Center for Business & Public Policy
Collaborative blog exploring the relationship between market forces and public policy.

Here is the third in a series of blogs that I started on May 18.  The first was called “Why YOU may LIKE Government ‘Theft’”.  In it, I listed four possible justifications for government to act like Robin Hood, taking from the rich to give to the poor.  The point is to think about whether the top personal marginal tax rate really should be higher or lower than currently, as currently debated these days in the newspapers.

However, perhaps we should also remember what is wrong with government using high marginal tax rates to take from the rich in order to help the poor.  The problem is that a higher personal marginal tax rate distorts individual behavior, particularly labor supply and savings behavior, by discouraging work effort and investment.  Since those are good for the economy, high marginal tax rates are bad for the economy!  In fact, economic theory suggests that the “deadweight loss” from taxation may increase roughly with the square of the tax rate.  In other words, doubling a tax rate (e.g. from 20% to 40%) would quadruple the excess burden of taxes – the extent to which the burden on taxpayers exceeds the revenue collected.

The point is just that we face tradeoffs.  Yes, we have four possible reasons that we as a society may want higher tax rates on the rich in order to provide a social safety net, but we also have significant costs of doing so.  Probably somewhere in the middle might help trade off those costs against the benefits, but it’s really a matter of personal choice when you vote: how much do you value a safety net for those less fortunate that yourself?  And how much do you value a more efficient tax system and economy?

In the first blog on May 18, I listed all four justifications, any one of which may or may not ring true to you.  If one or more justification is unconvincing, then perhaps a different justification is more appealing.  In that blog, I put off the last three justifications and mostly just discussed the first one, namely, the arguments of “moral philosophy” for extra help to the poor.   As a matter of ethics, you might think it morally just or fair to help the poor starving masses.  That blog describes a range of philosophies, all the way from “no help to poor” (Nozick) in a spectrum that ends with “all emphasis on the poor” (Rawls).

In the second blog on July 13, I discussed the second justification.  Aside from that moral theorizing, suppose the poor are not deemed special at all: every individual receives the exact same weight, so we want to maximize the un-weighted sum of all individuals’ “utility”, as suggested by Jeremy Bentham, the “founding figure of modern utilitarianism.”  His philosophy is “the greatest happiness of the greatest number”.   Also suppose utility is not proportional to income, but is instead a curved function, with “declining marginal utility”.  If so, then a dollar from a rich person is relatively unimportant to that rich person, while a dollar to a poor person is very important to that poor person.  In that case, equal weights on everybody would still mean that total welfare could increase by taking from the rich to help the poor.

The point of THIS blog is a third justification, quite different in the sense that it does NOT require making anybody worse off (the rich) in order to make someone else better off (the poor).  It is a case where we might all have nearly the same income and same preferences, and yet we might all be better off with a tax system that has higher marginal tax rates on those with more income, and transfers to those with little or no income.  How?  Suppose we’re all roughly equally well off in the long run, or in terms of expectations, but that we all face a random element in our annual income.  Some fraction of us will have a small business that experiences a bad year once in a while, or become unemployed once in a while, or have a bad health event that requires us to stop work once in a while.  To protect ourselves against those kinds of bad outcomes, we might like to buy insurance, but private insurance companies might not be able to offer such insurance because of two important market failures:

1. Because of “adverse selection”, the insurance company might get only the bad risks to sign up, those who are inherently more likely to become unemployed or to have a bad year.
2. Because of “moral hazard”, insurance buyers might change their behavior and become unemployed on purpose, or work less and earn less.

With those kinds of market failure, the private market might fail altogether, and nobody is able to buy such insurance.  Yet, having such insurance can make us all better off, by protecting us from actual risk!

Potentially, if done properly, the government can help fix this market failure.  Unemployment insurance is one such attempt.  But the point here is just that a progressive income tax can also act implicitly and partially as just that kind of insurance:

In each “good” year, you are made to pay a “premium” in the form of higher marginal tax rates and tax burden.  Then, anytime you have a “bad” year such as losing your job or facing a difficult market for the product you sell, you get to receive from this implicit insurance plan by facing lower tax rates or even getting payments from the government (unemployment compensation, income tax credits, or even welfare payments).

I don’t mean that the entire U.S. tax system works that way; I only mean that it has some element of that kind of plan, and it might help make some people happier knowing they will be helped when times are tough.  But you can decide the importance of that argument for yourself.

Next week, the final of my four possible justifications for progressive taxation.

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.

The Budget Control Act of 2011 established a joint congressional committee (the “Super Committee”) and charged it with the responsibility of reducing the deficit by $1.2 trillion over 10 years.  If the Super Committee fails to reach an agreement, automatic cuts of $1.2 trillion over 10 years are triggered, starting in January 2013.  These are said to be “across the board”, but they are not.   They would apply $600 billion to Defense, and $600 to other spending.  Entitlements are exempt, including the Supplemental Nutrition Assistance Program (SNAP, formerly food stamps) and refundable tax credits such as the Earned Income Tax Credit and child tax credit.  These entitlements are exempt from the cuts because anyone who qualifies can participate (that spending is determined by participation, not by Congress).

In addition, the Bush-era tax cuts are set to expire at the end of 2012, so doing nothing means that tax rates would jump back to pre-2001 levels.  That combination might be the best thing yet for our huge budget deficit.

The Federal government’s annual deficit has been more than $1 trillion since 2009.  Continuation of that excess spending might create a debt crisis similar than the one now in Europe.

The Center on Budget and Policy Priorities estimates that the trigger would cut $54.7 billion annually in both defense and non-defense spending from 2013 through 2021.  Meanwhile, U.S. defense spending is around $700 billion per year, with cuts of about $35 billion per year already enacted, so the automatic trigger would reduce defense spending from about $665 billion to about $610 billion.  Some may view that 10% cut as draconian, but the simple fact is that the U.S. needs to wind down its spending on two wars.  Congress and voters are fooling themselves if they think the U.S. can continue to spend the same level on defense, not raise taxes, and make any major dent in the huge annual deficit.

The same point can be made for automatic cuts in Social Security, which in its current form is unsustainable.  Since it was enacted in 1935, life expectancy has increased dramatically, which means more payouts than anticipated.  Birth rates have declined, which means fewer workers and less payroll tax than anticipated.  The system will run out of money in 2037.  Congress either needs to raise taxes or cut spending.  But they won’t do either!  The only solution might be the automatic course, without action by Congress!

For further reading, see “Why doing nothing yields $7.1 trillion in deficit cuts”.

Yesterday, I had the honor of hosting University of Illinois Jeff Margolis as a guest speaker in my Employee Benefits course here in the Illinois College of Business.  Jeff Margolis may not be a household name, but he ought to be.  Jeff just recently retired from the TriZetto Group, the company he founded in 1997 to provide the knowledge and the tools to help power “Integrated Healthcare Management.”  His company’s software touches the lives of over half the U.S. population.  He is also author of the book “The Healthcare Cure: How Sharing Information Can Make the System Work Better,” which is due out later this month (which is an extended and updated version of an earlier book, The Information Cure, from which I am drawing my post for today.)  Jeff understands the U.S. health care system inside and out.

Jeff’s talk to my classes yesterday had several really important take-aways.  Of these, perhaps the most important is the need to carefully define the problem that one is trying to solve.  I often point out to my class that there are many ways to define the problem with health care in the U.S., and each has a different set of solutions.  For example, if one simply wants to reduce health care spending, there are lots of easy ways to do that – restricting access, limiting innovation, reducing insurance coverage – but we probably would not like many of the outcomes!  Similarly, if one simply wants to increase insurance coverage, we can do that too.  But then don’t be surprised when health care spending rises as a result.

Jeff Margolis focused on a more clearly-defined problem – one with which economist like me tend to agree is right way to think about health care policy.  In my words, he was fundamentally focused on how do we get the right care to the right people at the right time?  At its essence, this is a question of resource allocation, and the only way we are going to get it right is if all the relevant actors (doctors, hospitals, patients, payers, etc.) have access to the information they need.  Information about patients.  Evidence-based information about which treatments work for which types of patients.  Information about costs.  And so on …

To give but one illustration, in Chapter 3 of Jeff’s “Information Cure” book, he has a great chapter (the title of which I have borrowed for this post), called “The Lexus and the Human.”  He starts with the provocative question – “which would you rather be: a Lexus or a human being?”  He then goes on to point out that when a Lexus is “ill” (i.e., something is wrong, and it needs to be diagnosed and fixed), there is a very rich, thorough, and transferable set of maintenance records that are easily communicated to the right mechanic in the right garage at the right time.  In contrast, when a human being shows up at a Doctor’s office, the information is often incomplete, fragmented, and out of date.

As Jeff states, “in stark contrast to Lexus’ systematic way of maintaining and repairing its cars, the U.S. healthcare system lacks the coordination to care for humans as reliably and comprehensively … the Lexus enjoys a much higher degree of precision regarding its care.  For starters, our system does not reliably enable providers and consumers to access medical records wherever and whenever we need them.”  He talks about the inefficiencies this creates in the form of duplicate tests.  But he also notes the much more serious consequences, such as being improperly treated because an emergency room doctor was unaware of your drug allergy.

He also points out that the information exists.  But the overall system needs re-engineered to optimize the use of this information.  He points out that health plan providers – such as Cigna, Aetna, United Health Care, and others – may be in the best position to help us get there because of the role they play in the health care supply chain.  Unfortunately, our politicians are so busy villain-izing these health care companies that we may be overlooking an enormous opportunity for increasing the efficiency and efficacy of our health care system.

It is worthwhile food for thought.  There is much, much more to say on this topic – and hopefully I will return to it in future posts.  But for now, thanks to Jeff Margolis for lecturing at his alma mater, and for helping to educate the next generation about ways to productively identify and solve problems.

If one town’s water pollution flows into another town, the two towns can negotiate a solution with no need for the state to intervene.  But if all towns are polluting all neighboring towns, the lines of communication are too complex to negotiate – requiring the state to pass a law to solve the problem.

If one state’s water pollution flows into another state, the two states can negotiate a solution with no need for Federal intervention.  But if all states are polluting all neighboring states, the lines of communication are too complex to negotiate – and it takes a national government to solve the problem.

In other words, those problems have solutions.  If one nation’s water pollution flows into another nation, then (potentially, at least) the two nations can negotiate a solution with no need for a global government to intervene.  But if all nations are polluting all neighboring nations, the lines of communication are too complex to negotiate – and no global government exists to solve the problem.

I’m currently pessimistic about two of the worst problems the world has faced: global climate change, and global financial contagion.  Both are “externalities” in the classic sense.  Each nation’s greenhouse gas emissions pollute the whole world, and the only really effective solution is a worldwide global agreement to reduce emissions.  In fact, we don’t really “need” all nations to reduce emissions; all we really need is an agreement among all nations saying that if SOME countries reduce emissions then the other countries won’t increase emissions to steal their business.  But the lines of communication are too complex to negotiate – and no global government exists to solve the problem.

Environmental policy is my usual bailiwick.  At the moment, however, I’m even more worried about global financial contagion.  It seems that one small country can have lax financial regulations that allow banks or investment companies to take on too much risk.  Or a small country can overspend, taking on too much debt.  In the olden days, that country could go down in flames, with no big problem for the rest of the world.  With tremendously increased globalization, however, all financial markets are highly integrated.  One country’s borrowing may come from any or all other countries of the world, and one nation’s problem become the world’s problem.  If banks in other countries loan to that small country, then a financial crisis in that small country may create fear about the financial well-being of the banks that lent to them, causing a run on the banks in all those other countries.  Moreover, globalization means much more trade in commodities.  If one small country faces severe financial difficulties and must cut back all spending, that reduces aggregate demand worldwide, and can spread a recession worldwide.

A strong global government could rein in the poorly managed countries by requiring larger capital requirements, careful financial scrutiny, and only tax-financed spending.  But we don’t have any such global government.  As a result, even a small country like Greece can over-spend for years without oversight.  The situation in Greece may be made worse when banks in other countries raise the rate at which Greece can turn over its debt and borrow again, making the financial situation in Greece even worse.

The problem may be caused by Greece or not.  Regardless of “fault”, if Greece any small country were to go into default in years past, then the cost would be primarily on that small country.  Now Greece could go bankrupt and impose horrible costs on the entire World?!?

Yes, I’ve written about the budget before, and perhaps I’m getting repetitive.  But it’s important, and surprising, so I’ll give it another go.  But nevermind President Obama’s recent release of a proposed budget for next year.  That document is already irrelevant!  Let’s start with the current budget. 

Current federal spending now is over  $3 trillion per year.  The deficit is $1.6 trillion.  The U.S. House of Representatives approved a plan to cut spending by $60 billion.  The Republicans chose not to change spending on defense and homeland security, nor entitlement programs like Social Security, Medicare, and Medicaid.  The problem is that then other discretionary spending must be cut for some government agencies by as much as 40%.  And yet that total $60 billion cut is only a drop in the bucket.  It cuts the annual deficit only from $1.6 trillion to 1.54 trillion!

My point is that you can’t get there from here.  First of all, it’s not wise to cast such a wide net, without thinking, making cuts of 40% or more to discretionary programs simply because they are called discretionary.  It means cuts to national parks, environmental programs, and federal employees who provide many public services people want.

Second, who says we need to leave defense and entitlements untouched?   Within just a few years, Medicaid will cost about $300 billion per year, Medicare will cost $500 billion, and Social Security will cost $800 billion, and defense $800 billion.  ALL of domestic discretionary spending will be only $400 billion.  By those round numbers, $60 billion from that last category is a 15% cut.   The same $60 billion cut proportionally from all of those categories would be only a 2% cut.  That’s what I mean by a drop in the bucket.

Anyway, that plan would still cut the deficit only from $1.6 trillion to $1.54 trillion.  The ONLY way to make any sizeable dent in the huge $1.6 trillion deficit is to look at all the current spending, not just at $400 billion of domestic discretionary spending, but at the $800 billion of defense spending, $800 billion of social  security, $500 billion of Medicare, and/or $300 billion of Medicaid.

And who says taxes are sacrosanct?  A $1.6 trillion deficit means we are spending more than our income, so one just MIGHT think that problem can be approached from both ends.

Earlier this month the House Republicans pressed forward on their aggressive agenda of passing legislation that will ultimately not get through the Senate or President.  This time, the topic was medical malpractice.  Republicans have long argued that the medical malpractice system, where aggressive plaintiff’s attorneys after a big score force doctors to engage in costly defensive practices, is in large part responsible for the increasing cost of health care in the country.   As I’ve argued, the current evidence on this point is not strong.  Medical malpractice and defensive medicine seem to be responsible for, at most, a relatively modest part of health care costs.  The malpractice system should be reformed because it doesn’t work, not because of its contribution to cost.  (Although, new study by the American Academy of Orthopaedic Surgeons argues that defensive medicine may be more prevalent that previously thought.  More on that next week.)

So, the House Judiciary Committee last week took up the question of medical malpractice, prepared to support a federal malpractice reform bill that would establish a 3 year statute of limitations on medical malpractice suits, limit noneconomic damages to $250,000 and assign damages based on proportional responsibility.   Given the Repulicans’ control of the House, this should have been easy.  But, and here I’ll give four stars to the Tea Partiers for ideological consistency, the bill was stalled when Tea Party Caucus members Ted Poe and Louie Gohmert, both Texas Republicans, raised issues of whether Congress has the power to overrule medical malpractice provisions in state constitutions.  In response, the committee’s chair, Lamar Smith, delayed the committee’s final vote on the legislation until they could clarify the bill’s states’ rights issues.

There’s a strange way in which the political spectrum bends around on itself sometimes, and liberals and libertarians end up on the same side of issues.   One thing is for sure, though.  If the Repulican mainstream thought that the Tea Party Caucus was going to fall in line, they’re in for a long couple of years (or more!).

On Tuesday night, President Obama gave the State of the Union (SOTU) Address (transcript) before a joint session of Congress.  The speech drew upon imagery from the Cold War past in order to spur action regarding America’s energy policy.  “This is our generation’s Sputnik moment,” the President declared, and thus he will send a budget to Congress that invests “especially [in] clean energy technology, an investment that will strengthen our security, protect our planet, and create countless new jobs for our people.”  To deal with this “Sputnik moment”, the President set forth two goals: (1) become the first country to have a million electric vehicles on the road by 2015; and (2) get 80% of America’s energy from clean sources by 2035. 

(Not quite as inspiring as President Kennedy’s urging on May 21, 1961 that “this nation should commit itself to achieving the goal, before the decade is out, of landing a man on the moon and returning him safely to the earth.”  On July 20, 1969, Apollo 11 landed on the Moon and Neil Armstrong took his first step on the lunar surface.)

I have three issues with the President’s approach.  First, the wording of the goals in the SOTU Address needs to be parsed carefully in order to understand their meaning or lack of meaning.  For instance, does “electric vehicles” mean all-electric vehicles or do hybrids count towards that goal?  Similarly, what is the definition of “clean sources”?  Fortunately, in this case we have an answer later in the Address.  As the President admits, “Some folks want wind and solar.  Others want nuclear, clean coal and natural gas.  To meet this goal, we will need them all.”  However, ambiguity still exists because clean coal and natural gas technologies can be deployed with or without carbon capture and sequestration technologies.

Second, the President did not offer details about HOW to achieve these goals.  The Address includes references to investments in clean energy technology, but it specifies neither investment level nor investment horizon required to meet the stated goals.  He did not say, for example, $10 billion annually for 10 years.  If clean energy is really a priority for the President, and given concerns about the fiscal deficit, then clarity about the needed investment level would be helpful so that other programs can be identified for cuts in order to balance the budget.  Also, the President said that “clean energy breakthroughs will only translate into clean energy jobs if businesses know there will be a market for what they’re selling.”  I agree.  However, an efficient, well functioning market requires a price signal.  This brings me to my last point.

Third, the President did not directly address environmental policy when setting his goals.  If the President really means “low-carbon” or “no carbon” when he says “clean”, then the absence of a carbon policy in the Address becomes conspicuous.  Specifically, the President did not indicate if he would again push for a cap-and-trade bill.  Given the composition of the new Congress, a cap-and-trade bill or any other piece of legislation that puts either an explicit or implicit price on carbon emission seems politically infeasible.  To have a market for these clean energy technologies, where is the price signal going to come from?  

In their forthcoming book called “Accelerating Energy Innovation: Insights from Multiple Sectors”, Rebecca Henderson and Richard G. Newell look at lessons from the histories of innovation in other industries and implications for the energy industry.   The introduction says: “Taken together the histories point to three key factors as critical to accelerating innovation: (1) well funded, carefully managed public research that is tightly linked to the private sector; (2) rapidly growing demand; and (3) antitrust, intellectual property and standards policies that together promote vigorous competition and the entry of new firms.”

How many people would ‘demand’ electric vehicles at a high price, just out of the goodness of their hearts?  Or would that demand depend on the existence of a policy that raises the price of burning fossil fuels?

The President noted that when Sputnik was launched, NASA did not exist.  Yet, the Department of Energy has existed for many years, and America’s energy policy is still unclear and uncertain.

Yesterday, I gave a talk at the Dutch Ministry of Health in the Hague (the political center of the Netherlands).  I was asked to make a presentation about the U.S. long-term care insurance system.  The problem is, we have no “system” to speak of.  Rather, we have a confusing patchwork of public and private programs that together do – at best – a modest job of protecting individuals from the financial risks of long-term care.

Long-term care is a classic case of a risk that people ought to insure – it is highly uncertain whether you will need it, but if you do, there is a chance of it consuming enormous sums of money.  A typical nursing home can cost you north of $6,000 per month, and having skilled RN care in the home can easily cost $30 or more per hour.  These numbers can quickly exhaust the limited financial wealth of a majority of American households.

And yet, most people in the U.S. do not insure against this risk.  In aggregate, people pay about 1/3 of all long-term care costs out of their own pocket, whereas only about 4% of expenses is paid by private insurance.  Who covers the rest?   Taxpayers – through Medicaid, and to a smaller extent through Medicare.

But Medicaid is pretty lousy insurance because it requires that you impoverish yourself before you qualify.  Normally, we think of buying insurance so that a big financial shock does not ruin our future consumption possibilities – for example, if your house burns down (say, for example, you failed to pay the fire department your annual fee – see Nolan’s latest post!), you get enough money to rebuild so that you do not have to cut back on your other expenditures.  With Medicaid, however, it helps you out only after you have spent virtually all your other money paying for care.

So why don’t people buy private insurance?  There are many plausible reasons, but one of them – as shown in my work with Amy Finkelstein – is because Medicaid’s means-testing and secondary payer status means that it is in your interest *not* to buy insurance.  Why?  Because most of what you buy ends up duplicating what you could have gotten for “free” from Medicaid.  And because many policies available in the private market fail to cover a large share of you possible expenditures, you may end up on Medicaid anyway.

This highlights a fundamental problem – and one that, I learned yesterday, is shared by the Netherlands and Germany (both countries about which others presented).  Namely, once you decide that you are going to not let people die on the streets for lack of funds to pay for long-term care (and thus provide a government program to help), you cannot help but mess up the private market.

This leaves a dilemma.  If the private market cannot function properly because of the government means-tested program, and if you are not willing to get rid of the means-tested program (which would almost certainly leave some people in need of care left without it), then the net result is that people will have significant exposure to uninsured risks. Of course, one solution is to drop means-testing altogether, and simply cover all long-term care under the universal Medicare program.  But I confess that I really dislike the notion that just because we allow one form of government intervention (e.g., Medicaid), we must then provide even more government intervention n (e.g., covering all long-term care under Medicare) just because the market can no longer work!  Not to mention that an expansion of our entitlement programs is the last thing we need given our long-term fiscal outlook.

Or do we just accept the status quo?  Let Medicaid continue to help those who need it, but at the cost of crowding out potentially better private coverage and thus leaving many people exposed to the risk of impoverishment.  It is a hard choice.  Different countries have taken very different paths – and none of them are happy with it.  The Netherlands covers all the care, but as a result they are facing large and growing government expenditures and are asking whether this is sustainable.

So, what are we to do?  There is only one solution I can think of that a) relies on private markets rather than a taxpayer –financed government program, and b) ensures that everyone gets the coverage against financially-catastrophic long-term care expenditures.  And that is to have the government mandate that everyone have coverage, but leave it up to the private market to provide it.  Then, take the money we are currently using to pay for long-term care through Medicare and Medicaid, and use part of it to subsidize the premiums for those with low-incomes.

The problem, of course, is that an “individual mandate” to purchase long-term care insurance would be politically unpopular in the U.S. (even then-candidate Obama was against an individual mandate for regular health insurance during the campaign).  It goes against our nation’s free market preference (which I am usually a huge advocate of!)  But in this case, the irony is that a government mandate would probably result in less government control of long-term care, at least compared to the current system under which the government provides $3 out of every $5 spent.

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!