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.


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.


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.


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.

28 replies »

  1. 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.

  2. 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.

  3. 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 can be charged a 50% premium on top of that.

    Regarding the retirees, how to provide them with health insurance, especially for those not yet eligible for Medicare, could be one of the greatest unintended consequences of the ACA. An academic who is an expert on state and local government finance recently told me that while pensions have constitutional protection in many states, no such protection applies to retiree health insurance.

    Since many, if not most, of these retirees would qualify for health insurance subsidies, it would likely be much more cost effective for state and local governments as well as large employers who still offer retiree health insurance as part of collective bargaining agreements to move these retirees to the exchanges. Once eligible for Medicare, retirees would have to get their health insurance there.

    Employers could, at their discretion, provide an additional supplemental pension payment to their retirees to help them purchase health insurance until they become Medicare eligible. In Chicago, Mayor Rahm Emanuel plans to phase out city provided health insurance for retirees by 2017. Look for many other cities and states to do the same. Then look for premiums to rise significantly due to the influx of older people looking to buy insurance through the exchanges beyond what was ever contemplated when the legislation was passed.

  4. 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 benefit pension plan disappeared, i.e in 15-20 years or less.

    The plans that amaze me, frankly, are those where the company plan pays most of the cost for retirees who are over age 65. Both the company and the employee have been paying into Medicare for years and years, and yet the employee gets company dollars first.

    I am not sure if anyone besides some idiot municipal governments have such plans, but they amaze me.

  5. 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 FICA taxes on the taxable wage increase. So, the employee is left with a gross pay increase of $18,578. His FICA liability on that amount is $1,421.22. If his marginal federal income tax rate is 25%, his federal income tax increases by $4,644.50. If he lives in a state with a state income tax averaging 3% (many states have higher rates), that’s another $557.34. That leaves a net of $11,954.95 to go to a state exchange to buy family coverage. If he qualifies for a subsidy for having total income of less than or equal to 400% of the federal policy level, the subsidy is based on the cost of the second least expensive SILVER plan in the market and he would have to spend 9.5% of his own income before the subsidy kicked in. If he wanted a gold or platinum plan to more closely replicate his prior coverage, he will probably have to spend all of his incremental pay or more while federal spending for subsidies would, of course, be much higher than currently estimated. If the employee had similarly generous single coverage, multiply all of the above numbers by 0.30-0.35. If he were willing to settle for a Silver or Bronze level plan, he could come out slightly ahead on a take home pay basis vs. his prior arrangement.

    Remember that in Switzerland, where everyone including the elderly, buys their own health insurance policy, 45% of the population qualifies for a subsidy. The comparable U.S. percentage would likely be at least that high and probably higher. The public sector unions and the large industrial unions whose members still have generous health insurance would oppose this approach with everything they have. That’s a virtual certainty. Unions with a preponderance of lower paid workers like the SEIU would probably be more supportive though.

  6. 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.

  7. 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.

  8. Bob, good points. My idea is only to have subsidies for the least fortunate among us, so while coverage will be universal, most of it will be privately financed. It’s estimated that the tax exclusion of employer sponsored health insurance adds up to about $260 billion in foregone revenues. If it were taxed, that amount alone would be enough to fully pay for coverage for 30-40 million people.

    I agree that the transition will have to be handled carefully, most likely through a gradual phase in. Wages should adjust (up), so there actually may be a stimulus effect.

  9. 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.

  10. 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 figuring out your income tax liability.

    Virtually all economists agree that taxing consumption does considerably less economic harm than taxing income but it takes a greater percentage of income from lower and middle income people than from higher income and wealthy people.

    What I see us eventually winding up with in the area of federal taxation is the FICA taxes that we have now, a VAT that could, before long after enactment, approach the European average rate of 20%, and a federal income tax that only applies to taxpayers with income of more than $100K per year. There would probably be a flat rate of 25% above the $100K level up to $1 million with minimal or no deductions allowed and a 35% rate above $1 million.

    Whatever social safety net we eventually wind up with, the broad middle class will have to pay for the broad middle class and the wealthy will largely pay for the poor as well as themselves.

  11. 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,

  12. 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 profits), or unless some phase-in approach like that in the ill-fated Wyden-Bennett bill is included.

  13. 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.

  14. 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.

  15. 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.

  16. 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 would require a VAT tax rate of 31.25%! Good luck with that.

    Just to replace employer based and individually purchased insurance would require a VAT of 14.1% which compares to 12.4% for the Social Security portion of the current FICA tax which would remain in place by the way. The current Medicare tax is 2.9% of uncapped payroll plus an additional 0.9% on income, including investment income, above $250K for couples and $200K for single filers.

    The people who suggest these schemes make them sound appealing but never squarely face just how high the tax rate would have to be to get the job done. Moreover, even the part of the tax nominally paid by an employer is actually paid by the employee in the form of lower wages than he or she would otherwise be paid.

  17. 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.

  18. 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% would be able to afford that.

    The government forcing insurance companies to take on all risk?I don’t think so…

    IMO your suggestions don’t make sense to me.

    Gabriel K MD

  19. 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.

    3) I assume (hope) you are aware that in PA, specialty hospitals are being opened by docs. They skim off all of the well insured patients and the healthy Medicare patients. That leaves the community hospital with the poor and sick. How will your payment system address this?

    4) Would suggest that licensing of docs be a national thing. Having to get a license in each individual state makes it difficult to move. It often takes the better part of a year to get licensed in some states. It is bad enough that I have hired a credentialing specialist just to get folks licensed.

    5)Love #7. To that, could we also add that we will eliminate individual state mandates?


  20. Finally – suggestions that make sense. I hope Republicans and Democrats alike read this blog.

  21. My own expertise in on the financing side, so let me ask some questions to move the discussion along:

    1. How much will a universal, tax-supported catastrophic plan actually cost?

    For the moment let’s leave Medicere and Medicaid out of this plan. You then have at least 120 million adults to cover. (very few children have catastrophic health events.)

    Let’s say that ten per cent of these working age adults have a condition or episode in a year that exceeds the deductible. That is 12 million claims.

    Say that the claims average $15,000 each. The total is $180 billion, plus let’s say $20 billion for claims on behalf of children. $200 billion total.

    The plan also covers preventive care. Say that comes to $500 a person per year, though i fear the number will be larger, and now we are including children.

    $500 times 200 million enrollees is $100 billion.

    3. Therefore the sales tax proposed here has to raise $300 billion a year.

    Can that be done? I do not know.

    To be honest, just looking at how hard ti is to make internet firms pay any sales right now makes me wonder.

    Finally, and this is less a question than a comment:

    I understand the desire to make employer paid health premiums subject to income tax. It certainly is grinding to see well-paid employees get free health insurance, while part-timers and the self-employed get almost nothing from the system.

    My hesitation about a tax change would be the transition.

    Let’s say that 80 million persons get tax free health insurance from their employers, of course in varying amounts.

    Now let’s add an average of $6000 in taxable income for each person involved here (I think my number is low).

    $6000 in additional marginal taxable income for a middle class and upper middle class taxpayer produces say $1500 in new taxes, or about $125 a month.

    How does this not cause a recession? $125 a month per peson means a lot of cable TV contracts cancelled or health club memberships cancelled or restaurants not visited or even fewer doctor visits.

    Comments welcome!

    The premiums in the

  22. Bobby, thanks. There will be a lot of changes over the next few years.

  23. I agree wholeheartedly with all of your suggestions, Martin, especially the one about reducing or eliminating public subsidies to medical education. Although medical-school graduates are saddled with enormous debt due to high tuition costs, their residence training is fully paid for through the Medicare Trust Fund. There is no other profession that I can think of, besides a few professions in the military, whereby the on-the-job training is fully paid for by the taxpayer, so it’s very hard for me have any sympathy for any medical-school graduate who’s up to their eyeballs in tuition debt.

    And since many medical residents can afford to buy a house and keep a spouse and a newly born baby at home on a residence salary, their take-home pay can’t be all that low. From what I’ve read, their salary range is from $45,000 to $65,000. The taxpayer doesn’t subsidize the training of nursing-school or pharmacy-school grads, much less the training of engineering or computer science grads, then the taxpayer shouldn’t be subsidizing the training of medical-school grads either.