Z: **Inactive:** Brad DeLong--Economics Only

Long-Run Health Care Cost Drivers

Long-Run Health Care Cost Drivers: One of our best graduate students here at Berkeley--Marit Rehavi--just came by with a truly depressing thought. No matter which subtribe of economists you think is correct in the intellectual health-care wars, the world is moving in directions that make the favored policies of both factions less likely to work in the future.

On health care issues, you see, economists divide into two subtribes depending on whether they think the big problem with America's health system today is adverse selection or moral hazard--two terms from the insurance industry.

Those economists on the left tend to think that the real big problem with American health care is adverse selection: Those who know they are healthy and likely to stay that way skimp on purchasing insurance. Insurance companies work like dogs to avoid selling insurance to people who are expensively sick or likely to get expensively sick. As a result, a huge amount of people's work-time and information technology processing power are wasted on the negative-sum game of trying to pass the hot potato of paying for the care of the sick to somebody else. The more people separate themselves or are separated into smaller and smaller pools with calculably different exposures to risk, the worse this problem gets. The way to solve it is to shove people into pools as big as possible. Ultimately, this line of thought goes, single-payer national health insurance is the best option, for the administrative and bureaucratic inefficiencies introduced are vastly outweighed by the reduction in the gaming the system that goes on under our current plan where profits are made by those insurance companies that are best able to avoid covering the sick.

Those economists on the right tend to think that the real big problem with American health care is moral hazard: that patients soak up scarce and valuable doctor and nurse time even when there is no benefit to the visit, and that doctors use up vast resources conducting tests and procedures that do patients very little good. And, this side argues, patients do this because their copays don't penalize them enough for wasting health professionals' time and doctors do this because their bottom lines don't suffer when they carry out barely effective, expensive, and inappropriate procedures. Sometimes economists on this side say these market failures are all the government's fault: the subsidy the government provides for low-deductible and first-dollar insurance. Sometimes economists on this side say that these market failures arise because of human irrationality: we half-intelligent jumped-up East African Plains Apes have a psychological propensity to overvalue certainty and thus to pay much more for first-dollar and low-deductible health insurance than we should.

The prescription of the right-wing subtribe of economists is to create hard incentives: regulate the insurance market so that the only policies allowable are high-deductible and fixed-reimbursement polices that make doctors feel in their purses the costs of the procedures they recommend, and that make patients feel in their purses the costs of the health professionals' time that they pointlessly soak up. Let insurance companies segment their market so that patients who make unhealthy lifestyle choices--who smoke, who get fat, who drink enough to pickle their livers, who give themselves diabetes by drinking Pepsi--feel the costs of those lifestyle choices in their insurance premiums. If the right-wing diagnosis is correct, this prescription would do a lot of good, because the gains from curbing moral hazard would be much bigger than the side-effects: dry mouth and additional adverse selection. But if the right-wing economists are wrong, this prescription is destructive. It means that those who have already drawn the big black X in life's lottery--those likely to die early and painfully of some dread disease--find their bad luck amplified by the workings of the health insurance market: not only do they die early and painfully, they die poor leaving their children poor as well.

The prescription of the left-wing subtribe of economists is nearly the opposite: it is to soften incentives as a side effect of eliminating opportunities for moral hazard by recognizing that the market for health care financing simply does not work very well, and cannot be made to work very well. If the left-wing diagnosis is correct, the prescription would do a lot of good. Nobody likes going to the doctor or undergoing invasive and usually painful costly medical procedures. The gain by eliminating adverse selection would be much bigger than the side-effects: frequent urination and a small amount of additional moral hazard. But if the left-wing economists are wrong, this prescription is destructive. Health care spending growth will accelerate as the few curbs on doing-everything-for-everybody drop away, and eventually a single-payer government with a budget constraint steps in to ration health care and to ration it badly and destructively, providing the wrong care to the wrong people.

Given these sharp disagreements between very smart, public-spirited, and hard-working economist like Uwe Reinhardt and Jon Gruber on the left hand and Kate Baicker and Mark McClellan on the other, one might despair. One would be further tempted to despair when one remembers that these issues will not be settled by locking Uwe, John, Kate, and Mark in a room until they reach agreement but by 535 legislators who are best described as a ping-pong ball, with the pharmaceutical and the doctor lobbies as the paddles.

And now Marit Rehavi comes by with an additional reason to despair. For according to her reading, as America ages and as American society changes an increasing share of the increase in health care costs is going to be driven not by increases in adverse selection by insurers or by moral hazard driven by doctors ordering inappropriate and barely effective care, but by expensive chronic diseases and risk factors driven by long-term lifestyle choices. Nationalizing the health insurance sector won't diminish the costs in 2050 of treating the lung cancer that the twenty year-old staring smoking today will develop. Increasing copays won't reduce the costs of treating the diabetes that the five year-old today with a two-coke and three-twinkie-a-day habit will develop in 2045.

Neither prescription will be very effective as a remedy to cost drivers like these. Our irresistible force is our belief that health care should not be rationed by price. Our immovable object is the unwillingness of American taxpayers to be turned into an IV drip bag for the health sector that the health sector itself controls. What happens when these meet is a crisis, which cannot be averted no matter whether we adopt the right-wing prescription, adopt the left-wing prescription, or muddle through.

Is there a magic bullet to reduce these chronic-diseases-of-aging-life-style-driven sources of secularly rising health care costs? I can see only one chance: the nanny state. Lectures every half hour, on every TV channel, by the surgeon general and the assembled celebrities of America, telling us to: lose weight, exercise more, don't smoke, don't drink to excess, watch your fats, watch your sugars, eat your vegetables, et cetera--remember that you are an East African Plains Ape that did not evolve to live in a world where fats and carbohydrates were abundant and smoke damaging to your lungs was laced with nicotine.

Andrew Samwick, Paul Krugman, Pecuniary Externalities in Health Prices, and Local Monopoly Power Created by Plans that Let You Choose Your Own Doctor

Andrew Samwick on pecuniary externalities:

Vox Baby: Pecuniary Externalities: For what it's worth, I think Paul Krugman makes some good points about the problems inherent in using the tax code to encourage or discourage the purchase of health insurance in his column.... However, I found this statement (highlighted in bold) in Krugman's column to be odd:

Mr. Bush.... The tax code, he said, "unwisely encourages workers to choose overly expensive, gold-plated plans. The result is that insurance premiums rise, and many Americans cannot afford the coverage they need."... No economic analysis I'm aware of says that when Peter chooses a good health plan, he raises Paul's premiums. And look at the condescension. Will all those who think they have "gold plated" health coverage please raise their hands?...

Andrew says:

That is almost the definition of a pecuniary externality. Wikipedia describes it as follows:

A pecuniary externality is an externality which operates through prices rather than through real resource effects. For example, an influx of city-dwellers buying second homes in a rural area can drive up house prices, making it difficult for young people in the area to get onto the property ladder. This is in contrast with real externalities which have a direct resource effect on a third party. For example, pollution from a factory directly harms the environment. Both pecuniary and real externalities can be either positive or negative.

So in the President's defense, there's a very simple argument to be made here. When one person feels inclined, for whatever reason, to purchase more health care services, that puts upward pressure on the price of health care services (if the supply curve is not flat) and thus the cost to everyone else in the market. Normally, we don't pay any attention to this, because that is precisely the mechanism by which a competitive market achieves economic efficiency.

The President is referring to the pecuniary externality generated by a tax distortion in the treatment of health insurance, which interferes with a market achieiving economic efficiency and thus should concern us. It goes as follows. Premiums are fully excludable from income tax, but out-of-pocket expenses are not tax advantaged. That favors health insurance arrangements in which there are low deductibles and high premiums. Such arrangements can lead to higher utilization of health services, since the insured faces no financial cost at the margin once the low deductible has been met. (This is just a standard moral hazard argument.) Krugman... [is] on shaky ground with his "Wow ... no economic analysis ..." comment.

I think Paul Krugman would say that he believes that health care is a constant-returns-to-scale industry, and that the subsidy provided by the tax code-driven increase in demand and spending increases quantities demanded but not prices in the long run. The supply curve, Paul Krugman thinks, is flat in the long run, and so Andrew Samwick's pecuniary externality argument fail.

It's not clear to me that Paul Krugman is wrong. It is also not clear to me that Paul Krugman is right. One of the things patients are buying with more expensive health-care plans is the freedom to choose their own doctors, and that gives the doctors they choose some monopoly power in their bargaining over reimbursement rates with the insurance companies.

I don't have a handle on how big this effect might be, however.

Why Oh Why Can't We Have a Better Press Corps? (When Is My Check for Reading the Washington Post Going to Arrive)

It's really unfair. In a just world, the journamalistic Washington Post would be sending me checks for reading it.

Today, in the left-hamd ring, we have Ruth Marcus performing the triple Democratic-trashing somersault.

She says that the Bush health proposals are bad:

Ruth Marcus - The Knee-Jerk Opposition - washingtonpost.com: Yes, there are big risks involved, primarily that the already-teetering employer-based system will collapse as healthy individuals use their tax deduction to buy cheaper, private insurance, leaving employers with the older and the sicker. And, yes, it's fair to argue that a more comprehensive approach -- Sen. Ron Wyden (D-Ore.) has proposed one -- is needed...

She says that it would be insane for all of the reality-based not to presuppose that everything Bush proposes is going to be bad:

This sad situation is largely of Bush's own making. He is reaping the poisonous state of affairs that he helped sow for six years. So many of the president's policies have been dishonest and wrongheaded, so much of his politics has been slashingly partisan, Democrats would be crazy if their instinctive reaction to a Bush plan for fill-in-the-blank wasn't intense distrust...

But still she manages to say that the Democrats shouldn't be pointing out that the Bush plan doesn't look like good health policy:

Listening to Democratic reaction to Bush's new health insurance proposal, you get the sense that if Bush picked a plank right out of the Democratic platform -- if he introduced Hillarycare itself -- and stuck it in his State of the Union address, Democrats would churn out press releases denouncing it.... Democrats -- if they care more about addressing health-care needs than scoring political points -- ought to be finding ways to improve and build on the Bush proposal, not condemning and mischaracterizing it. Given that nothing's going to pass without Democratic approval, what's the risk in engaging in the discussion?

Marcus ignores not only that the Bush health proposals are not good policy, but also that the Democrats are engaging in the discussion. As she herself writes, "Sen. Ron Wyden (D-Ore.) has proposed" a more comprehensive plan, and "it's fair to argue" that such a more comprehensive approach "is needed."

And, of course, Ruth Marcus hasn't done her homework. She doesn't understand the Bush proposals. An example: She copies a Republican talking point:

The deduction would... [leave] 80 percent of those with employer-sponsored coverage unaffected.

The deduction would indeed worsen the finances of only 20% of those with employer-sponsored coverage in 2009. But it would worsen the finances of about 50% of those with employer-sponsored coverage in 2019. And 90% of those with employer-sponsored coverage by 2030.

Why oh why can't we have Washington Post writers who do their homework? Or don't write about things when they haven't done their homework?

The Washington Post would have better served its readers if it had simply printed blank space where Ruth Marcus's column is, save for a link to Len Burman, Jason Furman, and Roberton Williams, "The President’s Health Insurance Proposal-—A First Look" (Washington DC: Tax Policy Center) http://www.urban.org/UploadedPDF/411412_firstlook.pdf.