How Much Should We Spend on Health Care? | John Goodman | NCPA

This is a question that is rarely asked. When it is asked, the answers are almost never sensible.

If you’ve spent a lot of time reading conventional health policy analysis, get ready for something completely different. To paraphrase Bette Davis, it’s going to be a bumpy ride.

To an economist, the titular question has a straightforward answer, at least at the theoretical level. We should spend on health care until, at the margin, a dollar’s worth of health care is equal to a dollar’s worth of anything else money can buy.

As a practical matter, I have no idea what tradeoffs you’re willing to make between health care and other uses of money. And you have no idea what tradeoffs I’m willing to make. That’s why, whenever possible, we should favor institutions that allow individuals to make these decisions on their own. People will reveal their preferences through their actions.

Fasten Your Seatbelts

Economic theory teaches that whenever relative prices change, people will change the basket of goods they consume. A very famous study by the RAND Corporation discovered what this means for health care. If a person’s health insurance deductible is increased from zero (completely free care) to about $2,500 (at today’s prices), they will reduce their consumption of health care by almost one-third. Furthermore, in the RAND experiment, this reduction in care had no impact on peoples’ health.

Suppose we redid the RAND experiment, but with a new twist. Start people with a zero deductible but meet them at the doctor’s office, the hospital admitting room, etc., and on the cusp of their use of the health care system offer them the cash equivalent of what they are about to spend if they agree to forgo the care. The RAND results suggest that many people would take the cash and skip the care.

In the current system, however, people rarely have the opportunity to trade off a dollar’s worth of care against a dollar of other goods and services. In general, every time we spend a dollar on health care, only 12 cents is coming out of our own pockets. This means we have an incentive to overconsume care — until it’s worth only 12 cents on the dollar, at the margin. To the degree that we act on these incentives, we will spend until 12 cents worth of care would have provided  a dollar’s worth of other consumption — if only we were free to allocate where our money goes.

If our goal is to maximize utility (happiness, wellbeing, etc.), we would be better off with institutional arrangements that allow people to spend less on health care and use the money they save to purchase other goods and services. Health Savings Accounts (HSAs) and Health Reimbursement Arrangements (HRAs) are imperfect vehicles that move us closer to the ideal.

Another interesting prediction of economic theory is that as income increases, people will spend more on most goods. Empirical evidence shows that health care is actually a superior good. When income goes up, people not only consume more care, they increase the percent of their income they spend on health care. This is one of the strongest relationships discovered in all of health economics. It holds for all countries and all population subgroups that have been studied. The relationship also works in reverse. In the first half of this year, real spending on health care declined — clearly in response to the income drop many families experienced.

As in the case of price changes, if our goal is to maximize utility, we need insurance arrangements that allow people to adjust their spending when income changes. People need to be able to spend more on health care when their income rises and less on care when their income falls. Again, HSAs and HRAs are imperfect vehicles for achieving this result.

Now if you’ve read this far, know that most conventional health policy analysts have not. Odds are, they became nauseous and quit reading several paragraphs back.

That’s because the vast, vast majority of all health policy folks do not believe the goal of society is to maximize people’s utility from their own point of view. Being social engineers, they believe there is a “right amount” of health care for everyone to have — to be determined by technicians, rather than by individual choice. And this “right amount” is independent of prices and incomes.

Medicaid, for example, was designed by people who think precisely this way. Suppose a single mother with children loses her job and is temporarily unemployed. She has difficulty putting food on the table for her children and is in danger of becoming homeless if she doesn’t pay the rent. Her automobile is about to be repossessed if she misses another car payment. Yet if she is on Medicaid, she has (at least on paper) access to everything the health care system has to offer, with no copayment or deductible. Even most members of Congress don’t have coverage this generous.

Normal people in this situation would trade in their gold-plated health plan for a silver or a bronze, and use the savings to buy food, pay the rent, etc. But Medicaid makes these choices impossible. If we applied the Medicaid mentality to housing, poor people would be forced to live in a luxury abode, even if their children were starving.

Medicare was also designed by the social engineering mentality. Enrollees can spend an unlimited amount of taxpayer money on end-of-life care, but they are not allowed to spend those same dollars to avoid the foreclosure on a home, provide home care to prevent nursing home confinement for a spouse, or make a bequest to their kids.

How would you like the government dictating to you how you must spend 40% of your disposable income?  Not a pleasant thought?  This is what the government routinely does to the elderly, the disabled and the poor. (And under ObamaCare, it will do it to many, many more.) Medicare insurance, at an average of $11,000 per enrollee, is as much a part of the income of the elderly as Social Security is. Yet while seniors can spend Social Security dollars without restriction, the $11,000 benefit they get from Medicare can be spent only on health care.

I have been arguing for the economic point of view. But it did not come down to us from Mt. Sinai, written on tablets of stone. Reasonable people can disagree with it. The economic way of thinking, however, is logically consistent, based on easily understood first principles, and is consistent with observed behavior.

The social engineer’s view of the world, by contrast, is not logically consistent, not based on first principles, not consistent with observed behavior and appears to stem from nothing other than the emotions of people who want to impose their worldview on everyone else.

In a future Alert I will discuss how people reduce spending on health without significant harm to themselves. I will close this missive with one final thought.

Why health care? Why are the social engineers so fixated on medical care, to the exclusion of all other consumption choices. After all, if there is one “right amount” of health care for each person isn’t there also a right amount of housing they should have? And food? And clothing? And…

Shhhhhh. Don’t give them any ideas.

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How Much Should We Spend on Health Care? | John Goodman | NCPA.

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