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The Health Care Crisis and What to Do About It

In 2004, according to census estimates, 63.1 percent of Americans under sixty-five received health insurance through their employers or family members’ employers. Given the inherent difficulties of providing health insurance through the private sector, that’s an impressive number. But it left more than a third of nonelderly Americans out of the system. Moreover, the number of outsiders is growing: the share of nonelderly Americans with employment-based health insurance was 67.7 percent as recently as 2000. And this trend seems certain to continue, even accelerate, because the whole system of employer-based health care is under severe strain.

We can identify several reasons for that strain, but mainly it comes down to the issue of costs. Providing health insurance looked like a good way for employers to reward their employees when it was a small part of the pay package. Today, however, the annual cost of coverage for a family of four is estimated by the Kaiser Family Foundation at more than $10,000. One way to look at it is to say that that’s roughly what a worker earning minimum wage and working full time earns in a year. It’s more than half the annual earnings of the average Wal-Mart employee.

Health care costs at current levels override the incentives that have historically supported employer-based health insurance. Now that health costs loom so large, companies that provide generous benefits are in effect paying some of their workers much more than the going wage—or, more to the point, more than competitors pay similar workers. Inevitably, this creates pressure to reduce or eliminate health benefits. And companies that can’t cut benefits enough to stay competitive—such as GM—find their very existence at risk.

Rising health costs have also ended the ability of employer-based insurance plans to avoid the problem of adverse selection. Anecdotal evidence suggests that workers who know they have health problems actively seek out jobs with companies that still offer generous benefits. On the other side, employers are starting to make hiring decisions based on likely health costs. For example, an internal Wal-Mart memo, reported by The New York Times in October, suggested adding tasks requiring physical exertion to jobs that don’t really require it as a way to screen out individuals with potential health risks.

So rising health care costs are undermining the institution of employer-based coverage. We’d suggest that the drop in the number of insured so far only hints at the scale of the problem: we may well be seeing the whole institution unraveling.

Notice that this unraveling is the byproduct of what should be a good thing: advances in medical technology, which lead doctors to spend more on their patients. This leads to higher insurance costs, which causes employers to stop providing health coverage. The result is that many people are thrown into the world of the uninsured, where even basic care is often hard to get. As we said, we rob Peter of basic care in order to provide Paul with state-of-the-art treatment.

Fortunately, some of the adverse consequences of the decline in employer-based coverage have been muted by a crucial government program, Medicaid. But Medicaid is facing its own pressures.


Medicaid and Medicare

The US health care system is more privatized than that of any other advanced country, but nearly half of total health care spending nonetheless comes from the government. Most of this government spending is accounted for by two great social insurance programs, Medicare and Medicaid. Although Medicare gets most of the public attention, let’s focus first on Medicaid, which is a far more important program than most middle-class Americans realize.

In The Health Care Mess Richmond and Fein tell us that Medicaid, like employer-based health insurance, came into existence through a sort of historical accident. As Lyndon Johnson made his big push to create Medicare, the American Medical Association, in a last-ditch effort to block so-called “socialized medicine” (actually only the insurance is socialized; the medical care is provided by the private sector), began disparaging Johnson’s plan by claiming that it would do nothing to help the truly needy. In a masterful piece of political jujitsu, Johnson responded by adding a second program, Medicaid, targeted specifically at helping the poor and near poor.

Today, Medicaid is a crucial part of the American safety net. In 2004 Medicaid covered almost as many people as its senior partner, Medicare—37.5 million versus 39.7 million.

Medicaid has grown rapidly in recent years because it has been picking up the slack from the unraveling system of employer-based insurance. Between 2000 and 2004 the number of Americans covered by Medicaid rose by a remarkable eight million. Over the same period the ranks of the uninsured rose by six million. So without the growth of Medicaid, the uninsured population would have exploded, and we’d be facing a severe crisis in medical care.

But Medicaid, even as it becomes increasingly essential to tens of millions of Americans, is also becoming increasingly vulnerable to political attack. To some extent this reflects the political weakness of any means-tested program serving the poor and near poor. As the British welfare scholar Richard Titmuss said, “Programs for the poor are poor programs.” Unlike Medicare’s clients—the feared senior group—Medicaid recipients aren’t a potent political constituency: they are, on average, poor and poorly educated, with low voter participation. As a result, funding for Medicaid depends on politicians’ sense of decency, always a fragile foundation for policy.

The complex structure of Medicaid also makes it vulnerable. Unlike Medicare, which is a purely federal program, Medicaid is a federal-state matching program, in which states provide on average about 40 percent of the funds. Since state governments, unlike the federal government, can’t engage in open-ended deficit financing, this dependence on state funds exposes Medicaid to pressure whenever state budgets are hard-pressed. And state budgets are hard-pressed these days for a variety of reasons, not least the rapidly rising cost of Medicaid itself.

The result is that, like employer-based health insurance, Medicaid faces a possible unraveling in the face of rising health costs. An example of how that unraveling might take place is South Carolina’s request for a waiver of federal rules to allow it to restructure the state’s Medicaid program into a system of private accounts. We’ll discuss later in this essay the strange persistence, in the teeth of all available evidence, of the belief that the private sector can provide health insurance more efficiently than the government. The main point for now is that South Carolina’s proposed reform would seriously weaken the medical safety net: recipients would be given a voucher to purchase health insurance, but many would find the voucher inadequate, and would end up being denied care. And if South Carolina gets its waiver, other states will probably follow its lead.

Medicare’s situation is very different. Unlike employer-based insurance or Medicaid, Medicare faces no imminent threat of large cuts. Although the federal government is deep in deficit, it’s not currently having any difficulty borrowing, largely from abroad, to cover the gap. Also, the political constituency behind Medicare remains extremely powerful. Yet federal deficits can’t go on forever; even the US government must eventually find a way to pay its bills. And the long-term outlook for federal finances is dire, mainly because of Medicare and Medicaid.

The chart in figure 1 illustrates the centrality of health care costs to America’s long-term budget problems. The chart shows the Congressional Budget Office’s baseline projection of spending over the next twenty-five years on the three big entitlement programs, Social Security, Medicare, and Medicaid, measured as a percentage of GDP. Not long ago advocates of Social Security privatization tried to use projections like this one to foster a sense of crisis about the retirement system. As was pointed out last year in these pages,1 however, there is no program called Socialsecuritymedicareandmedicaid. In fact, as the chart shows, Social Security, whose costs will rise solely because of the aging of the population, represents only a small part of the problem. Most of the problem comes from the two health care programs, whose spending is rising mainly because of the general rise in medical costs.

To be fair, there is a demographic component to Medicare and Medicaid spending too—Medicare because it only serves Americans over sixty-five, Medicaid because the elderly, although a minority of the program’s beneficiaries, account for most of its spending. Still, the principal factor in both programs’ rising costs is what the CBO calls “excess cost growth”—the persistent tendency of health care spending per beneficiary to grow faster than per capita income, owing to advancing medical technology. Without this excess cost growth, the CBO estimates that entitlement spending would rise by only 3.7 percent of GDP over the next twenty-five years. That’s a significant rise, but not overwhelming, and could be addressed with moderate tax increases and possibly benefit cuts. But because of excess cost growth the projected rise in spending is a crushing burden—about 10 percent of GDP over the next twenty-five years, and even more thereafter.

Rising health care spending, then, is driving a triple crisis. The fastest-moving piece of that crisis is the unraveling of employer-based coverage. There’s a gradually building crisis in Medicaid. And there’s a long-term federal budget crisis driven mainly by rising health care spending.

So what are we going to do about health care?


The “consumer-directed” diversion

As we pointed out at the beginning of this essay, one of the two big reasons to be concerned about rising spending on health care is that as the health care sector grows, its inefficiency becomes increasingly important. And almost everyone agrees that the US health care system is extremely inefficient. But there are wide disagreements about the nature of that inefficiency. And the analysts who have the ear of the Bush administration are committed, for ideological reasons, to a view that is clearly wrong.

We’ve already alluded to the underlying view behind the Bush administration’s health care proposals: it’s the view that insurance leads people to consume too much health care. The 2004 Economic Report of the President, which devoted a chapter to health care, illustrated the alleged problem with a parable about the clothing industry:

Suppose, for example, that an individual could purchase a clothing insurance policy with a “coinsurance” rate of 20 percent, meaning that after paying the insurance premium, the holder of the insurance policy would have to pay only 20 cents on the dollar for all clothing purchases. An individual with such a policy would be expected to spend substantially more on clothes—due to larger quantity and higher quality purchases—with the 80 percent discount than he would at the full price…. The clothing insurance example suggests an inherent inefficiency in the use of insurance to pay for things that have little intrinsic risk or uncertainty.

The report then asserts that “inefficiencies of this sort are pervasive in the US health care system”—although, tellingly, it fails to match the parable about clothing with any real examples from health care.

  1. 1

    America’s Senior Moment,” The New York Review, March 10, 2005.

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