Tuesday, June 12, 2018

Cross-subsidies

Cross-subsidies are an under-appreciated original sin of economic stagnation. To transfer money from A to B, it would usually be better to raise taxes on A and to provide vouchers or otherwise pay competitive suppliers on behalf of B. But our political system doesn't like to admit the size of government-induced transfers, so instead we force businesses to undercharge B. Since they have to cover cost, they must overcharge A. It starts as the same thing as a tax on A to subsidize B. But a cross-subsidy cannot withstand competition. Someone else can give A a better price. So our government protects A from that competition. That ruins the underlying markets, and next thing you know everyone is paying more for less.

This was the story of airlines and telephones: The government wanted to subsidize airline service to small cities, and residential landlines, especially rural. It forced companies to provide those at a loss and to cross-subsidize those losses from other customers, big city connections and long distance. But then the government had to stop competitors from undercutting the overpriced services. And as those deregulations showed, the result was inefficiency and high prices for everyone.

Health care and insurance are the screaming example today. The government wants to provide health care to poor, old, and other groups. It does not want to forthrightly raise taxes and pay for their health care in competitive markets. So it forces providers to pay less to those groups, and make it up by overcharging the rest of us. But overcharging cannot stand competition, so gradually the whole system became bloated and inefficient.

A Bloomberg article "Air Ambulances Are Flying More Patients Than Ever, and Leaving Massive Bills Behind" by  John Tozzi offers a striking illustration of the phenomenon, and much of the mindset that keeps our country from fixing it.

The story starts with the usual human-interest tale, a $45,930 bill for a 70 mile flight for a kid with a 107 degree fever.
At the heart of the dispute is a gap between what insurance will pay for the flight and what Air Methods says it must charge to keep flying. Michael Cox ... had health coverage through a plan for public employees. It paid $6,704—the amount, it says, Medicare would have paid for the trip.   
The air-ambulance industry says reimbursements from U.S. government health programs, including Medicare and Medicaid, don’t cover their expenses. Operators say they thus must ask others to pay more—and when health plans balk, patients get stuck with the tab.
Seth Myers, president of Air Evac, said that his company loses money on patients covered by Medicaid and Medicare, as well as those with no insurance. That's about 75 percent of the people it flies. 

Source: Bloomberg.com
According to a 2017 report commissioned by the Association of Air Medical Services, an industry trade group, the typical cost per flight was $10,199 in 2015, and Medicare paid only 59 percent that. 
So, I knew about cross-subsidies, but $45,950 vs. $6,704 is a lot!

OK, put your economics hats on. How can it persist that people are double and triple charged what it costs to provide any service? Why, when an emergency room puts out a call, "air ambulance needed, paying customer alert" are there not swarms of helicopters battling it out -- and in the process driving the price down to cost?


Supply is always the answer -- and the one just about everyone forgets, as in this article.

I don't know the regulation, and the article doesn't go near it, so I will hazard guesses.

a) Not just any helicopter will do. Look at any small airport. There are a lot of helicopters hanging around whose owners would jump in a flash for an uber-helicopter call that pays $45,000. So, it must be true that in every such case you have to have an air-ambulance. Which makes a lot of sense, of course -- the helicopter should have the standard kind of life-saving equipment on it. But clearly the emergency room is only going to call and allow a air ambulance.

b) Air-ambulances must be properly certified and licensed. OK, but there are still lots of people who could go in to this business, or the ones who are there could bid aggressively. That brings us to

c) I'm willing to bet part of the conditions for license is that operators must carry anyone regardless of ability to pay, and not ask any financial questions.

Competition for paying customers must be banned. Only such a ban can explain the crazy situation. If there were any way to compete for the paying customers, it would happen and the problem would evaporate.

The article comes close to confirming this suspicion.
“I fly people based on need, when a physician calls or when an ambulance calls,” he [Seth Myers] said. “We don’t know for days whether a person has the ability to pay.”
The alternative? Well, pass a tax on air ambulance rides, and use the proceeds to pay for rides for the poor or indigent. It's the same thing -- except with a tax, there needs to be no regulation or bar on competition. Or pass an income tax surcharge and do the same thing. Yes, I don't like taxes any more than you do -- but given we're going to grossly subsidize air ambulance rides, a tax and subsidy is much more efficient than banning competition and allowing an ex-post free-for-all price gouge.

The article is most revealing, I think, that neither the author nor anyone he interviews even thinks of supply. Their explanations are as usual: demand, negotiating ability, and lack of regulation. 

It is true that when faced with an emergency, a loved one needs an air ambulance and is in danger of dying, you are in a very poor position to negotiate. But supply competition should solve that problem. If you can get $45,000 for a 70 mile helicopter ride, competing helicopter companies would have representatives sitting in the emergency rooms! When you arrive at an airport at 11 pm and want a rental car, you're not in a great negotiating position either. Somehow they don't charge $45,000 then! Why not? Supply competition -- and the need to have good reputations in any business. 

The ex-post negotiation is surreal. 
For people with private insurance, short flights in an air ambulance are often followed by long battles over the bill.  
Consumer groups and insurers counter that air-ambulance companies strategically stay out of health-plan networks to maximize revenue. 
[This is an increasingly common scam. The hospital may be in network, but many emergency room teams are out of network contractors. You find out when you wake up.]
...the Cox family went through two appeals with their health plan. After they retained a lawyer, Air Methods offered to reduce their balance to $10,000 on reviewing their tax returns, bank statements, pay stubs, and a list of assets. The family decided to sue instead. [My emphasis]
“I felt like they were screening us to see just how much money they could get out of us,” Tabitha Cox said. 
You got it Mrs. Cox. On what planet do you get on a helicopter with no mention of cost, and then the operator afterwards looks at your tax returns, bank statements, pay stubs and lists of assets to figure out how much you can pay? Only universities get away with that outside of health care!

The reporter put the blame squarely on ...  wait for it... the lack of price controls and other regulations.
Favorable treatment under federal law means air-ambulance companies, unlike their counterparts on the ground, have few restrictions on what they can charge for their services. Through a quirk of the 1978 Airline Deregulation Act, air-ambulance operators are considered air carriers—similar to Delta Air Lines or American Airlines—and states have no power to put in place their own curbs. 
Air-ambulance operators’ special legal status has helped them thwart efforts to control their rates. West Virginia's legislature passed a law in 2016 capping what its employee-health plan—which covered West Cox—and its worker-compensation program would pay for air ambulances
It is a sad day in America that the average reporter, faced with insane pricing behavior, can only come up with the lack of price control and regulation as an explanation. If voters don't understand that consumer protection comes from supply competition, we cannot expect politicians to shove that enlightenment down our throats.

Does it take a genius to figure out what price controls mean? Well, medicare, medicaid and indigent people aren't about to pay the cost. So if the companies can't cover costs by looking at our tax returns and coming up with a tailored price gouge for each of us, that means less air ambulance flights. The kid with the 107 degree temperature will end up driving in rush hour traffic to the hospital that can help him. Some will die in the process. Actually, it means who "needs" an air ambulance will depend on connections.

That's the problem with negoatiation as the answer to everything. Negotiation can shift costs from one person to another, but we can't all negotiate for a better deal.

Actually, there is some supply competition -- just not competition of the sort that brings down costs for non-indigent customers. The business has grown in response to its overall profitability.
The number of aircraft grew faster than the number of patients flown. In the 1990s, each helicopter flew about 600 patients a year, on average, according to Blumen’s data. That's fallen to about 350 in the current decade, spreading the expense of keeping each helicopter at the ready among a smaller pool of patients. 
While adding helicopters has expanded the reach of emergency care, “there are fewer and fewer patients that are having to pay higher and higher charges in order to facilitate this increase in access,” Aaron D. Todd, chief executive officer of Air Methods, said on an earnings call in May of 2015, before the company was taken private. “If you ask me personally, do we need 900 air medical helicopters to serve this country, I'd say probably not,” he said. 
If there are too many helicopters for the number of patients who need them, market forces should force less-efficient operators out of business, 
Now pick up your jaw off the floor. So, the answer to inadequate supply competition is to ... reduce supply!

16 comments:

  1. OK, Dr. Cochrane, you're right. However, as Satchel Paige is supposed to have remarked, "There are some people that if they don't know, you can't tell them."

    Of course the answer to runaway costs in higher education and health care is supply expansion/competition. (Not to mention price transparency in health care.) The ignorant populace and the corrupt politicians who serve them don't know and/or don't care. Politicians pander to collect votes instead of making the difficult decisions leaders must make and WE let them get away with it. Maybe there's nothing WE can do, anyway.

    ReplyDelete
  2. Awesome post John, as usual. I feel like you're the only one talking about cross subsidies in healthcare, and it seems like such a huge part of the problem.

    ReplyDelete
  3. Though not the the intended thrust of your (excellent) piece, the huge surprise here for me was that medical helicopters are privately owned in the first place!

    While I'm generally a "privatize it" sort of guy, I accept there exist a (limited) number of tasks best handled by the state. And I'd have thought medical helicopters would be case in point. The task being performed is inherently dangerous, prohibitively expensive, sorta uncommon (~315K flights per year, if I understand the quotes correctly), and yet something that a majority of society wants to be available when needed.

    Though I guess the another possible slant is that if medical helicopters can be effectively privatized with the only downside being randomized injustice of a strictly monetary nature, then I guess pretty much anything can be privatized effectively. Bankrupting that unlucky family from the article is certainly terrible, but in the grand scheme of things a rather small price to pay for our (apparently) expansive fleet of medical helicopters.

    ReplyDelete
  4. i may be being a lazy thinker, but i dont understand why there are more helicopters now?

    ReplyDelete
    Replies
    1. I can imagine several interesting explanations, but the correct answer turns out to be boring. Per the Air Methods historic 10-Ks, hospital consolidation (which causes a reduction in services provided by local hospitals, which in turn requires more flights into regional hospitals) is the primary driver.

      Oh and also increased Medicaid doesn't hurt, though is a less important factor. While Medicaid does not pay the full cost of a flight, getting something back is far better than nothing. Since flight providers do not screen passengers for ability to pay, and most of those who benefit from Medicaid expansion would have otherwise paid nothing, the expansion is very helpful.

      Delete
    2. interesting, so a reduction in a supply of hospital services increases the supply of helicopters, but not enough to reach an efficient supply of helicopter services...I think that corroborates JC's exasperation with the proposal of restricting the supply of helicopter services...

      Delete
  5. Well that is a problem for economies of scale.

    The plan was to ship the chronically ill to specialists in LA. We are building massive hospital complexes in LA to gain scale. But if you charge 45k for the plane ticket then we have no deal.

    ReplyDelete
  6. I agree that cross-subsidizing is common in healthcare and it is better to bring this to the surface. A few comments are
    1. It is very common for any medical service providing emergent medical care to adjust the bill based on ability to pay. If you cannot decline service based on inability to pay, the initial bill is negotiated afterwards. The culture, if not reality, can be compared to "each according to his ability, each according to his need". This does not apply to non-emergent medical care.
    2. I am interested in the amount charged to self paying patients. This is often even higher than the amount charged to private insurance and I doubt it reflects the average cost of a helicopter ride of $10,000. For a functional market to develop I would like to see a universal price charged to self pay, private insurance and Medicare/Medicaid. Part of the bill not covered by private insurance or Medicare/Medicaid can be charged to the patient. A larger group of self paying patients (with catastrophic insurance if desired) would promote market efficiency. For poor and/or elderly patient who cannot pay their part there can be separate assistance programs or more transparent subsidies. However different prices for the same service causes huge distortions in the market.

    ReplyDelete
  7. Could this be a case where the need is there but the economics just don't work out without a little help?
    I can hear all the arguments now - "we didn't have air ambulances 100 years ago and we got along fine" etc. But who can argue that they're a huge contributor to the quality of life in this country? I agree with you that this might be something that's worth paying taxes for, and that taxation would be more efficient and less intrusive than regulation, subsidies, and disparities in price.

    ReplyDelete
  8. There are also a tremendous number of cross-subsidies buried in the tax code in the form of numerous exemptions and deductions. Personally, I would prefer that this be made completely transparent by removing the subsidies from the tax code (by making all income taxable and allowing deductions directly related to producing income).

    Then you could file a separate form to get your subsidies. For example, instead of receiving tax-exempt interest on muni bonds, the government would cut you a check (or deposit money into your bank account) to subsidize you for the taxes that you paid on your muni bond income. In this way, the subsidies would be explicit and be a part of government spending instead of an offset to revenue.

    ReplyDelete
  9. I am with you to the last step. If we force carriers to accept everyone but otherwise allow competition, we should get expected price = marginal cost:

    pr(medicaid)*Pfixed + pr(private)*Pmarket = MC

    This is the same as taxing the private users and subsidizing the medicaid users. The problem is therefore the distortions from a very narrow tax base, not the lack of competition per se. Right?

    ReplyDelete
  10. What? You mean consumer surplus is a bad thing? Ha. I jest. Welfare economics smashes into the unenviable position of being in a Paretto efficiency, even if reality says there's a Paretto Improvement to be made [I know this sounds like a stretch a bit!]. (Look at taxes and people who complain about them: "Why should I have to give my hard earned money to someone who doesn't even work?" We've all heard this from someone. Maximize someone's utility at the expense of another. Insert frowny face.)

    Oh, how micro can tell a story. Ha.

    Will a helicopter come and take you to the ER if you're in a helicopter crash? *scratches head*

    ReplyDelete
  11. Hi John,

    Thanks for the post! Two comments/questions:

    1) I recently moved to the Bay Area and housing is obviously a huge problem here. One policy I've heard bounced around requires new buildings to include "affordable housing" units that have to be rented at a lower rate. I'm wondering if a similar analysis applies:
    - The policy reduces supply by making it less profitable to construct a building
    - The reduced supply drives up the amount paid by "market price" renters, in effect cross-subsidizing renters in the affordable housing units
    - To clear the market for the affordable housing units, they will either be allocated via a long waiting list/connections, or they will be of very low quality (either very small or run down)
    - A smarter policy would be to increase housing subsidies for low-income people, paid for out of taxes

    2) I'm thinking about joining a seastead sometime in the future (https://www.blue-frontiers.com/en/) and am wondering how you would think about design an institution that prevents these types of issues from arising. I think a much more precise delineation of the policy tools available to government would be helpful, but I wonder if that would be too inflexible to sustain over a long horizon.

    ReplyDelete
  12. There are standby charges that the air ambulance service operator must cover irrespective of whether the aircraft flies or not. The more flights the aircraft makes the lower the per flight cost and hence the lower the marked-up cost charged to a paying patient or his insurer/employer, ceteris paribus.

    The notion that more aircraft and more air ambulance service providers will lead to lower charges per flight is probably mistaken given the relatively high investment in aircraft and the relatively high labor costs for manning the service on an "on-demand" around-the-clock basis.

    Unlike a physical commodity which can be stored with little depreciation in quantity or quality for later use if properly warehoused, personal services cannot be warehoused one day and then withdrawn from the warehouse in two or three days time or in a month's time when needed.

    The alternative to for-profit independent air ambulance services is to have the state provide the service and impose a tax or a surcharge on the state’s residents to cover the cost of service that cannot be recovered from private insurance or Medicaid/Medicare insurance.

    Provision of air ambulance service by the state can be had by contracting with private parties on a negotiated basis. Contracts can be awarded via competitive bids for specific geographic areas in the state and for specific time periods (e.g., 1-2 years), etc. Private air ambulance services need not be excluded from the state. The state provided service would likely drive the private operator out of the local market unless the private operator was capable of providing the service at a lower total cost. “Competition” in this fashion would address both requirements identified in your blog post.

    An overview of the air ambulance industry can be found in a September 2010 GAO report to requesting congressmen by navigating to: https://www.gao.gov/assets/320/310527.pdf

    ReplyDelete
    Replies
    1. The problem is not a high fixed cost of providing this particular service. Its that the "prices" are not tied to costs because of the market restrictions. Market competition would force prices to reflect costs as opposed to some opaque calculation of a consumer's "ability to pay". As a result, the competitive system incentivizes companies to find new ways to lower their costs rather than to search for new ways to price gauge.

      Delete
  13. It seems that, practically speaking, when your answer is, "why not just raise taxes to pay for it," you've lost. Price controls would be yet another distortion, but I don't see why, given the above, they are not a reasonable attempt. Your supply side solution is persuasive from a descriptive perspective, but I mean in the sense of looking for a practicable solution.

    ReplyDelete

Comments are welcome. Keep it short, polite, and on topic.

Thanks to a few abusers I am now moderating comments. I welcome thoughtful disagreement. I will block comments with insulting or abusive language. I'm also blocking totally inane comments. Try to make some sense. I am much more likely to allow critical comments if you have the honesty and courage to use your real name.