Economics

Beyond the Affordable Care Act: A Framework for Getting Health Care Reform Right

The following was drafted quite a few months ago, and had its genesis in a list of recommendations for improving the health care system that David Dranove solicited from a number of academics for an issue of Health Management, Policy and Innovation. I’ve dawdled in finishing and polishing it up, but seeing the stimulating reform proposal posted  recently by Jay Bhattacharya, Amitabh Chandra, Mike Chernew, Dana Goldman, Anupam Jena, Darius Lakdawalla, Anup Malani and Tom Philipson motivated me to return and finish it; so here it is finally.

Introduction

One can hardly say that there’s been too little discussion of health reform recently. However, much of the discussion is focused on the ACA and its details. That’s fine, but we’ve gotten very far away from thinking about overarching principles that we think should guide the design of a health system, and what that implies for what it would look like [1]. What follows are some thoughts on what such a health reform might look like. They are informed by my read of the research evidence, and my observations of the U.S. health care system over a long period of time, but should be understood as representing only my personal opinions.

This is not intended as a criticism of the ACA. While the ACA certainly isn’t perfect, in my opinion we’re better off as a country with it than without it. However, there will be modifications to the ACA and other changes to the health system as we move forward, so having a framework to structure our thinking will be useful as we consider these inevitable changes.

Guiding Principles

What I propose below is guided by the following. First, economic efficiency is a goal. This simply means avoiding waste, i.e, trying to generate the maximum benefits net of costs. The second goal is that no American is exposed to excessive risk to their health or finances due to medical expenses. Last, the overarching design principle is to create basic ground rules for the system and then let the system run, avoiding heavy handed regulation or micro management. The key objective of these ground rules is to give participants the right incentives insofar as possible, while achieving insurance objectives. With that in mind, compassionate, efficient health reform would do the following.

Health Insurance Reform

First, eliminate the tax exclusion of employer sponsored health insurance. The exclusion of employer sponsored health insurance from income taxation distorts the demand for insurance. This leads to people with employer sponsored health insurance holding excessive coverage, which drives up medical spending and thus insurance premiums. Ironically, not taxing health insurance ends up making both health care and health insurance less affordable. Eliminating the tax exclusion of employer sponsored health insurance will eliminate a major distortion in health insurance, health care, and labor markets. It can generate substantial tax revenues (it’s estimated that the value of the state and federal income tax exclusion for 2009 was $260 billion[2]), while potentially allowing for lower income tax rates. It’s also worth pointing out that the subsidy is biggest for those who face the highest marginal tax rates, i.e., it’s regressive.

Second, automatically enroll every U.S. citizen in a standard, basic health insurance plan. Everyone will be enrolled – there will be universal coverage. Individuals will be randomly assigned to insurance companies, who will be required to cover them. Individuals can opt out of this initial assignment into a different plan, so long as that plan offers at least the standard, basic coverage (it can be more generous, but not less).

Third, the plan will provide protection against medical expenses that are catastrophic for the individual or household, given their finances.
The function of the plan is to provide insurance against large expenses associated with treating episodes of ill health. It will therefore have a high deductible, and fairly high coinsurance or co-pays, but will have a stop-loss to prevent financial ruin. Preventive care that’s been shown to be effective can be “carved out” and have lower cost-sharing. Cost-sharing features will be on a sliding scale according to income, so individuals only face risk that they can reasonably bear. Low-income individuals will have lower deductibles, coinsurance or co-pays and stop-losses than will high-income individuals. In addition, premiums will be subsidized on a sliding scale according to income, so insurance is affordable for everyone. Insurer premiums will be risk-adjusted, and there will be a high-risk pool. No denials of coverage or coverage rescissions will be allowed. Under this plan ultimately Medicare and Medicaid will be phased out so that everyone will obtain coverage as indicated above.

Financing

The government subsidies for insurance coverage above will be entirely financed via a dedicated consumption (sales or value added) tax, e.g., a la Fuchs and Shoven [3], with as few loopholes as possible. All government funding must only be from this source – no other sources of revenues may be applied. This way the cost and financing of government spending on health care will be as clear and transparent as possible. All other funds will be privately financed.

Supply Side Reform

The main goal of reforms here is enable competition, and to eliminate barriers to entry to providing health services. Lack of competition leads to poor service, poor quality, and high prices, and impedes innovation (especially organizational innovation [4]).

First, strongly enforce the antitrust laws in health care. There has been a great deal of consolidation in health care markets in recent years, especially in hospital and insurance markets, but also in physician markets and between the different kinds of market participants (e.g., insurers-hospitals, hospitals-physicians, etc.). Consolidation has resulted if few, if any documented benefits, and has harmed competition and led to increased prices, reduced quality, and impeded the emergence of new, innovative forms of health care delivery.Antitrust enforcement can help solve problems in specific markets. It can also have a deterrent effect on those considering anticompetitive actions.

Second, ease barriers on new forms of health care organizations entering the market, such as retail clinics, freestanding surgery centers, specialty hospitals, telemedicine, etc. In contrast with much of the rest of the U.S. economy, the health care industry has been rigid and unresponsive. New organizational forms that are responsive to patients’ needs are long overdue.

Third, free up entry into the medical profession. Twice as many people apply to medical school as get accepted, and this has been true for many years. Quite a few more applicants can be accepted without diminishing the quality of medical students. Therefore, artificial barriers to creating new medical schools or expanding the number of slots in existing medical schools need to be eliminated. There has been some recent progress in this domain [5].

Fourth, free up entry into specialties. Specialty societies have a great deal of influence on residency training. This creates crazy distortions such as dermatology being the hardest specialty to enter, while primary care specialties have excess training capacity. Artificial barriers to entry into residency training programs should be eliminated.

Fifth, reduce or eliminate public subsidies to medical education. These only add to the crazy quilt of distortions in this area. With twice as many applicants as accepted students, there is clearly excess demand for medical education. Public subsidies are not only unnecessary, they overwhelmingly go to children from upper middle class or upper class families. Certainly medical training should receive no more in subsidies than training in science or engineering.

Sixth, allow non-physician medical personnel, such as nurses, nurse practitioners, psychologists, pharmacists, etc. much greater freedom to treat patients independent of physicians. Nurse practitioners and pharmacists (for example) are highly trained medical professionals who can do more than they are currently allowed due to restrictions on scope of practice in many states. Not only can these practitioners substitute for physicians in some cases, they can complement them and thereby enhance productivity.

Seventh, regulate health insurers nationally, rather than on a state-by-state basis. Insurers currently must operate separate risk pools in every state in which they operate and are regulated differently in every state. This is clearly inefficient. Insurers should be allowed to pool risk nationally and should face one set of nationally agreed upon rules and regulations. This will require a national regulatory body to replace state regulatory agencies.

Conclusion

These ground rules are intended to provide a general framework for the health care system. They are deliberately intended to be general, not specific, in particular so there are incentives for innovative and efficient new arrangements and so such arrangements can spontaneously emerge. While I believe these are sensible changes that would move our health care system in the right direction, there are and will be alternative proposals that are worthy of consideration as paths towards a more efficient, compassionate health care system.

Martin S. Gaynor, PhD is a professor of economics and health policy at Carnegie Mellon University’s Heinz College. He blogs regularly at Compassionate Economics, where this post originally appeared.

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Stanford CureauJennifer L. MaysRoger CollierRandy CoxBarry Carol Recent comment authors
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Stanford Cureau
Guest

Most people, if they have any income at all, can afford catastrophic coverage. The issue is not have ‘sniffle’ insurance, the issue is not going broke if you have a catastrophic ailment or accident. Critical care and accident insurance is a great stop gap if a full blown policy is too expensive.

Jennifer L. Mays
Guest

Healthcare is a serious matter that needs to be addressed properly. People need healthcare services but let’s face it, not all people can afford to get themselves a healthcare insurance because of it’s high cost. It’s a sad fact but it’s actually true.

Barry Carol
Guest
Barry Carol

Bob – Good points. I suppose that, in theory, if we eliminated the tax preference for employer provided health insurance, we could also mandate that employers gross up employee pay net of the incremental FICA tax that employers would become responsible for paying. There is an important and largely unaddressed issue, though, of how to fairly allocate the value of health insurance for tax purposes to the individual employee level because under the ACA, older people can be charged up to three times more than younger people for the same coverage to partially reflect their higher actuarial risk. Moreover, smokers… Read more »

bob hertz
Guest

Thanks again Barry. You did not even get to the example of what happens if the employer does not “gross up” the paycheck by the former health insurance premium. The federal government more or less pays whatever it wants to. It is no accident that northern Virginia is so affluent. An employer in the real world might be feeling all kinds of competitive pressure. The employer might decide that $70,000 is plenty good enough for salary, forget about the gross up. Once employers really figure this out, the company health care plan might disappear as fast as the company defined… Read more »

Barry Carol
Guest
Barry Carol

Martin – If the tax preference for employer provided health insurance were eliminated and other taxes were not lowered to compensate, I’ll provide an illustration of how it could affect a well insured middle income public employee who currently contributes little or nothing toward the premium. Suppose the employee earns a salary of $70,000 and has employer provided family health insurance coverage worth $20,000 for a high end plan. If the tax preference were eliminated and the employer grosses up pay, it would only increase pay by 92.89% of the prior premium because it would have to pay 7.65% in… Read more »

bob hertz
Guest

I was just making a general point about tax policy — i.e. build on what you have.

I do not favor replacing employer insurance. The tax hit would be enormous as you imply.

Besides, once employers get out of paying for health insurance, they will never get back in. I consider employer contributions right now as kind of a gentle sleeping dog, do not dare awaken him.

Barry Carol
Guest
Barry Carol

Bob – To replace employer based and individually purchased health insurance, do you really think that people would accept paying a Medicare tax rate of at least 17% on all of their wage income but not on investment income except for the 0.9% rate that just started to apply to investment income above the $250K income threshold for joint filers? Then we still have the 12.4% social security portion of the FICA tax that applies to the first $113K of wage income but not to investment income. Neither of these taxes, by the way, is deductible for the purpose of… Read more »

bob hertz
Guest

If a VAT raises $60 billion for every one percent, that is about the same revenue which we now get for every one percent of the Medicare payroll tax
The payroll tax of 2,9 per cent raises about $180 billion.

The payroll tax is much, much easier to collect than a VAT would be.
It is much easier to raise a tax we have had for 50 years than to install a brand new tax,

Barry Carol
Guest
Barry Carol

Bob —

No. Each one percentage point of VAT as broadly based as most in Europe would raise $60 billion. GDP is roughly $15 trillion. One percent of that is $150 billion. 0.4% of GDP is $60 billion. It IS a money machine but the tax rate would still have to be quite high even to replace employer based and individual market insurance let alone Medicare and Medicaid.

bob hertz
Guest

Thanks Barry for the fiscal cold shower. Well done.

Just curious, are you saying that each one percent in a VAT tax raises just $6 billion in revenue?

I had heard that VAT’s were a real revenue machine, but I guess not.

Randy Cox
Guest

Spot on with so many points. Thanks Martin!

Barry Carol
Guest
Barry Carol

Roughly 160 million people, including family members, get their health insurance through an employer plus another 18-20 million buy it in the individual insurance market. The aggregate annual cost of this is $800-$900 billion, possibly a bit more. The combined cost of Medicaid, including the state share, and Medicare is another $1 trillion or so including beneficiary premiums. Altogether, that works out to approximately 12.5% of our current GDP of $15 trillion. The broadest based value added taxes in Europe raise about 0.4% of GDP for each one percentage point of tax. So, to replace private insurance, Medicare and Medicaid… Read more »

Gabor Kaye
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Gabor Kaye

You didn’t take into account the important fact regarding of those 160 million with employer subsidized care.That portion is tax deductible to the employer. Therefore, it’s a huge loss of revenue to the government.

Roger Collier
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Roger Collier

There are no new moneys being raised in Martin Gaynor’s proposal, as I understand it. The suggested VAT or sales tax would replace current income and payroll taxes and (maybe) employer premium contributions. While any proposal involving a “new” tax would obviously be met with howls from the anti-tax lobby, the more important objections are: (1) VAT and sales taxes are inherently regressive, falling more heavily on lower-income individuals, and: (2) the proposal to eliminate the tax deductibility of employer contributions increases taxes paid by employees, unless employers simply decide not to make such contributions any longer (thereby increasing their… Read more »

Health Reformer
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Health Reformer

Solution: Take the $ billions being spent of advertising campaigns and lawyers for nonsense hospital competition matters and purchase medications for the indigent and reduce the cost of insurance.

It is that simple a no brainer.

Gabor Kaye
Guest
Gabor Kaye

Increase specialties? Presently 60% of MDs are specialists/40% generalists. Having more specialists will add to their current drain on health care costs. Most are procedure oriented ,which are much higher reimbursed than other types of care. It should be the opposite.More primary docs as “gatekeepers” ,which has shown to keep costs down in other countries. Eliminate subsidies for medical education? who could afford to go to medical school ?Today the average loan burden of a graduating student is well over $100,000. So you think there should be a 2-3X increase for those students? Only the children of the elite 1%… Read more »

Martin Gaynor
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Martin Gaynor

Hi Gabor, Thanks for your comments. Actually, freeing up entry into specialties should drive down the returns to being a specialist and make primary care more attractive than it is now. We should end up with more primary care physicians.

If subsidies are reduced or eliminated then people will have to decide if it’s worth going. Med schools will also have to work to find ways to keep tuition down. The current system ends up subsidizing children of the upper middle class and above anyway.

steve
Guest
steve

I generally agree with these suggestions, but have questions/comments. 1) If 2:1 is not the optimal ratio of applicants to acceptances, what is? How do you know? How does this affect quality. Bear in mind that I just fired a doc this week, a product of our 2:1 ratio system. 2) My practice has extensive experience in using mid-levels to decrease costs. One of the things we have learned is that most of them do not come right out of school prepared to work independently. If your plans assume they perform those duties straight out of school, it will fail.… Read more »

Martin Gaynor
Guest
Martin Gaynor

Steve, thanks for the excellent comments. Obviously even with the current stringent med school admissions requirements some people get through who just aren’t very good. That’s always going to happen. If we admit more people then med schools may have to wash some people out, and that could be a good thing.

I agree with your suggestion of national licensing for physicians. Much more sensible in our mobile society, and it will enable telemedicine efforts.