The Real Problem With the Health Care System

Health care costs are again in the news, and we are told they will be on the minds of voters this election season. The Affordable Care Act (Obamacare) was the Democrats’ latest attempt to address the issue. More recently, Republicans in Congress and the White House have passed a few reforms to try to address many of the shortcomings of the Affordable Care Act, such as its penchant for raising millions of Americans’ health care costs. However, despite their best efforts and good intentions, these politicians will fail to fix this issue as long as their policies are driven by misguided objectives.

For decades now, the main objective of reformers has been to find a way for Americans to consume health care at no or minuscule out-of-pocket costs. A simplified version of the differences in approach between Democrats and Republicans with regard to this issue is this. On the left, the efforts have mostly consisted of ways to get the federal government to pay for the provision of health care. Medicaid and Medicare are part of that effort. Republicans, with so-called free market reforms, on the other hand, have focused on getting state governments and insurance companies to pay the costs of health care. Overall, our system is a mix of these options.

Unfortunately, both sides are pursuing the wrong goals. The pursuit of one form or another of third-party payment for health care services has removed most incentives for consumers to be careful about how they spend money. According to the Center for Medicare and Medicaid Services, consumers pay only 11 percent of their health care costs. Everything else is paid by third parties, whether the government or private insurers. That's a problem because when people's consumption is paid for by someone else, demand artificially rises, thus driving up the prices and introducing inefficiencies in the production and delivery of the subsidized good or service. Further, such a system creates bad incentives among health care suppliers as these suppliers have no need to keep their prices low. The bad incentives exist with both government- and insurer-provided coverage even though private, competitive insurers have incentives to minimize adverse selection and moral hazard.

There are areas of health care where we can see the benefits of out-of-pocket payments. A great example is plastic surgery. With rare exceptions, insurance companies do not reimburse expenditures on plastic surgery. The result is greater consumer access to information on price and quality about cosmetic-surgery procedures and those who perform them. Also, while the demand for cosmetic procedures has increased significantly over the years, prices have remained stable or have dropped while quality of care has increased.

The same is true for laser eye surgeons, who generally do not accept insurance. This is an important factor in explaining how and why the price of laser eye surgery has dropped so much over time while the quality of the procedure and the results have improved dramatically. Of course, when the price of laser eye surgery drops, more people have access to the service. Anecdotally, when I got laser eye surgery a few years ago, the doctor’s office also provided many low-cost financing options.

The contrast is striking with health care services that rely heavily on a third-party payment system. Have you ever tried to get your doctor to tell you the cost of a particular procedure? If you have, they probably told you that it depends on your insurance policy and that they don’t know any details about pricing.  In addition, the prices of most medical services have gone up significantly, and faster than other consumer prices.

As my colleague Robert Graboyes’ entire research agenda has shown, the focus on the provision of health-insurance coverage has distracted us from a more important health care goal: producing better health for more people at lower cost, year after year. The solution here is innovation. Nothing would affect prices and quality of health care as radically as revolutionary innovation, which we've seen in other fields, such as information technology. To encourage such innovation, we have to free health care supply from the many constraints imposed by federal and state governments (both blue and red) and the special interests they serve.

It is a difficult task since special interests and other limitations get in the way. As Graboyes wrote recently: “Innovators and entrepreneurs are busily and successfully rolling out new and miraculous tools for bringing better care to more people at lower cost. Yet healthcare professionals and public policy-makers are surprisingly unaware of many of these developments. Where they are aware, they often show needless and destructive antipathy out of fear, self-interest, or willingness to impose subjective preferences on others.”

Yes, it will be difficult. However, it is the most important health care reform there is.

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Veronique de Rugy

AIER Senior Fellow Veronique de Rugy is also a Senior Research Fellow at the Mercatus Center at George Mason University and a nationally syndicated columnist. Her primary research interests include the US economy, the federal budget, homeland security, taxation, tax competition, and financial privacy.