Center for Business and Public Policy
at the University of Illinois, Urbana-Champaign

This coming Saturday, August 14, marks the 75^th birthday of the U.S. Social Security system. Specifically, it marks the date that President Roosevelt signed the Act into law, famously stating:

“We can never insure one hundred percent of the population against one hundred percent of the hazards and vicissitudes of life, but we have tried to frame a law which will give some measure of protection to the average citizen and to his family …”

The original Act specified that benefits were to be paid only to primary workers when they retired at age 65.  The Act established that benefits would be based on payroll tax contributions made during the working years.  Of course, the program has been modified many times over the years (e.g., allowing benefits to be taken at 62, expanding coverage to spouses, disabled workers, and others, dramatic increases in tax rates, changes in benefits, etc). 

Initially, benefits were paid as a lump-sum.  While Ida May Fuller is best known as the first recipient of Social Security benefits, SSA’s historian indicates that the first benefits were paid as a lump-sum, and that:

“The earliest reported applicant for a lump-sum benefit was a retired Cleveland motorman named Ernest Ackerman, who retired one day after the Social Security program began. During his one day of participation in the program, a nickel was withheld from Mr. Ackerman’s pay for Social Security, and, upon retiring, he received a lump-sum payment of 17 cents.”

It was not uncommon for early recipients to receive much more than they put in.  Indeed, it has been estimated that the net transfers to early generations of recipients is well in excess of $10 trillion.  In other words, for most of the last 75 years, the majority of Social Security recipients received far more in payments than they paid into the system (and, yes, this is true even if one accounts for inflation and implied interest on those contributions.)

How is this possible?  Actually, it is quite simple.  Social Security is not a funded pension system.  It is a “pay-as-you-go” transfer system in which the funds paid out to current beneficiaries are provided by current taxpayers.  Such a system can work quite well so long as we have wage growth and so long as the ratio of workers-to-retirees is stable or growing. 

But therein lies the crux of Social Security’s financing problems.  Unlike what many citizens believe, the true problem facing Social Security has very little to do with Congress’ penchant for “spending the Social Security surpluses” of the past 25 years.  It has far more to do with the basic financing structure of the program.

In the 1950s, there were 16 workers paying taxes to support each Social Security beneficiary.  By the time JFK was elected President, it was about 5 workers per beneficiary.  Today we have a bit more than 3 workers for each beneficiary.  In my lifetime, that will fall to 2 workers per beneficiary.

So do the math.  If you want to replace 40% of the average workers income upon retirement, and you have 16 workers supporting each retiree, you only need to collect taxes from each worker equal to 2.5% of their income (2.5 x 16 = 40).  With only 5 workers per retiree, you need to tax them at a rate of 8%.  When there are only 3.3 workers (today’s ratio), you need a tax rate of 12.1%.  (Today’s combined tax rate is about 12.4%).  As the ratio falls to 2-to-1, tax rates need to climb to 20% to keep the system in balance.

(I am simplifying a bit here, but it is remarkable how closely this very simple calculation mirrors the Social Security Trustees’ long-term financial outlook!)

So, as we celebrate the birthday of the Social Security system, we have to ask ourselves some difficult questions.  Can we afford the system we have?  If not, whose benefits do we cut? High income retirees ?  Low income retirees?  Today’s retirees?  Today’s workers?  Alternatively, whose taxes do we raise?  Everyone?  Only high income households?

Just as most members of the human race who are fortunate enough to live to age 75 begin to notice varying degrees of health declines due to aging, so too must we deal with the unhealthy economic consequences of an aging Social Security system. 

The Social Security Disability Insurance (SSDI) program is an important part of the social safety net in the U.S.  If ever there were a risk that ought to be insured, it is the possibility of experiencing a physical or mental disability that brings one’s working-life to an end.  Those of us that have loved ones who rely on the SSDI program as a major source of household income understand how important it can be to financially sustaining those who are unable to continue working.

But the program can also be criticized in many ways.  First, the backlog of cases is very high – meaning that those who are disabled must often a very long time – sometimes even years – before they receive their first check.  There has also been a tremendous rise in the SSDI program caseload, which is placing enormous financial strain on the program as well as on the Social Security Administration’s already stretched field offices.

Nearly all of these problems trace to one root cause – that there is no simple test for determining who is truly disabled, and who is just trying to pass themselves off as disabled so that they can receive monthly checks for the rest of their lives without working. 

I know, some of you are going to say, “who would possibly do that?”  Indeed, some are offended by the notion that any undeserving individual would attempt to “act” disabled when they are not. 

But let’s be honest.  If it were easy to determine who was disabled and who was not – if there were some simple and fool-proof blood test or lie-detector test – then there would be no need for a huge bureaucracy of SSA claims reps, no need for 50+ state disability determination units, no complex layers of case reconsiderations and appeals, no need for hundreds of Administrative Law Judges, and no delays in processing checks.  There would be no backlog of cases.  And, frankly, there would probably be a lot more willingness among the general public and elected officials to generously support the program. 

But it is not that easy.  When a person argues that their back pain or mental condition means that they will no longer be able to work, the law requires that Social Security determine whether the person is indeed unable to earn more than the “Substantial Gainful Activity” amount each month – not just in their prior job, but in any job.  They must also determine whether the disability is permanent and/or likely to result in their death.  No easy task.

Ultimately, however, it is an empirical question whether there are people who apply for benefits but do not truly qualify.  And economists have researched this topic for years.

One recent paper by researchers at Columbia University, the Social Security Administration and the Congressional Budget Office (http://www.columbia.edu/~vw2112/papers/dissa_vwjsjm_final.pdf) finds that “younger rejected mail applicants to the Disability Insurance (DI) program exhibit substantial labor force attachment.  Similarly, a significant fraction of rejected applicants with low-mortality impairments such as back pain and mental health problems is employed.” 

In other words, there are a lot of people who apply for SSDI benefits, thus explicitly claiming that they have a work-ending disability, who return to work after being rejected.  Pretty clear evidence that they were not actually disabled, at least according to the SSDI definition.  But they applied for benefits anyway.  Maybe they really are hurt, maybe they really think they deserve the benefits.  But the fact that they can work after being rejected indicates that they did not suffer a work-ending disability. 

And as long as it remains the case that non-disabled people apply for disability benefits, the disability determination process will continue to be difficult, complex, long and extremely frustrating for everyone involved.  Those who suffer the most are those who truly are disabled.

One of the key dividing lines between liberals and conservatives in the U.S. is the extent to which people believe that individuals should have the freedom to make their own choices, even when those choices appear to be “bad” for the individual.  Just think about the debates we have had over motorcycle helmet laws, seat belts, and smoking.

The standard libertarian perspective is that individuals should be free to make their own choices.  After all, we might think that it is really stupid for someone to ride a motorcycle down the highway at 70 miles per hour without wearing any protective gear, but perhaps the person doing it feels differently.  Thus, debates over such policies often hinge on the extent to which the policy helps prevent negative “externalities” – in other words, we restrict your behavior because we are trying to protect other individuals from the side-effects of your actions.  So the anti-smoking crusaders focus on “second hand smoke” while the mandatory-helmet proponents often focus on the costs to society of providing medical care to the uninsured motorcycle rider. 

In recent years, there has been much debate related to the food we consume.  There is no question that the U.S. is suffering from a rise in obesity, and that this trend has costs not only for individuals but also for society as a whole (e.g., rising costs of publicly provided health care).  Still, many of us recoil at the notion that the “food police” will tell us what we can and cannot eat.  After all, if I want to eat a half-pound hamburger with a side of fries while I am on vacation, it is hard to see why that should be the business of anybody but me and the restaurant.

Even in the absence of externalities, public health advocates will often argue that people do not make good eating choices because they do not have good information.  If true, then the best policy approach would seem to be to provide such information (rather than, say, outlawing half pound hamburgers!)  But does providing such information really make any difference?

In a new NBER working paper, three economists provide compelling evidence that posting calorie information affects behavior. Specifically, the studied food and beverage purchases at Starbucks stores in New York City (where calories are posted), as well as the purchases of Starbucks stores in other locations (where calories are not posted). 

The long and the short of it is that they found that mandatory calorie posting reduced calories per transaction by 6% (from 247 to 232 calories).  Intriguingly, they also found that commuters who lowered their calories per transaction while working in New York City during the week also lowered their calories while buying from Starbucks outside the city on weekends (where calories are not posted).  This suggests that the information sticks with people and causes them to change their habits.  Interestingly, all the reduction came from food, not from the beverages.  I guess true Starbucks aficionados are really there for the coffee, not the cakes.  (Of course, as my colleague Nolan just pointed out to me, a 15 calorie reduction is probably within the margin of error of how much milk the typical person puts in their coffee!)

This research is of much broader relevance than just Starbucks.  As part of the March 2010 health care reform bill, chain restaurants nationwide will have to start posting calorie counts sometime in 2011.  While such a regulation is certainly not cost-less for the restaurants, at least it is nice to know there is some evidence suggesting that this policy may actually have the desired effect.  That is not sufficient to suggest that this policy passes a cost-benefit test, but at least it is a start!

The next round of the health reform debate is shaping up.  While the first battle was fought in Congress, the next will be fought in various federal agencies as regulators begin to flesh out the vague provisions of the gargantuan health reform bill.   I know, you’d think that a 300,000+ word bill would be pretty specific, but many of the details, from exactly how the insurance exchanges will work to exactly how provisions aimed at “curbing insurance company abuses” will be implemented, have yet to be described.

One such provision that has gained a lot of attention following Wellpoint’s well-publicized attempts to increase premiums for some of its California customers by up to around 39 percent is aimed at preventing “unreasonable premium increases.”  Of course, exactly what is “unreasonable” is not described in the bill, which has led state and federal regulators and insurance companies to return to the fight.

Of course, the model for all of this is Massachusetts, which enacted health care reform in 2006.  Using Massachusetts as a model for national reform is interesting for several reasons.  First, Massachusetts has the highest insurance premiums in the country.  Second, in designing Massachusetts’ universal coverage program, policymakers understood that they were first going to tackle the coverage aspect of the problem, expanding insurance to more people, and then take on the cost problem.  And, while we’ve seen the results of the coverage expansion, Massachusetts hasn’t yet done anything  significant to curb costs.  Those steps they have taken (described in the article above) have yet to show a real effect on cost.  It’s like we saw Massachusetts jump down the rabbit hole and jumped down after them, not knowing if they had any idea how to get us out.

Massachusetts’ approach to “unreasonable” premium increases was apparent last month.  Out of 274 applications by insurers to increase rates, Massachusetts denied 235 of them.  According to the regulator, Massachusetts “disapproved requests when companies significantly exceeded the region’s medical inflation rate of 5.1 percent, failed to justify why varying rates were paid to different hospitals, and did not forcefully negotiate prices with providers.”  This seems like an entirely plausible reason for denying an increase.  Who knows whether the regulators were right to do so or not.  I will end with a story about my own time in Massachusetts, though.  When we moved to Massachusetts in 1999, we were surprised to find that none of the large, national auto insurers offered coverage there.  When we asked around, it turned out that because of the state’s (technically “commonwealth,” la-di-dah) strict regulation of the auto insurance industry, many of the national players decided simply to bypass Massachusetts.  

Premium controls enacted at the national level may not drive insurers out of the market.  After all, it isn’t like they can just choose to operate in another country.  However, policymakers should anticipate that clamping down on premiums directly as a means of controlling costs may ultimately be counterproductive if it reduces competition.  The solution to the cost of health care is not going to come from top-down regulation of premiums and profits, but rather from reforming the system to one where we create health more efficiently, providing greater quality using fewer resources.  And, to the extent that healthcare providers are able to do this, they’ll deserve higher profits.

I recently had a problem with my furnace.  Water was dripping from a joint in the PVC exhaust pipe.  So, I called the heating company.  The repair man came out and told me that it looked like the original installer had had a problem with that joint, so they smeared a bunch of glue over it to seal it.  He said that he could do the same, and it might work for a while.  But, if the joint opened up, there was the possibility that exhaust/carbon monoxide would enter the house.  The other option was to rebuild the exhaust pipe, which would cost $150 more but would eliminate the added risk of killing me and my family.  I weighed the options and chose to rebuild the pipe.

I thought about this story when reading this recent article from the New York Times about efforts to teach doctors about the costs of various medical treatments.  In particular, I wondered what the right role of a doctor is in deciding, based on cost, whether I should have a particular treatment or not.  Suppose, for the moment, that medical care were not insured.  You could imagine a conversation very much like the one that took place between me and the furnace repair man.  “We could put you on drugs, and that might help.  Or, we could do surgery, which would fix the problem but cost $5000 more.”  I could then weigh the costs and benefits and make a decision.  Actually, now that I think of it, the doctor doesn’t even really need to know the cost of the treatments.  Dr. Jones could explain the health effects of the various treatments, and then Smith from the business office could come in and explain the cost of things.

If people are given this kind of information and make decisions based on it, then we will tend to choose expensive treatment when we think the benefits warrant the extra cost.  While this may not bring the cost of care down to European levels, it will at least improve efficiency – we’ll tend to spend money on services we think are more valuable.  But, this is really a point about giving patients information on costs, not doctors.

So, what is the role of doctors in medical cost-benefit analysis?  I’m not sure.  But, it seems like there are at least two key differences between health care and furnace repair.  First, there’s insurance.  If I’m paying $0 out-of-pocket regardless of the treatment, I’ll tend to choose treatments that have higher cost.  So, informing the doctor of the costs and benefits of treatment might be important here.  But, this would only be the case if the doctor then makes different choices than he or she would without the information.  My sense is that doctor’s often view themselves as advocating for patients against insurance companies.  So, the doctor, just like the patient, may say that the patient doesn’t pay anything more for the high-cost treatment than the low-cost treatment, so why not go with the better one?  It is unclear whether just giving the docs information, without any financial consequences for choosing high-cost treatment, will make a big difference.

A second reason why health care is different than furnace repair is that people in need of health care often do not have the time or capacity to make well-reasoned decisions.  If I am acutely ill, doctors may have to make choices about how to treat me without consulting me about how I feel regarding various cost-benefit trade-offs.  In such a case, it is also unclear whether the doctor would get anything useful out of knowing the cost of various treatments, except maybe in the case of treatments that are dominated both on cost and benefit grounds.  As one surgeon put it “I get them out of the operating room alive.”

In the end, while it is interesting that medical schools are beginning to invest more time and energy into teaching doctors about the cost of care, it is unclear whether and how that will translate into changes in the overall cost of medical care in this country.

This week I just thought I’d point to a few interesting health-related pieces I’ve come across this week.

The first is a blog posting by Gary Becker laying out what he sees as the problems with the new health reform bill and a reasonable conservative approach to addressing some of the problems with our health care system, which relies on moving toward a health insurance system that focuses on paying for catastrophic care rather than routine care and puts more of the burden of anticipatable expenses on consumers, who will then have an incentive to shop more for care.  I agree with the point in general, although with two quibbles.  First, studies have shown that when people face higher out-of-pocket cost of medical care, they use less care across the board.  That is, they cut back on critically important care and less important care at about the same rate.  So, if we’re going to ask people to make decisions about how to spend their health care dollars, we’re going to have to give them better information about the costs and benefits of various treatments.  Second, although high-deductible plans will lower the cost of health insurance, they will not necessarily reduce the cost of health care.  There will always be people for whom even high-deductible plans demand a very high fraction of income.  Some conservatives would argue that if people don’t want to pay for insurance, then they won’t have insurance, but I think this argument is a bit to flip and does a disservice to the idea of market-centered reform.  I raised this point when Michael Tanner of the Cato Institute was visiting the Center for a health care debate last month.  His response, which I found quite reasonable, was to say that if we think that poor people do not have enough money to purchase a basket of required goods, which may include food, shelter and health care, then we should consider redistributing money to them.  But, the way to do this isn’t through messing with the health care system.  If we want to make sure people can “afford” to buy health insurance, then we should redistribute money the way we always do – through the tax system, without further distorting the health insurance system.

Becker and Richard Posner blog together (or at least alternate on the same blog, aptly named the Becker-Posner blog).  Posner’s response is also an interesting read.  I’d like to point out that, although both Becker and Posner are critical of reform and advocate more conservative, market-based approaches, neither of them resorts to hysterical and incorrect cries of “SOCIAISM!”  This is undoubtedly due to the fact that both know what Socialism is and understand that for all its faults, ObamaCare is not socialism.

The second article is by New York Times economics writer David Leonhardt.  The article, entitled “In Medicine, the Power of No,” echoes a theme I’ve raised here before, namely that reducing the cost of health care in this country is going to involve doing less of some kinds of care, and Americans don’t like to say no.  Interestingly, Leonhardt points to a recent study that shows that when people are given more information on the costs and benefits of various treatments, they tend to choose less invasive treatments than doctors would choose on their behalf.  If this phenomenon is generally true, then it suggests that the combination of higher out-of-pocket costs and better information about the costs and benefits of treatment may actually be effective in lowering the cost of health care and slowing its growth.

There was a really interesting piece this week in the New York Times about a recent FDA decision to allow AstraZeneca to market its drug Crestor to a new class of people – those who are basically healthy.  The story, I think, yields some insight into why our system is so costly and why it is not so easy to curb our spending.

As background, Crestor is one of the newest and most powerful statins, a class of drugs that had traditionally been used to treat high cholesterol.  Side effects associated with statins are generally low.  However, the risk of side effects increases with the strength of the drug, and Crestor is one of the most potent ones around.  There have even been claims that the risk of side effects with Crestor is significantly higher than other statins.

Now, here’s the interesting part.  How did the FDA come to approve this use of Crestor?  The approval is based on the results of a study that showed Crestor led to a a significant reduction in heart attack and other risks from mostly healthy men over 50 or women over 60 with a risk factor such as high blood pressure.  These people did not have high cholesterol, the condition for which Crestor was originally developed.  The study was funded by AstraZeneca and conducted by the inventor of the CRP test, Dr. Paul Ridker of Harvard Medical School, both of whom stand to gain financially from the study’s results, AstraZeneca through increased sales of Crestor  (which commands a high price due to its on-patent status) and Ridker through increased use of the CRP test, for which he receives royalties.  Now, I won’t speculate as to the motivations of AstraZeneca, since it is a huge corporation not a person, but it seems like Dr. Ridker is a sincere believer in the power of the CRP test to more accurately predict heart attack risk, and so his motivations for promoting greater use of the CRP may be entirely altruistic.

So far, so good.  This is the way the capitalist system is supposed to work.  AstraZeneca created Crestor in order to make a profit.  In order to increase its profit it went out and determined that Crestor could provide health benefits to a new class of people.  If these people can be convinced to buy Crestor, AstraZeneca will make more profit and the people will reduce their heart attack risk.  In an ordinary market, the mere fact that people were willing to buy Crestor for this purpose would be de facto proof that the benefits are worth the cost.  Crestor is willing to offer the pills at a price, around $3.50 per day, and people are willing to buy at that price.  So, they must value the benefit from the drug at least that much.  End of story.

But, health markets are not ordinary markets, for at least four reasons.  First, the government regulates the market, with the FDA endorsing the use of drugs for certain purposes.  FDA approval is based on clinical effectiveness, not cost effectiveness.  So, the mere fact that the FDA says that a drug can be used for a certain purpose does not mean that it is a cost effective measure.  There may be other, cheaper ways of achieving the same results.  FDA approval does not say anything about that.  Second, drugs are often covered by insurance, and insurers often decide whether to cover some or all of the cost of a drug based on FDA approval.  And, if a drug is covered by insurance, much of the cost of the drug is rolled into insurance premiums.  So, the out-of-pocket cost of an individual who decides to buy a drug may be much lower than the total cost of the drug charged to the insurer.  Third, decisions as to whether a patient should take a drug are made in cooperation with physicians.  Often, the patient plays little role in deciding which medication to take.  Physicians, on the other hand, are more concerned with health than cost, and they may recognize that the drug they are prescribing has a low cost to patients due to insurance.  If the pill has a benefit and little cost to the patient, they why not prescribe it?  Sure, it is costly to insurance companies, but many physicians have, at best, an adversarial relationship with insurers, anyway.  I don’t think they would bat an eye at costing the insurer a few bucks in order to improve their patients’ health.  Finally, health care decisions are incredibly complex.  Information on the benefits of treatments is hard to come by, and cost-benefit information is even harder.  Faced with FDA approval of a drug for a certain purpose and their physician’s advice that they should take it, many people will simply go along with the decision rather than try to overrule the experts.

All-in-all, these four factors on the “demand side” for drugs, and for health care more generally, point to why we tend to overuse them, at least from a cost-benefit perspective.  Drug companies produce drugs and put them out there in an attempt to make a profit.  There’s nothing wrong with that.  However, due to diffusion of decision-making responsibility, lack of information and muted price signals, people are not doing the right price-benefit calculation on the demand side.  The result is overuse.

In the case of Crestor, the Times article estimates that “500 people would need to be treated with Crestor for a year to avoid one usually survivable heart attack.  Stoke numbers were similar.”  Treating those 500 people for one year would cost about $640,000 (at $3.50) per pill.  Since these are usually-survivable heart attacks, that $640,000 might not even prevent any deaths.

Repeat this for every drug and every treatment, and that’s how you get to where we are today.  So, how can we encourage people to make better decisions?  As always, there answer here is not as clear.  One way would be to ask people to pay more of the cost of drugs and other health care out of pocket.  Faced with the full cost of their decisions, people will make better cost-benefit trade-offs.  Of course, doing this will erode some of the benefit of insurance in reducing risk due to health care costs, which may be undesirable.  (On the other hand, it can be argued that medication costs are predictable and, as such, are not really good subjects of insurance, anyway.)

While it is true in principle that increasing out-of-pocket costs can encourage people to make better decisions, the evidence here suggests that, due to the complexity of health decisions, this may not be the case in practice.  For example, it has been shown that, faced with an increase in drug copayments, people tend to cut back on all drugs – both essential and non-essential ones – by the same amount.  So, if we are going to ask people to do this sort of cost-benefit analysis, we’re going to have to give them better information about their choices.

Another suggestion has been to help educate doctors about cost-benefit tradeoffs.  Today, most of the information about the effectiveness of drugs that doctors receive comes from the drug companies themselves.  Of course, these companies have no interest in point out alternative treatments that are equally effective and less costly, and we shouldn’t expect them to.  Education of this sort would likely help, but there is currently no such infrastructure, and it is unclear where such information would come from.  The federal government has shown increasing interest in cost-effectiveness research in recent years, and the development and provision of this information (if it can be done in a fair, trustworthy way) might help.  Of course, the fact that the government will be actively working to undercut a firm’s product might undesirably dull firms’ incentives to innovate, so the implementation here would be tricky.

Both of these suggestions point to a critical need that must be addressed if we are going to bring down spending on health care.  Doctors and patients need better information on the benefit and cost of various treatments in order to make good decisions.  Although it wouldn’t solve the entire problem, I think that it is a necessary condition for improvement.  Some have argued that the right thing to do is for the government to make decisions regarding costs and benefits and directly regulate which treatments should be used in which cases.  Such one-size-fits all solutions, however, overlook the wide variability in patients’ conditions and individual taste regarding treatment.  Another approach would be for the government to invest in developing cost-effectiveness information and making that information available to physicians and patients in as useful a way as possible, allowing them to make better decisions.  To my mind, the government providing information to markets to help them work better is a much better intervention than directly regulating particular modes of treatment.

There is an interesting piece in today’s Wall Street Journal by Fred Barnes entitled “The Health-Care Wars Are Only Beginning.”  Here’s a good paragraph:

“America will be in a constant health-care war if ObamaCare is enacted. Passage wouldn’t end the health-care debate. Rather, it would perpetuate ObamaCare as the dominant issue for decades to come, reshape politics, create an annual funding crisis in Congress, and generate a spate of angry lawsuits. Yet few in Washington seem aware of what lies ahead.”

While I agree with Barnes’s basic factual prediction – that we’re going to be fighting battles in this war for decades to come – I disagree on the interpretation.  We’re not fighting a battle over ObamaCare.  We’re fighting a battle over health care.  ObamaCare is the first salvo in a battle against our country’s unsustainable increase in health care costs.  But whether or not Obama and the Democrats had tried to enact this particular set of reforms this year, we are still destined to be in a health care war that will last decades.  We could have removed all regulation from health care and let free markets rule, or we could have enacted a single-payer system and put the government in complete control of the system.  Either way, we’d still be headed toward a constant health-care war.

As I’ve written in the past, the primary challenge facing our health care system (and to a certain extent, our overall economic system) is that growth in health care spending is increasing at a faster rate than the overall economy.  The bulk of this gap appears to be due to rising incomes and increases in medical technology.  Some spending on new technology is probably excessive (other technologies may be under-developed), but to a certain extent we’re spending more and we’re getting more.  [For another interesting take on why health care costs rise faster than the economy as a whole, see this article on the “Baumol Effect.”]

Some people liken high health care spending to an unsightly mole.  All we have to do is find the way to cut out the problem – either through deregulation or nationalizing health care or a several-thousand-page reform bill – and the problem will be fixed.  This oversimplifies the point, and perhaps contributes to the disappointment that the current health reform bills aren’t going to solve the problem.  High health care spending (and more importantly, high health care spending growth) is more like a serious, chronic disease.  It is going to be with us as long as there is an us (U.S.?) for it to be with.  As annual health care spending heads toward one fifth of U.S. GDP and threatens to keep growing, it probably should become a central preoccupation of policymakers.

If ObamaCare passes, we’ll certainly make changes – some in a more free-market direction and others in a more nationalized one – in the years to come.  If it doesn’t pass, we’re going to have to confront these issues soon anyway.  In this sense, whether you favor the current attempt at reform or not, if its passage means that citizens and policymakers will begin to think seriously about the kinds of trade-offs between spending and health care that we want to be making and that we’ll begin to confront these issues instead of kicking them down the road, this should be counted as one of the benefits of the effort.

On February 18, the President Obama signed an Executive Order establishing the “National Commission on Fiscal Responsibility and Reform.”  The Commission will consist of 18 members.  Of these, 6 will be appointed by President Obama (with no more than 4 of the 6 being Democrats).  The remaining 18 will be divided up “3 each” among Democratic and Republican House members and Democratic and Republican Senators. 

The stated mission of this Commission is to identify “policies to improve the fiscal situation in the medium term and to achieve fiscal sustainability over the long run.”

The mission is a critical one.  As I have noted in other posts (see, for example, my post from 2/2/10 on the 2011 budget or my post on 1/14/10 about why deficits matter), the long-term fiscal outlook is dire.   While the short-term deficits are being driven by a combination of recession-induced revenue declines, aggressive spending policies targeted at averting an even worse credit crunch and/or recession (e.g., TARP, stimulus, etc), as well as high levels of spending on Iraq and Afghanistan, the most serious long-term fiscal problems arise as a result of the runaway growth of entitlement programs.  Social Security, Medicare, and Medicaid are growing faster than the economy as a result of an aging population, rising health care costs, and the important interaction of these two factors. 

Commissions have a long history in the U.S., some of them successful in terms of leading to real changes (e.g., the Greenspan Commission in 1983) and some of them not (e.g., the President’s Commission to Strengthen Social Security in 2001 on whose staff I served.)  One of the features of this new commission is that it will be dominated by sitting members of Congress.  IF (1) these members are ones with real power (e.g., chairs and ranking minority members of the key committees like Senate Finance and House Ways and Means) and IF (2) these members can somehow move beyond ideological bickering and election-year politics and come to some meaningful compromises, THEN such a Commission could have an extraordinarily meaningful and positive impact on our fiscal future.  If, however, they simply resort to their political safe zones - with Republicans calling for balancing budgets solely through spending cuts and Democrats calling for balancing budgets solely through tax increases - then I would not expect much to come out of it.   

The political outlook is not promising, however.  Recall that only a month or so ago - in January 2010 - the Senate failed to garner the 60 votes needed to pass the “Bipartisan Task Force for Responsible Fiscal Action Act of 2010.”  In a blog on this same subject (click here to see it), Stephen Huth notes that “even before members have been appointed, both liberals and conservatives are dooming the work …”

The economic consequences are real.  As the Financial Times reported in January, the credit rating agency Moody’s announced that the U.S. could be at risk of losing its tripple A credit rating in the future unless it took steps to reduce its long-term deficits.  While Treasury Secretary Geithner says the U.S. will “never lose” its top rating, the very fact that the Treasury Secretary has to engage in such a conversation is an indication of just how serious are the risks posed by long-term deficits.  As noted by CNBC, “even if a downgrade in US credit is not imminent, the underlying conditions that raised such fears are worrying investors about what the future holds.” And even if our credit rating is not at risk, the long-run tax burden required to finance projected levels of spending are so enormous that I am afraid we will risk something far more important - our potential for sustained economic growth.

In short, I am in the “glass half empty” camp when it comes to my political assessment of the Commission’s likely impact.  I hope they prove me wrong …

News from the West Coast today that Anthem Blue Cross, one of the largest private insurers in California, is raising the prices for the 800,000 or so people it sells individual health insurance policies by up to 39%.  The Obama administration is not happy, to say the least.  HHS Secretary Kathleen Sebelius fired off an angry letter to Anthem and its parent company, WellPoint, demanding an explanation.  Of course, this also comes at a time when the Obama administration is struggling to make the case that health insurance reform is urgently needed, so this also provides a perfect example for them.  The letter is kind of cool, since I have never seen an angry letter from a Cabinet Secretary before.  The text is here.

What I find more interesting as an economist, however, is WellPoint’s response.  They haven’t replied formally to the letter yet, but in a statement WellPoint’s spokesman said the following:

“As medical costs increase across our member population, premium increases to the entire membership pool result. Unfortunately, in the weak economy many people who do not have health conditions are foregoing buying insurance. This leaves fewer people, often with significantly greater medical needs, in the insured pool. We regret the impact this has on our members.”

So, where’s the economics lesson here?  In a competitive market, health insurance prices are driven by the cost of caring for the average person in the insurance pool.  That means that healthy people usually pay more than their actual cost of care and sick people pay less.  Although healthy people pay more than their average health expenditures in any year, they’re still willing to buy insurance because it provides them with, well, insurance.  In the event that they have a car accident or other unexpected, large expenditure on health care, they’re protected against the financial consequences.  This works fine as long as the premium (driven by the average cost of care) doesn’t get too high above what the healthy people are willing to pay for insurance against relatively rare events.

Now, enter the recession.  People are losing their jobs, wages for the employed are stagnating, and people are losing money on housing and financial investments.  In light of these challenges, some healthy people are looking at their health insurance premiums, their income, and the likely cost of going without insurance, and deciding not to buy health insurance.

This is a perfectly rational response to increasing premiums and decreasing incomes.  However, it results in the remaining people in the insurance people being, on average, sicker.  This means that the average cost of caring for the insurance pool will be higher, which will necessitate higher premiums.

Unfortunately (and interestingly if you study this stuff), this leads to the potential for what is known as an “adverse selection death spiral.”  The idea is that once premiums rise, the healthiest people who are still buying insurance may decide to drop out of the pool.  Since the remaining pool is even less healthy on average, premiums will once again need to rise to cover their higher medical needs.  And then the cycle starts over again.  In extreme cases, the premium just keeps going up until nobody is willing to buy insurance.

So, what next?  Well, the adverse selection story holds in competitive markets.  But, you can already see Secretary Sebelius telegraphing the administration’s punches.  They will argue that the price increases are not due to competitive pressure and an increasingly unhealthy insurance pool but rather a greedy, for-profit insurer trying to take advantage of people when they’re down.  For their part, WellPoint/Anthem will argue that this just shows why health reform is needed, but health reform of a fundamentally different sort than Obama has proposed.

My prediction is that we’re headed for a highly charged series of Congressional hearings that boil down to an attempt to drive home to voters that something needs to be done.  Really went out on a limb, there, didn’t I?