Saturday, June 27, 2009

Mixed Costs

In the previous three segments of this series (part 1, part 2, part 3) I put forward the argument that employer provided health care has some bad features that are inherent in the very structure of the program. I alluded to what some of these problems are. Now I will discuss them in greater detail.

Celebrated economist Milton Friedman explains in this 2001 article that employer provided health care has two cost-increasing effects.
“First, it leads employees to rely on their employer, 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 the insurance company or companies designated by the employer. Second, it leads employees to take a larger fraction of their total remuneration in the form of medical care than they would if spending on medical care had the same tax status as other expenditures.”
Friedman’s research shows that fully one-third of the increase in medical costs during the last half of the 20th Century are attributable to publicly subsidized employer provided health care. Another one-quarter of the rise is attributable to Medicare. That leaves about 42% of cost increases unaccounted for.

Friedman says in the 2001 article that while his research is incomplete, he is led to believe that much of this unaccounted cost increase is attributable to a mixed system. That is, overall health care would cost less if we had a fully private third-party subsidized system or a fully government provided system. Having two systems, he thinks, causes significant cost increases. This is an inconvenient theory for those that want to continue with both systems. The proponents of solely government paid (run) care are correct that it would lower costs somewhat.

Of course, there is a tradeoff. Access to services and products is currently greater than it would be under a single system either way. While the competition between the two rival health care subsidy systems has the perverse effect of driving costs up instead of driving costs down as competition does in the regular market, it has the effect of increasing access.

Experience from other countries shows that once a single system is selected; focus shifts from better quality and access to cutting costs, since the people are captive and no longer need to be sold on a ‘single payer’ system. At this point rationing of health care by the bureaucracy increases and becomes inescapable (see here for a sampling of what to expect).

So what would Friedman suggest? He writes:
“If the tax exemption were removed, employees could bargain with their employers for higher take-home pay in lieu of medical care and provide for their own medical care either by dealing directly with medical care providers or by purchasing medical insurance. Removal of the tax exemption would enable governments to reduce the tax rate on income while raising the same total revenue. This hidden subsidy for medical care, currently more than $100 billion a year, is not included in reported figures on government health spending.”
So Friedman is not advocating a tax increase. Rather, he’s advocating taxing the current employer provided health care benefit and lowering general tax rates to achieve revenue neutrality. The salutary effects would be increased liberty, decreased medical costs, and higher satisfaction.

You may ask why we don’t simply extend the same tax benefit to individuals that is currently available only through employers. For one thing, it would only help those that actually pay federal income taxes. Since nearly half of all ‘taxpayers’ pay no federal income tax, they would not be helped much. But isn’t it true that they are already not helped much if they have employer provided health insurance? So perhaps that is a red herring. Friedman says:
“Extending the tax exemption to all medical care—as in the current limited provision for medical savings accounts and the proposals to make such accounts more widely available—would reduce reliance on third-party payment. But, by extending the hidden subsidy to all medical care expenditures, it would increase the tendency of employees to take a larger portion of their remuneration in the form of medical care.”
Hearkening back to my last post, subsidized systems to help pay for home maintenance or food would have similar effects. People would be incentivized to spend more of their household income on these things than they do today, leaving them less for other things like charitable donations, furniture, clothing, and family vacations. The subsidy road always misallocates resources and produces higher costs in the long run.

It should be abundantly clear that almost every argument that applies against the employer provided third-party health care system applies at least equally to any system provided by the government. Hold on, we’re not quite done yet.

Next time: Scratches and Dents

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