To fix health-care costs, begin with prices

Geoffrey Lawrence

The level of confusion in Washington over how to fix American health care is astounding. Congressional leaders and the Obama administration appear to believe that rapidly rising health-care costs demonstrate that markets can't deliver quality medical services to consumers. The solution, they contend, is to insert greater government involvement into the delivery and financing of medical services.

Meanwhile, the Republican opposition calls this a "government takeover of health care" while simultaneously criticizing Democrats' proposed cuts to Medicare. Both sides fundamentally misunderstand the problem. Government already controls the health-care industry, and that is precisely why it is so inefficient.

About half of all medical spending in the United States is financed directly by federal or state governments. Yet even decisions in the remaining "private sector" half are heavily influenced by federal Medicare, Medicaid and tax policy, making that sector just as inefficient. Federal tax deductions favoring employer-provided comprehensive group insurance over individual insurance have generated a maze of bureaucracies that now effectively control the medical decisions of individuals — whether patients or doctors.

This is not a market. A market results when individuals decide how to spend their own resources. They look at prices — implicit in which are the relative scarcities and efficiencies of alternative procedures and providers — and make their choices accordingly. Under this dynamic, the competitive marketplace, over time, delivers ever greater value for ever lower costs. The reason the current American health-care system cannot control costs is because individuals not spending their own money are not sensitive to prices. As a result, both government and private-insurance bureaucracies resort to rationing as the only alternative way of controlling costs.

Competitive markets that are responsive to individuals' choices are largely nonexistent in the health-care industry, because of the peculiar combination of financing and regulation that has removed market discipline. Federal tax deductions for employer-provided insurance have encouraged individuals to look for comprehensive policies that will finance all medical procedures — even for those that are routine.

Insurance is intended to safeguard against calamity. Many scheduled or routine procedures do not constitute calamity and, as such, are not necessarily financed most efficiently through an insurance policy. Yet, because the federal tax code has encouraged individuals to seek the most comprehensive employer-provided insurance plans available by making those benefits non-taxable, individual patients and doctors have no direct stake in deciding which medical procedures would be the best use of health-care dollars.

The resulting moral-hazard problem erodes market discipline and encourages over-consumption of unnecessary treatments. Without the market discipline normally imposed by judicious consumers, price competition also breaks down and prices no longer convey the appropriate information about relative scarcity and efficiency. Indeed, knowledgeable critics from both the right and the left acknowledge that it is primarily a government-led distortion of the price structure in health care that has led to an escalating national cost curve.

The solution to the nation's health-care crisis lies in correcting the incentive structures and re-establishing some form of market discipline in the industry. That will come when policymakers realize that the best decisions over which medical procedures would benefit an individual patient are made by that patient, advised by a doctor. Moreover, when incentives for deciding how best to spend resources — always necessarily limited — are returned to patients, large insurance bureaucracies become unnecessary.

More than any other vehicle, health savings accounts (HSAs) combined with catastrophic insurance coverage are returning control over health-care decisions to patients. HSAs cut out the bureaucratic middlemen by giving the patient a non-taxable individual spending account from which he and his doctor can make decisions over planned medical procedures. Catastrophic coverage, on the other hand, insures against the unforeseen.

The competition resulting from the dynamics of consumer demand also imposes market discipline upon medical-service providers, ensuring that their offerings meet the needs of patients. When patients and doctors control health-care finances, any need for bureaucratic rationing evaporates.

Given the high energy of the health-care-reform effort, it's curious that the concept of pricing is so absent from the debate. Only a meaningful price structure can contain the cost curve, and that can only be accomplished by granting patients and doctors more direct control over the use of health-care dollars. HSAs have gone a long way toward establishing that control. Yet, not only have policymakers failed to recognize this, but the proposed health-care "reform" bills could potentially eliminate HSAs altogether.

What would come in their place? Mandates for comprehensive insurance policies, a greater degree of moral hazard and, inevitably, more rationing.

If policymakers want to fix costs, they have to begin with prices.

Geoffrey Lawrence is a fiscal policy analyst at the Nevada Policy Research Institute.

Geoffrey Lawrence

Geoffrey Lawrence

Director of Research

Geoffrey Lawrence is director of research at Nevada Policy.

Lawrence has broad experience as a financial executive in the public and private sectors and as a think tank analyst. Lawrence has been Chief Financial Officer of several growth-stage and publicly traded manufacturing companies and managed all financial reporting, internal control, and external compliance efforts with regulatory agencies including the U.S. Securities and Exchange Commission.  Lawrence has also served as the senior appointee to the Nevada State Controller’s Office, where he oversaw the state’s external financial reporting, covering nearly $10 billion in annual transactions. During each year of Lawrence’s tenure, the state received the Certificate of Achievement for Excellence in Financial Reporting Award from the Government Finance Officers’ Association.

From 2008 to 2014, Lawrence was director of research and legislative affairs at Nevada Policy and helped the institute develop its platform of ideas to advance and defend a free society.  Lawrence has also written for the Cato Institute and the Heritage Foundation, with particular expertise in state budgets and labor economics.  He was delighted at the opportunity to return to Nevada Policy in 2022 while concurrently serving as research director at the Reason Foundation.

Lawrence holds an M.A. in international economics from American University in Washington, D.C., an M.S. and a B.S. in accounting from Western Governors University, and a B.A. in international relations from the University of North Carolina at Pembroke.  He lives in Las Vegas with his beautiful wife, Jenna, and their two kids, Carson Hayek and Sage Aynne.