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Chapter 9

Government and Health Care

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Government Health Care Spending

Government spending represents 45% of the $1.3 trillion spent on Health Care.

20% of the Federal Budget is devoted to health care issues.

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

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Why Health Care is Different Uncertainty:

People do not typically know what their health care expenses will be. 

Insurance: Because of uncertainty (risk), people

typically buy health insurance. This means that people do not typically

pay the full marginal cost of their health expenses.

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Health Insurance Coverage

82% of Americans are covered.

44 million are uncovered.

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

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Problems with Health Insurance—(cont.) Adverse Selection People at greater risk for high health expenses will

purchase health insurance, even at very high premiums.

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

This problem can create a vicious cycle that drives insurance companies out of business and leaves people without health insurance.

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Problems with Health Insurance Asymmetric Information:

Sellers (health insurance companies) know more about the health industry needs than buyers of policies know.

This can lead to over-consumption, because doctors may prescribe unnecessary procedures.

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Figure 9.3 Health Insurance and the Market for Health Care

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P2

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C Loss in Net Benefits

Supply =Marginal

Social Cost

Demand = Marginal Social Benefit

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Problems with Health Insurance (cont.) Third-Party Payments

Neither the insured nor the physician has incentives to keep costs down.

This leads to over-consumption.

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

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

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Problems with Health Insurance (cont.) Moral Hazard

People with insurance often behave in ways that cause them to need the insurance.

People may fail to eat right or exercise, knowing that they have health insurance to help defray the monetary costs of such unhealthy decisions.

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Other Features Contributing to Inefficiency and High Cost

Malpractice Insurance: Doctors must pay high malpractice insurance premiums. These costs are passed on to health insurance companies and then on to patients in the form of higher insurance premiums.

Uninsured Patients: Doctors and hospitals that accept Medicaid patients are not able to deny service to patients based on patients’ ability to pay. 

Technological Advance: Third-party payments encourages over-consumption of health care services, which leads to over-

development of health care technology.

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Governments and Health Care: Compensating for Market Failure

Market Imperfection Government Reaction

Asymmetric Information FDA drug approval

Adverse Selection with the retired population

Medicare

Income Inequality Medicaid

Public Health Vaccinations and Research

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Why Worry About Growth in Health Care Costs? An increasing share of income is devoted to health

care, which implies other priorities lose out.

High health insurance costs for employers cause them to contract labor rather than hiring people outright.

Employees with a poor health history can be inefficiently locked into particular jobs.

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Program Spending in Billions

Medicare 238.0

Medicaid 224.3

Other

Total

99.6

561.9

Government Health Insurance

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Medicare 65 and older

40 million covered

Part A: Hospitals

Part B: Doctors

Prescription Drugs and Long-Term care not covered

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Cost Containment in Medicare Prospective Payments and the DRG

A Diagnosis Related Group is a broad type of illness.

Medicare pays hospitals based on DRG and payments are the same nationwide, regardless of actual costs.

This creates an incentive for hospitals to control costs, because if they succeed they get to keep the savings.

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Medicaid

Medicaid is health insurance coverage for the poor.

Eligibility is tied to household income. Children of low income parents can be

eligible, even if their parents are not.

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Controlling Medicaid Costs State government spending under the Medicaid

program has been increasing at an average annual rate of between 10% and 13% since 2001.

In some states (AZ, MS, NM, NC, WA) costs have risen between 30% and 50%.

To compensate, states have: reduced reimbursement rates to Medicaid providers; restricted reimbursement rates to providers of

prescription drugs; required special authorization for use of the drugs,

and required recipients to pay some of the costs.

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Indirect Government Subsidies of Health Care

  Because employer-paid health

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

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Taxable Income Lost to Governments

Figure 9.5 The Effect of Preferential Tax Treatment of Employer-Provided Health Insurance

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Demand forHealth InsuranceC

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Quantity of Health Insurance

225

Q1

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Health Care Reform Issues Controversy over health care reform and

the role of government in that process has centered around two issues: Controlling the growth of health care

spending to prevent health care from absorbing ever-increasing shares of our GDP

Moving toward universal coverage for Americans by making health insurance a government-guaranteed right for all citizens

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Impact of Coinsurance on Health Care Price

Low coinsurance rates cause patients to ignore health care costs.

This increases demand and encourages an inefficiently high level of consumption.

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Figure 9.6 How an Increase in Coinsurance Can Reduce Health Care Spending and Improve

Efficiency in the Market for Health Care Services

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Health Care Services per Year

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Controlling Costs Through Managed Care HMOs (Health Maintenance Organizations)

are forms of insurance that pay a “capitation” or fixed amount of money for every patient in their care. This puts pressure on HMOs and doctors to control costs.

PPOs (Preferred Provider Organizations) are forms of insurance that negotiate a reduced fee structure for participating physicians. 

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Controlling Medicare and Medicaid Expenses Medicare: Prospective payments for

DRGs Problem: encourages early discharge

and low levels of service Medicaid: Low reimbursement rates

reduce doctor incentives to provide service. Problem: reduces access to quality care

in many places

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Gaps in Coverage

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

It is one of only a few countries without universal health insurance guaranteed by government.

No long-term coverage.

Universal Coverage

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Tax Credits for Health Insurance One method to extend health insurance to the

uninsured is through government subsidies that lower the cost per policy.

A $2,000 per year subsidy could pay 84% of insurance policy costs for some families in some parts of the United States.

The subsidy could be added to the eligible recipient’s paycheck (like the EITC).

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U.K. System National Health Service Capitation paid to general practice

physician Universal coverage Specialists difficult to see Waiting lists for common operations;

low cancer survival rates Capital expenses budgeted by national

board.

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Canadian System Provincial governments administer the

system.

Costs shared by national and provincial taxes.

Waiting lists and shortages cause the wealthy to go to U.S. for service.

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Universal Entitlement Systems with Managed Competition

One way to provide universal coverage is to mandate that all employers provide insurance.

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

President Clinton’s (1993) plan was to couple mandates with proposals for managed competition to limit the growth of health care costs.

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National Health Insurance National health insurance in the United States would

ensure at least a minimal amount of health care.

National health insurance financed through taxation would benefit some Americans at the expense of others. Benefits:

Universal coverage Some would get better coverage than they have

now. Costs:

Higher taxes and tax-related distortions Rationing of care