The Agenda

What Do We Pay for When We Pay for Health Care?

Ezra Klein and Matt Yglesias have been trying to explain the implications of the Ryan budget to their readers.

Ezra writes:

The big cut here isn’t to health care for old people, though that gets the headlines. It’s to health care for poorer Americans. The biggest category of cuts is “everything else,” which shrinks to implausibly low levels, and Ryan, to my knowledge, has never detailed, even in broad strokes, how he gets it that low. But since he’s opposed to further defense cuts — he in fact raises spending on defense in the next 10 years — it seems inevitable that the non-defense side of “everything else” would have to shrink considerably, and that means cutting quite a bit from income supports and veterans’ benefits and infrastructure.

And Matt writes:

Here’s Ryan’s big idea. Right now the way Medicaid works is that the federal government pays states a fixed share of what it costs them to provide health care services to Medicaid beneficiaries. Under Ryan’s vision for Medicaid, the way it will work is that states will get a fixed sum that grows with population growth and general CPI inflation.

So let’s imagine that, by magic, health care costs grow in line with general CPI inflation. Now what happens as the population ages? Well, as everyone knows older people need more health care servces than do younger people. So if you cap the per capita availability of health care services in an aging population, you get declining adequacy of coverage. That’s the very heart and soul of the Ryan vision for Medicaid—lower taxes on the rich financed by less adequate coverage for the poor and disabled. And keep in mind that’s the consequences of his plan with the heroic assumption that medical care inflation can be held to the level of average economy-wide inflation.

How likely is that? I would be willing to wager basically any sum Rep Ryan cares to name that whether or not his budget is enacted, medical costs will grow faster than overall inflation over the next 20 years.

Matt dismisses the idea that “magical efficiencies” can save money “without really hurting people.” He is right, however, that this is the crux of the debate, i.e., some people, on the left and the right, believe that medical cost growth flows from a combination of misaligned incentives, licensing restrictions, and the political influence of medical providers, and that addressing these drivers could potentially lower the cost of high-quality medical care, not just reduce the rate of cost growth.

Addressing these drivers is extremely difficult to do, so perhaps Matt is right to suggest that Ryan really does intend to create a situation in which the poor and disabled receive less adequate coverage. I see things somewhat differently.

(1) Ryan might believe that a more growth-friendly tax code and lower levels of public spending will contribute to a higher rate of growth, which will in turn mean that there will be fewer poor people, or rather that poor people will be richer. And as the economy continues to evolve towards a greater emphasis on knowledge-intensive services and skilled in-person services, certain kinds of disability might become less common. Matt may well consider this view naive. It strikes me as pretty intuitive that a increased wealth will give individuals, and civil society organizations, more opportunities to meet the needs of those who find themselves in distress. The deeper question, of course, is whether Ryan’s approach really will generate more growth and more wealth, which is very much in dispute.  

Disabling mental illness is, as we’ve discussed, a special issue: the rate of prime-age adults who receive disability payments on grounds of mental illness has increased dramatically in recent decades, and one controversial hypothesis is that this partly reflects the dominant treatment regime, as Robert Whitaker and Marcia Angell have argued, among others. It is thus possible that we’d reduce the cost of caring for the disabled by embracing a different treatment regime. One interesting argument is that shifting to a new treatment regime would involve higher upfront costs but lower downstream costs, which might be difficult to achieve in a fragmented provider landscape. Some might argue that this means that we need a more centralized health system, in which the state is the ultimate payer. Others might argue that we need more trial-and-error experimentation in this space, and that centralization has actually stymied the embrace of alternative treatments. This isn’t a no-brainer. (Relatedly, check out Whitaker on the AMA and the rise of prescriptions.)

(2) Where exactly does the money we spend on health care go? Kocher and Sahni offered some insight into this question:

Of the $2.6 trillion spent in 2010 on health care in the United States, 56% consisted of wages for health care workers. Labor is by far the largest category of expense: health care, as it is designed and delivered today, is very labor-intensive. The 16.4 million U.S. health care employees represented 11.8% of the total employed labor force in 2010.

What happens in industries in which wages represent a large share of costs? Firms in other sectors have pursued a variety of strategies: automation, offshoring, combining technology and labor in new ways to boost the effectiveness of workers across the skill spectrum, etc. 

While all of these strategies have been pursued in the health sector, this process has arguably been undermined by licensing restrictions, the power of organized labor, etc. The politicization of medical care might contribute to its cost structure. In a discussion of medical care, John Cochrane of Chicago Booth informally observed that in some Latin American markets, one could get a discounted CAT scan by going to a clinic at an off-peak time — going at 2 AM would be far cheaper than going at 4 PM. Medicare beneficiaries might be very displeased if they were forced to go to a clinic at 2 AM to save the system money, but they’d be far more amenable to doing so if it saved them money. A centralized system could introduce innovations of this kind, and of course many have, but we might see a faster innovation cycle in a more decentralized system, in which a variety of providers and payers are empowered to pursue diverse strategies. Moreover, a state-dominated system might be less willing to employ strategies like offshoring and medical tourism on political grounds, despite the fact that consumers might choose firms that embrace these strategies on the grounds that they offer lower costs. 

Some believe that the status quo allows is a competitive, multi-payer landscape that allows us to do exactly that and that this market-oriented approach simply doesn’t work. Others argue, correctly in my view, that the power of hospitals, entrenched through regulations at the state and increasingly at the federal level, stymies a great deal of provider-level regulation. 

Another way of putting this: as Medicaid expenditures have grown, who has reaped the benefits? Has the health profile of Medicaid beneficiaries improved in line with cost increases? This is a hard question to answer, as expenditures tend to be concentrated in a small minority of high-cost patients, who may well have benefited disproportionately. But I think one can reasonably argue that it is providers, device manufacturers, etc., that have grown more effective at extracting rents over time, to the detriment of taxpayers.

Viewed through this lens, the only thing that matters is facilitating new entry by firms that have the freedom to engage in organizational innovation. This will require shifting the locus of regulation (we could call this “deregulation,” but that’s an oversimplification) and imposing spending discipline. The latter can be helpful because it allows efficient providers to grow at the expense of inefficient providers.

But again, spending discipline alone won’t yield the kind of change the health system needs. So it may well be fair to criticize Ryan for not emphasizing that, say, incumbent medical providers will face more competition in this new landscape, etc. In fairness, however, the regulation issue is not really in the wheelhouse of the House Budget Committee. 

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