The Economics of US Healthcare
According to the US Department of Health and Human Services (HHS), national health expenditures were $2.5 trillion in 2009, or $8,086 per person. The usual critique of US healthcare discusses how the money is spent and argues that it could be better spent in other ways.
I will not discuss how the money is spent, because value is subjective. Instead, I will show that the United States cannot afford what it spends, and, as a result, the US healthcare system is a credit-induced bubble.
HHS estimated that national health expenditures per individual were $7,845 in 2008 — over $31,000 for a family of four. That is the minimal cost of a fully homogenized national health-insurance policy where everything is covered, everyone is covered, and there are no preexisting conditions. That figure is fairly close to what an individual pays for very good commercial insurance if one does not belong to a large insurance pool. The average American family is not going to pay that much for health insurance willingly.
The Census Bureau claimed that the average household size was 2.63 in 2008. The average household share of national health expenditure was therefore $20,632. The census estimated that 18.6 percent of households had an income less than $20,000 in 2008. So, almost one-fifth of US households earn less income than their share of national health expenditure.
What about the average household? According to the Bureau of Labor Statistics (BLS), a typical US consumer unit in 2008 of 2.5 persons made $63,563 pretax income, and paid $13,077 in taxes, $6,443 for food expenses, $17,109 for housing expenses, $1,801 for clothing expenses, and $8,604 for transportation expenses, with $16,529 left over.
Their "share" of national health expenditure was $19,612. The typical US household cannot possibly afford a healthcare product targeted to the entire US population. No amount of redistribution will solve this shortfall. The shortfall is being financed, at least prior to September 2008, by foreign credit.
Providers of healthcare make decisions based not on consumer preferences but rather based on what the government will pay for. The government involvement in Medicare is obvious, but the so-called private sector of healthcare is increasingly made up of government employees and employees of private companies whose income largely comes from government. The US healthcare system is a classic credit-induced bubble of malinvestment where notions of profit and loss have been hopelessly distorted by government decisions.
What about Medicare? Don't we spend a lot more on the elderly? Can't US healthcare be solved by fixing Medicare? We do spend more on the elderly, but not by as much as one would think. According to the Medicare trustees, Medicare paid $509 billion in expenditures in 2009 to 46.3 million beneficiaries for an average benefit of $11,743. This is higher than the per capita national health expenditure of $8,086 but not that much higher. Medicare is a major part of the problem, but government expenditures include coverage for government employees and employees of private companies whose incomes come from the government.
While Medicare cannot be completely blamed for the money woes of the healthcare system, Medicare is largely responsible for the completely distorted view of health insurance held by many people. A common misconception is that Medicare is a healthcare provider. The reality is that Medicare does not provide a single cent of healthcare. Medicare guarantees payment for certain services under certain restrictions. If either the payment becomes too low or the restrictions become too onerous, the healthcare for elderly people will vanish.
A far more damaging myth is that Medicare is a health-insurance plan for the elderly. Medicare is not insurance. Medicare is a scheme to socialize the healthcare costs of the elderly to the much larger group of working people. Medicare is not even a fiscally sound scheme to socialize costs; Medicare is a Ponzi scheme. Lest anyone think my characterization is hyperbole, here is what the US Securities and Exchange Commission states about Ponzi schemes:
A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.
With little or no legitimate earnings, the schemes require a consistent flow of money from new investors to continue. Ponzi schemes tend to collapse when it becomes difficult to recruit new investors or when a large number of investors ask to cash out.
The new investors are new workers entering the labor force. The promised return on investment is that healthcare will be paid for starting at age 65. Rather than funding a defined-benefit pension plan, the monies paid in are spent immediately for elderly beneficiaries, and anything left over is lumped together with general revenue. This particular Ponzi scheme is collapsing due to a large number of baby boomers cashing out. The Ponzi nature of Medicare has completely distorted the American view of insurance beyond recognition.
A tornado is an insurable event. Tornadoes are devastating, but they only affect a small number of people. Rather than each homeowner having to set aside capital to rebuild his or her home after a tornado, large numbers of people can pool their risk by each setting aside a smaller amount in the form of premium payments. The payments are called premiums because the amount paid is a premium to the actuarial risk. The excess of premium payments over damage claims pays administrative costs plus the cost of capital required to handle claims in the current time frame. The insured willingly pay a premium to their actuarial risk for peace of mind and to free up their capital for other uses.
Unlike the tornado, not all healthcare costs are insurable events. There is a current recommendation for people aged 50 years or more to have a screening colonoscopy every ten years. This leads to earlier detection of colon cancer and greater likelihood of curative therapy. While a screening colonoscopy might be a very good idea, the age of 50 is not an insurable event. There is no risk to share. If one desires a colonoscopy at age 50, one must save the required funds before the 50th birthday. Any attempts to cover screening procedures by insurance are schemes to socialize cost.
The promotion of Medicare as health insurance for the elderly has led many Americans to expect that health insurance should cover all their healthcare costs including costs that are not insurable. The only way existing beneficiaries profit by inclusion of noninsurable costs is to force people with lower risks to join their insurance pool. The end result of this process is the demand for universal coverage that covers everything related to healthcare.
Medicare is called the third rail of politics. It is a very popular program with its beneficiaries. An examination of the costs and benefits to beneficiaries makes it clear why it is so popular. The Medicare tax is 1.45 percent of all income. The employer pays the same amount as an additional tax (the self-employed pay 2.9 percent to cover both employee and employer portions). A Medicare beneficiary would have to earn over $358,000 as an employee for the Medicare payroll tax to cover his or her average Part A benefit of $5,205.
According to the Census Bureau, in 2009 the mean income for persons 65 years or older was $29,718. The median income for this group was $19,167. As a group, the elderly pay $430.91 in premium for their Part A benefit of $5,205. Half of this elderly group paid $277.92 or less. The socialization of healthcare costs for the elderly via Ponzi finance has led to a national mythology of health insurance: Americans expect to pay less than $300 in "premium" for over $5,000 of healthcare.
Medicare is insolvent. Even the Medicare trustees admit as much. Here are data for 2009 from the annual report by the Medicare trustees.
Medicare has three major components. Part A pays for hospital and other inpatient services. Part B pays doctors' fees and other fees for outpatient tests and procedures. Part D is the prescription-drug benefit. Part A is paid for largely by the Medicare payroll tax.
There is a common misconception that Medicare taxes pay for all Medicare services. Some Medicare beneficiaries pay an optional Part B premium to receive Part B benefits. This premium is only 25 percent of Part B income and only 27 percent of Part B expenditures. Medicare Parts B and D are both financed largely through general revenue. General revenue was the source of $211.7 billion of Medicare's total income and expenditures. That is a lot of money even by the standards of the US Congress in 2011.
The Medicare trustees gave a warning about the coming bankruptcy of Medicare. This warning was based on the negative $0.7 billion in the Medicare trust fund. The trustees make projections about when the trust fund will be depleted. Some of the assumptions made for this projection seem wildly optimistic. One example is the trustees' projection that the growth in expenditures will average 2.98 percent to 2019. The historical data show growth in expenditures of 12.81 percent since 1970 and 8.46 percent since 2000.
A number of people, including the former US comptroller General David Walker, have warned about Medicare's unfunded liability. This liability is due to the demographics of the baby boom. As the baby boomers retire, they will be expecting payments. Income into Medicare will be insufficient to make these payments. The unfunded liability is the amount of money that is necessary to add to the current trust fund to ensure these payments can be made. The size of the unfunded liability depends on economic assumptions, and estimates range from $50 trillion to over $100 trillion. Regardless of which assumptions are used, it is clear that the money will not be there.
Concerns about the unfunded liability and depletion of the trust fund are years into the future. The $211.7 billion contribution from general revenue represents a very real problem today, since the US government runs a very large fiscal deficit. Tax revenue is only about 60 percent of general-revenue expenditures. The remaining 40 percent has to be borrowed or created out of thin air by the Federal Reserve. Medicare is dependent on an increasing amount of credit.
In 1970 general-revenue contributions to Medicare were $2.02 billion or 24.6 percent of total Medicare income. This has grown to $211.7 billion or over 40 percent of total Medicare income. The US healthcare system is a huge bubble fueled by credit. When the flow of credit stops — say, by a failure to raise the debt ceiling — the bubble will burst. Expansion of the US healthcare system is based not on consumer preferences but rather on arbitrary reimbursement decisions made by HHS.
There are four ways to finance healthcare for the elderly:
Young and healthy people can forgo current consumption to save money for future healthcare;
The current healthcare expenses can be socialized to everyone in the present;
The money can be borrowed from external parties; or
The money can be created out of thin air.
The first method is the correct way to finance healthcare. Medicare uses an accounting gimmick of a trust fund to pretend that money is actually stored away safely in order to delude people into thinking that the first method is what is being done. The second method is what Medicare was supposed to do from the start. Promising something for nothing is what politicians like to do. The elderly got a healthcare benefit created out of thin air and young people were given an IOU.
Eventually, general revenue went from a rough balance to an ever-increasing deficit in no small part due to growth in Medicare expenditures. There is some debate as to whether the US has covered its fiscal deficit with foreign borrowing or created the money out of thin air since September 2008.
Does it make a difference whether the first or second method is used to finance healthcare? Leaving demographic problems aside, why not finance current healthcare out of current cash flow? If the initial beneficiaries get something for nothing, somebody has to pay. The payment is lost capital formation that will not be available to the young when they grow old. The lost capital means the future workers will be less productive and have a lower standard of living. An improved standard of living for the current elderly comes at the expense of the future standard of living for the young.
We cannot afford our current healthcare system. Any solution to healthcare must make healthcare more affordable. The solution requires four basic changes:
Limit insurance to insurable conditions and eliminate all regulatory barriers to the provision of health insurance;
Eliminate the barriers to the production and delivery of healthcare, including licensing restrictions;
Eliminate the barriers to the production and delivery of medicines and medical technology, including patents; and
Eliminate the socialization of healthcare costs and the subsidies for being sick.
The four changes are simply the elements of a truly free market in healthcare as opposed to the convoluted system of cartels in place now. Now I would like to discuss common objections to free markets in healthcare.
Health insurance is a contentious topic, especially among healthcare providers. The healthcare profession tends to view insurers as the enemy. One cause of this contentious relationship is that healthcare providers provide healthcare to their patients, but the providers receive their payment from the insurance companies. Medicare is largely responsible for this change. Patients have come to expect that they will receive everything and that the insurer will pay for it. If patients were responsible for their payment and patients negotiated with insurers for reimbursement, patients would be far more selective about what care they received.
The concept of preexisting conditions is also a point of contention within the healthcare industry. On the surface, it does not seem fair that someone pays their premium for many years, then, after developing a life-threatening condition, they are denied further insurance.
Yet the concept of preexisting conditions is necessary for insurance companies to remain solvent. Nobody would expect an insurer to sell a term life insurance policy to a corpse. Nobody would expect an insurer to sell a homeowner's policy to somebody whose home was already destroyed by a tornado. Health insurance is no different.
A free-market insurance industry would be allowed to sell policies against the treatment of leukemia. This treatment is catastrophically expensive, but because the condition is very rare, large numbers of people can pool their risk and make the premiums very inexpensive. No insurer is going to sell a policy against leukemia to somebody who has leukemia for the same premium as it would sell it to the general population. Any attempt by government to force insurers to cover preexisting conditions is a socialization of cost rather than an insurance.
Many disease conditions require therapy for long periods of time. Anyone who purchases insurance for the next year becomes vulnerable to losing insurability after the policy expires. The solution is to have insurance policies for many years or life. With a condition such as leukemia, there is no reason that insurers could not and would not offer policies covering people for their entire lives as long as they had no signs of leukemia at the time they enroll. The main reason we do not have health-insurance policies for life is that insurers are forced by government to cover conditions that are not insurable, such as the example of screening colonoscopies I gave earlier. The costs required to cover these uninsurable conditions for life make the policies so expensive that nobody will purchase them.
Rare conditions can be insured cheaply, but common conditions necessarily become more expensive to insure. At some prevalence, it becomes foolish to cover a condition via insurance rather than paying for it out of pocket when it arises. Uninsurable conditions such as the screening colonoscopy have to be paid for by the beneficiary. Any other payment scheme is a socialization of cost.
Doctors and nurses are both cartels. It should come as no surprise that these cartels are resistant to competition. As with all cartels, barriers to entry increase over time, reducing competition. And as with all cartels, barriers to competition are disguised as assurances of quality. Quality is subjective; different consumers have different priorities. Licensing requirements are attempts to objectify what is purely subjective.
Standards used as points of information, on the other hand, are objective and can be used by consumers to determine their choice of provider. A truly free market in healthcare would have no licensing requirements, and assurances of quality would be handled via ratings agencies or certification boards. Decisions about which quality standards were important would be determined by consumers rather than providers.
Would anyone be able to set himself up to perform open-heart surgery? No! Open-heart surgery is a complicated procedure requiring many skilled people working together and a huge capital outlay for facilities. Neither the anesthesiologists, nor the technicians, nor the nurses, nor the hospitals are going to work with a quack heart surgeon; they have no desire to share liability with the quack.
Many doctors have the misconception that without licensure there would be no standards. Hospitals have credentialing processes. It is very likely that the process of credentialing would have little or no change in a free market. Hospitals would demand letters of reference and would continue to inquire where a heart surgeon received training.
Healthcare is not a single entity. There is a continuum of services with a continuum of expertise. The market is best suited to match expertise with complexity of service. Consumers would demand considerable expertise of heart surgeons. They would not likely demand the same expertise for the treatment of a sore throat. Certification of expertise would remain an important source of information, but consumers would decide what value to attach to any certificate, rather than certificates barring entry into any given service. Certifiers, including the educational institutions that grant degrees, would either be attentive to consumer demands or lose their prestige.
A free-market healthcare system would develop tiers of care. The lowest tier would provide services for the most common ailments. For example, one might see an alcove in Walmart where one could have blood pressure checked and routine blood tests performed. People would pay for these services out of pocket, and intense competition among providers would keep price down. The use of physician assistants and nurse practitioners to deliver primary care is a step in that direction.
A bone-marrow-transplant team would serve a much larger community. Teams would compete on the basis of quality of service. Consumers would purchase insurance against the need for a bone-marrow transplant. The insurers would set standards of quality for teams they would work with. Any attempt by insurers to compromise quality for cost on such a high-end service would likely lose insurance customers because the effect on premiums would be small. Cost would not be limitless, however. The market would determine the optimal price of quality rather than some government committee.
What about quacks? There will always be quacks selling snake oil. Licensure simply guarantees that the quacks are licensed quacks, which are arguably more dangerous. A market would develop information about providers. Just as consumers consult websites for product information before purchasing a car or a computer, they would consult analogous sites for information on physicians in their area.
What about snake oil? If a consumer wanted to try snake oil, they would be free to do so without a licensing agency standing in their way. Sometimes the official "experts" are quacks. For example, in the 1960s the medical establishment was going to wipe tuberculosis off the face of the earth by treating everyone with a positive skin test for TB with the drug INH. The experiment had to be stopped, however, when too many people died of liver failure.
Sometimes it is not clear what is snake oil and what is good medicine. There are many controversies today about nutrition, vaccines, and cholesterol. The market is the most efficient way of resolving these controversies, as long as people have access to information. Experts should be free to give advice and warnings, but consumers should be free to accept or reject the advice of experts.
Cartel privileges do not come without strings attached. The regulatory burdens on healthcare providers are the prices paid for privilege. Providers are being told what questions they must ask, how they must record the answers, what tests must be ordered, and what treatments must be prescribed. Pay-for-performance standards are being developed for hospital length of stay. If patients typically require four days of hospitalization to recover from pneumonia, then HHS will wave a magic wand and decree that hospital stays longer than three days constitute waste, fraud, and abuse. Patient therapy will be decreed the same way fuel-economy standards were imposed on American automobile manufacturers. That did not turn out too well for the American auto manufacturer.
Regulatory burdens plague American business in general and US healthcare in particular. There are so many regulations that no provider can possibly be aware of them all. Lawyers and consultants must be hired to advise what the law actually means. The complicated nature of the regulatory environment is intentional. When the law is so complicated that nobody understands its boundaries, then government agencies can terrorize every provider about compliance with the law.
Patents and Pharmaceuticals
Intellectual property (IP) has important implications for the cost and availability of pharmaceuticals and medical devices. Medicine tablets and pacemakers are both things that require property rights. Only one person can use a medicine tablet or pacemaker at a time, so property rights allow the owner to decide use and avoid conflicts with other people who would like to use the items.
Ideas, on the other hand, are not exclusive. My use of an idea, whether the idea represents a molecule or a gadget, cannot possibly impair the use of the same idea by another person or many other persons at the same time. Ideas do not require property rights to avoid conflicts. Patents serve only to grant monopoly privileges, thereby raising costs and decreasing innovation.
A common defense of pharmaceutical patents is that people would not invest such enormous amounts of capital to have drugs approved by the FDA without monopoly privileges and the extra profit they confer. The problem here, however, is the FDA and its barriers to production rather than the absence of monopolistic intellectual property rights. Inventors would have enormous advantages of first use of any idea. The retention of that advantage would require the development of brand loyalty. In a world without the FDA and patents, inventors would have to demonstrate safety and efficacy to the public, rather than government agencies dictating which drugs are to be used in which situations. Drug costs would be dictated by consumer demand rather than arbitrary decisions made by Medicare Part D. Competition would lower drug costs and improve delivery systems.
The United States has a peculiar combination of patents and cartels to ensure that pharmaceuticals are outrageously expensive. Drug companies are granted monopoly privileges over the supply of pharmaceuticals, and doctors are granted monopoly privileges over the distribution of pharmaceuticals.
Patients should be able to purchase whatever medications — including narcotics — they wish to use without the permission of a doctor. Patients would continue to seek advice from doctors about how best to treat their signs and symptoms of disease. Doctors would continue to diagnose ailments and make recommendations about how to treat them. Patients would be free to accept or reject that advice. Consider a patient with high blood pressure. The doctor prescribes lisinopril. The patient accepts the advice, he buys the medication, and his blood pressure falls to normal levels. After 20 years of taking lisinopril, why should the patient require a doctor's permission to continue taking the medication?
Pharmaceuticals are much cheaper in Canada where US patent laws are not obeyed. Pharmaceuticals are much cheaper in India where a prescription from a physician is not required. The usual claims and concerns about patient safety are not validated by the experiences in Canada and India.
Doctors and nurses in the United States are caught in the middle of the war on drugs. Our lives are made miserable by preventing people from obtaining medications like Lortab. Pain cannot be objectively measured, so healthcare workers are forced to decide if patients are in pain or seeking euphoric effects. There are situations, such as the inpatient care of patients with sickle-cell anemia, where this conflict interferes with the proper care of the patient. Doctors should sell advice rather than dictate what medicines people take for their problems.
Subsidies for Illness
A subsidy is a government price control where members of a group pay less than the market cost for an item or service. All subsidies lead to a desire by those outside the privileged group to be included in the group. All subsidies lead to demand for the item being higher than it otherwise would be, and that always leads to prices being higher than they otherwise would be. Subsidies for illness are no exception. As a physician, I am asked to do more than diagnose illness and recommend therapies. I am asked to write letters excluding patients from jury duty. I am asked to write letters excusing patients from paying their electric bill on time. I am asked to sign applications for privileged parking spaces. I am asked to certify eligibility for scooters.
Prices are signals to producers and consumers on which behaviors would be profitable to change. Prices are set by voluntary exchange, which is the free market. Without voluntary exchange there are no prices, and without prices neither producers nor consumers know what to do. Subsidies interfere with the price mechanism. People will always demand more of something when they are spending some other person's money.
US healthcare is no longer affordable for the average American. Prices are not held in check by voluntary exchange; rather, healthcare prices are a bubble fueled by foreign credit. When the credit is cut off, the bubble will burst, and it will turn out badly for everyone involved.
Healthcare is a scarce economic resource. Like all scarce resources, the production, distribution, and consumption of healthcare is best left to the free market. The free market is frequently blamed for the problems of US healthcare, but the US healthcare system is a complex leviathan of interdependent cartels rather than a free market, and that leviathan is responsible for the problems.
 During my lecture, I explained basic tenets of Austrian economics, such as the mechanics of capital formation, because my audience was unfamiliar with these concepts. I'll forgo that here, because there are plenty of references on capital formation and free markets available on Mises.org.