrane has taken a giant step in that direction with his recent post. He has come up with what he refers to as the "two original sins" of healthcare regulation. These two sins explain most if not all of the problems that we face with healthcare today. 

The first original sin appeared in the 1940s, when the government agreed to allow companies to deduct the cost of health insurance, but neglected to allow individuals to do the same. (I've discussed this in a number of posts over the years.) This made health insurance provided by employers much cheaper than health insurance purchased by individuals. Not only that, but it created a strong incentive for employers to offer health insurance which covered a whole lot of things; and why not, if the costs were uniquely deductible by companies? Not surprisingly, the vast majority of us today get our health insurance either from our employer or the federal government, and most of the healthcare policies offered (or mandated) today cover all sorts of trivial expenses—it's like buying car insurance that includes oil changes. As a result, only 10.5% of healthcare expenses are paid for out of pocket, while the vast majority of expenses are paid for by third parties—consumers don't know what medical services really cost, and they don't care, so free market forces are absent. This tax distortion is also largely responsible for the problem of portability, since employees can't take their insurance with them when they change or lose their job. We could fix this problem easily by simply changing the tax code to allow everyone to deduct their healthcare insurance costs. 

The second original sin, Cochrane argues, is that "Instead of straightforwardly raising taxes in a non-distortionary way (a VAT, say), and providing charity care or subsidies -- on budget, please, where we can see it -- our political system prefers to fund things by forcing cross subsidies. Medicare and medicaid don't pay what the service costs, because we don't want to admit just how expensive that service is. So, large hospitals make up the difference by overcharging you and me instead." 

Instead of levying a tax designed to cover the cost of healthcare for the unfortunate among us, we have chosen instead to use a system of cross subsidies:

Cross-subsidies are dramatically less efficient than taxes. Cross-subsidies cannot stand competition. Low prices, efficiency, and innovation in the provision of services like health care come centrally from competition, and especially disruptive competition. With no competition -- especially no entry by new doctors, hospitals, clinics, insurance companies -- costs spiral up. As costs spiral up, the cost of the charity care spirals up. As that spirals up, the size of the cross-subsidies spirals up. As that spirals up, the need to restrict competition spirals up.

Read the whole thing.


Benjamin Cole said...

Egads, U.S. healthcare is a mess.

70 million Medicaid recipients, paid by state and federal revenues. No co-pay.

59.3 million Medicare recipients, paid mostly from payroll taxes (recipients paid in).

21.8 million potential VA recipients, paid from general federal revenues. No co-pay.

12.7 million Obamacare recipients, paid for from mix of revenues and cross subsidies, and by recipients.

The private-sector provides most of the care in the above programs, with the exception of the VA medical program for former federal employees, which is provided by federal doctors, nurses and administrators in federal hospitals and clinics---pure, distilled communism.

So which program to kill---why Obamacare, of course!

I think Scott Grannis is correct in theory, and we should end government involvement in medical care.

Shut down the VA?

Tell old folks, "No more Medicare. Please sign up for euthanasia."?

Given the political realities, maybe single-payer is better. Seems to work in other developed nations, which have similar medical results but for much lower outlays.

Japan pays less than 1/2 for their health care system than does the US. Sheesh, let's just copy them.

steve said...

No one has the Ba98s I mean temerity to address health the right way. The left wants to give away everything and is shocked when costs go through the roof and those who don't receive 99% of the benefits pay 99% of the cost.

xr-3609 said...

This question does not deal with health care but I would be interested in your opinion. Banks commercial and industrial loans (BUSLOANS) peaked just prior to, or during the last three recessions. As such it was a pretty good coincident indicator. It has been flat now for about 6 months. Do you see this as a problem for an ongoing economic expansion?

Scott Grannis said...

Re C&I Loans: I've been looking at this issue for some time (i.e., C&I Loans have been flat for an extended period), but have not yet had any great insights. My fallback for now is my belief that lending can facilitate growth, but it can't create growth, and from that it follows that flat credit growth doesn't necessarily signal that the economy is weak or is likely to get weaker. A few years ago I had a longish post on the subject of debt that is worth revisiting:

One interesting observation: C&I Loans as a % of GDP are currently just under 11%. They have averaged just under 10% since 1970, and have moved in a range of 8-12%. The ratio tends to rise during expansions and tends to fall during recessions, but not always. The ratio was flat to down during most of the Reagan era.

Thinking Hard said...

Benjamin – Your comment regarding no copays ties into my thoughts as well. Posted this on The Grumpy Economist too…

One option for consideration is to have proper disincentives in place to prevent unnecessary medical treatment being utilized by the increasing portion of society on Medicaid. This is the crux of the problem, with the enrollment in Medicaid roughly doubling over the last 4 years, there has been an artificial economic increase in demand for health care services by those with no disincentive preventing them from utilizing such available services. This artificial increase in demand for health care services is ultimately driving up health care costs for all, most of whom must make a rational decision if a medical problem warrants a trip to a health care provider. There is a proper financial disincentive for most people to prevent the unnecessary utilization of health care services in the form of co-pays, deductibles, and out of pocket costs. In order to allow for Medicaid recipient numbers to continue to climb, or even remain stagnant, there must be a proper disincentive for unnecessary health care utilization by this growing portion of the population. Let's talk about health care COSTS and not just health insurance.

RE C&I lending: I also look at another C&I indicator known as senior loan officer surveys measuring domestic bank tightening standards for C&I loans.
Please see: (Large and Middle Market Firms) (small firms)

We have seen tightening lending standards to mid and large size firms in C&I lending for 6 qtrs in a row. This would portray further stagnation in upcoming C&I lending. Please see ( comparing mid to large senior loan officer survey results to C&I lending.

randy said...

Re: "it attempted to rejigger a huge fraction of the U.S. economy, and that is something that is virtually impossible to accomplish in a successful fashion by government diktat. Only a freely functioning market economy can make something so huge and so complex work in an efficient manner."

As other blog readers have noted, issues of transparency, fear in illness, authoritarian role of doctors severely undermine the magic of market forces. Another angle, insurance is a numbers game, the pools need to be very large to spread risk. Maybe macro pools at government level are relevant.

Segue - this article discusses attributes of key periods in US economy. Lot's of observations. For instance considering arguments that transformative leaps are sometimes attributable to, and maybe only possible, when driven by government initiatives (discussing why productivity peaked in 70s). (I can't do the argument justice in a soundbite.)

Gordon concludes that “the Great Depression and World War II directly contributed to the great leap.” Specifically, government investment and direction of the economy in the 1940s were the main sources for U.S. innovation and economic growth during 1950s and 1960s according to Gordon. [..].”

This argument need not imply central command of the economy. As Arthur Herman argued in Freedom’s Forge (Random House, 2012), a book cited by Gordon, a distinguishing aspect of the Roosevelt administration’s war mobilization was its decentralization. Herman described the process, when functioning properly, as follows: “All you had to do was put in the orders, finance the plant expansion, then stand back and let things happen.” In short, Herman portrays an economy that is not purely planned but is also not purely responsive to market signals. It rather follows a corporatist structure in which defense contracts are bid on by firms and practical production decisions taken in a decentralized fashion, while the government sets the general direction and may even manipulate prices. Financial markets are highly regulated and savings are channeled into war bonds. This is not a Five-Year Plan. But it is also not a free market.

NormanB said...

Drug cost remedy: Mandate that drugs cannot be sold in the US for more than the average cost incurred by the ten largest foreign buyers of those drugs.

Scott Grannis said...

More mandates are the last thing we need to fix our healthcare mess.

Thinking Hard said...

"Excessive federal regulation is a de facto tax on employers and consumers that stifles job creation, hampers innovation and postpones investment in the economy."

Hmmm let's get back to that mentality in the GOP! Instead the majority of the GOP, the President, and the media are portraying the only people that upheld the value listed above as enemies of positive change. Where oh where are the conservatives today?

DanQ said...

Scott, you are spot on! So why has no one in congress offered a bill to phase out employer healthcare tax breaks while phasing in individual healthcare?

McKibbinUSA said...

Obamacare is the law of the land, and Republicans are apparently not going to change that...

honestcreditguy said...

Nice write up....

the main issue in health care seems to also center around the FIRE industry....

Insurance has become a car deal with folks making decisions on monthly payments instead of health...

Terex said...
This comment has been removed by the author.
Terex said...

Scott, a follow-up question about loans and credit.

Right now bank credit growth is at its best flat (C&I, L&L, even aggregate growth in banks' balance sheets are almost flat). Some refer to the growth in corp. bond issuance as one explanation for weaker loan demand. But since banks are the main source of new money, if bank generated credit growth stops shouldn’t there be an negative impact on money growth, on total liquidity?

Should we expect M2 growth to slow as well?

If banks do not lend more and FED is not buying (more) assets what then (if anything) drives money growth? I think that this is the situation right now. Still M2 growth is spot on trend.

Thanks for your insights Scott!!


The Cliff Claven of Finance said...

There is a difference between health care and medical insurance.

If you had an ObamaCare-compliant medical insurance policy with a $6,000 deductible, for example, the first $6,000 of spending is out of your own pocket ... and that means people may not have enough money in their pockets to get all the health care they really need.

Also, it's a sad fact that baby boomers are less healthy than their parents (at the same ages) = potentially higher medical expenses over their lifetimes.

And baby boomers also live longer than their parents = more years to spend money on medical care.

Doctors are doing a good job keeping bodies alive longer than ever before .... which means more people will be living long enough to get dementia, which often requires expensive nursing home care for many years.

In the "good old days", a lot more "healthy" people died young from wars and traffic accidents.

Unknown said...

There is another factor that is important and yet not mentioned. That is the cost of medical education. Graduating physicians have such heavy student debt loads that they are forced to become employees of corporate hospital chains. This gives tremendous control of medical care to the executives of the medical corporate elite. If physicians had some relief from debt they would have the choice of entering primary care instead of specialty care and thus provide consumers more choice in selecting their medical care. This would limit the power of hospital chain executives and thus provide more choice to both physicians and patients.

McKibbinUSA said...

If Trump leads the US into a shooting war, then the prospects for healthcare reform, tax reform, and immigration reform become remote. Trump should keep our troops home and instead offer a billion dollar contract on Bashir Assad or Kim Chun Un, dead or alive. A billion dollar bounty would no doubt motivate trusted aids to assassinate these two lunatics. The US focus on wars, globalization, and terrorism is not profitable, at least for me personally. I hate war...

NormanB said...

To Scott Grannis: So what is your solution to the problem that US drug prices are higher than foreign ones meaning that US citizens are paying for R&D and the foreigners are getting a free ride? Just having the religion of 'NO MANDATES' ain't enough. Use your brain here.

WealthMony said...

William, I really like your idea. I too hate war. We could saves both money and lives. However, I do believe there are laws against such a bounty. And if we get the wrong replacement, we'd have to do it all over again. If we do such a thing, let's add Venezuela to the list.

I am 71 and still working. I have 4 employees and all make good money. I have always paid for my own health insurance as a self-employed individual and did not find it deductible on my 1040, and usually could not deduct healthcare costs either, and sometimes they were pretty high, $40k+. I paid for my three children to go to a private school and am now paying for my grandchildren to do the same. At the same time, real estate taxes (mostly for government schools) keep going higher and homeowner insurance costs more and more, and auto insurance rates go higher. I am now on Medicare (for which I have paid my entire adult life and still pay on my $60k salary) and pay a $407 premium each month out of my Social Security. I pay about $6000 a year for pharmacy and it is not deductible.

There are millions of individuals in the US who get about a $10,000 health insurance benefit each year from their employers and do not have to count that as income. Why not? Why can't I deduct my premiums if they don't have to declare their's? NOT FAIR.

Why in the world are healthcare and retirement tied to employers? I write checks to pay for my taxes. Most do not, it is withheld from their pay as is SS and Medicare. They don't see its costs so they essentially don't care.

During the past two weeks I talked with two men who served in the military and both get VA health benefits. One got a whole mouth of teeth implants that would have cost about $35,000 privately. He paid nothing and did not have to declare it as income. I got one and my wife got two implants. Cost was around $10,000 and the money used to pay for it I had to declare as income, and I could not deduct the costs. NOT FAIR.

The government does not reward me for continuing to be productive and provide 4 high paying jobs, as well as an intern in the summer. It wants to punish me. I do it because I care for my family and my employees and I give a lot away to help others (20%) and I am greedy (they say).

Benjamin Cole said...

Way OT but interesting. Tesla now worth more than GM.

Amazing story.

Scott Grannis said...

NormaB re drug prices: there are lots of ways to ensure that drug prices are more rational and reasonable. Reform the tort system so that drug companies don't have to fear exorbitant liability costs. Have Medicare pay market prices for drugs, just like everyone else (currently it's a cross-subsidy situation, in which medicare pays artificially low prices and the rest of us pay artificially high prices). Reform the FDA so that it's easier and cheaper and faster to bring new drugs to market and easier and cheaper to produce and sell generic drugs (currently it's very difficult to get approved to sell generics). Allow insurance companies to offer policies that don't cover drugs or cover only drugs that are very expensive, thus allowing more people to pay out of their own pocket. In short, remove government mandates and regulations from the system as much as possible.

NormanB said...

RE Scott Grannis: All of these ways of reducing drug costs are fundamental changes that will take forever to implement, if ever. My start to this process is a one page rule (mandate?) with probably a few issues to be resolved. But it would pass easily because it is easy to understand: Make foreign countries pay their fair share of drug costs and our drug prices go down. Simple, wimple. Add a mandate and many others will be unnecessary. A specific mandate could be your best friend. Embrace it. I have not heard your argument against it just other approaches.

Also, I was told by a doctor at Stanford that there is a law on the books forbidding, yes forbidding, the US government from negotiating drug prices. The only alternative is to take a high priced drug off of the formulary. (I've only heard this from one person so it would need verification.)

Scott Grannis said...

"Fair share" is a very loaded phrase that makes me cringe. It's totally subjective, and you want bureaucrats to determine what is fair? No thanks. This is not something to mandate or put in any regulation. Free markets are the only way of making things fair: fair for sellers as well as buyers.