Are Health Care Costs 'Too High'?

In 2005, Americans spent roughly $2 trillion on health care, or an average of $6,700 per person.  This amounted to 16 percent of the gross domestic product.  In other words, nearly one-sixth of the total output of goods and services produced by our economy in 2005 was devoted to health care (including both public and private expenditures).  Many analysts expect total spending on health care to rise to $4 trillion and 20 percent of GDP by 2015.

The question is:  Is this a good thing, a bad thing, or just a fact of life in an advanced technological society with an aging population?

The answer is that it is all three.

On the one hand, high levels of health care spending is a good thing because it means that millions of Americans are receiving the highest quality medical care that is available anywhere in the world.  Compared to citizens of other western countries, the average American has more access to the best doctors, the best facilities, the best medicines, and the best diagnostic and treatment technologies.  This is why people from Canada and Britain and Europe, indeed from all over the world, come to the United States to obtain needed medical care that is not available to them in their home countries.  This even includes Canadian mothers who are sent to the United States to give birth because their local public hospitals lack bed space and the ability to handle high-risk pregnancies.  So much for the alleged superiority of "single-payer" health care systems.

Yet the highest quality medical care in the world comes at a steep price.  This price has nothing to do with "greedy" doctors, HMOs, and drug companies.  Rather, as with any other good or service, the price of medical care fundamentally is determined by the value of the resources required to produce it.  And the resources required to produce, say, a world-class cardiologist or orthopedic surgeon or oncologist are extremely valuable. 

For starters, only the smartest people in our society (roughly the top 10 percent) have the innate ability to become competent, modern doctors.  Then these people must go through 10 to 15 years (post-high school) of very demanding, and very expensive, education and training.  Then they must be equipped with the most advanced tools and drugs and machines, all of which cost many more millions (sometimes billions) of dollars to develop and produce.  Only at this point can these doctors start providing us with the high-quality medical care that we expect in this country. 

To expect that this medical care can come cheap is to indulge in wishful thinking.  Such wishful thinking lies at the heart of the health care plans being offered by the leading Democratic presidential candidates.  They all claim to be able to provide more Americans with better health care at a lower cost.   For example, according to Hillary Clinton, her plan "covers all Americans and improves health care by lowering costs and improving quality."  John Edwards  likewise promises "universal health care reform that covers everyone, cuts costs, and provides better care."  Barack Obama  at least acknowledges that "the best medical technology and scientific research in the world" come at a heavy price, but he too believes it is possible to provide "affordable, comprehensive, and portable health coverage for all Americans."

This is pure fantasy.  True, we can provide more Americans with lower cost health care -- by reducing the quality of the health care they receive.  For example, by prescribing trusses for hernias instead of repairing them surgically, as often happens in Britain.  Or we can provide more Americans with higher-quality health care -- by increasing the total amount of health care spending.  But we cannot provide every American with the best medical care money can buy, while at the same time reducing the amount of our gross domestic product devoted to health care.  This is an economic impossibility.

But what about the argument -- which has become commonplace in public policy circles since the days of Hillarycare -- that the main reason health care costs are so high in this country is because we pay for our medical care through third-party payment plans, i.e., insurance (both public and private)?  Washington Post and Newsweek columnist Robert Samuelson makes this argument in his most recent column

The gist of this argument is that if consumers had to pay more for their health care out-of-pocket, instead of through insurance, they would make wiser and more efficient health care decisions.  For example, if a doctor's visit cost $100, instead of only a $10 co-pay, consumers would be less likely to go to the doctor for minor illnesses and injuries, like common colds and sprained ankles, and instead would save their visits for more serious conditions.  However, as Samuelson argues, because "[m]ost Americans think that someone else pays for their care," they have no incentive to "control spending."  Although Samuelson does not say so explicitly, what he and others who subscribe to this argument really are saying is that health care costs are so high in this country because Americans use too much health care. 

But what does "too much" mean in this context?  And who is to decide how much is enough?

Certainly, if Americans were to consume less and lower-quality health care, total health care spending would decrease.  This is precisely why health care spending in countries like Canada and Britain is lower than in the United States.  Their citizens are provided by their governments with less and lower-quality health care than the vast majority of Americans currently enjoy under our mixed system.  If we adopt one of the health care plans being peddled by the Democrats, in the future Americans, too, will consume less and lower-quality health care.  This may reduce the portion of our gross domestic product that is devoted to health care, but will this make us better off, individually and as a nation?  For some Americans, yes.  Overall, no.

        

Moreover, there is a hidden fallacy in Samuelson's analysis.  The problem with health care spending is not the reliance on insurance arrangements, per se.  In a free market, insurance arrangements are economically efficient.  Insurance works by pooling resources and rationally distributing risks and costs among large numbers of people.  This enables more people to enjoy the benefits of various goods and services at a lower cost per person.  Indeed, insurance arrangements are a vital feature of any modern commercial economy. 


Importantly, the critical feature that underlies the economic efficiency of insurance arrangements is that individual premiums are based on each consumer's risk-cost profile.  That is, riskier consumers, i.e., those who are more likely to need the insurance, must pay a higher price for their coverage.  For example, people who have speeding tickets are charged more for car insurance than those who have clean driving records.  Similarly, consumers who want a larger amount of coverage must pay a higher price.  For example, people who drive Cadillacs are charged more for collision coverage than people who drive Hyundais.  Where insurance companies are allowed to charge each consumer a premium commensurate with the consumer's level of risk and amount of coverage desired, then insurance arrangements are economically efficient.  This also comports with our basic moral intuition that people who need or want more coverage should pay for it.   


There is no question that the American health care market is inefficient.  But this inefficiency does not stem from the use of third-party payment plans.  Rather, it is the inevitable result of government tax-and-spend programs and regulatory mandates that interfere with the free market by eliminating the vital link between insurance premiums and each consumer's risk-cost profile. 


Consider Medicare and Medicaid, which in 2005 had combined expenditures of approximately $500 billion.  Significantly, the premiums for these programs are not based on a rational assessment of each beneficiary's risk-cost profile.  Instead, these programs require only small co-pays based on income level.  Moreover, these payments do not come close to paying the full cost of the medical care provided.  On the contrary, the cost of this medical care is primarily paid for by payroll taxes and income taxes on all Americans.  In other words, Medicare and Medicaid are not insurance arrangements in the correct sense of the term.  They are entitlement programs.  And like all entitlement programs, they are woefully inefficient.


What about private health insurance?  Here, too, government regulations have transformed these policies into pseudo-entitlements by mandating that employers and insurance companies provide a panoply of benefits without taking into account each consumer's risk-cost profile.  Not surprisingly, such mandated benefits are a key component of the health care plans being offered by the Democratic candidates.  For example, Hillary's health care plan prohibits insurance companies from charging "excessive insurance company premiums" and denying coverage to any person based on pre-existing conditions.  Obama's plan requires insurance companies "to provide comprehensive benefits, issue every applicant a policy, and charge fair and stable premiums."  And Edwards' plan requires insurance companies "to keep plans open to everyone and charge fair premiums, regardless of preexisting conditions, medical history, age, job, and other characteristics."


In other words, under the Democratic plans, insurance companies will be strictly limited in their ability to calculate premiums based on the nature of the risks and costs to be covered for each consumer.   As is already happening, this will raise the cost of insurance, unjustly shift costs from some consumers to others (by requiring consumers with more favorable risk-cost profiles to subsidize the premiums of those with less favorable risk-cost profiles), and create an increasingly untenable situation for all but the largest and most diversified insurance companies.


The bottom line is that there is only one truly efficient solution to the high cost of health care in this country:  expanding the free market by eliminating mandates and phasing out entitlement programs.  Socialized medicine is not the answer.  Either it will lead to even more health care spending, and therefore higher taxes, because the government will mandate that all Americans receive top quality medical care; or it will lead to shortages, rationing, and lower-quality medical care for most Americans, as a way to reduce total spending.  Neither scenario is desirable.   Indeed, the first scenario inevitably will lead to the second.  Plus, unless the government tyrannically prohibits wealthier citizens from paying separately for private medical care - effectively eliminating property rights - we still will have a mixed system that inefficiently adds to total costs.


Under greater free market conditions, Americans will be required to pay more individually for the health care they receive.  Whether these payments are made out-of-pocket or through rationally priced insurance premiums, this will create the financial incentives to control spending that Samuelson stresses in his article.  Yes, this also will mean that many Americans will not be able to afford the same level of health care that they currently enjoy as a result of government subsidies.  However, the moral and financial responsibility for providing medical care should rest with each individual citizen and his or her family, not the business community or general public.  Where an individual's resources are not enough, private charity, not the government's taxing authority, should fill the gap.    


Nevertheless, even in a free market, total health care spending in this country still will be very high.  As noted previously, high-quality health care is extremely expensive, and Americans have enormous demand for the best medical care money can buy.  There is nothing inherently "bad" about this.  The United States is an extremely rich country, and we have enough wealth to expend a large percentage of our gross domestic product on health care, while still providing for our other vital needs, e.g., national defense.


However, we do not have enough money for the government to "promise" every American, regardless of age or condition, that he or she will receive the best available medical care.  We are not that rich, and never will be.


Steven M. Warshawsky  smwarshawsky@hotmail.com

In 2005, Americans spent roughly $2 trillion on health care, or an average of $6,700 per person.  This amounted to 16 percent of the gross domestic product.  In other words, nearly one-sixth of the total output of goods and services produced by our economy in 2005 was devoted to health care (including both public and private expenditures).  Many analysts expect total spending on health care to rise to $4 trillion and 20 percent of GDP by 2015.

The question is:  Is this a good thing, a bad thing, or just a fact of life in an advanced technological society with an aging population?

The answer is that it is all three.

On the one hand, high levels of health care spending is a good thing because it means that millions of Americans are receiving the highest quality medical care that is available anywhere in the world.  Compared to citizens of other western countries, the average American has more access to the best doctors, the best facilities, the best medicines, and the best diagnostic and treatment technologies.  This is why people from Canada and Britain and Europe, indeed from all over the world, come to the United States to obtain needed medical care that is not available to them in their home countries.  This even includes Canadian mothers who are sent to the United States to give birth because their local public hospitals lack bed space and the ability to handle high-risk pregnancies.  So much for the alleged superiority of "single-payer" health care systems.

Yet the highest quality medical care in the world comes at a steep price.  This price has nothing to do with "greedy" doctors, HMOs, and drug companies.  Rather, as with any other good or service, the price of medical care fundamentally is determined by the value of the resources required to produce it.  And the resources required to produce, say, a world-class cardiologist or orthopedic surgeon or oncologist are extremely valuable. 

For starters, only the smartest people in our society (roughly the top 10 percent) have the innate ability to become competent, modern doctors.  Then these people must go through 10 to 15 years (post-high school) of very demanding, and very expensive, education and training.  Then they must be equipped with the most advanced tools and drugs and machines, all of which cost many more millions (sometimes billions) of dollars to develop and produce.  Only at this point can these doctors start providing us with the high-quality medical care that we expect in this country. 

To expect that this medical care can come cheap is to indulge in wishful thinking.  Such wishful thinking lies at the heart of the health care plans being offered by the leading Democratic presidential candidates.  They all claim to be able to provide more Americans with better health care at a lower cost.   For example, according to Hillary Clinton, her plan "covers all Americans and improves health care by lowering costs and improving quality."  John Edwards  likewise promises "universal health care reform that covers everyone, cuts costs, and provides better care."  Barack Obama  at least acknowledges that "the best medical technology and scientific research in the world" come at a heavy price, but he too believes it is possible to provide "affordable, comprehensive, and portable health coverage for all Americans."

This is pure fantasy.  True, we can provide more Americans with lower cost health care -- by reducing the quality of the health care they receive.  For example, by prescribing trusses for hernias instead of repairing them surgically, as often happens in Britain.  Or we can provide more Americans with higher-quality health care -- by increasing the total amount of health care spending.  But we cannot provide every American with the best medical care money can buy, while at the same time reducing the amount of our gross domestic product devoted to health care.  This is an economic impossibility.

But what about the argument -- which has become commonplace in public policy circles since the days of Hillarycare -- that the main reason health care costs are so high in this country is because we pay for our medical care through third-party payment plans, i.e., insurance (both public and private)?  Washington Post and Newsweek columnist Robert Samuelson makes this argument in his most recent column

The gist of this argument is that if consumers had to pay more for their health care out-of-pocket, instead of through insurance, they would make wiser and more efficient health care decisions.  For example, if a doctor's visit cost $100, instead of only a $10 co-pay, consumers would be less likely to go to the doctor for minor illnesses and injuries, like common colds and sprained ankles, and instead would save their visits for more serious conditions.  However, as Samuelson argues, because "[m]ost Americans think that someone else pays for their care," they have no incentive to "control spending."  Although Samuelson does not say so explicitly, what he and others who subscribe to this argument really are saying is that health care costs are so high in this country because Americans use too much health care. 

But what does "too much" mean in this context?  And who is to decide how much is enough?

Certainly, if Americans were to consume less and lower-quality health care, total health care spending would decrease.  This is precisely why health care spending in countries like Canada and Britain is lower than in the United States.  Their citizens are provided by their governments with less and lower-quality health care than the vast majority of Americans currently enjoy under our mixed system.  If we adopt one of the health care plans being peddled by the Democrats, in the future Americans, too, will consume less and lower-quality health care.  This may reduce the portion of our gross domestic product that is devoted to health care, but will this make us better off, individually and as a nation?  For some Americans, yes.  Overall, no.

        

Moreover, there is a hidden fallacy in Samuelson's analysis.  The problem with health care spending is not the reliance on insurance arrangements, per se.  In a free market, insurance arrangements are economically efficient.  Insurance works by pooling resources and rationally distributing risks and costs among large numbers of people.  This enables more people to enjoy the benefits of various goods and services at a lower cost per person.  Indeed, insurance arrangements are a vital feature of any modern commercial economy. 


Importantly, the critical feature that underlies the economic efficiency of insurance arrangements is that individual premiums are based on each consumer's risk-cost profile.  That is, riskier consumers, i.e., those who are more likely to need the insurance, must pay a higher price for their coverage.  For example, people who have speeding tickets are charged more for car insurance than those who have clean driving records.  Similarly, consumers who want a larger amount of coverage must pay a higher price.  For example, people who drive Cadillacs are charged more for collision coverage than people who drive Hyundais.  Where insurance companies are allowed to charge each consumer a premium commensurate with the consumer's level of risk and amount of coverage desired, then insurance arrangements are economically efficient.  This also comports with our basic moral intuition that people who need or want more coverage should pay for it.   


There is no question that the American health care market is inefficient.  But this inefficiency does not stem from the use of third-party payment plans.  Rather, it is the inevitable result of government tax-and-spend programs and regulatory mandates that interfere with the free market by eliminating the vital link between insurance premiums and each consumer's risk-cost profile. 


Consider Medicare and Medicaid, which in 2005 had combined expenditures of approximately $500 billion.  Significantly, the premiums for these programs are not based on a rational assessment of each beneficiary's risk-cost profile.  Instead, these programs require only small co-pays based on income level.  Moreover, these payments do not come close to paying the full cost of the medical care provided.  On the contrary, the cost of this medical care is primarily paid for by payroll taxes and income taxes on all Americans.  In other words, Medicare and Medicaid are not insurance arrangements in the correct sense of the term.  They are entitlement programs.  And like all entitlement programs, they are woefully inefficient.


What about private health insurance?  Here, too, government regulations have transformed these policies into pseudo-entitlements by mandating that employers and insurance companies provide a panoply of benefits without taking into account each consumer's risk-cost profile.  Not surprisingly, such mandated benefits are a key component of the health care plans being offered by the Democratic candidates.  For example, Hillary's health care plan prohibits insurance companies from charging "excessive insurance company premiums" and denying coverage to any person based on pre-existing conditions.  Obama's plan requires insurance companies "to provide comprehensive benefits, issue every applicant a policy, and charge fair and stable premiums."  And Edwards' plan requires insurance companies "to keep plans open to everyone and charge fair premiums, regardless of preexisting conditions, medical history, age, job, and other characteristics."


In other words, under the Democratic plans, insurance companies will be strictly limited in their ability to calculate premiums based on the nature of the risks and costs to be covered for each consumer.   As is already happening, this will raise the cost of insurance, unjustly shift costs from some consumers to others (by requiring consumers with more favorable risk-cost profiles to subsidize the premiums of those with less favorable risk-cost profiles), and create an increasingly untenable situation for all but the largest and most diversified insurance companies.


The bottom line is that there is only one truly efficient solution to the high cost of health care in this country:  expanding the free market by eliminating mandates and phasing out entitlement programs.  Socialized medicine is not the answer.  Either it will lead to even more health care spending, and therefore higher taxes, because the government will mandate that all Americans receive top quality medical care; or it will lead to shortages, rationing, and lower-quality medical care for most Americans, as a way to reduce total spending.  Neither scenario is desirable.   Indeed, the first scenario inevitably will lead to the second.  Plus, unless the government tyrannically prohibits wealthier citizens from paying separately for private medical care - effectively eliminating property rights - we still will have a mixed system that inefficiently adds to total costs.


Under greater free market conditions, Americans will be required to pay more individually for the health care they receive.  Whether these payments are made out-of-pocket or through rationally priced insurance premiums, this will create the financial incentives to control spending that Samuelson stresses in his article.  Yes, this also will mean that many Americans will not be able to afford the same level of health care that they currently enjoy as a result of government subsidies.  However, the moral and financial responsibility for providing medical care should rest with each individual citizen and his or her family, not the business community or general public.  Where an individual's resources are not enough, private charity, not the government's taxing authority, should fill the gap.    


Nevertheless, even in a free market, total health care spending in this country still will be very high.  As noted previously, high-quality health care is extremely expensive, and Americans have enormous demand for the best medical care money can buy.  There is nothing inherently "bad" about this.  The United States is an extremely rich country, and we have enough wealth to expend a large percentage of our gross domestic product on health care, while still providing for our other vital needs, e.g., national defense.


However, we do not have enough money for the government to "promise" every American, regardless of age or condition, that he or she will receive the best available medical care.  We are not that rich, and never will be.


Steven M. Warshawsky  smwarshawsky@hotmail.com