Econ 101: Health Care Reform

Nearly 90 years ago Ludwig von Mises, one of the founders of the Austrian school of economics, pointed out that once government intervenes in a market it creates unintended consequences that lead to further government intervention. This process continues until the government attempts to control the entire market.

America’s health care industry is a perfect example of what Mises was talking about. Government intervention in the health care industry, from favorable tax treatment of health care plans that are provided by employers to the creation of two massive government health insurance companies (Medicare and Medicaid), has created unintended consequences that have driven up the price of health care and distorted the allocation of resources in the health care industry. Medicare and Medicaid are very inefficient and account for half of the health care expenditures in the U.S.

The Obama administration and the leadership in the House and Senate want to respond with further intervention in this market. The end result is likely to be a health care system where central planners decide who receives what type of health care, what procedures must be covered by insurance and what prices can be charged for different procedures, until eventually our diet and exercise may even be regulated by government bureaucrats.

But right now the fundamental problem in health care is that much of the services are paid by a third party. Imagine if grocery stores worked that way. If your employer has provided you with grocery insurance, you would walk through the aisles and pick up any item that was covered by insurance. You wouldn’t need to know the prices, since your grocery insurance would pick up the tab. It is pretty obvious that those with grocery insurance would load up their cart with costly wine, steak, shrimp, lobster, and whatever they goods felt they might use.

With no price restraint, we would expect shortages of food and increased prices that would have to be paid by the grocery insurance companies and those who didn’t have grocery insurance. Producers of groceries would have an incentive to innovate in the production of new costlier foods to entice buyers who have grocery insurance. Employers would find the insurance premiums rising and begin to reduce or eliminate coverage.

The government would respond by providing government grocery insurance to those who were retired or didn’t have jobs. This would create even higher demand and higher prices. The insurance premiums would rise even more and there would be political demands to expand grocery insurance to cover everyone so that those without insurance wouldn’t starve because of the high prices. Sound familiar?

Improvement in our health care industry will occur only when we move it back to how the grocery industry actually works — the person purchasing the item is the person who pays for the item. Health insurance would be similar to car or fire insurance -- protection against catastrophic events. The preferential tax treatment for insurance provided by an employer would end. A person who chose to purchase their own health care plan would be able to do it with pretax dollars. 

We will probably continue to tax people in order to provide health care for the elderly and indigent. However, Medicare and Medicaid should be moved to what is now known as health savings accounts.  Medicare and Medicaid would provide recipients with a high deductible policy meant to cover extreme situations, say $6,000. Then recipients would be given an account, for example $2,000 per family, that the family could spend on medical services. The recipients could put their own funds into the account on a tax free basis and all earnings on the funds would be tax free.  Any unspent funds would accumulate in the account and the account could be passed on as part of the estate.

This would alter drastically the incentives of both consumers and producers of health care, and as all economists will tell you, incentives matter. The recipient would now have an incentive to ask a health care provider how much a service would cost and would seek information on the cost of other health care providers.

Health care providers would have an incentive to efficiently use resources to keep down costs and to demonstrate the quality of their care. Organizations and firms would have an incentive to provide information on the quality of providers to consumers in the same way that information on mechanics is available on Web sites like Car Talk and hotels on Trip Advisor.

You can imagine that pharmacies such as Rite Aid and Wal-Mart would have a nurse practitioner in their pharmacy to examine patients and determine care for many health care problems. While they may not offer brain surgery, they will be able to tell you that your child has pink eye and recommend the proper medication. 

Rather than further government intervention through a single-payer system, or through employer or consumer mandates, we should move our health care system away from the central planning model that has failed wherever it has been tried, and towards the market method of allocating resources that has already provided so much innovation and production in the rest of the economy.

Gary Wolfram is the William Simon Professor of Economics and Public Policy at Hillsdale College. He is also a Business & Media Institute adviser.