Wednesday, September 29, 2010

The Real Reason Medical Costs Are Rising

If a doctor misdiagnoses the cause of a symptom, his treatment will not help and will likely make things worse.

If a President misdiagnoses the cause of rising health care costs, his solutions will not help, and will likely make things worse.

This is the situation we currently have with ObamaCare.

The new health care control laws are constructed on the belief that the large numbers of uninsured along with profit-driven behaviors of hospitals, doctors and insurance companies are the cause of run-away spending and cost increases. For these reasons, the new law concentrates its efforts on mandating insurance coverage and increasing government control over the private medical decisions made between patient and physician. Attempting to increase access, the law lowers or eliminates a patient's out-of-pocket payments, increases mandated benefits by third parties (both governmental and private) while simultaneously reducing payments to doctors and hospitals.

This analysis has it exactly wrong.

The numbers of uninsured are the result not the cause of rising costs. Patients are insulated from the cost consequences of their medical care while doctors, hospitals and insurance companies are blocked from competing on price and quality. This hinders innovation and interrupts the normal market signals to increase supply and decrease cost.

The REAL cause of spiraling health care costs is our current third-party payment system and the consequent economic separation of consumer from payer (and of effort from reward.) This disconnect is enhanced under ObamaCare. In "The Prognosis for National Health Insurance," Dr. Arthur Laffer (of Laffer Curve* fame) refers to this separation as "the health care wedge."

"The health care wedge is one way of thinking about government involvement in the economy. When the government or a third party spends money on health care, the patient is not. The patient is then separated from the transaction in the sense that the costs are no longer his concern. This separation--how far the supplier and consumers are separated from one an another--is what the economic wedge is measuring."**
Multiple segments of the new health control law aggravate this wedge: removal of co-pays, caps on the portion of premiums paid by the insured, government subsidies, price controls on provider payments, mandated benefits, and much more.

On the consumer side of the market, the wedge diminishes consumers' incentives to monitor costs...On the supplier side, doctors and other medical providers receive no incentive to provide higher quality services for less cost.

President Obama has no excuse for failing to grasp this vital connection. His Council of Economic Advisors stated in their June 2009 report, "The Economic Case for Health Reform":

There is well documented evidence that individuals respond to lower cost-sharing by using more care, as well as more expensive care, when they do not face the full price of their decisions at the point of utilization.
Americans have progressively been paying less and less of the costs of their personal medical care. In 1960, patients directly paid for almost 50% of their medical care. Today, out-of-pocket payments for patients in the private sector are only slightly more than 10% of the total cost for the medical care they receive.

"Accelerated medical inflation, consequently, is strongly correlated with a growing separation (wedge) in the medical market between doctors and patients."

What are the forces which cause this "wedge"? The primary forces are government actions themselves: rising government expenditures on health care, insurance mandates and regulations which favor third-party payment systems and "protect" patients from the financial consequences of their actions, cost-shifting due to medical welfare and entitlements programs, price controls integral to Medicare and Medicaid, to name just a few.

But it is not just the cost of medical care which is affected.

In the case of health care, the wedge also separates patients from doctors in determining what type of care should be provided. Decisions are made by government, insurers, and judges deciding medical malpractice liabilities.The government, lawyer, and third-party wedge in our current health care system causes [both] higher costs and diminished efficiency.

Additionally, as health care costs rise and government increasingly foots the bill, the damaging effects spill over into the wider economy leading to slower economic growth, rising tax burdens, as well as lower wages and standards of living.

The acceleration in health care costs needs to be brought under control. Because Obama has misdiagnosed the cause, the measures enacted in the new health care control law push us in exactly the wrong direction. ObamaCare increases the health care wedge, bolstering incentives to consume medical goods and services without the ability, let alone the requirement, to consider cost, efficiency or quality.

Laffer concludes this excellent article with a list of suggestions for a patient-centered health care reform which would remove the artificial and destructive incentives government currently has in place and "empower the patient and doctor to make effective and economical health policy choices":

1.Remove the tax advantage for employer-based health insurance by giving the tax deduction to individuals
2. Remove limits and disincentives on Health Savings Accounts
3. Allow interstate purchasing of insurance
4. Reduce [or preferably eliminate] mandated benefits that insurers must cover
5. Eliminate unnecessary scope-of-practice laws to allow non-physician health professionals practice to the extent of their education an d training
6. Reform tort liability laws.

Although written before the final passage of the health control law, this article provides an excellent analysis of the economic and governmental forces which created our current situation and explains how Obama's policies will only make things worse. I encourage you to read the whole 24 page paper.

Government has much to gain by following this key principle of medical ethics:

*For a more humorous explanation of the Laffer Curve, you may enjoy watching this video clip by San Jose State University student, Gregory Downs, one of a series of ShortHand Politics clips he is producing to try and engage college students in economic ideas.
**All quotes are taken from Laffer's article.


  1. Tony,

    Thank you for commenting.
    Yes--"medical inflation" does lead to increased premiums. The question is why prices in healthcare rising at a faster rater than prices in the rest of the economy.
    I have to disagree that medical innovation alone is a significant contributer to the sustained greater price inflation of health care goods and services. Although new drugs, therapies and equipment may initially be high, if subjected to normal market forces, these would eventually come down in price just as technologies in other fields have.
    The problem is that every new treatment is available to everyone at once right from the start without regard for cost and prices are not based on supply/demand. For almost 50% of the market, the government sets the price, creating a non-market baseline from which insurance companies extrapolate.

    Do you have information which indicates otherwise?

  2. I like this. Especially the recommendations.

    What's the best single reference describing the gov't caused health care crisis? Something that touches on the tax breaks for the Blues, tax breaks for employer supplied packages, medicare, medicaid, prescription drug. Something short too :) I usually refer back to the short series ARI published on its blog a while back but would be interested in others.

    One of the reasons I'm interested is that I've been hearing from the pharmaceutical trade group and my own executives that 'health care had to be reformed' and that it was better to be involved than not, as excuses for supporting Obamacare. I'd like to send them all a brief article.

  3. Shane--

    I don't know of a short article that explains it well. I will see what I can do to construct one.
    In the meantime, you can check out this article published by Cato, "Health Care Regulation: A $169 billion hidden tax" by Christopher Conover. I haven't read it, but glancing through, it's not exactly what you are looking for, but does address the the cost of government intervention.

    John Goodman wrote the short (134 pgs) book "The Regulation of Medical Care: Is the Price Too High?" back in 1980. Although it is missing recent stuff, the history of US medical regulation is excellent.

    I will keep an eye out for other good sources and post them when I find them.

  4. Thank you. I'll check those out.

    This is the series I've been referring to most frequently:

  5. When Medicare and Medicaid were started that was when healthcare cost started to rise. When bureaucrats set the rate of reimbursement for geriatric doctors, you'll have problems. The government is a very inefficient middleman at best.

    I got some art to go along with this comment...

  6. Robert--
    A HUGE acceleration took place after the passage of Medicare. That's because Medicare combines the perverse incentives of third party payment along with a blank check from the government. That's a double whammy for spending increases.
    If I had to get rid of only one of those (Medicare/Medicaid or private 3rdPP insurance), I would end the government's role as a payor--but it would be wrong to ignore the contribution private 3rdPPs have as well.

    The government also contributes to the problem by encouraging people to choose private 3rdPP over other types of insurance through preferential tax laws and insurance regulations. If the playing field were truly level, we would see health insurance evolve more along the lines of auto, life, and homeowner insurance, and expenditures for routine medical care would decrease.

    Thanks for your comment. It's important to point that fact out.

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