Commentary: Two Reforms to Really Fix Health Care

Now that Obamacare has been upheld by the Supreme Court, unless voters deliver a different verdict on Nov. 6, genuine reform of America’s health care system may be delayed for some time.

The current system is filled with dysfunctions because unlike in other markets, consumers have little incentive to behave as prudent, value-seeking economizers, and providers have little incentive to become innovative efficiency-maximizers. Obamacare doesn't fix these problems — it doubles down on them.

The bad incentives are the accidental result of two government policies: Making employer-provided health insurance tax deductible, and the fee-for-service payment model used by Medicaid and Medicare, the government systems that now pay for half of all health care.

Undoing these past mistakes would restore proper incentives, which in turn would drive countless other useful reforms.

These two  policies are the real reason health care cost increases have outstripped inflation for decades — there’s no natural reason for this to happen. Some say price hikes are caused by technology, but in markets with proper incentives technology causes prices to go down, not up (think home electronics, or cars, where the average worker must work many fewer hours to buy a lot more car than 30 or 40 years ago).

Still, it seems odd that a small thing like letting employers deduct the cost of employee health insurance should have such a huge negative impact. A little thought experiment helps explain: Imagine if we got auto insurance this way. Since it’s tax deductible, the incentive would be to load as many services as possible into the coverage. Instead of just paying for unpredictable crash-related injuries and repairs, it would make sense to add routine expenses like tune-ups and new tires. Why not, it’s tax deductible.

If all you had to pay for new tires was a $50 co-pay no matter what brand, how hard would you shop? How hard would tire makers and dealers work to become more efficient and innovative? When you walked in their door, the tire shop staff would request your insurance card before doing anything else, and would look puzzled if you asked about prices. Who cares about price when insurance is paying? “What’s my co-pay?” would be your only question.

It sounds crazy, but it would be no less crazy (or destructive) than doing health insurance this way.

Medicare and Medicaid fee-for-service payment systems have also wrecked health care incentives, and a particular example explains how.

Some years back one of the nation’s leading health care centers created an innovative new program for people with congestive heart failure. This was an integrative, supportive management system that wasn’t cheap at nearly $8,000 per person, but it improved patients' health so much that hospitalization rates plummeted. In just one year, the program had reduced annual costs by 40 percent.

In a properly functioning market this innovative provider would have made a bundle and been copied by every other health care system. Instead it lost money, because Medicare only pays for hospital days, not improvements in health.

Multiply that example thousands of times over and you begin to see why — unlike competitive markets for such things as groceries, home electronics and tires, where we’re used to steadily getting more for less — in health care getting less for more is the norm.

Any serious proposal to fix health care must begin by correcting these two policies. The tax deduction for employer-provided health should be immediately capped and gradually eliminated. Medicare and Medicaid fee-for-service payment systems should be replaced by giving individuals a voucher to obtain private insurance, with policies and related benefits designed so that each beneficiary has an incentive to behave as a value-seeking economizer.

When people buy their own insurance with their own after-tax dollars, the coverage they choose will look more like today’s auto insurance — protection against unexpected and potentially catastrophic events rather than what amounts to incentive-wrecking “pre-paid health care.” Deductibles would be higher, and predictable; routine expenses would not be covered. People would have an incentive to shop hard (the way we do for tires), and this in turn would force many other reforms.

For example, there is no reason an expensive full-blown medical doctor is needed to stitch up a bad cut, give a tetanus shot and prescribe an antibiotic — a well-trained health nurse in a walking clinic located in Wal-Mart store would be perfectly capable. But the expansion of such services is limited by various state laws designed to keep the supply of medical professionals down and prices up (in particular, restrictive “scope of practice” licensure laws).

The public tolerates such inefficiencies today because “insurance pays for it,” and usually someone else pays for the insurance with tax-deductible dollars. When this is no longer the case and these routine costs instead come out of people’s own pockets, that toleration will cease, and the political system will respond by reducing these artificial limits on supply. This is just one source of cost-increasing inefficiency, and getting the incentives right also will force reform in many others.

Finally, nothing in the above prohibits giving taxpayer-funded subsidies to individuals who have chronic bad health or “preconditions,” or even to the entire population if that is the will of the people. But unless the subsidies are provided in a manner that generates proper incentives, the inevitable result will be bankrupting cost increases and eventual rationing.

Unless it is repealed, this is the path we are on now that most of the federal health care law has been allowed to proceed by the Supreme Court.

Sooner than its proponents expect, that law may well collapse of its own bureaucratic weight, plus its budget-busting costs and the government health care rationing these will inevitably generate. Should that happen America will get a second chance at real reform — lets hope the politicians don't blow it next time.