Last week, Republican Congressman Paul Ryan unveiled his plan to save Medicare and Medicaid. Supporters hailed the plan as revolutionary; critics decried the plan as revolutionary. For something so revolutionary, it sure is based on some old ideas.

In 1978, Stanford Business School professor (and my soon to be advisor) Alain Enthoven published an article in the New England Journal of Medicine in which he described his “Consumer Choice Health Plan.” Enthoven proposed tax-funded vouchers that all Americans could use to purchase health insurance. The amount of the voucher would be tied to income and individuals could use their own money to purchase a plan that cost more than their voucher. Enthoven even included some rules limiting the ability of insurers to cream skim healthier enrollees; new and improved versions of these rules are written into the insurance exchanges as part of the Affordable Care Act.

In 1986 I published a paper that described how states were trying to control Medicaid expenses by regulating the prices they paid to hospitals. I pointed out that states had surprisingly little interest in reining in hospital costs because the federal government paid for half or more of the Medicaid bills. The solution was apparent to any economist – convert the “percent of Medicaid spending” formula to a block grant, so that the states are 100% responsible for the costs of Medicaid expansions.

Ryan’s “revolutionary” proposals for Medicare and Medicaid reflect an age-old principle of microeconomics: in the absence of consumption or production externalities (e.g., pollution), efficiency demands that decision makers are 100% financially responsible for the marginal expenses they incur. Ryan’s proposals make so much economic sense that some version of them might even have a chance to survive. If I had to choose, I would put my money on Medicaid block grants. I think that the states will embrace block grants provided that the federal government gives them flexibility in choosing plan design, enrollments, and coverage. Once states are 100% responsible for the marginal Medicaid dollar, we might see sensible reforms like a massive shift away from nursing homes to home care, and a movement of younger beneficiaries into low cost, narrow network HMOs. Some oxen will be gored, of course, but you can’t spend less money on health care without spending less money on health care. That ought to be plain enough.

Medicare vouchers may seem like a tougher sell, but the idea is not too far removed from the present situation, in which Medicare Managed Care plans have captured 20% of Medicare enrollments in many markets, despite rules that limit beneficiaries’ financial incentives to enroll. I could even imagine shifting Medicare enrollees into the insurance exchanges. And if we need to keep “traditional Medicare” as a “public option,” that compromise might be worth it if we can restore some sanity to this budget chewing nightmare of an entitlement.

I never thought that I would live long enough to see comprehensive health reform on the scale of the Affordable Care Act. President Obama proved me wrong. And I never thought I would live long enough to see economically sensible comprehensive health reform. Will Congressman Ryan prove me wrong again?

David Dranove, PhD, is the Walter McNerney Distinguished Professor of Health Industry Management at Northwestern University’s Kellogg Graduate School of Management, where he is also Professor of Management and Strategy and Director of the Health Enterprise Management Program. He has published over 80 research articles and book chapters and written five books, including “The Economic Evolution of American Healthcare and Code Red”. He has a Ph.D. in Economics from Stanford University.

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5 Responses for “To the Barricades!”

  1. steve says:

    ” Will Congressman Ryan prove me wrong again?”

    No. While I can see the need to cut federal health care spending, why did he choose the most expensive option for seniors, ie private health insurance. The CBO estimates that by 2022 private health insurance for seniors will cost about $20,000. Ryan’s voucher will be worth $8,000.

    “Some oxen will be gored, of course, but you can’t spend less money on health care without spending less money on health care. That ought to be plain enough.”

    The Medicaid cuts result in about 50% less money by the year 2050 (2030?). Narrow network HMOs will save that much? I think it more likely it will be done by keeping people off with stringent income requirements.

    ” in the absence of consumption or production externalities (e.g., pollution), efficiency demands that decision makers are 100% financially responsible for the marginal expenses they incur. ”

    Ahh, but here’s the thing. Medicaid is already the first or second most expensive category in state budgets. Economists, some anyway, fail to realize that when budgets are crunched, people managing those budgets look at the largest items first. The states have long had ample motivation to decrease Medicaid spending. Cutting the amount of money they receive will not create new incentives, it will just provide less money to spend. They will spend less because they have less.

    Steve

    • nate ogden says:

      Steve where are you getting these numbers? WHat private insurance is more expensive then federally offered Medicare, unless your comparinf apple and orange policies.

  2. steve says:

    @nate- CBO data here.

    http://www.cbo.gov/ftpdocs/121xx/doc12128/04-05-Ryan_Letter.pdf

    Or, if you dont want to dredge through it, Rick Ungar summarizes at Forbes.

    http://blogs.forbes.com/rickungar/2011/04/07/cbo-says-gop-medicare-plan-would-double-the-cost-of-health-care-for-seniors/

    Also, privately managed Medicare, Medicare Advantage cost, on average, 14% more than traditional FFS Medicare.

    Steve

    http://blogs.forbes.com/rickungar/2011/04/07/cbo-says-gop-medicare-plan-would-double-the-cost-of-health-care-for-seniors/

    Steve

  3. Matthew Holt says:

    Dave. Come on, you know full well that Alain’s original idea meant that EVRYONE had to play in a voucher-based world, in which significant regulation of the integrated Kaiser like entities would make them compete on value.

    Other than the vouchers, none of that is in the Ryan plan, which is a pretty naked play to defund Medicare and turn it into Medicaid part II.

    You can of course see Enthoven’s work in practice–go to Holland–but please don’t besmirch it by associating it with Ryan

  4. nate ogden says:

    “Also, privately managed Medicare, Medicare Advantage cost, on average, 14% more than traditional FFS Medicare.”

    LOL Steve please tell me you know why? Have you ever looked at the benefits offered under MA versous traditional FFS?

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