By Wayne Winegarden, Ph.D.

In the wake of a landmark Supreme Court decision, President Obama’s signature policy achievement is safe, and the implementation of the Patient Protection and Affordable Care Act (“Obamacare”) will continue as planned. The U.S. economy is another story. Obamacare’s projected economic consequences were negative when the legislation passed in 2009, and they remain so today, increasing the likelihood that national economic growth will under-perform expectations and budget crises at the national and state levels will persist.

The reason is simple: Obamacare increases government regulations, increases taxes, and increases spending, but it never addresses the central problems with the current health care system. That is, it neither improves health outcomes nor controls skyrocketing health care costs. At a time of trillion dollar federal deficits and state and local budgetary stress, the legislation mandates additional expenditures by the federal and state governments (to the extent they choose to participate) with. According to the Congressional Budget Office, Obamacare will cost an additional$1.5 trillion through 2021, some of which may be financed by the states through higher Medicaid and other health programs. This $1.5 trillion is equivalent to an additional annual cost of $1,261 per U.S. household, or a diversion of 2.5% of the average household’s gross income.

Back in 2009, President Obama noted that health care reform is not a luxury. It’s a necessity we cannot defer. Soaring health care costs make our current course unsustainable. It is unsustainable for our families … It is unsustainable for businesses.”[i]And in this, he was correct.  Medical costs have been growing at an unsustainable pace for far too long: compared to 1990, overall consumer prices have risen nearly74 percent based on the consumer price index. Prices for medical care grew nearly twice as much – 146 percent, (see Figure 1).  

 

Figure 1
Cumulative Average Inflation (CPI-U) versus

Cumulative Average Medical Inflation (CPI-Medical Care)[i]

 

 

Obamacare’s fundamental flaw is its inability to “bend this cost curve” because it does not alter the incentives driving health care inflation. The adverse impact from the inability to bend the health care cost curve is visible in Figure 2.  Since 1960, higher medical inflation has caused national health expenditures to grow significantly as a percentage of the Gross Domestic Product or GDP (the total value of all goods and services produced by the economy) – from around 5 percent in 1960 to nearly 18 percent as of 2010.  Although the private sector’s share of health expenditures has been declining as a percentage of total national health expenditures, relative to GDP private sector health expenditures have been increasing as well, just not as quickly as public expenditures. 

Figure 2
National Health Expenditures, Private Health Expenditures and Public Health Expenditures

As a Percentage of Gross Domestic Product (GDP)[i]


Uncontrolled medical inflation is the expected consequences of the market distortions that pervade the healthcare markets in the U.S.  The consumers and suppliers in the healthcare market, like any other market, respond to incentives. In the healthcare market, the incentives are established by the current third party payer system, in which patients’ payments to doctors and other health professionals are mediated by third parties such as insurance companies. This system creates adverse incentives for patients and medical providers by separating medical consumers from medical providers – it drives an economic wedge between them. 

The health care wedge is created when government expenditures and expenditures of private third-party payerssubstitute for individual expenditures.  And, this wedge has been growing over time via two trends: a rising share of government expenditures (visible in Figure 2 above) and an even sharper decline in the share of out of pocket expenditures.  The growth in the share of private third-party payer expenditures is reflected in the gap between the rise in the government expenditures share and the sharper decline in the individual expenditures share.

In 1960, over 75 percent of total health expenditures in the U.S. were funded by private expenditures.  Beginning in 1966, with the passage of Medicare, the private sector’s role in the health care market began to change.  In 1965, the private sector was still funding over 75 percent of total national health expenditures.  This fell to 70 percent in 1966, and 63 percent in 1967.  Since 1967, the private sector has been slowly funding less and less of the total national health expenditures; and as of 2010 around 55 percent of total national health care expenditures are paid for by the private sector. 

As the private sector’s share has been declining, the individual patient’s share has been declining, at an even faster pace.  In 1960, while the private sector funded over three quarters of national health care expenditures, individuals were responsible for nearly one-half of the total national health expenditures through out-of-pocket costs. Today, the entire private sector funds only slightly more than half of all national health care expenditures, and individuals cover just over $1 of every $10 spent on health care, see Figure 3. As consumers now bear only a fraction of the costs from any additional health care service, their incentives to control costs are significantly diminished.

Figure 3
Out of Pocket Expenditures as a Percentage of Total National Health Expenditures[i]

From the consumer’s perspective, this wedge has diminished their incentive to monitor costs.  As the discipline from an active demand side of the market has faltered, bureaucratic decrees and rules have attempted to fill the void, making the market even less efficient.

On the supplier side, doctors and other medical providers receive no incentive to monitor costs, and they could face catastrophic penalties from lawsuits if they do not cover themselves by ordering enough tests. This so-called tort liability threat is one of the most important disincentives for doctors to monitor costs. According to the American Medical Association, this factor alone adds $70 billion to $126 billion in additional health care costs per year. 

Thus, the separation of consumers from suppliers blinds both patients and doctors to the cost of health care.  Meanwhile the risks of litigation give doctors an incentive to run additional tests to limit their liability exposure. Government regulations and the third party payer system are also diminishing the market incentives to implement programs that would help eliminate waste, fraud, and abuse.  Whether government or an insurance company pays the bills, the process diminishes the competition and patient feedback that are necessary to drive market innovation.

Further, experience shows that the government rarely competes on a level playing field with private companies and firms. Obamacare’s taxpayer subsidies will empower the publically supported options to be priced at uneconomical levels in order to meet political goals, regardless of their economic merit or viability.  This will further reduce the number of Americans with private health care insurance, increase government costs, and worsen the economic viability of the U.S. health care industry.

In fact, the combination of federal subsidies and what amounts to a new public insurance option will actually worsen the problem by reducing people’s incentives to monitor the costs of their own care. Health care inflation will, consequently, accelerate – unless, of course, the government turns to price controls and the problems of shortages they create. The additional expenditures will likely add significantly to the $2.6 trillion spent on health expenditures annually without improving health outcomes or addressing the rising cost crisis. 

As illustrated in Figure 2, government expenditures on health care have been growing faster than the national economy and have become a primary driver of rising government expenditures and debts.  Figure 4 breaks down the growing government burden on the private economy (measured as corporate and non-corporate income) by government health care expenditures and all other government expenditures.  This chart demonstrates two important trends.  First, the government burden on the private economy outside of health care is volatile, but until recently it was on a generally downward trend that began in the mid-1980’s and accelerated significantly during the 1990s.  However, the burden created by government health care expenditures has been on a generally rising path. They have risen from an insignificant burden of 1.8 percent of the private income in 1960 to nearly 7 times that amount (12.2 percent) by 2010.  Consequently, health care expenditures have been an important force in driving overall government expenditures. 

Figure 4

Total Federal, State and Local Government Expenditure Wedge

Health Care Compared to All Other Government Expenditures

1960 – 2010[i]

Figure 5 places this growth in health care expenditures as a share of total federal, state and local expenditures. It shows that health expenditures only comprised 5.5 percent of total government expenditures (or less than $1 in $20) in 1960. A half century later (2010), health expenditures were 22 percent of total government expenditures (or more than one dollar in every five). Obamacare puts additional pressure on overall healthcare expenditures. Consequently, it will be even more difficult to control government expenditures in the future.

Figure 5

Total Federal, State and Local Health Expenditures as a Percentage of Total Government Expenditures

1960 – 2010[i]

 

Due to the higher expenditures, new taxes earmarked to pay for these new expenditures, and increased regulations, economic growth will suffer. Lower economic growth will lower tax revenue growth for the federal and state governments. The combination of lower tax revenue growth and higher government expenditures will burden government budgets at both the federal and state level.

For now, the Supreme Court’s decision ensures that the Patient Protection and Affordable Care Act remains the law of the land.  However, the Supreme Court cannot re-write the economic consequences. And throwing more money and more regulations at the healthcare problem without addressing the fundamental drivers is a recipe for stagnation.

 

 [1}Wayne Winegarden, Ph.D. is a Partner in the economic consulting firm, Arduin, Laffer & Moore Econometrics and a contributor to EconoSTATS.

[2]www.whitehouse.gov/blog/The-President-Spells-Out-His-Vision-on-Health-Care-Reform.

[3] Source: Consumer Price Index, Bureau of Labor Statistics; www.bls.gov

[4]Source: Centers for Medicare & Medicaid Services, Office of the Actuary, National Health Statistics Groupwww.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/Downloads/tables.pdf.

[5]Source: Centers for Medicare & Medicaid Services, Office of the Actuary, National Health Statistics Groupwww.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/Downloads/tables.pdf.

[6]Author Calculations based on Bureau of Economic Analysis Data

[7] Source: Bureau of Economic Analysis, National Income and Product Accounts, Table 3.16 www.bea.gov.