The key to decreasing health care costs is to decrease over-utilization of services by expanding choices and personal responsibility. The health care delivery systems in place today strip consumers of incentives to constrain spending. This is true for fee-for-service as well as managed care. In providing employees and the elderly with generous health care benefits paid for by third parties, we have shielded health care consumers from the true costs of the system. Deductibles and co-payments represent only a fraction of total health care costs. Contrary to what most seniors think, the Medicare Part B premium covers only 25 percent of program costs. The health care benefits provided by employers are generally tax-free and are effectively "hidden" income to employees.
The phenomenon of third party payment in health care delivery is relatively new. Prior to 1940, most people paid for their own health care. During the Second World War, wages were subject to strict government controls, so employers attracted labor by offering health insurance as a non-wage fringe benefit. This policy encouraged employers to offer their workers excessive coverage, which eliminated individuals from sharing in the costs of their health care and resulted in extensive over-utilization of medical goods and services. Between 1960 and 1990, individuals' out-of-pocket expenses for health care dropped from 50 percent of total costs to barely 20 percent. The dominance of third-party payers (whether insurance companies, businesses, or the government) insulated individuals from the true economic costs of their health care decisions, destroying their incentives to be cost-conscious consumers of health care.
Because health insurance is the primary method by payment for health care, it is the insurer and not the patient who is the consumer of health care. Third party payment so dominates health care delivery in this nation that treatments are given in response to insurance company bureaucrats, rather than decisions reached by patients in consultation with their doctors. As the National Center for Policy Analysis argued, "in many places, a hospital must receive telephone approval from a third-party bureaucrat before admitting a patient. The person giving or denying the approval has not met or examined the patient. The decision is based on a cost-benefit analysis using statistical averages, with little or no room for the nonaverage, abnormally sick patient. These decisions can have life or death consequences."
First-dollar coverage leads to over-utilization and higher overall health care costs. Under the current system, health care consumers are relatively indifferent to the cost of the care they receive. Most consumers would never know if the flu shot they receive each year cost their insurance company $4 or $40. And those that do know probably wouldn't care. At a meeting of the Jackson Hole Group, one participant observed that if people bought cars under the same scheme as they buy health care, everyone would purchase a new Cadillac every year. The Congressional Budget Office agreed that consumers do not internalize the costs of their health care, breaking down the "normal discipline of the marketplace." The continuing rapid growth of medical costs can only be slowed if we enact fundamental changes which encourage consumers to lower utilization of unnecessary services and pressure doctors and hospitals to compete on the basis of price and quality.
A historical review of health care costs bears out the breakdown of the marketplace resulting from third-party payment. Data provided by the Health Insurance Association of America reveals that health care cost growth between 1965 and 1990 has been much steeper in those fields where third parties pay a greater share of total expenses. For example, hospitalization costs, 75 percent of which are paid for by third parties, increased by 350 percent. Costs for drugs and dental care, which enjoy relatively low rates of third-party payment, increased by 150 percent over the same period. This pattern points to one conclusion: when consumers pay a greater share of their actual health care costs, health care inflation is kept in check.
Third party contribution rates for different classes of service also drive up health care costs by skewing market choices. The CATO Institute reported that doctors and patients are more likely to choose expensive in-patient surgery to less costly but equally effective treatments which have higher co-payments. The National Center for Policy Analysis estimates that this phenomenon increases national health spending by $140 billion each year.
Continued reliance on third-party payers providing first-dollar coverage will lead to rationing of health care services. As we move into the twenty-first century, the advancing pace of technology and an aging population will force us to choose between meeting our balanced budget goals and providing patients with all the care they want. The current rates of growth in overall health care expenditures are not sustainable, especially as the baby boomers move into retirement. Any realistic examination of the projected growth of federal health care expenditures reveals the enormous budget deficits facing the system in the not-too-distant future. Lacking the financial resources to provide every retiree with all the health care they want will lead us to some form of health care rationing. We can euphemistically refer to this problem as "choices" but cannot escape its eventuality.
Congress has a number of options to reign in the growth of health spending. We can bury our heads in the sand until the crisis materializes and then rely on government bureaucrats to make these "choices." President Clinton's health plan stood on two principles, price controls and bureaucracy. If the election of 1994 stood for one thing, it represented the American people's recognition that Washington bureaucrats don't solve problems, they create them.
A second forum for making these "choices" might be through private insurance companies. A number of policy makers and academics have cited the potential of managed care to generate significant savings from Medicare and slow the rate of growth of the program. Managed care is premised on the notion that effective case review can lower overall health care costs without affecting the quality of care delivered. But studies have consistently shown that Medicare managed care programs do not save the government money and do little to address the long-term problems facing the Medicare program.
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Marginal Utility