Health care is as frustrating an issue for politicians as it is important to the rest of us. We all know the complaints. At nearly 14 percent of gross domestic product, health care claims almost twice as large a share of the economy in the United States as in Britain or Japan and generally produces no better health results. And for all that money, the number of Americans with health insurance keeps falling. Since 1987, the share of Americans with health coverage, including Medicare and Medicaid, has declined from 87 percent to 85 percent, and setting aside government programs, the share with private health insurance fell from 75.5 percent to less than 71 percent.
Since Clinton-care flamed out, most politicians, including President Bush, have given up trying to solve the problem. That makes new proposals to ensure universal coverage from two presidential hopefuls, Dick Gephardt and Howard Dean, worth examining. (Click here to read William Saletan's "Ballot Box" take on how the two plans fit into the Democratic race.)
There are three ways of achieving universal coverage: Force business to provide insurance for everyone working; induce business to do it by providing big subsidies; or have government provide it. Gephardt's plan combines the first two: Every business would have to cover all employees and their families, and taxpayers would pick up 60 percent of the cost. Dean starts with a patchwork of all three approaches—extend Medicaid to lower-income working families and moderate-income young people, require that firms include dependents up to age 25 in their workers' coverage, and provide a fat tax subsidy to small businesses and any other individuals without coverage. Then he tops it off by withholding tax deductions and federal contracts from firms that don't provide coverage.
It's sensible to give business a leading role, since more than 60 percent of us are covered through work, and more than 80 percent of the uninsured live in households headed by someone working. One problem with Gephardt's plan is its price tag of $250 billion a year, much of it for subsidies to firms that already offer coverage. Dean's plan is cheaper but also more complicated to administer and operate.
The real problem for both is that they ignore the core economic issue: It's the rising cost of health care that has left some 41 million Americans without health insurance today. For the last 30 years, health-care costs have been rising 6 percent to 8 percent a year—more than double the inflation rate in the rest of the economy—because demand keeps outstripping supply. Moreover, the forces behind this exploding demand cannot easily be changed or affected. As people's real income rises, they expect more medical care; our society is aging, so people need more care; and with new technologies treating formerly intractable conditions, people want more care.
In practice, almost everyone, insured or not, has access to health care, especially in emergencies. Insurance affects how much people actually use health services: The access of the uninsured involves inconveniences and costs that encourage them to underconsume medical services, sometimes with grim results. By contrast, people with insurance often have such broad access that many overconsume those services. These consumption patterns drive the price increases that ultimately shrink insurance coverage. Still, it's hard to blame Gephardt or Dean for skipping past the cost issues, since every effort in the last 30 years to stem those costs—creating Medicare and Medicaid, wage and price controls, government threats of strict cost containment regulation, and the rapid spread of managed care—has failed. Anyway, who gets elected president by telling people that their health-care costs will soar so long as everybody has access to the most expensive forms of care?
The problem lies not in people's natural desire for the best (and most expensive) care, but in the way our health-care market operates—especially the weakness of the market forces that normally slow high inflation. That makes health care a prime example of what economists call "path dependency," where pivotal events from long ago shape a sector's development more than normal competitive forces. Health care's path began when employers in World War II, desperate to attract workers without breaching wage controls, first offered health insurance as an untaxed fringe benefit. This approach took strong root, because tax law requires that firms providing any tax-free form of compensation have to offer it to all their employees.
Over time, these beginnings brought most people into an insurance system that insulated them from the full cost of each treatment; they also left government as the insurer for everyone outside the work force, notably retirees and the poor. All insurance markets are subject to "moral hazard," where the small personal cost of using the insurance—a co-payment in this case—encourages people to overuse it for minor complaints. The hazard is intensified in the case of health care, because people don't pay for the insurance directly. To be sure, working people ultimately pay for their coverage in lower and slower-rising wages, but the cost of premiums is still subsidized by its tax-free treatment; and since employers write the checks for us, we don't even feel the pinch directly when premiums go up. (Imagine how much less coverage many would accept if we all had to write annual premium checks for $4,000 or $5,000.) These hazards are even greater in public-sector health care, where the retirees and poor people consuming most of the services don't bear most of the taxes financing them.
Individual costs are rising, but other forces continue to undercut greater price discipline. In most markets, for example, this discipline also depends on people having the information required to judge the value of goods or services before they buy them. In health-care markets, how many people have the information to say no to a more expensive test for diabetes or a treatment for a heart murmur? The norms of the medical profession are supposed to reduce this "agency" problem by aligning a doctor's incentives with a patient's medical interests (especially when the prospect of a malpractice suit reinforces these incentives). But there's no mechanism to align the financial interests of doctors and their patients. So doctors can deliver sound health services in ways that maximize their billings.
When prices rise unusually fast in other markets, people can usually find and substitute cheaper products: Beef prices rise and people eat more chicken, or a real-estate bubble drives up housing prices and people downsize their residential ambitions. That doesn't work nearly as well in health care, when patients are told that the alternative to a costly test or procedure is poor health or even premature death.
Finally, health-care inflation suffers from a classic "free rider" problem. Everyone has a common interest in moderating demand if it will ensure continuing coverage. But no one has an incentive to take the step alone, so no one does.
Despite all these problems, health-care inflation abated briefly in the mid-1990s when firms turned to managed care, which promised to reduce costs by rationing more expensive forms of treatment. A massive shift to managed care slowed health-care inflation to 2.5 percent a year for four years in the mid-1990s. But those savings mainly reflected the lower initial costs of HMOs (and their decision to take small profit margins to build market share). In time, the same factors driving up costs in fee-for-service medicine—personnel, technology, facilities—drove up HMO costs as well. By 1999, with more than three-fourths of privately insured Americans in managed care, health-care inflation was over 7 percent again. In 2001, with prices across the economy up less than 2 percent, hospital costs rose 8 percent, drug costs increased 16 percent, physician costs jumped 9 percent, and insurance premiums increased 10 percent.
There aren't any attractive alternatives—which is why politicians are so silent on the topic. Government price and wage controls would cut quality along with costs. A single-payer public system could ration care as such systems do in many other countries; that would put all of us in the position of the uninsured today, with waiting periods for everything but emergencies and limited access to expensive technologies. We could use prices to ration health services, for example, by requiring 50 percent co-payments; that would force people to receive less care, but not necessarily based on medical need.
Perhaps we spend 14 percent of GDP on health care because that's how much we value it. If so, the best answer may lie not in reducing demand but in increasing supply. We could try federal and state deregulation and subsidies to sharply increase the numbers of doctors, nurses, and clinics over the next decade; and shorter patent protection periods could mean more generic-drug substitutes and cheaper versions of high-tech equipment. Maybe it would mean lower-quality care and fewer new drugs and technologies—but maybe not. And if it did slow health-care inflation, we might be able to get to universal coverage without breaking the budget or the bank.