Breaking News: Supreme Court Upholds Individual Mandate

Filed Under (Health Care, U.S. Fiscal Policy) by Nolan Miller on Jun 28, 2012

Hot off the Internet, the Supreme Court has upheld the “Obamacare” individual mandate, which requires most people to buy health insurance or else pay a tax.  The ruling isn’t available yet, but I have to say that I’m really, really impressed by this decision because it shows that the Supreme Court was able to look beyond the politics of the situation and the poor argument by the administration in defense of the bill, and rule according to the law.

The argument against the mandate was that it violated the Commerce Clause of the Constitution in that it regulated economic “inactivity” rather than activity.  That is, it forced people to participate in the individual insurance market even if they didn’t want to.  The administration flubbed its defense on this point by failing to show how health insurance markets are different than most other markets, giving the Supreme Court a limiting principle that would prohibit the ruling from establishing that Congress can regulate anything it wants.

It sounds like the Supreme Court did not buy the argument that the indivual mandate was justified under the Commerce Clause.  But, in some sense this is all a red herring.  The individual mandate is a tax, plain and simple.  People who do not buy health insurance must pay a fine to the IRS.  A fine paid to the IRS is a tax.  The Democrats and the administration tried to hide the fact that this was a tax while rallying support for the bill for obvious reasons.  Nobody wanted to be seen as raising taxes, and President Obama had promised during the campaign that he would not raise taxes for middle income Americans.  But, just because the Democrats wanted to pretend that this wasn’t a tax, that doesn’t make it true.  It’s a tax. And, Congress has the right to impose taxes.

Despite the fact that the administration did not emphasize the tax aspect of PPACA’s indivual mandate in either its presetation of the bill to the public or in its defense before the Supreme Court, the Court was able to step beyond the narrative that was being fed to them and identify the key legal principle involved.

Whether you support the bill or not, I think that in a post Bush v. Gore / Citizens United world, when people are wondering whether the Supreme Court really is an impartial arbiter of the law, you have to see this as a great moment for the Court.  Hooray for them.

More after I have a chance to look at the ruling.

The Choice Between Two Unconstitutional Options is Not Constitutional

Filed Under (Other Topics, Retirement Policy, U.S. Fiscal Policy) by Nolan Miller on May 29, 2012

As I’ve said before, I’m not a lawyer.  But, since the Illinois House Democrats have decided to move into incentives, why not?  The details of the pension reform proposal that passed an Illinois House committee today are still vague, but here is a write up about it.

Simply put: the proposals currently under consideration in which members are offered a “choice” between options, as currently constructed, are not constitutional.  Here’s why.

The Illinois Constitution says that membership in a state pension program is a contractual relationship the benefits of which shall not be diminished or impaired.

Any contractual relationship has to have, well, a contract.  In this case, the terms of the contract are spelled out in the Illinois Pension Code.

The Illinois Pension Code specifies the way in which pension benefits will be calculated.  The details are slightly different for different pension funds, but I’ll talk about the part that pertains to Tier I participants in the State Universities Retirement System (SURS).  In particular, the amount of the retirement annuity is specified in Section 15-136 of the Pension Code.  Here it is:

Rule 1: The retirement annuity shall be … for persons who retire on or after January 1, 1998, 2.2% of the final rate of earnings for each year of service.

That seems pretty clear.  The “final rate of earnings” is defined in Section 15-112.  For a person who first becomes a participant before Jan. 1, 2011 (i.e., Tier I participants), the final rate of earnings is defined as:

For an employee who is paid on an hourly basis or who receives an annual salary in installments during 12 months of each academic year, the average annual earnings during the 48 consecutive calendar month period ending with the last day of final termination of employment or the 4 consecutive academic years of service in which the employee’s earnings were the highest, whichever is greater. For any other employee, the average annual earnings during the 4 consecutive academic years of service in which his or her earnings were the highest. For an employee with less than 48 months or 4 consecutive academic years of service, the average earnings during his or her entire period of service.

That also seems pretty clear.

One more excerpt from the Pension Code.  This one has to do with annual cost of living adjustments (COLAs).  From Section 15-136

The annuitant shall receive an increase in his or her monthly retirement annuity on each January 1 thereafter during the annuitant’s life of 3% of the monthly annuity provided under Rule 1, Rule 2, Rule 3, Rule 4, or Rule 5 contained in this Section. The change made under this subsection by P.A. 81-970 is effective January 1, 1980 and applies to each annuitant whose status as an employee terminates before or after that date.

Beginning January 1, 1990, all automatic annual increases payable under this Section shall be calculated as a percentage of the total annuity payable at the time of the increase, including all increases previously granted under this Article.

This part of the Pension Code also seems clear: COLAs are to “include all increases previously granted under this Article.”  In other words, COLAs compound rather than being based on the original amount of the annuity.  And, COLAs start the January after retirement.

So, let’s review.  The Illinois Constitution says that membership in a pension system is a contractual relationship. The terms of that contract are given by the Pension Code, and the Pension Code specifies the way in which final pension benefits should be computed.  In particular, it specifies that the final rate of earnings is average earnings over the final 4 years of service, or the 4 consecutive years in which earnings were the highest.  Thus, the Pension Code states that future pay raises will be included in future pension benefits.  The Pension Code also states that COLAs are to begin immediately after retirement and be computed on a compound basis.

So, let’s return to the “choice” that would be offered to members of the pension system under the proposal.  Details are sparse, but the basic choice to be offered to members will be:

(A)  Keep the current pension plan, but give up the state subsidy for retiree health benefits and having future raises be included in pension benefits, and

(B) Keep the state subsidy for retiree health benefits, but receive a less generous cost of living adjustment (COLA) where annual increases are based on the pension payment at the time of retirement rather than the most recent year’s pension.  That is, the COLA is not compounded over time.  Further, the COLA will not kick in until 5 years after retirement or age 67, whichever comes first.  There is also language in at least the governor’s proposal that will limit the COLA to a simple 3% or ½ the increase in the consumer price index, whichever is lower.

Now, supporters of this approach claim that is constitutional because it offers participants a choice.  This claim is invalid.  While a choice might be constitutional, in order for this to be the case, it must be that one of the options does not impair or diminish the benefits of the current pension system.  This is not true here.  Option (A) denies members their contractual right to have the final annual rate of earnings be based on their highest 4 years of earnings, which would include future raises.  Option (B) denies members their contractual right to have COLAs be 3% compounded each year.  Since both options impair and diminish the benefits of the pension, if members are forced to make a choice between A and B, their pension benefits will necessarily be reduced.

Constitutionally speaking, two wrongs don’t make a right.

Consequently, to me it seems clear that the proposals are not constitutional.  Given that so many of our legislators are backing these proposals, there must be an argument for why the proposal is constitutional.  I can’t see it, though.

ADDENDUM (5/30/12):  This isn’t a post about whether it is right or fair to reduce retiree health benefits (it isn’t), but rather whether it is constitutional (it probably is).  Retirees who began working for the State of Illinois before April 1986 (at least in the case of SURS) may not be eligible for Medicare Part A.  In this case, removing health insurance benefits would leave workers exposed to significant financial and health risk even after the age of 65.  The state also does not contribute to Social Security, so state workers who retire are also not eligible for Social Security (unless it is by virtue of having worked for another employer).  Obviously, removing employer-sponsored health benefits and reducing the COLA is going to expose retirees to substantial new risks, and the proposal becomes much more complicated and controversial in this case.

Thinking Waaaaaaaaaay Outside the Box on Public Pensions

Filed Under (Other Topics, Retirement Policy) by Nolan Miller on May 16, 2012

I’ve written over the past couple of weeks about public pensions in Illinois.  Short version: they’re a possibly-unfixable mess.  Since the state constitution forbids reducing promised benefits for current employees (or increasing contributions) and the state has failed to plan for their pension promises in a timely manner, the state is stuck between the proverbial rock and a hard place.

With this in mind, over the past few days I’ve been trying to think of unconventional ways in which the state can save money.  This is a bit tricky, since in the case of public employees the state pays their salary when they’re working AND their pension when they retire.  It’s the overall cost that matters.  So, for example, when the University of Illinois had an early retirement program last year, the University stopped paying them and SURS, the state university retirement system, started paying them.  But since both are ultimately using state dollars (but less-so in the case of the University, whose state appropriation as a fraction of overall cost has fallen drastically in recent years), this is really just a reshuffling of which pocket the money comes from.  The state is still on the hook.

Thinking outside the box leads to some crazy ideas.  And here’s one of them.  I make no promises about whether it will work in practice.  But it does point to some of the strange features of state finance.

Here’s the idea: to help the state’s pension system’s finances, the state should pay its workers more as they near retirement.  That’s right.  More.

As I started to play around with the idea, I had a dim recollection of reading something related.  It turns out that a couple of weeks ago, Andrew Biggs wrote in the Wall Street Journal about how cutting the Social Security payroll tax for workers nearing retirement could actually help the system’s finances.  The idea is simple: if older workers get to keep more of their wages, they’ll work longer.  And, if they’re working, they’re not collecting Social Security.  Lowering the payroll tax pushes back retirement, and this helps the system’s finances.  The idea is also related to my post from two weeks ago, where I discussed research showing that retiree health benefits induce early retirements.  If the state can’t pay retirees less and can’t ask them to contribute more, the only thing it can do to reduce pension costs is induce them to retire later, and it needs to do so in a way that costs less than the potential savings from delayed retirement.

So, how does it work?  Consider a worker near retirement age who has been working for the state his whole career, or at least long enough to reach the earnings cap on the state’s retirement system.  This worker, let’s call him Charlie, will earn 80% of his final salary after retirement.  And, assuming this worker was actually fulfilling a necessary function (e.g., teaching students finance), that worker will have to be replaced after retirement by a new worker.  Let’s call him David.  New workers tend to earn less than senior workers, so David will earn less than Charlie did.  Maybe David earns 80% of Charlie’s final salary.  But, essentially, after Charlie retires the state will be paying both Charlie and David – two people – to do work that could be supplied by one person.  While the state paid 100% of Charlie’s salary for that work before retirement, it pays 160% of Charlie’s salary after retirement!

So, the state has the potential to save a lot of money overall – 60% of Charlie’s salary per year – if it can induce Charlie to delay retirement.  Due to the non-impairment clause, a lot of the ordinary ways of doing this such as increasing the full retirement age are off the table.  One thing the state can do is increase Charlie’s salary.  This could be done through an actual wage increase or, as Biggs suggests, by reducing the 8% of wages that Charlie must pay into the retirement system as he nears retirement.

It is easy to see how it might be worth it to the state to spend more money on Charlie’s wages in order to delay his retirement.  But, let’s make up some simple numbers.  I’m going to ignore things like the fact that pension payments increase 3% per year and other details of the retirement system. They don’t change the basic insight, and the uncertainty involved with the other numbers that I’M JUST GOING TO MAKE UP is a much bigger deal than details like this.  I’m illustrating – not proposing policy.

So, suppose that increasing Charlie’s wage by 10% per year leads him to delay retirement by 3 years.  Suppose Charlie makes $50,000 per year and has maxed out his service so he’ll earn 80% of that ($40,000) after he retires.  Assume that David will earn $40,000 after he’s hired.

There are two things that should be taken into account.  If Charlie’s wage goes up, the basis for his pension will go up as well.  Roughly speaking, pensions are based on average earnings over the last four years of work.  Over these years, Charlie earns 50,000 for one year (the year before he gets the raise) and 55,000 for three years (after he gets the raise).  His final pension is 80% of the average, or 0.8 * 53,750 =  $43,000 per year.  Again, there are subtleties to the formula, but too many details obscure the main idea.  And, if Charlie works additional years, he will pay an additional 8% of salary into the pension system.  This would seem to be money that the state gets back.  But, as far as I can tell, these “excess contributions” are refunded to the employee at retirement.  So, in the case of a worker who has maxed out his pension, there would be no additional benefit to the state.  (For a worker who has not maxed out their pension, the state would receive additional contributions from the worker who delays retirement, but it would also have to pay an additional 2.2 percent of final earnings for each additional year of work, so it is unclear that this would benefit the state.)

Total 10 year cost if Charlie retires now:

Charlie’s pension payments: 10*40,000 = 400,000
David’s wages: 10*40,000 = 400,000
Total Cost:   $800,000


Total 10 year cost if Charlie retires in 3 years:

Charlie’s wages (years 1 – 3): 3*55,000= 165,000
Charlie’s pension (yrs 4 – 10): 7*43,000= 301,000
David’s wages (yrs 4 – 10): 7*40,000= 280,000
Total Cost:   $746,000


So, the total savings over 10 years from my COMPLETELY MADE UP numbers is $54,000, or 6.75% of the cost under the current system.  And, this savings occurs in the first three years from not having to pay David.  Although I’ve ignored the time-value of money to keep things simple, the fact that the savings come up front would favor giving Charlie the raise if there were a positive interest rate.

Whether a scheme like this could actually save money would depend on a lot of things.  Among them are how much more near-retirees need to be paid to delay retirement, how long the delay retirement for, the relative cost of replacement workers, the length of time over which retirees draw pensions, and the time-value of money. Again, for the purposes of illustration, I COMPLETELY MADE UP THE NUMBERS ABOVE.  Economists invest a lot of time and energy in estimating quantities like these, though, and they’d need to do so before anything like this could go forward.

One crucial factor would be how well the state can target workers who are really on the margin of whether or not to retire.  While a wage increase across the board would be extremely unlikely to save the state money, one that is targeted at workers who are thinking about retiring and induces them to delay retirement just might.  One thing’s for sure: it wouldn’t run afoul of the non-impairment clause!

Incredible Pension Promises

Filed Under (Other Topics, Retirement Policy, U.S. Fiscal Policy) by Nolan Miller on May 8, 2012

in•cred•i•ble (adjective): too extraordinary and improbable to be believed.

I wrote last week about the Illinois public pension mess and how ceasing to offer fully-paid retiree health benefits might help to address the problem by causing workers to delay retirement.  The reason why such a convoluted route to reducing pension costs is needed is because of the non-impairment clause of the Illinois state constitution, which prevents the state from reducing benefits for current employees.  In short, the non-impairment clause says that membership in a state pension system is a contractual relationship between the worker and the state.  And since contracts cannot be unilaterally renegotiated by one of the parties, the state is in a situation where it would seem to have no way out of its obligation to pay promised benefits to its current and future retirees.

In his proposal to reform the state pension system, Governor Quinn has tried to avoid the non-impairment clause by offering workers a choice.

On the one hand, current workers can keep their current pension plan but lose the right to have future pay increases be included in their final pension benefits and lose the subsidy that the state currently pays for retiree health benefits.  (Now, the first part of this plan clearly violates the non-impairment clause because the formula used to compute final benefits is specified in the Illinois Pension Code and clearly includes future pay raises.  But, that’s not today’s topic.)

On the other hand, employees can accept a significantly less-generous pension plan but maintain the employer subsidy toward retiree health benefits.  (Now, the less-generous pension plan pushes full retirement to age 67, when employees would be eligible for Medicare anyway, so it is unclear how valuable this promise would be to retirees.  But, that’s not today’s topic either.  There is also the real question of whether this would be considered “coercion” by the state.  In the past the Supreme Court of the United States has ruled that an employee cannot be coerced into giving up his pension benefits.  But, that’s also not today’s topic.)

This would be the time to ask ourselves why the non-impairment clause was included in the Illinois Constitution in the first place.  An analysis by Eric Madiar, Chief Legal Counsel to Illinois Senate President John Cullerton, confirms what you might suspect.  Public workers in the state of Illinois were concerned about whether the state would pay the pension benefits that it had promised them.  State and local workers generally receive lower cash wages than their private-sector counterparts, but higher benefits, including more generous pensions.  Thus, when an employee accepts a job working for state or local government, promised future pension benefits play a major role in making that job attractive enough for them to accept.  In light of this it is not surprising that they would be concerned about whether the state could be trusted to pay those future benefits.  This led state and local workers to propose that pension benefits be guaranteed in the Illinois constitution, and this proposal ultimately became the non-impairment clause.

Economists think a lot about commitment.  That is, we wonder about things like how it is that an agent can commit to take an action in the future that is not it its own short-term interest.  Or, we wonder how it is that an agent can be given incentives to take actions today that do not benefit it until the distant future.  Both of these issues arise in the context of pension funding.  In order to induce an worker to take a government job that pays less today, that worker must believe that the state will actually fulfill its promise to pay higher pension benefits in the future.  Similarly, in order for current legislators to cut current spending and use the money to fund future pension payments, there must be consequences.  The non-impairment clause addresses both of these issues.  The highest law of the state guarantees that the state will make the future payments.  This guarantee is so strong that a state that fails to properly plan for these payments will face fiscal collapse – as we do now.  Even in the face of fiscal collapse, the non-impairment clause suggests that pension payments must take precedent over many other payments.  With these promises in place, workers should be confident that the state will fulfill its future obligations.  Ideally, knowing that failure to plan for the future will jeopardize the entire state, legislators will make appropriate funding decisions to avert disaster.

Consequently, the non-impairment clause plays a vital role in the state’s finances.  Over the years it has been used to induce workers to accept a lower wage today in exchange for the seemingly-credible promise to provide higher benefits in the future.  In other words, the non-impairment clause has allowed the state to push the cost of paying current workers onto future taxpayers.  Kicking the can down the road in this manner has been a major tool in the state’s fiscal toolbox.

Let’s think about the role of commitment in regards to Governor Quinn’s proposed choice.  The plan says that those who want to keep their current pension will lose retiree health benefits.  The governor can take away retiree health benefits because they are not guaranteed by the non-impairment clause.  An employee who accepts the governor’s proposal would get a less-generous plan but keep the state’s promise of retiree health benefits.

In order for an employee to voluntarily accept this plan (if they believe that current pensions cannot be impaired), it must be because the employee values retiree health benefits.  But, even an employee who values retiree health benefits would have to believe that, when they retire in the future, the state would actually provide the promised benefits, and would continue to do so even if times were tough.  In fact, when times are tough that’s when people need their pensions the most.  So workers might be particularly concerned about whether a state under fiscal pressure would continue to fulfill their promises.  Sound familiar?

This is where things become a bit tricky for the state.  Times are tough right now, and the state has responded by threatening to take away retiree health benefits.  This has occurred both in the governor’s proposal and in the state legislature, where pending legislation would eliminate the state’s subsidy for retiree health premiums, which amounts to about $7400 per retiree per year.  So, the state is, on the one hand threatening to take away retiree health benefits and on the other hand asking workers to believe that their promise that those who accept the governor’s proposal will continue to receive these benefits in the future.  And, all of this is taking place in a situation that was brought about by the state’s failure to adequately plan to meet its constitutional obligation to pay pension benefits.

This brings us to the big question: Why should workers expect the state to honor its commitment to provide a non-guaranteed benefit when it isn’t even honoring the benefits that it is constitutionally obligated to provide? While the governor’s plan should be commended for attempting to address the pension crisis through asking workers to voluntarily accept a change in benefits, in the end I would be surprised if workers are willing to give up their constitutionally guaranteed pension benefits for an incredible promise to provide health benefits.

Practically speaking, any proposal that asks for voluntary acceptance by workers is going to have to exchange currently promised benefits for some promise of future benefits, and any such promise of future benefits is going to face this same credibility problem.  The state, by finding a way around its constitutional promise of future benefits, may find that it loses the ability to induce people to work today for lower wages and promises of higher payments via pensions in the future.  If workers respond to this by insisting on higher wages today, the state may find itself facing a choice between higher wage costs or lower-quality workers.  Even if the state can find a way around the non-impairment clause, it will not be without its costs.


ADDENDUM (5/30/12):  Retirees who began working for the State of Illinois before April 1986 (at least in the case of SURS) may not be eligible for Medicare Part A.  In this case, removing health insurance benefits would leave workers exposed to significant financial and health risk even after the age of 65.  Obviously, removing employer-sponsored health benefits is much more complicated and controversial in this case.

Retiree Health Insurance, Early Retirement and the Illinois Pension Mess

Filed Under (Health Care, Retirement Policy, U.S. Fiscal Policy) by Nolan Miller on May 2, 2012

Ever since Governor Quinn proposed his plan to reform government employee pensions in Illinois, I’ve been thinking about how to blog about it.  The problem is, my primary opinion is a legal one – that the proposal clearly violates the non-impairment clause of the Illinois state constitution because it threatens current employees with excluding future pay raises from pensionable earnings in contradiction of the “contractual relationship” laid out in the Illinois Pension Code – and I’m not a lawyer.  Better to stick with what I am supposed to know.

So, let’s turn to economics.  While the non-impairment clause prevents the state from reducing pensions, it does not affect other benefits.  In particular, the state would seem free to reduce or remove subsidies for retirement health benefits without running afoul of the non-impairment clause.  New research from by Steven Nyce, Sylvester Schieber, John B. Shoven, Sita Slavov, and David A. Wise suggests that doing so might be a way to lower pension costs.  In short, they show that removing the employer subsidy for health benefits for early retirees would cause people to work longer.  And, when people work longer they contribute more toward the pension fund and draw pensions for less time, improving the overall finances of the pension system.

In the new article, entitled “Does Retiree Health Insurance Encourage Early Retirement,” the authors investigate the relationship between employer subsidies for health insurance to retirees.  The paper begins by noting that many Americans delay retirement until they reach age 65 because employment gives them access to health insurance at far better prices than they could receive in the private market (if such insurance is even available).  When an employer offers subsidized health insurance to those who retire before age 65, it makes it possible for people to retire earlier than they otherwise would.  Using newly-available data, the paper finds that retiree health coverage significantly increases retirements among people in their early 60s.  In fact, when employers subsidize 50 percent or more of the cost of retiree health insurance (as the state of Illinois does), retirements increase by “1-3 percentage points at ages 56-61, by 5.9 percentage points (33.7 percent) at age 62, and by 6.9 percentage points (43.7 percent) at age 63. Overall, an employer contribution of 50 percent or more reduces the total number of person-years worked between ages 56 and 64 by 9.6 percent relative to no coverage.”

What does this mean for the state of Illinois?  Take, for example, SURS, the State Universities Retirement System.  In this system, a worker’s total retirement benefit is limited to 80% of final salary.  This means that, after about 36 years of working for the state, the worker’s pension no longer increases with additional years of service.  Further, state law provides that the state will pay 5% of retiree health premiums for each year of service.  (Importantly, the applicable law is not the Pension Code!)  So, a person who started working for the state at age 25 would, by age 62, be eligible for the maximum pension and free health benefits.

Given this deal, it is no wonder that people choose to retire before age 65.  This costs the pension system, since early retirees do not contribute and they draw their pension for longer.  Removing retiree health benefits would have a significant financial impact on early retirees.  Back in 2006, the most recent data I could find in a quick search, the average health insurance premium for an adult age 60 – 64 on the non-group health insurance market was around $360/month.   A family policy would cost about twice that.  Such policies are usually less generous than employer-provided insurance and feature higher deductibles and coinsurance rates.  So, a near-elderly state employee contemplating retirement might face expected monthly costs of $500 – $700 or more if they had to pick up their own health insurance, and even more if they had a dependent spouse or children.

So, suppose the state were to eliminate retiree health benefits.  Faced with such costs, many people would choose to work until age 65 (or at least until age 63.5 when the COBRA law would allow them to continue to purchase health insurance under the state plan until they become eligible for Medicare at age 65).  And, when people retire later, they draw pensions for less time.

Now, I am not necessarily advocating this, and certainly not across the board.  There are strong arguments why for some government employees – in particular police and firefighters –the physical demands of the job make early retirement reasonable.  For other government employees, such as professors, there is no strong reason why the state should be subsidizing early retirement through providing free health benefits after I stop working.

My broader point is that whatever the state does, and it must do something, it must be done in a way that does not violate the constitution.  While the state cannot touch pension benefits, it is free to reduce health insurance.  And, since retiree health insurance makes retirement more attractive, reducing or removing retiree health benefits would seem to be a constitutional and, based on recent research, effective way to delay retirement, which would improve the ailing pension systems’ finances.

ADDENDUM (5/30/12):  Retirees who began working for the State of Illinois before April 1986 (at least in the case of SURS) may not be eligible for Medicare Part A.  In this case, removing health insurance benefits would leave workers exposed to significant financial and health risk even after the age of 65.  Obviously, removing employer-sponsored health benefits is much more complicated and controversial in this case.

PPACA goes to SCOTUS: Health reform appears to be in danger.

Filed Under (Health Care) by Nolan Miller on Mar 28, 2012

The argument over the fate of the Patient Protection and Affordable Care Act, a.k.a “Obamacare,” is taking place before the United States Supreme Court this week.  Three questions are being considered.  The first is a technical question regarding whether the challenge to the law can be heard now or if it has to wait until someone actually pays the penalty the law imposes.  Perhaps this is an interesting legal matter, but there isn’t much economics there.  The second question is whether the individual mandate, which requires most Americans to buy health insurance or face a penalty, is a constitutional exercise of Congress’s power to regulate interstate commerce or not.  This is the key question, since, if the justices decide that Congress overstepped its powers in passing the law, the part of the law that results in nearly universal health insurance could be struck down.  The third question is, if the individual mandate is struck down, how much of the rest of the law will go along with it.

As I said, the second question is the key, and SCOTUS heard arguments on this question yesterday.  By all accounts, the administration bumbled it.  Here’s an excerpt from the New York Times:

But several of the more conservative justices seemed unpersuaded that a ruling to uphold the law could be a limited one. Justice Alito said the market for burial services had features similar to the one for health care. Chief Justice Roberts asked why the government could not require people to buy cellphones to use to call emergency service providers.

Justice Scalia discussed the universal need to eat.

“Everybody has to buy food sooner or later, so you define the market as food,” he said. “Therefore, everybody is in the market. Therefore, you can make people buy broccoli.”

Justice Alito asked Mr. Verrilli to “express your limiting principle as succinctly as you possibly can.”

So, the justices wanted to know if they allow the individual mandate to stand, what won’t Congress be able to regulate.  The administration’s response:

Instead of a brisk summary of why a ruling upholding law would not have intolerably broad consequences, Mr. Verrilli gave a convoluted answer. First of all, he said, Congress has the authority to enact a comprehensive response to a national economic crisis, and the mandate should be sustained as part of that response.

He added: “Congress can regulate the method of payment by imposing an insurance requirement in advance of the time in which the service is consumed when the class to which that requirement applies either is or virtually most certain to be in that market when the timing of one’s entry into that market and what you will need when you enter that market is uncertain and when you will get the care in that market, whether you can afford to pay for it or not and shift costs to other market participants.”


Here’s what they should have said.  It is true that people need to buy burial services and food, but these markets differ from health care in that there is no threat of “adverse selection” as there is in health insurance, and adverse selection has the potential to make it impossible for individuals to purchase insurance at reasonable rates (i.e., the sick pay less than their expected cost of care and the rich pay more) unless that market is regulated.

Take the market for broccoli or burial services.  As the justices point out, it is true that everybody needs food or burial, eventually.  However, my ability to consume food or be buried does not depend in any crucial way on what others do.  In economic terms, we say that there is no “market failure” here.

Now, take the market for health care services.  Suppose there are two kinds of people.  Healthy people have expected annual health care costs of $1000, while sick people have expected annual health care costs of $11,000.  If there are equal numbers of healthy and sick people, then the average cost of caring for all people is (1000 + 11000)/2 = $6000.  Next, assume that individuals know whether they are healthy or sick, but health insurers don’t know whether a person is healthy or sick, or, as is done in the new health care law, are prohibited from using this information to charge different prices to healthy and sick people. 

Suppose the insurer charges a price of $6000.  If everyone purchased this insurance, the insurer would break even.  But, a person who expects to have only $1000 healthcare costs would not be willing to purchase this coverage, since by doing so they spend $6000 for something worth $1000.  A person who expects to so spend $11,000 on health care would be willing to buy coverage.  But, if the insurer expects that only sick people will buy the insurance, it will not be willing to sell it at a price of $6000, since by doing so it would lose $5000 on each policy.

In this example, the only sustainable outcome is where the insurer charges $11,000 and only the sick people buy insurance.  But, at this price, the sick people are no better off than they would be without insurance, and the insurer earns zero profit.  So, nobody benefits from this market.  In cases like these, we say that adverse selection (the fact that those who value a product the most are likely to be the most costly to serve) has led to a market failure.  In this case, the fact that the healthy are unwilling to purchase health insurance voluntarily makes it impossible for the sick to purchase it at a reasonable price.  It is this interdependence that makes health care markets and broccoli markets fundamentally different.

This market failure could be addressed by mandating that everybody had to buy insurance, as is done in PPACA.  In this case, the price of insurance would be $6000.  Firms would just break even, sick people would benefit from insurance, and healthy people would be forced to subsidize the sick against their will.

Rather than focus on the distinction made above, the administration has argued that the key distinction between health care and other markets is that there is a degree of uncertainty about future use in health care markets that is not present in other markets.  This case is empirically weak, and more importantly, not a market failure that requires government intervention.  They have also argued that even those who choose not to purchase health insurance often consume health care, and in many cases these costs are passed onto others.  This argument, however, would seem to fail the broccoli test: if not eating broccoli today means I’ll be less healthy and more likely to collect government benefits in the future, then, by extension, the government should be able to force me to eat broccoli.  I don’t think the administration wants to be making this argument (at least not today, in front of the Supreme Court).

The example I discussed above illustrates how the PPACA provisions that prohibit charging higher prices to sick individuals and the individual mandate work together.  The result is a situation where everyone is covered by private insurance.  However, there is clear redistribution from the healthy to the sick.  This may be desirable from a social perspective, and somewhere in the administration’s convoluted argument is the idea that the healthy are always at risk of becoming sick.  Whether you favor PPACA on social grounds depends on your individual preference for redistribution and, even if you are in favor of increased redistribution, whether you think intervening in health insurance markets is the best way to do it.  However, one thing that is indisputable is that health insurance markets are different from broccoli and burial markets.   The administration’s failure to effectively show that there is a bright line between the market for health insurance and broccoli might result in PPACA being overturned.

Doc Fix: Time to Start Over

Filed Under (Health Care) by Nolan Miller on Feb 22, 2012

Last week, Congress struck a deal to head off a pending 27 percent decrease in what Medicare pays to physicians.  Well, head it off until the end of the year.  Then we’ll be right back where we started from, except the amount of the pay cut will be even larger.

So, what’s it all about?  It all goes back to an attempt in the Balanced Budget Act of 1997 to slow the rate of growth in what Medicare pays to physicians.   Each year, Medicare decides how much to increase the fees it pays to physicians.  In order to reduce the rate of growth in these fees, the 1997 BBA instituted something called the Sustainable Growth Rate formula to help dictate what those increases should be.  In hindsight, the term has turned out to be quite ironic, since the growth rate it proposes has turned out to be anything but sustainable.  In fact, Congress often overrides the changes dictated by the SGR in what has become called a “doc fix.”

The SGR formula is too complicated to discuss, but it’s basic aim is to reduce the rate of Medicare spending on physicians.  Each year, Medicare projects what it thinks it will cost to care for recipients based on past behavior, inflation, and population growth.  If actual spending turns out to be close to this projection, physicians are rewarded by an increase in fees the following year.  On the other hand, if actual spending is too much above the projection, the SGR formula kicks in and lowers fees across the board in an attempt, over time, to bring actual spending back in line with projections.

As usually happens, in the early years the formula worked fine.  Medical expenditures were in line with expectations and docs got a small increase in fees.  However, in 2002, the SGR formula imposed a 5 percent cut in physician fees that was actually implemented.  Then, in 2003, when the SGR formula once again dictated a fee reduction, Congress stepped in and prevented the fee cut from happening.  This was the first Doc Fix.  Along with the Doc Fix, Congress included language that said that the SGR formula in future years should continue to be calculated as if Congress had not imposed the Doc Fix.

In subsequent years, actual expenditure continued to be high relative to projections, and Congress continued to override the SGR formula.  Since past Doc Fixes were not taken into account, each year the size of the adjustment to physician fees needed to bring payments in line with the original SGR formula has grown until now it has reached a whopping 27%.  And, every year it becomes clearer that if Congress wasn’t going to let physician fees decrease by 5% or 10%, they’re certainly not going to let them decrease by 27% or 35%.

So, what should we do about the Doc Fix?  The original intent of the SGR was a good one: slow down the rate of growth of healthcare spending. But, it is clear that the SGR approach doesn’t work.  At this point, physicians rightfully assume that eventually Congress will pass another Doc Fix, and they will continue to get paid higher rates than the SGR would dictate.  Consequently, the SGR formula has no power to persuade physicians to rein in spending.

Thus, I think the first step to is to reset the SGR.  Instead of sticking to the original formula, which requires a thirty percent reduction in physician fees, in the short run we should re-base the formula, so that next year maintaining the SGR would require a much smaller decrease in fees — on the order of a few percentage points — if physicians do not reduce overall spending on their own. This would restore the original intent of the SGR, applying pressure on providers to reduce overall spending.

Next, we need to rethink the way we approach the whole problem.  Even if Congress had the courage to enforce the payment reductions imposed by the SGR, the approach would still be fundamentally flawed because it creates a situation where it forces physicians to compete for an increasing share of an ever-shrinking pie.  If physicians know that the total amount of money available to physicians is fixed and they expect fees to be reduced as they are under the SGR, then a rational physician who wants to maintain income will have to respond by performing more procedures.  However, all physicians have this incentive, so we should expect all of them to deliver more services (some of which may not be as medically necessary), and this will force the SGR to lower physician fees even more.  The result is a vicious cycle that leads to more and more care being provided without substantially increasing patient outcomes.

While it is clear the SGR has to go, it is less clear what it should be replaced with.  However, the fundamental problem – that the SGR actually encourages more care – would be alleviated if we switched a greater share of provider compensation from payments for the quantity of services provided to payments for the quality of outcomes.

Health Reform and Cost Reduction: So Far, No Good

Filed Under (Health Care) by Nolan Miller on Jan 25, 2012

Since the 1960’s, Medicare has the authority to conduct pilot studies to determine whether particular innovations might reduce the cost of providing healthcare services to Medicare beneficiaries.  The 2010 health reform law (PPACA) expanded this power, giving Medicare the authority to expand nationally any program that has been shown to reduce projected spending and improve quality.  While many of us were disappointed by PPACA’s lack of attention to cost reduction (and quality improvement), there was reason to hope that, out of the garden of demonstration projects, a few flowers might bloom.  Unfortunately, while the first group of demonstration projects has taught us something about what kinds of demonstrations we should look at in the future, none successfully reduced overall Medicare spending (including the costs of implementing the pilot programs).

Broadly speaking, the Center for Medicare and Medicaid Studies (CMS – note the government did successfully save money by removing the second “M” from the acronym!) has focused on two types of programs: disease management programs aimed at improving care for patients with chronic conditions and reduce costs by decreasing the likelihood of costly complications and hospital admissions, and value-based payment programs that attempt to reward providers for quality and efficiency of care rather than paying them for providing more care (as is the case in the standard Medicare fee-for-service model).  Earlier this month, the Congressional Budget Office (CBO) released a series of reports (here and here, and summarized here and here

 The results on the disease management programs were uniformly disappointing.  Quoting from the CBO Issue Brief on the topic:

 The evaluations show that most programs have not reduced Medicare spending: In nearly every program involving disease management and care coordination, spending was either unchanged or increased  relative to the spending that would have occurred in the absence of the program, when the fees paid to the participating organizations were considered.

 The results for the Value-Based Payment initiatives were somewhat mixed.  One of the four programs considered, in which CMS made bundled payments to providers to cover all hospital and physician services for patients receiving coronary artery bypass surgeries, rather than paying for each service (and each additional service) that the hospitals and physicians chose to provide, reduced overall spending by about 10 percent.  The other three programs were less successful, and on average the savings generated by the four programs were far less than the costs and fees associated with running them.

 So, does this mean that the demonstration projects were a failure?  Not necessarily.  No reasonable person thinks that reducing Medicare spending is going to be easy.  If it were, we would have done it already.  Even in the failed demonstration projects there are lessons to be learned about where we should look for cost savings in the future.  In its issue brief, CMO lists several of these.  In my mind, the two most important are the need to limit the costs of interventions and the need to move away from the fee-for-service model of care delivery.

Regarding the costs of interventions, a number of the projects CMS implemented actually did improve quality and efficiency of care.  However, they were unable to generate savings sufficient to offset the fees paid to service providers and the other costs associated with the programs.  It is possible that if these costs could be reduced, perhaps through a competitive bidding process, disease management programs might prove to deliver the savings we suspect they can.

Regarding the need to move beyond the fee-for-service model, the CBO issue brief sums things up as:

Demonstrations aimed at reducing spending and increasing quality of care face significant challenges in overcoming the incentives inherent in Medicare’s fee-for-service payment system, which rewards providers for delivering more care but does not pay them for coordinating with other providers, and in the nation’s decentralized health care delivery system, which does not facilitate communication or coordination among providers. The results of those Medicare demonstrations suggest that substantial changes to payment and delivery systems will probably be necessary for programs involving disease management and care coordination or value-based payment to significantly reduce spending and either maintain or improve the quality of care provided to patients.

In light of this, the next thing to keep your eye on are is Medicare’s experiment with so-called “Accountable Care Ogranizations,” a program that will offer comprehensive provider groups bundled payments for taking care of all of a group of patients’ healthcare needs, where these payments will be based in part on how well the ACO meets certain quality goals.  The Medicare ACO experiment is just getting under way now. We’ll see whether it is more successful in bringing down costs than CMS’s earlier experiments.

Not something that happens every day …

Filed Under (Other Topics) by Nolan Miller on Dec 1, 2011

That is, somebody said something nice about a bipartisan US effort.  Given the partisan rancor in this country right now, I found it refreshing to read this piece in the New York Times.  Of course, it was by Bono, but he was writing about something he’s actually an authority on — the worldwide fight against AIDS.  This is a fight that we’re actually starting to win, and Bono chalks the success up to American leadership by the Clinton, Bush and Obama administrations.

Read it here:

Dallas Fed President: Buy a ticket!

Filed Under (U.S. Fiscal Policy) by Nolan Miller on Nov 3, 2011

Dallas Fed President Richard W. Fisher gave a highly interesting, thought-provoking speech last week.  His full remarks are posted here.  Among the interesting points he raised are:

  • “[I was told] the story of a God-fearing man who prayed several times a day, imploring the Lord to let him win the lottery. Day after day, year after year, God listened to this man. Finally, He grew weary of the man’s prayers and spoke to him: “Help me out, my son, so that I might help you,” the Lord said. “Buy a ticket!”…  I am going to suggest that our nation has a crying need for public leadership to correct what is wrong with our economy; that the Federal Reserve has provided the leadership required of it; that monetary policy cannot do it alone and must be complemented by responsible fiscal policy—policy that is exclusively the responsibility of those whom we elect to represent us in Washington; that rather than posturing for political expediency and positioning for victory at the polls in November 2012, our nation’s political leaders need to actually “buy a ticket” and put themselves at risk, right now and without delay. Each passing day they fail to do so further jeopardizes our economic stability and our nation’s future.”
  • “The parties involved must stop the hemorrhaging without inducing cardiac arrest; they must solve the long-run debt and deficit problem without, in the short run, pushing the economy back into recession, creating still more unemployment. And they not only must confront their addiction to debt and spending beyond their means, but also reorganize the tax system, redirect the money they spend and rewrite the regulations they create so as to be competitive in a world that wants to beat us at our own game.”
  • “Only fiscal authorities have the power to affect this outcome. Monetary authorities, like me and my colleagues on the Federal Open Market Committee (FOMC) of the Federal Reserve, have limited influence. We can fill the gas tank with attractively priced fuel―abundant and cheap money―needed to propel the economy. But we cannot trigger the impulse to step on the pedal and engage the transmission mechanism of job-creating investment by the private sector. This is the province of those who write our laws and regulations―the Congress of the United States.”
  • “I would suggest to you that the time is now. Our nation’s economy is at risk. The Federal Reserve is doing everything it can to bolster unemployment without forsaking our sacred commitment to maintaining price stability. I personally don’t care which party is in the White House or controls Congress. All I know is that the “honorable” members of Congress, Republicans and Democrats alike, have conspired over time, however unwittingly, to drive fiscal policy into the ditch. They purchased their elections and reelections with popular programs so poorly funded that they now threaten the economic well-being of our children and our children’s children. Instead of passing the torch on to the successor generation of Americans, the Congress is simply passing them the bill. This is the opposite of honorable, and it must stop.”

HT: Leeds on Finance via Jerry Carson.