Anyone who wants to understand fiscal policy in the United States for the next fifty years will need to understand health care costs. There are many important issues in tax policy – the income/consumption debate, whether and how to tax wealth (especially at death), how to deal with transfer-pricing problems, when to tax capital gains, how to handle tax protesters, and so on – but the single issue that is going to drive tax policy is health care inflation.
Scary proclamations that the U.S. faces a “long-term fiscal crisis” are actually statements that health care costs could ruin the economy. If health care costs stop increasing – either by government action or because of some “natural” maturation process in the medical-industrial complex – then there is no long-term fiscal crisis. The so-called Social Security crisis is an over-hyped non-event, as I have argued elsewhere, and as even the most serious budget hawks will admit. Nothing else in the budget (certainly not “waste, fraud, and abuse”) even comes close to justifying alarm about the long-term need to raise taxes. It is all about health care.
Of course, the health care cost crisis is really a crisis for the whole economy, not just the federal and state governments. Even if we were to raise taxes to cover all government health care expenditures, the scariest predictions about health care costs indicate that half of the economy’s resources will be dedicated to health care long before the end of this century. Of course, there are good reasons to be skeptical about any long-run forecast, especially one that predicts such an extreme result. If there is going to be a long-term fiscal crisis in the United States, however, it will be because health care costs have continued to spin out of control.
This basic fact – that the politics of tax policy will be driven largely by health care costs – suggests that tax policy scholars in the United States (and possibly elsewhere) need to expand their knowledge base to include some fundamentals about how health care works (and fails to work) in this country. An extremely good place to start is with Atul Gawande’s article from The New Yorker, “The Cost Conundrum.” Gawande is a Harvard Medical School professor who has written on health care issues for, among others, The New York Times op-ed page. His analysis of the challenges facing health care provides a bracing insight into the ways that bad policy choices interact with self-interest to produce a terrible combination of high costs and bad health outcomes.
Although written for a non-academic audience, and although written by a medical doctor, Gawande’s article is in some ways among the best empirical social-science writing available. As has become the trend in many economics departments, he exploits a “natural experiment,” that is, a situation where two outcomes can be compared meaningfully because the underlying facts of the two situations are otherwise so similar. (A natural experiment, therefore, mimics a controlled laboratory experiment by “holding constant” other possible explanations for an observed outcome.)
The natural experiment in question is the difference in health care costs between two cities in Texas: McAllen and El Paso. McAllen is the second-most expensive city in the country for per-person health care costs, behind only Miami, which has much higher labor and living costs. By contrast, El Paso’s health care costs are only one half of McAllen’s. Gawande spends much of the article exploring the various reasons that might explain the difference between the two cities’ health care costs. It turns out that both cities have similar poverty rates, racial and ethnic profiles, high-fat diets, and nearly every other possible factor that could explain a difference in health care costs.
Notably, because both of these cities are in the same state, the doctors and hospitals in each city are operating under the same medical malpractice laws. When I gave a talk on this subject at a conference in Jackson, Mississippi, earlier this year, an otherwise extremely receptive audience turned a bit icy when I denied that malpractice is a meaningful explanation for rising American health care costs. No matter how one reads the national evidence, however – and for what it is worth, credible evidence suggests that perhaps 1% of the growth in health care costs is explained by malpractice costs – this explanation cannot possibly explain the difference in costs between two cities in the same state – a state, by the way, that has already adopted aggressive “tort reforms” in response to assertions that malpractice costs are driving up health care costs.
Gawande narrows down the list of possible explanations to one: the fee-for-service model in U.S. health care reimbursements. If you are a doctor and you want to earn money with a Medicare patient, the rules set up a very simple incentive structure: the more you do to the patient, the more you will be paid. If you do unhelpful and even dangerous things, such as surgeries that have a low chance of fixing the problem, you will be paid. If you need to go back and fix something that would not have needed fixing but for your first medical intervention, you will be paid again. Your income has nothing to do with your patients’ health.
There are, of course, professional ethics to consider, as well as anti-fraud provisions in the reimbursement rules. What Gawande shows, however, is that an entire city can work within the rules and run up its costs to twice the level of another (extremely similar) city’s costs, because the latter city’s doctors and hospitals have simply not yet responded as strongly to the income-producing incentives inherent in the fee-for-service system. Worse, he shows that El Paso (the low-cost city) is moving in the direction of McAllen, with medical professionals in El Paso finding it nearly impossible to continue to resist the financial incentives in the system.
No single article, and no pair of cities, can explain health care inflation. If you are looking for a place to start to understand the myriad of issues underlying America’s biggest fiscal time bomb, however, you could do much worse than starting with this extremely engaging article.