The Becker-Posner Blog

Does Medical Care Cost Too Much in the United States? Posner

A New York Times article of June 1 called “Paying Till It Hurts,” www.nytimes.com/2013/06/02/health/colonoscopies-explain-why-us-leads-the-world-in-health-expenditures.html?pagewanted=all&_r=0, by Elisabeth Rosenthal, presents disturbing data concerning prices of medical procedures in the United States relative to the prices in other wealthy countries. The article reports that the average price of an angiogram is $914 in the United States and $35 in Canada, of a colonoscopy $1185 in the United States and $655 in Switzerland, of an MRI scan $1121 in the United States and $319 in the Netherlands, of a hip replacement $40,364 in the United States and $7731 in Spain, and of Lipitor (probably 90 mg., although the article doesn’t state the quantity) $124 in the United States and only $6 in New Zealand—a greater than 20 to 1 difference.

 

This is not actually the correct way to compare U.S. and foreign prices: picking a different nation to compare the United States with for each procedure. For what if (for example) in Canada though the average price of an angiogram is very low the average price for a colonoscopy is very high? Nevertheless the comparisons are illuminating, and are consistent with the fact that the United States devotes some 18 percent of GDP to health care, twice that of most other countries. (The second most expensive nation for health care is Switzerland, which spends 12 percent of its GDP on health care.) The significance of the article is that it plausibly assigns much of the cost differences to higher prices for standard medical procedures and excessive use of those procedures, rather than to demographic differences, such as greater inquality of income in the United States than in the other wealthy nations of the world, let alone to higher quality of U.S. medical care. 

According to the article, the difference in cost between the U.S. and the foreign medical procedures is unrelated to quality but has a lot to do with the fact that the foreign countries regulate the price of medical procedures and the United States does not. The difference is between a regulated and a free market, and the free market does not show up well in the comparison. It is not just the bottom line—the relative costs—that illuminates the difference, but the competitive practices that the article describes that, together with absence of price regulation, may explain the difference. 

Free-market competition is supposed to optimize quality and price; if quality is the same, price should be lower under competition than under regulation. Quality includes availability. A traditional and well-documented complaint about price ceilings is that they create shortages, resulting, in the medical sphere, in long and potentially dangerous delays in treatment. But at least if the Times article is to be believed, the longer delays in foreign countries (if they are longer, which the article doesn’t discuss) do not result in poorer medical outcomes.

The evidence of market failure in our medical care system is reinforced by data presented in the article of large price differences for identical procedures in the same U.S. states, and even in parts of the same state, southern California for example, where according to the article a colonoscopy costs on average $2041 in San Diego and $5559 in Los Angeles.

It appears that in a market in which buyers have poor information, in part because the products and services sold in the market are highly technical and the market itself is pervaded by uncertainty and its products and services are constantly changing and being reevaluated and discarded or improved, and in which extensive private and public insurance obscures prices, and in which on top of everything the consumption decision is often blurred by pain and fear, a private, unregulated market does not operate efficiently. Of course there is government regulation of the U.S. health system, but it is nothing like the public-utility type health regulation found in most other countries. There is in the U.S. regulation in the form for example of malpractice liability, but malpractice liability doesn’t deal with overpricing or (with rare exceptions) unnecessary procedures. Medicaid sets tight payment limits, but Medicare, for most medical procedures, does not—for fear that too many physicians will stop taking Medicare patients. 

There is an approach to inefficiently competitive markets that is in between regulation or nationalization (as pioneered by the British national health service), on the one hand, and free-market competition on the other. It is the professional model of providing services, about which Becker and I blogged on December 10 of last year, as distinct from the competitive, or business, model. In the professional model, which is the traditional model in which health services like legal services used to be provided, which persists to some degree, but which is rapidly giving way to the competitive model, the physician or lawyer in effect trades the very high incomes earned by those who succeed in business for a reduction in financial risk, brought about by legal or ethical restrictions on competition. With lower rewards for engaging in sharp practices, those practices, involving exploitation of consumers in markets pervaded by consumer incompetence, can be expected to be less frequent.

The professional model can thus, in principle anyway, enhance market efficiency. For example, in a medical system governed by the professional model, physicians’ incentive to establish “surgical centers” in their offices in which to perform colonoscopies for which they can charge much higher prices, though there is no need for such centers, is weakened, because physicians imbued with the professional model do not think of themselves, or behave, as profit maximizers. 

The professional model remains dominant in career government service, where employees are salaried and have secure tenure, thus trading the possibility of a much higher income for job security and the benefits, which are not merely financial, that come with it, such as not having to compromise ethical standards to succeed. In contrast, free-market competition is Darwinian: the presence of rapacious and unprincipled competitors will often limit the ethical options of the other firms in the market, and of their employees. 

The outstanding example of the professional model of medical care in American government appears to be the provision of medical care to veterans, in VA hospitals and medical centers. VA physicians are salaried government employees. A number of studies, including a study by the RAND Corporation, have found that the medical care provided by the Veterans Administration is superior to private health care and costs less. See Arthur L. Kellerman, “’Socialized’ or Not, We Can Learn from the VA,” The RAND Blog, Aug. 8, 2012, www.rand.org/blog/2012/08/socialized-or-not-we-can-learn-from-the-va.html. Although there is no reason in principle why the professional model should be limited to government employees—and traditionally it was not—it may be that the competitive model has made such inroads in medicine that the professional model cannot survive in the market. It may be worth considering whether the VA model can be extended as part of an effort to improve health care in the United States and at the same time reduce its cost.

Medical Competition and the Cost of Medical Care-Becker

Patients in the United States pay considerably more for standard medical procedures, like colonoscopies or mammograms, than do patients in Switzerland, Germany, and other rich countries. One important qualification is that international comparisons of health costs, as in the New York Times’ article referred to by Posner, do not adjust for differences in quality of treatment, such as quickness of access to the procedures, speed of reporting the results, and so forth. The US does better on some of these quality dimensions, but probably patients pay more in the US even after adjustments for the quality of treatment.

The health care delivery system in the United States is based on strong competition among private physicians and not for profit hospitals. Although a full consideration of why procedures are more expensive in the US would require the analysis of many factors, I will concentrate my discussion on whether this competition among physicians and hospitals is an important factor raising the cost of procedures.

As Posner indicates, the great majority of patients have only limited knowledge about the procedures they need and the quality of physicians and hospitals. Doctors and hospitals interested in increasing their revenues can sometimes take advantage of this consumer ignorance by suggesting expensive procedures and medical treatments that are not warranted. This incentive to push for excessive treatments may be stronger in the US because physicians and hospitals’ incomes in the US are more closely related to the cost of treatment than in most of Europe and Japan.

However, most American consumers of medical care, even when ignorant of the treatments they need, have some protection against excessive medical care. The federal and state governments through Medicare and Medicaid pay over 35% of total spending on medical care in the United States. The American government officials involved in approving payments for different procedures have no more financial interest in approving excessive charges for different treatments than do officials in other countries.Medicare and Medicaid do get lower prices for different procedures than most private insurance companies because the government can use its economic power in the health market to get better prices.

About 55% of Americans, 68% of employed persons and another 1/3 of those without jobs are covered by employers’ health insurance. The tax deductibility of their health care costs gives employers an incentive to increase the extent of the coverage provided employees, and reduces their incentives to increase co-pays and other costs borne by employees. This distortion in incentives to keep down health care costs is not caused by competition in the health care sector, but by the tax treatment of employer spending on health care. The Affordable Care Act reduces the tax advantage to employers of more expensive health insurance plans-the so-called “Cadillac” plans-presumably because of the belief that these plans allow treatments and other medical care that are not necessary and too expensive.

Still, even when their spending is tax deductible, employers have the same financial incentive to reduce their spending on expensive medical care as they do in lowering other costs that are tax deductible. They try to reduce health costs by the type of health insurance coverage they provide employees. The larger firms also hire knowledgeable specialists on health care that are informed about what kinds of treatments are useful for different medical problems and what they should cost. They also try to educate their employees about healthy eating and other behavior. Employers help themselves while protecting their employees against redundant and expensive treatments and care suggested by physicians, clinics, and hospitals.

Even consumers ignorant of their health care needs have an incentive to reduce their medical spending because they have to pay health insurance premiums and out of pocket payments for medical care. Yet one problem with the American health care delivery system is that it has much lower co-pays than many European countries; out of pocket spending on health care is only about 11% of all US spending on health care compared to, for example, over 30% in Switzerland. This means that American patients have much less incentive to economize on their health care spending than do the Swiss.

I am not arguing that the American system of health care is ideal or efficient, or that it does not allow for excessively expensive procedures and other treatments. I am suggesting, however, that strong competition among doctors and hospitals is not the major reason why the US spends much more on health care than do other countries.

 

 

Reform of the Tax Code-Becker

The federal tax code is a mess from any economic perspective. It is not efficient, fair, or clear. A complete set of suggestions to improve the tax system would take hundreds of pages, as did the excellent 2005 Report of the President’s Advisory Panel on Federal Tax Reform. My discussion will concentrate on a few of the needed changes that would help stimulate a more efficient and faster growing American economy.

A major priority is to eliminate taxes on savings and investments. One reason is that they involve double taxation since personal and corporate incomes are first taxed, and then the returns on the savings and investment out of these incomes are taxed again later on. A second even more important problem with taxes on savings and investments is that in the long run they are shifted to labor because these taxes lower after-tax returns, and thereby discourage investments. A lower rate of investment slows down capital accumulation, which leads to a lower ratio of capital to labor. Wages are lower and pretax returns to capital are higher when the capital/labor ratio is lower.

Moreover, the present system taxes different forms of saving and different types of investment goods at different rates. This distorts the allocation of investments among investment categories. For example, depreciation tax rules allow durable capital to be depreciated more slowly than less durable capital, which lowers the relative tax rate on more durable capital. Similarly, savings that enter tax-free IRA or Roth accounts are taxed less heavily than other forms of savings.

One way completely to eliminate taxation of investments is to allow all investments to be written off immediately as expenses instead of being depreciated over time. Taxing only earnings would eliminate double taxation of savings.

Expensing investments and taxing earnings moves the income tax code a long way in the direction of a tax on consumption rather than on incomes. The basic efficiency advantage of consumption taxes is that they do not distort the decision to consume now rather than consume later since the returns on savings and investments are not taxed. By contrast, income taxes do distort this decision since they tax the incomes earned on savings as well as the incomes that led to the savings.

Whether ones moves to a consumption tax or not, taxes should be simpler and flatter because that would reduce the large cost of tax compliance, and encourage greater investment and work effort. A reasonable proposal that would maintain progressivity yet have a much flatter tax structure would be to have only two or three tax rates, such as 20%, 25%, and 30%. The 20% rate would apply to incomes below a certain threshold, 25% would be the rate on incomes above this lower threshold until an upper income threshold, and 30% would be the tax rate on all incomes above the higher threshold. The tax rate on low labor market earnings would be even less than 20% if the earned income tax credit on low earnings were retained. This credit encourages poorer individuals to enter the labor force rather than staying out to become eligible for various welfare benefits, such as food stamps, unemployment compensation, and housing subsidies.

The income tax base should be widened both because that would be more efficient, and because a wider base would also help maintain tax revenue as rates are flattened, and taxes on savings and investments are removed. For starters, the deductibility of mortgage interest should be eliminated because that artificially encourages investments in home ownership relative to investments in other forms of capital. This deduction also favors higher income families since they are more likely to itemize deductions, and they have higher marginal tax rates. If it were too difficult politically to eliminate this deduction, a big improvement would be to allow a tax credit to all homeowners equal to a fraction of their mortgage interest payments. There would be an upper bound to the amount of interest payments that could qualify for the tax credit.

The exclusion of interest on state and local bonds from income taxes should be abolished because that artificially encourages spending by these governments relative to spending by households and businesses. Since higher income individuals hold the vast majority of state and local bonds, this tax exemption also favors higher income persons in an undesirable way.

The tax on business cash flow (net of investment outlays) should be aligned with the proposed flatter personal income tax structure by lowering corporate and partnership tax rates to the proposed maximum tax rate on personal income, say 30%. Doing this, and taxing business cash flow net of investment deductions, would integrate the business tax into an overall consumption tax.

I discussed the most needed reforms, although other reforms are also desirable-many are considered in the report mentioned above on federal tax reform. Unfortunately, major reforms do not have much chance of enactment in the present political climate, but they are longer run goals that should appeal to both Democrats and Republicans.

Tax Reform—Posner

There is a good deal of dissatisfaction with the federal tax system (the state and local systems as well, but I’ll confine my attention to the federal). Most proposals for reform, however good in theory, are totally impractical from a political standpoint. But since politics is volatile, there is value to evaluating such proposals in order to lay a foundation for future reform. 

A tax can be evaluated along four dimensions: cost of collection, allocative effect, revenue effect, and distributive effect. Let me by way of illustration evaluate the Obama Administration’s proposal to raise the marginal income tax on couples with taxable income of at least $250,000 a year from 35 to almost 40 percent and to increase the tax on capital gains and dividends from 15 to 23 percent (the 23 percent including a new tax imposed by the Affordable Health Care Act). But I will confine my consideration to the increase in non-capital-gains and non-dividend income. 

The cost of collection is likely to increase slightly because a tax increase increases the return to tax avoidance. The increase could also cause a substitution of leisure (which is not taxed) for work; that would be the allocative effect. I am skeptical that an increase even of 14 percent (5/35) would have a significant such effect, given a possible offsetting income effect (taxpayers working harder to maintain their standard of living). Income tax rates have varied greatly over the history of the United States without seeming to affect economic growth, though so much else is happening at the same time that isolating the effect of a tax increase or reduction is very difficult, maybe impossible, to do. The higher tax would increase federal tax revenues and reduce after-tax income inequality (the distributive effect). Given growing income inequality, which seems to be having bad effects particularly on children, and the large federal deficit, the proposed increase in income tax may be a good idea, especially given the political infeasibility of the alternatives. 

One of those alternatives would be a federal value-added tax, which is essentially a sales tax but a sales tax imposed at every level of distribution rather than just at the retail level. Such a tax generates large revenues at a low cost of collection, and operates as a tax on consumption and therefore encourages investment. It also increases income inequality, but its revenue potential is such that federal expenditures on wealth redistribution and social welfare benefits could be significantly increased. However, such a tax is politically infeasible, in part because of conservative concern that it would enable a significant increase in the size of the federal government. 

The corporate income tax is criticized as penalizing investment, because it taxes the income generated by corporate investment twice—first at the corporate level and second when corporate earnings are distributed to the corporation’s shareholders in the form of capital gains or dividends. And penalizing investment reduces economic growth, which depends on investment. But the corporate income tax is so riddled with exceptions and opportunities for avoidance that it accounts for only 8 percent of total federal tax revenues. If the tax were abolished, some other federal tax would have to be increased. 

Or would it—the alternative would be to broaden the tax base, so that the same or even a lower tax rate generates the same or even greater tax revenues. Broadening the tax base mainly means eliminating or reducing deductions. The most popular target is the home-mortgage interest deduction. It is an absurd deduction, based on the silly premise that owning a home generates positive externalities: improved maintenance of residential property and enhanced sense of commitment to the community. All residential ownership does is reduce job mobility by increasing relocation costs and delay. But it’s a sacred cow. 

The charitable deduction is questionable as well; charitable deductions reduce the demand for certain government services, but involve a great deal of duplication and administrative expense, and would probably decline only modestly if the deduction were removed. But again it’s a sacred cow, though in the case of both the morrgage-interest and charitable deductions a reduction in the size of the deduction permitted may be feasible. 

Regulatory (“Pigouvian”) taxes should not be ignored. They are intended to alter behavior rather than to generate revenue, but invariably they generate some, and often a great deal, of revenue. We desperately need a heavy tax on carbon emissions, which pose a great long-term threat to the economy; and undoubtedly such a tax would generate substantial revenues. As would an increase in federal gasoline tax, which would reduce both carbon emissions and traffic congestion. 

Given political resistance, the practical feasibility of substantial tax reform is very limited. But at least a modest increase in federal income tax rates seems a politically feasible as well as economically defensible response to the need to increase federal revenue to cope with the fiscal deficit.

Abenomics and Japan’s Stagnation-Becker

During the past 17 years, Japan has experienced sizable deflation; for example, the GDP price deflator declined on average by about 1% per year since 1995, and it declined during the past couple of years by 2% per year. Since many wages and other prices cannot be adjusted downward very easily, deflation tends to distort labor and other markets. To end deflation and stimulate the Japanese economy, Prime Minister Shinzo Abe has introduced a set of policies called “Abenomics”.

These policies have “three arrows”: massive fiscal stimulus, aggressive monetary policy a la the Federal Reserve’s QE’s 1-3, and improved competitiveness of the Japanese economy. It will take many years to greatly improve the competitiveness of the Japanese economy, so for the next few years Abenomics has to rely only on fiscal stimulus and aggressive monetary policy.

Given that Japan’s ratio of debt to GDP is already the highest in the world at almost 2 to 1, Japan can hardly do much more in the way of fiscal stimulus without creating an even larger debt burden. The debt/GDP ratio has reached such a high level because fiscal stimulus was the main weapon used to try to jumpstart the Japanese economy during the 1990s and early part of this century. This policy was basically a failure since large fiscal deficits did not prevent the Japanese economy from growing slowly, and they did not prevent consumer and asset prices from consistently falling.

Short-term interest rates in Japan have hovered near a zero nominal rate during the past 20 years, partly because of the fiscal and other efforts to stimulate the Japanese economy. Long-term nominal rates have also been quite low. Abenomics wants the Central Bank of Japan to start purchasing bonds and other assets on a large scale with the intent of both lowering real long-term interest rates further, and greatly increasing bank lending and the money supply. Increased bank lending and a greater money supply would likely end the many years of deflation and cause prices to rise, with a goal of a 2 per cent annual increase in prices.

The hope is that lower long-term interest rates and greater availability of credit will also stimulate investment and innovation, and thereby increase the growth rate of the Japanese economy on a sustained basis. Lower real interest rates are also expected to reduce the value of the yen in international markets by making Japanese bonds and other assets less attractive to world investors. A lower real value of the yen-that is, lower after adjustment for the increase in Japanese prices-would increase consumer demand in other countries for Japanese exports.

Will Abenomics, and its main manifestation in more aggressive buying of assets by the Bank of Japan, succeed in increasing the economy’s growth rate? Japan is trying to copy the Fed’s large-scale asset purchases in the Fed’s efforts to limit damage from the financial crisis, and get the American economy rolling again. The Fed’s actions have had 3 stages: QE1, introduced during the early days of the crisis, attempted to prevent the American economy from slipping into a very serious depression. QE2 and QE3 were implemented after the American economy was in a major recession, and they were designed to reduce unemployment and increase the growth rate of American GDP.

Most economists, including myself, believe that QE1 was extremely important in providing liquidity to the American banking system at a time when liquidity was in scarce supply. But I have many doubts about the efficacy of QE2 and QE3 that further increased bank reserves, and lowered long-term interest rates even further. Although the evidence on the effects of these Fed actions is not conclusive, despite the aggressive actions the recovery of the American economy has been slower than in any previous recession. More than 4 years after the crisis erupted, unemployment is still about 7 1/2 % (compared to under 5% before the crisis), and the growth rate of GDP is still far below its long-term growth path.

Japan is not in a financial crisis, so the success of QE1 in providing liquidity to banks is not very relevant. Expansive monetary policy by Japan is likely to end its deflation and lead to price increases. That is the good news. The bad news is that the evidence so far on QE2 and QE3 is not reassuring that Abenomics’ monetary loosening will significantly raise the long term growth rate of Japan’s real GDP.

Should the European Union Emulate Japan's Inflationary Monetary Policy?—Posner

For many years now Japan has been plagued by deflation, which has retarded its economic growth; since 1981 the average annual growth of Japanese GDP has been only 2.1 percent. Deflation implies that the value of money relative to goods and services is rising, which reduces consumption (and hence production) by inducing people to postpone purchases in the expectation that prices will be lower in the future. Recently the Japanese central bank at the behest of Prime Minister Abe increased the volume of Japanese money in order to increase the ratio of money to goods and services, and thus change deflation to inflation. Inflation can induce a temporary spurt in consumption, but not a permanent increase; although Japan has announced a goal of 2 percent annual inflation, I assume the major goal of the increase in the money supply is to increase exports and reduce imports, thereby stimulating domestic production (both of exported goods, but also of domestic substitutes for imports made more costly by the devaluation since their prices in yen rise) and so consumption, employment, and economic growth, as well as ending deflation. In addition, an increased supply of money should reduce interest rates, thereby stimulating borrowing and so further stimulating consumption. 

Keynes urged devaluation of the pound against the dollar in the 1920s in order to stimulate the stagnant British economy, but the British Treasury refused because of Britain’s very substantial foreign investments, which would be worth less if the pound were weaker. Apparently no similar obstacle was interposed to the Japanese devaluation. 

It is not yet clear how effective Japan’s devaluation will be either in reducing deflation or in stimulating production and employment. The reason is that Japan has many very inefficient labor regulations, along with a very aged population (the Japanese people have the greatest longevity of any nation’s population), a combination that, by making for sluggish production and cautious consumers, depresses economic growth. The depressive effect may greatly limit the efficacy of the new policy. Abe wants to remove inefficient regulation, but the political obstacles may be formidable. 

Europe is suffering from protracted economic stagnation too, so the question arises whether it might benefit from emulating Japanese devaluation. The obvious objection is that the major European countries (except Britain) have the same currency, the euro, so that devaluation would not alter relative prices among the euro countries—and they are major trading partners of one another. Then too for such a large part of the world’s economy (roughly 20 percent) to devalue could well, depending on the size of the devaluation, induce retaliatory devaluation. 

For devaluation to stimulate economic growth without provoking retaliation from outside the euro bloc might require that the economically weakest European countries, primarily Spain, Portugal, Italy, Greece, and Cyprus, abandon the euro and then devalue the local currencies that would replace it. But for a nation to abandon the euro would be very difficult, because as soon as the abandonment was realized to be imminent, euros would flow out of the country to avoid the devaluation that would ensue from the replacement of the euro by a local currency, and because all sorts of legal and financial tangles would ensue from the fact that contracts in euro countries are denominated in euros. 

A devaluation of the euro, as distinct from abandonment of the euro by the economically weak European nations, would not involve these problems. And if it were a modest devaluation (modest enough to avoid retaliation by the United  States, China, or other leading non-EU nations), it would increase the weak EU countries’ exports outside the EU and reduce their imports from outside the EU, and thus strengthen the economies of the EU nations. The resulting spur to economic growth would reduce the rates at which the weak EU countries borrow, by reducing the risk of default, and so would reduce their fiscal deficits. 

Devaluation is no silver bullet, however. To minimize the risk of retaliation, it cannot be too great. if it is small, it is unlikely to overcome the drag on economic growth that anticompetitive labor and other regulations, heavy taxes, inefficient state companies, corruption, and waste impose on an  economy.