The Becker-Posner Blog

Health Care Reform-BECKER

The American system of health care has many attractive features, and the evidence indicates that Americans of all ages greatly value the large increase in life expectancy and the health quality of life that occurred during the past several decades. In addition, many persons from other countries in all parts of the world come here for advanced medical treatment, while few Americans find it worthwhile to go abroad to treatment. But this system is also the most expensive in the world as both per capita health spending and the fraction of GDP spent on health are larger than in any other nation. Fortunately, many of the problems in the health system are correctable with the right policies. I believe the three most important defects are the over 40 million Americans who are not insured, the weak incentives to economize on unnecessary medical spending by most people covered by some form of health insurance, and the tying together of health insurance with employment as a result of special tax privileges provided to employers. Arguably the best parts of President Bush's State of the Union address are his suggested reforms in the health care system. They do not fully attack all the problems, but they do offer significant improvements. I will concentrate particularly on his proposals to extend Health Savings Accounts (HSAs), and to improve the portability of health insurance when workers change jobs. HSAs were introduced in 2003 to help consumers pay for non-catastrophic health care, and to give them financial incentives to economize on unnecessary medical expenditures. The law allows contributions to these accounts of up to $2700 for individuals and $5450 for a family, as long as their contributions are not greater than the deductible on their health insurance, which is required to be at least $2100 before a person or family is eligible to open such an account. The number of persons with high deductible health insurance has increased rapidly to about three million persons since HSAs were introduced, and some estimates indicate that over one million persons have an HSA. If a company provides employees with an HSA, the company can deduct the amount they contribute each year from its reported taxable income. Employees do not have to report as taxable income either their employer contributions or their own contributions. As a result, the number of companies offering health savings accounts to their employees has been growing rapidly, especially among larger companies. The well-known companies that offer these accounts include Wal-Mart, Microsoft, General Motors, and Daimler Chrysler. Companies are attracted by health savings accounts because of their ballooning spending on the medical care of employees. During the flush times in the past, companies like GM offered health insurance coverage that often had minor or even no deductibles. They discovered much to the damage to their balance sheets that employees can find many frivolous ways to spend money on medical care when they do not bear any of the cost. And since employees have become accustomed to this "entitlement", it is hard to raise co-payments when negotiating with unions. So many companies have started offering HSAs in the few years since the present law took effect. Individuals who take out health savings accounts on their own are at a disadvantage compared to employees since individuals have to contribute after-tax dollars to their accounts. Other tax advantages are common to both individual health savings accounts and those provided by employers. The amount contributed in any year does not have to be spent during that year on medical care, but can be carried over to future years. This distinguishes HSAs from flexible-spending accounts, where contributions in any year have to be spent in the same year. The balance in a health saving account can be carried over to later years without paying any taxes on it, or on the interest earned on these balances. After age 65, dollars in these accounts can be also spent on non-medical items without penalty, but this spending is treated as income and is subject to income taxes. The President proposed several highly desirable reforms in the system of health savings accounts. Perhaps most important, individuals setting up an HSA on their own would also be allowed to deduct their annual contributions before reporting their income for tax purposes. Since this eliminates one major advantage of employer-based HSAs over accounts set up by individuals, it is an important step in the right direction of leveling the playing field between individual and employer-based health insurance. This change, if adopted by Congress, would reduce the number of persons without any type of health insurance. For many of them have jobs at companies that do not offer health plans, and they feel the premiums on insurance that they can take out on their own are too high. The proposed exclusion of contributions to an HSA from taxable income would encourage some of these uncovered individuals to buy insurance and set up an HSA. This would reduce a glaring hole in the American approach to health care. President Bush also proposed raising the ceiling on how much might be contributed each year to a health saving account by tying the limit to the annual deductible in an health insurance policy. This gives families and individuals even greater incentives to economize on their less essential medical expenditures. After all, the purpose of insurance, health or otherwise, is to protect against very large outlays, not against outlays that are more or less expected year in and year out. Of great importance, Bush also proposed allowing companies to offer employees portable health savings insurance that they could take with them if they change jobs or retire. A major defect in the employer-based health insurance that the United States has relied on since World War II is that employees may lose their company-based private health coverage when they become unemployed, when they retire, or when they change jobs to one of many companies without health insurance plans. Studies show that this lack of "portability”"of health insurance coverage reduces job turnover, and makes the American labor market less flexible and efficient than it could be. Indeed, under the present system, virtually the only way people can be reasonably assured of continued health insurance coverage is by remaining throughout their working career with stable employers that offer health insurance. This “"ock-in" effect is undesirable in a dynamic economy where good jobs open up in growing industries, and opportunities in declining industries dry up. In contrast to employees who continue coverage by remaining with the same employer, individuals with their own health insurance plans sometimes lose coverage after contracting a serious illness, or by making too many claims. For various reasons, it is not possible for individuals to buy long-term health insurance, although what they want is protection against future major medical expenditures since it is uncertain how healthy they will be when they get older. Bush's proposal to allow employers to offer portable HSAs is an important step toward providing such longer-term coverage for the many men and women who do not continue to work for the same employer, or who want to maintain their health insurance plans after retirement. If the ceiling on how much can be placed in these plans is raised to high enough levels, HSAs could cover all but the medical claims induced by major illnesses. Under present rules, individuals can have a health saving account only if that is combined with a catastrophic health insurance policy. The President also proposed offering up to $3000 in annual tax credits to help low -income families buy health insurance if they also set up a health savings account. Since tax savings are much less important for lower income families, tax credits seems to be the appropriate way to give poorer families greater incentives to economize on their medical spending. It could also reduce the number on Medicaid since lower income families might prefer to get the tax credit and buy their own health insurance combined with a health savings account. President Bush has proposed changes in the health care system that initially will reduce tax collections and increase federal spending at a time when the US government is already spending too much and running a sizeable budget deficit. However, by making the health delivery system more efficient, this important set of proposals in the State of the Union address might end up raising tax collections, and certainly would improve the efficiency of the American economy. \

Reform of the Health Care System--Posner's Comment

President Bush has proposed a number of incremental improvements in the regulation of health care, and, as Becker explains, they seem desirable. Incremental improvements are doubtless the only ones that are politically feasible until crisis hits. But I would like to examine the issue of health care reform from a more fundamental, though less practical, angle. Generally, economists believe that the supply of products and services should be left to the market unless there are significant positive or negative externalities. If some people are too poor to be able to buy a minimum market basket, they can be subsidized out of tax revenues, as by a negative income tax, but still left free to choose what to buy. So what is special about medical care? The primary answer is that our society does not permit people to be denied medical care (for other than trivial complaints) merely because they can't pay for it. They may not be poor; it may simply be that they didn't buy health insurance because they were gambling on staying well, and now a major medical problem has hit them and they can't afford to pay for treatment. If these forms of "free riding" are thought to present a serious social problem, they could be mitigated by making the purchase of health insurance compulsory, with the premiums for poor people being paid for by the government and with every insurance policy being required to contain a major-medical component to prevent underinsurance that would enable the gamblers to shift the costs of a major medical problem to the government. People with such dreadful health prospects that they, though not poor, could not afford to buy health insurance could be placed in an "assigned-risk pool" and distributed among the insurers, who would not be permitted to charge more than some fixed maximum rate to the assigned (poor) risks. Health insurers would compete to reduce premiums by adopting policies, such as generous deductibles or copayments, that encouraged the policyholders to economize on their demand for medical services. I don't think the problem of the free-riding patient is a very serious one, however, because people who don't have insurance don't get the best (and most expensive) treatment and because most people don't demand medical care unless they have a serious need for it; many people have a horror of doctors and hospitals. The basic reason why so much money is spent on medical care in the United States is that people attach a very high value to their health. The frequent complaint that 15 percent of GDP is "too much" to spend on health care is superficial. When 80 percent of the average family's budget was spent on food, no one thought that this signified a "market failure" in the food industry. There are problems of information in health care, as in many markets. Greater use of performance measures for hospital and doctors would reduce those problems, and digitization of medical records, which is now under way, will increase competition among health care providers. The tax burden of government health programs is a matter of concern. There are several measures, though none at present is politically feasible, that would reduce that burden. One would be to eliminate all tax deductions for medical care. Another would be to reduce federal funding of medical R&D. This measure, combined with reducing patent protection for drugs and medical devices, would have the effect of slowing the rate of technological advance in the medical industry. Such slowing would reduce the amount of money that the government spends on Medicare and Medicaid because once an expensive new technology is developed, it is impossible for the government (or insurers for that matter) to refuse to make it available to charity patients. (I do not suggest eliminating federal funding of medical R&D altogether, just as I do not suggest eliminating patent protection for drugs and medical devices altogether. Both basic and applied research generate positive externalities that justify government support, which in the case of basic research takes the form of direct subsidy and in the case of applied research of patent protection.) Another measure would be to repeal Medicare. Medicaid would remain available for the indigent; and the "assigned-risk pool" device could be used to spare the nonpoor the crushing burden of a major medical problem. There is no reason the taxpayer should pay for the medical care of elderly people who can afford to pay for it themselves. Finally, an efficiency measure worth considering would be to reallocate federal funding of R&D from diseases that afflict mainly elderly people, such as most cancers, and from diseases avoidable by behavioral modification, such as AIDS, cirrhosis of the liver, and most Type II diabetes, to diseases that are not avoidable by changing behavior and that afflict mainly children and young adults. Such a reallocation would reduce net medical expenditures and also increase productivity.

On the Economy and Hamas-BECKER

Just one comment related to the role of economic factors in Hamas' retaining power. It is of course quite possible that Hamas would try to put an end to further elections, but that would fail unless it either greatly weakens Fatah or they shared power. Still, my post and Posner's emphasize that one election is not democracy, and time will tell whether free elections will continue. The Palestinian people being ruled by Hamas are very poor with rampant unemployment and with out migration of the most talented. Hamas could possibly replace the one and half billion dollars or so received in aid from other Arab nations, Europe, and the US. Venezuela and Iran alone could give that much, and rich Saudis might also continue to provide generous assistance. But even twice that amount would not be enough to generate any significant economic improvement in the lot of the typical Palestinian family. The government has to encourage or allow sustained economic progress to accomplish that. I do not see how that is possible, nor are there any historical examples in modern times where that has occurred, without investing in and retaining productive human capital, and encouraging trade in goods and physical capital with other nations. Can Hamas achieve that while maintaining the destruction of Israel as its primary goal? I think not. So Hamas can highlight its opposition to the existence of Israel, or it can push that into the background, and try to promote economic progress of the Palestinian people. I am not sure which path they will choose, but I believe the probability that they will elect to promote economic progress is being greatly underestimated.

Hamas Victory--Posner Reply to Comments

Several comments accuse Becker and me of neglecting the importance of institutions. I don't think this is an accurate accusation. Of course just drafting a constitution or laws creating rights to free speech, etc., is not enough to create a liberal democracy--you need media, courts, police, etc. That goes without saying. My point was only that democracy is not enough; that a nation needs rights as well. A very interesting question raised by several comments is whether the Palestinians who voted for Hamas were behaving "rationally." On the one hand, Fatah was corrupt and inefficient; on the other hand, Hamas by its extremism and lethal antagonism to Israel could easily bring complete disaster on the Palestinians. I don't think the issue is rationality; it is information. In situations of great uncertainty, the error rate is high. It is easy to point to electoral outcomes, even in nations such as the United States that have a highly educated population and a long history of democratic politics, that in retrospect were clearly mistaken. But I agree with those of you who suggest that redistributive policies, for example those championed by Hamas, have particular appeal to an unsophisticated eelctorate, which doesn't understand the downside of such policies in retarding economic growth. It was certainly a weakness of my post not to say anything about the religious element in Hamas's victory. I wish I had something to say about the causes and cures of religious zealotry. The one thing that is clear about Islam is that its votaries take religion more seriously than any other body of religious believers. This has profound political implications, but I do not know of any satisfactory analysis of the underlying phenomnenon. I completely agree with those commenters who say that democracy is not a panacea, that it is compatible with cruel and aggressive policies (with many illustrations from U.S. history). Remember that I'm a Schumpeterian; to me, democracy is simply the system in which the rulers stand for election at frequent intervals. Such a system tends to align policy with public opinion, but there is no reason why public opinion can't be exploitive, discriminatory, etc. What does seem true is that democracy, plus rights, provides a good framework for prosperity, and that a prosperous country is unlikely to initiate a war, because commercial values tend to be antagonistic to martial values. "Unlikely" is an important qualification. A democratic country such as the United States, which has been thrust into an "imperial" position, becoming the "world's policeman," is liikely to be involved in frequent military operations, some of which it will have initiated. But if democratic countries are indeed unlikely to go to war, then two democratic countries are very unlikely to go to war with each other.