Ideal Health Reform

Princeton University economist Uwe Reinhardt and I find ourselves in remarkable agreement on some fundamentals of health reform.

A recent post of mine was paean to a proposal by Sens. Tom Coburn (R-OK) and Richard Burr (R-NC), along with Reps. Paul Ryan (R-WI) and Devin Nunes (R-CA). That bill, in turn, was based on an idea that Mark Pauly and I proposed in a Health Affairs article more than a decade ago. It was also roughly the plan endorsed by Sen. John McCain in his presidential campaign in 2008.

Professor Reinhardt in a post at The New York Times Economix blog found much to like in these ideas, especially when modified by my proposal to make Medicaid available as a public plan alternative to private insurance. He also raised some additional questions that I want to address here.

Parenthetically, I find that it’s not that hard for economists on the left and right to agree on health reform. The reason: economists are naturally sensitive to incentives. They don’t like reforms that leave people with perverse incentives to do antisocial things. Once you are determined that the incentives have to be right at every margin, a lot of things begin to quickly fall in place.

You may say I’m a dreamer,
But I’m not the only one.

In what follows I want to address the fundamentals of health reform in the context of five choices people must make. Much of what I have to say is based on my Journal of Legal Medicine article, “Applying the ‘Do No Harm’ Principle to Health Policy.”

The Choice to Insure or Be Uninsured. In any rational health care system, public policies don’t encourage people to choose to be without health insurance. But for millions of people, that is what we are currently doing. Under the interim measures (2010 to 2014) of the Affordable Care Act (ObamaCare) those perverse incentives for some people have become even worse. How does that work?

Currently we are “spending” close to $300 billion a year on tax subsidies for private health insurance. These subsidies primarily consist of the ability of employers to pay insurance premiums with pre-tax dollars. As a result, government is effectively paying almost half the cost of the insurance for many middle-income families. Yet people who do not have access to employer-provided coverage get very little help from government when they buy insurance on their own. For the most part, they must purchase insurance with after-tax dollars — effectively making the after-tax cost of insurance twice as high as it is for their cohorts who get insurance at work.

What happens to people who stay uninsured? Estimates differ, but I’m going to guess that the uninsured get about $1,500 in “free” (uncompensated care) per person per year. Granted, the “free care” system is uncoordinated, largely disorganized and probably inadequate. Yet it amounts to de facto public insurance worth about $6,000 for a family of four.

Think about that for a moment. For millions of people, public policy does nothing to encourage the purchase of private insurance. But if they choose to be uninsured, they can count on a system of public and private charity that is actually quite valuable. Further, people don’t actually have to rely on free care once they become ill. A host of federal and state regulations has made it increasingly easy for people to get health insurance “after the fact” for the same premium a healthy person would pay. Under an interim measure, ObamaCare even establishes federal risk pool insurance — guaranteeing insurance to anyone, regardless of health condition, for the same premium a healthy person would pay after a six month wait!

The wonder is not why there are so many who are uninsured. The wonder is: why aren’t there even more?

The economist’s solution: never make uninsurance more attractive than insurance.

Here is my most recent iteration of the first step toward a more rational approach. By replacing all existing tax and spending subsidies and by making certain tax breaks (like the $1,000 child credit) conditional on proof of insurance, I believe we can offer everyone a refundable tax credit of $2,500 per adult and $1,500 per child — or $8,000 for a family of four — to be applied to the purchase of private health insurance.

If they turn this offer down — and many will turn it down — the uninsured will pay higher taxes than someone at the same income level who chooses to claim the credit and obtain insurance. You can think of these higher taxes as the penalty for being uninsured. All unclaimed tax credit money — and this is important —  should be made available to a safety net institution in the area where uninsured people live to serve as a source of funding in case uninsured patients cannot pay their medical bills.

I call this approach “public policy neutrality,” since it commits the same number of dollars, regardless of the choices people make. Further, I believe such an approach qualifies as “universal coverage.”

The idea that unclaimed tax credits should go to safety net institutions is critical, in my opinion. Its absence is a major flaw in ObamaCare, in RomneyCare and in the Republican plans mentioned above.

Professor Reinhardt asks if $8,000 is enough, considering that family coverage for the average employer costs more than twice as much. Of course, it is more than the subsidy the average family gets from the government under the current system. More importantly, the current subsidy is open ended. The federal tax subsidy pays from one-third to one-half of each dollar of wasteful coverage for the average employee. That means that employees have an incentive to obtain insurance even if it is worth only half of what their employer pays for it. Under the fixed-sum tax credit proposed here, however, each additional dollar of wasteful spending, at the margin, is a dollar the employee could use to purchase other goods and services.

The typical employer plan today covers every doctor and every facility that employees have ready access to, even though costs vary radically, as does quality. The plans pay seven times as much for an MRI scan for one employee as they pay for another.

Previously I have estimated that employers could cut their health care costs in half without sacrificing quality by (a) taking advantage of value-added purchasing and domestic medical tourism, (b) letting employees control all of their primary care dollars and (c) letting most chronic patients manage their own health care dollars (a la the Cash and Counseling program. Given appropriate incentives, many might decide to try this approach.

The Choice between Public and Private Insurance. I won’t review all of the evidence here, but there is substantial empirical support for a proposition that I’m sure most people probably believe anyway: Medicaid is worse than private insurance. In fact, there is some evidence that being on Medicaid is worse than being uninsured. Regardless of its quality (which probably varies from place to place), I have never understood why so many on the left want to segregate poor families into a health plan where the single biggest problem is finding doctors who will see them.

At a minimum, we should be neutral between public and private insurance. Everyone on Medicaid should have the opportunity to apply her allocation of Medicaid funds to a private plan, including employer plans and plans purchased in the marketplace.

I think the surprise for Professor Reinhardt was my willingness to reverse the process and give everyone in the private sector the opportunity to join Medicaid. To continue with the above example, a family of four should be able to use its $8,000 refundable tax credit to apply for Medicaid insurance. I suspect that Uwe would like to require Medicaid to accept the family for that amount. I would prefer to leave Medicaid programs free to charge a higher total premium, perhaps as high as 10% of family income.

In any event, Medicaid will always be an unattractive alternative to private insurance for most people.

The Choice between Employer Sponsored Insurance and Individually Purchased Insurance. As noted, federal tax subsidies pay for as much as half the cost of employer purchased insurance, while people who purchase their own insurance get very little tax relief. To make matters worse, almost every state makes it illegal for employers to buy individually owned insurance with pre-tax dollars. That means we have effectively outlawed the type of insurance most employees want and need: insurance they own and that travels with them from job to job and in and out of the labor market.

Under ObamaCare things will get worse. All of the inequities and inefficiencies will remain for above-average income families. But for low-income families the bias in federal tax subsidies will be reversed. A family at 133% of poverty will be able to get a subsidy in a newly created health insurance exchange that is as much as $20,000 higher than a family at the same income level getting insurance at the place of work.

Clearly this makes no sense. Worse: if left in place, this bizarre subsidy system will lead to a completely restructuring of American industry. Businesses will dissolve and reform, not in response to economic factors, but in response to the way government subsidizes health insurance.

Under the reform I am proposing, everyone will get the same subsidy regardless of where the insurance is purchased. If insurance is purchased on a level playing field, employers will not get involved unless they have a comparative advantage in providing insurance. Perhaps some large companies do. Most small ones do not.

The Choice between Third Party Insurance and Individual Self-Insurance. There are essentially two ways to insure against risk: pay an insurer to take the risk or self-insure, say, by putting money aside in a savings account. In health care, the insurer is often referred to as the third party (the first two parties are the doctor and the patient). Since medical expenses tend to be irregular and since most families are not accustomed to saving for them during periods of good health, my colleagues and I have proposed putting aside money every pay period in a Health Savings Account (HSA) or a Health Reimbursement Account (HRA), although the deposits are “notional” in the latter case.

For most of the post-World War II period, federal tax policy subsidized third-party insurance and penalized individual self-insurance. That is because employers could pay health insurance premiums with pre-tax dollars, whereas employees had to pay medical expenses directly with after-tax dollars. The advent of HSAs and HRAs over the past decade has leveled the playing field considerably, but the law is still too restrictive. For example, the HSA rules more or less force people into plans with high deductibles and sometimes coinsurance above the deductible as well. The problem with deductibles is that incentives are excellent when you are below the deductible limit, but disappear entirely when you are above it. The problem with a 20% coinsurance rate is that people have an incentive to over-consume —until health care is worth 20 cents on the dollar.

Elsewhere I have argued that ideal health insurance would dispense with deductibles and copayments and carve out entire areas for complete patient control. For example, patients should in general directly manage all their primary care dollars, including most diagnostic screenings. Chronic patients should be given the opportunity to manage their own care as well as the dollars that pay for that care.

Clearly, the market needs to be free to combine the two forms of insurance in creative ways without artificial restrictions. Also we need to re-think how we are subsidizing self-insurance. Mark Pauly and I proposed the Roth approach, under which deposits are made with after-tax dollars and withdrawals are made tax free. This levels the playing field between health care and other goods and service in the current period, in the future and between current period choices and future choices.

Choices in the Market for Risk. The single biggest mistake we have made in the market for medical care is to completely suppress the price system. As a result, no one ever sees a real price for anything. No doctor, no patient, no employer, no employee, etc. Similarly, the single biggest mistake we have made in the market for health insurance is to suppress the ability of insurers to accurately price risk.

Consider life insurance. If you develop cancer while you are uninsured and then try to buy life insurance you will find that it is very expensive. You might be denied coverage altogether. But if you buy the insurance while you are healthy and then get cancer you are protected. The insurer cannot cancel your policy or charge you a higher premium because of your illness. And since life insurance is portable, you are protected until you die. Cancer is what health insurers call a “pre-existing condition,” and in buying life insurance you are insuring against the unfortunate possibility that you might develop a pre-existing condition.

People don’t normally switch from one life insurer to another. But suppose one insurer (company A) bought a block of business from another (company B). In looking over the people with coverage, the two insurers would note that some people are paying a premium that is above the true actuarial value of their insurance and some are paying a premium that is below theirs. Individual health conditions change over time, but the premiums increases stay the same for all the members of the same pool. Given that fact, insurer A would pay more for the individuals who are overpaying (because they are profitable) and less for individuals who are underpaying (because they are unprofitable).

This very sensible arrangement is what doesn’t happen in the health insurance market, however. If a cancer patient leaves plan B and enrolls in plan A we require A to accept him for no more than the premium a healthy person would pay. In essence, we allow B to keep all the premiums the individual has been paying (perhaps for many years) and expect A to pay all the medical bills. This type of regulation destroys any possibility of, say, a vibrant market for cancer care — or any other kind of expensive care, for that matter. Instead, insurers will try to avoid the sick and attract the healthy. After enrollment, they will face perverse incentives to overprovide to the healthy and under provide to the sick.

John Cochrane has shown that it is possible and practical to structure health insurance so that people can insure for pre-existing conditions. Such a market would replace perverse incentives with good ones.

An adjunct to all of this is that we cannot allow people to game the system. That principle is already recognized under Medicare. Seniors are penalized if they fail to insure when they are eligible for Medicare Part B, Medicare Part D and for Medigap insurance. In other words we don’t allow people to avoid paying premiums while they are healthy and then enroll with impunity after they get sick.

Strangely, there are no similar penalties built into ObamaCare. People can stay uninsured while healthy and enroll after they get sick for the same premium everyone else is paying. There is a penalty for being uninsured. But the penalty is a small fraction of the premium savings people will enjoy if they decide to remain uninsured.

Comments (17)

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  1. Devon Herrick says:

    I love the song pairing!

    On Uwe’s blog post, a few commenters denigrated the idea of an $8,000 tax credit as either being too small; or too expensive for taxpayers. The current system rewards excess spending by higher-income families. Providing moderate-income families with the same tax break would go a long way toward helping the uninsured. Forcing everyone (especially high-income families) to pay for excess health coverage with after-tax funds (at the margin) would also help control spending.

    I’m generally not a supporter of mandates and regulations designed to coerce people into doing what Do-Gooder policy wonks think they should. But if I were to venture into that territory, I would be tempted to favor tax credits that limit their use to only high-deductible policies with HSAs. That way, people would be free to get the coverage they prefer. But government subsidies would steer people into exercising more control. A tax policy such as this would help alleviate the damage done to the health care system by open-ended, employer subsidies.

    Of course, this is precisely the opposite of what Left-Wing, Do-Gooder public health advocates want.

  2. Ramesh Chandra says:

    We need a comprehensive tax policy. We should only have consumption tax, collected nationally and distributed on a fair share basis to states. every citizen should get a check out of it to cover basic needs, irrespective of income and wealth. abolish soc sec , medicare , medicaid and all other soc services. Let private providers compete for business. If people come to providers w/o insurance, the payments should come from their future govt. checks or other collection means. This eliminates all inequalities, provides real safety net Eliminates all tax issues and frees up professionals to work on productive jobs. Then all of us Fed, States. localities and persons(natural and not-natural) can focus on maximizing returns on our assets. This is the real path to prosperity. We need to continue the critical conversations you started.

  3. Ralph @ MediBid says:

    Tax credits? We dont need no stinkin tax credits!
    We need ot focus on medical care, not healthcare. The big stuff is not controllable or predictable, except over a large number of people, so for that stuff we allow doctors to set their own prices and introduce competition and transparency. We’ve been doing that at for 2 years.
    For the small stuff which is both controllable and predictably, get rid of any third party payer system, since it increases both costs and administration, while decreasing choice and quality.

  4. Cochran’s research also enables portable, private, universal, cradle to grave, government subsidized health insurance. See my website

  5. Alieta Eck, MD says:

    I think these ideas involve too much bureaucracy– well paid bureaucracy with benefits. The taxpayers are tapped out.

    You state that people on Medicaid have worse outcomes than people without insurance. This is absolutely true, as most doctors do not take Medicaid, which grossly underpays them yet leaves them with full liability. Medicaid patients cannot find a physician.

    Why do you not see that we could solve the problems of the poor by making physicians part of the Public Health system for the purpose of liability protection?

    Simply allow doctors to donate a significant amount of time in non-government free clinics, and have the state protect them against medical malpractice claims in their private practices. Don’t try to pay them for charity care– just protect them.

    This is a win-win-win proposition. Patients know where to go when they are sick and have no funds to pay.

    Physicians are relieved of a large part of their overhead and are thus thanked instead of paid for their work in caring for the poor. They will actually have to pay more taxes, but that’s OK.

    Taxpayers are the huge winners. The Medicaid system consumes 1/3 of the average state budget– and does a tremendously terrible job of meeting the health care needs of the poor. Why do we put up with that? The state would not have to buy medical malpractice insurance for the doctors, but simply extend the same coverage it gives to the attendings, residents and medical students in the medical schools. Lawsuits would be directed at the state instead of the physician. And physicians with poor track records could be dropped from the program.

    Win-win-win– and go back to real charity, the way it was before 1965 when the poor got care and the physicians were thanked and respected.

  6. Ramesh Chandra says:

    I think all policies should be HDDP. Let people control how they spend their tax dollars and yet are covered unlimited for major medical. Let freedom live.

  7. Ramesh Chandra says:

    The problem with good Doctor’s solution is it is forcing people. If Docors want to donate their time they can find ways of doing it themselves. No need for Govt. involvement.

  8. Alieta Eck, MD says:

    It would be totally voluntary, Ramesh. No on is being forced.

    The point is that the poor would get care without the government trying to be so involved. We operate a free clinic in NJ ( at a cost of $15 per patient visit (all voluntary donations) The federal government covers us for medical malpractice there, but surgery or anything that would be referred out is not covered.

    The way to expand the voluntarism would be to protect the doctors who choose to donate. Surgeons could agree to do two cases a month; obstetricians could deliver 2-3 babies per month all through the non-government free clinics. The taxpayers get relief– what ARE they paying for in the bloated Medicaid system?

    Government cannot provide medical care. It can only coerce, restrict, meddle and underpay for services it promises, while taxing the taxpayers beyond their ability to pay.

  9. Ramesh Chandra says:

    Thank you for your good work and good suggestion.
    May be i will look you up when i come to NJ.
    We are focusing on educating small businesses on hdhp-hra-hsa and building up HSA funds.
    Hopefully all the contributors here will finf a bigger audience and this movement will have a tremendious success.

  10. Ramesh Chandra says:

    sorry, for typing this quickly. next time i will reread before submitting.

  11. brian says:

    Great plan by Coburn et al.

  12. frank timmins says:

    John, your approach using the Coburn tax credit approach as the basis is spot on IMO. I am a bit curious however (perhaps you intend to address this later) regarding the example of an $8,000 tax credit with the option to “opt out” of Medicaid. For the most part, would someone who paid enough taxes to get an $8K credit be eligible for Medicaid in the first place. Are we talking about “vouchers” as well as tax credits in this scenario?

    Your point about “carving out entire areas for complete patient control” is also well considered. Personally I feel we should be looking “back to the future” by resurrecting “hospitalization” insurance. That is to say addressing only what should be addressed with insurance – high risk unpredictable occurrences. Should we not be separating in-patient hospital expenses from “almost” all other healthcare expenses?

  13. frank timmins says:

    “Parenthetically, I find that it’s not that hard for economists on the left and right to agree on health reform.”

    This statement brings to mind a reasonably hopeful hypothesis. Consider that there are two basic mentalities among those who support Obamacare. One being the statist, controlling, power seeking group who essentially are using PPACA as a tool for a different end game (Obama, Pelosi, et-al). The other being one that is genuinely seeking a solution to what is unquestionably a financially dysfunctional healthcare system. As you suggest it is probably the economists such as your friend Mr. Reinhardt (possibly) that, after the PPACA’s ultimate demise, will be amenable to considering changing direction from the top down approach to the consumer directed approach. If the goal is truly to create the best possible platform for growing the best healthcare system possible, reasonable people can come together.

    If this is true it seems that it may actually be possible to pass legislation with a reasonable amount of bi-partisan support. We can dream anyway huh?

  14. MarkH says:

    Strangely, there are no similar penalties built into ObamaCare. People can stay uninsured while healthy and enroll after they get sick for the same premium everyone else is paying. There is a penalty for being uninsured. But the penalty is a small fraction of the premium savings people will enjoy if they decide to remain uninsured.

    What about the penalty of paying the penalty yet receiving nothing in return? And still being uninsured and responsible for additional medical bills?

    If you can afford insurance, but instead choose to pay the penalty, your screwed, because if you get sick you have to pay out of pocket. If you’re too poor to pay for insurance you’re subsidized to be included in the exchanges, so you’re incentivized to be insured, since the insurance is cheaper than the penalty.

    I don’t see how paying a penalty and receiving no coverage isn’t a disincentive. It’s based on the assumption that one can just not pay medical bills, when I’m sure the bill collectors will disagree with such a plan.

    Is it just me or is this post being purposefully obtuse about the incentives for buying insurance under Obamacare?

  15. Ramesh Chandra says:

    The whole is issue is the mandate and then costs. Also perpetuating union and pension funds corruption their manadating their members have to insure thru them.

  16. Greg Scandlen says:


    One of the strongest benefits of your plan is that there is a not-small portion of the population that simply can’t cope with insurance of any kind. They may be illiterate, mentally ill, drug addicted, underground criminals, or just too dysfunctional to have any impulse control. Reading contracts, making and keeping appointments, taking recommended medications are all beyond their capacity. They need the direct provision of services — show up at the clinic when you feel sick.

    This is a serious issue that no one (except you) is accounting for.

  17. Dr. Bob Kramer says:

    Would that politicians follow the lead of economists on the left and right and agree on anything?

    Dr. Bob Kramer.