The role of government in health care

1. The role of government in health care Today: Reasons for having government-provided health care; Medicare; Medicaid; Reform efforts

2. Previously… • We saw that health care costs (as a percentage of GDP) have rapidly increased over the last 50 years • Health care insurance • Advantages and disadvantages

3. Today • Government-provided health care • Why should government provide health care? • Programs • Medicare • Medicaid • The government’s role in health care reform

4. Why should gov’t provide health care? • Adverse selection • Moral hazard • Paternalism • Income too low for some people

5. Recall adverse selection problem (see example to the right) The government could force everyone into the same health care plan Pro: Adverse selection problems go away Con: Low-risk people subsidize high-risk people Example: 6 people at a firm Spending if sick: $10,000 3 people have a high risk of getting sick 10% each 3 people have a low risk of getting sick 5% each With no employer contribution, some at low risk do not buy insurance Adverse selection

6. Some activities are more likely to occur to an insured person Bungee jumping Mountain climbing Skydiving Smoking? Bad eating habits? These activities lead to inefficient outcomes The government can intervene to try to discourage these things from occurring Anti-smoking campaigns Commercials promoting good eating habits Prohibiting certain very dangerous activities Withholding care due to dangerous activities Moral hazard

7. Paternalism • A paternalist would argue that some people “don’t get it right” when it comes to health insurance • These people would say that everyone should be forced to have a minimum level of health care • Much of the 2008 presidential debate involved paternalistic arguments

8. Some people do not make enough money to afford health care Problem made worse by increasing health care cost (see “Downward spiral” at right) Young adults and noncitizens make up a substantial fraction of the uninsured in the US Downward spiral Health care costs go up More people are unable to afford health insurance These people must use the Emergency room, driving up premiums for those insured When premiums go up due to increased numbers in the Emergency room, the cycle repeats Income too low for some people

9. What does the government do? • The government provides over 45% of health care funds in the United States • Two main programs of government-provided health care • Medicare • People 65 and older • Disabled people • Medicaid • Poor people

11. Medicare • Enacted in 1965 • Second largest domestic spending program • Funded by a 2.9 percent tax on earnings of current workers • Tax split evenly between employers and employees • Provides health insurance to seniors and the disabled, primarily through the private sector • Seniors must have worked and paid payroll taxes for at least 10 years • About 35 million seniors enrolled

12. Medicare: Overview Expenditures on Medicare as a Share of GDP Real expenditures on Medicare

13. Different aspects of Medicare • Parts A and B of Medicare are the largest components • Part A: Hospital insurance • Part B: Supplementary medical insurance • New Medicare component: Part D • Prescription drug benefit

14. Cost control measures for Medicare • Before 1983, Medicare reimbursement was retrospective for Part A • Compensation is made after services are completed • Little incentive to economize on costs • Since 1983, this changed to a prospective payment system (PPS) • Compensation level is set before services start • 500 diagnosis related groups exist for the prospective payment system • This gives incentives to economize on costs

15. Cost control measures for Medicare • Recall DWL that occurs when MB is low • PPS appears to have decreased DWL • Average stay for Medicare patients in short-stay hospitals decreased from 10.5 days in 1981 to 8.5 days in 1985 • The decrease in stay appears to have no effect on health outcomes

16. Cost control measures for Medicare • To keep costs down for Part B, a resource-based relative value scale system is used • Fees are set per service provided • Does not necessarily keep down number of services • If fees are set too low, many medical practices will not accept Medicare patients • Medicare patients would then get low-quality care

17. Cost control measures for Medicare • Managed-care options • Since 1985, Medicare beneficiaries could enroll in HMOs • Originally, the HMO received 95% of the average amount that the average patient would require • Problem: Adverse selection… Healthier patients enrolled in HMOs  The government was overpaying the HMO

18. Cost control measures for Medicare • Solution to adverse selection problem: Risk-adjusted payments to HMOs • Reduced HMO enrollment • New methods are being tested to try to increase HMO enrollment and decrease costs simultaneously

19. Medicaid: Overview

20. Medicaid eligibility • 1965: Health insurance for recipients of cash welfare payments • 1980s: Children of low-income two-parent families became eligible • “Children” can include care to pregnant women • 1997: State Children’s Health Insurance Program • Allows states to get additional money from federal government to reduce number of uninsured kids

21. Financing and benefits • Federal and state governments share the cost • Poor states get higher matching rates than rich states • Federal government contribution comes from general revenues • States must offer major services with Medicaid • Hospital stays, physician visits, prenatal care, vaccines for children

22. Financing and benefits • States have some flexibility in program administration • Example: Capitation-based reimbursement is allowed • Recall that health care provider receives annual payment per patient in their care, independent of services rendered • Some empirical evidence (Duggan 2004) shows that forcing people into managed care increased Medicaid costs • Questionable if the causation implied is actually true • Other relevant factors may be missing, leading to bias

23. Medicaid stigma • Many people do not enroll in Medicaid • Guilty feelings • Stigmas • Uninformed about benefits • Public service announcements help to get more eligible children on Medicaid

24. Does Public Insurance Crowd Out Private Insurance? Person who is uninsured before public insurance Person who values private insurance relatively lowly Person who values private insurance relatively highly Quantity of all other goods Quantity of all other goods Quantity of all other goods F F A F A A B B B C C C 0 0 0 M M M Health insurance Health insurance Health insurance Amount of publiclyprovided insurance Amount of publiclyprovided insurance Amount of publiclyprovided insurance

25. Are Medicaid expansions effective? • Unclear for two reasons • How much is due to crowding out? • Many eligible people do not enroll in Medicaid • Cutler and Gruber (1996) estimate that about half of new Medicaid enrollment previously had private insurance • Card and Shore-Sheppard (2004) estimate that crowding out occurs less than Cutler and Gruber estimate • They also find that take-up rates due to expansion are low

26. Another issue: Job lock • Job lock • If a new job does not offer insurance due to a pre-existing condition, the worker will stay at the old job • Health Insurance Policy Portability and Accountability Act of 1996 (Kennedy-Kassenbaum Act) • Provides provisions to reduce job lock • Mixed success

27. Health care reform • Why is health care reform a hot topic? • Increased costs • Significant portion of population without insurance • Increases cost to others • Two parts to discuss here • Some questions about possible reforms • What has actually been passed?

28. Health care reform • Some proposals to try to solve the health care problem • Mandating everyone to have insurance • Hot topic in the 2008 Presidential race • Catastrophic insurance • Only provides payment when expenses become large • Health Savings Accounts can be used to pay for this type of insurance • Nationalized health care… • Consumer-driven health care (CDHC)

29. Pros Everybody is covered Commodity egalitarianism No adverse selection problems Government can use cost-cutting measures to prevent care with low MB Cons Predetermined budget may lead to a suboptimal amount of health care provided Long lines in some cases Government determines what is “medically necessary” New technology may not be adopted quickly Moral hazard problems Nationalized health care reform

30. What is CDHC? • Recall inefficiencies of providing coverage for basic services • Over consumption of medical services • Deadweight loss • CDHC advocates health insurance to be like other types of insurance • Covers truly catastrophic events • High deductibles • Shoppers can shop many companies, not just what is offered by employer

31. CDHC example • Recall we have seen this type of example already • Provide a yearly fund to each person or family • Carries over to the following year if not used • After the yearly fund is used, up to $5,000 of expenses must be made out-of-pocket • After out-of-pocket expenses are paid, 90% of expenses are covered • Insurance for years with truly high expenses

32. Pros Reduces deadweight loss by letting consumer pay full cost of health care Increased competition by allowing consumers to shop around Cons Unhealthy people could be priced out of the market due to high risk Most consumers are unable to make completely informed decisions about health care Routine exams and immunizations with high levels of positive externalities may be forgone CDHC reform

33. Is there a solution? • Is there a solution to the health care problems presented over the last week? • There will probably never be a complete solution • Security and efficiency will be “at odds” with each other • Some people will always choose NOT to have insurance unless forced to • Current trend: More middle-class Americans are deciding to have little or no insurance  This increases health care insurance premiums for those that remain insured  Downward spiral Changes coming from the 2010 Reform Law soon

34. Is there a solution? • What if we are willing to accept new ways for health care and insurance to be administered? • We will likely be able to increase security without giving up efficiency • Catastrophic insurance may be most important at reducing risk • Higher deductibles, co-payments, and co-insurance rates can decrease loss of efficiency

35. Is there a solution? • Is prevention the key? • Should people be encouraged to eat healthy? • Should healthy food be subsidized? • Should unhealthy food be taxed? • Are taxes on smoking and alcohol set at the optimal level? • Should some drugs be legalized, taxed, and regulated? • Tax money can be used for health care costs

36. Some parts of the reform package… • Another part of the solution: General requirement to have health insurance • Most firms must provide the option • Most Americans would be required to buy coverage • “Fairness” issue: Increased pooling • Companies are prevented from denying coverage due to pre-existing conditions

37. What will the reforms lead to? • Fewer downward spirals • Lower frequency of insured people paying uninsured’s costs  Possible reduction in insurance premiums • Probable net increase in use for services • Many more routine visits • Fewer ER visits

38. What is still needed? • Ways to deal with DWL due to not paying full cost • Policies to increase efficiency are needed • Figuring out how to pay for these reforms • Value added tax (VAT) needed? • Dealing with the high costs of the retiring Baby Boom generation

39. Summary • The government provides health care insurance for millions of Americans through Medicare and Medicaid • Some believe that every person should be able to access needed health care • Adverse selection and moral hazard are significant problems • Health reform efforts try to increase medical coverage • Paternalistic issues and efficiency are at odds with each other

40. Next lecture • Social Security • Chapter 11 • Read pages 227, 231-235, and 239-250 • History • Current structure • Long-run problems due to the graying of America • How people’s decisions differ with and without Social Security

41. Problem • Timothy has the following utility function • U(x, y) = x + (10,000y)½ • x denotes Timothy’s consumption on everything except health care • y denotes Timothy’s consumption on health care • Note: We assume no disutility from work

42. Problem • Timothy is currently working 1,500 hours per year • Hourly wage is $10 • He also receives government health care, valued at $3,000 per year • Timothy could work a second job for 700 hours per year • Hourly wage is $8 • With the second job, Timothy would make too much money for government health care

43. Problem • What should Timothy do? • We need to find Timothy’s highest possible utility working one job • …working both jobs

44. Problem: Working one job • Total wages: $15,000 • Total government health care: $3,000 • Total benefits: $18,000 • How does Timothy maximize utility if he has $18,000 in total benefits? • Note that at least $3,000 must go to health care • Maximize x + (10,000y)½ subject to x + y = 18,000 and y≥ 3,000

45. Problem: Working one job • Maximize x + (10,000y)½ subject to x + y = 18,000 and y≥ 3,000 • For now, ignore y≥ 3,000 • Maximize x + (10,000y)½ subject to x + y = 18,000 • Equivalent to Maximize 18,000 – y + (10,000y)½ • First order condition • –1 + 10,000½ / 2y½ = 0 • y = 2,500 • Since Timothy would only want $2,500 in care, he is constrained to take at least $3,000

46. Utility from working one job • Utility when x = 15,000 and y = 3,000 • 15,000 + (10,000 * 3,000)½ = 20,477

47. Working two jobs • Wages • $15,000 from first job • $5,600 from second job • $20,600 total

48. Working two jobs • Timothy’s maximization problem • Maximize x + (10,000y)½ subject to x + y = 20,600 • Notice that x and y only need to be nonnegative here • Maximize 20,600 – y + (10,000y)½ • First order condition is the same as with one job • y = 2,500

49. Working two jobs • What is Timothy’s utility if he works both jobs? • He spends $2,500 on health care • He has $18,100 left for everything else • Utility is 18,100 + (10,000 * 2,500)½ = 23,100

50. What should Timothy do? • Utility from one job: 20,477 • Utility from both jobs: 23,100 • Timothy should work the second job and give up his government health care