Topic 15 Government Healthcare Spending Programs US National Healthcare Expenditure (NHCE) in 2012 amounted to $2.8 trillion (17.2% of GDP or $8915 per person). By any measure, the US spends more (total dollars, per capita dollars, or percentage of GDP) on healthcare than any other country in the world. As a percent of GDP, the Netherlands is second with 12.0% of GDP. The average over all OECD countries is 9% of GDP. Government finance of healthcare in the US was just over $1.23 trillion in 2012, 60% of it by the Federal government. This is about 44% of all US healthcare spending. In other industrialized countries, the fraction of healthcare spending financed by government is higher (around 75%).The biggest government healthcare spending programs in the US are Medicare ($573 billion) and Medicaid ($421 billion). Not counted in the government healthcare finance, but perhaps should be, is the $210 billion tax expenditure for employer paid health insurance. This amount is the revenue loss to the Federal government attributed to the fact that employer-paid health insurance benefits are not subject to income tax, unlike other forms of compensation. This tax expenditure is, in effect, a government subsidy for private health insurance. If we count this tax expenditure as government finance of healthcare spending, as we should, US government finance of healthcare spending is 52% of NHCE. Government Finance of Health Insurance in the US Unlike most other industrialized countries, the US does not have universal government health insurance. The government insures the elderly (through Medicare), the poor (through Medicaid), many children (through State Children s Health Program or SCHIP), government employees and veterans, and subsidizes private health insurance through the tax system. The majority of the US population, 171 million residents or 55.1% of the population, receives health insurance as a fringe benefit from employment compensation. Another 9.8% of the population purchases health insurance directly. In 2010, Congress passed a healthcare reform bill, which attempts to expand coverage under the existing mixed private and government health insurance system. 1
In 2011, 47 million US residents (15.2%) were insured through the Medicare program. Part A Medicare (hospital care) is funded by a 2.9% FICA tax on earnings. Part B Medicare (physician and other provider service) is funded through general tax revenue and enrollee premiums ($104.90 per month in 2013). Part D Medicare is a subsidized prescription drug plan. Part A Medicare is an unfunded PAYGO program like OASDI (together they are called OASDHI). The solvency threat to Medicare is more serious than for Social Security whereas the Social Security trust fund will not run out for several decades, the Medicare trust fund will run out by 2017 or sooner. One reason for this is inadequate funding of Medicare. Another is healthcare cost inflation healthcare costs are rising significantly faster than the rate of inflation so the relative cost of healthcare is rising. In 2011, 51 million residents (16.5%) were enrolled in Medicaid/SCHIP. These are persons in families who are poor enough to meet the Medicaid/SCHIP means test and eligibility requirements. Finally, 49 million residents (15.7% ) did not have health insurance in 2012. Uninsured persons must pay for healthcare services out of pocket, rely on charity care, or go without healthcare services Healthcare reform changes In response to the significant fraction of uninsured residents and rising healthcare costs, Congress passed two healthcare reform bills in 2010. Together they are known popularly as Obamacare, because they were passed at the urging of President Obama. The purpose of these healthcare reform acts is to gradually expand health insurance coverage to an additional 32 million residents. They will do this using a number of measures. The main changes are as follows 1) Expansion of Medicaid. States are encouraged to expand their Medicaid programs to include all families with income less than 133% of the OPT, including families without children. The Federal government will pay 90%-100% of the cost of the expansion and threatened to withhold Medicaid funding from States that would not expand. 2
2) Health Insurance Exchanges. Beginning October 1, 2013 newly formed state health exchanges allowed the uninsured and selfemployed to purchase health insurance. States could choose to set up their own exchanges or let the Federal government do it. Persons with incomes between 133% and 400% of the OPT will receive government subsidies for insurance purchases on the exchanges. Since the exchanges opened, about 3 million residents have purchased health insurance through them. 3) Private Insurance Regulations. Since 2010, people with preexisting conditions can obtain health insurance through government subsidized high-risk pools. After 2014, private insurance companies cannot deny coverage on the basis of pre-existing conditions. 4) Employer Mandate. Businesses with more than 50 employees working more than 30 hours a week must provide affordable health insurance to employees or face fines. This mandate has been delayed by executive order of the President. 5) Individual Mandate. Beginning in 2014, everyone must purchase health insurance or face up to a $695 tax/fine. This is to discourage adverse selection. To pay for the above reforms, the Medicare payroll tax will be extended to investment income for families with income over $250,000 after 2012 and, beginning in 2018, a 40% excise tax will be levied on high-end (those worth over $27,500 per family) insurance plans. The constitutionality of this legislation, particularly the individual mandate and the Medicaid expansion, was challenged by several states, and the SCOTUS ruled on the case in 2012. By a narrow 5 to 4 majority, the Supreme Court ruled that the mandate and fine was Constitutional based on the Federal government s power to tax. SCOTUS also ruled that the Federal government could not withhold existing Medicaid funding of States that did not expand their Medicaid programs. Thus, the expansion of the Medicaid program has been left up to the individual States. 3
The Economic Effects of Health Insurance Some important aspects of healthcare insurance can be explained with the simple diagram below. The demand curve shows the quantity of healthcare services demanded by sick people at each level of price they must pay, and the supply curve shows the quantity of healthcare services supplied at each price. In a pay-for-service system (i.e., one without healthcare insurance), the market equilibrium price and quantity are denoted P M and Q M. To each individual, getting sick can pose a significant cost because the costs of healthcare services at the market price must be paid out of pocket. Since the risks of getting sick are independent (the probability of one person getting sick is not related to the probability of another getting sick), this health cost risk can be insured. P X $/Q Supply A P I Demand A P M E B Coinsurance payment B Q M Q I Q X Quantity However, health insurance market failure is very likely. One reason is that people have different risks of getting sick, and health insurers cannot distinguish high risk (poor health) customers from low risk (good health) customers. If health insurers price insurance at the 4
average risk level, the price of the insurance will be too high for the low risk customers and they will not buy it, whereas the high risk customers will be anxious to buy. Of course, the insurance company cannot make a profit by pricing its insurance at average risk if only high risk customers buy insurance. As a result, insurers will need to raise the price of health insurance to cover the cost of the predominantly high risk customers, meaning that even people with average risk will not want to buy health insurance. This phenomenon is called adverse selection. Many people who are without health insurance are younger and find the cost of health insurance a poor bargain given their good health status, so they opt out. Of course health insurers try to protect against adverse selection by not covering existing conditions. As a result, people who wait until they are sick or old to buy insurance are out of luck. Obamacare addresses this problem by compelling insurance companies to cover all persons whether or not they have existing conditions and compelling persons to purchases health insurance, whether they want to buy it or not. A second reason for market failure in the health insurance market is that people who are insured have an incentive to consume too much health services. This problem is called moral hazard. For example, in the figure above, if all sick people are fully insured so that the insurance company pays all of their healthcare expenses, they will face a zero price of healthcare services and will consume the maximum amount Q X. Also, healthcare providers have incentives to over-provide when their patients do not directly foot the bill. But healthcare, whether insured or not, is expensive. To supply Q X healthcare providers would need price P X, which is paid by the insurers. The total cost of healthcare would rise significantly from P M times Q M to P X times Q X. Note that healthcare costs rise both because more services are demanded and because the price of healthcare services is higher. Health insurance is a cause of healthcare cost inflation. Also, the excessive use of healthcare services from moral hazard leads to deadweight loss. The DWL is equal to the excess of the cost of healthcare services above its value to the consumer (the demand price) and is equal to the area of the triangle EAB in the figure above. 5
One way to reduce moral hazard is coinsurance. Coinsurance takes the form of deductibles (a certain level of cost must be paid each year by the patient say, $200 before insurance coverage kicks in) and copayments (a certain percentage of the healthcare cost say 10% must be paid by the patient). With a copayment, the patients do not treat healthcare as free but face the supply curve labeled Coinsurance payment. The equilibrium quantity of healthcare is now Q I. The copayment to the patient is the distance Q I B and the insurance company pays the difference A B. Note that the copayment reduces the price of healthcare services from P X to P I, and reduces the DWL of moral hazard by the area AA B B. Of course, the price and DWL are still higher than a pay-for-service system, but people do enjoy some insurance from healthcare cost risk. The effects of coinsurance payments on the demand for healthcare services have been widely studied. A Rand Corporation study found that coinsurance reduced the demand for physicians services by 25% and ancillary services by about half of that. The effect on health outcomes has also been studied. Medicare and most private health insurance plans have deductibles and required co-payments by enrollees. Medicaid has some nominal copayments, but no coinsurance to speak of because the enrollees are poor. Another way of controlling health cost inflation is Health Maintenance Organizations (HMOs), also called managed care. An HMO contracts to provide all of the healthcare needs of an individual or family for an annual fee. In effect, an HMO functions as both healthcare provider and insurer. Typically, the HMO determines what services are procedures the patient receives, and the patient is not able to shop around for different healthcare providers. Part C Medicare is an HMO option that can be chosen by Medicare enrollees. Most HMOs have low or no coinsurance requirements. Another way of controlling healthcare cost inflation is the single payer system. This is the system used in Canada and other countries where health insurance is socialized. In most of these countries, healthcare providers are private persons or organizations, but the compensation for healthcare services comes from a single insurer the government. A single payer can act as a monopsony. 6
That is, it can is exercise market power as the only buyer of healthcare services. In single payer systems, the government insurer sets maximum rates at which the healthcare providers will be compensated for their services. Typically, government control goes further than that. In order to allocate a scarce resource (healthcare services) across those needing it without price rationing, the government engages in quantity rationing, including waiting lists for procedures that are not life threatening (and in some documented cases, for some that are life threatening.) Also, low compensation rates by the government insurer limits the ability of healthcare providers to invest in expensive diagnostic equipment. For example, Canada has less than one quarter as many MRI machines per person than in the US. Neil Bruce 2014 7