Are U.S. physicians overpaid?

Filed Under (Health Care) by Nolan Miller on Sep 28, 2011

Let me begin by stating that the answer to this question is “no.”

Now that I’ve headed off the slew of angry calls from my family, the reason why I’m writing about this question is a recent article in the journal Health Affairs by Miriam Laugesen and Sherry Glied entitled “Higher Fees Paid to US Physicians Drive Higher Spending For Physician Services Compared to Other Countries.”  The study compared fees paid to general practitioners and orthopedists in the US with those paid in Austrailia, Canada, France, Germany and the UK.  They summarize their findings as:

“Public and private payers paid somewhat higher fees to US primary care physicians for office visits (27 percent more for public, 70 percent more for private) and much higher fees to orthopedic physicians for hip replacements (70 percent more for public, 120 percent more for private) than public and private payers paid these physicians’ counterparts in other countries. US primary care and orthopedic physicians also earned higher incomes ($186,582 and $442,450, respectively) than their foreign counterparts. We conclude that the higher fees, rather than factors such as higher practice costs, volume of services, or tuition expenses, were the main drivers of higher US spending, particularly in orthopedics.”

In light of this finding, one might be tempted to conclude that physicians in the US are overpaid relative to other countries.  However, while it is true that physicians in the US make more than physicians in other countries, in order to interpret this finding it is critical to note that high earners in the US in general make more than high earners in other countries.  Relative to other countries, the US income distribution is more skewed, meaning, for example, that the highest 1% of earners in the US make more than the highest 1% of earners in other countries.

Now, we might ask ourselves, what is the relevant comparison group for a US physician?  A US college student who is deciding whether to be a physician doesn’t compare the income that could be made as a physician in the US with the income that could be made as a physician in German.  He or she compares the income to be made as a US physician with the income to be made as a US lawyer or MBA.  In other words, the right question isn’t whether US physicians are paid too much relative to German physicians, but whether US physicians are paid too much relative to others at the top end of the US skill/eduction/income distribution.  With respect to this point, the answer seems to be that incomes for US physicians are largely in line with incomes to other high earners in the US.  (Not to be too hard on Laugesen and Glied, they discuss this point at the end of their article.)

The issue of how physician incomes fit into the broader income distribution is discussed in a paper from earlier this year by David Cutler and Dan Ly that appeared in the Journal of Economic Perspectives.  They compare incomes for general practitioners and specialists to the income of “high earners,” (people in the 95th to 99th percentile of the income distribution) in 13 other OECD countries.  In the US, this ratio is about 1.37 for specialists.  In the other OECD countries, the ratio ranges from 2.56 in the Netherlands to 0.8 in the UK, with the average being 1.45.  For GPs, the ratio of income for US physicians to that of other US high earners is 0.92.  In the other countries, this GP ratio ranges from 0.68 in Norway to 1.41 in Canada, with the average being 0.98.  Thus, in both cases, US physician earnings seem to be in line with earnings of high earners, with the US being slightly below the OECD average for both GPs and specialists.

So, what do we make of the two studies?  Well, Laugesen and Glied have a point that high physician incomes appear to drive the high cost of healthcare in the US relative to other countries.  But, the reason why US physicians earn so much isn’t because “the system is broken,” they “take advantage of the system” or some other nefarious motive.  Rather, US physicians earn a lot because high earners in the US earn a lot.  So, the skewness of the US income distribution is in part responsible for the high cost of health care in the US.

This point is potentially important for understanding how we might reduce healthcare costs in the US.  Often, proposals to reduce Medicare spending focus on reducing provider payments.  However, if this reduces physician incomes we might expect that in the long run, as physician incomes drop relative to other professions, we’ll have fewer physicians and more lawyers, MBAs, etc.  As long as wages in these competing professions remain high, it will be difficult to squeeze down on physicians too much without driving them out of medicine.  If the highest-ability students are the most likely to move to a different profession, we might find that those who still choose to be doctors are not as good: the overall quality of the talent pool of young physicians might drop.  At the same time, to the extent that this reduced physician supply leads to shortages, it will put upward pressure on physician fees, and we’ll be right back where we started from.  In short, it is unclear that we can reduce healthcare costs too much by reducing payments to physicians.

You Can’t Diversify Your Investment in Your House!

Filed Under (Finance, U.S. Fiscal Policy) by Don Fullerton on Mar 5, 2010

Jim Berkovec was a colleague and co-author of mine when I was at the University of Virginia.  He then became an economist at the Federal Reserve Board, and later moved to Freddie Mac.  Just a couple of months ago, I got some very bad news that Jim had died in a bicycle accident.  At the young age of 50, he was out for some exercise near his home in the Washington DC area.  He was going too fast down a hill and around a curve, and hit a slippery patch.

So in honor of my friend Jim, I want to tell you about our joint research project, a 1992 paper in the Journal of Political Economy, called “A General Equilibrium Model of Housing, Taxes, and Portfolio Choice.”

This research starts with the observation that a wise diversification strategy would include not only U.S. stocks and bonds, but also real estate (and even assets in other countries).  You don’t want all your eggs in one basket.  And for real estate, diversification would mean spreading your investments across properties in many different locations.  That kind of diversification might be possible for rental real estate, but for two reasons it is not possible for your owner-occupied house. 

First of all, you can’t live in all those diversified locations.  The fact that you own the house where you live means that you must have all your eggs in one basket.  And the federal government encourages people to own their own homes, through tax advantages for homeownership, so the government is discouraging diversification.  When a bad event occurs, the homeowner loses the whole basket.

A second reason the homeowner cannot diversify properly is that the amount of the housing investment must be tied to the amount of housing one wants to consume.  You can’t pick the house size that is best for your investment portfolio, if you have to choose the house size that fits your family or other life style choices.  Some people like to spend their money on vacations or electronics, while others like to live in a great house.  Choosing based on those preferences means not balancing your investment portfolio. 

Having an unbalanced portfolio means taking extra risks, and it makes us worse off.  If you invest in one stock or one asset, you get the normal expected rate of return and a large variance (large risk).  If you invest in a diversified portfolio, you still get the same normal expected rate of return, and low variance (low risk).

That might all seem like an unavoidable fact of life, if folks are to own their own homes.  But government policy can make it better or worse.  Just compare the following alternatives.   If government were to take away some housing incentives by disallowing property tax deductions or mortgage interest deductions, then you would still own your whole house.  Those measures do not help share this risk.  But suppose that government were to treat housing just like any other asset.  That is, suppose you had to treat yourself as a renter in your own home: (1) calculate the amount your house would rent for, if it were rented to someone else, (2) include that imputed rent as income on your income taxes, and (3) continue to deduct mortgage interest paid and property taxes paid, just as a landlord would do.  You could also (4) take additional deductions for maintenance and insurance, as a landlord would do.

If homeowners were all in a 33% tax rate bracket, then the government would be taking one-third of all returns to all housing investments, and it could then return that money to everybody through some other tax reduction.  We would NOT be paying higher taxes, overall, but the net effect is that we each would “own” only 2/3 of our own home, and we would each – through our government – become part owner in one-third of everybody else’s home.

In other words, we all would be better diversified, effectively sharing in the returns to all real estate all around the country, with less of an investment in the one house we choose to live in.  According to the economic model in my research with Jim Berkovec, that policy would make us all unambiguously better off.

Jim was a pretty smart guy, and a great researcher and friend.  We’ll miss him.  Here is the official “abstract” of the more technical version of this research paper:

We describe a model in which rental and owner housing are risky assets, tenure choice is endogenous, and each household is constrained to consume the same amount of owner housing that it has in its investment portfolio. At each iteration in the search for an equilibrium, we determine the new taxable income for each of 3,578 households (from the Survey of Consumer Finances), and we use statutory schedules to find the marginal rate and tax paid. Equilibrium net rates of return are major determinants of the amount of owner housing, but a logit model indicates that demographic factors are the main determinants of ownership rates. In our simulation, taxes on owner housing would raise welfare not only by reallocating capital but also by the government’s taking part of the risk from individual properties and diversifying it away. Measures to disallow property tax or mortgage interest deductions do not help share this risk. Simulations of the 1986 tax reform indicate a small shift from rental to owner housing and welfare gains from reallocating risk.