Wednesday, August 29, 2018

The Tax-and-Spend Health-Care Solution

A Wall Street Journal Oped, From July 29 2018. Now that 30 days have passed, I can post the whole thing.

The Tax-and-Spend Health-Care Solution

Honest subsidies beat cross-subsidies. They’d encourage competition and innovation.

By John H. Cochrane

Why is paying for health care such a mess in America? Why is it so hard to fix? Cross-subsidies are the original sin. The government wants to subsidize health care for poor people, chronically sick people, and people who have money but choose to spend less of it on health care than officials find sufficient. These are worthy goals, easily achieved in a completely free-market system by raising taxes and then subsidizing health care or insurance, at market prices, for people the government wishes to help.

But lawmakers do not want to be seen taxing and spending, so they hide transfers in cross-subsidies. They require emergency rooms to treat everyone who comes along, and then hospitals must overcharge everybody else. Medicare and Medicaid do not pay the full amount their services cost. Hospitals then overcharge private insurance and the few remaining cash customers.

Overcharging paying customers and providing free care in an emergency room is economically equivalent to a tax on emergency-room services that funds subsidies for others. But the effective tax and expenditure of a forced cross-subsidy do not show up on the federal budget.

Over the long term, cross-subsidies are far more inefficient than forthright taxing and spending. If the hospital is going to overcharge private insurance and paying customers to cross-subsidize the poor, the uninsured, Medicare, Medicaid and, increasingly, victims of limited exchange policies, then the hospital must be protected from competition. If competitors can come in and offer services to the paying customers, the scheme unravels.

No competition means no pressure to innovate for better service and lower costs. Soon everybody pays more than they would in a competitive free market. The damage takes time, though. Cross-subsidies are a tempting way to hide tax and spend in the short run, but they are harmful over years and decades.

We have seen this pattern over and over. Until telephone deregulation in the 1970s, the government wanted to provide telephone landlines below cost. It forced a cross-subsidy from overpriced long distance and a telephone monopoly to keep entrants out and prices up. The government wanted to subsidize small-town air service. It forced airlines to cross-subsidize from overpriced big-city services and enforced an oligopoly to keep entrants from undercutting the profitable segments. But protection bred inefficiency. After deregulation, everyone’s phone bills and airfares were lower and service was better and more innovative.

Lack of competition, especially from new entrants, is the screaming problem in health-care delivery today. In no competitive business will they not tell you the cost before providing service. In a competitive business you are bombarded with ads from new companies offering a better deal.

The situation is becoming ridiculous. Emergency rooms are staffed with out-of-network anesthesiologists. Air ambulances take everyone without question, and Medicare, Medicaid and exchange policies underpay. You wake up with immense bills, which you negotiate afterward based on ability to pay. The cash market is dead. Even if you have plenty of money, you will be massively overcharged unless you have health insurance to negotiate a lower rate.

Taxing and spending is not good for the economy. But it’s better than cross-subsidization. Taxing and spending can allow an unfettered competitive free market. Cross-subsidies must stop competition and entry at the cost of efficiency and innovation. Taxing and spending, on budget and appropriated, is also visible and transparent. Voters can see what’s going on. Finally, broad-based taxes, as damaging as they are, are better than massive implied taxes on very few people.

This is why continued tinkering with the U.S. health-care system will not work. The system will be cured only by the competition that brought far better and cheaper telephone and airline services. But there is a reason for the protections that make the system so inefficient: Allowing competition would immediately undermine cross-subsidies. Unless legislators swallow hard and put the subsidies on the budget where they belong, we can never have a competitive, innovative and efficient health-care market.

But take heart—when that market arrives, it will make the subsidies much cheaper. Yes, the government should help those in need. But there is no fundamental reason that your and my health care and insurance must be so screwed up to achieve that goal.

Mr. Cochrane is a senior fellow of the Hoover Institution at Stanford University and an adjunct scholar of the Cato Institute


  1. Well done piece, as usual. I think there is yet another benefit of eliminating cross-subsidies worth mentioning: it would force the average VOTER to understand the costs they are already bearing, forcing change.

    Voters in both parties are confused about healthcare. The political left thinks the current system is highly progressive (i.e., they think the rich are picking up most of the tab), but it's not. And the political right doesn't get just how massive healthcare spending truly is; they know it's large, but do not comprehend the federal government is quickly becoming a healthcare company that happens to have a military. Both sides would demand reform if they knew who was paying what.

    And ANY reform would be good at this point. I don't care which faction wins anymore... free market, free-market with a crappy VA-style safety net, letting the ACA take full effect, single payer, the UK system, whatever. All would be an improvement, and at some point we need to stop letting "best" be the enemy of "better." Healthcare now exceeds 18% of GDP, so even a mild efficiency improvement would meaningfully increase collective well-being.

  2. First comment. This one is a report:

    "Ohio State’s Wexner Medical Center boasts 9% revenue increase"
    By Jennifer Smola
    The Columbus Dispatch
    Aug 28, 2018

    The nonprofit medical center ... brought in $3.7 billion in revenue in fiscal year 2018, which ended June 30 ... an 8.9 percent increase over the previous fiscal year ...

    the operating margin of nearly $328 million on the $3.7 billion in revenue for fiscal year 2018 was similar to the medical center’s previous fiscal year’s operating margin of 8.8 percent ...

    the medical center has announced a plan to hire 500 new faculty members over the next five years. ...

    The medical center also had about $1.375 billion in cash and capital-funding assets to end the recent fiscal year ... That’s more than double the $643 million the medical center had in those categories about four years ago

    ... a new hospital tower project ... along with a proposed ambulatory care center on the university’s west campus are anticipated to cost more than $2 billion. ...

  3. Large scale medical tourism for high dollar elective procedure could be just one solution. Get the knee or hip replaced in Costa Rica, Thailand, or India.

  4. This is so great John, please keep it up !!

    How I wish that more people understood markets... what they're good at and what they're not. Markets are not the solution to every problem, but they can help so much if we would just let them.

  5. Second comment: You will note that the Ohio State University Wexner* Medical Center is labeled in the report as a "nonprofit". The article did not put scare quotes around the word, but it should have. The institution makes a very considerable profit. The first question is who does the profit benefit?

    The answer is that management has taken control of the profit and is channeling it into expanding the enterprise which will require more, and more expensive management.

    One of the flaws in the US health care system is that it is largely controlled by "nonprofits" that make enormous profits and plow them back into their enterprises which grow and produce even more profits. This has resulted in a heavily overcapitalized health care sector that demands higher prices and more subsidies so that it can continue to expand. The US spent 17.2% of its GDP on health care in 2017. The next highest OECD country is Switzerland at 12.3%, and the average of the top 15 economies ex-US is 11.5%. The US is 50% above that average.

    Trying to reign in the US healthcare system runs the risk of an economy shattering write down of capital investment in the health care sector.

    If hospitals were run by ordinary business corporations, they would pay some of that surplus into the general treasury as taxes, and shareholders would demand a very substantial. return of capital as dividends and distributions. The whole sector would be less highly capitalized which would reduce its demands for revenue.

    There are other institutional arrangements that could constrain the health care "nonprofits". The State of Ohio through its instrumentality, The Ohio State University, owns the Medical center and is entitled to the profits. They could be given over to the the University and used to defray the cost of education. That they are not is a testimony to how the inmates have taken control of the asylum. With equal justice the State of Ohio could demand that the profits of its wholly owned enterprise be delivered to the General Fund to be disposed of by the Legislature.

    Other "nonprofit health care systems could be required to have trustees who have no connection to management control their profits and use them for the care of the sick and poor within the hospitals catchment area. They could be required to hold public hearings on the use of the funds, and be empowered to spend the profits outside of the institution that generated them.


    *Wexner is a local billionaire who is best known for controlling the Victoria's Secret lingerie stores. Nice work if you can get it.

  6. On the subject of cross-subsidies, where I live, businesses pay about double the rate for utilities, i.e., telephone, electric, etc. as compared to residential. The same goes for tax rates, higher for business than residential.

    But for businesses, utilities and taxes are simply another cost which gets passed along in the price of goods and services. Ultimately, these are borne by consumers.

    So what we have, cross-subsidies between business and residential, that aren't really cross-subsidies.

    So in the examples given in this article, are some of these cross-subsidies not really cross-subsidies, when you account for incidence?

  7. I completely agree with this analysis.

    I believe that the current "hybrid" private/public medical insurance model just doesn't work in the long run.

    At some point we will need to decide between a much more competitive medical marketplace or a single payer arrangement. Each has its problems, but neither is the steaming pile of poo that is our current system.

    Don’t hold your breath about big changes to our current system though, the projections for 2018 spending is about $3.5 trillion. That gives current stakeholders about 3.5 trillion reasons not to change.

    For those who lean towards a single payer system, the following article in the BBC News is cautionary.

    “Patient waited 62 hours for ambulance”

  8. Third Comment. OSU Medical Center is located in Columbus, Ohio. The States' capital. Columbus is in Franklin County. Franklin County, together with 9 surrounding counties form a metropolitan area of 2.1 million people. The area has 4 hospital systems. OSU is one of them. Another is Nationwide Children's hospital. The 4 systems control substantially all of the hospital beds in the area. The state has a certificate of need program for opening new facilities. Only Nationwide Children's has all of the pediatric beds in the area. The other systems will not compete in pediatric services.

    I have never seen the systems engage in price competition. All of their advertising is focused on quality. To my knowledge all of them are profitable.

    I think the market could be fairly characterized as an oligopoly, which acts as a shared monopoly. I think this characteristic of most metropolitan areas in the US and is a major driver of health care cost increases.

    Either the federal and State governments have to use legal coercion to prevent anti-competitive behavior, or they have to impose public utility price regulation on them. Failure to do that will simply allow costs to increase until they bankrupt country. Even more than the banks, the Health Care System has become TBTF. The prognosis is grim.

  9. Wonderful piece and agree with most all of the diagnosis. The problem is mainly political.
    Let's look at Congress as a spectrum from Left to Right:
    -About one-quarter are Medicare4All / public option - all Dems.
    -Another quarter are ACA plus more subsides/fixes.
    -Another quarter are pragmatic Republicans who opposed ACA but want some variant of it with more personal responsibility and slightly more market forces (not what John is proposing)
    -Another quarter are basically tea party Republicans maybe interested in legal reform, removing state line restrictions etc. and that's about it.

    I think the 25% on each side is mostly immovable. The "middle 50%" are the ones most open to consider solutions but are impacted by another force: The healthcare industrial complex knows these politicians are not as ideological and tries very hard to keep them from changing things up. The HIC isn't worried about persuading Bernie Sanders or Mark Meadows from the Freedom caucus. They cannot allow the pliable middle to start making deals.

    If the Republicans lose the house they would be wise to work with Democrats in the middle to try to do a grand overall while Trump is President. They can incorporate some of the market forces into a plan and remove some of those cross-subsidies. It won't be a panacea.

    I say the compromise is Switzerland. The freedom caucus would never accept that. I'm more worried about what comes if Dems take back House, Senate, and WH. Then the power shifts again to where I would suspect Medicare4All / U.K/ Canadian style. Decade after decade the Democrats have been pushing in this direction. The tail winds of high cost, high deductibles, media outrage are extremely favorable.

    Smart people need to start to develop a plan that can achieve broader consensus - something more "neutral". Like I said, Switzerland.

    1. I think you have accurately depicted the Senate. But sadly the House must also approve any changes, and it's awfully tough to be a moderate in the House these days.

      In fact, I'm not so sure the old left/right political spectrum still exists in the House at all. With "progressives" and "populists" taking over their respective parties -- and the old-guard liberals & Reaganites disappearing -- there's now way more variability than you can chart on one axis. For example I'm center-right, but share far more ideology with people like Lawrence Summers than I do with the "populists" who are supposedly closer to me on the political spectrum.

      So with all that, I think the only way to achieve success on healthcare now is to go back to the politics of the 60s: somehow cobble together enough different one-issue factions to achieve a majority. So build the plan you want, but then add some special treat for union health plans, something along those lines. That'll be the only way to get it done.

  10. "when that market arrives, it will make the subsidies much cheaper"

    That statement could be true, but it is conditional.

    The German health insurance system would be one example of what you describe: with state-funded public insurance carrying explicit subsidy, while people can and do opt for more comprehensive private insurance or elective self-paid treatments (and with the private market free to innovate). The German healthcare system is far cheaper than America's (with comparable quality and plenty of innovation), but also exhibits fast rising costs.

    If public insurance (or subsidy) is to contain costs, then it must have limits (e.g. a year of healthy life is worth at most $100,000 of state-funded intervention). Arguably, such limits already exist today - insurance (with cross subsidies) objectively fails to provide the best-technically-possible (but super expensive) treatment to most people receiving healthcare. The more directly public subsidies are defined, the more explicit we'll need to be about limits on taxpayer-funded (expected) extra years of healthy life.

    If a public insurance/ subsidy is too generous (or not "brutally rationed by death panels", as some would frame it), then costs can and will grow arbitrarily.

    At the same time as defining some taxpayer-funded public healthcare insurance, eliminating cross subsidies and vastly stripping out barriers to market entry, America would also need some tough rationing r.e. what public healthcare insurance covers.

  11. Home triage is gone, the hospital does the first sort in the emergency room.
    Parents who take care know when to put ice on a sore ankle and make an orthopedic appointment in the AM. That home triage cuts costs way down, the emergency room is very long wait and chaos.

  12. It feels like the ACA opt-outs and exemptions will lead to a spiral, that turns ACA into a high-risk pool. I think that helps, because a market-based system is not possible with high-risk folks. The law that requires everyone to take Medicare will forever create cross-subsidies. If that law could be relaxed, then short-term plans could grow to be a viable solution. I don't see a political solution, perhaps the courts could invalidate the Medicare law as some kind of illegal tax. Not holding my breath....

  13. I think the original "original sin," tying healthcare subsidies to employment, deserves mention as well. Predicating your ability to access decent health care options on having above-average employment situation with benefits and a decent income is directly at odds with a regulatory framework that pays for expensive treatment for those who don't.

    Your Hoover Institute colleague Lanhee Chen gave a short talk about single-payer healthcare for the Youtube channel PragerU. The video is approaching 1 million views!

    I'd love to see you give a talk there and share your insights. Perhaps a title like "Want to fix healthcare? We need more freedom, not less." Unfortunately I'm not affiliated with the channel myself, just something I'd be excited to see!


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