Chapter 9

Government and
Health Care

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Government Health Care Spending

 Government spending represents 45% of the

$1.3 trillion spent on Health Care.

 20% of the Federal Budget is devoted to

health care issues.

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Figure 9.1 U.S. Health Expenditures as a
Percentage of GDP 1960-2001

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Why Health Care is Different
 Uncertainty:
 People do not typically know what their
health care expenses will be.
 Insurance:
 Because of uncertainty (risk), people
typically buy health insurance.
 This means that people do not typically
pay the full marginal cost of their health
expenses.

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Health Insurance Coverage

 86% of Americans are covered.

 40 million are uncovered.

5
Figure 9.2 Financing Health Care Expenditures
in the United States, 2001

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 Problems with the Health Care Market
 Adverse Selection
 People at greater risk for high health expenses will
purchase health insurance, even at very high premiums.

 At those higher premiums, people who are healthy may

opt to go without insurance. This lack of healthy insureds
in the pool forces insurance companies to raise rates,
because companies must assume that only those with
higher risk will apply for insurance.

 This problem can create a vicious cycle that drives

insurance companies out of business and leaves people
without health insurance.

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Problems with the Health Care Market
 Asymmetric Information:

 Sellers (providers) know more about the cost

and benefits of medical services than buyers
know.

 This can lead to over-consumption, because

doctors may prescribe unnecessary
procedures.

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Problems with the Health Care Market
 Third-Party Payments
 Neither the insured nor the physician has
incentives to keep costs down.

 This leads to over-consumption.

 Patients evaluate the benefits of a

procedure against only a fraction of the
procedure’s cost (i.e, (their coinsurance
rate).

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 Figure 9.3 Health Insurance
and the Market for Health Care
Marginal
Supply =
Price (Dollars per Unit Service)

Social Cost
P2 A

C Loss in Net Benefits

P*

P1 B

Demand = Marginal
O Social Benefit
Q* Q1
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Problems with Health Insurance (cont.)
 Moral Hazard

 People with insurance often behave in ways

that cause them to need the insurance.

 People may fail to eat right or exercise,

knowing that they have health insurance to
help defray the monetary costs of such
unhealthy decisions.

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 Other Features Contributing to
Inefficiency and High Cost
 Malpractice Insurance: Doctors must pay high malpractice insurance
premiums. These costs are passed on to health insurance
companies and then on to patients in the form of higher insurance
premiums.

 Uninsured Patients: Doctors and hospitals that accept Medicaid

patients are not able to deny service to patients based on patients’
ability to pay.

 Technological Advance: Third-party payments encourages over-

consumption of health care services, which leads to over-
development of health care technology.

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 Governments and Health Care:
Compensating for Market Failure
Market Imperfection Government Reaction

Asymmetric Information FDA drug approval

Adverse Selection with Medicare

the retired population
Income Inequality Medicaid

Public Health Vaccinations and

Research
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Why Worry About Growth in Health
Care Costs?
 An increasing share of income is devoted to health
care, which implies other priorities lose out.

 High health insurance costs for employers cause

them to contract labor rather than hiring people
outright.

 Employees with a poor health history can be

inefficiently locked into particular jobs.

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Figure 9.4 Government Health Spending,
1965-1998 in billions (Selected Years)

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Government Health Insurance

Program Spending
in Billions
Medicare 238.0

Medicaid 224.3

Other 99.6

Total 561.9

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Medicare
 65 and older

 40 million covered

 Part A: Hospitals

 Part B: Doctors

 Prescription Drugs and Long-Term care not

covered

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Cost Containment in Medicare
Prospective Payments and the DRG
 A Diagnosis Related Group is a broad
type of illness.

 Medicare pays hospitals based on DRG and

payments are the same nationwide,
regardless of actual costs.

 This creates an incentive for hospitals to

control costs, because if they succeed they
get to keep the savings.

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Medicaid

 Medicaid is health insurance coverage for

the poor.

 Eligibility is tied to household income.

 Children of low income parents can be

eligible, even if their parents are not.

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Controlling Medicaid Costs
 State government spending under the Medicaid
program has been increasing at an average annual
rate of between 10% and 13% since 2001.
 In some states (AZ, MS, NM, NC, WA) costs have
risen between 30% and 50%.
 To compensate, states have:
 reduced reimbursement rates to Medicaid providers;
 restricted reimbursement rates to providers of
prescription drugs;
 required special authorization for use of the drugs, and
 required recipients to pay some of the costs.

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Indirect Government Subsidies of Health
Care

 Because employer-paid health

insurance premiums are not subject to
income taxes, such uncharged taxes
constitute a substantial subsidy to
health insurance.

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Health Care Reform Issues
 Controversy over health care reform and
the role of government in that process has
centered around two issues:
 Controlling the growth of health care
spending to prevent health care from
absorbing ever-increasing shares of our GDP

 Moving toward universal coverage for

Americans by making health insurance a
government-guaranteed right for all citizens

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Impact of Coinsurance on Health Care Price

 Low coinsurance rates cause patients

to ignore health care costs.

 This increases demand and

encourages an inefficiently high level of
consumption.

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 Figure 9.6 How an Increase in Coinsurance Can
Reduce Health Care Spending and Improve
Efficiency in the Market for Health Care Services
Price (Dollars per Unit if Service)
Supply

P4
A
P3
E A’

B’
P2

P1 B

Demand

Q* Q1 Health Care Services per Year

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Controlling Costs Through Managed Care
 HMOs (Health Maintenance Organizations)
are forms of insurance that pay a “capitation”
or fixed amount of money for every patient
in their care. This puts pressure on HMOs
and doctors to control costs.

 PPOs (Preferred Provider Organizations) are

forms of insurance that negotiate a reduced
fee structure for participating physicians.

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Controlling Medicare and Medicaid Expenses
 Medicare: Prospective payments for
DRGs
 Problem: encourages early discharge
and low levels of service
 Medicaid: Low reimbursement rates
reduce doctor incentives to provide
service.
 Problem: reduces access to quality care
in many places

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Universal Coverage
 Gaps in Coverage

 The U.S. has more than 40 million uninsured.

 It is one of only a few developed countries

without universal health insurance guaranteed
by government.

 No long-term coverage.

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Tax Credits for Health Insurance
 One method to extend health insurance to the
uninsured is through government subsidies that
lower the cost per policy.

 A $2,000 per year subsidy could pay 84% of

insurance policy costs for some families in some
parts of the United States.

 The subsidy could be added to the eligible

recipient’s paycheck (like the EITC).

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 Universal Entitlement Systems with
Managed Competition
 One way to provide universal coverage is to mandate that
all employers provide insurance.

 The government would then fill in the gaps for those who:
 are unemployed,
 choose not to participate in the labor force, or
 otherwise do not have health insurance.

 President Clinton’s (1993) plan was to couple mandates

with proposals for managed competition to limit the
growth of health care costs.

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 National Health Insurance
 National health insurance in the United States would
ensure at least a minimal amount of health care.

 National health insurance financed through taxation

would benefit some Americans at the expense of others.
 Benefits:
 Universal coverage
 Some would get better coverage than they have
now.
 Costs:
 Higher taxes and tax-related distortions
 Rationing of care

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U.K. System
 National Health Service
 Capitation paid to general practice
physician
 Universal coverage
 Specialists difficult to see
 Waiting lists for common operations; low
cancer survival rates
 Capital expenses budgeted by national
board.

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Canadian System
 Provincial governments administer the
system.

 Costs shared by national and provincial

taxes.

 Waiting lists and shortages cause the

wealthy to go to U.S. for service.

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