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Eight Questions You Should Ask About Our Health Care System
(Even If The Answers Make You Sick)
By Charles E. Phelps
Hoover Institution PressCopyright © 2010 Board of Trustees of the Leland Stanford Junior University
All rights reserved.
How Did We Get into This Mess, and Why Will It Get Worse?
At the writing of this book, Congress grapples to reform the U.S. health care system. Whatever it enacts will merely stand as the beginning of a long endeavor to change and control health care spending in the United States. History tells us as much: when Congress enacted Medicare and Medicaid in 1965, nobody understood the consequences, and subsequent legislation has massively changed the structure and purposes of both. During the same period, other large federal governmental health care systems also changed markedly, most notably health care and insurance for military personnel, retirees, and their families. We can expect nothing different from any nationwide reforms affecting the entire health care system.
In order to understand the likely consequences of federal legislation and the private sector response, it is useful to understand how the current system evolved and then to dig into some of the details about how the health care sector behaves. Subsequent chapters delve into some of these issues with a new slant: Eight Questions You Should Ask About Our Health Care System (Even if the Answers Make You Sick). Some of them have scary implications, but you do need to ask.
A quick overview
The U.S. health care sector is an amazing endeavor. It produces about one-sixth of the nation's Gross Domestic Product (GDP). If viewed as a separate country, it would rank as the seventh largest economy in the world, not far behind the United Kingdom and France and just ahead of Italy. It has not always been this way. Half a century ago, the United States and Canada spent about 6 percent of their GDPs on health care. Health spending in the United States has increased faster than that of other nations, and our 16 percent GDP share exceeds that of any other nation by a considerable amount.
Some of this comes as no surprise to those who have studied the U.S. health care system over the years. Figure 1.1 shows a remarkably strong pattern between per capita income and medical spending. It's easy to see that per capita income goes a long way toward explaining why the United States spends so much on health care: we are wealthier than any other nation, and wealth leads to more spending on health care in a very systematic fashion. But the United States sits far above the trend line drawn through the other countries in this graph.
One of the remarkable things about the data portrayed in Figure 1.1 is that the organization of the health carefinancing and delivery systems of the nations shown has almost nothing to do with per capita spending. Very close to the trend line, we find nations such as Canada (social insurance, private production of health care), Germany and Japan (mixed sources of insurance, private production of health care), Great Britain (social insurance and health care through the British National Health Service), and Sweden (county-level financing and control of health care). None of this seems to matter: per capita income tells almost the entire story, except for the United States.
That the United States sits far above the trend line suggests that something else affects our health care spending. One difference is compensation of our health care providers. Doctors in the United States have incomes significantly higher (relative to the average worker's income) than doctors in most other nations. We have a relatively decentralized financing system with no central budget constraints. We also invest more in technology. And we have different health habits. All of these things contribute to the United States' position above the trend line in Figure 1.1.
Despite common political rhetoric that "health care is a necessity" or "health care is a right," these data contain another surprise to many: health care acts much more like a luxury than a necessity. In standard economics jargon, spending on a necessity grows less rapidly than income growth, and spending on luxury goods grows faster than income growth. In these data, medical spending grows about 25 percent faster than the rate of income growth.
This graph contains a lesson for the future as well: as our per capita income grows in the future, so will our medical spending. Since we can expect income growth in the future (despite the recession of 2008–2009), we can expect growth in both the level of spending and the GDP share. It will inexorably grow no matter what governmental policies emerge or what reforms Congress might enact or modify through the years. Figure 1.1 tells us that.
Figures 1.2 and 1.3 show something even more disquieting. Despite outspending the rest of the world for medical care, our health outcomes are depressingly low. Whether measured by life expectancy at birth (Figure 1.2) or the more-responsive infant death rate (Figure 1.3), it is easy to see that we are not getting as much bang for the buck as other nations do. (As in Figure 1.1, the trend lines here go through the other countries in the graphs.) Many nations, in fact, have much lower infant mortality and higher life expectancy than the United States, often while spending about half as much per person as we do. This discrepancy between spending and outcomes drives much of the concern about our health care system.
One might ask if the life expectancy data in Figure 1.2 don't just reflect the infant mortality rates in Figure 1.3, but with pretty much the same outcomes in every country for those who survive birth. The answer again is a very disquieting "no." Figure 1.4 shows the graph of life expectancy at age twenty-five for the same countries graphed against medical spending per capita. The United States still looms as a larger outlier. Country number fifteen, Japan, again gets the best outcome for about half of our per capita spending. The predicted value for the United States using a line fitting the other twenty-five nations in this graph is ninety-two years of life expectancy (given our medical spending rates), versus the actual outcome of just under eighty-four years. Those eight years of missing life expectancy do not come from the higher infant mortality rates we have; they come from something else.
Nobody can rightfully claim to understand fully why we get such relatively poor results for our medical spending efforts. Many things contribute to our high spending and poor outcomes. The United States has a greater degree of population heterogeneity than do most other nations. Our lifestyle habits are better on some dimensions than other nations' (most notably regarding tobacco use) but worse on others (most notably obesity). Subsequent chapters in this book detail the importance of these lifestyle issues. All we need to know at this point comes directly out of Figures 1.1 — through 1.4: we spend much more per person than do other nations (much, but not all, of that difference arising because of our income level) and we don't have health outcomes as good as many other nations, all of whom we outspend.
Examining the spending changes: The overall change in dollars spent on health care over the past half century is mind-numbing. Table 1.1 shows the relevant data in decade-wide intervals from 1960 to 2010 (with a bit of extrapolation to the final numbers). A useful way to understand these changes parses out the shifts through time. Begin with the real mind-boggler: we have grown from $23 billion in 1960 to approximately $2.6 trillion by the end of 2010, the latter number 113 times larger than the former. How on earth did we get more than a hundred-fold increase in medical spending over a fifty-year period?
The second column of table 1.1 tells much of the story: it's simple inflation. If we adjust the data in column one so that everything appears in constant 2005 dollars, the earlier numbers rise (to adjust for inflation) so that the ratio of 2010 to 1960 spending is 15. A further adjustment assumes that the population was the same in 1960 as in 2010, hence taking out the effect of population growth in the numbers. The ratio now falls to 8.8, representing an annual compound growth rate of 4.4 percent.
The next column takes a potentially risky step: it adjusts for the change in the relative prices of medical care versus all other goods and services. If the Consumer Price Index (CPI) adjustment did this just right, this would adjust for changes in the relative payments to providers of health care (hospitals, doctors, etc.) for services with constant quality. But of course quality has changed immensely over that half century, and only some of those changes get captured in the CPI relative price adjustment. So some of the 8.8 factor is pricing of services and some of it is increases in quality. We have no really good way to tell how much of the 8.8 factor is quality change. What we do know is that after the relative price adjustment, we still see an increase by a factor of about 3.0 in medical spending in the past half century, even after making all of these adjustments. Adjusting finally for the shift in age mix (older people use more health care), we still have a 2.6 multiplier.
What does the 2.6 factor represent? Many observers (myself included) attribute this to changes in technology. The world of health care is vastly different now than it was in 1960. We have seen incredible changes in imaging tools for diagnosis, far-less-invasive surgery, new pharmaceutical treatments for physical and mental illnesses, and many other changes (a few of which Chapter Three goes over in more detail).
The point can be made simply: If you had your choice of 1960s medicine at 1960s prices or 2010 medicine at 2010 prices, which would you choose? For many (myself definitely included), the choice is simple: 2010 dominates 1960.
The baby boom's echo: One more factor affects both the past history of medical spending and projections into the future. The baby boom following the end of World War II had many consequences for our economy in the subsequent decades, but none more important than the effects on health care costs, past and future. Figure 1.5 shows the key data in what demographers call a population pyramid.
Reading these charts is easy and informative. The left side shows the number of males, the right side the number of females, and each "layer" shows a different age group, youngest at the bottom. Figure 1.5a shows the U.S. population in 1950. It looks like a classic population pyramid from age twenty upward. It is "thin-waisted" for the young age groups either with reduced birth rates (because many young potential fathers were overseas during World War II) or early deaths (of young soldiers). The bottom row of Figure 1.5a shows the beginning of the baby boom when the soldiers returned from the war and began to form families and father children.
Now fast-forward for fifty years to the 2000 population pyramid (Figure 1.5b). The pyramid (like many Americans) has a pretty nice set of "love handles" at its waist. That's the baby boomers in their forties. By 2025 (Figure 1.5c) they're aging into the Medicare set, and the pyramid has pretty much become a column. By 2050 (Figure 1.5d) the shape has completely changed, becoming very top-heavy.
The scary part of these population trends comes from the world of public finance. Members of the working-age population (those about twenty to sixty-five) support those layers below them (their children) and those above them (their parents and grandparents). The 1950 pyramid shows many workers to provide support for the non-workers. That still held in 2000, with the baby boomers in their prime productive years. By 2025, the ratio will have shifted considerably, and the projections to 2050 show a very large fraction of the population as non-workers compared with the fraction of working age.
Our system of Social Security in the United States is not a retirement program in the sense that people save and invest their own money for use in retirement years. Rather, it is partly a "pay as you go" system, with Social Security taxes on current workers funding the retirement payments to those beyond age sixty-five. The same is true of the Medicare Trust Fund, with the added wrinkle (if you'll pardon the expression) that as humans age, their use of medical care accelerates because their bodies wear out faster. The Social Security-like financing system works fine when the ratio of workers to non-workers is favorable, but it becomes more troublesome when the pyramid looks like the 2025 version, and is even more problematic in the 2050 version. The upper layer of the 2050 pyramid is particularly scary, since people over age eighty consume far more medical care than younger people do. Somehow the Medicare Trust Fund has to deal with these issues over time.
With these macro-economic issues out of the way (spending and population trends), let's look at health care as individuals know it. We'll look at things from the consumers' point of view, and then from the medical care suppliers' point of view.
Key issues on the consumers' side of the market
Health insurance changes the way we use health care: Most (but not all) people in the United States have health insurance of some sort to help pay for their medical costs. This insurance operates differently than other types of insurance. If you bang up your car or your home gets damaged, an appraiser (or several repair estimates) provides the basis for the insurance payment. Using a specific example, if the damage costs $2,000 to fix, the insurance company pays you $2,000 less any amount of deductible that the insurance plan you chose specifies (say, $500). Thus, $2,000 in damages gets you a check for $1,500. You can use it to fix the car or you can drive around with the damaged car and spend the $1,500 on food, a new refrigerator in your kitchen, a vacation weekend at some golf resort, or a case of really, really nice wine. But you don't have to fix your car to get the money. It's just money.
With health insurance, things don't work that way. Since there's no easy way for an appraiser to estimate the damage to your body, health insurance invariably pays a different way. It pays for medical care that you decide to buy. Sometimes you pay, for example, a $20 copayment for a doctor visit that would have cost $225 if you didn't have insurance. Sometimes the insurance pays for 80 percent of the doctor's bill, and you pay the remaining 20 percent. But in every case, it reduces the price you pay when you make the decision about getting treated. It's not "just money," but rather it's "funny money." You only get something from your insurance when you buy medical care.
To economists, this is a key issue. Health insurance reduces the price you pay at the point of purchase. That's how health insurance reduces the financial risk that arises from illnesses and injuries. But we know that when people face lower prices for things, they buy more. This is true also in health care. Chapter Two presents the evidence on how much this matters, but for now, we just need to know two things: health insurance reduces prices that people pay at decision time; and this affects their choices.
Taken to the extreme, it's easy to see how this works. When we make choices between buying a lower-cost Chevy or a really snazzy BMW, we ask ourselves, "Does the extra cost of the BMW bring me enough extra pleasure to justify the extra cost?" If so, we drive a BMW. If not, we drive a Chevy. But in medical care, the insurance causes us to ask a different question: "Can this procedure provide me with any possible benefit above the risks and pain of doing it?" If so, we tell the doctor, "Sure, go ahead." If not, we say, "No thanks, I'd rather just wait it out." Even if the insurance does not cover the procedure fully, the same type of shift occurs in most of the decisions we make with our doctors, dentists, and other health care providers.
Our health insurance comes from many sources: For many people in the United States, the government provides health insurance coverage. For those over sixty-five and some others, it's Medicare (about 36 million total). For many people in low-income families (about 42 million), it's Medicaid and the State Children's Health Insurance Program (SCHIP), both of which are state-federal partnerships with an income test. Active-duty and retired military personnel, reservists, and their families get coverage through TRICARE, and low-income veterans can receive care through the Department of Veterans Affairs. Through these and other programs, a bit over a quarter of the U.S. population currently has health care coverage from the government.
The bulk of health insurance in the United States comes through the places people work. Employer-provided health insurance covers about 157 million people (workers and their families) and has been the corner-stone of the health care financing system for well over half a century. For most workers, part of this cost comes as a deduction from their paychecks, but most of the cost is hidden as an "employer contribution." As shown in Chapter Four, this employer-based financing contains numerous pitfalls, but is nevertheless a staple of the U.S. health care system. About 14 million people just go out and buy health insurance as they would buy auto or homeowners' insurance. This is relatively more costly than employer-paid insurance for a number of reasons (most notably the higher administrative costs of dealing with people one at a time rather than in large-group purchases), and it carries no tax break, as does employer-paid insurance, so most people choose the employer-provided option when available, even if it's not exactly the insurance coverage they might choose on their own.
Excerpted from Eight Questions You Should Ask About Our Health Care System by Charles E. Phelps. Copyright © 2010 Board of Trustees of the Leland Stanford Junior University. Excerpted by permission of Hoover Institution Press.
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Table of Contents
Foreword by John Raisian
How Did We Get into this Mess, and Why Will It Get Worse?
When Is Less Insurance Better than More?
How Does Good Technology Go Bad? A Tale of Two Cities (and More)
Why Is the Employer-Paid Foundation of Health Insurance Riddled with Termites?
Do Dollars Distort Doctor’s Decisions?
Why Are We All Killing Ourselves? 105
Why Is Our K–12 Educational System a Public Health Menace?
Where Does the Congress Miss Opportunities and Hit Potholes?
About the Author
About the Hoover Institution’s Working Group on Health Care Policy