Health Care Spending Is Out of Control

Health insurance doesn't just protect people from financial ruin. It insulates them from individual decisions about price and service quality.

Health care in America costs too much because we pay for it the wrong way. And it's all but certain that we're going to continue doing so for a very long time.

The crux of the problem is third-party payment, or, as most people think of it, insurance. Health insurance doesn't just protect people from financial ruin. It insulates them from individual decisions about price and service quality. Those decisions become invisible, outsourced to a middleman—either a private insurer or a federal program—while the patient whose health is at stake is removed from the equation. The result is a system where prices are inscrutable, if they can even be called prices at all.

The dominance of third-party payment is almost entirely a result of two policy decisions that have warped the nation's health care system for decades.

The first was the decision, in the wake of World War II wage and price controls, to allow employers to provide fringe benefits, including health coverage, tax-free. This created an incentive for employers to provide more expansive and more expensive coverage. It made an extra dollar in salary, which would be subject to taxes, worth less than an extra dollar in benefits, which did not incur taxes.

The result is that most private insurance is provided through employers, and it tends to be reasonably comprehensive, covering everything from ordinary doctor visits to foreseeable surgeries to truly catastrophic events. Because employers and insurers manage the costs for everything, patients have little incentive to shop based on prices or quality, which can be difficult to determine anyway. In addition, employers typically pay a large share of the monthly premium, meaning that tens of millions of people are kept ignorant about not only the cost of medical services but the true price of the insurance itself.

The second policy decision was the introduction of Medicare (and, to a lesser extent, Medicaid) in the 1960s. Medicare expanded a system of government-run third-party payment to seniors, who, for understandable reasons, consume an outsized share of health care services.

Initially, that system was designed to ensure profitability for America's hospitals and health care providers, paying them based on self-reported costs plus a guaranteed-percentage markup. Later, the system imposed price controls, but not caps on total spending or volume.

The result was a huge new revenue stream for the health care industry, which rapidly reorganized itself around extracting funds from the program—which is to say, from American taxpayers—by any means possible. In the first year alone, average daily charges for U.S. hospitals shot up by 21.9 percent, according to professors Ted Marmor of Yale and Jon Oberlander of the University of North Carolina at Chapel Hill. The rate of growth of physician fees more than doubled in the year between the law's passage and Medicare going into effect. During the first five years of the program's existence, reimbursements through the program grew by 72 percent, while enrollment grew by just 6 percent.

And the program kept on growing, accounting for a larger and larger proportion of both the federal budget and total national health spending. If the latter had grown at pre-Medicare rates, the United States would be spending just $220 billion today, according to Charles Silver of the University of Texas at Austin and David A. Hyman of the University of Illinois. Instead, the figure is a staggering $3.4 trillion, or about 18 percent of the economy.

In their recent book, Overcharged: Why Americans Pay Too Much for Health Care (Cato), Silver and Hyman argue that the U.S. health system is best understood not as a means of delivering the best possible care but as a system for funneling as much money to health care providers as possible. Medicare, they note, will pay for countless expensive in-hospital tests and treatments for a dying individual but not less expensive palliative care offered in that same individual's home.

There are few meaningful checks on doctor reimbursements under the program; fraud and waste are pursued after the fact (if at all), which means doctors can always be assured of payment. The tax carve-out for employer-sponsored insurance pushes people into more comprehensive coverage, which increases overall demand for health care services, which makes health care providers more money. The American Medical Association, a lobbying group for doctors, controls Medicare's price-fixing system. In the case of some specific maladies, hospitals don't focus on preventive services, because the payment system is designed so that it brings in more revenue to treat patients who are already sick with a disease. Until very recently, Medicare had no system for judging the quality of the care it paid for.

It was as if the system was designed with only one goal in mind—maximizing not health or patient satisfaction but the amount of money Americans spend on health care. The fiscally ruinous results speak for themselves.

Silver and Hyman argue that retail delivery of health care services represents the best hope for injecting true market mechanisms into the current mess. Only retail—from cosmetic surgery to Lasik—has managed to keep prices down. They note that the Surgery Center of Oklahoma, a clinic that posts prices online and focuses on patients who pay cash, charges less than $20,000 for a knee replacement; the average price paid across the country is $57,000.

Direct payment by quality-conscious consumers is an effective way of bringing down costs and total spending. Which is exactly why it will never happen at scale.

Obamacare was billed as a way of solving some of these problems, but it has largely failed to hold costs down. Its primary attempt to mitigate the distortionary effects of the tax break for employer coverage, an excise tax on high-end plans, has been delayed repeatedly under pressure from unions and other groups.

Heading into the 2020 election, Democrats have proposed multiple ways of expanding Medicare, including pushing Medicare for All, a single-payer system in which the government finances nearly all health care services in the United States. The moderate position among Democrats is either to allow more non-seniors to buy into the program or to start a "public option"—a new government-run health care plan that would operate alongside the regulated plans sold through Obamacare's exchanges.

Republicans, meanwhile, often seem in thrall to medical lobbying groups, which vehemently resist any effort to reduce total expenditures. The failed 2017 effort to "repeal and replace" Obamacare would have left much of its infrastructure, including most of its spending, in place. President Donald Trump altered his plan to renegotiate drug prices after hearing from pharmaceutical lobbyists. There may be reasonable explanations for some of these decisions, but the larger pattern is clear: Any effort to slow the growth of, much less actually reduce, health care spending dies under a combination of industry and political pressure.

The best hope for change is very bleak indeed. Medicare is racing toward a predictable fiscal crisis. The program's actuaries predict it will be insolvent in 2026, able to pay only about 89 percent of its bills. That percentage will drop below 80 percent in the coming decades.

The system as it exists today, in other words, is unsustainable. It simply can't go on like it is—and if Congress continues to do nothing, it won't.