ACA/Obamacare: Cross Subsidy as a Hidden and Inefficient Tax

“But the great puzzle of health care policy: Just why is it, to accommodate this worthy goal, must your and my health care and insurance be so deeply regulated and so thoroughly dysfunctional? As one small example, why does a 20 minute skin check with the resident of my dermatologist generate a phoney baloney bill for over $1000, meaning a cash and carry market for such a simple, elastically demanded, and perfectly predictable service is impossible?

Why, in order to provide for the unfortunate, do we not simply levy taxes, and pay for charity care, and leave the rest of us alone? Regular Americans have jobs, buy houses, buy TVs, cars, and smartphones, negotiate the complexities of 401(k) and IRA plans, cell phone contracts, frequent flyer programs; hire the complex professional services of contractors, car mechanics, lawyers and accountants, and deal with the insane complexity of our tax system.”

“I think the answer is relatively simple. Our political system is allergic to the word "tax." Instead of straightforwardly raising taxes in a non-distortionary way (a VAT, say), and providing charity care or subsidies -- on budget, please, where we can see it -- our political system prefers to fund things by forcing cross subsidies.

Medicare and medicaid don't pay what the service costs, because we don't want to admit just how expensive that service is. So, large hospitals make up the difference by overcharging you and me instead. The poster child (though not really a cost driver) is emergency room care. The government passed a law saying hospitals must provide emergency room care for free. But money does not grow on trees, so again you and me (via private insurance) must get overcharged to cross-subsidize. The ACA tried to force young healthy wealthy (not getting subsidies) to vastly overpay for insurance, to cross subsidize the poorer and sicker.

This might seem like a wash. OK, if instead of paying taxes, it makes you feel good to pay business class prices for health insurance, what the heck. Economically, a cross-subsidy works the same as a tax. In fact, we do have Europe-size taxes and subsidies, we just hide them.

But it's not a wash. Cross-subsidies are dramatically less efficient than taxes. Choosing cross-subsidies over taxes is indeed the second original sin of health care and insurance regulation. Cross-subsidies cannot stand competition.

If as now you and I are grossly overpaying for health care and insurance, to cross-subsidize others, a competitive market would come along and peel us off. A local skin-check clinic could offer that service for $50.

Low prices, efficiency, and innovation in the provision of services like health care come centrally from competition, and especially disruptive competition. With no competition -- especially no entry by new doctors, hospitals, clinics, insurance companies -- costs spiral up. As costs spiral up, the cost of the charity care spirals up. As that spirals up, the size of the cross-subsidies spirals up. As that spirals up, the need to restrict competition spirals up.”


“Bottom line: Much of the pathology of health care and health insurance comes from this second original sin, choosing cross-subsidies rather than straightforward taxes. Cross-subsidies require the government to stop competition, so an initially clever way of hiding taxes eventually builds into a monstrously inefficient system. (That's a key point. Initially, it is about the same. But the cross subsidy system gets more and more inefficient over time.)

We would be far better off to admit this; raise explicit taxes enough to provide the charity end of our care, and let health insurers and care givers compete for the rest of us, as airlines, computer makers, and everyone else does. The politician's job is to explain to people that what they pay more in taxes they will more than make up in lower health care and insurance costs.” - The second original sin of healthcare regulation, John Cochrane, 04/05/2017

Link to the entire essay appears below:

http://johnhcochrane.blogspot.com/2017/04/the-second-original-sin-of-healthcare.html


　

　


　

For-Profit or Non-Profit in Health-Care and Health Insurance: Who in Fact is Supplying the Majority of Health-Care and Health Insurance?

A common talking point/debate point in the ongoing ACA debate is: for-profit health-care and health insurance is a mal-motive in health care/health insurance and hence leads to inefficiencies. As with most debate points little insight is gained and merely debate points earned.

What about for-profit in health-care and health insurance? Is the majority of health-care and health insurance produced by for-profit or non-profits? What form, for-profit or non-profits, is in fact providing the majority of supply regarding health care and health insurance? Who in fact is producing inefficiencies?

　

Consider this:


  “My cost-cutting examples are all for-profit companies. About 70% of hospitals and 85% of health-care employment is in non-profits, (10) whose legal and regulatory treatment protects much inefficiency from competition.”


“Maybe for-profit companies pay too much attention to stock prices. But non-profits can go on inefficiently forever, with no stockholders to complain. The whole point of a non-profit is to pursue goals other than economic efficiency.” (1)

**10 Lakdawalla, D., and T. Philipson (2006), “Non-Profit Production and Industry Performance”, Journal of
Public Economics, v 90 (9), 1681-98.

　
The sophistry of the for-profit talking point/debate point of mal-motive leading to inefficiencies is further illustrated in that the vast majority of health insurance supply is non-profit [e.g. Blue Cross, Kaiser Permanente, Health Care Service Organization, and Himark, Inc. not to mention Medicaid and Medicare]. “…more than 60% of the health insurance providers in America with at least 100,000 subscribers are nonprofit organizations” (2) (3)

Hence one ends with the talking/debate point of for-profit health-care and health insurance as a mal-motive in health care/health insurance leading to inefficiencies, as completely backwards, as the majority of health-care supply and health insurance supply is provided by non-profits. Further, as pointed out by Cochrane: “The whole point of a non-profit is to pursue goals other than economic efficiency”.




 
 
 Notes:

(1) After the ACA: Freeing the market for health care, John H. Cochrane, October 18 2012, pg. 6



http://johnhcochrane.blogspot.com/2012/10/after-aca-freeing-market-for-health-care.html

Updated version 02/06/13:
 
http://faculty.chicagobooth.edu/john.cochrane/research/papers/after_aca.pdf

(2) Do non profit health insurance companies exist? Health insurance provider, 01/04/2012

http://www.healthinsuranceproviders.com/do-non-profit-health-insurance-companies-exist/


(3) Basic facts & figures: nonprofit health plans. Alliance for Advancing Nonprofit Health Care.

http://nonprofithealthcare.com/resources/BasicFacts-NonprofitHealthPlans.pdf

The Demand Side of ACA: “overutilization”, insurance deployment and the risk management matrix

In the book Obamacare Survival Guide, Nick Tate makes the point that the architects of the Affordable Care Act (ACA) were determined to tax “Cadillac” health insurance plans as the plans lead to overutilization of health-care. That the architects believe the prime driver of health-care price is overutilization. How can the master schemers of ACA argue, in any convincing fashion, that Cadillac plans be “taxed” based upon overutilization then in turn create a maintenance policy design within Obamacare, that indeed promotes overutilization? (1)


Somehow one is to believe it is a perfect and airtight argument to vilify one overutilization design meanwhile creating another overutilization design -and- tax one overutilization design in order to cross subsidize the other overutilization design? Huh? How can one put forward an aggregate argument that overutilization of health-care is a prime driver of health-insurance price yet create the very plan one argues against? That is a new zenith in the realm of nitwitery!


John Cochrane of the University of Chicago Booth School of Business has stated on numerous occasions that insurance is being promoted and deployed within the ACA for the wrong reasons. That is, that insurance should be for catastrophic events. True. However, the argument of catastrophic events and the insurance match might be better illustrated/supported/delineated by a basic insurance tenet: the risk management matrix. (2)


Within the risk management matrix low frequency/high severity is the only efficient deployment of insurance given the known-known of the matrix of frequency and severity. All other deployments of insurance within the matrix are inefficient uses of insurance and should be avoided. Hence inefficient deployment of insurance is very much related to movements, within the matrix, away from low frequency/high severity. Stated alternatively, moving away from low frequency/high severity toward high frequency/high severity, high frequency low severity and/or low frequency/low severity means one has knowingly elected to deploy insurance in an inefficient manner.


Hence the argument that insurance should be for catastrophic events might be better and more fully framed as: insurance should be for catastrophic events as any other deployment of insurance, given the known-known of the risk management matrix, is a movement in the direction of inefficiency.


The basic and valid point of “insurance should be for catastrophic events” may not resonate, to the degree one would hope, with James and Jane Goodfellow. That knowledge and decisions need enhanced, for as much as James and Jane pay for a variety of insurance on a daily basis, James and Jane simultaneously suffer from unfamiliarity with insurance. Hence the argument needs that second step of: how the knowledge and decisions set forth in the risk management matrix allows James and Jane to identify and avoid an inefficient allocation of their scarce resources. That is, the “why” behind the oft quoted “insurance should be for catastrophic events”.


　

Notes:

　

(1) ObamaCare Survival Guide, Nick J. Tate, 2012, pgs 195 -197.

http://www.amazon.com/ObamaCare-Survival-Guide-ebook/dp/B009HLPCJ2/ref=sr_1_1?ie=UTF8&qid=1369911932&sr=8-1&keywords=obamacare+survival+guide


(2) After the ACA: Freeing the market for health care, John Cochrane, 10/18/2012.

http://faculty.chicagobooth.edu/john.cochrane/research/papers/after_aca.pdf


 

After the Affordable Care Act? After Obamacare? Part Five: “bending the cost curve” in health-care means removing supply-side limits and allowing robust competition.

 

Reviewing parts one, two, three and four of this series, John Cochrane professor of finance at the University of Chicago Booth School of Business wrote a recent essay entitled After ACA: Freeing the market for health care. The essay is very interesting as it makes the case of the need for decoupling health care from health insurance when discussing the demand and supply for health care and insurance merely being a mechanism to address catastrophic losses. Others have also pointed out the need to decouple the two concepts, however Cochrane does so in such a way that points out that the supposed market failure in health care is directly related to government failure in the realm of health care due to government lead market distortions on both the demand and supply side of health care.

Subsidies, price fixing schemes and regulation to supposedly reduce price vs. robust supply-side competition

A question that begs asking is why would the taxpayer subsidize computerized medical records as called for the Affordable Care Act (ACA)? Why were computerized medical records not already computerized by the current health-care sector suppliers on their own accord?

“On reflection, it’s amazing that computerizing medical records was part of the ACA and stimulus bills. Why in the world do we need a subsidy for this? My bank computerized records 20 years ago. Why, in fact, do doctors not answer emails, and do they still send you letters by post office, probably the last business to do so, or maybe grudgingly by fax? Why, when you go to the doctor, do you answer the same 20 questions over and over again, and what the heck are they doing trusting your memory to know what your medical history and list of medications are? Well, this is a room full of health policy wonks so you know the answers. They’re afraid of being sued. Confidentiality regulations, apparently more stringent than those for your money in the bank. They can’t bill email time. Legal and regulatory roadblocks.

　

So, medical records offer a good parable: rather than look at an obvious pathology, and ask “what about current law and regulation is causing hospitals to avoid the computer revolution that swept banks and airlines 20 years ago,” and remove those roadblocks, the government adds a new layer of subsidies and contradictory legal pressure.” (1)



What happens to robust supply-side competition when legislation and consequential regulations become merely discretionary powers?

“The impediments to supply-side competition go far beyond formal legal restrictions. Our regulatory system has now evolved past laws, past simple, explicit, and legally challengeable regulations, to simply hand vast discretionary power to officials and their administrative bureaucracy, either directly (“the secretary shall determine..” is the chorus of the ACA) or through regulations vague enough to let them do what they want. Witness the wave of discretionary waivers to ACA handed out to friendly companies. Those administrators can easily be persuaded to take actions that block a disruptive new entrant, and with little recourse for the potential entrant. (Lobbying government to adopt rules or take actions to block entrants is legal, even if those actions taken directly would violate anti-trust laws, under the Noor-Penington doctrine.)” (2)

If one wants to drive down the cost of health-care then one must create an environment that fosters robust supply side competition. Hence Cochrane offers a simple rule for what would seem to be a complex world:

“So, what’s the biggest thing we could do to “bend the cost curve,” as well as finally tackle the ridiculous inefficiency and consequent low quality of health-care delivery? Look for every limit on supply of health care services, especially entry by new companies, and get rid of it.” (3)

Changing gears for a moment and considering the deployment of complex rules for what appears to be complex, we can consult Richard Epstein’s book by the title of none other than Simple Rules for a Complex World. Epstein argues that the intuitive position is when one us faced with complexity then complexity requires complex rules. The result is to create complex rules that have burdensome administration costs and that such complex rules leave James and Jane Goodfellow with no earthly idea on how to interpret the rules. Epstein’s counterintuitive proposition is that simple rules lower administrative prices and costs and yield the same or better benefit. (4)

Moreover, Epstein points out that legislation spawning regulation causes rent seeking opportunities at each step of regulation hence the barriers to entry mentioned by Cochrane. Further, the regulations in and of themselves create rent seeking by an army of attorneys to interpret the rules, at a price, for James and Jane Goodfellow.

Both Epstein and Cochrane point out that over time increased administration price and cost, across entire economies and specific sectors, accumulate into explosive levels that create major drag.

Regarding health-care administrative price, one may find insight in the following:

“….administrative costs in our disintegrated U.S. system are $1059 per capita. The fact that this is an astonishing thirty-one percent of total health care expenditures itself suggests that excessive administrative costs are being imposed.” (5)

Cochrane goes onto to point out ACA’s approach to administration price and removing barriers to entry to foster robust supply-side competition is in fact to ramp up the price of administration and to continue with barriers to entry as the status quo:

"Now, this is of course not the way of current policy. The ACA and the health-policy industry are betting that new regulation, price controls, effectiveness panels, “accountable care” organizations, and so on will force efficiency from the top down. And the plan is to do this while maintaining the current regulatory structure and its protection for incumbent businesses and employees.

Well, let’s look at the historical record of this approach, the great examples in which industries, especially ones combining mass-market personal service and technology, have been led to dramatic cost reductions, painful reorganizations towards efficiency, improvements in quality, and quick dissemination of technical innovation, by regulatory pressure.

I.e., let’s have a moment of silence.

No, we did not get cheap and amazing cell phones by government ramping up the pressure on the 1960s AT&T. Southwest Airlines did not come about from effectiveness panels or an advisory board telling United and American (or TWA and Pan AM) how to reorganize operations. The mass of auto regulation did nothing to lower costs or induce efficient production by the big three.

When has this ever worked? The post office? Amtrak? The department of motor vehicles? Road construction? Military procurement? The TSA? Regulated utilities? European state-run industries? The last 20 or so medical “cost control” ideas? The best example and worst performer of all,…wait for it...public schools?

It simply has not happened. Government-imposed efficiency is, to put it charitably, a hope without historical precedent. And for good reasons.

Regulators are notoriously captured by industries, especially when those industries feature large and politically powerful businesses, with large and politically powerful constituencies, as in health insurance or as in most cities’ hospitals. In turn, regulated industries quickly become dominated by large and politically powerful businesses. See banks, comma, too big to fail. (Several insurance companies were bailed out in the financial crisis, so too-big-to-fail protection is not a distant worry.) This is not to say that regulators are not well-meaning and do not put great pressure on many industries. But the deal, “you do what we want, we’ll protect you from competition” is too good for both sides to resist.

Needless to say, price controls have been an unmitigated disaster in every case they have been tried. Long lines for gas in the 1970s are only the most salient reminder. Their predictable result is, vanishing supply. Try finding a doctor who will take new Medicare or Medicaid patients.

The current regulatory approach is not really well described as simple price controls, e.g. $3 per gallon of gas, but rather as fiddling with a payment system of mind-numbing complexity and endlessly discovered unintended consequences. The past record of “cost control” and “incentive” efforts should warn us of how likely adding more complex rules is to work. It seems instead to be a challenge to the next generation of planners.” (6)

　Notes:

(1) After the ACA: Freeing the market for health-care, John H. Cochrane, 10/08/2012, pg. 7.

(2) Ibid, pg. 8

(3) Ibid.

(4) Simple Rules for a Complex World, Richard Epstein.

http://www.amazon.com/Simple-Rules-Complex-Richard-Epstein/dp/0674808215/ref=sr_1_1?s=books&ie=UTF8&qid=1357997966&sr=1-1&keywords=simple+rules+for+a+complex+world

(5) Why We Should Care About Health Care Fragmentation, Einer Elhauge, pg. 5.

(6) After the ACA: Freeing the market for health-care, John H. Cochrane, 10/08/2012, pg. 9.

　

　

After the Affordable Care Act? After Obamacare? Part Two: Supply and Competition

In reviewing part one, John Cochrane professor of finance at the University of Chicago Booth School of Business wrote a recent essay entitled After ACA: Freeing the market for health care. The essay is very interesting as it makes the case of the need for decoupling health care from health insurance when discussing the demand and supply for health care and insurance merely being a mechanism to address catastrophic losses. Others have also pointed out the need to decouple the two concepts, however Cochrane does so in such a way that points out that the supposed market failure in health care is directly related to government failure in the realm of health care due to government lead market distortions on both the demand and supply side of health care.

Supply and competition is now examined. Cochrane uses several examples of firms in sectors other than health care that have pushed the cost, innovation and quality frontier “out to its limits, and then discovering where  people really want to be”.  That is, what does the consumer value and at
what price and hence what part of the cost, innovation and quality frontier creates maximum utility. Further, the cost, innovation and quality frontier has been pushed out to “choosing a different point on a far better frontier than we faced 20 years ago.” (1)

Problem is, the cost, innovation and quality frontier in health care is not reacting to generate what the consumer values and at what price and hence what part of the cost,innovation and quality frontier creates maximum utility for the consumer. Why? Cochrane’s explanation is very public choice theory oriented: old status quo suppliers within the health care sector are protected by government regulation and new competitors have massive barriers to entry and hence the protected firms merely collect rents with little incentive to find what part of the cost, innovation and quality frontier creates maximum utility for the consumer.

In order to change the situation, Cochrane states:

 "How will this change come about? My examples share a common thread: Intense competition by new entrants, who put old companies out of business or force unwelcome and disruptive changes. Microsoft displaced IBM, and Google is displacing Microsoft. Walmart displaced Sears, and Amazon.com may displace Wal-Mart. Typewriter companies didn’t invent the world processor, nor did they adapt. The post office didn’t invent FedEx or email. Kodak is out of business. Toyota gave us cheaper and better cars, not Ford/GM/Chrysler competition. When the older businesses survive, it is only the pressure from new entrants that forces them to adapt.

My examples share another common thread. They remind us how painful the cost control, efficiency, and innovation processes are. When airlines were regulated, artificially high prices didn’t primarily go to stockholders. They went to unionized pilots, flight attendants and mechanics. Protection for domestic car makers supported generous union contracts and inefficient work rules, more than outsize profits. A look at a modern hospital and its supply network reveals lots of similar structures. “Bending down cost curves” in these examples required cleaning out these rents, through offshoring, elimination of union contracts and work rules, mechanization, pressure on suppliers, and internal restructurings.

　

The fact that so much cost reduction comes from new entrants, not reform at the old companies, is testament to the painfulness of this process, and the ability of incumbents to protect the status quo.” (2)

Cochrane is correct that the process which is very akin to Schumpeter’s creative destruction is by no means painless. However, it’s totally painless to status quo old firm protected by government regulation that merely pass on higher and higher prices with little or no interest in finding what part of the cost, innovation and quality frontier creates maximum  utility for the consumer.

Finally, Cochrane makes an excellent point if government regulation was removed protecting old firms and allowing new competitors to enter the market at will: “The fear, so often expressed in medical contexts, that unregulated competitive suppliers will pawnpawn off shoddy merchandise on consumers seems exactly false.” Cochrane is correct. The argument is merely the argument put forward by the old firm collecting rents under the protection of government regulation. The same argument has been put forward many times by old firms in protected industries. It is by no means a new argument. His point is very correct and he points to examples such as Toyota dislodging the Big Three Auto makes was not done by selling shoddy products. Nor did Southwest airlines gain market share from United and American by selling shoddy product/service. Rather, Toyota and Southwest actually exposed the shoddy product/services of the old firms. (3)

　

Notes:

(1) After ACA: Freeing the market for health care, John Cochrane, 10/18/2012.

(2) Ibid.

(3) Ibid.

After the Affordable Care Act? After Obamacare? Part One: Moore's law

John Cochrane professor of finance at the University of Chicago Booth School of Business wrote a recent essay entitled After ACA: Freeing the market for health care. The essay is very interesting as it makes the case of the need for decoupling health care from health insurance when discussing the demand and supply for health care and insurance merely being a mechanism to address catastrophic losses. Others have also pointed out the need to decouple the two concepts, however Cochrane does so in such a way that points out that the supposed market failure in health care is directly related to government failure in the realm of health care due to government lead market distortions on both the demand and supply side of health care.


The essay uses the term “after” in its title as it become very apparent after reading Cochrane’s essay that coupling health insurance to health care through massive government intervention becomes a situation of government failure supposedly corrected through additional government failure. That mandating insurance does nothing more than perpetuate the underlying health care demand and supply distortions and the inherent failure of the system. Hence “after” is a term used to point out that “after” more government failure in the form of the Affordable Care Act aka Obamacare a point will come when health care will actually be repaired by the withdrawal of market distortion produced by government failure.



One of the first points in the essay, as mentioned above, is to examine health care separate from health insurance. One of the first observations in the essay is very worthy of note and one would be well advised to reflect upon the observation: why does technological innovation in other sectors either drive costs down or produce significant additional benefits at the same cost yet technological innovation in the health care sector drives cost down at a snales pace in comparison to other sectors, produces additional benefits at a much higher cost or even drives up cost ?


"Why does Moore’s law not apply to medical devices? Why has the price of cell phones, GPS, and computers come down so fast relative to the prices of medical technology? Where is the home MRI? There is nothing deeply different about medical and other technology. The answer is that supply and demand – in the current highly regulated system – is not producing the Moore’s law incentives.” (1) (2)


To be continued.

Notes.

(1) After ACA: Freeing the market for health care.

(2) Moore’s law: http://en.wikipedia.org/wiki/Moore%27s_law