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Combating Macroeconomic Infirmity In U.S. Health Care

It is inescapable now. It is on the evening news. It is in every paper. Something is sick with America. Knowledge of the ailment has achieved its exodus from the confines of its ivory-sheathed towers and made its way, told phen24 onto our televisions and political Teleprompters, read more

The American health care system, its financing, its delivery, is surely as sickly and mephitical to the body-economic of this nation than any viral pathogen. If we do not act soon, to understand, constrain and adjust the cost of this illness, it will eat away at us as surely as any cancer. Approaching a consumption rate of 1/5th of one of the world's largest economies, more than $2 trillion annually, it is entirely proper that we discuss this topic in such stark and dire terms.

Within the confines of this paper, we will explore the ultimate cost of this national contagion. We will discuss the measurements used to draw such conclusions, based on the traditional concepts of delivering medicine, comparing our findings with hypotheses to be drawn from less conventional methods of health care delivery, finance and coverage. Interestingly enough, this economic paper will focus primarily on the one good which economists appear so hesitant to firmly classify as such, yet could not be more aptly described for those who find its consumption beneficial.

Most importantly, it will be clearly demonstrated why, when accounting for costs, traditional methods of medical delivery, and variations thereof, including increased governmental intervention and so-called "agency" are mistaken, are at best a Faustian bargain which kicks the problems of cost and quality down the road for other generations, neglecting our fiduciary responsibilities as conscientious stewards of the present.

This may seem an ambitious undertaking for such a paper, but two reasons compel such an approach. First: The disease of health care cost explosion is not going to go away; it is a fire that will refuse to burn out until all available fuel (capital, labor, GDP) is exhausted. Second: The available literature on the subject provides us, generally speaking, with but two alternatives for reform: the government method, and the market method. This reality necessitates a choice.

To ensure the wisest approach to moving forward we must be cognizant and fully knowledgeable of both the status quo and potential alternatives. As the more "government-heavy" approach has been receiving significant media and political attention for some time now, this paper will place its emphasis on the market-orientated approach, endeavoring to take account of both the positive and negative aspects revealed in the literature in the hopes of forming a synthesis of opinion.

With good fortune, as the issue continues to press itself, we will make the operos but exigent choices that must be made for the perseverance of our future, our health care system and our way of life.


According to the most recent data, the United States, as a whole, spent $2.4 trillion on health care in 2008, representing about 17 percent of GDP. Moreover, that figure is expected to nearly double to $4.3 trillion by 2016. Although U.S. health care spending never exceeded more than 6% of GDP in the 189 years of nationhood prior to 1965, the figure now reflects a greater degree of spending than all other Organization for Economic Coordination and Development (OECD) nations. In short, health care costs are on a trend to crowd out all other government functions and private consumption.

These days, words and figures like "stimulus," and "trillion," are thrown around quite a bit, with the unfortunate consequence of perhaps diluting the sheer enormity of what it is we are actually talking about. So, before we proceed, let us just engage in a quick thought experiment:

Imagine you earned $1 a second, 24 hours a day, and 365 days a year. At such a rate, it would take you 32,000 years to earn $1 trillion; yet somehow we manage to spend more than twice that amount on health care alone, every year, increasing that amount as the clock ticks on.


A local supermarket announces a new sales formula. From that moment on, customers who pay a relatively small fee, through their employer, can have access to every item in the store at (let's say, fourteen) cents on the dollar. What's more, because food is an essential survival good, the government has agreed that those who participate may pay their fee automatically with pre-tax dollars. Economically speaking, shoppers are now incentivized to purchase food until it is worth only fourteen cents on the dollar to them at the margin.

Predictably, the plan grows immensely popular, and soon other stores are following suit. Over time, customers begin to pack supermarkets in ways never seen before. Who wouldn't buy a 10 lbs. lobster if it only cost fourteen cents on the dollar? Given such a scenario, it wouldn't be difficult to imagine the dwindling supplies, over-crowded stores and rising costs for workers who have come to depend on this method of purchasing as a necessity.

Though admittedly crude, this allegory elucidates an important point: the paradoxical truth behind American healthcare is that the reason it is so expensive is that it is so cheap. The implications of this practice, particularly the tax-exclusion of health coverage dollars (amounting to close to $200 billion each year), are most visible at the margin, where the intense regresivity is revealed. The regressive nature, in a cruel sense of irony, is actually a by-product of our system of progressive taxation established, presumably, for the purpose of ensuring "fairness" in our tax system. Yet a simple example shows how one government policy, stacked on top of another, can often yield unintended consequences:

As one earns more money, they move into higher tax brackets. This produces the corollary affect of saving more money for those who need it least, in so far as it pertains to health coverage purchased via an employer. For example: A wealthy individual, in a 50 percent tax bracket, saves fifty cents for every dollar he receives as (health) benefits rather than cash wages. A poorer individual who may only be subject to a 15 percent FICA tax saves just fifteen cents for his dollar of coverage remuneration.

While such a disparate system, the quirk of World War II government policy, should be seen for what it is (unfair and discriminatory), its economic implications extend far beyond injustice or partiality. As Nobel Laureate Milton Friedman pointed out, the tax-exemption has two deleterious affects, both of which serve to increase health costs, which affect the least of us most of all:

"Firstly, it leads employees to rely on their employers, rather than themselves, to make arrangements for medical care. Yet employees are likely to do a better job of monitoring medical care providers - because it is in their own interest - than is the employer or insurance company, government, or other [entity] designated by the employer. Secondly, it leads employees to take a larger fraction of total remuneration in the form of medical care than they would if spending on medical care had the same tax status as other expenditures."

This apparent idiosyncrasy of the tax code has managed to accomplish something phenomenal: to redefine a word. "Insurance," in health care, has taken on a very different meaning than in any other industry. For instance, in the real world, we generally rely on our insurance policies to protect us against events that are unlikely to occur but would involve huge losses if they ever did. The tax exclusion for employer-provided health insurance (EPHI), in contrast, has managed to take this traditional concept and turn it on its head, leaving us vulnerable to the catastrophic, but fully covered for the common.

Although the tax exclusion for EPHI plays a profound role in the way we approach and purchase health care, there are still more pernicious pathogens that play equally prevalent roles in driving up the costs of our health system. While too numerous to chronicle in detail here, we can certainly focus on perhaps the second most culpable culprit, one that has been at work for decades. The effects of EPHI in conjunction with government health programs.

According to the work of MIT economist Amy N. Finkelstein, the rise of third-party payers, as a result of EPHI and government health programs, have caused costs to explode. Using data going back to the advent of Medicare and Medicaid back in 1965, Finkelstein demonstrates that health costs have risen in statistically significantly proportion to the amount of health care paid for by third parties. Prior to the dawn of the two major government health programs, such spending never exceeded six percent of GDP. Today, as we have already seen, that number is closer to 17%. Further, as Finkelstein shows, half of the growth in health care expenditures has been due to Medicare alone.

This research is particularly important for two reasons: (A) it leads one to consider the disturbing possibility that we are spending ourselves into national bankruptcy, and (B) it has fundamentally reshaped the way health economists approach their field. For years, it was thought that rising costs could be attributed to more intensive medical encounters, improved technology and pharmaceuticals. These elements obviously play a role, but certainly not the omnipotent one initially thought. With 20/20 hindsight, of course, it seems strange that we for so long failed to connect our method of payment with the increase of payments themselves, to say nothing of the incentives provided us through such mechanisms.


Strides have been made to make up for lost time and address the rapidly approaching time bomb that is medical care cost explosion. Not all are pleased with the direction some are going, to be sure, but for all the discord there most certainly exists a level of intellectual enthusiasm, as the field is now being approached from a fresh perspective.

By far the most radical approach to the problem has been the consumer-directed health care (CDHC) movement. The concept is, like so many other areas of economics, deceptively simple. As a 2006 Health Affairs article by John C. Goodman, President of the National Center for Policy Analysis sums it up:

"To control health care costs, someone must choose between health care and other uses of money. The value of most health care is experienced subjectively... No one is in a better position to make these subjective trade-offs than patients themselves: Patients [would be] better off if they could manage more of their own health care dollars and if providers were free to compete to meet their needs."

In essence, the idea focuses on ending the discrimination in the tax code against the unemployed and those who do not receive health coverage through their place of business, while simultaneously empowering individuals and providing appropriate incentives to providers. To do so, tax-free savings accounts would be offered, usually in conjunction with a high-deductible health plan, which could be accessed to pay for the relatively minor medical procedures we can all expect to endure. The beneficiary is generally responsible up to the level of the deductible, at which point something close to traditional insurance coverage would kick-in. In most cases, employers, rather than making premium payments on behalf of their employees as part of their compensation, would make equally tax-free contributions to the employees' savings account. These funds, if unused at the end of a given calendar year, would rollover, tax free, as savings for the employee. In fact, such products are already in existence, having been created by the Medicare Modernization Act of 2003. They are called health savings accounts (HSAs). Think of it a bit like a health care 401(k) and you will get the idea.

And just what is that "idea?" People will come to think of this money, which would have been squandered on insurance premiums whether or not they used any health care at all that year, as their own, and rightfully so. That being the case, they are more likely to be prudent consumers and less likely to fall victim to the moral hazard problems posed by the supermarket example. Remember Milton Friedman's famous axiom: no one spends someone else's money as wisely as they spend his own.

But is this idea really all it's cracked up to be? Some swear by it, others decry it as social Darwinism at its worst. Reasonable people on either side will likely agree however that the answer sits somewhere in the between. It is neither the end of the "progressive" world or a panacea.

Among the most recent critics have been Dahlia K. Remler and Sherry A. Glied, two exceptionally intelligent professors at respected institutions. Their major concern, according to a 2006 article in Health Affairs is that CDHC-oriented plans, such as HSAs, would fail on their promise of increased cost sharing and thus render their ability to improve consumer price-sensitivity null. The basis behind the charge is that, once the deductible is met, even though it may be far larger than traditional insurance options, patients fall immediately back into the traditional FFS system where there is little cost consciousness and no incentive for prudent consumerism.

This criticism does indeed have some teeth to it, but it makes a fundamental omission in reasoning: although policy-holders might fall back out of cost-consciousness after they have reached their deductible, the average individual does not reach that mark on a yearly basis and thus is able to save money from year to year, improving their ability to self-insure in future years. Furthermore, up to the point of the deductible, the policyholder is still in the driver's seat, so to speak, and as such is in a position to make more prudent decisions with the funds involved than they might have been otherwise.

Such an enthusiastic defense may not yet be warranted however in light of further evidence. Melinda Buntin, et al. acknowledge that demand for CDHP plans is in fact growing, although moderately. Keeping that in mind, there is evidence of "modest favorable health selection and early reports that [such plans] are associated with both lower costs and lower cost increases. The early effects of CDHC on quality [, however,] are mixed, with evidence both of appropriate and inappropriate changes in care use. Greater information about prices, quality, and treatment choices will be critical if CDHC is to achieve its goals."

Surely this assessment is not quite a blank condemnation of CDHC, but the methods of analysis used in the study deserve some scrutiny. The paper, for all its worth and diligent research, does not endeavor to discuss the problems that CDHC advocates set out to solve. The Buntin paper, unfortunately does not even seem to acknowledge that health care, just like other goods and services, must be rationed in one way or another, the two most popular methods of course being administratively and via price, a grievous economic error. As Goodman points out: "Because [the authors] do not acknowledge that scarce resources must be allocated among unlimited wants, they do not compare price rationing {which, after all, is an essential ambition of CDHC}* with other rationing schemes."

Irrespective of one's political ideology or desires for empirical outcome, it surely a shortcoming of any research to neglect the basic tenets of the movement you seek to explore.


Both economic and empirical wisdom make it clear just as to why our health care system is as sick as it is, what the costs of that sickness are, and what our treatment options are. Unfortunately, that is really the shore at which we as researchers are forced to stop. We provide the data we can, but the future now lies firmly in the realm of politics.

Will we continue to insulate ourselves from costs, believing health care to be a fundamental human right, restricting costs administratively [i.e. rationing access to care]? Or, will we continue in our tradition of looking to the free-market, the sovereign individual, as the most efficient vessel of change and progress? Only time will tell, but the ultimate decision will rest on all of our shoulders for generations to come.