Health Tank - May 29, 2010: Medicare & Medicaid Reform

Introduction   |   I. Bringing Down Costs   {Health Insurance Reform}   {Hospital Reform}   {Malpractice Reform}   |   II. Medicare & Medicaid Reform   {Medicare}   {Medicaid}   |   III. Improving Health-Care Quality   |   IV. Increasing Access to Health Care   |   V. Reducing the Uninsured Population


Health care policy is a unique challenge: while we often think of health care in moral terms, its delivery is subject to the laws of economics. We cannot address the problems of our health care system while ignoring either element.

Health Tank strives to be a comprehensive repository of the best ideas in health-care reform. It starts from the premise that the Hippocratic ideal of medicine—caring for the sick without regard to self-interest—requires us, paradoxically, to understand how self-interest dominates our health care system.

Patients seek the best care they can get their insurers to pay for, regardless of how much it may cost the overall system. Doctors seek the best care for their patients, so long as they can get reimbursed and not sued. Hospitals seek to treat the critically ill, but make more money when their beds are full of sick people. Insurers, by contrast, seek to keep everyone healthy, because they then receive more in premiums than they pay in medical expenses. Governments seek to spend the wealth of future generations, who don’t vote, upon the present generations, who do.

Self-interest cannot be outlawed; it is a ubiquitous fact of life. But history shows us that the self-love inherent in free markets can be harnessed for the public good. Applying that wisdom, Health Tank seeks to improve the quality and affordability of medical care by aligning the incentives of patients, doctors, hospitals, insurers, manufacturers, and the government.

No small task, I know. But we have to start somewhere.

There are four major problems with our health care system: (1) that the cost of health care is increasingly unaffordable for families and businesses; (2) that our nation cannot pay for all of the promises we have made to provide for the health care of the elderly (Medicare) and the poor (Medicaid and S-CHIP); (3) that structural inefficiencies hamper health care innovation and lead to unnecessary medical errors; (4) that we lack the facilities and the medical professionals to care for every American in need.

The problem of the uninsured, a major focus of the progressive political agenda, is actually a derivative of these four core issues; the reason why some needy families lack health insurance is because it is expensive and inflexible, and because other elements of the system conspire to prevent them from being able to access health care when they need it.

Below are some of the most interesting approaches to these problems, culled from think tanks, industry analysts, academics, politicians, and even a stray blogger or two. I hope to continuously improve the depth and quality of this compilation, so check back in from time to time.


Health care inflation is by far the biggest problem with our health care system. First, some math. In 2010, the average household spends $13,000 a year on health insurance. Under our old healthcare laws, the average household was projected to spend $21,900 in 2019; with Obamacare included, that number goes up to $25,900.

That is an average of 8% a year, three times the rate of inflation. If the cost of health insurance went up at the rate of inflation from 2000-2009, it would cost $16,341 in 2019. Given that the median household income in the U.S. is around $50,000, the difference between Obamacare and CPI inflation—$9,559 per household—is like an additional 19% income tax on every household in America. (Liberals argue that this is an unfair analysis, because it doesn't include the subsidies that some lower-income individuals would receive in the new insurance exchanges. But this is illogical: government subsidies don’t just fall out of the sky; they come out of the pockets of taxpayers.)

Some elements of health care inflation are not actually bad: new therapies that address previously untreated diseases, for example. Others, like demographics, are unavoidable: while baby boomers don’t want to grow old, their senescence will have a big impact on overall health expenditures.

Nonetheless, there is a lot we can do about health-care inflation, by bringing competition and common sense to three key areas of the health care system: health insurance, hospitals, and litigation. A fourth, and critical, driver of health-care inflation is Medicare and Medicaid, which I discuss in more detail in Part II.

A. Health Insurance Reform

The biggest reason why health-care costs are spiraling out of control is also the simplest: nobody has an incentive to care. Until patients are able to shop for their own insurance plans, and their own medical treatment, nothing else we try will have a meaningful impact on health costs. (I discussed this problem extensively in my article for the Spring 2010 issue of National Affairs.)

  1. Harmonizing the tax treatment of employer-sponsored and individually-purchased health insurance. A health-reform law that did nothing but equalize the tax treatment of employer-sponsored and individually-purchased would have a dramatic and salutary impact on the cost of health insurance. Finally, individuals and families would be able to shop for plans that fit their needs, and able to keep those plans even if they changed or lost their jobs. Currently, if your employer buys your health insurance on your behalf, it does not count as taxable income. However, if you buy insurance on your own, it does—a major disadvantage.

    Nearly all health care economists agree that this is a serious problem. The only issue is the politics. In order to achieve tax equalization, one must either raise taxes on those with employer-sponsored insurance (unpopular); or lower taxes on those with individually-purchased insurance (increase the deficit). Perhaps a deficit-neutral combination of these two approaches provides a happy medium. See the section entitled “Anticipated reforms for Principles 2 and 3” in this paper from former CBO Director Douglas Holtz-Eakin for one man’s thoughts on this topic. Peter Hansen recently made an interesting proposal in The Weekly Standard: replacing the employer tax subsidy with a flat individual deduction for the first $1,000 spent on “certified health insurance policies.” One would have to ensure that “certified” includes high-deductible health plans (see below).
  2. Giving patients more control over how they spend their health-care dollars. MIT economist Amy Finkelstein, in a provocative paper in the Quarterly Journal of Economics, showed that half of the six-fold rise in real per-capita health spending from 1950 to 1990 can be explained by the introduction of Medicare. That is to say, once people had the ability to consume health care without really paying for it, they consumed more of it. A lot more. This is a huge problem, one that can only be solved by giving individuals the incentive to consume health care more responsibly.

    Consumer-driven health care, or CDHC, is the most promising approach to this problem. Think of the difference between auto insurance and health insurance in America. Auto insurance is typically catastrophic: if your car is stolen, or damaged in a crash, the insurer compensates you; otherwise, you’re on your own. Health insurance is typically comprehensive: not only are you covered if you get hit by a bus or a lethal disease, but also your routine checkups and nagging injuries. Imagine if your auto insurance paid for car washes, oil changes, and gasoline. Why wouldn’t you always order the deluxe car wash and the premium gas?

    Consumer-driven health care seeks to change all of this. Instead of comprehensive health insurance, which incentivizes everyone to spend as much as they can on health care, CDHC pairs a catastrophic health plan with tax-free health savings accounts (HSAs) that are controlled by you. If you're healthy, and don't spend what's in your HSA, you can invest it to use at a later date. And since it's your money, you have every incentive to spend it on the things you need, but not on the things you don't. Best of all, these plans are significantly cheaper than comprehensive insurance plans, precisely because they result in lower health costs. Their popularity has exploded in recent years; at their creation in 2003, less than one million people had HSAs. Today, that number is over 20 million.

    For more information on CDHC, see the work of John Goodman at the National Center for Policy Analysis, or read any book or article by Regina Herzlinger of Harvard Business School. The RAND Corporation has conducted an extensive analysis of the performance of CDHC.

    John Mackey, CEO of Whole Foods, instituted CDHC at his company, with spectacular results. Indiana Governor Mitch Daniels brought CDHC to Indiana state employees, and used CHDC to expand Medicaid for the poor. David Goldhill, CEO of the Game Show Network, wrote compellingly about the need for CHDC in a widely cited article for The Atlantic Monthly.

    Unfortunately, Obamacare may contain language that constrains, and possibly outlaws, health savings accounts. A key element of any good health reform plan should be to increase the maximum-allowed tax-free contributions to HSAs, and to make it easier for individuals to withdraw the money when needed.

    The gentlemen at InsureBlog have done an excellent job digging into some of the technical issues with current CHDC plans, and make technical suggestions as to how to improve them.
  3. Purchasing health insurance across state lines. This was a popular element of Republican proposals during the Obamacare debate of 2009. It would help reduce the cost of insurance in two ways.

    First, it would limit the degree to which overzealous state legislatures and insurance commissioners can pile costly mandates onto all insurance policies. Today, individual states like New York require all insurance policies to cover things—acupuncture, say—that most people don't need. By allowing people to buy insurance across state lines, people could buy cheaper policies that suited their needs. (Peter Suderman summarized these arguments nicely in a 2009 piece for the Wall Street Journal.)

    Secondly, increasing the scale of insurance companies will help them gain leverage over hospital monopolies, one of the biggest drivers of health cost inflation (see below).
  4. Rescission reform. There has been much criticism of the extremely rare practice of an insurer dropping a patient’s policy after he has fallen ill, because patient failed to report a previous medical condition when applying for the insurance policy (and thereby gaining a discount from the insurer). This is called rescission. While it is necessary for insurers to root out fraud, there are problems with the way rescission is practiced today, because insurers try to have it both ways: they take your money for years and years, and drop your policy when you get sick. Obamacare seeks to restrict insurers’ ability to rescind insurance policies; John Goodman points out in this article for Kaiser Health News why Obamacare's reforms aren't of much consequence. What we really need is a system where insurers check up on the prior medical histories of patients before agreeing to the policy, but are then restricted in their ability to drop patients. Otherwise, patients are put in the extremely unfair position of paying large sums for worthless insurance policies.
  5. High-risk pools? In 2008, John McCain campaigned on the idea of setting up high-risk pools for people with preexisting conditions who are unable to buy normal health insurance. The idea is to bring together all such people into one plan where they can pool their health risks; the pool would then be subsidized by governments in order to ensure that the insurance policies are affordable. The advantage of such a system is that it helps cover those with preexisting conditions without increasing the cost of insurance for healthy people (other than in taxes).

    There are two inter-related problems with high-risk pools: (1) nobody knows for sure what the right level of subsidy is; (2) not everyone is confident that politicians are capable of figuring it out. In the Summer 2010 issue of National Affairs, James Capretta and Tom Miller do an excellent job of describing the history of high-risk pools, and propose a federal program to address the issue. I provide some thoughts on their proposal in a blog post.

    Obamacare does set up some temporary state-based high-risk pools, but several analysts, including Douglas Holtz-Eakin, are concerned that they are under-funded and burdensome to the states. Many states are opting out of the program.
B. Hospital Reform

Everybody loves to hate insurers. They, after all, are the ones who have to say “no” when a patient or a doctor asks for reimbursement for a test or therapy that is unreasonably expensive. As we described in Part A of this section, it is important to put as many of these choices back in the hands of patients and doctors through consumer-driven health care.

But even if you enacted all of the insurance reforms described above, you would still be left with the second big driver of health inflation: hospital monopolies. (I have discussed the topic extensively on this blog.) In many parts of the country, patients are dependent on one or two hospitals to provide acute care services. These hospitals can demand whatever prices they want from insurers, and insurers have no choice but to cave in. Without ending hospital monopolies, there can be no end to health-care inflation.

  1. Stronger antitrust enforcement. The U.S. Department of Justice has opened an investigation into the merger of two Boston hospitals that did much to drive up the cost of health care in Massachusetts. In the past, government lawyers have tried to bring such cases against hospital monopolies, but courts have ruled in the hospitals' favor. This time around, the government needs to do a better job of making its case. This should be an area where free-market conservatives and trust-busting progressives can come together.
  2. Deregulation of new hospital construction. One of the worst aspects of Obamacare is how lobbyists from the American Hospital Association convinced Congress to insert a provision banning the construction of new, physician-owned hospitals. Physician-owned hospitals are small, specialized hospitals that are founded by a group of doctor-entrepreneurs. The doctors, typically focused on an area like heart surgery or orthopedics, compete against larger general hospitals for patients. This competition holds down health care inflation, and drives quality up, as competition does in any typical situation.

    The incumbent hospitals complain that this competition is unfair, as physicians “cherry-pick” the most profitable hospital specialties, while sticking the general community hospitals with less profitable services like trauma. However, as Stuart Guterman of the Commwealth Fund has observed, there is little evidence that cherry-picking is an economically significant phenomenon. Specialty hospitals do tend to take less Medicaid and Medicare patients, because the government underpays hospitals for caring for those patients. This, however, is no reason to make everyone else suffer, but instead speaks to the need to reform Medicare and Medicaid.
  3. Encouraging medical tourism. For many expensive medical procedures today, it can be cheaper to fly to Singapore or India and get treated at luxury, world-class centers over there. This concept is called “medical tourism”, and it is spreading like wildfire. According to a study by the Deloitte Center for Health Solutions, 750,000 Americans traveled abroad for medical care in 2007, a number that is expected to grow at 35% a year over the next decade.

    Some insurance policies encourage medical tourism, while others don’t. Certain federal laws prevent U.S. doctors from recognizing the medical licenses of doctors practicing in other countries, hampering the ability of U.S. doctors to provide follow-up care to patients who have been treated elsewhere.
  4. Price and quality transparency. Transparency is a key component of keeping down the cost of health care. After all, if you don’t know how much something costs, how are you able to shop for the best price?

    Of course, transparency matters most if you actually have the ability to shop around, which is why reforms #1 and #2 above are so important. Even so, some states, such as Wisconsin, have made intriguing progress on health care transparency. In Wisconsin, hospitals voluntarily contribute data to a website run by the Wisconsin Collaborative for Healthcare Quality. The website has allowed hospital administrators to figure out where they were lagging their peers, and adopt best practices for both cost and quality.

    There are those, such as Congressman Frank Pallone (D-NJ) and White House Budget Director Peter Orszag, who argue that too much transparency would lead to higher prices in concentrated health care markets. Their arguments are unpersuasive.
C. Malpractice reform

Malpractice litigation is one of the biggest drivers of health care inflation. Exactly how much is a matter of debate, but conservative estimates of the annual cost of defensive medicine at $60 billion, while other estimates place it closer to $200 billion.

It would be the easiest thing to fix, but it is also the most politically difficult, because the American Trial Lawyers Association is one of the biggest donors to the Democratic Party. This is corruption, pure and simple, despite the excuses made by some.

  1. Tort reform. State-based case studies of tort reform are a powerful rebuke to those, like Sen. Dick Durbin (D-IL), who defend the trial lawyers. In 2003, Texas voters approved Proposition 12, a constitutional amendment that capped non-economic medical liability damages at $250,000. The law had a dramatic effect on health care in Texas: the supply of physicians increased 26%; and the cost of malpractice insurance declined significantly (which directly impacts the cost of health care). Replicating the Texas model nationally would do wonders.
  2. Specialized health courts. Progressives at The American Prospect and elsewhere push health courts as an alternative to tort reform. The idea would be to funnel malpractice litigation into specialized courts that would be better able to distinguish between real malpractice and the kind favored by ambulance-chasing lawyers. This is a promising idea that does not conflict in any way with the need for tort reform.


Medicare and Medicaid are, from a fiscal standpoint, out of control. Reforming these programs is critical to the long-term solvency of the United States. We all know this, but for those needing an up-to-date overview, read James Capretta’s piece in the premiere issue of National Affairs. What is especially troubling about the problem is that it is relatively easy to solve. We just haven’t shown the political will to do so. At the end of the day, Medicare and Medicaid reform is a test of our national character.

A. Medicare

What can be said about Medicare that hasn't already been said a thousand times? More than you might think, because the problem is actually far worse than people realize. It’s not just that Medicare threatens to swallow up the Treasury. It’s that, as I discussed earlier with the work of Amy Finkelstein, Medicare is the dominant driver of health care inflation. Medicare incentivizes the elderly to consume health care at irresponsibly high levels, and underpays hospitals and doctors for the privilege, leading providers to overcharge those with private insurance in compensation.

It is no exaggeration to say that successful reform of Medicare and Social Security must be our nation’s highest domestic priority.

  1. Means-testing benefits. One of the simplest reforms of Medicare would be to reduce the number of people who receive it. Today, Medicare is an entitlement, which means that every American, regardless of income or status, is eligible for the program. But there is no obvious policy reason why it is necessary for the government to subsidize health care for the wealthy. There is, however, a political reason: proponents of government programs believe that those programs are less likely to be dismantled if everyone participates in them. Today, with the fiscal pressures facing the nation, that rationale is no longer sufficient.

    Tyler Cowen, an economist at George Mason University, writes eloquently of the desirability of reducing the Medicare subsidy for the wealthy. The rich are already seeing their taxes go up to pay for Medicare; it makes far more sense to tax them less but also subsidize them less. Cowen suggests “tying the size of Medicare benefits to a person’s lifetime income, which is relatively easily measured and hard to game.” In 2004, the median net wealth of the nation’s richest quartile was $422,400 per household; surely this group can survive without government subsidies.

    The numbers are quite powerful: Richard Foster, the chief actuary of the Centers for Medicare and Medicaid Services, projects that we will spend $898 billion in 2019 on Medicare (up from $516 billion in 2010). If we passed a law today that removed Medicare funding for the wealthiest quartile for those under 55 years of age, we would save $239 billion in 2020, and over $3.2 trillion in the 2020-2029 period (see the above charts).

    Just as importantly, means-testing would reduce the number of people using Medicare, and thereby the number of people who are incentivized to overconsume health care. This, in turn, would have the salutary effect of tamping down health care inflation. Foster, the CMS actuary, predicts that Medicare expenditures will grow by 6.35% annually from 2010-2019. If means-testing Medicare reduced that growth rate to 5% from 2020-2029, we would save an additional $588 billion over that timeframe.
  2. Indexing the eligibility age to life expectancy. When Medicare was enacted in 1965, the average life expectancy was 70.2 years. In other words, it was expected that Medicare would cover one’s health expenditures for the last 5.2 years of life. In 2010, the average American lives 78.4 years; Medicare thereby covers the last 13.4 years of life: a 158 percent increase.

    It is essential that we begin to adjust the eligibility age of Medicare to take this change into account. Ideally, we would index the eligibility age of Medicare to Census life expectancy statistics; e.g., the average life expectancy subtracted by 9 years.

    Raising the eligiblity age would not be an unprecedented reform; in 1983, the retirement age for Social Security was gradually increased from 65 to 67, significantly extending the solvency of the program. A similar effort to gradually raise the eligibility age for Medicare to 69, for those younger than 55, could do wonders. The National Bipartisan Commission on the Future of Medicare estimates that raising the eligibility age to 67 would save $620 billion over 30 years, and that raising it to 70 would save $1.8 trillion over the same period.

    Raising the eligibility age would have other salutary effects. By incentivizing people to work longer, it would increase the number of economically productive people in the population, thereby improving the ability of the taxpaying population to support the retiree population.
  3. Consumer-driven reform. In 1998, a bipartisan commission was organized by President Clinton and Congressional leaders to address Medicare reform. A proposal by Sen. John Breaux (D-LA) and Rep. Bill Thomas (R-CA) received broad support from that commission, and should represent the starting point for a thorough overhaul of Medicare. The proposal would convert Medicare into a consumer-driven system modeled after the Federal Employee Health Benefits Program, allowing individuals to choose the plan that best suits their needs. (Rep. Paul Ryan advocates a related system whereby Medicare subsidies would be converted into a voucher system for health insurance.) Either of these approaches would do a lot to convert the unlimited liability of Medicare into something more manageable. Combining consumer-driven reform with means-testing and eligibility-raising would have an even more powerful impact.
  4. Reforming Medicare cost-sharing. In theory, Medicare tries to control costs by requiring that beneficiaries pay a portion of the costs of their care. This cost-sharing falls into two categories: the deductible (the amount someone must pay before the insurance kicks in), and coinsurance (a percentage of the overall amount that the insurer pays). The problem is three-fold: (1) Medicare requires cost sharing for outpatient services, but not hospitalizations, incentivizing more people to get hospitalized; (2) Obamacare, by closing the prescription-drug “donut hole”, has eliminated cost-sharing from the Medicare prescription drug benefit; (3) Medicare beneficiaries can easily buy inexpensive "Medigap" plans that cover the cost-sharing provisions of Medicare, eliminating any incentive these beneficiaries have to control costs.

    This entire problem can be fixed by moving Medicare into a voucher system, as described above. Barring that, however, the various parts of Medicare (hospitalization, outpatient services, prescription drugs, etc.) could be consolidated into one plan, so as to prevent arbitrage between the different areas, with stronger cost-sharing considerations (i.e., restricting Medigap plans). Closing the donut hole was one of the least wise elements of Obamacare, and will be politically difficult to reverse without repealing the whole law.
  5. Independent Payment Advisory Board (IPAB). The IPAB was the favorite cost-control idea of White House Budget Director Peter Orzag. It became a flash point in the debate about Obamacare, when Sarah Palin attacked the IPAB as a “death panel” that would “decide, based on a subjective judgment of their ‘level of productivity in society,’ whether [the elderly] are worthy of health care.” This became a rallying point for Obamacare opponents.

    However, if Medicare is not reformed along consumer-driven lines, and the single-payer model is preserved, there is no alternative to the IPAB or something like it. At the end of the day, as I have written elsewhere on this blog, if the state pays for our health care, then the state has a responsibility to ensure that it is paying for cost-effective treatments; otherwise taxpayer dollars are wasted. We as a society have to agree that if you choose to accept government subsidies of your health care, you also must accept bureaucratic interference as a necessary corollary.
  6. Tackling underpayment and cost-shifting. Those with privately purchased insurance—the 27 million who buy it directly, and the 150 million more who receive it through their employers—also shoulder $90 billion per year of the cost of government-funded care for the poor and elderly. Since the 85 million patients covered by Medicare and Medicaid give these programs huge negotiating power, they are able to force hospitals and doctors to offer care at below-cost prices. But these health-care providers have to make up their losses somewhere. And so they charge privately insured people more for the same care—approximately $500 per person or $1,800 per family—in order to cover the gap. (Many liberals dispute the existence of cost-shifting; for an articulate view of this position, see Austin Frakt.)

    Why does this happen? Politics. It is politically easier to underpay physicians and doctors than to restrict benefits or raise eligibility standards. In 1989, as part of the Omnibus Budget Reconciliation Act (OBRA-89), Congress set up Medicare Volume Performance Standards, which were essentially a system of price controls for physician and hospital reimbursement. In 1997, this system was replaced by the Sustainable Growth Rate method, whereby the growth of expenditures per Medicare beneficiary were required to match GDP growth. However, since health care inflation keeps going up at a rate faster than that of GDP, Congress has routinely enacted ”doc fixes” to make up the difference. The American Medical Association endorsed Obamacare in exchange for promises that the sustainable growth rate methodology would be permanently fixed, but the SGR fix was left out of the law due to its enormous fiscal cost.

    What should happen is that a permanent doc fix, bringing payments in line with the rest of the market, should be paired with one or more of the other cost-cutting measures described above. But if we moved to a consumer-driven system, the doc fix wouldn’t be necessary.
B. Medicaid

There are three basic problems with Medicaid: (1) the federal government at the states share the cost of the program, incentivizing the states to spend as much as possible; (2) Medicaid has not yet adopted the principles of consumer-driven reform; (3) Even more so than Medicare, Medicaid underpays physicians and hospitals for the cost of care, reducing access to physicians and driving up costs in the private sector.

  1. Block grants to the states. While some people, like Tyler Cowen, have advocated a re-federalization of Medicaid, to eliminate the incentive for states to spend too much, the opposite approach is superior: issuing block grants to the states, with few to no strings attached, so that states can experiment with optimal forms of Medicaid delivery. This way, more states would be able to experiment with cost-saving approaches, and would realize the financial benefits of doing so. Over time, states could be weaned off of these block grants, so that they can gain the responsibility (and the tax revenue) for their own poverty programs.
  2. Consumer-driven reform. In the 1990s and 2000s, governors in certain states were able to enact impressive and innovative reforms of the Medicaid program, and of welfare in general. By far the best of these is that enacted by Gov. Mitch Daniels of Indiana. Daniels was granted a waiver by the federal department of Health and Human Services to institute consumer-driven health care for Indiana's Medicaid program. As a result, Indiana has been able to cover people at 200% of the federal poverty level, compared to 100% elsewhere.
  3. Repealing Obamacare. Unfortunately, Obamacare is an unmitigated disaster for Medicaid. Obamacare requires all states to cover people at up to 133% of the federal poverty level, from 100% previously, a move that will place a massive fiscal strain on the other 49 states which haven’t been allowed to adopt a consumer-driven system. Even in Indiana, Gov. Daniels believes that Obamacare will require him to terminate his consumer-driven system, and drive up state health care costs by several billion dollars.
  4. Tackling underpayment and cost-shifting. As blogger The Happy Hospitalist put it recently, “Medicaid is not insurance. It’s an insult.” Many physicians no longer accept Medicaid patients, because they are not paid nearly enough to cover their costs. Basically, as with Medicare, this is a problem of the government overpromising and underdelivering. Doctors and hospitals need to be reimbursed at market prices for their costs, otherwise they will continue to drop out of the Medicaid program. Those who stay in will overcharge those with private insurance in order to make up the difference.

For another perspective on Medicaid reform, turn to John Hood's thoughtful piece on the topic in the Summer 2010 issue of National Affairs.

Coming soon: