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Faulty Health Cost Accounting What is the cost of a Medicare prescription drug benefit? According to official estimates cited in the Washington Post today, “[t]he drug benefits, to start in three years, are the most popular and expensive element of the plan, which is predicted to cost $400 billion over its first decade.” Currently the “cost” of such programs and proposals is measured and reported, misleadingly, as the accounting cost to the federal government – that is, the amount of additional outlays needed to finance the program. However, this is a poor measure of the true cost of the program – to get a better measure, we need to also measure the value of the associated benefit. To illustrate, suppose that every day you consume about a gallon of water. Suppose the water costs about $1 a day – so over the course of a year you spend about $365. Suppose an average American drinks about the same as you, so total water consumption would be somewhere around $110 billion per year. Now, let’s say that the government is debating a water benefit – all citizens will receive allotments of 1 gallon of water per day. What is the cost of this program? According to federal government accounting – the cost would be $110 billion per year. But in reality, the total cost to everyone would be close to zero, since the extra government expenditure would be offset by the reduction in individuals’ expenditures. What does it matter if you pay the $1 to the water company or to the federal government in taxes? If the program were financed by an increase in general revenues, there would be some winners and losers from the program as a whole, but on average people will see a net cost of zero. For prescription drug care, this means that the cost of a prescription drug benefit would be offset by the lower out-of-pocket expense of medication purchases. Of course, some choose not to drink ordinary tap water, but rather to spend a little extra for fancy bottled water or soda. These people then face the decision of whether or not to “top-up” their government allotment with additional purchases of beverages – and they would not be receiving the kind of liquid they would otherwise desire. In addition, some people might not drink that gallon of water provided by the government and are then (inefficiently) receiving too much. In both these cases the government provision of the “water” benefit may contain some inefficiency. In the case of health insurance more broadly, however, most people do not typically actively choose how much, or what quality, insurance they desire. They typically get what they need, or what their employer offers, and then pay what they have to. (There is often some choice, but the price usually ranges from expensive to very expensive.) The point is that if you need open-heart surgery, you will likely get an operation – so there is little choice about the bulk of health care expenditure. The inefficiencies that arise because the government is the provider are thus likely to be small. So, by having, say, universal health insurance financed by the government, you no longer need to pay for health insurance yourself – (or your employer wouldn’t have to pay on your behalf and could raise your salary.) The government accounting cost needs to be offset by the cost savings at the individual level when deciding if it is a good policy. In addition, universal health insurance is very likely to save money, since those without health insurance typically incur health care at a greater cost to society by, for example using emergency room service more often or not receiving preventative care. These costs are born by the system as a whole; and just because they are not accounted for in the government’s books, doesn’t mean they don’t exist. Ok, so the water example is a bit silly, since there is not a very strong case to be made that the federal government should be in the water business – at least not in a modern US economy (although we can always talk network externalities, increasing returns to scale, and/or health benefits... perhaps another time). However, there are two strong reasons why government needs to be in the market for health care. First, the private market doesn’t work. Because of what economists call “information asymmetries,” the market is likely to break down. Since only the sickest are likely to buy really good insurance, the price for good insurance will be very high – and most of us have settle for cheaper, but inadequate insurance coverage. By segmenting consumers of insurance, we lose the real benefits of insurance – the spreading of risk across individuals – and we end up having to pay the full cost of care. Try buying insurance directly from a company and you’ll see what I mean. The solution is to group consumers together for purposes of purchasing insurance – this is one reason you get health care offered by employers. But the same problem arises; the information problem is just shifted to the group level. The best option is to create a single group, which contains everyone – universal health insurance. Allowing people to opt out and purchase private plans just returns us to the same problems as the private market. Second, the government needs to be involved because there are significant “externalities” involved in the health care system. No one likes to see someone have to forgo needed medical care just because they can’t afford to a doctor. When someone can’t get an operation, can’t afford needed medication, or can’t take a child with asthma to a doctor, we all suffer. In these cases there is a role for government to intervene in the private market and to provide what the market is ill equipped to handle. Would a real prescription benefit have an accounting cost more than $400 million? Yes. But prescription drugs are being purchased anyway, the government should provide this benefit; and, importantly, we should be willing to pay for it through a fair tax system and not put costs off to future generations. And just to be clear – I oppose the bill that just passed the congress; it would have been simple to just add a real benefit for prescription drugs, without loading the bill with all kinds of funky semi-privatization schemes, a ban on drug price negotiation, billions in subsidies to HMO’s and other businesses, and 1,100 pages of other who-knows-what. If it’s so great, why wait for three years to have it take effect?
What is the cost of a Medicare prescription drug benefit? According to official estimates cited in the Washington Post today, “[t]he drug benefits, to start in three years, are the most popular and expensive element of the plan, which is predicted to cost $400 billion over its first decade.” | Posted November 25, 2003 07:46 PM by John Irons |
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The Medicare Bill should be understood in terms of eventual cost to Receptients. Seniors need worry that the Bill was supported by the entire Health Care industry; who will not sponsor any legislation which does not increase their Profits. One does not have to be a Socialist to realize increased Profitability of Health provision brings higher cost to Consumers of that Health care.
Health Care Providers stand to earn about fifty percent greater Profits for health care provision through this Bill. This means a total Price increase for this Care of around ten percent. Other portions of the Bill smell worse.
The Deductibles will be keyed to the CPI, so will not alter in magnitude; same for the Premiums. The Federal Government, at least Republicans, expect the spread of risk alongside the Co-payments and Deductibles will pay for the Cost of actual Proscription drugs. This means all Health Care will be subsidized by the Government, through the expensive Tax benefits; while Seniors will actually bare the Costs of both Drugs and Tax benefits.
The Tax incentives, by the way, allow HMOs to monopolize by region; especially when Republicans forces Social Security to limit Medical Center offices. The greatest victory comes for the Drug companies, who protected themselves from Wholesale purchasing by Medicare; a fact which will raise Consumer Cost between 30-40 percent for all Drugs supplied. lgl
Two comments. First, your water analogy misses a step that is important in this bill's failings. The people buying water themselves don't have group bargaining power. If the government itself buys the water it supplies to the people from private producers, theoretically it does. But if the government doesn't negotiate, or worse, isn't allowed to, the private producers can force the government to pay far more for water than is necessary. And either the government has to run a deficit, or ask the people for more money.
In the new Medicare drugs bill, as I understand it, the government is not allowed to negotiate prices with the drug producers/suppliers, but the private competitors to Medicare drugs can negotiate. That's pretty outrageous, especially since one main reason drugs are cheaper in Canada is that the government negotiates the price.
The second point: in talking about people buying insurance, I think that more people buy the insurance they can afford than the insurance the need.
paulo, http://whosecapitalism.typepad.com/
Me never got to learn much about health sector and I certainly don't know much about either Medicare or the proposed amendments to it. I do have comments however on the basis of notes here and a Reuters story on draft bills in House and Senate, comments concerning an issue not pointed to in the notes here: Role of cultural makeup and moral values, even attitudes.
It is pretty clear to me that the basic structure of the plans as described in Reuters story aim fundamentally to minimize waste due to misuse and abuse of medication and services and the public funds involved thereof.
The less the people in general are inclined to move with integrity and prudence in consumption of public goods, the simpler the matter of public provision. Else, arguments for private provision of public goods gain ground -- along with increased opportunity for misuse and abuse in still different modes and still other parties including private sector providers.
What about a bit of trasnparency here, then? Why not render public the individual's records on consumption of any goods and services paid for by public funds? There is certainly the technology for it, available and affordable. The cost of bringing about that kind of transparency would I'm sure far outweigh the cost of misuse and abuse of public funds.
Ah, there is the matter of privacy, no? I don't know. I am not sure if consumption of public funds should be a matter of privacy.
You dismiss the ability of markets to handle health care out of hand. How could you know that? We haven't had a free market in health care since before the early sixties (before Medicare).
Health insurance has been tightly regulated and re-regulated and the gov't's refusal to pay the full price of services for Medicare and Medicaid recipients has severely distorted the price structure of the entire industry.
Imagine if grocery stores were reimbursed for Food Stamps according to a government schedule of "permissible" prices for food instead of paying full-price. And imagine if those same supermarkets were required to feed anyone for free who was hungry -- thus shifting the unpaid portion to the rest of us.
Add to that mess the policy that Food Stamp recipients can have all the stamps they want as long as they feel hungry. Demand would skyrocket (prices would rise from that increase in demand alone).
We would by now, no doubt, be rushing to nationalize the food distribution system as it would have proven itself incapable of handling our nutritional "needs".
Your water analogy ignores the most obvious aspect of the prescription drug bill: the benefit is not available to everyone. You ask, "What does it matter if you pay the $1 to the water company or to the federal government in taxes?" I suggest that it matters a great deal if you have to pay the tax, and must STILL pay the water company. While the net cost may be zero to the population as a whole, those 65 and over see a net gain while those under age 65 see a net loss. The drug benefit represents another transfer of income from the young to the old.
Two questions suggest themselves. First, is this transfer sustainable? Attempts to answer that are difficult due to the large number of variables that can come into play. Population growth? Productivity growth? Ability and willingness of the elderly to continue working? Distribution of national income across different demographics? Total existing tax burdens? All of these will affect how well and for how long the young will tolerate such transfers.
Second, and less direct, is the issue of how much of national income we are willing to spend on health care. Health care currently accounts for about 15% of GDP. Modern medical technology certainly makes it possible for that fraction to increase, simply because more conditions can be treated. People who are seriously ill will live longer, but often at significant expense. Open markets in health care would easily resolve that issue as individuals choose between health care (and insurance) and other goods and services. A universal health care plan might reach very different conclusions as to what levels of spending are appropriate, and on the types of care that should be delivered. The drug benefit is a great example: it has taken nearly 40 years for the government to decide that drugs are an aspect of care worth subsidizing.
The truth is outhere