Fannie Med? Why a "Public Option" Is Hazardous to Your Health

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No. 642                                       August 6, 2009

                                           Fannie Med?
          Why a “Public Option” Is Hazardous to Your Health
                                         by Michael F. Cannon

                                      Executive Summary

         President Obama and other leading Demo-              A health insurance “exchange,” where con-
     crats have proposed creating a new government         sumers choose between private health plans with
     health insurance program as an option for             artificially high premiums and a government pro-
     Americans under the age of 65, within the context     gram with artificially low premiums, would not
     of a new, federally regulated market—typically        increase competition. Instead, it would reduce
     described as a “National Health Insurance             competition by driving lower-cost private health
     Exchange.” Supporters claim that a new govern-        plans out of business. President Obama’s vision of
     ment program could deliver higher-quality             a health insurance exchange is not a market, but a
     health care at a lower cost than private insurance,   prelude to a government takeover of the health
     and that competition from a government pro-           care sector. In the process, millions of Americans
     gram would force private insurers to improve.         would be ousted from their existing health plans.
         A full accounting shows that government              If Congress wants to make health care more
     programs cost more and deliver lower-quality          efficient and increase competition in health
     care than private insurance. The central problem      insurance markets, there are far better options.
     with proposals to create a new government pro-           Congress should reject proposals to create a
     gram, however, is not that government is less         new government health insurance program—not
     efficient than private insurers, but that govern-     for the sake of private insurers, who would be
     ment can hide its inefficiencies and draw con-        subject to unfair competition, but for the sake of
     sumers away from private insurance, despite           American patients, who would be subject to
     offering an inferior product.                         unnecessary morbidity and mortality.

     Michael F. Cannon is director of health policy studies at the Cato Institute and coauthor of Healthy
     Competition: What’s Holding Back Health Care and How to Free It.
The central                                                               percent) are well below the overhead
      problem with                  Introduction                                  costs of large companies that are self-
                                                                                  insured (5 to 10 percent of premiums),
       proposals to        President Obama,1 Senate Finance Commit-               companies in the small group market
       create a new    tee chairman Max Baucus (D-MT),2 and other                 (25 to 27 percent of premiums), and
                       leading Democrats have proposed creating a new             individual insurance (40 percent of
       government      government health insurance program as an                  premiums).12
    program is that    “option” for Americans under the age of 65. This
   government can      program would operate within the context of a           Supporters claim they are willing to put gov-
                       new, federally regulated market—typically               ernment to the test by having it compete
            hide its   described as a “National Health Insurance               against private plans in the context of a new
 inefficiencies and    Exchange.” House Speaker Nancy Pelosi (D-CA)3           government-run “exchange.” President Obama
   draw consumers      and four House caucuses representing more than          claims that a new government program “gives
                       100 Democrats4 have stated that a new govern-           consumers more choices, and it helps keep the
away from private      ment health insurance program modeled on                private sector honest, because there’s some
insurance, despite     Medicare is the sine qua non of health care             competition out there.”13 The House Demo-
                       reform. Sixteen Democratic senators have signed         crats’ legislation would create a “public health
        offering an    a letter signaling their support.5 Senate Health,       insurance option” that would be “self-sustain-
  inferior product.    Education, Labor, and Pensions Committee                ing and compet[e] on [a] ‘level field’ with pri-
                       chairman Edward M. Kennedy (D-MA) has pro-              vate insurers.”14 Columnist E. J. Dionne writes,
                       posed legislation that would create such a pro-         “The public-option idea . . . would allow the
                       gram,6 as have three key House committees.7             United States to move gradually toward a gov-
                           Others have suggested that Congress                 ernment-run system if—and only if—a substan-
                       should adopt a different model. Senate Budget           tial number of consumers freely chose to join
                       Committee chairman Kent Conrad (D-ND)                   such a plan. The market would test the idea’s
                       and Sen. Charles Schumer (D-NY) have pro-               strength.”15
                       posed that Congress create one or more health-              A full accounting, however, shows that
                       insurance “cooperatives,” although each                 government programs are less efficient than
                       endorses different structures and different lev-        private insurance. Administrative costs are
                       els of government support. Cooperatives are             higher in government programs such as
                       member-run health plans that already exist in           Medicare, because they avoid administrative
                       many areas of the country; for instance, Group          activities that increase efficiency and incur
                       Health Cooperative already covers 580,000               other administrative costs that are purely
                       Americans in the states of Washington and               wasteful. Government programs also sup-
                       Idaho.8 Schumer proposes that Congress                  press innovation, and thereby reduce the
                       spend $10 billion to create a single nationwide         quality of care for all patients, whether pub-
                       cooperative, which would be governed by a fed-          licly or privately insured.
                       eral board and endowed with the power to use                The central problem with proposals to cre-
                       Medicare-like price controls.9 Conrad proposes          ate a new government program is not that
                       multiple cooperatives10 with start-up subsidies         government is less efficient than private insur-
                       in the neighborhood of $4 billion.11                    ers, however, but that government can hide its
                           Advocates of a new government health                inefficiencies and draw consumers away from
                       insurance program claim that government                 private insurance, despite offering an inferior
                       provides coverage more efficiently than the pri-        product. If the government plan’s premiums
                       vate sector. University of California–Berkeley          reflected its full costs—and private insurance
                       political scientist Jacob Hacker writes:                premiums reflected only their actual costs—
                                                                               there would be no reason not to let the gov-
                          The public Medicare plan’s adminis-                  ernment enter the market. As Dionne sug-
                          trative overhead costs (in the range of 3            gests, the market would test the idea’s

strength. Yet government possesses both the           new program to everyone, it could pull 120 mil-
power to hide its true costs (which keeps its         lion Americans out of private insurance—more
premiums artificially low) and to impose costs        than half of the private market.20 The share of
on its competitors (which unnecessarily push-         Americans who depend on government for
es private insurance premiums higher). It             their health care would rise from just over one-
makes no difference whether a new program             quarter to two-thirds.21 Many of those millions
adopts a “co-operative” model or any other.           would be involuntarily ousted from their cur-
The government possesses so many tools for            rent health plans—much like President Obama
subsidizing its own program and increasing            suggested ousting 10 million seniors22 from
costs for private insurers—and has such a long        their private Medicare Advantage plans and
history of subsidizing and protecting favored         forcing them into the traditional Medicare pro-
enterprises—that unfair advantages are                gram.23 Yet even those who voluntarily chose a
inevitable. This is in no small part because          new government program over their existing
supporters of a new government program                coverage would do so not because the govern-
want it to have unfair advantages.                    ment program provides better value for the
                                                      money, but because the government program
Literally Ousting Patients from Their                 would hide some of its cost.
Health Plans                                              A health insurance “exchange,” where con-
   In a speech to the American Medical                sumers choose between private health plans         Obama’s vision
Association, President Obama reiterated a             with artificially high premiums and a govern-      of a health
promise that he has made repeatedly since the         ment program with artificially low premiums,
2008 presidential campaign:                           would not increase competition. Instead, it        insurance
                                                      would reduce competition by driving lower-         exchange is not a
   No matter how we reform health care,               cost private health plans out of business.
   we will keep this promise to the                   President Obama’s vision of a health insurance
                                                                                                         market, but a
   American people. If you like your doc-             exchange is not a market, but a prelude to a       prelude to a
   tor, you will be able to keep your doc-            government takeover of the health care sector.     government
   tor, period. If you like your health care          In the process, millions of Americans would be
   plan, you’ll be able to keep your health           ousted from their existing health plans, and all   takeover of the
   care plan, period. No one will take it             would suffer the consequences of government-       health care
   away, no matter what.16                            run health care.                                   sector.
After the Congressional Budget Office estimated
that as many as 15 million Americans could lose                 Is Government
their existing coverage under Senator Kennedy’s                 More Efficient?
legislation,17 the Associated Press reported,
“White House officials suggest the president’s           Supporters of a new government program
rhetoric shouldn’t be taken literally.”18             note that private insurers spend resources on a
    Indeed, a new government program would            wide range of administrative costs that govern-
literally oust millions of Americans from their       ment programs do not. These include market-
current health plans and threaten their rela-         ing, underwriting, reviewing claims for legiti-
tionships with their doctors, as employers            macy, and profits. The fact that government
choose to drop their current employee health          avoids these expenditures, however, does not
plans and as private health plans close down. A       necessarily make it more efficient. Many of the
Lewin Group analysis estimated that Obama’s           administrative activities that private insurers
campaign proposal would move 32 million               undertake serve to increase the insurers’ effi-
Americans into a new government-run plan.19           ciency. Avoiding those activities would there-
Lewin subsequently estimated that if Congress         fore make a health plan less efficient. Existing
used Medicare’s price controls and opened the         government health programs also incur

administrative costs that are purely wasteful.                 costs may come at a price. 28
                      In the final analysis, private insurance is more
                      efficient than government insurance.                        CMS further estimates that it made $10.4 bil-
                                                                                  lion in improper payments in the fee-for-ser-
                      Administrative Costs                                        vice Medicare program in 2008.29
                          Time magazine’s Joe Klein argues that “the                 Medicare keeps its measured administra-
                      profits made by insurance companies are a                   tive-cost ratio relatively low by avoiding
                      good part of what makes health care so expen-               important administrative activities (which
                      sive in the U.S. and that a public option is need-          shrinks the numerator) and tolerating vast
                      ed to keep the insurers honest.”24 All else being           amounts of wasteful and fraudulent claims
                      equal, the fact that a government program                   (which inflates the denominator).30 That is a
                      would not need to turn a profit suggests that it            vice, yet advocates of a new government pro-
                      might enjoy a price advantage over for-profit               gram praise it as a virtue.31
                      insurers. If so, that price advantage would be                 Medicare also keeps its administrative
                      slight. According to the Congressional Budget               expenditures down by conducting almost no
                      Office, profits account for less than 3 percent             quality-improvement activities. Journalist
                      of private health insurance premiums.25                     Shannon Brownlee and Obama adviser Ezekiel
                      Furthermore, government’s lack of a profit                  Emanuel write:
                      motive may not be an advantage at all. Profits
                      are an important market signal that increase                   [S]ome administrative costs are not only
                      efficiency by encouraging producers to find                    necessary but beneficial. Following
                      lower-cost ways of meeting consumers’                          heart-attack or cancer patients to see
                      needs.26 The lack of a profit motive could lead                which interventions work best is an
                      a government program to be less efficient than                 administrative cost, but it’s also invalu-
                      private insurance, not more.                                   able if you want to improve care.
                          Moreover, all else is not equal. Government                Tracking the rate of heart attacks from
                      programs typically keep administrative expen-                  drugs such as Avandia is key to ensuring
                      ditures low by avoiding activities like utilization            safe pharmaceuticals.32
                      or claims review. Yet avoiding those activities
                      increases overall costs. The CBO writes, “The               According to the CBO, private insurers spend
                      traditional fee-for-service Medicare program                nearly 1 percent of premiums on “medical
                      does relatively little to manage benefits, which            management.”33 The fact that Medicare
                      tends to reduce its administrative costs but may            keeps administrative expenditures low by
                      raise its overall spending relative to a more tightly       avoiding such quality-improvement activities
                      managed approach.”27 Similarly, the Medicare                may likewise result in higher overall costs—in
                      Payment Advisory Commission writes:                         this case by suppressing the quality of care.
                                                                                      Supporters who praise Medicare’s appar-
                         [The Centers for Medicare & Medicaid                     ently low administrative costs often fail to note
                         Services] estimates that about $9.8 billion              that some of those costs are hidden costs that
                         in erroneous payments were made in the                   are borne by other federal agencies, and thus
                         fee-for-service program in 2007, a figure                fail to appear in the standard 3-percent esti-
       In the final      more than double what CMS spent for                      mate.34 These include “parts of salaries for leg-
                         claims processing and review activities. In              islators, staff and others working on Medicare,
  analysis, private      Medicare Advantage, CMS estimates that                   building costs, marketing costs, collection of
insurance is more        erroneous payments equaled $6.8 billion                  premiums and taxes, accounting including
    efficient than       in 2006, or approximately 10.6 percent of                auditing and fraud issues, etc.”35
                         payments. . . . The significant size of                      Also, Medicare’s administrative costs
      government         Medicare’s erroneous payments suggests                   should be understood to include the dead-
        insurance.       that the program’s low administrative                    weight loss from the taxes that fund the pro-

gram. Economists estimate that it can easily              istrative burden of government health insurance       Medicare hides
cost society $1.30 to raise just $1 in tax revenue,       programs conclude that administrative costs are       its higher
and it may sometimes cost as much as $2.36                far higher in government programs than in pri-
That “excess burden” of taxation is a very real           vate insurance. In 1992, University of                administrative
cost of administering (i.e., collecting the taxes         Pennsylvania economist Patricia Danzon esti-          costs from
for) compulsory health insurance programs                 mated that total administrative costs were more
like Medicare, even though it appears in no               than 45 percent of claims in Canada’s Medicare
                                                                                                                enrollees and
government budgets.                                       system, compared to less than 8 percent of            taxpayers, and
    Comparing administrative expenditures in              claims for private insurance in the United            public-plan
the traditional “fee-for-service” Medicare pro-           States.40 Pacific Research Institute economist
gram to private Medicare Advantage plans can              Ben Zycher writes that a “realistic assumption”       supporters rely
somewhat control for these factors. Hacker                about the size of the deadweight burden puts          on the hidden
cites a CBO estimate that administrative costs            “the true cost of delivering Medicare benefits [at]   nature of those
are 2 percent of expenditures in traditional              about 52 percent of Medicare outlays, or
Medicare versus 11 percent for Medicare                   between four and five times the net cost of pri-      costs when they
Advantage plans. He writes further: “A recent             vate health insurance.”41                             argue in favor
General Accounting Office report found that                   Administrative costs can appear quite low if
in 2006, Medicare Advantage plans spent 83.3              you only count some of them. Medicare hides
                                                                                                                of a new
percent of their revenue on medical expenses,             its higher administrative costs from enrollees        government
with 10.1 percent going to nonmedical expens-             and taxpayers, and public-plan supporters rely         program.
es and 6.6 percent to profits—a 16.7 percent              on the hidden nature of those costs when they
administrative share.”37                                  argue in favor of a new government program.
    Yet such comparisons still do not establish
that government programs are more efficient               Cost Containment vs. Spending
than private insurers. The CBO writes of its              Containment
own estimate: “The higher administrative costs                Advocates of a new government health care
of private plans do not imply that those plans            program also claim that government contains
are less efficient than the traditional FFS pro-          overall costs better than private insurance.
gram. Some of the plans’ administrative                   Jacob Hacker writes, “public insurance has a
expenses are for functions such as utilization            better track record than private insurance
management and quality improvement that                   when it comes to reining in costs while pre-
are designed to increase the efficiency of care           serving access. By way of illustration, between
delivery.”38 Moreover, a portion of the                   1997 and 2006, health spending per enrollee (for
Medicare Advantage plans’ administrative                  comparable benefits) grew at 4.6 percent a year
costs could reflect factors inherent to govern-           under Medicare, compared with 7.3 percent a year
ment programs rather than private insurance.              under private health insurance.”42 In fact, looking
For example, Congress uses price controls to              at a broader period, from 1970 to 2006, shows
determine how much to pay Medicare                        that per-enrollee spending by private insur-
Advantage plans. If Congress sets those prices            ance grew just 1 percentage point faster per
at supracompetitive levels, as many experts               year than Medicare spending, rather than 2.7
believe is the case,39 then that may boost                percentage points.43 That still omits the
Medicare Advantage plans’ profitability                   1966–1969 period, which saw rapid growth in
beyond what they would earn in a competitive              Medicare spending.
market. Those supracompetitive profits would                  More importantly, Hacker’s comparison
be a product of the forces that would guide a             commits the fallacy of conflating spending and
new government program—that is, Congress,                 costs. Even if government contains health care
the political system, and price controls—rather           spending better than private insurance (which
than any inherent feature of private insurance.           is not at all clear), it could still impose greater
    Economists who have tallied the full admin-           overall costs on enrollees and society than pri-

vate insurance. For example, if a government              compared with [private insurance].”47 Patients
                     program refused to pay for lifesaving medical             with Medicaid coverage experience more
                     procedures, it would incur considerable non-              unmet medical needs than similar patients
                     monetary costs (i.e., needless suffering and              with private insurance.48 Studies have found
                     death). Yet it would look better in Hacker’s              that Medicaid patients suffer worse outcomes
                     comparison than a private health plan that                than similar privately insured patients when it
                     saved lives by spending money on those ser-               comes to cancer,49 unstable angina,50 and
                     vices. Medicare’s inflexibility also imposes              coronary artery bypass graft surgery.51 The
                     costs on enrollees. Medicare took 30 years                Veterans’ Health Administration appears to
                     longer than private insurance to incorporate              outperform private insurance on some dimen-
                     prescription drug coverage into its basic bene-           sions of quality,52 but exhibits serious defi-
                     fits package. The taxes that finance Medicare             ciencies in others.53 President Obama’s secre-
                     impose costs on society in the range of 30 per-           tary of Health and Human Services, Kathleen
                     cent of Medicare spending.44 In contrast, there           Sebelius, has called the government-run
                     is no deadweight loss associated with the vol-            Indian Health Service a “historic failure.”54
                     untary purchase of private health insurance.                  Nevertheless, supporters make the demon-
                         Hacker nods in the direction of nonspend-             strably false claim that government programs
    Medicare and     ing costs when he writes, “Medicare has main-             are more innovative than private insurance.
other government     tained high levels of . . . patient access to             Hacker writes, “Medicare has been slow to
        programs     care.”45 Yet there are many dimensions of qual-           adopt quality innovations—though generally
                     ity other than access to care. It is in those areas       quicker than private health plans.”55 Peter
    uniformly lag    that government programs impose their                     Harbage and Karen Davenport of the Center
  private insurers   greatest hidden costs, on both publicly and               for American Progress cite Medicare’s policy
                     privately insured patients.                               on “never events”—severe medical errors that
   when it comes                                                               should “never” happen—as proof of govern-
        to quality   Government Programs Suppress Quality,                     ment’s superior ability to promote quality:
     innovations.    Cost Lives                                                “Witness steps such as Medicare’s refusal to
                        Supporters also claim that government                  pay medical care providers for ‘never events,’
                     programs outperform private health insur-                 where a patient suffers a knowable and cata-
                     ance on quality. On the surface, the quality of           strophic mistake, such as having the wrong
                     medical care in government programs tends                 limb removed. This is something other major
                     to be similar to, or worse than, the quality of           insurers are now adopting.”56
                     care under private insurance. This may be                     In reality, Medicare and other government
                     largely due to the fact that government pro-              programs uniformly lag private insurers when
                     grams uniformly lag private insurance in                  it comes to quality innovations. For example,
                     adopting quality innovations. Beneath the                 private insurers began experimenting with
                     surface, however, government programs sup-                “pay-for-performance” financial incentives
                     press the quality of care for all patients,               almost an entire decade before Medicare.57
                     whether publicly or privately insured.                        “Never events” provide an even clearer illus-
                        Researchers estimate that patients receive             tration. In 2003, an estimated 181,000 severe
                     high-quality, evidence-based care only about              medical errors occurred in hospitals alone.58
                     half of the time, regardless of whether they are          Throughout its 43-year history, Medicare has
                     enrolled in Medicare, Medicaid, or private                actually encouraged such errors by financially
                     insurance.46 A recent Minnesota study found,              rewarding health care providers when an error
                     however, “On eight of the nine statewide mea-             leads to more services, and financially penaliz-
                     sures, performance in achieving high-quality              ing providers who reduce error rates.59 In
                     care was significantly lower at both the                  October 2008, Medicare eliminated those per-
                     statewide and medical group levels for                    verse incentives for a short list of medical
                     [Medicaid and other government programs]                  errors called “never events.” That policy will

likely discourage some medical errors by forc-               such patients to only 1 in 25, down from
ing providers to pay for some of the associated              nearly 1 in 6. But the reduction has been
costs. Yet the first private health plan to force            a losing proposition. Although the
providers to bear the full financial cost of all             effort saved Medicare roughly $5 million
medical errors was offered by the Ross-Loos                  a year, Park Nicollet is not paid to pro-
Clinic in 1929.60 Kaiser Permanente has done                 vide the follow-up care. Meanwhile, few-
so since the 1940s. Medicare didn’t even play a              er returning hospital patients mean low-
leading role on “never events” among fee-for-                er revenue for Park Nicollet. “We’ve kept
service plans, as Harbage and Davenport                      it up out of a sense of moral obligation
claim. HealthPartners of Minnesota stopped                   to these patients, but we’re getting
paying for “never events” in January 2005.61                 killed,” said David K. Wessner, chief
Medicare merely followed suit.                               executive of Park Nicollet. “We will total-
                                                             ly run out of gas.”62
Stagnation Costs Lives
    Government programs are not merely slow                  Medicare suppresses countless quality
to innovate, they are outright hostile to quali-          innovations by making them “a losing
ty innovations. Government programs inject                proposition.”
rigidity into health care markets that sup-                  A free market would use competition from
presses the quality of care for publicly and pri-         different methods of paying providers to keep
vately insured patients alike. The result is              those perverse incentives in check. Under “pre-
greater morbidity and mortality.                          payment” or “capitation,” for example,
    This can be seen most clearly in the way gov-         providers receive a flat fee to provide medical
ernment suppresses competition between dif-               care for a given patient or group of patients.
ferent methods of paying doctors, hospitals,              Group Health Cooperative is an example of an
and other health care providers. As noted above,          integrated, prepaid health plan. Prepayment
Medicare financially rewards medical errors               rewards providers for avoiding unnecessary
and penalizes error-reduction efforts because it          and harmful services: whatever money
pays providers on a fee-for-service basis. Fee-for-       providers save by avoiding medical errors, for
service payment, as the name suggests, means              example, the providers get to keep. It is no
that providers collect an additional fee for each         coincidence that prepaid health plans, like
additional service they provide. Conversely, if           Kaiser Permanente, lead the market in innova-
providers deliver fewer services, they collect less       tions such as coordinated care and electronic      Government
revenue. Fee-for-service payment thus creates a           medical records, which help avoid unneces-
perverse incentive: if low-quality care (e.g., a          sary services. Prepayment also creates its own
                                                                                                             programs inject
medical error, poor coordination between                  perverse incentive: providers get to keep what-    rigidity into
providers, insufficient attention to medical evi-         ever money they save by denying access to          health care
dence) results in a patient requiring more ser-           needed care as well. In a free market, however,
vices, then low-quality providers will receive            competition from fee-for-service providers         markets that
more revenue than providers who adopt quali-              would force them not to stint on necessary         suppresses the
ty innovations. According to the New York                 care. By the same token, competition from
Times, for example:                                       prepaid plans would force fee-for-service
                                                                                                             quality of care for
                                                          providers to coordinate care, offer electronic     publicly and
   Park Nicollet Health Services, a hospital              medical records, and avoid medical errors.         privately insured
   and clinic system based in St. Louis Park,                Government health insurance programs—
   Minn[esota] . . . started . . . spending as            principally Medicare—block competition             patients alike.
   much as $750,000 annually on more                      between different payment systems, and there-      The result is
   nurses and on sophisticated software to                fore dramatically reduce the quality of care. As   greater morbidity
   track heart failure patients after they left           the largest purchaser of medical services in the
   the hospital. It reduced readmissions for              United States, Medicare accounts for two-          and mortality.

Harbage and      thirds to four-fifths of revenues for many hos-         Medicare program promotes quality care
  Davenport write      pitals and specialties.63 Medicare’s influence is       alongside cost containment.”65 That is precise-
                       so vast that hospitals and other providers              ly the problem. A new government program
         that a new    organize the delivery of medical care around            would suppress quality, just as Medicare has,
       government      the financial incentives it creates. Providers          by further stifling competition between pay-
                       like Park Nicollet Health Services cannot stay          ment systems. Sebelius says that making
    program “will      in business by providing high-quality coordi-           Medicare “a strong and sustainable program
  create incentives    nated care, because that means less revenue             depends on our ability to fix what’s broken in
       for effective   from Medicare. Because privately insured                the rest of the system.”66 Sebelius has it exact-
                       patients use the same doctors and hospitals,            ly backward: Medicare is what’s broken in the
 performance just      that means Medicare suppresses the quality of           rest of the system.
          as today’s   care even for privately insured patients.64                 We need not look to Canada to find horror
                           The main reason that the U.S. health care           stories about government-run health care.
Medicare program       sector lacks coordinated care, electronic med-          Estimates of 100,000 deaths each year in the
 promotes quality      ical records, and comparative-effectiveness             United States from medical errors should be
    care alongside     research is that government rewards providers           frightening enough.67 A new government pro-
                       who avoid these quality innovations and                 gram, whether modeled on Medicare or not,
cost containment.”     penalizes providers who adopt them. The                 would further suppress health care quality
  That is precisely    main reason that as many as 100,000                     and cause additional morbidity and mortality.
      the problem.     Americans die from medical errors each year is
                       that the nation’s largest health care purchaser
                       rewards providers who tolerate medical errors                The Fair-Competition
                       and punishes providers who reduce them.                            Fantasy
                           Congress cannot solve this problem by
                       reforming Medicare’s payment system, creat-                 President Obama admits, “I think there can
                       ing a new program that uses a different pay-            be some legitimate concerns on the part of pri-
                       ment system, or attempting to incorporate               vate insurers that if any public plan is simply
                       such competition into a government program.             being subsidized by taxpayers endlessly, that over
                       All methods of paying health care providers             time they can’t compete with the government
                       create perverse incentives. If Medicare or a new        just printing money.”68 Nevertheless, supporters
                       program adopts the payment system used at               claim that Congress can create a new govern-
                       Group Health Cooperative, Congress will                 ment program that competes with private insur-
                       merely trade the perverse incentives of fee-for-        ers on a level playing field. The “Blue Dog
                       service payment (uncoordinated care, medical            Coalition” of moderate House Democrats has
                       errors) for those of prepayment (less provider          offered several criteria that a new program would
                       choice, greater rationing). Only competition            have to satisfy in order to do so.69 The Blue Dogs
                       between different payment systems can hold              insist, for example, that the program would have
                       those perverse incentives in check. Yet govern-         to be completely self-sustaining (i.e., premium
                       ment programs like Medicare and Medicaid                revenue would cover all costs), that the govern-
                       stifle such competition. Medicare Advantage             ment not leverage its market power to favor the
                       attempts to allow such competition, yet differ-         new program, and that government not enact
                       ent health plans with different payment sys-            any regulations that favor a new government
                       tems constantly lobby Congress for special              program over private insurers. Supporters such
                       advantages. Meanwhile, politicians, such as             as Len Nichols and John Bertko of the New
                       President Obama, propose eliminating such               America Foundation claim that a new program
                       competition entirely.                                   can satisfy those conditions.70
                           Harbage and Davenport write that a new                  Yet the government need neither subsidize
                       government program “will create incentives              its own program with taxpayer money, nor
                       for effective performance just as today’s               newly printed money, nor must it do so “end-

lessly,” to supplant private insurance with an            Direct Subsidies
inferior option. Indeed, government has count-               Among the many ways that Congress
less other ways to prevent the true cost of a new         could favor a new government program is
program from appearing in its premiums, and               through direct subsidies—that is, real
to increase the premiums of its competitors.              resources provided to the government pro-
Moreover, government’s long history of subsi-             gram, yet withheld from private insurers:
dizing, protecting, and bailing out favored
enterprises shows that such special advantages               •   The federal and state governments
would be inevitable. For example, Amtrak                         finance Medicaid and the State
requires repeated taxpayer subsidies to stay                     Children’s Health Insurance Program
afloat.71 And Congress famously bailed out                       almost entirely through tax revenue. As
Fannie Mae and Freddie Mac.                                      a result, those programs crowd out pri-
    Congress has made Medicare increasingly less                 vate insurance among individuals who
self-sustaining over time. When Congress creat-                  could otherwise obtain coverage on their
ed Medicare in 1965, enrollee premiums covered                   own.75 Likewise, taxpayer subsidies fund
50 percent of the cost of physician services.                    nearly 90 percent of Medicare spending,
Under pressure from Medicare enrollees, subse-                   which helps that program almost com-
quent Congresses gradually reduced that share                    pletely crowd out private health insur-      Government has
to 25 percent. The U.S. Postal Service is similarly              ance for the elderly.76                      countless ways to
unable to sustain itself. According to one critic:           •   Creating a new program around
                                                                 Medicare’s existing infrastructure, as       prevent the true
   Make no mistake . . . the Postal Service is                   some supporters propose, would bestow        cost of a new
   not self-sufficient. It is kept afloat by a                   start-up subsidies not available to new      program from
   number of hidden taxpayer subsidies.                          private health plans.77 Senator Schumer
   For starters, it has a monopoly on First                      has insisted that a government-spon-         appearing in its
   Class and Standard mail. No private                           sored “co-operative” receive $10 billion     premiums, and to
   company can deliver a letter for less than                    in start-up subsidies.
   $3 or twice what USPS charges, whichev-                   •   The leading Democratic proposals
                                                                                                              increase the
   er is greater. . . . Meanwhile, USPS is                       would create a “risk-adjustment” mech-       premiums of its
   immune from antitrust lawsuits and                            anism that would essentially tax all         competitors.
   exempt from taxes on its massive real-                        health plans to compensate those that
   estate holdings. . . . It enjoys power of                     attract a disproportionate share of high-
   eminent domain. And it doesn’t even                           cost patients and/or that do little to
   pay parking tickets.72                                        reduce wasteful expenditures.78 Whether
      It calculates the amount of corporate                      a new government program proves to be
   income tax it would owe if it were a pri-                     more attractive to high-cost patients or
   vate company—and then pays that                               does a poorer job of controlling unnec-
   amount to itself.73                                           essary expenditures, the risk-adjustment
                                                                 program could easily become a tool for
Likewise, state governments have repeatedly                      taxing private insurers to subsidize the
crowded out private insurance in markets for                     government plan.
workers’ compensation insurance, crop and                    •   When estimating Medicare’s adminis-
flood insurance, and reinsurance for medical                     trative costs, the federal government
malpractice and natural disasters, according                     does not count the cost of activities
to University of Pennsylvania economist                          undertaken by other federal agencies to
Scott Harrington, because “the public sector                     support Medicare.79 If the government
is supported by various types of subsidies or                    fails to include such costs when calculat-
special rules that allow it to compete with the                  ing the premiums for a new program,
private sector.”74                                               that would constitute an implicit sub-

sidy and enable the new program to set                drives prices higher for private insurers.82
                            its premiums below its true costs.                    Whatever the case, such price controls
                                                                                  would increase the cost of private insur-
                       To the extent that a new government pro-                   ance relative to a new government pro-
                    gram receives direct subsidies that are not                   gram.
                    available to private insurers, its relative cost          •   Tightening the price controls that
                    would also be higher due to the deadweight                    Medicaid uses to purchase prescription
                    loss of taxation, yet that added cost likewise                drugs, or expanding those price controls
                    would not appear in the government pro-                       into either Medicare or a new govern-
                    gram’s premiums.                                              ment program, would likewise increase
                                                                                  costs for the new program’s private com-
                    Indirect Subsidies                                            petitors. The price controls that
                        To subsidize a new government program,                    Congress imposes on drug purchases
                    Congress need not hand it bags of cash or use                 through the Medicaid program have the
                    creative accounting when setting premiums.                    effect of increasing prices for private
                    Congress can instead subsidize its program                    insurers by an estimated 15 percent.83
                    indirectly, whether by granting it special status             The Senate Finance Committee has sug-
                    or increasing its competitors’ costs:                         gested tightening this price control,84
                                                                                  while House Energy and Commerce
                        •   The taxpayer subsidies and other advan-               Committee chairman Henry Waxman
                            tages granted to Medicare give the feder-             (D-CA) has proposed importing those
                            al government a degree of market power                price controls into Medicare.85 Either
                            that private insurers cannot match. That              move would further increase costs for
                            market power in turn creates opportuni-               private insurers.
                            ties for Congress to grant other special          •   Any new program would come with an
                            advantages to a new government pro-                   implicit guarantee that Congress would
                            gram. Many supporters propose that a                  bail it out if premiums proved insuffi-
                            new program should adopt price con-                   cient to cover its costs. Hacker argues for
                            trols identical or similar to Medicare’s,             an explicit bailout guarantee when he
                            or that the federal government should                 writes that reserve requirements “would
                            require providers to participate in the               not make sense for the public health
                            new program as a condition of Medicare                insurance plan, which has the full faith
                            participation.80 Sen. Jay Rockefeller (D-             and credit of the federal government
                            WV) proposes to let a new program use                 behind it.”86 Even if the bailout guaran-
                            Medicare’s price controls for two years,              tee were only implicit, that would enable
                            and to require doctors who participate                the new program to set its premiums
                            in Medicare to participate in the new                 below costs. According to a 1996
                            program for three years;81 yet those time             Treasury Department report signed by
                            frames could easily be extended to four               Larry Summers, who is now President
                            years, six years, or beyond. Leveraging               Obama’s National Economic Council
       Adopting             the special advantages granted to                     chairman, a similar implicit guarantee
   Medicare-like            Medicare would enable a new govern-                   saved Fannie Mae and Freddie Mac an
   price controls           ment program to achieve a level of                    estimated $6 billion per year.87
                            provider participation at a lower cost                Meanwhile, private insurers would effec-
  would increase            than private insurers.                                tively face higher reserve requirements
  the prices that       •   Adopting Medicare-like price controls                 than the government program.
providers charge            would also increase the prices that               •   Unlike many private insurers, govern-
                            providers charge private insurers. Experts            ment programs pay no taxes. The pres-
private insurers.           disagree about the exact mechanism that               ence of corporate income taxes, invest-

ment taxes, etc., increases the price of           playing field between a government program           The only
        private insurance relative to a govern-            and private insurers could never be level. The       rationale for
        ment program. The CBO estimates that               Medicare Advantage program allows private
        taxes account for 1.2 percent of private           insurers to compete with the traditional, gov-       having Congress
        health insurance premiums, on aver-                ernment-run Medicare program. The playing            construct a new
        age.88 Government could further advan-             field shifts depending on whether the party in
        tage its program by raising taxes on pri-          power prefers government or private insur-
                                                                                                                health plan is to
        vate insurers, such as through the special         ance. In 2003, President George W. Bush and a        create socially
        tax on insurance-company profits pro-              Republican Congress adopted fairly high price        harmful
        posed by Senator Schumer.89                        controls for the Medicare Advantage plans.
    •   Government can increase the effective              More recently, a Democratic Congress has             competition
        cost of private insurance by imposing              sought stricter price controls. President            whose objective is
        penalties on consumers who choose it               Obama even proposed to throw private plans           a government
        instead of the government plan. Federal            out of Medicare entirely, which is not so much
        regulations penalize seniors who opt out           a level playing field as it is a cliff.              takeover of the
        of Medicare to obtain private health                   Nichols and Bertko admit that the playing        U.S. health care
        insurance by taking away their Social              field isn’t level in Medicare Advantage due to
        Security benefits, past and future.90              congressional interference, and they claim that
        That penalty exists in spite of a provision        such interference is “not inherent in public-pri-
        in the Medicare statute called, “Option            vate competition.”93 Yet when Congress creates
        to Individuals to Obtain Other Health              a federal health insurance program and a fed-
        Insurance Protection,” which reads:                eral bureaucracy to craft and enforce the rules
        “Nothing contained in this title shall be          of competition between that program and pri-
        construed to preclude . . . any individual         vate plans, nothing is more inherent to such a
        from purchasing or otherwise securing,             scheme than Congress and its whims.
        protection against the cost of any health              If wise philosopher-kings could somehow
        services.”91                                       create a new government health insurance pro-
                                                           gram and (permanently) deny it of any special
    Even if Congress could create a new govern-            advantages, it would cease to be a government pro-
ment program with no special advantages, a                 gram. It would be just another private insurer. If
truly level playing field would require a credible         that is what supporters of a new government
guarantee that no future Congress and no                   program want, there is no need for Congress to
future regulator would ever confer any special             act. Supporters can gather investors and
advantages on that program. Given the bailout              launch their own private health plan right now.
craze of 2008–2009, it is not credible to suggest          The only rationale for having Congress con-
the government would not bail itself out if pre-           struct a new health plan is to create socially
miums were insufficient to support the new                 harmful competition whose objective is a gov-
program’s outlays. That public perception                  ernment takeover of the U.S. health care sector.
would itself create an implicit bailout guaran-
tee, and redound to the exclusive benefit of a
new government program. Moreover, today’s                                Conclusion
Congress cannot bind future Congresses.
Supporters of a new program know this, and                    A new government program would sup-
they are already contemplating future efforts              plant private insurance, despite offering inferi-
to secure special advantages for any new pro-              or care at a higher cost. The program would
gram that Congress creates.92                              attract consumers not by virtue of its superior
                                                           performance, but by government’s ability to
Medicare Advantage                                         prevent the full cost of its program from
  Medicare Advantage demonstrates that the                 appearing in enrollee premiums and its ability

to increase the cost of private options. As the          sake of American patients, who would be sub-
                      new program’s artificially low premiums                  ject to unnecessary morbidity and mortality.
                      crowd out private insurance, the government
                      would exert even greater downward pressure
                      on quality. Any new government health insur-                                  Notes
                      ance program would shortly lead to a govern-             1. See Obama ’08, “Barack Obama and Joe Biden’s
                      ment takeover of health insurance markets—               Plan to Lower Health Care Costs and Ensure
                      and the entire health care sector.                       Affordable, Accessible Health Coverage for All,”
                          No one should be surprised. President      
                      Obama has repeatedly affirmed his preference
                      for a single-payer, government-run health care           2. Max Baucus, “Call to Action: Health Reform
                      system, such as exists in Canada.94 Many peo-            2009” (white paper, Senate Finance Committee,
                      ple, including New York Times columnist Paul             November 12, 2008),
                      Krugman, support a new government pro-
                      gram precisely because they believe it will lead         3. Ryan Grim, “Pelosi: Health Care Reform Can’t
                      to a single-payer system.95 Hacker has                   Pass Without Public Option,” Huffington Post,
                      quipped, “Someone once said to me, ‘This is a            June 11, 2009,
If Congress wants     Trojan Horse for single-payer,’ and I said,
    to make health    ‘Well, it’s not a Trojan Horse—it’s right there!
                      I’m telling you: we’re going to get there, over          4. “Caucuses Unite behind Public Health Insurance
         care more                                                             Plan Option” (press release, The Congressional
                      time, slowly.’”96
      efficient and       If Congress wants to make health care more
                                                                               Black Caucus, April 28, 2009), http://www.
           increase   efficient and increase competition in health             news/04_28_09_Public_Plan_ Option.html.
                      insurance markets, there are far better options.
    competition in    Congress should let consumers—rather than                5. Sherrod Brown, “Letter to Senator Kennedy
  health insurance                                                             and Senator Baucus,” April 29, 2009, http://
                      employers or the government—control their      
markets, there are    health care dollars and choose their health plan.
                      It should convert Medicare into a program that           6. Ceci Connolly, “Kennedy Readies Health-Care
far better options.   gives seniors a voucher and frees them to pur-           Bill,” Washington Post, June 6, 2009, http://www.
                      chase any health plan on the market.97                   2009/06/05/AR2009060504036.html; and Senate
                      Reforming the tax treatment of employer-spon-            Committee on Health, Education, Labor, and
                      sored insurance with “large” health savings              Pensions, “Affordable Health Choices Act,” http://
                      accounts would give workers the thousands of   
                      dollars of their earnings that employers cur-            7. House of Representatives Committee on Ways
                      rently control, and likewise free workers to pur-        and Means, “Key Features of the Tri-Committee
                      chase any health plan on the market.98 Finally,          Health Reform Draft Proposal in the U.S. House
                      Congress should expand competition by pro-               of Representatives,” June 9, 2009, http://waysand
                      hibiting states from denying market entry to
                      health plans and providers licensed by other             8.Group Health, “Group Health Overview,” http://
                      states—that is, by making clinician and health- view/
                      insurance licenses portable across state lines.99        index.jhtml.
                      Those reforms would reduce costs, increase               9. Dana Bash and Ted Barrett, “Negotiations over
                      innovation, and reduce the number of unin-               Health Insurance Co-Ops at Impasse,”,
                      sured—without higher taxes or additional gov-            June 23, 2009,
                      ernment spending.                                        TICS/ 06/23/
                          Congress should reject proposals to create a         10. Kent Conrad, “Bridging the Divide with a
                      new government health insurance program—                 Cooperative Health Care Proposal” (press release, June
                      not for the sake of private insurers, who would          30, 2009),
                      be subject to unfair competition, but for the            record.cfm?id=315210&.

11. Kevin Sack, “Health Co-op Offers Model for              com/content/publications/LewinCostand
Overhaul,” New York Times, July 6, 2009,                    CoverageImpactsofPublicPlan-Alternative%20                    DesignOptions.pdf.
policy/07coop. html.
                                                            21. Author’s calculations based on Carmen
12. Jacob S. Hacker, “The Case for Public Plan              DeNavas-Walt, Bernadette Proctor, and Jessica
Choice in National Health Reform: Key to Cost               Smith, “Income, Poverty, and Health Insurance
Control and Quality Coverage,” Center for Health,           Coverage in the United States: 2007,” U.S. Bureau
Economic and Family Security, University of                 of the Census, August 2008, p. 61, http://
California–Berkeley School of Law, and the Institute
for America’s Future, December 16, 2008, p. 5,          22. Kaiser Family Foundation, “Medicare Fact
Public_Plan_Choice.pdf.                                     Sheet: Medicare Advantage,” April 2009, http://
13. Reed Abelson, “A Health Plan for All and the
Concerns It Raises,” New York Times, March 24,              23. President-elect Obama opined, “We’ve got to
2009,             eliminate programs that don’t work, and I’ll give
policy/25medicare.html.                                     you an example in the health care area. We are
                                                            spending a lot of money subsidizing the insurance
14. House of Representatives Committee on Ways              companies around something called Medicare
and Means, “Key Features of the Tri-Committee               Advantage, a program that gives them subsidies to
Health Reform Draft Proposal in the U.S. House of           accept Medicare recipients but doesn’t necessarily
Representatives,” June 9, 2009, p. 3, http://               make people on Medicare healthier. And if we elim-               inate that and other programs, we can potentially
                                                            save $200 billion out of the health care system that
15. E. J. Dionne Jr., “Not Yesterday’s Health               we’re currently spending, and take that money and
Fight,” Washington Post, April 23, 2009, http://www.        use it in ways that are actually going to make peo-                  ple healthier and improve quality. So what our
2009/04/22/AR2009042203091.html. Emphasis                   challenge is going to be is identifying what works
in original.                                                and putting more money into that, eliminating
                                                            things that don’t work, and making things that we
16. “Remarks by the President at the Annual                 have more efficient.” ABC News, This Week with
Conference of the American Medical Association”             George Stephanopolous, January 12, 2009, http://
(White House press release, June 15, 2009),                        8cb4275f6a44ad3.
Conference-of-the-American-Medical-Association/.            24. Joe Klein, “The Fire This Time: Is This Health
                                                            Care’s Moment?” Time Magazine, May 7, 2009, http://
17. Congressional Budget Office (letter to the    ,8599,
Honorable Edward M. Kennedy, June 15, 2009, p.              1896574,00.html.
06-15-HealthChoicesAct.pdf.                                 25. Congressional Budget Office, “Key Issues in
                                                            Analyzing Major Health Insurance Proposals,”
18. Ricardo Alonso-Zaldivar, “Promises, Promises:           December 2008, p. 69,
Obama’s Health Plan Guarantee,” Associated                  docs/99xx/doc9924/12-18-KeyIssues.pdf.
Press, June 19, 2009,
hostednews/ap/article/ALeqM5gK8UACQa5gEv1                   26. If profits fail to serve that purpose in private
cZ-SRxXDc3XDwRw D98TPSP80.                                  health insurance markets, the reason may be that
                                                            government gives employers control over 70 per-
19. The Lewin Group, “McCain and Obama                      cent of all spending on private health insurance,
Health Care Policies: Cost and Coverage Com-                which forces insurers to respond to the needs of
pared,” October 15, 2008, p. ES-3, http://www.              employers more than consumers. U.S. Centers for                    Medicare & Medicaid Services, “Sponsors of
McCain- Obama_Health_Reform_Report_and_                     Health Care Costs: Businesses, Households, and
Appendix.pdf.                                               Governments, 1987–2007,” http://www.cms.hhs.
20. John Sheils and Randy Haught, “The Cost and             g07.pdf; and author’s calculations.
Coverage Impacts of a Public Plan: Alternative and
Design Options,” The Lewin Group Staff Working              27. Congressional Budget Office, “Key Issues,” p. 93,
Paper no. 4, April 8, 2009, http://www.lewin.     

12-18-KeyIssues.pdf. Emphasis added.                         36. Martin Feldstein, “How Big Should Govern-
                                                             ment Be?” National Tax Journal 50, no. 2 (June
28. Medicare Payment Advisory Commission,                    1997): 197,
Report to the Congress: Medicare Payment Policy,             nsf/36CFE3E5BCCB188C85256863004A5939/
March 2009, p. 12,              $FILE/v50n2197.pdf.
                                                             37. Hacker, “The Case for Public Plan Choice,” p. 6,
29. Lewis Morris (testimony before Senate Finance  
Committee, U.S. Department of Health and                     Public_Plan_Choice.pdf.
Human Services, Office of the Inspector General,
April 21, 2009, p. 2),            38. Congressional Budget Office, “Designing a
hearings/testimony/2009test/042109lmtest.pdf.                Premium Support System for Medicare,” Decem-
                                                             ber 2006, p. 12,
30. The Department of Health and Human                       76xx/doc7697/12-08-Medicare.pdf.
Services’ Office of the Inspector General estimates
that every $1 it spends on Medicare audits saves tax-        39. Medicare Payment Advisory Commission,
payers $17. Morris, p. 1, http://finance.senate.             Report to the Congress: Medicare Payment Policy,
gov/hearings/testimony/2009test/042109lmtest.                March 2009, p. 252,
pdf. A rational health care purchaser would keep             ments/Mar09_EntireReport.pdf.
increasing such audits until $1 of oversight yielded
exactly $1 of savings—in economic jargon, the mar-           40. Patricia M. Danzon, “Hidden Overhead Costs: Is
ginal return would be $1. Unfortunately, the OIG             Canada’s System Really Less Expensive?” Health
does not calculate the marginal return on invest-            Affairs 11, no. 1 (Spring 1992): 40, http://
ment for Medicare audits. Donald B. White,         
Department of Health and Human Services’ Office
of the Inspector General, Public Affairs, e-mail mes-        41. Benjamin Zycher, “Comparing Public and
sage to author, July 9, 2009. However, the average           Private Health Insurance: Would A Single-Payer
return on investment is not only high, but has been          System Save Enough to Cover the Uninsured?”
steadily rising in recent years. U.S. Department of          Manhattan Institute Medical Progress Report no. 5,
Health and Human Services, Office of the Inspector           October 2007, http://www.manhattan-institute.
General, “FY 2010 Online Performance Appendix,”              org/html/mpr_05.htm. Private health insurance             in the United States is no doubt less efficient than
FY2010_online_performance_appendix.pdf. At a                 it could be. Danzon writes, “Although there may
minimum, that raises the question of whether                 well be waste in U.S. private insurance markets, it
Medicare underinvests in claims auditing.                    is attributable primarily to tax and regulatory fac-
                                                             tors and is not intrinsic to private health insur-
31. On the vices of government health insurance              ance.” Danzon, p. 40. Yet Medicare’s administra-
programs, see generally, David A. Hyman,                     tive costs are still higher.
Medicare Meets Mephistopheles (Washington: Cato
Institute, 2006).                                            42. Hacker, “The Case for Public Plan Choice,” p. i,
32. Shannon Brownlee and Ezekiel Emanuel, “5                 Public_Plan_Choice.pdf. Emphasis in original.
Myths about Our Ailing Health Care System,”
Washington Post, November 23, 2008, http://www.              43. Medicare Payment Advisory Commission, Report to                   the Congress: Medicare Payment Policy, March 2009, p. 10,
2008/11/20/AR2008112002420.html.                             h t t p : / / m e d p a c . g ov / d o c u m e n t s / M a r 0 9 _
33. Congressional Budget Office, “Key Issues,”
pp. 69–70,               44. See, for example, Amy Finkelstein and Robin
9924/12-18-KeyIssues.pdf.                                    McKnight, “What Did Medicare Do? The Initial
                                                             Impact of Medicare on Mortality and Out-of-Pocket
34. Hacker is a notable exception. See Hacker, “The          Medical Spending,” Journal of Public Economics 92, no.
Case for Public Plan Choice,” p. 6, http://institute.        7 (2008): 1660, http://econpapers.                eeepubeco/v_3a92_3ay_3a2008_3ai_3a7_3ap_3a1
Choice.pdf.                                                  644-1668.htm.
35. Mark E. Litow, “Medicare versus Private                  45. Hacker, “The Case for Public Plan Choice,” p. i,
Health Insurance: The Cost of Administration,”     
Milliman, January 6, 2006, p. 4, http://www.cahi.            Public_Plan_Choice.pdf.
TechnicalPaper.pdf.                                          46. Asch et al., “Who is at Greatest Risk for

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