To Really Fix Health Care, Republicans Must Get At What Spurred Obamacare

To Really Fix Health Care, Republicans Must Get At What Spurred Obamacare

The Ryan Plan is dead. It's time to figure out how conservatives can actually fix our health care woes, and not just put another Band-Aid on the problem.
Willis L. Krumholz
By

The Ryan Plan is dead. Conservative groups and talk radio pundits are jubilant, while the Wall Street Journal editorial board is crestfallen. Both sides had their respective points—the Ryan Plan was better than the status quo, but not much better.

One thing is certain. Through this entire debate, GOP leaders on both sides merely tinkered around the edges of what makes healthcare in America unaffordable. More disappointing, GOP leadership now plans on putting off conservative healthcare reform indefinitely. Meanwhile, Freedom Caucus types hail a victory and simply assume that a better bill will eventually come down the pike.

This is bunk. The GOP incessantly pledged to repeal and replace Obamacare (the ACA), and that is what they should do. Not only do Republican majorities depend on conservative healthcare reform, people’s lives and livelihoods depend on an affordable health delivery system.

What Should Conservatives Do Now?

Congress should put off tax reform until later this year. If you thought the swamp creatures came out for the ACA repeal, just wait until they come out for a corporate tax reform bill with $1 trillion less in fiscal space due to the dud launch of the Ryan Plan. Any tax bill with a modicum of revenue-neutrality is now more likely than ever to be watered down as it creates winners and losers between various industries.

Instead, the GOP should go back to the drawing board on health reform. A conservative bill that repeals Obamacare, reforms Medicaid, and passes muster with conservative and moderate Republicans is possible without a 60-vote Senate majority.

It’s imperative that the GOP realize Americans dislike more than just Obamacare. Obamacare, despite its many faults, has simply allowed people to put a name to the problems that existed in healthcare for the last 50 years. Any Republican health reform plan must deal with these problems, or risk replacing the ACA as the object of the public’s ire about the entire health system. What the American people hate about healthcare has been entirely caused by government. Healthcare in America was no free market before Obamacare.

American Medicine Was Broken Before Obamacare

During World War II, as a workaround to wage and price controls, firms began compensating employees with health insurance benefits. The IRS blessed the practice in 1943 by issuing a special ruling that said employer-provided insurance wasn’t subject to income taxes. In 1954, Congress enshrined the tax exemption for employer-provided health insurance into law. The exemption still exists today, and is closely guarded by business lobbies, healthcare providers, and insurance companies. It costs roughly $350 billion per year, or $4 trillion over the next decade, and is one of the biggest loopholes in the tax code.

The exemption for employer-provided coverage means that health benefits provided by the employer, unlike cash wages, are not subject to income or payroll taxes. There is also no limit to the amount of compensation in the form of health benefits that can go untaxed. This means that an employer could theoretically pay an employee’s health insurance premium of $100,000 per year, tax-free. Two things are encouraged as a result.

1. The Employer-Provided Insurance Exemption Hurts Employees

First, this gives employers competing for workers an incentive to offer bigger and better health benefits to employees instead of higher cash compensation. Employers that stick to only increasing cash compensation are at a disadvantage versus other firms competing for labor.

Don’t fool yourself into thinking such a system benefits employees—they are just accustomed to it. As anyone mildly proficient in basic economics will tell you, in return for employer-provided health insurance, employees receive lower cash compensation. Between 1999 and 2014 alone, the average employer contribution for family coverage tripled while cash wages increased by only half that amount.

Employers on the other hand, especially big ones, love the exemption. Because when they pay their employees in cash and health insurance, it costs the employer less than if the employee was paid the same amount, from the employee’s perspective, in only cash. Said a different way, the exclusion allows firms to keep their labor costs the same, even while increasing employee compensation.

Conveniently, the tax exclusion also serves to make employees more “sticky,” meaning that many are afraid to change jobs because their current job is tied to their health insurance, which is tied to their family’s choice of doctor. Worse than reducing labor mobility, when an employee gets very sick they often lose their job, and thus lose their insurance when they need it most. We’ll come back to this later.

Another oddity created by the exemption is that because the employer contributes to employees’ premiums, while employees also contribute to premiums, the employee doesn’t see the full cost of the health insurance they are consuming. Employees are implicitly picking up the whole tab through lower cash compensation, but they only see the dollar value of what they contribute. 

2. How The Exemption Changed America’s Health Insurance

The other result of the exemption for employer coverage is even more consequential. Given the unlimited tax-free money that can be poured into health benefits as a means of competing for employees, the type of health insurance purchased with employer-provided coverage increasingly had high premiums and ultralow deductibles—it covered just about everything.

Routine medical services are not insurable risks, however. Health insurance in America morphed from actual insurance—something with low premiums that protects against calamity—to a tax-code subsidized pre-paid card. This transformation was anything but benign.

Not only did those receiving employer-provided coverage—the majority of insured Americans and the vast majority with private health insurance—not see the total premium cost of the health insurance they were consuming, the type of insurance they were buying made them indifferent to healthcare costs at the provider level. Why would consumers price-shop when the insurance company foots the bill? Instead, insurance companies negotiated prices with the providers, and providers happily stopped showing prices to consumers.

But insurance companies aren’t that worried about provider’s prices, either. Any price increase from a provider is passed along to consumers in the form of higher premiums and lower cash wages—though, again, consumers don’t notice.

Why Providers Love Our Current System

Providers of course love the current system. They do what any rational actor would do: seek to maximize billings and reduce competition, even if that means engaging in anti-competitive behavior that would be wholly unacceptable and politically untenable in a more consumer-driven and transparent market.

For example, providers routinely lobby against new hospitals being built, even if demand in that area is high. And medical professionals’ lobbies fight tooth-and-nail if state or federal legislation threatens to make pricing more transparent. Consumers are unaware and uninterested in either case, because they don’t see the prices in the first place. So the special interests win out.

In the same vein, consumers didn’t notice lobbyists’ efforts at the state level over the preceding decades. Lobbyists pushed state legislators to require that insurance sold in the state cover certain diseases or treatments. This is called community ratings. Not all community ratings are unjustified: many states require plans to cover autism care, for example. Users of autism care pay a little less, while everyone else pays a little more. But many community ratings are unjustified. California, for example, requires all insurance plans sold in the state to cover acupuncture. Blame that one on the chiropractor’s lobby.

3. Healthcare’s Third-Party Payer Problem

Economists refer to this as a third-party payer problem. In a third-party payer system, the entity paying the cost of goods and services is disconnected from the consumer of those goods and services. This acts as an economic morphine drip, numbing normal consumer shopping behavior. The end result is rampant overpricing, free riding, and overconsumption. There can be no free market without cost-conscious, price and quality shopping consumers.

To wit, in 1960, private insurance covered just 22 percent of total healthcare expenditures, and out of pocket spending amounted to 3.2 percent of personal income. By 2015, third-party payments were 186 times larger than in 1960 on a per capita basis, and out of pocket spending was only 2.0 percent of personal income. In other words, the share of national income spent on healthcare increased by 3.5 times, while healthcare’s take from cash budgets decreased by 40 percent.

The government-subsidized numbing of the consumer’s price-sensitivity explains why a single aspirin pill in the hospital could end up costing you $30. It explains why an operation might cost $5,000 at one hospital, and over $20,000 at another, all within the same state. It explains why an MRI in Houston might vary in price by five times depending on where you go, and why a cholesterol test in New York City commands a 79-fold difference in price, depending on the provider. It goes a long way to explain why so many medical services provide so little value, and why 30 cents out of every dollar spent on healthcare in the US goes to waste, as price-indifferent consumers buy services they don’t really need.

The net result is health care inflation that consistently outpaces overall inflation, and healthcare spending as a percentage of GDP that sits at 18 percent, versus 12 percent for the rest of the developed world. During the last 50 years, the consumer price index increased by eight times, wages by 10 times, and the cost of a hospital stay per day by 40 times.

Congress Only Gives Us Band-Aids, Not Permanent Fixes

If all that wasn’t bad enough, the tax subsidy for employer coverage created an uneven playing field for those without employer-provided insurance: the elderly, the poor, and working people who are either self-employed or don’t have a job that is able to provide health care as a benefit, usually because they work hourly or their employer is too small. Insult is then added to injury. Health insurance is more expensive without the employer-provided insurance subsidy, even while the employer coverage exemption sends the cost of healthcare felt by all Americans to the moon.

It is against this backdrop of unaffordable healthcare that Congress created Medicare, Medicaid, and even the COBRA program, attempting to place a legislative Band-Aid over the burden felt by the elderly, the poor, and those in-between jobs due to the uneven playing field that Congress created. This amounted to no less than a doubling down on the third-party payment system.

The consequences of this irresponsible double-down have been disastrous.

The consequences of this irresponsible double-down have been disastrous. Medicare is now a sacred cow thanks to oldies who think they are receiving no more than they paid in, despite the fact that the program runs out of money in the next decade.

Medicaid, a program for the poor and disabled, requires that states contribute 40 percent of the funding but only allows states to control 5 percent of the program. States then have an incentive to low-ball provider compensation as the only means of controlling costs. This leads providers to either game the system via overbilling, or to stay out of the program altogether. The lack of providers who accept Medicaid likely explains why Medicaid recipients experience the same outcomes as those without insurance.

Future Generations Are Already Footing The Bill

Aside from the legitimate questions surrounding the efficacy and sustainability of these programs, future generations are already footing the bill. According to David Stockman, Ronald Reagan’s former Office of Management and Budget (OMB) director, the federal government now spends $350 billion per year on the tax subsidy for employer-provided plans (combining the impact on both income and payroll taxes). That’s $4 trillion over the next decade.

On top of this, the Feds are set to spend $16.5 trillion over the next 10 years on Medicaid, Medicare and tax credits for the individual market, not counting the $3.5 trillion required of states for their contribution to the Medicaid program. Altogether, the costs of this third-party payer system are roughly double the $13.2 trillion 10-year cost of social security, and 7 times the $3.3 trillion 10-year cost for all non-medical means tested benefits like food stamps and welfare.

Despite all of this spending, there was one piece of the health insurance pie that had yet to receive its bailout. If people don’t get government insurance or the employer insurance subsidy, they buy insurance from the individual market. Because individual market buyers don’t get the employer-provided insurance subsidy, their cost of insurance is high. Individual market participants also lack the bargaining power of the big blue-chip firms when buying insurance, further increasing expenses. As a result, 50 million Americans went without health insurance before 2010. Obamacare aimed to fix this.

Obamacare Doubles Down On Government Control

The ACA intended to fill the gap in the third-party payer system’s subsidies in three ways. At the bottom of the income ladder, it expanded Medicaid to able-bodied, working-age adults. For those with jobs, the ACA tried to expand employer coverage further by mandating that firms with over 50 employees cover their full-time staff. This is the infamous employer mandate that stunted business growth and condemned too many to part-time work. At the same time, the ACA tried to cut down on the most generous employer-provided plans through the overly complex Cadillac tax, which wasn’t supposed to take affect until 2018, and now has been put off until 2020.

The big push of the ACA, though, was in the individual market. Obamacare tried to equalize the imbalance between the employer and individual market by creating a new entitlement of tax credits to individual-market buyers, who would then buy highly regulated insurance on “exchanges.” Aside from creating disincentives to work and marriage, the tax credits faced an immediate problem.

The GOP has done a terrible job explaining healthcare to the American people.

Despite the generous subsidy, many people were in the individual market because they had serious health issues, and were no longer able to work. To make sure expanded coverage included these higher-cost individuals, the ACA expanded “community ratings” by capping the amount older-and-sicker individual-market buyers could be charged versus younger-and-healthier buyers. Fearing insurance companies would deny coverage to the sicker patients once the ability to charge these consumers higher prices was capped, the ACA mandated “guaranteed issue,” popularly known as “you can’t be denied for pre-existing conditions.”

Guaranteed issue sounded good, even to Republicans, which is prima fascia proof that the GOP has done a terrible job explaining healthcare to the American people. But guaranteed issue necessitated mandating that everyone purchase health insurance—lest people only buy health insurance when they are sick, which would cause costs in the individual market to levitate to heights unknown. To keep this from happening, and to get the young-and-healthy crowd to overpay for health insurance, the ACA’s mandate was enforced through a penalty for not buying health insurance.

This Is The ‘Death Spiral’ For Our Healthcare

The rest is history. In the individual market, because the penalty for not buying health insurance is much less than the cost of buying insurance, people continue to wait on the sidelines to purchase insurance until they are sick. The more enrollment periods that go by with the healthy eschewing the market, the more the sticker price of insurance goes up the next year. Higher prices make any healthy person who did sign up the year before think long and hard about dropping coverage. This is the “death spiral” you hear about, also known as “adverse selection” in economist-speak.

This has meant rising premiums, higher deductibles, and health insurers exiting the individual market in droves due to unsustainable losses—despite the bailout fund (risk corridors) initially in place to shield the insurance companies from market forces. As things sit today, nearly a third of American counties only have a single health-insurer.

Meanwhile, the ACA’s Medicaid expansion meant that traditional recipients of the program, such as expecting or nursing mothers, found their services crowded out by an influx of able-bodied adults. In other words, expanding the Medicaid rolls without fixing the program’s fundamental flaws was anything but compassionate. And for all the new spending and taxes, 27 million Americans still go without health insurance, largely due to the high cost of individual market insurance.

What The Ryan Plan Was Trying To Achieve

Into the fray ran the Ryan Plan, meant to fulfill the incessant GOP campaign pledge to “repeal and replace Obamacare.” The plan had positives: it would have ended the ACA’s employer and individual mandates, taxes, and eventually the Medicaid expansion. It also sought to give states greater control over their Medicaid programs.

The Ryan bill even hinted at a move to a more consumer-driven market, through the expansion of Health Savings Accounts (HSAs), a tax-exempt account for healthcare spending originally created by Republicans back in 2003. Further, on the insurance front, Health and Human Services Secretary Tom Price promised that once the bill was passed he would cut back on price-inflating Obamacare insurance regulations via executive-branch fiat.

Too often, elements of the GOP rip subsidies, but only the subsidies they don’t like.

The Ryan bill fell short, though. Along with Obamacare, it chose to subsidize the individual market. Yet, unlike Obamacare, it did absolutely nothing to roll back the subsidy for employer-provided insurance. The original House bill included a cap on the tax exemption for employer-provided plans running above the 90th percentile of premium costs—an eye-watering $20,000 per year. Lobbying from insurance companies, providers and business groups quickly snuffed out this meager provision, as the special interests feared it would soon be extended to somewhat less-indulgent employer-provided plans. Even some conservatives joined in against the measure, reasoning that it isn’t conservative to raise taxes.

That is ridiculous. There’s a continent-sized difference between raising tax rates and getting rid of tax loopholes. Ditching an exemption in the tax code that favors a certain group over others and has disastrous results to boot is the embodiment of conservatism. Too often, elements of the GOP rip subsidies, but only the subsidies they don’t like. To an untrained eye, this instance of no-tax fundamentalism was just a cover for pleasing the gang of swamp creatures who benefit from the employer-provided coverage subsidy: insurance companies, providers, and big business (everybody benefits but the consumer).

The shiny object many Freedom Caucus members did choose to focus on was the Obamacare regulations, or community ratings, kept alive in the Ryan Plan. Yes, these regulations push up the cost of health insurance relative to plans that would cover less. Yet these regulations have little to do with the fundamental driver of healthcare overpricing, freeriding and overutilization. This happens at the provider level.

Obamacare And The Ryan Plan Don’t Fix What’s Broken

In truth, the proper way to see Obamacare and the Ryan Plan is simply two competing ideas over how to subsidize the individual market, with both assuming the individual market should be subsidized to make up for the fact that everyone else is subsidized.

And why not? If there must be government intervention in the employer-provided market, it is conservative to make that government intervention occur in the most equitable way possible. The problem with simply ending here is that the most conservative thing to do—the thing that would actually reduce the cost of American’s healthcare bills, increase the quality of healthcare, and boost take-home pay—would be to begin to phase out all subsidies that give the third-party payment system its lifeblood, not to make sure that everybody is subsidized.

The proper way to see Obamacare and the Ryan Plan is simply two competing ideas over how to subsidize the individual market.

The truth is that employer-provided coverage has operated as an entitlement for the past 50 years. It costs $4 trillion per decade, and corrupts the entire American healthcare market. Any GOP healthcare plan should laser-focus on destroying this insidious entitlement.

Yes, the government-run programs of Medicaid and Medicare contribute to the third-party payer problem also. Dr. Dan Jones has written a wonderful article in this publication attributing much of the third-party payer problem to Medicare. Medicare is part of the third-party payer problem, but getting rid of the tax exemption will be both more consequential and much easier than reforming an entitlement depended on by older Americans. Besides, the employer coverage subsidy’s effect on healthcare costs was a deciding factor behind Medicare’s creation in the first place. Getting rid of the employer insurance subsidy may eventually open the door to transitioning Medicare into a more market-based system, but go after the root of the problem first, not the heavily-guarded branch.

There Is A Far Better Way Than The Ryan Plan

All this is still easier said than done. Even the $4 trillion per decade employer insurance exclusion is heavily guarded by the swamp creatures, and the public is unaware of the problem. Further compounding matters, the universal coverage cat is out of the bag. Any Republican bill will have to focus on cost reduction and increased coverage at the same time.

This is possible. There is a far better way than the Ryan Plan, one that could provide universal coverage at much less cost, as well as a far heavier dose of market forces. It could also pass through budget reconciliation, or even convince moderate Democrats to provide support in the Senate. Here’s how:

  • Pass a complete repeal of the ACA through the reconciliation process. In that repeal, include Medicaid reform that sends more control to the states.
  • Double the allowable HSA contribution, as did the Ryan Plan.
  • Begin a multi-year phase out of the employer-provided insurance exclusion. Instead, allow employers to pay employees with untaxed HSA contributions that don’t count towards an individual’s HSA contribution limit, and cap these contributions at $5,000 per year. If the political resistance to a complete phase out is insurmountable, at least cap the employer health benefit exclusion at $5,000 per year, and require that this only include what individual’s pay out of their paychecks, so employees actually see the cost of the insurance they are purchasing.
  • Use the savings from ending the $4 trillion per decade exclusion to pay for universal catastrophic-coverage insurance. As the Federalist’s Ben Domenech points out, such a program would cost less than the Ryan bill’s tax credits for the individual market, and much less than the subsidy for employer-provided insurance. It would also placate one of American’s most deeply-felt fears – bankruptcy due to an unforeseen health crisis. Catastrophic coverage can also include basic services like prenatal care.
  • The size of the deductible of this universal catastrophic coverage should vary according to income and age, and be phased out for individuals making more than $400,000 per year. For example, a family making $40,000 per year might have a $5,000 deductible, while a single person making $100,000 would have a $15,000 deductible. A wealthy person aged 55 might have a $10,000 deductible, while a person of the same age just above the poverty line might have a $1,000 deductible. The incentives of such a program would have to be carefully thought through, in order to stem overbilling once a patient’s deductible is reached, and the program would need to keep pace with medical cost inflation.
  • If universal catastrophic coverage can’t be passed with budget reconciliation, use a two pronged approach. Pass Obamacare repeal and the conservative elements of Ryan’s bill, and force Democrats to vote up or down on universal catastrophic coverage in a second follow-up measure.
  • In the meantime, President Trump and Congress need to sell the plan to the American people. Hit the road and explain why the employer insurance subsidy is so bad. Try using Dr. Dan Jones’ great grocery store analogy.

We Could Have A Freer Market Than We Had Before Obamacare

There are several advantages to this approach. First, because day-to-day health needs would be subject to price-sensitive consumers, healthcare spending and prices would become much more efficient and affordable for all Americans.

Universal catastrophic coverage also fixes several problems inherent in both the Ryan Plan and Obamacare. First, it removes the political-necessity for insurance market regulation. These can be done away with under budget reconciliation also, as long as government expenditures are on the line, as Avik Roy has so thoughtfully pointed out.

There is no such thing as a free market unless there are cost conscious, price shopping consumers.

Next, if deductibles are tied to income, instead of premiums being tied to income, much of the Obamacare credits’ disincentives to work and marriage are removed. People won’t be forced to pay high health insurance premiums, and see an immediate hit to the amount they are subsidized when earning more or marrying. Here, the only time the incentive will be felt is if a catastrophic health event occurs.

Conservatives might balk at such a bill. True, it would be creating a new entitlement. But the end goal should be to immunize ourselves from single payer—even worse than third-party payer. Moving to market based forces for day to day medical care and government protection from catastrophic health emergencies accomplishes this because it would both reduce healthcare costs and ease American’s fear of medical bankruptcy.

The result of this better way would be more of a free market than America had before Obamacare, let alone after. And after such a system takes off, the same model can be extended to replace Medicaid and Medicare. There is no such thing as a free market unless there are cost conscious, price shopping consumers. Will the GOP jump into action with new ideas of their own, or wait for progressives to “fix” the problem with single payer?

Willis L. Krumholz lives in Minneapolis, Minnesota. He is a JD/MBA graduate from the University of St. Thomas, and works in the financial services industry.

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