The Covert Rationing Blog

Healthcare Economics, Explained At Last

March 17th, 2008 by DrRich

Dr. Gaulte of Retired Doc’s Thoughts recently suggested that DrRich might want to weigh in on the Fuchs-Emanuel “Universal Health Care Voucher” proposal for financing American healthcare. Specifically, Dr.Gaulte allowed that he has trouble implementing his normally reliable “follow-the-money” rule to figure out whether this voucher system makes sense, or why neither the Republicans (who like vouchers) nor the Democrats (who like universal healthcare) have ever addressed - much less supported - the Fuchs-Emanuel proposal.

DrRich is humbled that anyone (much less the perceptive Dr. Gaulte) would seek out his opinion on a matter of such a complex fiscal nature. However, having had the audacity to entitle his recent book “Fixing American Healthcare,” and the even greater audacity to advance a Grand Unification Theory of Healthcare, DrRich (try as he might) cannot reasonably shrink from Dr. Gault’s comparatively “simple” request.

So.

Distilled to its essence, the Fuchs-Emanuel proposal postulates a certain unfortunate truth about healthcare economics, and then offers a new way of financing healthcare aimed at rectifying that underlying problem. Accordingly, DrRich will offer his commentary on the Fuchs-Emanuel voucher proposal in two separate posts. In the present post we will consider their analysis of present healthcare economics. In a later post we will consider the voucher proposal itself.

The Fuchs-Emanuel view of healthcare economics

Fuchs and Emanuel argue that the widely discussed ideal of “shared responsibility” - wherein individuals, the government, and employers all will contribute their fair share in bearing the financial burden for healthcare - is inherently a “myth.” To support their contention that shared responsibility does not and cannot exist, they focus their analysis mainly on American businesses. (Their argument extends to government-funded healthcare, but their focus on business is reasonable since at least until recently, most Americans got their health insurance through employee benefits.)

Fuchs and Emanuel make a convincing case, supported by plenty of data, that there is a direct trade-off between wages and healthcare costs. Simply put, businesses treat employee health insurance premiums as a straightforward employee expense, that is, they put those expenses into the same bucket as wages. Since limiting the size of the overall employee expenses “bucket” is critical to any business, changes in wages tend to become the inverse of changes in health insurance premiums. Their data show that that, for decades, wage changes have moved in the opposite direction of changes in insurance premiums. The result is that companies aren’t really paying their employees’ insurance premiums; the employees themselves are paying, directly out of their own pockets, in the form of lost wages. Indeed, because of the soaring cost of healthcare, inflation-adjusted wages have actually fallen over the past 30 years.

But employees believe they are getting healthcare for (nearly) nothing - so why should they tax themselves, or agree to any other changes in healthcare policy, to get what they’re already receiving for free? The “myth” of shared responsibility distorts the public’s view of how healthcare is paid for, and places a roadblock in the way of any meaningful reform. Somehow, Fuchs and Emanuel say, we must make the public understand that the entire cost of healthcare is already being taken from their own pockets. Otherwise we are all stymied.

DrRich comments:

The Fuchs/Emanuel synthesis of healthcare economics is unquestionably accurate. In fact, DrRich believes that their synthesis, to a large degree, is essentially trivial. It ought to be completely obvious (and would be if not for our dysfunctional educational system and for the lies that political leaders of both parties pass off as truth) that neither businesses nor the government have access to funds that don’t ultimately come out of the pocket of individuals. The government gets its money from taxes. Companies get their money from selling stuff. Any expenses incurred (healthcare or otherwise) must be provided by individuals, either through an increase in taxes or the price of goods (or, in the case of the employees themselves, in reduced wages). That’s just basic economics.

Certainly, the failure of individuals to realize they’re actually the ones paying for their (and everyone’s) healthcare is a major root of the problem. The notion that healthcare expenses are “shared” with business and the government makes healthcare feel “free,”and any time something feels free it’s nearly impossible to set limits. It is our now-institutionalized inability to set limits on healthcare spending that promises ruination. (Our “no limits” paradigm is fundamentally what requires us to engage in covert rationing, rather than open rationing, of healthcare.)

As DrRich sees it, however, the actual reasons we are unable to set limits on healthcare spending go deeper than the synthesis described by Fuchs and Emanuel. If we’re going to consider their proposed voucher solution to healthcare financing, we ought to first take a closer look on why such limits have become impossible.

On limits, and why we can’t have them
A fundamental principle in economics is that when we are buying consumable products that we are consuming ourselves - like Caribbean cruises, sports cars, ice cream, or healthcare - we should spend no more on those products than we are able to pay ourselves.

Now, before you click away in anger, be assured that DrRich is not trying to make a political statement here, just an economic one. It is certainly true that some societies have decided to purchase some of these consumable products (healthcare, for instance) collectively. And the collective purchase of consumables constitutes a somewhat different situation that we will address in a moment.

But for consumable products that everyone agrees ought to be paid for by the individual (let’s just take Caribbean cruises as a relatively non-controversial example), the individual must arrange to cover the cost. The reason for this principle is obvious. If individuals could arbitrarily decide to go on a cruise, but leave the cost to others who have no say in whether the cruise happens, the economic system would soon collapse.

Three quick asides on this basic principle:

1) The fact that our economic system is in severe turmoil at the moment - and, according to some, is indeed at risk of total collapse - is precisely because we encouraged too many people to borrow too much money that they have no means of repaying.

2) This principle permits occasional exceptions among small groups. Certain privileged factions, such as politicians, have awarded themselves the ability to take Caribbean cruises on somebody else’s tab whenever they choose. Such a practice will not cause a widespread economic catastrophe as long as the size of the privileged group is carefully circumscribed.

3) However, when those same politicians “forget” that the rules under which they are personally privileged to operate cannot be generalized, and then, say, pass laws that encourage lending institutions to extend those same privileges to the masses, economic turmoil is inevitable. See item 1.

But what about those societies which have decided to collectively purchase certain products and services (like healthcare) that are consumed by individuals? It turns out that these societies must operate under a very similar economic principle: A society should spend no more on such consumable products than it can pay without incurring long-term, multi-generational debt.

In the U.S., we have decided to pay for healthcare collectively. A large chunk of healthcare is provided directly through big government programs like Medicare and Medicaid. But even the “private” healthcare that Americans get through their employers is collectively supported through the tax deductible insurance premiums enjoyed by businesses. So whether your healthcare is provided directly through government payments or through tax-deductible insurance premiums, to a great extent society is collectively footing the bill.

This would not be a problem, economically, if we were doing it on a pay-as-you-go basis. But we’re not. We’re running a huge national debt today, and largely because of healthcare obligations that debt will reach stupendous proportions in the foreseeable future.

Reasonable people can argue over whether having a large national debt is good or bad, but the answer lies at least partially in what it is that the debt has been incurred to pay for.

The ability to borrow money, and carry debt, is important to a vibrant economy. Individuals can borrow even large amounts of money as long as they promise to pay it back and their credit rating is high enough. But if a person fails to pay back what they owe according to a predetermined schedule, society takes steps to stop further borrowing and to force them to repay. If they get in too deep, society ushers them into bankruptcy, and allows them to slowly make themselves whole again. But society does NOT allow them to simply keep borrowing indefinitely.

This is because individuals die. If we were to allow individuals to simply accumulate as much debt as they want until they die, leaving it to somebody else to pay it back, the economic system would soon disintegrate. So before people can borrow money, they need to demonstrate their ability to repay it, or to have their estates repay it upon their death. In this way there is a natural limit to how much individuals can spend on consumable products in their lifetime.

Societies, like individuals, must borrow no more than they can eventually pay back. The difference is that, unlike individuals, society lives “forever.” That is, the accumulation of debt that cannot be paid off in a single generation is not necessarily alarming, because society will “always” be there to pay it off.

As it turns out, the ability to accumulate even huge amounts of debt is vital for complex societies like ours, as it permits us to maintain a buffer for economic stability, to smooth out boom-bust cycles, and to maintain reasonable predictability, stability, and steady growth. The ability to carry multi-generational debt enables the government to borrow the money it needs to make multi-generational investments, things like building up the nation’s infrastructure, providing for national defense, advancing medical research, and engaging in other forms of non-commodity spending that will allow society to progress, to grow stronger, and to steadily improve the lives of successive generations of its citizens.

The “right” kind of long-term national debt, then, is a chief enabler of economic growth and prosperity, an investment in the nation’s future. It is appropriate to ask future generations of Americans to share the financial burden of that debt, since they will reap the benefits of the investment.

Things go very wrong, however, when we burden society with the “wrong” kind of debt, the kind that represents an open-ended promise to purchase products and services that are consumed by individuals, such as healthcare. There are two problems with this kind of debt.

First, this kind of debt is not an investment in the future, whose fruits will be realized by our children and grandchildren, and whose returns will more than cover the overall debt obligation. Instead, it benefits only the individuals currently alive who are the direct recipients of the consumable services, leaving no direct benefits but only an ever-increasing debt burden to those who will be left paying the bills decades later.

Second, while there is a natural limit on how much an individual can spend for products and services they consume during their lifetime, once the responsibility for paying for those consumables shifts to society, there is no longer such a natural limit (since societies live forever). The debt can now be borne by multiple generations. Because there is no longer an inherent limit to what an individual can consume, and because it is to the advantage of present and would-be officeholders to eliminate any remaining arbitrary limits, individuals are eventually encouraged to consume as much as humanly possible. And without these limits (whether natural or imposed by rules) the provision of such services to individuals rapidly becomes an entitlement, whereupon the natural checks and balances that apply to other parts of the federal budget are no longer available.

When society faces an accelerating debt burden that is completely open-ended and is not subject to normal checks and balances, that society is dealing with a disproportionate economic variable (DEV) - that is, an economic obligation that grows without limit and completely out of proportion to the growth of the overall economy. Healthcare spending, which unrelentingly consumes an ever-increasing proportion of the GDP, already has become a DEV.

DEV’s are inherently destructive to a society, and for that reason are rare. Indeed, in viable societies the only commonly encountered DEV is wartime spending, a form of spending that is temporarily required for survival. Indeed, the disproportionate spending in wartime is tolerable only because war is temporary. It should be noted, however, that one reason war is temporary is that in a prolonged war, a runaway DEV can cause a country to spend itself into oblivion. (See: the multi-decade Cold War and the demise of the Soviet Union.)

Our government has made apparently irrevocable but unsustainable promises to its citizens regarding future spending for their healthcare. As DrRich pointed out in an earlier post, the GAO now tells us that Medicare alone has created an unfunded obligation that, over the next several decades, will reach an unimaginable 34 TRILLION dollars. The reason this massive debt burden exists is the same reason similar debt burdens exist for companies such as General Motors, i.e., because of open-ended promises for whatever healthcare their future retirees may need, without limits. The threatened result - oblivion - is also the same.

Americans need to admit that there’s a limit to what we can spend on healthcare, even if that limit is liberally defined as “something less than would eventually cause the disintegration of our society.” Our current political discourse disallows us from setting even that modest limitation.

Fuchs and Emanuel accurately describe the mechanism by which Americans have become enabled to ignore the truth, i.e., the myth that our present and future healthcare obligations can be “shared” into feasibility. But the truth is actually far more troubling than merely that Americans are already paying for their own healthcare without acknowledging it. The real truth is that, while individuals are already paying far more than they realize, they’re not paying nearly enough; and that indeed, they can’t pay enough to cover the multi-generational societal obligations we have have already signed up for (even excluding the new healthcare obligations our politicians are promising us, and which many of us seem quite anxious to add).

In this way, shared responsibility is not really a myth. In fact, we all - individuals, businesses and the government - do share responsibility for what we have wrought; and unless we figure out how to reestablish limits (either the natural ones or the kind established by rules), when the bill comes due we will all pay in a very similar manner.

In later posts we will consider how far the universal healthcare voucher system proposed by Fuchs and Emanuel might take us toward resolving our looming fiscal crisis in healthcare.

Note: This is the first in a series of posts that discuss healthcare economics, and the three basic questions we will have to answer before we can devise a way to fix American healthcare. The second post in this series, “Can a Voucher System Fix American Healthcare?” can be found here.

Posted in Fixing American Healthcare, Healthcare economics

2 Responses to “Healthcare Economics, Explained At Last”

1. Dr. Val wrote on 03/17/08 at 9:07 pm :

   I recognize your arguments from pages 40-42 of your book, Fixing American Healthcare.

2. DrRich wrote on 03/18/08 at 7:47 am :

   Val,

   Yes, truly I didn’t just make this up over the weekend. I made it up a while ago.

   Rich

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