In our quest to design an optimal healthcare insurance system, we need to assess the relative strengths and weaknesses of our current system to that of other countries. You might have noticed that the U.S. healthcare system doesn’t get a lot of respect in many quarters nowadays. In the universe of developed countries, the percentage of people in the U.S. without health insurance is an outlier. Many politicians point to Canada and the UK and wonder “why not us”?
The fact is though that few politicians have the patience to really understand the U.S. healthcare system. It’s much more complex than those in Canada and Europe. It certainly has its relative weaknesses, but it also has its relative strengths and those are poorly understood and rarely mentioned in the current policy debates. Many of these strengths require the standard tools and theories of economists to fully appreciate. So, here is the Lone Economist to the rescue!
The Problems with Health Insurance
Every national healthcare system must attract resources (e.g. doctors, nurses, hospital buildings, etc.) to the production of healthcare (i.e. supply) and limit the quantity and quality of healthcare consumed by its residents (i.e. demand) in some way. Otherwise there would not be enough doctors, hospitals, etc. to treat all the people who want to consume healthcare in a given time period. In a pure market system, this is achieved via the price mechanism. The costs incurred by healthcare providers are equal to the prices charged to healthcare consumers, i.e. patients. If a patient doesn’t have enough money to pay the price of healthcare, he doesn’t receive any. Whether or not you believe it to be fair, the market system automatically equalizes the quantities of healthcare supplied and demanded.
Since an individual’s need for healthcare can be very expensive and highly unpredictable, health insurance is used to spread the costs onto a broad swath of the population; even the lucky ones who have no need for healthcare in a given year. Insurance, however, presents a new set of problems. For one, it divorces the cost of care from the price borne by the patient, thus removing the automatic supply and demand equilibrium feature of the price mechanism. This problem is called moral hazard. For another, the premiums charged by insurers and the informational advantage the insured have over the insurers creates incentives that result in some people with expensive health problems not being able to obtain health insurance, i.e. the uninsured. This second problem is called adverse selection.
The Single-Payer Model
To prevent the moral hazard and adverse selection posed by health insurance, many developed countries, like the UK and Canada, have adopted the single-payer model. Simply put, the single-payer model cures moral hazard by placing strict limits on the quantity and quality of healthcare provided. These include long wait times and lack of coverage for certain procedures and medications. Adverse selection, on the other hand, is eliminated by replacing insurance premiums with tax revenues. This redistributes the cost of healthcare away from patients — a population that is disproportionately old and sick – and onto taxpayers. For many people, this redistribution of costs solves the fairness problem of the market system.
You might have noticed by now that with every government solution to an economic problem, another problem tends to arise. The single-payer model is no exception to this rule. The limits on the quantity and quality of healthcare meant to solve moral hazard can be arbitrary and even harmful. Any collection of preset rules and prohibitions cannot anticipate all the possible variations of needs and costs encountered in the healthcare market. An expensive treatment might be a waste of precious resources for some patients, but not for others.
Taxation too has its problems. It is a well-known fact that a dollar of insurance premium revenue does not equal a dollar of tax revenue in its cost to the economy. Every tax creates something called deadweight loss. This is the decreased employment caused by the payroll tax, the lost investment caused by the corporate income tax, and the foregone transactions caused by the sales tax. It is an unavoidable, but necessary extra cost of paying for government services through taxation.
Speaking in very broad terms, there are only two sources of income from which we extract tax revenues: labor and capital. For example, for low and middle-income households the personal income tax is a tax on labor, but for wealthy households it is mostly a tax on capital. The payroll tax is a tax on labor and the corporate income tax is a tax on capital.
It is perhaps an unfortunate, but inescapable fact that taxes on capital create much greater deadweight losses than taxes on labor. That is why the U.S. tax system tends to shy away from taxes on capital and relies so heavily on taxes on labor. I say ‘unfortunate’ because for many people a good tax is a fair tax and they consider taxes on capital (e.g. the capital gains tax, the corporate income tax, Elizabeth Warren’s wealth tax proposal) to be particularly fair. Why this is inescapable is a subject for a future posting.
So, the Achilles’ heels of single-payer systems are the deadweight losses caused by the taxes raised to pay for all the healthcare costs incurred by providers. The need to minimize these deadweight losses explains some of the more draconian limits placed on the provision of healthcare to control moral hazard and why the U.S. spends so much more per capita on healthcare than single-payer countries. For example, when dialysis was first made available, the U.K.’s National Health Service did not cover the cost of dialysis for anyone over the age of 50. This was a virtual death sentence for anyone over that age with End Stage Renal Disease (ESRD) except for wealthy individuals who could pay for private healthcare out-of-pocket. In contrast, the U.S. made everyone with ESRD eligible for Medicare regardless of age.
How could the U.S. afford to do that while the U.K.’s single-payer system could not? That is the subject of my next posting.