US healthcare: government failure and market-based reform

During discussions about reform of the National Health Service (NHS), reference is often made to the state of US healthcare. Defenders of the UK status quo, who oppose the introduction of market mechanisms, point to the USA as a case study of the undesirable outcomes that result when markets allocate healthcare resources. This view of the US healthcare system permeates across the UK political spectrum, from those who are outright opposed to any challenge to the central place of government-directed resource allocation in UK healthcare to those who are prepared to countenance some degree of patient choice and provider competition.

However, the claim that the undesirable features of the US system are the result of market operation does not stand up to rigorous analysis. Government accounts for almost half of total US healthcare expenditures. By no means can the US healthcare system be considered an example of how a well-designed market-based healthcare system would operate. The oft noted problems of the US system (absence of insurance coverage for about 17% of the population concurrent with the highest per capita healthcare spending) stem from perverse tax and regulatory policies while other important policies are absent. In short, the poor features of the US system result from government failure, not markets. Key instances of government failure are explained below.

Government failure

Tax subsidy for employment-based health insurance

Private health insurance is mostly purchased through the workplace with employer contributions exempt from income tax. This open-ended subsidy is regressive, providing most benefit to those paying income tax at the highest marginal rate. It encourages the purchase of comprehensive healthcare coverage with minimal use of mechanisms to control moral hazard (marginal healthcare expenditures where costs exceed benefits), fuelling demand for healthcare and fostering cost indifference by consumers. The subsidy is both inefficient and inequitable. By promoting healthcare cost inflation, the subsidy renders healthcare coverage unaffordable to lower income groups, and does nothing for those who do not have access to employer-based coverage.

Lack of individual mandate to purchase health insurance

Historically, the purchase of health insurance coverage has been voluntary, with about 17% of the population remaining without cover. For some groups, such as the healthy young, this will be a rational strategy, as free care will invariably be available if needed: public hospitals are obliged to provide care irrespective of a patient’s financial circumstances and not-for-profit institutions provide charity care as a condition of tax-exempt status. For low-income groups, there is the public means-tested programme, Medicaid.

State regulation and federal programmes

Health insurance is regulated at state level. Most states mandate that policies must include various (non-essential) benefits, often the result of lobbying by providers. This increases the cost of coverage, making purchase unattractive. Other desirable regulation to facilitate efficiency in insurance markets or to promote wider population coverage, is often lacking. The presence and design of two big federal government entitlement programmes, Medicaid for low-income families and Medicare for the elderly, influences the design and operation of private sector plans inhibiting market innovation.

In summary, those undesirable features of the US healthcare system which particularly exercise policy commentators, flow from failures of government and are not inherent to market-based approaches to healthcare finance and provision.

Market-based universal coverage

Appropriate goals for a healthcare system are universal coverage for its population, efficiency in the provision of healthcare services, and equitable financing and availability. Whilst a libertarian perspective might argue that individuals should be free not to purchase healthcare insurance, the free-rider problem wherein developed societies invariably provide essential healthcare to all regardless of personal provision, justifies mandatory insurance cover. Hence, one essential function for government in a competitive market-based approach to healthcare is an individual mandate for the purchase of a defined basic benefits package.

Individuals would be free to purchase more comprehensive (un-subsidised) cover, if they so choose. A second essential government function is ensuring the availability of cover to low income and high risk groups, who might otherwise find purchase of cover unaffordable. This can be achieved through a system of income- and health risk-related tax credits or vouchers for the basic benefits package. Public insurance and/or direct government provision of healthcare services is not necessary for the achievement of equity objectives. A third role for government is the implementation of an appropriate regulatory framework for the efficient operation of insurance markets.

Some commentators argue that universal coverage can be achieved more efficiently through a single government monopoly insurer rather than multiple competing private insurers, pointing to lower reported administrative costs for single public insurance programmes. But such analysis ignores sizable hidden overhead costs for public insurers which are not reported in accounting cost systems, especially the dead weight loss (or excess burden) of tax-based financing. An analysis comparing total economic overhead costs of the Canadian (monopoly public insurance) system and US private insurers found that Canadian overhead costs were greater as a proportion of claims paid.

Whilst the package of healthcare system changes encompassed in President Obama’s Patient Protection and Affordable Care Act (PPACA) includes an individual mandate from 2014 to promote universal coverage, the overall thrust of the legislation is in the opposite direction from the market-based approach to healthcare reform outlined above. The legislation significantly increases the extent of federal government regulatory intrusion on healthcare markets. For instance, the scope of cost-increasing mandated benefits is expanded and also extended to previously exempt self-insured company plans. The contractual terms that private insurers can offer is also heavily prescribed. Meanwhile the distortionary income-tax subsidy to employment-based coverage remains intact. In short, the PPACA does not address and arguably increases the shortcomings within the regulatory framework that currently distort the private sector.

12 thoughts on “US healthcare: government failure and market-based reform”

  1. Posted 03/08/2012 at 09:18 | Permalink

    If any state started a national health system today they would be bonkers to design it the way that the NHS works now.

  2. Posted 03/08/2012 at 09:18 | Permalink

    Nice theoretical analysis. Now look at the data; for all the vested interests and union activists trying to bugger up the NHS, the UK government spends significantly less on healthcare than any other developed nation and the health outcomes for the UK remain pretty much around the average. Where the UK does fall behind much of the effect seems to be in the population’s appetite for junk food, tobacco and binge drinking and its aversion to serious exercise. That means that for all its faults the system in the UK is the best of a bad lot in delivering value for money. Unless you can find a system that costs less and delivers as good outcomes or costs more and delivers very proportionately better you are on rather weak ground.

  3. Posted 03/08/2012 at 09:28 | Permalink

    Well, hoo-bloody-ray. I have been pointing this out to pro-uk status quo bigpts for years. Now, get it out there.

  4. Posted 03/08/2012 at 21:44 | Permalink

    A payment of money from one private entity to another that is exempt from Income Tax is not a subsidy, so the first point is misguided in principle. Perhaps it is still factually correct in the statement avout inflating cost. I would be interested to hear whether the IEA thinks flat rate taxes are regressive and de facto subsidies, since that is what I would expect from a socialist redistributive position. If you let someone keep their own money this is not a subsidy.

  5. Posted 03/08/2012 at 21:48 | Permalink

    Cost seems to be the main thrust of this article which is fair enough I suppose, but even the heathen English believe that the US system which allows tens of millions to slip though the net and die in poverty and obscurity is unacceptable in a civilised country, until that changes any comparison to the market lead US system will raise hackles and rightly so, most in the UK still see the NHS as a service and not a business, value for money is an admirable goal, profit and money grubbing is not.

  6. Posted 05/08/2012 at 22:39 | Permalink

    Choosing not to tax a transaction between two private entities is not a subsidy. The point about inflating cost might be factually correct, the moral principle stated as regressive is suprising from IEA.

  7. Posted 06/08/2012 at 11:10 | Permalink

    @Ben – different IEA authors would have different views, we do not have a corporate view. Some authors would argue, as you do. Others would argue that to choose to tax some transactions and not others distorts economic behaviour in the same way as subsidies do (though I do accept that they are morally different, the economic effect is the same). Surely you would accept that, at least, all forms of health provision should have the same form of tax treatment.

  8. Posted 07/08/2012 at 08:51 | Permalink

    Forlornehope makes a series of assertions about the UK and NHS that cannot be justified.
    The OECD found that we spend about the average on medical care but that we get a lower quantity and quality of services for that expenditure than average.

  9. Posted 07/08/2012 at 22:52 | Permalink

    Thanks repsondents for your comments. Some replies:

    To Ben Taylor: The income tax exclusion for income spent on employment-based health insurance is in effect a subsidy equal to the employee’s marginal rate of income tax. If one accepts the principle that a legitimate function for government is to ensure the availability of affordable health insurance cover for all citizens, then it follows that government assistance be appropriately targeted at those with greatest need (the concept of vertical equity). The US income tax exclusion delivers most benefit to high income earners (those paying income tax at the highest marginal rate). In this sense the income tax exclusion is inequitable and regressive. It is also inconsistent with horizontal equity, as the tax exclusion is not available to those who do not obtain health insurance through their workplace.

    To Anonymous (Friday 3/8/2012 @ 2248): It is not correct that “tens of millions” of US citizens are left without any health cover. The uninsured do have access to care although it may not be timely, nor optimal. The government Medicaid programme provides care for lower income families and for those above the income eligibility threshold who experience catastrophic medical expense; public hospitals are obliged to provide care; and not-for-profit hospitals provide charity care as a condition of tax-exempt status. As outlined in my article, the lack of universal health insurance coverage results from a gap in government policy, it is not intrinsic to market-based resource allocation.

    To Forlornehope: Historically UK healthcare spending was low compared to similar countries. However, expenditure increased by 47% in real terms from 1999 to 2007, such that by 2009 UK health expenditure was 9.8% of GDP, just above the OECD average of 9.6% (OECD 2011). But over this period, NHS productivity actually declined: the Office of National Statistics estimates that across the UK, productivity fell by 3.3% from 1995 to 2008, or by 0.3% per year. On certain outcomes, such as cancer mortality, where medical care is impactful, the UK ranks poorly compared to similar countries (Health at a Glance, OECD Indicators 2011). The UK can learn from the experiences of other countries where market-based institutions have more of a role.

  10. Posted 08/08/2012 at 12:23 | Permalink

    I agree, with the exception of this point: “A third role for government is the implementation of an appropriate regulatory framework for the efficient operation of insurance markets.” Government regulation of markets rarely ensures efficiency – what it does ensure is that barriers to entry are created, large, pre-existing entities are able to dominate the market at the expense of new entrants. They are able to raise prices and lack the same cost and innovation drivers. Thus it would be better if government did not regulate the healthcare insurance market. I would also suggest that IHAs are a probably a more effective way of funding healthcare, but that ought to be left to the market discovery process to decide…

  11. Posted 09/08/2012 at 22:36 | Permalink

    Reply to Whig (Wed 8/8/12 @ 1323): What I meant by my comment about government regulation, was that there is a role for government to establish a minimum regulatory framework to ensure continuing insurance coverage availability for those who become high risk. Such regulatory measures might include guaranteed renewability of insurance contracts for a set number of years priced at group rates rather than being individually rated, open enrolment periods, and provision of a fall back insurer or reinsurance arrangement. For a detailed treatment of these questions see, for instance: (1) Patel V and Pauly MV. Health Affairs (Web Exclusive) 28 August 2002: W280-W289; (2) Pauly MV. Inquiry 1992;29:137-147.

  12. Posted 10/08/2012 at 11:25 | Permalink

    Ok thanks for clarification and reading – I enjoyed the post.

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