The Cost of Health Care

In 2005, Americans spent roughly $2 trillion on health care, or an average of $6,700 per person.  This amounted to 16 percent of the gross domestic product.  In other words, nearly one-sixth of the total output of goods and services produced by our economy in 2005 was devoted to health care (including both public and private expenditures).  Many analysts expect total spending on health care to rise to $4 trillion and 20 percent of GDP by 2015. 

In the aggregate, high levels of health care spending is a good thing because it means that millions of Americans are receiving the highest quality medical care that is available anywhere in the world.  Compared to citizens of other western countries, the average American has more access to the best doctors, the best facilities, the best medicines, and the best diagnostic and treatment technologies.  This is why people from Canada and Britain and Europe, indeed from all over the world, come to the United States to obtain needed medical care that is not available to them in their home countries. 

Yet the highest quality medical care in the world comes at a steep price.  This price has nothing to do with “greedy” doctors, HMOs, and drug companies.  Rather, as with any other good or service, the price of medical care fundamentally is determined by the value of the resources required to produce it.  And the resources required to produce, say, a world-class cardiologist or orthopedic surgeon or oncologist are extremely valuable. 

For starters, only the smartest people in our society (roughly the top 10 percent) have the innate ability to become competent, modern doctors.  Then these people must go through 10 to 15 years (post-high school) of very demanding, and very expensive, education and training.  Then they must be equipped with the most advanced tools and drugs and machines, all of which cost many more millions (sometimes billions) of dollars to develop and produce.  Only at this point can these doctors start providing us with the high-quality medical care that we expect in this country and thank goodness for their grit and determination (and debt). 

To expect that this medical care can come cheap is to indulge in wishful thinking. 

Barack Obama acknowledges that “the best medical technology and scientific research in the world” come at a heavy price, but he believes it is possible to provide “affordable, comprehensive, and portable health coverage for all Americans.”  This is pure fantasy.  True, we can provide more Americans with lower cost health care — by reducing the quality of the health care they receive.  Or we can provide more Americans with higher-quality health care — by increasing the total amount of health care spending.  But we cannot provide every American with the best medical care money can buy, while at the same time reducing the amount of our gross domestic product devoted to health care.  This is an economic impossibility. 

To some, the argument is that Americans use too much health care because they do not pay the true costs of services as a result of insurance and a lack of out-of-pocket payments for a doctor visit transaction.  Surely, if Americans were to consume less and lower-quality health care, total health care spending would decrease.  This is precisely why health care spending in countries like Canada and Britain is lower than in the United States.  Their citizens are provided by their governments with less and lower-quality health care than the vast majority of Americans currently enjoy under our mixed system.  If we adopt one of the health care plans being peddled by the Democrats, in the future Americans, too, will consume less and lower-quality health care. 

However, there is a flaw in the over-consumption and insurance argument.  The problem with health care spending is not the reliance on insurance arrangements, per se.  In a free market, insurance arrangements are economically efficient.  Insurance works by pooling resources and rationally distributing risks and costs among large numbers of people.  This enables more people to enjoy the benefits of various goods and services at a lower cost per person.  Indeed, insurance arrangements are a vital feature of any modern commercial economy.  The critical feature that underlies the economic efficiency of insurance arrangements is that individual premiums are based on each consumer’s risk-cost profile.  That is, riskier consumers must pay a higher price for their coverage.   

Where insurance companies are allowed to charge each consumer a premium commensurate with the consumer’s level of risk and amount of coverage desired, then insurance arrangements are economically efficient.  This also comports with our basic moral intuition that people who need or want more coverage should pay for it. 

The inefficiency in the American health care market is the inevitable result of government tax-and-spend programs and regulatory mandates that interfere with the free market by eliminating the vital link between insurance premiums and each consumer’s risk-cost profile. 

The premiums for Medicare and Medicaid are not based on a rational assessment of each beneficiary’s risk-cost profile.  Instead, these programs require only small co-pays based on income level.  Moreover, these payments do not come close to paying the full cost of the medical care provided.  On the contrary, the cost of this medical care is primarily paid for by payroll taxes and income taxes on all Americans.  Medicare and Medicaid are not insurance arrangements but entitlement programs. 

Government regulations have transformed private health insurance policies into pseudo-entitlements by mandating that employers and insurance companies provide a panoply of benefits without taking into account each consumer’s risk-cost profile.  Barack Obama’s plan requires insurance companies “to provide comprehensive benefits, issue every applicant a policy, and charge fair and stable premiums.”  From his own website, the “Obama plan will create a National Health Insurance Exchange to help individuals who wish to purchase a private insurance plan. The Exchange will act as a watchdog group and help reform the private insurance market by creating rules and standards for participat­ing insurance plans to ensure fairness and to make individual coverage more affordable and accessible. Insur­ers would have to issue every applicant a policy, and charge fair and stable premiums that will not depend on how healthy you are. The Exchange will require that all the plans offered are at least as generous as the new public plan and have the same standards for quality and efficiency. The Exchange would evaluate plans and make the differences among the plans, including cost of services, public.”  Thus, insurance companies will be strictly limited in their ability to calculate premiums based on the nature of the risks and costs to be covered for each consumer.   

In addition, Obama’s plan forces companies to “contribute a percentage of payroll toward the costs of the national plan.”  He also makes it mandatory that all children have insurance and defines children as all people under the age of 25.  Also, while he claims to support the rights of states to experiment and provide solutions to their constituents, he will insist that the state plans are in line with his federal mandates. 

This will raise the cost of insurance, unjustly shift costs from some consumers to others, and create an increasingly untenable situation for all but the largest and most diversified insurance companies. 

Under greater free market conditions, Americans will be required to pay more individually for the health care they receive.  Whether these payments are made out-of-pocket or through rationally priced insurance premiums, this will create the financial incentives to control spending.  Yes, this also will mean that many Americans will not be able to afford the same level of health care that they currently enjoy as a result of government subsidies.  However, the moral and financial responsibility for providing medical care should rest with each individual citizen and his or her family, not the business community or general public.  Where an individual’s resources are not enough, private charity, not the government’s taxing authority, should fill the gap.

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