By John C. Goodman
Originally posted on Forbes, December 2015
The reason why the health care systems of developed countries are so dysfunctional is that most of the time patients are not spending their own money; they are spending someone else’s money. That means when they spend a dollar on health care, they have no incentive to ensure that they get a dollar’s worth of value in return. And, unlike a normal market, when the providers receive a dollar in payment, they have no incentive to deliver a dollar’s worth of value.
The health policy analysts assembled by the American Enterprise Institute are fully aware of these perverse incentives and in a new reform proposal they have an idea on how to correct them. Any assistance we get from government should be in the form of a fixed sum of money (a defined contribution) instead of a blank check to pay for a promised set of services (a defined benefit), regardless of what that might cost.
Let people make the marginal purchasing decisions with their own money, rather than with the taxpayer’s money. In the words of the AEI team:
Any federal subsidization of health care should take the form of defined contributions to support consumer choices in highly competitive open markets rather than defined benefits to control provider behavior in highly restricted captured markets. That subsidy would not vary based on a person’s choices of coverage or where they get their care. Those selecting more expensive options would pay for the added cost out of their own pockets. Those choosing low-cost, high-value options would pocket the savings, ideally in personal health savings accounts.
The authors have some interesting ideas on how to do this — in Medicaid, Medicare and in a reformed (ObamaCare) exchange. But (and here is a big missed opportunity) they ignore the single most wasteful violation of their principle in the entire health care system.
Roughly 150 million people – about half the entire population – get health insurance through an employer. And no matter how wasteful these plans might be, employers get to deduct and employees get to exclude from their taxable income every single penny that is spent. This means that employees can always lower their taxes by asking employers to spend more on health insurance instead of paying those same dollars in wages.
In a state like California, for example, less than half of the cost of more generous health insurance for Silicon Valley employees is paid for by the employees and the employers. The bulk of the expense is coming out of the pockets of taxpayers!
So what does the AEI propose to do about it? Nothing. Nothing? That’s right. Other than a kinder, gentler Cadillac plan tax, they leave half the population alone. More on this below.
In Medicaid, the authors point out that almost two-thirds of the spending comes from the federal government – with the amount varying by state and by year. That means that if the average state wastes a dollar, it only has to bear one-third of the costs. On the other hand, if a state saves a dollar, it only gets to keep one-third of the benefits. To correct these perverse incentives, the report calls for a block grant – a fixed sum of money that is independent of the state’s actual spending. As a result, state governments would reap 100% of the benefits of their cost-saving decisions and bear 100% of the cost of any wasteful decisions.
Although this idea is common in Republican health policy proposals, the authors break new ground with a proposal to individualize the block grant, resulting in a defined contribution for each enrollee. Furthermore, they propose to integrate this benefit with private sector insurance, so that enrollees do not lose coverage when they earn too much to qualify for Medicaid.[The report is somewhat simple on how this could be accomplished, but here is one idea. About two-thirds of Medicaid enrollees are already in private health plans. Let these plans also offer their product in the health insurance exchange – at least to those who are near the poverty level. That way, the Medicaid enrollees could remain in the same plan (but possibility receive a different fixed-sum subsidy) as their income rises and falls.]
In Medicare, about one-third of enrollees are enrolled in private sector Medicare Advantage plans and these plans receive a risk-adjusted, fixed-sum premium for each enrollee. Seniors can choose to be in (defined contribution) MA plan or in the (defined benefit) traditional Medicare. But the latter choice is the default for anyone neglecting to make a choice. The authors recommend randomly assigning enrollees to the two types of coverage – at a minimum.
Also, the authors recommend deregulating and modernizing both Medicaid and Medicare and introducing Health Savings Accounts into both programs. Both ideas are admirable suggestions.
As for the (ObamaCare) exchanges, the reforms are mainly those you may have already seen in the writings of James Capretta and Yuval Levin:
- There would be no federal mandates – either for individuals or for employers.
- People could buy insurance inside an exchange or outside of it, with the states choosing their own regulations.
- Everyone in the individual market would get a fixed sum tax credit for the purchase of health insurance. The credit would increase by age, but would not vary by income.
- People who have continuous insurance coverage could not be discriminated against because of pre-existing conditions, but this protection is lost (with a possible risk pool alternative) for those who try to game the system by remaining uninsured while they are healthy and buying insurance only after they get sick.
As I have pointed out before, making the government subsidy independent of income is a huge problem solver. If the exchanges do not have to verify income, virtually all the technical glitches the exchanges have had, and are continuing to have, would vanish. Also, enrollees would no longer have to guess their next year’s income and pay big penalties if they guess wrong.
As good as all these ideas are, there are three missed opportunities in the report.
First, there is no serious discussion of what happens when a high-cost enrollee leaves one health plan and joins another. Right now there is a race to the bottom in the health insurance exchanges, as health plans try to attract the healthy and avoid the sick through low premiums, narrow networks and high out-of-pocket payments – especially for life-saving, specialty drugs. That same race to the bottom will also emerge in the AEI market unless something is done to prevent it.
I don’t know how many times I have to say this. Perhaps it will sink in if I use capital letters. HEALTH INSURANCE MARKETS CANNOT WORK IF HEALTH PLANS CAN DUMP THEIR HIGH-COST ENROLLEES ON OTHER PLANS WITH IMPUNITY. Free market risk adjustment is the right solution. I have written about it elsewhere.
Second, as Mark Pauly and I pointed out 20 years ago, third-party health insurance and individual self-insurance (say, by means of a Health Savings Account) must be on a level playing field under the tax law. If one gets a deduction, the other must get a deduction. If one gets an exclusion, the other must get an exclusion. If one gets a tax credit, the other must as well. So wherever there is a defined contribution subsidy — as AEI recommends for Medicaid, Medicare and in the exchange – the savings account must be a Roth account. At the margin (beyond the subsidy level), people must pay premiums and make HSA deposits with after-tax dollars.
On the other hand, for employer-provided coverage — where premium payments are made with pre-tax dollars — deposits to HSA accounts must also be made with pre-tax dollars. So, roughly half the population should be using Roth HSAs and the other half should be using conventional HSAs.
That brings us back to a prior question and the third missed opportunity: why would we want to treat employer-provided coverage differently than the way we treat everyone else’s coverage?
The conventional wisdom in Washington is that it is politically impossible to change the employer system because big business and big labor will resist it. And that is certainly their knee jerk reaction to proposals for reform. But my own experience with labor and business leaders is that they become much more favorable once they understand that even groups with high-cost plans are better off getting their tax subsidy up front (covering the core insurance we want everyone to have) instead of at the (potentially wasteful) margin.
AEI would have done us all a great favor if they had explained how the tax credit could work at the place of work to almost everyone’s advantage