Friday, May 02, 2003

Gephardt of Darkness

Part 2: “It was reckless without hardihood, greedy without audacity, and cruel without courage…”

To understand what’s wrong about Gephardt’s National Healthcare proposal, you need to understand (some of) what’s wrong with the status quo. The basic flaw in our current system can be traced back to WW2, when firms laboring under government-imposed wage and price controls were casting about for ways to attract employees without raising wages. They hit upon the idea of providing workers with health insurance and other benefits, and the War Labor Board gave them the thumbs-up. Eventually, the Board’s policy was written into the tax code.

Ever since then, employers have been able to provide health insurance to their employees tax-free. If your employer buys your health insurance, you’re not taxed on it, because it’s treated as a cost of business; but if you buy health insurance for yourself, you have to buy it using after-tax dollars. Now, tax breaks are generally a good thing, but not when they create perverse incentives. This particular tax break creates two. First, it encourages people to buy their health insurance through their employers, instead of individually or through other organizations like churches, schools, fraternal societies, etc. The result is that your health insurance is tied to your job, so that you may lose it if you lose your job. (Subsequent COBRA legislation mitigated this problem marginally.)

Second, and more importantly, the fact that the tax break is for health insurance only – not for other healthcare expenditures – encourages people to get the most expansive health insurance policies possible. Why pay for any healthcare with after-tax dollars if you can use pre-tax dollars instead? Routine and elective expenditures are now regularly included in health insurance plans, which is much like including gasoline and car washes in auto insurance plans. Consequently, health insurance has increasingly been transformed into a pre-payment system. You send checks to bureaucrats who send checks to doctors, even though it would be simpler and cheaper to pay your doctor directly for most services. The unsurprising result is rising healthcare prices.

The regular inclusion of routine and elective expenditures in health care plans has an additional disadvantage. Because these expenditures are typically more elastic than expenditures for low-probability high-cost (a.k.a. catastrophic) expenses, consumers respond to the low price at the point of service by purchasing a lot more of them. Every sniffle or cough leads to a doctor visit, because the doctor visit has effectively already been paid for. Healthcare providers are enabled to raise prices for these visits, because the consumers are insensitive to the price increase (because the insurance company is picking up the tab). In the aggregate, of course, everyone ends up paying more, because premiums must rise to cover all the extra visits and higher service prices. But the insurance system transforms the marginal costs (what you would have paid per doctor visit) into a fixed cost (the amount you pay out of your wages each year for insurance). Fixed costs don’t affect marginal decisions, so people continue to buy too many healthcare products and services for prices that are too high.

Of course, employers and other buyers of insurance policies have a strong incentive to control these costs. But how can they do so while maintaining the tax break? More and more, the solution has been to rely on HMOs. The primary function of an HMO is to ration healthcare services demanded by patients who pay close to nothing at the point of service. If the rationing is not accomplished by price, it will be accomplished by queues and bureaucracy. This is, of course, the primary source of animosity toward HMOs: people don’t like having someone else make all their decisions for them. But healthcare services are not costless, and therefore they must be rationed somehow. The only alternative to bureaucratic control of personal healthcare choices is to face the consumers with more of the cost at the point of service. (This is also, by the way, the problem with single-payer systems: they replace rationing by price with rationing by bureaucracy and queuing. A single-payer system is like one really big HMO.)

Back to Gephardt. Given all the above problems, which can in large part be traced back to the tax incentive for employer-provided healthcare, you might think that a healthcare reformer would try to break that link. We could eliminate the tax break, or we could expand it to cover all forms of healthcare expenditure (not just insurance) and types of buyer (not just employers). But Gephardt does nothing of the sort; in fact, it does precisely the opposite. His plan is designed to strengthen the bond between health insurance and employment. As noted in my post below, he would require all employers to provide health insurance. In addition, he would *double* the size of the tax break.

Interestingly, this is how Gephardt plans to dodge accusations of expanding Big Government: he’ll point out that he’s using a tax break, which is allegedly good for business. Yep, this is what passes for free market policy these days: corporate welfare. Calling it a “tax break” sounds good on the surface to free marketers, but it’s a complete misnomer. In the status quo, the tax break excludes health insurance expenditures from all income tax. There is already 100% tax avoidance here; anything over 100% is no longer a tax break, it’s a subsidy! In this respect, Gephardt’s “tax break” is a lot like the “tax credits” given to low-income people who paid almost no taxes in the first place. (See Amy’s comments on this subject.) And let’s not forget that Gephardt plans to finance his “tax break” by eliminating the tax cuts planned by the Bush Administration, which means the net impact on the nation’s tax burden will be breakeven *at best* – and that’s assuming Gephardt’s own optimistic cost projections are correct. In all likelihood, the cost will be much larger because of the incentives in his proposal for the further inflation of healthcare prices.

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