Wednesday, April 5, 2017

The second original sin of healthcare regulation

Whenever I advance one or another view of how a relatively free health care and insurance market could work a lot better than the mess we have now, the obvious question comes up: Well, what about the homeless person with a heart attack? You won't let him die in the gutter will you?

No. Of course not. We are a compassionate society. We will provide for poor people, very sick people, those with diminished mental capacity, the unfortunate, the incompetent, or the merely improvident. People don't die in the gutter.  Any half-reasonable health care reform proposal, including mine, provides some system of charity care; whether via medicaid, government run hospitals (VA for everyone, county hospitals), premium subsidies or vouchers, support for charity hospitals, and so forth; and in our society the government will have a big part in this; I do not appeal to private charity alone.  Such systems will also always be a thorn in our public side; as the tension between cost, effectiveness, quality, moral hazard will not magically disappear no matter how nice the promises of their architects, and the fraud, inefficiency, and bureaucracy of anything run by governments will not disappear as well.

But the great puzzle of health care policy: Just why is it, to accommodate this worthy goal, must your and my health care and insurance be so deeply regulated and so thoroughly dysfunctional? As one small example, why does a 20 minute skin check with the resident of my dermatologist generate a phoney baloney bill for over $1000, meaning a cash and carry market for such a simple, elastically demanded, and perfectly predictable service is impossible?

Why, in order to provide for the unfortunate, do we not simply levy taxes, and pay for charity care, and leave the rest of us alone?
Regular Americans  have jobs, buy houses, buy TVs, cars, and smartphones, negotiate the complexities of 401(k) and IRA plans, cell phone contracts, frequent flyer programs; hire the complex professional services of contractors, car mechanics, lawyers and accountants, and deal with the insane complexity of our tax system.

Why do we not leave such Americans (you and me) to a largely free market (as much as anything is a free market anymore) in dealing with their health care and health insurance? Dealing with a free-market health insurance, offered by companies competing hard for your dollar,  is surely no more complex than dealing with Obamacare exchanges with their constantly shifting plans and networks, and the impossibility of finding out actually what doctor takes what.

I think the answer is relatively simple. Our political system is allergic to the word "tax." Instead of straightforwardly raising taxes in a non-distortionary way (a VAT, say), and providing charity care or subsidies -- on budget, please, where we can see it -- our political system prefers to fund things by forcing cross subsidies.

Medicare and medicaid don't pay what the service costs, because we don't want to admit just how expensive that service is. So, large hospitals make up the difference by overcharging you and me instead. The poster child (though not really a cost driver) is emergency room care. The government passed a law saying hospitals must provide emergency room care for free. But money does not grow on trees, so again you and me (via private insurance) must get overcharged to cross-subsidize. The ACA tried to force young healthy wealthy (not getting subsidies) to vastly overpay for insurance, to cross subsidize the poorer and sicker.

This might seem like a wash. OK, if instead of paying taxes, it makes you feel good to pay business class prices for health insurance, what the heck. Economically, a cross-subsidy works the same as a tax. In fact, we do have Europe-size taxes and subsidies, we just hide them.

But it's not a wash. Cross-subsidies are dramatically less efficient than taxes. Choosing cross-subsidies over taxes is indeed the second original sin of health care and insurance regulation. Cross-subsidies cannot stand competition. 

If as now you and I are grossly overpaying for health care and insurance, to cross-subsidize others, a competitive market would come along and peel us off. A local skin-check clinic could offer that service for $50.

Low prices, efficiency, and innovation in the provision of services like health care come centrally from competition, and especially disruptive competition.  With no competition -- especially no entry by new doctors, hospitals, clinics, insurance companies -- costs spiral up. As  costs spiral up, the cost of the charity care spirals up. As that spirals up, the size of the cross-subsidies spirals up. As that spirals up, the need to restrict competition spirals up.

In a sensible world, government assistance lives beside a free market, where innovation and price discovery happen. That keeps the cost of government assistance somewhat in check. But when we choose assistance by cross-subsidy, then kill off competition and force us all in the regulated system, that check disappears.

We do not force you and me into government housing in order to cross-subsidize housing assistance for the poor. (Well, "affordable housing" mandates are going that direction, with predictable results.) We don't force you and me into buses to cross-subsidize public transit for the poor. (Well,... And I don't want to defend the rather atrocious public housing and public transit systems.) We don't force you and me into government-regulated grocery stores and restaurants to provide food stamps and other nutrition assistance. And housing, transportation, and food remain functional markets.

Bottom line: Much of the pathology of health care and health insurance comes from this second original sin, choosing cross-subsidies rather than straightforward taxes. Cross-subsidies require the government to stop competition, so an initially clever way of hiding taxes eventually builds into a monstrously inefficient system.  (That's a key point. Initially, it is about the same. But the cross subsidy system gets more and more inefficient over time.)

We would be far better off to admit this; raise explicit taxes enough to provide the charity end of our care, and let health insurers and care givers compete for the rest of us, as airlines, computer makers, and everyone else does. The politician's job is to explain to people that what they pay more in taxes they will more than make up in lower health care and insurance costs.

The principle goes more deeply. For example, the government wants to provide free birth control. I think that's a great idea -- given the personal and social costs of unwanted pregnancy, and the political turmoil over abortion, sure, every pharmacy should stock free birth control. It would take a very small tax to cover it, and I would gladly pay. But no, the ACA decreed that insurers must "pay" for it, from a cross-subsidy, that people opposed to birth control objected to. Are annual checkups good for public health? If you think so, tax and spend (on budget!) and send people vouchers. And so forth.

What happens in a free market to people who fail to buy health insurance? Don't we need a mandate? On economic grounds, a mandate for extremely high deductible catastrophic coverage makes some sense. People who don't buy health insurance and get some rare cancer cost a lot of money. However, such people are not really the heart of health care costs (or the government's health care costs). There is no real case for forcing such people to buy insurance with lots of first-dollar services, if they choose to pay for those out of pockets. We mandate car insurance, but not that it covers oil changes (to cross-subsidize oil changes for poor people.)

In a free but compassionate market, people who fail to buy health insurance and get sick suffer the same fate as people to fail to buy home insurance and their house burns down, or people who bet on the stock market and lose. The demands of a compassionate society are to make sure everyone gets reasonable health care. But it is not to protect the wealth of relatively well off people who choose to take risks. So, the average person with a job, house, etc. who fails to buy health insurance and then gets sick receives health care -- but also personal bankruptcy. With that stick in front of us, I'm not persuaded that a mandate is going to be necessary for average Americans like you and me. Any more than a mandate is necessary to get us to buy home insurance.

(This isn't really a new thought; it's in After the ACA, for example. But a bunch of correspondence following my last health post makes it worth punching up,.)

(And the first original sin? The tax deduction for employer provided group insurance, but not for employer contributions to individual, portable, guaranteed renewable, individual insurance. That caused the preexisting conditions problem pretty much by itself.)


  1. One option for consideration is to have proper disincentives in place to prevent unnecessary medical treatment being utilized by the increasing portion of society on Medicaid. This is the crux of the problem, with the enrollment in Medicaid roughly doubling over the last 4 years, there has been an artificial economic increase in demand for health care services by those with no disincentive preventing them from utilizing such available services. This artificial increase in demand for health care services is ultimately driving up health care costs for all, most of whom must make a rational decision if a medical problem warrants a trip to a health care provider. There is a proper financial disincentive for most people to prevent the unnecessary utilization of health care services in the form of co-pays, deductibles, and out of pocket costs. In order to allow for Medicaid recipient numbers to continue to climb, or even remain stagnant, there must be a proper disincentive for unnecessary health care utilization by this growing portion of the population.

  2. We are already paying 2.9% for Medicare. Of course those whos income is in capital gains or business profits can dodge that easily. See John Edwards, Trump or Warren Buffett.

    What percentage of the population would not be incentivized by the threat of bankruptcy? Well the bottom 20% who have no net worth certainly would not. The point is, this may not be ½ the population but it isn’t small.

    Why bump the Medicare tax to 10% on all income? That should be enough to create a national health system for those who want it. Private insurance will still be there to supplement if you want all the bells and whistles.

  3. A quick addition to the (private/social) advantage of a competitive healthcare market: with competition, chances are that many healthy people that today do not (want to) buy insurance, will be confronted with premiums at which they VOLUNTARILY choose to buy it. Moreover, even for those who decide not to buy insurance, the fees for care in a competitive market would not necessarily mean bankruptcy.
    Now John, what about litigation? I live in Switzerland. Last month I slightly sprained a knee while skiing. Went to the doctor, she asked me a few questions, watched me standing, bended my knee this and that way, and gave me some OTC anti-inflamatories and a few sessions of physiotherapy. I am essentially fine now. In the States, the same treatment would have come after several X-rays, MRIs, even blood tests. That over-diagnosing is usually attributed to doctors covering from malpractice litigation. That seems a pretty intractable problem, unless you are willing to somehow restrict people's right to sue...

  4. For what it's worth, my own private insurance actually forces me to utilize unnecessary medical services MORE than I would if on Medicaid. I've got one of those plans where you can't go see a specialist without visiting your primary care first, creating numerous useless visits. Also, the co-pays on my plan aren't big enough to impact visit decisions.

    None of this contradicts your key point that Medicaid needs better quantity control. I'm just observing that none of the payers seem to have figured this out especially well.

  5. ' We mandate car insurance, but not that it covers oil changes (to cross-subsidize oil changes for poor people.)'

    We don't mandate car insurance at all. The only requirement for driving a car on public highways is that it either be *insured for liability to others*, or that the owner of the car be financially capable of paying for damages to someone they might injure.

    Bill Gates wouldn't be required to even have liability auto insurance, for instance. And, no one who chooses not to drive at all, but take buses, taxis and ride sharing services, has to have any auto insurance.

  6. A VAT tax in government hands is a concern. Fica doesn't cover SS and medicare may be insolvent in 10 years. Why not voluntary medical savings accounts? 401k, IRA and self insuring retirement plans are voluntary. If we rely on the government, an institution of force with no money of it's own, to, in FDR's words, "protect us against the hazards and vicissitudes of life," we lose dominion, authority and jurisdiction over our lives.

  7. Could you explain your theory of "overcharging"? If the hospitals could profitably increase prices in the market for "you and me," why don't they? Please write out your model of how profit maximizing firms cross-subsidize.

  8. I hope you are sending this to some of our Washington political friends. Just maybe they would learn something (or maybe not)!

  9. I agree with you wholeheartedly regarding both original sins, with the exception of the sentiment behind this statement: "I think the answer is relatively simple. Our political system is allergic to the word tax."

    I think that comes dangerously close to blaming the victim. For the fundamental reason for both "sins" is evil: the evil of the medical (and pharmaceutical) establishments, which want things to be so unfair because they profit so immensely from them.

    And so for decades they have been using their tremendous politicians to buy ("lobby") politicians (much the same way as the military-industrial complex buys politicians to ensure endless war and the weapons contracts that go with it), causing a vicious cycle that has gotten us to the horrendous point we are now.

    And I'm not just talking about specialists and executives: I know people who I'm almost certain couldn't hold down even the simplist and/or lowest-paying job in the real (non-subsidized) world, but they are getting paid a ton of money (plus generous medical and retirement benefits) because they work in the health-care industry.


  10. Thank for your posts John I always enjoy reading them, I have never commented on your posts, but I had a couple of questions that I'm really curious about. First, if the American Medical Association did not control the supply of doctors, I suspect that an excellent Spanish-trained doctor would be happy to take 40$ for this visit. Isn't this what Milton Friedman would recommend? If medicine is so special and requires controlling the supply and quality of doctors, then why not control the demand side as well?

    Second, given that it's globally accepted that people have to buy car insurance, why not health insurance?

    Second, I'm not sure how your plan would deal with people born with a health problem?


  11. "We are a compassionate society. . . . People don't die in the gutter." But you fail to note that our "compassion" seems to have a very strong *nationalistic* bias. We don't want people dying in U.S. gutters, but plenty of people can die in *foreign* gutters; that's (almost) none of our concern. This attitude is not accurately denominated "compassion."

  12. In 1944 FDR proposed a second Bill of Rights.

    I quote from Wikipedia.

    The Second Bill of Rights is a list of rights that was proposed by United States President Franklin D. Roosevelt during his State of the Union Address on January 11, 1944.[1] In his address, Roosevelt suggested that the nation had come to recognize and should now implement, a second "bill of rights." Roosevelt's argument was that the "political rights" guaranteed by the US Constitution and the Bill of Rights had "proved inadequate to assure us equality in the pursuit of happiness." His remedy was to declare an "economic bill of rights" to guarantee these specific rights:…

    ‘Among these are:

    The right to a useful and remunerative job in the industries or shops or farms or mines of the nation;

    The right to earn enough to provide adequate food and clothing and recreation;

    The right of every farmer to raise and sell his products at a return which will give him and his family a decent living;

    The right of every businessman, large and small, to trade in an atmosphere of freedom from unfair competition and domination by monopolies at home or abroad;

    The right of every family to a decent home;

    The right to adequate medical care and the opportunity to achieve and enjoy good health;

    The right to adequate protection from the economic fears of old age, sickness, accident, and unemployment;

    The right to a good education.’

    The tragedy in all this is when an arrogant, if not malicious, government is absolutely convinced that they know how to accomplish this.

    The consequences of their arrogance is the ACA with its ‘cross subsidies’, and regulations which you pointed out.

    In a democracy with economic freedom and free markets, I can take care of myself. Thank you. I’ve been doing it for 70 years. Apparently many folks in our country do not believe in democracy.

    Why can’t they just move to Cuba or Venezuela and enjoy the Socialist miracle without us.

    And you nailed the ‘first original sin.’

    (And the first original sin? The tax deduction for employer provided group insurance, but not for employer contributions to individual, portable, guaranteed renewable, individual insurance. That caused the preexisting conditions problem pretty much by itself.)

    In 1998 I opted out of the employer insurance plan. I wanted my own plan that went with me wherever I worked and therefore no preexisting conditions problems. I was upset that I couldn’t deduct the entire premium from my taxes and couldn’t shop across state lines for the best rate.

  13. John, thanks for an interesting post. But can you expand on your third paragraph about the "phoney baloney" bill for a dermatologist? It sounds like you are talking about one of those explanation of benefits forms that come from your insurance company. I don't understand what this has to do with regulation. Isn't this the product of a freely entered contract between your private-sector insurance company and your privately owned doctor's office? Is the government somehow preventing you from paying cash to your dermatologist?

  14. Healthcare in the U.S. is a patchwork of so many different systems, people can become easily frustrated and not seek even basic care such as checkups. That's why I like the "nudge" idea in the healthcare context.

    In addition to sending the usual complicated declarations, send a simple, one page list in plain English stating all the completely "free" services under the policy. For example, do you get a "free" checkup every year? What about blood tests for cholesterol, glucose, STDs, etc.? Where is the ER closest to your house? When is urgent care a better choice? Is there an app that will tell you the nearest covered ER and urgent care when you need them? And so on.

    Until we resolve these communication issues, some people won't use preventative services--even when covered under a policy--or will increase costs and complexity for everyone by going to the "wrong" hospital in an emergency situation.

    Also, psych services seem disconnected from proper checks and balances. Is it reasonable to allow a psych to charge 250/hr+ hourly each week without having to show objectively measurable progress? Does this lack of checks and balances have something to do with why 70% of Americans over the age of 18 are on prescription drugs?

  15. Taxes to cover the indigent and the incompetent. Everyone else navigates a "competitive market" with gigantic information asymmetries and often very few real choices in local providers. If your solution was really that simple, why has no other country in the world implemented it? Short answer, it isn't that simple.

    1. Of course its not that simple. What do you propose? A program like the NHS is the US? Its a possibility, but Cochrane's point is that the key is competition, and if you have a monopoly in health services like Britain (or Canada) have there is no competition and no gains in efficiency. Better to give subsidies to those who cant pay and allow competition, like you see in cosmetic surgery, which is much less regulated and is paid out of pocket.

    2. Having Medicare for all does not imply a monopoly in providers. It's single payer, not single provider. You want billions of sweet Medicare dollars, you have to compete for them.

  16. I'm a physician and I have an HMO bronze plan with a $6,000 deductible. That's because I know where I can go and get something at a cash price for below the contracted rate with my insurer, and although $6,000 would be painful it wouldn't be lethal. I saved over $5,000 on premiums last year and spent $1,700 out of pocket. I won the bet.

    For example, my insurance might have a contract with a facility for $1,000 for an MRI. Given my deductible that $1,000 will pass directly to me. Instead I call around and ask MRI facilities for their cash price. I can get a lumbar MRI for under $400 cash.

    Exploiting this principle and the devastating distortions of Obamacare I have been gradually building a practice based on cash payments. People are coming to see me who paid cash even though they have insurance.

    The secret of the success of this approach is that I exploit the price distortion of cross-subsidies. I do this by performing most of my procedures in my office rather than taking my patients to a facility such as a hospital or an Ambulatory Surgery Center. You get the same doctor and the same procedure at a far lower price. Plus we usually have the patient in and out in the time it takes a facility to get them registered since we did all the paperwork at the first visit.

    The main difference is in the facility fee, where the cross subsidy lies. Rather than go into the details here I would direct you to my website where under the fee schedule section you can see an illustration of the differences produced by facility fees and anesthesia fees.

    This won't work for heart surgery but as John said, the dermatologist who figures out a decent cash price should do very well.

  17. This is from my marketing brochure

    Example Using Medicare Rates*

    Lumbar epidural steroid injection, CPT 62323

    Performed at an ASC under sedation

    Physician’s fee $93
    Anesthesia (15 mins) $88
    Facility fee $327
    Total $508

    Performed at a hospital under sedation

    Physician’s fee $93
    Anesthesia (15 mins) $88
    Facility fee $585
    Total $766
    Note: Hospitals can bill extra for recovery room
    time so the bill may run even higher.

    At The Center for Pain Relief under sedation

    Global fee $228
    IV sedation $34
    Total $262

    Office savings vs ASC $246 (48%)
    Office savings vs HOPD $504 (66%)

  18. BTW we could save a lot of money by revising Medicare Part D. The legislation as written prohibits CMS from negotiating prices on medication. Imagine Medicare telling a drug maker that if they want their drug on the Medicare formulary and sell their product to tens of millions of Medicare beneficiaries they need to cut their price.

    Why didn't Obama push for this while working on the ACA? Pelosi? Reid?

    Why aren't the Republicans pushing it as part of ACA repeal/reform?

    Today's lesson is brought to you by the letter K, as in K Street.

  19. Regarding the phoney baloney bill (which is a huge pet peeve of mine): I'll stick with a single example. My wife got physical therapy. PB bill of $324 per hour but our insurer always just paid "reasonable and customary" of $81 per hour. When the insurance ran out, I figured it would not be a problem to get the service for $81 (it's better for them, right? No paperwork. Cash paid on the day of service). Nope. They said that their contract with the insurer required them to bill cash payers and the uninsured $324. It seems like some sort of collusion that is probably already illegal under anti-trust laws. But in any event, the least we could do is require "one price". If an insurer pays $X, then everyone pays $X, not a multiple of X. This helps the uninsured. But it also helps create a better market because then some people might choose to be uninsured. I would. I still carry insurance but mostly for the bargaining power of the insurer. I'm not really interested in the catastrophe element. If they offered it, I'd get insurance with a $250,000 deductible just to have access to the prices the insurance companies have negotiated.

    1. I agree with your statement. The same is true with car insurance. I used to only carry liability insurance as the maximum loss of damage to my car would be the price of the car. however when I brought my car to an auto shop when not carrying any coverage, I found that I was billed to every small detail which probably would not have occurred if the cost were paid by car insurance with more knowledge of the state of my car.

  20. One of the ways to fix health care, cover everyone, create better doctor and patient relationships, and prevent bankruptcies from costly treatments/healing is the following health care plan.

    The health care plan linked above addresses Cochrane’s part 1 and part 2 and offers a great way to remedy the ailing system by combining strands of Medicare, the open market, individual participation, and the elimination of health insurance companies--these four together in one elegant weave. Everyone will be covered and no one will go bankrupt because of health care costs.

    1. That's actually quite ingenious yet elegantly simple -- especially in excising insurance Big Corp. Is it viable...wishing the ACA politicos would consider such a plan.

  21. As a Canadian I am extremely biased but a couple things I struggle to understand about this debate. How much does you Byzantine medical structure impact the mobility of your workers. I live in Alberta which is an energy province. We routinely have thousands of Newfoundlanders which distance wise is Denver and Vermont apart provide needed Canadian labour in our energy industry. Not one of them even considers not coming to work because their crap job provides crap healthcare. It isn't even factored into the equation. Would it not be better to have half of Kentucky mobily taking great jobs in North Dakota and paying taxes vat or not. As an admirer of many things your country does this one always baffles me. Even worse because of this dislocation and this disincentive you have fostered a migratory yet illegal labour force from Mexico. Great nations need mobility or everything becomes NIMBY and new ideas and tolerance for strangers is not fostered. At one time Americans moved for work now they just stay in either rich or poor centres with the rich erecting real estate barriers to entry making them richer but the problem worse. How much does healthcare play into this I wonder? In your dynamic years as a country health costs were much lower so the cost of mobility was greater than the loss of healthcare. That is not the case today. Also some used car insurance earlier as an example. I do not understand how insurance and care became interchangeable in this debate. Healthcare is NOT insurance. It is like my car may maitenance is my care cost and insurance is for unforeseen accidents. Why not have basic healthcare and insurance for larger issues. John you used some earlier examples such as government run airlines as examples in this debate. I think a better analogy would be privately run fire departments. I am sure they would be more efficient until they started burning down our houses. Some things do not lend themselves only to private enterprise. One last thing to ask if alright is why did Ryan's plan fail it was a voucher system as close to your proposal as I have seen. Is that too complex for people? Just wondering what your take is on that?

  22. The problem is that complex hidden money transfer systems have been more politically viable than open and honest money transfer systems. The problem isn't the word "tax", it's that a policy that doesn't hide the costs, it would've politically lost. The rest of this article is brilliant but the summary of the problem as the word "tax" is incorrect. I'd also love to see Cochrane talk more about health care policy, critique the specific policies being proposed, and even advocate specific alternatives.

  23. I disagree with the statement that a person who chooses not to buy health insurance will become bankrupt when diagnosed with serious illness. If they buy insurance only after developing illness and insurance companies cannot differentiate against pre-existing conditions, it is the entire group of insured members that is paying for expensive treatment.

  24. There are many good points raised in this article, but in my opinion no argument about health care system is complete without addressing the problem of adverse selection.

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