Politics & Policy

Running for the Exits

Health-care consumers -- not their employers -- should choose their insurance plans.

The sharpest, most stubborn exchange between Democratic presidential hopefuls Barack Obama and Hillary Clinton last night came on the topic of health care, with Senator Clinton accusing her Illinois colleague of producing a flawed “universal” health-care plan that would leave 15 million Americans uninsured.

The exchange made for great political theater, but it also underscored how far we’ve come since HillaryCare in 1994. What had been the “third rail” of national Democratic politics for the past 14 years — universal coverage — is today a test of the candidates’ seriousness.

What happened? One critical change is that the business community — which helped sink Hillary’s single-payer plan in 1994, and which today pays for the health care of 177 million Americans — has taken a long hard look at the bottom line and has decided that it is impossible for them to contain health-care costs. Now, they want an exit strategy.

On policy matters, American CEOs rarely speak with one voice. But on the subject of health care, they are reaching consensus: the costs of employer-provided health insurance hurt U.S. competitiveness and siphon off human and financial capital that could be invested more productively in other ways.

The good news is that all the major presidential candidates that remain — Senators Obama, Clinton, and McCain — are offering alternatives to our current employer-provided health-insurance system. Most of the reforms the Democratic and Republican presidential candidates propose give individuals a tax credit or subsidy for whatever kind of coverage they buy apart from the workplace.

Doing so offers employers the exit strategy they want. But the structure of the Democrats’ proposals ensures that they will evolve into a government-provided, single-payer scheme. While embryonic, the Republican approach is not to replace one set of constraints — dependency on an employer — with another– dependency on the state. Instead, it is to empower consumers in a transparent competitive marketplace.

The disadvantage that employer-based health care poses for American competitiveness is neatly expressed in the $1,500 more it costs Detroit to build a car than it costs Tokyo. In addition, American managers must spend hours poring over health insurance contracts and dreaming up cost-containment strategies. CEOs of large firms must direct expensive HR departments to monitor health-care spending, while smaller firms oversee the brokers to whom they outsource those tasks. Despite their efforts, health-insurance premiums grew at about four times the rate of inflation between 2000 and 2006.

Well-established companies aren’t the only ones harmed. Too many employees at large firms are reluctant to join or to start small, entrepreneurial firms — the key to economic growth — since doing so often means going without health benefits.

Strangely, all these personal anxieties and macroeconomic distortions are the inadvertent result of a WWII-era wrinkle in our tax code that generally permits employers, but not employees, to use pre-tax income to purchase health insurance and other benefits. This tax preference distorts health-care spending by encouraging employers to provide a substantial portion of total compensation in the form of health benefits, because they are untaxed, rather than wages, which are taxed.

Employers’ central role in buying health insurance diminishes competition between insurers. It curtails the variety of health-insurance policies available to employees, whose preferences are not solicited. And because employers do not routinely disclose to employees the size of the financial contribution they make, employees misguidedly clamor for packages that include such extravagant features as low-deductible insurance plans, in the mistaken belief that these benefits are “free.”

Senator Clinton’s exit ramp would require that all Americans purchase health care by choosing between private health-insurance plans and public ones, like Medicare. But because Medicare’s costs are largely funded by future generations of taxpayers, a Medicare-like program could offer lower prices than private plans, which are, by contrast, obliged to balance their books. Very quickly, the private plans would lose policyholders to the cheaper – because subsidized — government-sponsored alternative. The private plans would soon be forced to exit the market, leaving Americans the captives of a single-payer, government-sponsored bureaucracy.

Senator Obama takes a slightly different tack, one that many employers support: He proposes that the federal government indemnify private insurers for the costs incurred by their sickest and thus most expensive patients. But because the small minority of people with serious ailments consume far more resources than the great majority of people with garden-variety problems, the government, under Obama’s plan as well, would soon find itself covering most health-care costs.

Judging from their debate exchange on costs and coverage, the Democratic candidates seem to believe that government can rein in health care costs without impairing quality. But if the cases of Medicaid and Medicare are at all revealing, the government’s idea of cost control is to reduce or freeze payments to providers and to ration patient care. Consequently, many doctors limit the number of Medicaid and Medicare patients they will accept — some take none at all. Despite the hardships inflicted by the government’s approach, spending in both programs threatens to swamp federal and state budgets.

Cost-control and quality improvement won’t be provided by innovative entrepreneurs, who typically avoid industries in which there is only a single payer. As for businesses that opt out of arranging coverage for their employees, both Clinton’s and Obama’s plans would tax them, encouraging businesses to replace U.S. workers with either technology or moving those jobs abroad.

Although less detailed than the plans of his Democratic rivals, Senator McCain’s plan has the best long-term potential. His is the only one that would end the employer deduction entirely and give all individuals a $2,500 tax credit ($5,000 for families) to purchase health insurance, including innovative multi-year policies. He would also allow consumers to shop out-of-state for affordable ones. McCain’s plan would also require hospitals and physicians to publish information on treatment outcomes and the cost of services, encouraging patients to become informed health-care shoppers. In short, he envisions a health-care market that closely resembles other sectors of the economy.

From Detroit to Silicon Valley, the business community is eager to shed its role in providing health care, an instance of terrible miscasting. But doing so does not demand surrender to central planning. Instead, in McCain’s plan, business leaders have the chance to endorse the formula that led to their own success: consumer choice and innovation.

– Regina Herzlinger is Nancy R. McPherson Professor of business administration at the Harvard Business School, a senior fellow at the Manhattan Institute, and author of Who Killed Health Care?

Regina E. Herzlinger, a professor of business administration at Harvard Business School and a senior fellow at the Manhattan Institute, is the author of Who Killed Health Care?


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