The Health Care ..II Ta Ie Of COIl'len 1.5

Introduction by John A. Tatom, Ph.D.

Second Thoughts on Public Systems pg 9 by David Gratzer, Ph.D.

Consumer Directed Health Care pg 23 by John C. Goodman, Ph. D.

The implications of Paying 101" Current Medicare pg 32 by Thomas R. Saving, Ph.D.

Health Care Reform in the United States: Why, When, and How? pg 44 by Douglas J. Holtz-Eakin, Ph.D.

The Ills of America's Heali:h Care System: Root Causes and Potential Cures by Sydney Taurel

1 Rising health care costs and the dysfunctional system that the United States uses to pay for it have made health care financing one of the big­ gest problem that faces the nation's policymakers, employers and house­ holds today. Health care expenditures reached 16 percent of GDP in 2006. In the absence of policy reform, expenditures are expected to rise to 20 to 33 percent of GDP over the next 25 years, as baby boomers move into their retirement years and the relative price of health care services con­ tinues to rise rap idly. Compounding the baby boomer effects on demand are the way that we pay for health care, which largely separates demand from price, and the technology explosion, which in creases available treat­ ments but is not allowed to cut the costs of production, management, dis­ tribution or payment for health care services. Such a climb in the cost of health care would make health care expenditures the largest component of national spending, larger than national expenditures on food or housing as a share of income. The number is projected to continue to climb over the subsequent 50 years.

Networks Financial Institute sponsored a Financial Forum, The Health Care Financing Bomb: Where's the Money (or the Solution)?, on August 29, 2006 in Indianapolis to discuss this problem and possible solutions to the health care funding debacle. Three leading national experts presented papers on the extent, source and possible solutions for the current and future problem of outsized spending and financing of health care. They are John Goodman, Founder and President of the National Center for Policy Analysis, David Gratzer, a practicing psychiatrist and Senior Fellow at the Manhattan Institute, and Professor Thomas R. Saving, Director of Texas A&M's Private Enterprise Research Center, Distinguished Professor,

2 and the Jeff Montgomery Professor of Economics. Professor Saving also has been a Public Trustee of the Social Security and Medicare Trust Funds since 2000. In addition, Douglas Holtz-Eakin, until recently the Director of the Congressional Budget Office and now the Director of the Maurice R. Greenberg Center for Geoeconomic Studies and Pau l A. Volker Cha ir of International Economics at the Council of Foreign Re lations, presented the keynote address. Th is volume contains the three papers, the keynote address, and the remarks of Sidney Taurel, Chairman and Chief Executive Officer of Eli Lilly and Company, presented to the Indiana University Business Conference, March 8, 2006, in Indianapolis and pub­ li shed in July 2006 as Networks Financial Institute Policy Brief 2006-PB- 12.

A recent paper by Professor Laurence Kotlikoff, te llingly titled "Is the United States Bankrupt?" (July/August issue of the Federal Reserve Banl< of St. Louis Review), argues the affirmative case, largely based on the US comm itments for Medicare, as well as other unfunded commitments for future outlays. In addition to the inadequate financing possibilities for this health care program, the financing for the rest of health care threatens bankruptcy for many more households in the future.

The US is bankrupt in the sense that the government's promised future benefits have a present value in excess of the dedicated funding commit­ ted to paying those benefits. We are simply not at the point where the Treasury cannot pay the bills. There are steps that can be taken that will eliminate this bankruptcy and there is unanimity that these steps will be taken. For all federal programs or for the health care financing bill, the positive news is that what cannot happen, will not happen. Something will change to stave off bankruptcy; the hard question is, what will change, and how much will those actions cost? The principal issue explored in this vol­ ume is how to fix the current financing system to reduce the problem and how to reform it so that bankruptcy can be removed. It is equally impor­ tant to hold down the future cost of health care without jeopardizing inno­ vation and the quality of health care. Finally, solutions to these questions must first confront how the nation got into its financing problem, to seek ways to stop it from growing and to begin to turn it around . These papers I confront all of these aspects of the health care financing bomb.

Any reform of health care financing will have to fall especially heavily on the federal government. Some analysts believe that this is so because of a national consensus that our founding fathers were correct that life, libeliy, the pursuit of happiness and health care are inalienable rights, or perhaps that we or our political leadership subsequently agreed that we would treat health care as such. Neither is historically accurate; no such I' right has ever been discovered or claimed in discussions of the penumbra

3 of natural rights or of US constitutional rights. Nevertheless, the federal government has come to be responsible for nearly half of the financing of health care because of its Medicare and Medicaid programs and its programs for federal employees and retirees. Moreover, through employ­ ment laws, the government has given us a system that disproportionately relies on employer-sponsored health insurance. That is changing, but the indirect effects of these interventions has altered both demand and sup­ ply conditions, so that the quantity and price of health care have exhibited explosive and ultimately unsustainable growth. The entry of baby boom­ ers into the ranks of the aged, where the share of health care demand is greatest and where the financing falls most heavily on government, places the solution even more inevitably on the shoulders of the federal govern­ ment.

C(QHIl ~ llJJ m~ rr ~ M IlJJ~ ~ D rr~v ~ H ~Sl ~ Ull CSl rr ~ Dr. John C. Goodman, often credited as the "father of the Health Savings Account," examines the depth of the health care deficit today as well as how consumer driven behaviors are beginning to change the health care landscape. Goodman notes that all governmental spending today, includ­ ing defense, education , etc., represents approximately 30 percent of GOP. But he indicates that health care costs alone will likely exceed this share of GOP by the year 2050, an impossible expense for the economy to incur. Goodman argues for a consumer driven approach to health care, where more health care decisions and responsibilities are shifted from the doctor to the patient.

Dr. Goodman describes the current, third-party payment system as one hindered by bureaucracy and inefficiencies, noting that more than 7,500 individual physician tasks are codified by Medicare. Variances in billing practices, a lack of consistent quality in coverage, poor technology and the lack of a transparent pricing structure are among the weaknesses of the current system. "The problem is not the doctor, it's the system that pays the doctors," he notes.

Demographics are another key factor impacting health care. As the baby boom generation begins to retire and employers continue to restrict their employee benefit programs, Goodman predicts that the baby boomers will drive a change in the insurance industry. While health insurance has tra­ ditionally been considered a fringe benefit, its declining availability means that employees increasingly are staying in a job or selecting a job based on the coverage offered . Goodman says that it is not so much the cost of the health care as the difficulty in accessing it that is impacting American consumers. "Health ca re can be free or accessible, but not both. We're providing it nearly free, but it's not easy to get." Portability of insurance

4 as employees retire or change jobs is likely to be a significant issue in the years to come. Of the 77 million baby boomers, 80 percent will retire before becoming eligible for Medicare. Employer-defined contributions to health savings accounts are likely to become much more common in the future, according to Goodman.

Goodman points to some signs indicative of a more consumer driven approach to managing health care. In 2005, 95 million Americans con­ ducted online medical research. The practice of securing online consulta­ tions and online second opinions is also beginning to emerge. Some drug and diagnostic manufacturers are developing self-monitoring devices and new online options for prescribing drugs and even ordering blood tests. The emergence of fee-based concierge health services, telephone/online physician visits and minute clinics are also impacting the way consumers receive their health care.

l~§§©rrIl§ le~rril!eca1 fr©m C~n~ca1~ ~ 1i'ilca1 lE~r©p~ Dr. David Gratzer, a practicing psychiatrist, is a native Canadian and well-versed in the single-payer health care system. The overriding mes­ sage from Dr. Gratzer: single-payer systems are not the panacea sup­ porters purport them to be. He points to the steady emergence of private clinics in Canada as a signal that government-sponsored health care is not serving the needs of its citizens. On average, one private clinic is introduced in Canada each week and the newly-elected President of the Canadian Medical Association has been among the staunchest critics of publicly-funded health care programs. Gratzer indicates that excessive waits - measured in days for ER visits and months for important tests - a shortage of doctors, lower investments in research and technology, and outmoded equipment are a few of the problems created by central plan­ ners responsible for building and sustaining Canada's health care system. "Universal health care is proven to create a surge in demand. Planners are unable or unwilling to invest the dollars necessary to support that surge," Gratzer notes. The problems are not specific to Canada but also are apparent in other countries with socialized medicine. Gratzer cited survivor rates for diseases such as prostate cancer in the US versus other countries. The mortality rate for prostate cancer in the US is less than 20 percent; in Germany and Britain, survival rates are only 35% and 40% respectively. Similarly, women who get breast cancer are likely to be diag­ nosed later in Canada and Europe and to have lower survival rates than in the US.

According to Gratzer, politicization, whereby popular drugs become cov­ ered at the expense of less well-known drugs, frequently occurs in a universal funding environment. Health care clinics and facilities in rural areas with fewer voters are usually among the first to close due to budget-

5 ary constraints. Bureaucracy - Gratzer cites, for example, a Manitoba law that requires investments above $10,000 be approved by a province treasury - further bog down the system and hinder innovation. Gratzer concludes that socialized medicine would negatively impact care, impede research and development and not result in a more satisfied marl

Wh®rrte wm ~h te M~li'ille1f C~mte fll"@m? Professor Saving, a member of the Board of Trustees of the Social Security and Medicare Trust Funds since 2000, surveys the implications of growing Medicare costs as the first baby boomers reach Medicare eligibility in 2011 . Proposals that address this funding by focusing on tax increases would fall most heavily upon younger workers. Existing taxes would have to rise by more than 60%. Alternatively, if the retired benefi­ ciaries of Medicare had to bear the projected cost increases, middle- and low-income retired people would lose more than all of their Social Security to make the necessary payment for Medicare, and even the highest Social Security recipients would have to give back 80 percent of their Social Security checks to pay for the increases in the cost of Medicare under existing official arrangements. Obviously the existing arrangements are not sustainable, according to Saving. Such large tax increases or benefit cuts cannot occur.

Other proposals on the table include means-based premium increases and raising the age to qualify for Medicare eligibility. "Raising the age of entry by a few years will not significantly impact costs," Saving states, nor would premium increases be well received by older voters. Saving echoes the "individual consumer" messages of Goodman and Gratzer. "When buyers don't care what it costs, neither do the sellers . The trans­ parency of pricing in the health care market is a key problem," he stated. "Imagine seeing a hospital billboard that adveliised what a room stay costs every day before you check in," he writes.

LJJ § 1R.~1~lrm: Why? Wh reff1 ~Ii'ild H@w? Dr. Douglas Holtz-Eakin led studies of Medicare and its reform for the US Congress until recently. His keynote address and paper look at why reform is necessary, when reform should occur and the general nature of the reforms that are likely. He reiterates that the cost and expenditures for Medicare are likely to rise so much that the Medicare program would be a greater share of federal spending than all existing federal spending is today. Such a change, together with a likely increase of the overall health care burden to 55 percent of US spending and output over the next 50 years, is unsustainable.

6 Holtz-Eakin shares the other participants' conclusions that reform is inevi­ table and he suggests that for both economic and political reasons the time for change is now. Otherwise, he explains, the three basic pillars of the US economy, a large and robust private sector and low taxes and pub­ lic spending compared with other developed countries, will be in jeopardy. When baby boomers start to qualify for Medicare in 2011, the unsustain­ ability of the system and its threat to the strength of the underpinnings of the economy will emerge very quickly. To avoid this will require that actions begin right away.

Holtz-Eakin discusses several steps to reform Medicare, emphasizing the role of consumer-driven health care and more market-based solutions. He suggests that how we transition to providing long-term health care is going to be the litmus test of reform because currently this care is largely provided outside the market place by relatives. In the future, market-based approaches will be required as the relative numbers of care givers and those requiring care will change.

C~ u §e~ ~ Wild C UlrI®§ In "The Ills of America's Health Care System: Root Causes and Potential Cures," Sidney Taurel, Chairman and Chief Executive Officer of Eli Lilly and Company, describes problems of the US health care system pertain­ ing to funding and costs, government regulation, and a gap in the flow of necessary information due to outmoded information technology and lack of consumer access to information. This paper complements the others presented at NFl's August 2006 Forum, from a key insider's perspective. As does Goodman, Taurel describes the spiraling costs of a third-party payer health care system when consumers are disconnected from price and value as consumer issues. He bemoans the costs of government over-regulation, leading to systemic waste and inefficiencies, and he fur­ ther decries the lack of availability of both electronic medical records and consumer access to online information about price and performance in the health care system. Taurel advocates jump-starting a national health IT system, reform of medical liability and health insurance laws, targeted tax credits to shrink the ranks of the uninsured and insurance market deregu­ lation. He argues for reform and describes Bush administration proposals for Health Savings Accounts, tax credits, medical tort reform, and legisla- I tion to both aid consumers in finding the best insurance values and to pro­ mote the use of electronic medical records. Lastly, Taurel makes a strong case for HSAs, arguing that they have the greatest probability of generat- ing true health care reform . He suggests that employee flexible spending accounts could, for example, be converted to HSAs.

7 Key COrB clusions All of the papers help to clarify what is meant by "unsustainable" and discuss the advantages and disadvantages of various proposals to achieve a more sustainable financing scheme, including major reform of how health care decisions are made. The $econd major conclusion from the papers is that there is currently increasing interest in consum­ er-driven health care, which is likely to cut costs and improve care, but current systems still do not fully allow prices to ration scarce resourc­ es. That is the next hurdle in seriou s efforts for financing reform. Th ird, in evaluating single payer or socialized health care plans, it is important to take into account that comparisons of other national systems to the US focus on healthy people, who dominate population comparisons, instead of sick people. According to Gratzer, the health care system is better in the US for sick people, largely because of easier and faster access to higher quality care. Finally, the authors are in broad agreement that the sooner significant reform is achieved, the smaller will be the cost of transition to a sustainable health care system. Growing pressures for reform make some action inevitable, but the risk exists that reforms will involve the wrong choices, at least in terms of selecting higher cost, less efficient, lower quality care, and/ or with less incentive for research and de~elopment. As baby boom­ ers move toward retirement and the strains on the entitlement health care system become untenable, Ta ure I urges the types of free market economy reforms as a preferable option to the government-centered approach common in Canada and Europe.

John A. Tatom Director of Research

8 • 0 • ...

. . "' " .

Rex Morgan has done battle with many a medical problem - from epilepsy to AIDS, from organ transplantation to depression - but he feels that he must tackle a new one: American health care. Dr. Morgan may not have the name recognition of former Surgeon General C. Everett Koop or the political skill of Senator Bill Frist, but he certainly is a prominent physician. Having practiced since 1948, the handsome and affable Dr. Morgan used to be thoroughly apolitical. Nowadays, Morgan champions a very political cause: single-payer, state-sponsored health care.

What would drive Morgan into the heavy world of health policy? Try the death of a close friend. Dick Coleman, Morgan's best friend, lost his job after being diagnosed with colon cancer. Without a job, he had no insur­ ance. The medical bills threatened foreclosure on the mortgage of the family home. By the time Coleman ultimately died, his personal health insurance crisis had pushed his wife into suicidal thoughts and his daughter into drug use. Morgan sums it up: "All because they couldn't afford health insurance."

Of course, Dr. Morgan wouldn't be attending any rallies or lunching with prominent policy makers. Dr. Morgan is a fictional character - the main character in a comic strip that bears his name. The comic strip appears in some 300 newspapers in 15 countries.

Government-run health care - what proponents now euphemistically call "single-payer" - is not poised to sweep the body politic this year and trans-

9 form the nation. Indeed, it is an idea that exists in the shadows. When Oregon voted in 2002 on a ballot-initiative promising Canadian-style health care, voters in the liberal bastion responded with uncharacteris­ tic resolve. Measure 23 was defeated by a 4 to 1 margin

A few months later, Congressman John Conyers proposed the United States National Health Insurance Act. The response was equally unen­ thused in the nation's capital. Even the sympathetic New York Times failed to run a single story on the motion.

But national health care is not a dead idea. Rather, it lies dormant, qui­ etly capturing the imagination of esteemed intellectuals and frustrated Americans. Rex Morgan, after all, may not be real, but the frustration the character exhibits is . Consider this: the author of Rex Morgan, MD is an Arizona Republican who cast a ballot for George W. Bush in 2000. Conyers' attempt at national health insurance may have been a fleet­ ing liberal tilt against the conservative leadership windmill in the House of Representatives, but his support was striking - nearly 4,000 physi­ cians endorsed the proposals including two former Surgeon Generals, a Nobel Laureate, several authors of respected medical textbooks and the organizer of emergency services in New York on 9/11.

Government-run health care is the on-going temptation . Since the death of Clinton-care in 1994, there has been a quiet but growing movement to re-embrace some type of publicly funded system. And no wonder: the problems with American health care are very real. Dr. Mar­ cia Angell, the former editor of the New England Journal of Medicine, reviews the woes in an opinion piece for the New York Times:

Private health insurance premiums are rising at an unsustainable average of about 13% per year and as much as 25% in some areas of the country. Coverage is shrinking, as more employers decide to cap their contributions to health insurance plans and workers find they cannot pay their rapidly expanding share. And with the rise in unem­ ployment, more people are losing what limited coverage they had .. . 1

And as Americans grow more aware of the shortcomings of their sys­ tem, the desire to look elsewhere for answers becomes more tempting. For Dr. Angell, it's enough to consider a serious overhaul of the system - to recognize the "fatal flaw" that "we treat health care as a commod­ ity" - and to embrace single payer.

What we need is a national single-payer system that would elimi­ nate unnecessary administrative costs, duplication and profits. In many ways, this would be tantamount to extending Medicare to the entire population. Medicare is, after all , a government-financed single-payer system embedded within our private, market-based system. It's by far the most efficient part of our health-care system, with overhead costs of less than 3%, and it covers virtually every­ one over the age of 65. Medicare is not perfect, but it's the most popular part of the American health-care system. 2

1. Marcia Ang ell. 'The Forgotten Domestic Crisis." New York Times. 13 October 2002. 2. Ibid.

10 Drs. Himmelstein and Wool handler, tireless proponents of single payer health care, describe the siren song well by looking North:

Canada's single payer health insurance plans provide universal cover­ age and are far more efficient than US healthcare. Despite spending about one half as much per capita as Americans, Canadians receive more of most types of care. They live longer, enjoy unfettered choice of doctors and hospitals, and a quality of care that is on a par with the care of insured Americans. Finally Canadians are secure that their health­ care will be covered. 3

If that sounds like a welcome break from the misery of American medicine - the swelling ranks of the uninsured, the unease of the middle class, the frustration of everyone - it is.

Even prominent politicians recognize the angst of middle America and flirt with single payer. "I think we've reached a point where the entire health ca re system is in impending crisis. I have reluctantly come to the conclu­ sion that we should begin drafting a single-payer national health plan," former Vice President AI Gore stated in the fall of 2002. His comments weren't greeted with a sea of enthusiasm but the fact that a serious con ­ tender for the Democratic presidential nomination would flirt with the idea suggests that single-payer health care is at least a possibility.

And it is. True, there is limited enthusiasm on the part of federal politicians to take on a sweeping new initiative after the grand failure of Clinton-care - especially for a Republican-dominated Congress. True, too, that Ameri­ can journalists increasingly report the problems of single-payer systems like Canada's medicare. But Americans wouldn't completely dismiss the idea.

It lives on because of its simplicity. Those who promote single payer present the idea as a magic bullet. Why fuss with the sticky economics of health care when all you need is a simple government initiative? Indeed, the word simple (and its derivatives) seems to appear as often in Himmel­ stein and Woolhandler's book as motivation speakers shower their talks with the word empowerment.

In this paper, we explore the government temptation. Far from being an elegant solution, we find that government-run health care systems are universally plagued with deep problems. Whether we look to Canada or Britain or Germany, we find that single payer is a fanciful temptation, like hoping that a new house will save a troubled marriage.

3. David Himmelstein and Steffie Woolhandler. Bleeding the Patient: Th e Consequences of Corporate Healthcare. Common Courage Press. Monroe, ME: 2001 . 183.

11 Confessions of CD Former Believer

He had the arrogance, but I had the knowledge. Some years ago, a Cana­ dian organization invited me to debate Theodore Marmor, a Yale professor, on the future of single payer health care. Marmor is a tireless proponent of the Canadian-model for the United States. After a particularly heated exchange, Marmor looked up at the audience and declared, "well, I've been an observer of the Canadian system for 25 years." Marmor immediately smiled, as though he had just placed a full house on the poker table. Per­ haps Marmor temporarily forgot one thing: I'm a Canadian doctor.

My thoughts on Canadian health care aren't based on casual observations, the sort of opinion one gathers by reading the occasional article in the New York Times or discussing the topic with like-minded graduate students. Personal experiences are the basis of my views - as a doctor and a pa­ tient.

My interest in health policy grew from these experiences. As a college stu­ dent, I remember thinking little about medicare; I have a degree in Microbi­ ology and Zoology. Like so many schooled in Canada, I simply accepted that medicare was a major success story, the fusion of compassion with pragmatism. All this changed on a crisp February day during my medical training.

Emergency rooms overcrowd in every city of the world. Usually there is some system of patient referral. Most Canadian hospitals will accept all patients when they aren't overtaxed; they will accept only very ill patients (such as those suffering heart attacks) when on "redirect"; they will decline all patients when on "critical care bypass." Obviously, the latter is used only when the ER is completely overwhelmed. On that February day in 1999, every hospital in Winnipeg went on critical care bypass for an eight hour period. "It's just this simple," an emergency doctor commented, "you just don't get a heart attack in Winnipeg. " Winnipeg, incidentally, isn't a small village buried in the Great White North - it's a town of roughly 800,000.

What was more alarming about that February is the extent to which Cana­ da's health care system collapsed from coast to coast.

A few examples:

o At Cite de la Sante, the largest hospital in suburban Laval, Quebec, staff took the unusual step of issuing a press release early in the month. The sick were asked not to come to the hospital. In Montreal, nurses at Sacre-Coeur staged a wildcat strike to protest the overcrowding, a problem experienced by every hospital in the city.

o For instance, at Maisonneuve-Rosemont - a hospital that had drawn national attention the year before because an elderly patient had died while waiting to be seen in its overcrowded emergency room - 79 patients jammed into a room designed to accommodate only 34.

o In Nelson, British Colombia, a 74-year-old ER patient was placed in a hospital storage area. No other room could be found for him at a time

12 when patients were routinely placed in hallways and linen closets. And, in Victoria, facilities were running at 110% capacity - since the sum­ mer before.

Witnessing the overcrowding personally had a profound impact on me - no longer was health policy remote; the problems with Canadian health care were very real.

Over the years, there have been countless experiences that have re-en­ forced my concern. A quick example: a provincial government promised to abolish "hallway medicine" (the phenomena of hospital hallways being littered with patients on stretchers); by the end of its first term in office, it had established oxygen prongs in the hallways of various hospitals so that patients could at least get oxygen on their stretchers.

Slowly, over time, I reconsidered Canadian health care. No longer was I willing to accept that medicare functioned relatively well. And no longer was I willing to accept our politicians' prescription of more funding. These are the hard observations made by a medical student and, later, a physi­ cian.

If angst is a reason to seek psychoanalysis, Canada's medicare seems to have transformed that nation into one ripe for a therapist's couch. Con­ sider: in 2000, a survey involving 1,500 people suggested that a full 8 out of 10 Canadians consider their health care system "in crisis."4 Since then, polls consistently show health care as the top concern of voters.

No wonder. Consider stories that are all too commonly reported:

The long, long wait in great pain: From being put on list for hip replacement to operation may take 15 months Montreal Gazette

'Patients deserve better,' fed-up Canadian says Edmonton Journal

Patient pays $6,000 to skip surgery wait list Vancouver Sun

Heart-surgery wait claims 3 lives: 47 more patients languishing on list Winnipeg Free Press

Provinces spend millions on US care for patients Globe and Mail

4. Ipsos-Reid Media Release. "Healthcare in Canada: Eight in ten (78%) of Canadians agree that the healthcare system in their province is currently in a crisis." 2 February 2000.

13 And for those familiar with health care, there's no difficulty giving examples of patients waiting too long for care. The head of family medicine at a large Montreal hospital told me that the system is so overwhelmed that emergen­ cy surgeries are often delayed. He relates the tale of an elderly man with a broken hip. While his orthopedic surgery was postponed for three days, he developed a blood clot and a potentially life-threatening pulmonary embo­ lism.

In his speech to the Canada Club, Dr. Albert Schumacher, a former Presi­ dent of the Ontario Medical Association, neatly describes the situation:

When I began practising medicine nearly twenty years ago, the very idea of waiting for care in Ontario would have seemed farfetched. How the world has changed -- waiting lists have become the norm rather than the exception. They are now a fact of life.

Ask anyone who serves on the front lines of the health care system. And compare their recent experiences to the way things used to be .... People are on waiting lists just to get onto other waiting lists for the treatment they need. So it has come to the point where we have wait­ ing lists to get on waiting lists.5

Schumaker goes on to describe his own community:

[In] Windsor, for example it now takes: six months to obtain a hip replacement; five months to get a CAT scan; one of my patients waited more than a year for cardiac surgery. And some of our cancer patients still have to go to the United States for their treatment.·

All these are anecdotes. But major studies, too, have documented prob­ lems in the availability and timeliness of care:

o In the fall of 2000, the Canadian Association of Radiologists released a report suggesting that 63% of X-ray equipment is out of date, as is a majority of all diagnostic machinery in Canada. 6

o In a five-country survey of health care, the Harvard School of Pub- lic Health asked specialists if the quality of care had declined in their country. 63% of Canadian specialists responded in the affirmative, the highest percentage of all nations surveyedJ

o In a major international study, the Heart and Stroke Foundation of Canada finds that Canadian heart attack survivors have a dramatically lower quality of life than their US counterparts.B

5. Dr. Albert Schumacher. "A prescription for health care reform : From myth to dialogue to so lutions." Address to the Canadian Club of Toronto. 19 March 2001. 6. Canadian Association of Radiologists, Special Ministerial Briefing - Outdated Radiology Equipment: A Diagnostic Crisis (Saint-Laurent, QC: September 2000), p. 7. 7. Robert J. Blendon, Cathy Schoen, Karen Donelan, Robin Osborn, Catherine M. Des­ Roches, Kimberly Scoles, Karen Davis, Katherine Binns, and Kinga Zapert, "Physicians' Views on Quality of Care: A Five-Country Comparison," Health Affairs 20(3): 233-243, Mayl June 2001 . 8. Brad Evenson. "Cardiac care better in U.S., study shows: Fewer are dying, but Canadian heart attacl< patients have poorer quality of life." National Post. 8 February 2001. A4.

14 And there are, of course, many other studies pointing in the same direction. 9

Canadian politicians repeatedly promise that soon people wouldn't need to wait so long for care. It's a reassuring campaign pledge. The reality is, however, that waiting lists serve a very important function: they help ration health care.

Health care is expensive. And, with all expensive services, there are hard decisions to make. In the United States, the rise of managed care was an attempt by insurance companies to contain rising expenses. Single-payer proponents suggest that public system can avoid such harsh decision-mak­ ing . In truth, Canadian bureaucrats don't - they just find other ways to limit expenditures.

Therein lies the dirty truth of Canadian health care. It is just like the old Soviet system: everything is free, nothing is readily available. Of course, it's entertaining to talk about people queuing for toilet paper in Moscow in 1976. It's far less funny to think about Canadian breast cancer patients waiting months for radiation therapy in 2006.

Nowhere is this clearer than in the technology gap. Canada lags badly behind the United States in terms of basic diagnostic machinery. Indeed, Canada lags behind most Western countries. The OECD analyses the availability of such machinery and ranks the various countries. Canada's results are striking: it ranks 21 st of 28 OECD nations for CAT scanners, 19th of 22 in availability of lithotriptors (used to treat kidney stones and gallstones), and 19th of 27 in availability of MRls. Canada ranks 6th of 17 in availability of radiation equipment. 1o

Such statistics, however, fail to illustrate the aged state of Canadian di­ agnostic machinery. Neil Seeman writes extensively on Canadian health care. A Torontonian who holds a Masters in Public Health from Harvard, Seeman is particularly interested in the technology gap.

In a recent essay, Seeman lists other examples:

Toronto doctor Mark Prieditis said his colleagues are wont to cope with an antideluvian machine by "kicking it on the side or using duct tape, or turning it off and on 10 times until it finally turns on ." In Prince Albert, Sask., Dr. Holy Wells reports that both of her hospital's fluoroscopy machines "die on a regular basis" so she is forced to ration barium enemas, a test to help detect colon cancer. At the Queen Elizabeth II Health Sciences Centre, the largest training and referral centre in Atlantic Canada, almost 45% of imaging equipment needs replacing, according to Dr. Paul LeBrun, chief of imaging. In P.E. I. , cancer-treat­ ment technology consists of a 25-year-old cobalt therapy unit, and there is no diagnostic MRI. All the way over on Canada's other coast, Dr. Phil Malpass, a general-practice physician in the B.C. Kootenays,

9. For a more extensive discussion, please see: David Gratzer. Better Medicine: Reforming Canadian Health Care. ECW Press, Montreal: 2002. 10. OECD Health Data 1998. OECD, Paris.

15 describes his practice environment thus: "Our 1954 hospital is dilapi­ dated and termed "functionally obsolete" ... Equipment, including a secondhand fluoroscopic unit for pacemaker insertion and a 1947 au­ toclave for sterilizing debris, is frequently broken . We do not even have access to standard technology, like a CT scanner.. ."

If patience is a virtue, some Canadians are less than virtuous: with waiting lists for practically any diagnostic, procedure, or surgical intervention, some cross the border for care.

Government statistics on cross-border shopping are hard to come by. A few academics have suggested that the number of Canadian patients seeking American medicine is limited. Their studies, however, are steeped in methodological flaws and tend to reflect more their bias than the actual situation. Jane Fulton, who served as Alberta's deputy minister of health, ball parked Canadian patient spending at about a billion dollars a year.

The fact of the matter is that there is a Canadian market for private medi­ cine - in the United States. Open the Vancouver Sun or a host of other pa­ pers and you are likely to see ads for "no wait health care," glossy promo­ tions of American clinics offering their neighbors something they can't get at home: fast access to health care.

Some Canadians have gotten into the business as well. Doug Hitchlock runs a small company that offers Canadians discounted rates for medical care in the United States. The Free Trade Medical Network has contracts with various US hospitals from Florida to Hawaii, along with ties to numer­ ous diagnostic centers. The Free Trade Medical Network works to cut expensive American health care bills. Hitchlock's group claims that "if we don't save you money, we don't make money." They brag about discounts of up to 40% for Canadian patients. And Hitchlock's company provides full packages, including air and hotel discounts. The Free Trade Medical Network offers, in one sense, surgical holidays.

When the Toronto Star profiled Hitchlock's business, Dr. Michael Rachlis called Hitchlock a "parasite." Dr. Rachlis, a physician, left his practice in order to defend Canadian medicare, largely by doing contract work for unions. Hitchlock also left his original career to involve himself in health care, but for different reasons. He stopped working as a stockbroker after almost 40 years because of his daughter's illness. She needed an angio­ plasty for a weak heart. She didn't get it - she died waiting for the proce­ dure. Hitchlock's daughter was 9.

If we accept the opinion of former Chancellor of the Exchequer Nigel Lawson - that the British National Health Service is that country's religion - then Pam Hardyment is an agnostic. Ms Hardyment let her views be known in the pages of the Guardian. Unlike the many other invited par­ ticipants in the health series that paper ran in 2002, she isn't a prominent politician, physiCian or hospital administrator. Ms. Hardyment is a patient.

16 And her perspective on the NHS is very personal.

Over a three painful years, I had been in a 'queue' in London awaiting gall bladder removal. Despite being taken by ambulance to the emer­ gency room on three occasions during this time, I was returned home with painkillers. Finally, unable to move, jaundiced and prepared to die, I endured a five-hour wait, vomiting on the floor of my local hospital while the harassed nurses searched for a bed . I got my operation . It was free. But at what price?11

Proponents of government-run health care tend to look beyond Canada when they cite a potential model for the United States. European systems now serve the role that Canada once did. A paper in the prestigious journal ~/ealth Affairs opens with the following: "Americans have often looked with envy at the German health care system where citizens enjoy universal access to a comprehensive set of health benefits, all for about half of what Americans pay per capita. As if that weren't enough, outcomes and satis­ faction in Germany are at least as good as (if not better than) those in the United States."12 The editors of journals aren't the only ones with a keen interest in Europe - a young governor from Vermont, Howard Dean, saw the continent's social insurances as the inspiration for his health reforms. But while the woes of these systems are less appreciated in the United States, public health care is anything but a success story in Europe.

Britain's NHS may be the most plagiarized health care system in the west­ ern world - decades ago, it was the British model that served as the inspi­ ration for politicians in the Sweden, Canada, Australia and New Zealand. These days, Britain's NHS doesn't seem like much of a model for anything - except, perhaps, frustration. Consider that Britain's NHS has roughly a million people waiting for care and two hundred thousand wait longer than six months. So overstretched is the system that horror stories litter British papers.

I decided to see the state of the NHS by looking in on a small hospital in Southern England. My choice of Dover's Buckland Hospital was not ran ­ dom - several years ago, the Spectator ran a cover story on the NHS that had mentioned the institution. The writer vividly described the dirty, dark waiting room of the hospital that came complete with an overwhelming odor (the nurse suggested that a dead rat was the source and promptly sprayed air freshener).

Was the NHS hospital as bad as it had been described? Actually, it's worse. Single payer proponents consider government-financed health care to be wonderfully compassionate. In East Kent, unclean would be a better adjective. Years before I set foot in Dover, I toured D.C. General in Wash­ ington with an Englishman by the name of Tim Evans (now president of a European think tank). D.C. General was in such dire straights that it was eventually closed, an embarrassment to local administrators. Dr. Evans commented to me: "This is nicer than any British hospital I've visited."

11 . Pam Hardyment. 'Yes my operation was free, but the wait took three painful years.' The Guardian. 25 April 2002. 12. Alison Evans Ceullar and Joshua M. Wiener. "Can Social In surance For Long Term Care Work? The Experience of Germany." Health Affairs. Volume 19, 3. May/June 2000. 8.

17 Standing in Buckland Hospital, I now understood the attraction of D.C. General.

So bad is the British NHS that some look across the Channel for ideas. In contrast to the top-down model of the NHS, France and Germany have a social insurance model for health care - essentially, workers contribute part of their wages for coverage. And, on the surface, France and Germany are doing well - waiting lists plague neither health care system . In contrast to dark and dreary Buckland Hospital, the facilities in Calais are clean and modern. Obviously, they sit in a different country (France, as opposed to Britain) - but it feels like a different world.

But neither country is exactly a utopia of health care. True, the French run circles around the English - decision-making is more decentralized; little distinction is made between public and private facilities (allowing patients choice); modest user fees are charged, cutting down on some frivolous expenses; care is timely.

However, all European systems have major problems. But, then, so does American health care. Let's ask a very simple question: How do they stack up to American health care?

International comparisons are few and far between. Such analysis is rare - but not unknown. The WHO' World Health Report 2000, for example, ranks the performance of the health systems of several nations. For propo­ nents of a single payer plan, the WHO is the smoking gun, definitive proof that American health care just doesn't measure up.

What does the WHO find? "In terms of total results, the US health care system ranks 37th in the world, as measured by the WHO, the worst perfor­ mance of any affluent democratic nation."13 So writes Dr. Rudolph Mueller, a New York physician, in his book calling for government-run health care. Dr. Mueller considers the WHO finding so revealing that he mentions it on page two.

The WHO study may make for good speaking points, but the work is any­ thing but definitive. Indeed, like a book review written by a biased reviewer, the WHO report says more about those drafting the study than the health care systems that they analyze.

Consider that according to this study, the United States has some of the best doctors and nurses in the world, but has a health care system that ranks behind those of Colombia, Oman, Morocco, Cyprus, Andorra, Malta, and the United Arab Emirates. Now, it would seem that in a proper com­ parative study, the better systems (that is , say, Colombia rather than the United States) actually boasts the best care. In other words, looking at the WHO report, if your daughter develops a cough late at night, you'd rather take her to a hospital in Bogota or Medellin than in Boston or Memphis.

1. Rudolph Mueller. As Sick as it Gets. Dunkirk, NY: Olin Frede ri ck, Inc. 2001. 2-3.

18 But before packing up your daughter for the long plane ride to South Amer­ ica, remember that the WHO criteria are soft - and ideological. Nations are marked down for having private medicine or user fees. Fairness - that is, everyone gets the same treatment regardless of income - is important. Competition, WHO officials believe, is bad since it leads to "fragmentation and duplication in health services." If the criteria aren't skewed enough, the WHO report also considers how well countries perform compared to what experts feel they ought to be doing. It's a bit like giving a gold medal to the eighth fastest runner because he has the shortest legs and tried harder.

It is beyond the scope of this paper - or, perhaps, any paper - to attempt to produce a meaningful and comprehensive ranking of different health care systems. A couple of simple conclusions, though, can be made. First, the problem of uninsured citizens is unique to the United States. Canada, Brit­ ain, France and Germany may have shortcomings; citizens don't lack basic coverage, however. That type of predicament, however, is not seen in other western countries to the extent it is in the US Second, Americans re­ ceive better care than people in anyone of those countries - or any other.

The latter point deserves some explanation. Most comparisons confuse health with health care. As a result, much attention is focused on mea­ sures like life expectancy. But a good health care system is only one part of life expectancy - indeed, it could be argued that compared to diet, exer­ cise, and genetics, it is less important. But quality health care is all about the treatment of the sick. And looking at various studies comparing treat­ ment-related issues, American health care comes out on top.

Consider the following cancer studies:

o Women who get breast cancer in Europe are four times more likely to be diagnosed when the tumor has spread and are less likely to survive the disease than women in the United States. 14

o The WHO, in partnership with the International Union Against Cancer, compiles 5 year survival rates for various types of cancers. The United States consistently bests Europe. For leukemia, for example, the American survival rate is almost 50% . The European rate is signifi­ cantly lower, at just 35%. Esophaegeal carcinoma is often deadly - but American patients fare much better than those across the Atlantic. 5 year rates in the US are 12%; European, just 6%.15

Looking at other areas of medicine, we find similar results: American health care bests state-financed systems. Earlier in this chapter, for example, the Heart and Stroke Foundation of Canada study looking at quality of life post­ heart attack in the United States and Canada finds that American heart attack survivors are significantly healthier.

Why do American patients fare so much better than those in Europe or

14. Richard Woodman. "Breast Cancer Diagnosed Late in Europe." Reuters Hea lth . March 3,2003. 15. Global Action Against Cancer. World Health Organization, Geneva, Switzerland: 2003. Available at: http://www.uicc.org/index.php?id=497.

19 Canada? Oliver Schoffski's paper on European pharmaceuticals provides some answers. Schoffski, chair of Health Management at the University of Erlangen-Nuremberg in Germany and the author of 8 books, looks at the treatment of twenty illnesses across Europe and incorporating nearly two hundred studies. He paints a picture of non-treatment and under-treatment for common diseases like schizophrenia, heart disease, and asthma. The reasons are complex and not exclusively related to government policies - but he finds governments are a major source of the woes.

He finds in France, for example, 9 in 10 patients with acute asthma do not receive adequate care. One million people in Germany suffer from migraines unnecessarily. 83% of Italian patients who could benefit from statins, a lipid-lowering medication that reduce cholesterol and thereby protect against heart disease, don't receive it.

Under-treatment, of course, speaks to more than just the quality of health care. Studies in the United States have noted, for example, that some patients suffering from depression don't reach a family doctor, let alone a psychiatrist. Still, Schoffski's comparative work hardly puts European medicine in a favorable light.

Statins, the drug group that lowers fats in the blood, are a major weapon against the harmful effects of heart disease. In the United States, Schoffski suggests that about 44% of patients who could benefit from the drug actu­ ally get it. But in Europe, far fewer people take statins. In Germany, 26% take the medicine; in Britain, 23%; and in Italy, 17%.

Treatment of mental illness is surprisingly different in the United States and across the Atlantic. Antipsychotics, the main treatment for schizophrenia, have been revolutionized in the past decade. Newer drugs are linked with fewer and more benign side effects. In the United States, 60% are on the newer drugs. In Spain, only 20% are, while in Germany, fewer still at just 10%. Some patients, of course, may opt for the older medications but studies suggest most prefer (and do better on) the new so-called atypical anti psychotics. Thus, when it comes to the treatment of mental illness, Europeans get the best the 1970s provided.

SchOffski sees Europe's drug problem as being multifactorial. In general, specialists are more difficult to refer to, for example, meaning that family doctors handle more complicated problems - and yet, may not have the expertise to do so . He also suggests that governments haven't helped the situation.

In Europe, EU drug approval is relatively speedy - but individual nations throw up their own hurdles to slow the introduction of new drugs. In a re ­ cent paper, University of Pennsylvania Professor Patricia Danzon finds that in regulation-heavy countries like Greece, Belgium, and France, medica­ tions take an extra 9 months after EU approval to finally reach patients.16 Some drugs are delayed longer still. Taxol, a medication used to treat

16. Patricia M. Danzon, Y. Richard Wang, Liang Wang. ''The Impact of Price Regulation on th e Launch Delay of New Drugs - A Study ofTwenty-Five Major Markets in the 1990s." Available at Prof Danzon's web site, http://hc.wharton.upenn.edu/danzon/. Th e paper is under review by Law & Economics.

20 advanced breast cancer and refractory ovarian cancer, was approved for use in Europe in 1995. It didn't reach British cancer patients, however, for another half decade.

Why are all these governments working feverishly to keep doctors from prescribing proven and effective medications? It's a matter of money. In the Canadian province Ontario, for example, the state pays more than 40% of prescription drug costs; in Germany, public spending approaches 70%. To bureaucrats eager to keep within budgets, new drugs are seen only as new expenses - even if they save lives.

Will it ever be realized? With disappointment, Stanford economist Victor Fuchs writes in the New England Journal of Medicine: "National health in­ surance will probably come to the United States after a major change in the political climate - the kind of change that often accompanies a war, a de­ pression, or large-scale civil unrest. Until then, the chief effect of the new plans will be to make young and healthy workers better off at the expense of their older, sicker colleagues."17 Professor Fuchs may be overly pes­ simistic. It was under circumstances not unlike today's that Clinton-care became an option in the early 1990s.

Let's leave the political prognostication to others. Instead, let's consider a more pertinent question: is single payer really the magic bullet?

Advocates of a single payer system suggest simply that American health care fails to deliver on its promise. Though their arguments are often com­ plex (and frequently eloquent), the thrust of their point of view on the Ameri­ can system can be summarized in 7 words: too much too poorly for too few. The single payer crowd suggests that American medicine costs more than any other system on earth, falls short in basic standards and, finally, fails to deliver care to everyone.

These arguments are so often made that they require little elaboration. Besting 15% of GDP, the US health care system soaks up considerably more money than, say, the Canadian (10%) or German (10%) systems. Yet, despite the robust spending, basic health statistics like life expectancy and infant mortality are poorer. Finally, there is the issue of the uninsured.

But beware the siren song: American health care may have its deep flaws but the alternatives may be far worse. Just as the cancer patient looks to alternative medicines that offer the promise of recovery without the pain of chemo, it's easy to be seduced - and not necessarily advisable.

17. Vi ctor Fuchs. "What's Ahead for Health Insurance in th e United States?" New England Journal of Medicine. 346:1822-1824. 6 June 2002. Number 23.

21 A quick rebuttal to the three criticisms. First, American health care does cost more than the public systems. But such statistics must be read care­ fully. Consider: the M. D. Anderson Cancer Center in Texas spends more money than all of Canada on research & development. There are other cost drivers that can be overlooked in straight comparisons, such as the costs of America's litigious cu lture .

Second, as noted in the last section, crude health statistics often speak more to cultural and economic factors than to quality health care. Yes, Canadians live longer than Americans - but this probably has very little to do with their respective systems. Consider that studies looking at infant mortality rates among American ethnic groups find that Hispanics do better than African-Americans, yet the latter have better access to health insur­ ance, relatively speaking , and are more likely to give birth in hospitals. In other words, the individuals with limited access to health care tend to do better than those on Medicaid. The bigger issue: how do people do when they are actually sick? Whether looking at cancer care or heart attack pre­ vention, Americans come out on top - and that's why people from around the world come to the US when they are sick.

Finally, there is the issue of the uninsured. Obviously, the lack of univer­ sal coverage is a serious problem. But let's not confuse a lack of health insurance with a lack of health care. Single payer advocates point to the uninsured and damn the whole system. It would be more appropriate to conclude that the US health care works very well for most Americans - but that reforms are still needed.

Of course, single payer proponents bristle at such a suggestion. After all, they see utopia abroad, why not wish for it at home? Government-run health care, however, is anything but utopian. Whether it's the decentral­ ized German sickness funds or the top-heavy National Health Service, public systems suffer from similar woes.

A common question people aslc why don't their systems serve their citizens better? In a way, they do what they are supposed to - most people (and . thus most voters) have access to the care they need (simple primary care) and at a relatively low cost. It's true that these systems tend to fall short on more complicated treatments. But how many voters suffer from cancer in any given year? How many people are concerned about access to sub­ specialists or high-tech diagnostic tests?

Public systems ultimately serve the interests of the majority of voters - who tend to be healthy. Americans shou ld remember that - and beware.

22 Consumer driven health care (CDHC) is a potential solution to two per­ plexing problems: (1) How to choose between health care and other uses of money, and (2) how to allocate resources in an industry where normal market forces have been systemically suppressed. In the consumer-driven model, consumers occupy the primary decision-making role regarding the health care that they receive. From an employee benefits perspective, consumer driven health care in the broadest sense may refer to limited employer contribution or dual option plans featuring high deductible health coverage with tax advantaged savings vehicles such as Health Savings Ac­ counts (HSAs), Flexible Spending Accounts (FSAs) and Health Reimburse­ ment Arrangements (HRAs) (Daly, 2005). However, before we consider the solution, we must first investigate why a solution is needed in the first place.

Busy people are often unaware of how easy it is to spend other people's money on health care. Here are a few examples. The Cooper Clinic in Dallas offers an extensive checkup (with a full body scan) for about $2,000 or more. Similar clinics have sprouted in other large cities. If everyone in America tool< advantage of this opportunity every year, we would increase our nation's annual health care bill by almost one-third . More than 1,000 diagnostic tests can be done on blood alone; one doesn't need too much imagination to justify, say, $7,000 worth of tests each year. But if everyone

23 did so, we would double the nation's health care bill. Americans purchase nonprescription drugs almost 12 billion times a year and almost all of these are acts of self-medication. Yet if everyone sought professional advice before making such purchases, we would need 25 times the number of pri­ mary care physicians we currently have (Rottenberg, 1990). Some 1,100 tests can be done on our genes to determine if we have a predisposition toward one disease or another. At, a conservative estimate of, say, $1,000 a test, it would cost more than $1 million for a patient to run the full gamut. But if every American did so, the total cost would run to about 24 times the nation's annual output of goods and services.

Notice that, in hypothetically spending all of this money, we have not yet cured a single disease or treated an actual illness. We are simply collect­ ing information. If in the process of search we actually found something that warranted treatment, we could spend even more.

One of the cardinal beliefs of advocates of single payer health insurance (and one that is shared by the advocates of the HMO form of health care delivery) is that health care should be free at the point of consumption, re­ gardless of willingness or ability to pay. But if health care really were free, people would have an incentive to obtain each and every service so long as it had any value at all to them. In other words, everybody would have at least an economic incentive to get the Cooper Clinic annual checkup, order dozens of blood tests, check out all their genes and consult physicians at the drop of a hat.

In short order, unconstrained patients would attempt to spend the entire gross domestic product (GOP) on health care even though, as a practical matter, that would be impossible. One could argue that the current system of third-party payment automatically discourages many of these expendi­ tures by failing to cover them. But if we continue with the current payment system indefinitely, we are still on an unsustainable path.

Government at all levels in the United States currently spends about 7.2 percent of GOP on health care, mainly on Medicare and Medicaid. This is an amount comparable to government health care spending in other coun­ tries. Yet Larry Kotlikoff and his colleagues have shown that, if benefits expand at the rate of the past 30 years and if the population ages the way demographers predict, spending will equal one-third of national income by mid-century, when today's college students reach the retirement age (Hagist and Kotlikoff, 2006). If that is not immediately alarming, note that one-third of mid-century GOP is about equal to all government spending for all purposes today. If private spending on health care keeps up with public spending, the nation will devote about two-thirds of national income to health care by mid-century - an amount roughly equal to total consump­ tion of all goods and services today.

So in the public sphere, health care is on a course to crowd out every other government program - from education and roads and bridges to Social Security and national defense. And for the economy as a whole, health care is on a course to crowd out every other form of consumption, including food, clothing, housing, etc.

24 We need not endure an inordinate wait in order to see what the future has in store for us. Currently, well over half the consumption of people age 85 years of age and older is on health care. 1 By 2025, the same will be true - of the entire senior population (everyone age 65 and over) (Fuchs, 2001). To say that the government path we are on is unsustainable is trivial. To ask how we are going to get off that path is a serious question which ur­ gently needs to be answered.

At the federal level, the Social Security trustees' reports implicitly show how health care will crowd out all other government spending. Only two years ago, Social Security and Medicare combined took in more revenue than was spent, thus contributing a small surplu s to the general budget. But this year, we will need 7 percent of general income tax revenues to cover the shortfall in these programs. By 2020, we will need one in four income ta x dollars to pay for the deficit in Social Security and Medicare, implying that the government will have to stop doing one out of every four things it does today. By 2030, we will need one of every two income tax dollars (and these estimates do not even include the cost of Medicaid!) (OASDI Trust­ ees, 2005). In order to avoid this disastrous scenario, someone must be forced to choose between health care and other uses of money. The ques­ tion is: who will that someone be?

Critics of CDHC are fond of pointing out that there are times when patient choice is not desirable or appropriate. They are, of course, correct. We don't want a parent to choose not to have her child vaccinated, or an at­ risk expectant mother to avoid prenatal care, or a heart patient to eschew aspirin or beta blockers. The reason: there is overwhelming evidence that the social benefits of the care exceed the social cost (Tengs et aI, 1995 and Eddy, 1991). Yet instances where we can be absolutely sure that we know which alternative is the right choice are rarer than one might suppose. At the other extreme, there are literally thousands of cases where only the patient can make the right choice.

Take patients with arthritic pain. Viox)( and Bextra (before they were tal(en from the market) and Celebrex cost about $800 more over the course of a year than such over-the-counter remedies as ibuprofen (Herrick, 2004, Table 3). Let us concede that, for some patients, the brand name drug is superior. Are the extra benefits of a brand drug worth $800 a year in addi­ tion to the risks of side effects? Patients must weigh this individually.

Drugs affect different people differently. Moreover, different people have different attitudes toward risk. So it is virtually impossible for one person to make such a choice for another. When people are spending their own mon­ ey, presumably they will reveal their preferences through their actions. But most of the patients who were taking Vioxx (and should not have been) were not spending their own money. Third-party payers were paying the bill. And most of those insurance plans probably did not cover the cost of ibuprofen. 1. In 1997, the elderly spent slightly more than one-third of their "full income" on health care. Seniors older than 84 spent about three time more per capita on health care than seniors between th e ages of 65 and 74 . Se e Fuchs (1999, 2001).

25 Another example is the prescription drug Clarinex, used by allergy suffer­ ers. Some scientists claim that the over-the-counter drug Claritin is chemi­ cally the same (Schieber, 2004). Yet a year's supply of the former costs about $949, compared to only $280 for the latter and less than $15 for an OTC generic equivalenP As in the case of arthritic pain relief, many insur­ ers will cover the cost of a brand name drug but not the OTC alternatives - inducing patients to opt for the drug with the highest social cost.

The problem with the current system is that all too often patients have no opportunity to make such choices. The reason : most of the time they are buying health care with someone else's money. Ironically, most of the people who were taking Vioxx should not have been taking it; and the best predictor of whether a patient was tal

How do patients react when they are asked to manage their own health care dollars? We actually have far more experience with consumer di­ rected health care than many scholars realize. For example, we have more than a decade of experience with Medical Savings Accounts (MSAs) in South Africa, and, in this country, seven years of experience with the MSA pilot program, four years of experience with Health Reimbursement Arrangements (HRAs) and a year and a half with HSAs. The problem is, the data mainly resides with insurers who regard it as proprietary and, therefore, the results are reported by entities with a financial self-interest in the outcomes. Even so, reported results of MSAs in South Africa (Dis­ covery Health) and HRAs in the United States (Aetna, 2006) are consistent with common sense (Matisonn, 2000, 2002). Patients cut back in areas where there is presumed to be a lot of waste and substitute less expensive treatment options for more expensive ones. That is, there are fewer trips to primary care physicians, brand-name drug purchases are down, generic purchases are up, etc.

A McKinsey study found that CDHC patients were twice as likely as pa­ tients in traditional plans to ask about cost and three times as likely to choose a less expensive treatment option .4 Further, chronic patients were 20 percent more likely to follow treatment regimes very carefully (McKinsey,

2 .Prices for Clarinex and Claratin are for 30 doses from Walgreen s. com . The price for the generic version of Claritin (Loratadine) is for Costco.com. All prices surveyed October 7, 2005. 3. A recent study found th at two-thirds of patients on Cox-2 inhibitors were not at risk for gastrointestinal conditions like ulcers or bleeding, and most of th em had not tried cheaper alternatives. See Cox e/ a/. (2003) A separate study found that seniors with generous drug coverage but moderate risk of gastrointestin al problems we re more likely to be on a COX-2 inhibitor than seniors with high gastrointestinal risk but no drug coverage. See Doshi, Brandt and Stuart (2004). 4. Observations are of CDHC participants enrolled at least on e year in plan . Due to an in ade­ quate length of tim e since HSAs have existed, most of the CDHC parti cipants in the McKinsey study (2005) were enrolled in HRAs rather than HSAs.

26 2005). A South African study suggests that CDHC patients can control drug costs as well as managed care, but without the cost of managed care (Matisonn, 2002). What about preventive care? McKinsey, Aetna, National Center for Policy Analysis (Discovery Health) and Humana (2005) all report an increase in preventive care - even as they report other, significant cost­ reducing changes in patient behavior. Note, however, that many CDHC plans contain extra incentives to seek and obtain preventive care. Dis­ covery Health tried to determine whether skimping on care in the short run caused higher costs in later years and found no evidence to support the claim.s

Many people assume that a system of national health insurance would be radically different from the American health care system. In fact, the U.S. system is far more similar to national health insurance than it is different. The reason: in our country, as in other developed countries, people primar­ ily pay for care with their time rather than with money. In fact, as far as financial outlays are concerned, health care is almost as free in this country as it is in Canada and in Europe (Goodman, 2006).

On the average, every time Americans spend a dollar on physicians' services, only 10 cents is paid out-of-pocket; the remainder is paid by a third party - an employer, insurance company or government (Smith et aI, 2005). From a purely economic perspective, then, our incentive is to consume these services until their value to us is only 10 cents on the dollar. Moreover, millions of Americans do not even pay the 10 cents. Medicaid enrollees, Medicare enrollees who have Medigap insurance, and people who get free care from community health centers and hospital emergency rooms pay nothing at the points of service. Most members of HMOs and PPOs make only a modest co-payment for primary care services. Clearly, we are not rationing health care on the basis of prices.

But if not price rationing, how do we ration physicians' services? We ration the same way other developed countries ration care. We ration by waiting. In both the United States and in Canada, the price of physicians' services is mainly set by large, impersonal bureaucracies, and the physician's time is rationed to patients based on their willingness and ability to pay for care with time rather than money. Both countries have largely achieved what has been a goal of the political left for almost 100 years. Yet the suppres­ sion of the price system has been bad for patients in a number of ways.

Whereas lawyers and other professionals routinely communicate with their clients by phone and by email, it is very rare for physicians to communicate

5. Apparently MSA holders are not healthier as a group. A compari son of catastrophic cl aims under the two different health plans did not show more catastrophic claims under the MSA plan than under the non-MSA plan. See Matisonn (2000).

27 that way - even for routine prescriptions (Health on the Net Foundation, 2001 ).6 Why is that? Why do doctors avoid telephone and email con­ sultations? The short answer is, they do not get paid for these types of consultations (Wiebe, 2001).1 Medicare does not pay for them, nor does Medicaid or most private insurance. In general, doctors only get paid to see patients in their offices. Doctors paid under capitation arrangement would seem to have different incentives, but HMO doctors ration their time by waiting as well.

The fact that patients cannot consult with physicians by telephone or email leads to two bad consequences. First, the unnecessary visitors (say, patients who have a cold) expect at least a prescription in return for their investment of waiting time, and all too often the drug will be an antibiotic. For physicians, these prescriptions may be thought of as a convenient way of maintaining a patient clientele (Soumerai and Lipton, 1995). Were tele­ phone consultations possible, the physician would more likely recommend an OTe remedy, thus avoiding the cost of waiting for the patient and the cost of degrading the effectiveness of antibiotics for society as a whole.

The second bad consequence is that rationing by waiting imposes dispro­ portionate costs on patients who need more frequent contact with physi­ cians. Because the chronically ill need more interactions with their doctors, they face above-average waiting costs. This may be one reason why so many are not getting the one thing they most need from primary physicians and the thing that is most likely to prevent more serious and costly health problems later on - a prescription (Kleinke, 2004).

The ability to consult with doctors by telephone or email could be a boon to the chronically ill. Face-to-face meetings with physicians would be infrequent, especially if patients learned how to monitor their own condi­ tions and manage their own care. Remote consultations could be used to change a drug prescription or determine whether an office visit was needed.

One consequence of rationing by waiting is that the time of the primary care physician is usually fully booked, unless she is starting a new prac­ tice or working in a rural area. This means that almost all the physician's hours are spent on billable activities. Further, there is very little incentive to compete for patients the way other professionals compete for clients.

6 There are exceptions. It is common for people to get test results by phone and to get refills on prescriptions by phone conservations with doctors and nurses. What is rare is an actual telephone consultation. Only about 14 percent of patients exchange e-mail with their physi­ cians. Of this, slightly less than two percent do so on a frequent basis. Survey results from Health on the Net Foundation (2001). 7. Among health plans that do pay, some will not compensate doctors for e-mail exchanges unless th e patient has first been examined in an office. Other insurers reimburse less for e-mail exchanges than for in-person visits. See Freudenheim (2005). An exception is, Blue Shield of California, which pays physicians the same for an e-mail consultation ($25) as it does for an office visil. See Koenig (2003). The American Medical Association has created a reim­ bursement code for online consultation patients, making it easier for physicians to get paid.

28 The reason: neither the loss of existing patients nor a gain of new patients would affect the doctor's income very much. Loss of existing patients for example, would tend to reduce the average waiting time for the remaining patients. But with shorter waiting times, those patients would be encour­ aged to make more visits. Conversely, a gain of new patients would tend to lengthen waiting times, causing some patients to reduce their number of visits. Because time, not money, is the currency we use to pay for care, the physician doesn't benefit (very much) from patient-pleasing improvements and is not harmed (very much) by an increase in patient irritations.

This insight may explain why doctors in some areas now refuse to take new Medicare patients.8 Assuming that retirees have a lower opportunity cost of time, odds are they are willing to out-wait the nonelderly patients. And since Medicare pays at a lower rate than private insurance, such crowding out actually lowers the physician's income. Medicaid typically pays even less than Medicare and since Medicaid patients also tend to have a lower­ than-average opportunity cost of time, small wonder that many doctors refuse to see any new Medicaid patients. 9

Virtually all of these features of our health care system discussed above are the direct result of the way in which we pay for health care, especially the way we pay doctors. That is, we compensate physicians in ways that are different from the way we pay for other professional services and those differences create problems in the medical marketplace that do not arise in other markets. The principal payment methods, moreover, are not the natural result of free market forces. They are instead the product of distor­ tions created by public policies. And in most cases, mistakes embedded in the public policies and in the payment mechanisms reflect a failure to understand the economics of time. 10

Would physicians practice medicine differently if they were paid differently? There is ample evidence that the answer is yes. Unlike other forms of surgery, the typical cosmetic surgery patient can (a) find a package price in advance covering all services and facilities, (b) compare prices prior to the surgery and (c) pay a price that is lower in real terms than the price charged a decade ago for comparable procedures - despite the technologi­ cal innovations in the interim (Herrick, 2003).

Ironically, many physicians who perform cosmetic surgery also perform oth­ er types of surgery. The difference in behavior is apparently related to how they are paid. A cosmetic surgery transaction has all the characteristics of a normal market transaction in which the seller has a financial interest in how all aspects of the transaction affect the buyer. In more typical doctor­ patient interactions, doctors are not paid to be concerned about all aspects

8. According to an American Medical Association survey, about 30 percent of physicians limit the number of new Medicare patients they will accept -- or do not accept Medicare patients at all. See Hawryluk (2002). 9. According to a recent survey by the Medicare Payment Advisory Commission more than 30 percent of physicians refuse to access any new Medicaid patients (Hackbarth, 2002). 10. On the general economics of time, see DeVany and Saving (1983).

29 of care and therefore typically ignore the effects on the patient of the cost of time, the cost of drugs, and other ancillary costs. Note, this holds for HMO doctors as well as fee-far-service doctors. What is true for US doctors in general is also true of doctors who practice in the government-run health systems of other developed countries.

References

Aetna, (2006, October 2). Aetna Releases Broadest Study To Date Of Consumer-Di­ rected Plans. Web site: http://www.aetna.com/news/2006/pr_20061001 .htm

Agrawal, V, Ehrbeck, T, O'Neill Packard, K., and Mango, P. (2005, June). Consumer­ Directed Health Plan Report - Early Evidence is Promising: North American Payor Provider Practice. McKinsey & Company. Web site: http://www.ahipresearch.org/pdfs/ ConsumerDirectedHealthPlanReport_Promising.pdf

Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insur­ ance Trust Funds, (2005, March 23). 2005 Annual Report of the Board of Trustees of the Federal Old-Age and Survivors Insurance and Disability Insurance Trust Funds, from The 2005 OASDI Trustees Report. Web site: http://www.ssa.gov/OACTITRlTR05/

Cox, E. et al (2003). Prescribing COX-2s for Patients New to Cyclo-oxygenase Inhibi­ tion Therapy. American Journal of Managed Care 9,735-742.

Daly, T (2005, January 24). Who's Really Driving Consumer Driven Healthcare. From Insurance Journal Web site: http://www.insurancejournal.com/magazines/ westl200510 1/24/features/51351. htm

DeVany, A, and Saving, T (1983). The Economics of Quality. Journal of Political Economy. 91,979-1000.

Doshi, J, Brandt, N, & Stuart, B. The Impact of Drug Coverage on COX-2 Inhibitor Use In Medicare. Health Affairs, Web site. http://content.healthaffairs.org/cgilcontentlfull/ hlthaff.w4.94v1/DC1.

Eddy, D. (Ed.). (1991). Common Screening Tests. Philadelphia: American College of Physicians.

Freudenheim, M. Digital Rx: Take Two Aspiris and E-Mail Me in the Morning. (2005, March 2). New York Times.

Fuchs, V (2001). The Financial Problems of the Elderly: A Holistic Approach. National Bureau of Economic Research, NBER Working Paper 8236.

Fuchs, V (1999). Provide, Provide: The Economics of Aging. In Rettenmaier, A. and Saving, T, Eds., Medicare Reform: Issues and Answers. Chicago: U of Chicago P. 15-36.

Goodman, J. (2005). Time, Money and the Market for Drugs. National Center for Policy Analysis, Web site: http://www.ncpa.org/pub/speciaI/20051205-special.html.

Hackbarth, G. (2002). MEDPAC Recommendations on Physician Payment Policy. Sub­ committee on Health, Committee on Ways and Means, U.S. House of Representatives Web site: http://www. medpac. gov/publications/congressionaUestimony/022802_ SGR. pdf

30 Hagist, C. and Kotlikoff, L. (2006). Health Care Spending: What the Future Will Lool( Uke. National Center for Policy Analysis, NCPA Policy Report 286. Web site: htlp:llwww.ncpa.org/pub/sVsI286/

Hawrylul(, M. (2002, October 21). Physician Payment Crunch: Medicare Cuts Hit Medicaid Access. Americen Medicel News, from http://www.ama-assn.org/amed­ news/2002/1 0/21/gv l1 102 1.111m

Heallh on Ihe Nel Foundalion, (200 1, Feb/March). Evolution of Internet Use for Health Purposes. HON Surveys Web site: http://www.hon.ch/Survey/FebMar2001/survey.htm l

Herrick, D. (2004). Shopping for Drugs: 2004. National Cenler for Policy Ana lysis, NCPA Policy Reporl 270. Web site: http://www.ncpa.org/pub/sVst2701.

Herncl(, D. (2003 ). WilY Are Health Care Costs Rising? National Center for Policy Analysis, NCPA Brief Analysis 437. Web site: http://www.ncpa.org/pub/balba437/.

Humana Inc. (2005, June). Health Care Consumers: Passive or Active? Web site: http://www. humana.comivisitors/pdf/victory. pdf

Kleinke, J. (2004). Access Versus Excess: Value-Based Cosl Sharing for Prescription Drugs. Heelth Affairs. 23, 34-47.

Koenig , D. A Few Doctors Seeing Patients Online. (2003, December 21). Akron Beacon Journar.

Making a Difference: Aetna Heal lhFund. Aetna, September 2006.

Mattisonn, S. (2002). Medical Savings Accounts and Prescription Drugs: Evidence from South Africa. National Center for Policy Analysis, NCPA Policy Report 254. Web sile: http://www.ncpa.org/pub/sVst254/.

Mattisonn, S. (2000 ). Medical Savings Accounts in Soulh Africa . National Center for Policy Analysis, NCPA Policy Report 234. Web site: http://www.ncpa.org/pub/sVst234/.

Rottenberg, S. (1990). Unintended Consequenees: The Probable Effecls of Mandated Medlcallnsuranee. Regulation 13, 27-28.

Schieber, S. (2004). Why Coordination of Health Care Spending and Savings Accounts is Importan t. From Watson Wyatt Worldwide Web site: http://www.watsonwyatt.com/re­ searchlwhitepaperslwprender.asp?id=wp-22

Smith, C. el el (2005). "Health Spenciing Growth Slows in 2003. Healll1 Affairs 24, 192.

Soumerai, S. and Upton, H. (1995). Computer-Based Drug-Utilization Review: Risk, Benefi t, or Boondoggle? New Eng/end Journel of MedicIne 332, 1641-1645.

Super, N. (2005). Medicare Physician Paymenl: How to Build A More Efficient Payment System. Subcommittee on Heallh, House Com mittee on Energy and Commerce, U.S. House of Representatives Web sile: Il ttp:llenergycommerce.house.gov/108/Hearingsl 11172005hearing 1718/Super.pdf

Tengs, T. e/.' (1995). Five-Hundred Ufe-Saving Interventions and Their Cost-Effective­ ness. Ris'( Ana'ysis 15, 369-390.

Wiebe, C. (2001). Doctors Still Slow to Adopt Email Communication. Medscapo Money & MedicIne 2, http://www.medscape.com/viewarticle/408356.

31 • -. - . .

Medicare is America's second largest entitlement program and this year will account for 14 percent of the federal budget, 3.2 percent of the nation's Gross Domestic Product (GDP). The program provides health care insur­ ance for the retired population, including, since the beginning of 2006, a prescription drug benefit. By the end of the Medicare Trustees 75-year projection period, 2080, the Trustees project that Medicare alone will ac­ count for 11.0 percent of GDP and all health care will consume 42 percent of GDP.

The extreme growth of Medicare is the result of two factors. First, the inescapable demographics that will increase the share of the population, especially the elderly, that is on the receiving end of Medicare benefits. The share of the US population 65 years of age and older is expected to almost double from its current level of 12 percent of the population to 20 percent of the population by 2080. Second, since 1960, per-capita health care expen­ ditures have grown three percentage points faster than per-capita GDP. Even though the Medicare premium income from Medicare Parts Band D rise with the growth of expenditures, Medicare Part A, tax revenues rise only as fast as GDP. Thus, the share of Medicare expenditures that must be financed with general revenues is expected to continue to rise over the entire Trustees 75-year projection period.

32 In Figure 1, I show the Trustees projected share of Medicare expenditures that will have to be financed using general revenues. The general revenue share is projected to rise rapidly from its current level of 41.3 percent to the 2003 Medicare Modernization Act's critical 45 percent level that requires a determination of "excess general revenue funding" in 2012, just six years from now. 1 The required transfers will continue to rise reaching 53 percent in 2020, 63 percent in 2030, and 67 percent in 2040. Finally, at the close of the Trustees 75-year projection period, funding current Medicare will require general revenue transfers for more than 73 percent of all expendi­ tures. Figure 1 Medicare's Gener"l Revenne B"rden

80 ,-----,--.----,--r--~------_,

75

70

65 20 12 62 . 1,,~ r' 60 .. / 45% Excess 55 53.2~/ ' General Revenu e Funding Trigger 50 ,// 4 5.6~/9 ·1 / 4 5+-~,~/~--~---+----+----2~------~ .' 40

35

30~~rrrnmn~~~~~~~~~~~~~~~ 2000 20 10 2020 2030 2040 2050 2060 2070 2080 Cnlendar YeaI' Source: 2006 lvfcdicnre TnJ SleeS Report

It is clear from the implications of current Medicare's general revenue requirements that Medicare as it is currently structured cannot continue. The implications of the projected transfer for the remainder of government expenditures imply that significant tax increases or benefits cuts will be required to pay for the level of benefits projected by the Trustees. To get a feel for the magnitude of the problem, I present here the revenue that must be raised if no benefit cuts are made. My approach throughout will be to as­ sume that the Medicare expenditures projected by the Trustees will in fact happen so that the resources implied by these expenditures will be found. Since we cannot expect other nations to help us we must either place ad­ ditional taxation on workers or force the elderly to pay additional premiums.

M ~ ~nWil g ~h e V(Q)!UJ[lllg lP ~ y: rhl ~ r~J{ § (Q)~IlJJ~n (Q) Wil Balancing the Medicare Part A Budget with Payroll Taxation

Currently, 94 percent of Medicare Part A revenues come from the 2.9% payroll tax. The remainder of Part A revenue comes from Medicare's share

1. The 2003 Medicare Modernization Act set the trigger for informing the President of poten­ tial program in solvency at 45 percent. Specifically, if projected Medicare expenditures are expected to require general revenue transfers of more than 45 percent of total expenditures within a seven-year horizon for two consecutive years, the Trustees are required to send an alert to the Presid ent and the President is required to produce proposals to Congress to rectify the problem.

33 of the taxation of Social Security benefits and premiums from buyers of Medicare.2 Since Medicare Part A revenue comes primarily from the pay­ roll tax, I begin by calculating the payroll tax rate that would balance the Medicare Part A budget.

Based on the 2006 Medicare Trustees Report and accounting for both the revenue from premiums and the taxation of Social Security benefits, I show in Figure 2 the payroll tax rate required to balance the Medicare Part A budget. The required payroll tax immediately begins a slow rise that accelerates in the middle of the next decade as the front edge of the baby boomers reach age 65. In 2020, the HI payroll tax rate will have to rise from its current 2.9% level to 4.3% and by 2030, the required HI payroll tax will be at 6.0%, more than double its current level. By the end of the 75-year period, 2080, the required payroll tax rate will be 11.6%.3

Figure 2 Payroll Tax Rate Required to Balance the Medicare Part A Budget

14

12 11 .6% ,-

JO 2030

8 7.7% " 2020

G.O% _,,~ 6

4 . 3'Y~ ~ , " 2

I) 2005 20 15 2025 2035 2045 2055 2065 20 75 Cnlenda.' Year

SOll re.:: : Fig. u l"l: II.E I 2006 I\ k J i'::lf<: Tn ' ~ kc s Report

Balancing the Medicare Parts Band 0 Budgets with General Taxation

Medicare Parts Band D are financed by a combination of premium payments from participants and general revenue transfers. The current leg­ islated level of Medicare Part B premiums is set at 25 percent of per-capita cost for the elderly and 20 percent disabled participants. For Medicare Part D, premiums are expected to generate 22.8 percent of total expenditures. In 2005, general revenue transfers covered 77.7 percent of total Medicare Part B expenditures, including the disabled. The Medicare Moderniza- tion Act of 2003 (MMA) included some means testing for Medicare Part B

2. The law provides for individuals 65 years of age and older, who do not have the required number of quarters to be elig ible for Medicare, th e opportunity to purchase Medicare. In addi­ tion, th e 1983 Social Security reform provided for the taxation of up to 50% of Social Security benefits if recipient income exceeded leg islated levels, with the proceeds going to Social Security. In 1992, up to 80% of Social Security benefits became subject to income taxation with the revenues collected from th e taxation of Social Security benefits above the 50% level dedicated to Medicare Part A. These revenues can be expected to grow as more retirees become subject to Social Security benefit taxation. 3. Bear in mind that payroll taxes are pre-income-tax dollars so that the payroll tax payments themselves are subject to income taxation.

34 premiums so that when fully implemented the means testing is expected to reduce the general revenue share of Medicare Part B cost to 74.6 percent from the current long-run leg islated level of 75 percent.4

In Figure 3, I show the projected path of the general revenue transfers required to pay for Medicare Parts Band D after accounting for premiums paid by participants. To show the effect of the general revenue transfers to Medicare on the federal budget, these general revenue transfers are expressed as a share of non-entitlement federal tax receipts.

Beginning with Medicare Part B, general revenue transfers accounted for 7.8 percent of non-entitlement federal income. By 2020, funding Medi- care Part B will require 10.7 percent of non-entitlement federal income, by 2030, 14.5 percent, and by 2040, 17.7 percent. At the close of the Trustees 75-year projection period, 2080, Medicare Part B transfers from general revenue will consume more than 24 percent of non-entitlement federal revenues.

The full Medicare Part D prescription drug benefits began in 2006. The share of non-e ntitlement federal tax receipts required to fund Medicare Part D is projected to rise rapidly throughout the Trustees fu ll 75-year projec­ tion period. In 2020, the Trustees project that Medicare Part D will require general revenue transfers equal to 6.4 percent of non-entitlement federal tax receipts, by 2030, 9.4 percent, and by 2040, 11.2 percent. At the end of the Trustees 75-year projection period, Medicare Part D will require more than 15 percent of non-entitlement federal revenues. S Figlll'c3 MNlkarc Paris Il and D Required Trausfers % NOIl-Elllillefllf!1II Federal TaWls 60,------,---,---,------,

;0

2030 40 39)';( Tota l

2020 30 18.9%

23.9% ? -< H.l o/, Part B

20 17.1% ,/ IW( PartD 10

o h.~~~~~~~~~~~~~~~~ 21100 2111U 2010 2030 2040 20511 10(,0 2070 20W C;I Il'I1i1 ;lrYcar Sourc~ : lOIlG t-. kd icnr

4. The 2004 Medicare Modernization Act introduced a higher "in come-related" premium for individuals whose modified adjusted gross income exceeds a specified th reshold, set for 2007 at $80,000 for individual retu rn s and $160,000 for joint returns and then in dexed to inflation. Individuals exceeding the threshold will pay premiums covering 35, 50, 65 or 80 percent of average program cost for aged beneficiaries, depending on their in come level. 5. For these ca lcu lations we treat as revenue all premium payments. We note here however, that approximately 12 percent of Part B premium revenues represent th e federal share of Part B premiums paid by the states for those citizens on Medicaid. Thus, our estimated general revenue tra nsfers are a lower bound on th e required level of such transfers.

35 Taken together, by 2020, Medicare Parts Band 0 together will require more than 17 percent of all non-entitlement federal revenues, by 2030, almost 24 percent, and by 2040, almost 29 percent of non-entitlement federal revenues. At the close of the 75-year projection period, paying for projected Medicare Paris Band 0 benefits will require almost 40 percent of all non­ entitlement federal revenues.

If the only change in taxation that occurs is the increased payroll taxes required to balance the Medicare Part A budget, then non-Medicare fed­ eral expenditures as a share of the economy will have to fall by roughly 40 percent. Further, if payroll tax increases are not used to cover the Medicare Part A deficits, and general revenues are used to make up the Medicare Part A deficits, more than two-thirds of non-entitlement federal revenues will be required to cover all Medicare. Such transfers would require a two-thirds reduction in non-Medicare federal expenditures.

Since a two-thirds reduction in the role of the federal government outside Medicare seems unlikely, here I proceed by assuming that the non-entitle­ ment role of the federal government should remain at its current share of the economy. Based on the projections of GOP from the 2006 Medicare Trustees Report, I calculate the non-entitlement federal revenues that would be required to maintain non-Medicare federal programs. The sum of the revenues required to maintain federal non-Medicare programs and the projected general revenue transfers to Medicare becomes my estimate of the level of non-entitlement federal revenues that will both maintain the non-Medicare federal government at its current share of the economy and cover projected Medicare shortfalls.

Since Medicare Part A is currently financed with payroll taxation, I begin by assuming that the projected Medicare Part A deficits are financed by increases in the HI payroll tax rate. Thus, only the Medicare Parts Band o deficits must be financed through increases in federal non-entitlement revenues. The ratio of estimated required non-entitlement federal revenues to the projected level of non-entitlement federal revenues yields the per­ cent change in tax revenues that would keep the federal government at its current share of the economy and pay projected Medicare Parts Band o benefits. Figure 4 shows the projected percentage increase in average federal tax rates that would be required to maintain non-entitlement federal government at its current share of the economy and provide the transfers necessary to pay projected Medicare Parts Band 0 benefits.

Taking the year 2006 as the base, the figures show the percentage in­ crease in non-payroll tax federal revenues required to pay for Medicare Parts Band 0 deficits and maintain non-entitlement federal spending as a share of the economy. The required tax increases are so significant that in 2020, federal non-entitlement revenues will have to rise by more than 9 percent to cover the projected Medicare Parts Band 0 shortfalls and main­ tain the federal government's share of GOP, which by 2030 is more than 16 percent, and by 2040, more than 21 percent. Finally, by the end of the Trustees 75-year projection period, federal non-entitlement revenues must rise by more than 31 percent.

36 I'lgul,,,4 A\'cl'tl~e 'I'll\: Ihlt' Ilinens... Hl'fluil'tti to I'AY rol' P,'ojtctttl "lcllicnrt Pnrt ~ IJ ~ml J} RUt! t\ l~illtrt ; n Non -Elilitll'ment Ih: Jl l'n tl itll l't'S /'"", . J/.I .:/id,. • FI" " ,, ~, ~I .. lrIl l'".I''''''' 1."\,, " ~ .l U % 20311 " , 20:W 211 % " 1(, I'

IU 9 l",

"lOl lS 211tS 21 ,25 2O \S ms ~ ' H 2(It,S 201S Cn lrnd:1I" Venl'

The Pure Taxation Solution to Paying for All Projected Medicare Benefits

The previous secti on estimated the tax increases required to pay for future Medicare assuming that Medicare Part A deficits were financed by increases In the HI payroll tax. In order to malle the total tax requirements of funding Medicare's future defici ts more transparent, I do away with that assumption. Rath er, In this exercise I assume that the HI payroll tax rate remains at its current level of 2.9 percent of payroll. Then, letting all pro­ jected Medicare deficits, including the projected Medicare Part A deficit, be financed through general revenue transfers yields a complete picture of the tax impact of the projected deficits inherent In current Med icare.

Figure 5 shows the percent Increase In federal non-entitlement revenues th at would be required to fund all projected Medicare deficits while at th e same time allowing th e non-elderly entitl ement federal government to remain at its 2006 share of the economy. For example, th e Medicare Part A deficit's share of federa l non-entitlement revenues, at th e current payroll tax rate, will ri se from essentially zero to 4. 1 percent between now and 2020. During th e same period, the share of federal non-entitlement tax revenue consumed by Medicare Parts Band D will ri se from 11 .1 percent to 17. 1 percent, resulting in a 2020 total transfer to Medicare 21.2 percent of federal non-entitlement revenues. Thus, by 2020 th e average federal tax rate will have to increase by 13.3 percent if other federal expenditures are to remain at th eir current share of the economy.

By way of comparison, over the past twenty-five years, reven ue from per­ sonal income taxation has averaged 14.38 percen t of personal Income, so that th e required 13.3 percent increase in personal income taxation would increase th e average taxation of personal income from 14.38 percent to 16.29 percent. By 2030, the average taxation of personal income would have to be 18.19 percent and by 2040, 19.8 percent. Finally, al lhe end of lhe 75-year Trustees estimation period, the average taxation of personal income would have ri sen by just more th an 60 percent to 23.11 percent.

37 Figure 5 Average Tax Rate Increase Required to Pay for all Projected Medicare Deficits and Maintain Non-Entitlement Expenditures /'(11'1 A }'ayrol/ Tar lIale Re/llaills il 2,9% 711

m.7%•.... 60 ~ 50 " 2030 r ./ ·10 37J~% "" 2020 ./ .111 16.5'Yo ,,'

" zn ,,' , ILl% 10 .' "

o~~~~~~~~~~~~~~~~~ 2005 20 15 2025 1035 2045 2055 20G5 2075 Calendar Yea r

An alternative way to express the magnitude of the tax changes necessary to fund the projected cost of Current Medicare is in terms of payroll taxes. Figure 6 shows the payroll tax rates that would be required to maintain the share that federal non-entitlement spending is of the economy and make the necessary transfers to pay the projected cost of Medicare Parts A, B and D. The upper line in the figure shows the total payroll tax rate required to fund all projected Medicare deficits at current premium and tax rates. The lower line shows the Trustees projected Medicare Part A cost rate, The widening difference between the payroll taxes required to fund Medicare Part A and the payroll tax rate required to fund all Medicare is a result of the rising share Medicare Parts Band D in total Medicare expenditures.

The payroll tax rate required to fund all projected Medicare deficits will, by 2020, be 6.23 percent, than double the current 2,9 percent rate. By 2030, the Medicare payroll tax rate will have to be 9.66 percent, more than three times the current rate, and in 2040, 12,66 percent, more than four times the current rate. Finally, at the close of the Trustees' 75-year projection period, the required Medicare payroll tax rate would be 19,9 percent, almost seven times the current Medicare tax rate. Figure 6 The Payroll Tax Reqlli,'ed to Pay fOl' P,'ojected Current Medicare Deficits and Maintain NOli-Entitlement Expenditure Sh are of GDP

25

19.1, 20 ~ 2030 15

1 2 . 72 ~ 2020 "

ID 9.660/. A Medidme Pari 6 . 23'}~ Cosl Rate 5 ."

(J-h-r~~~rI-r.~~~~crrI-~""'~nTT~~~~""'~ 2005 20 15 2025 2035 2045 20SS 2065 207' Calendar Ye3l'

38 It is clear that a one-sided solution to solving the funding issues of the pending Medicare deficits that imposes all the cost on the young through taxation would require tax rates that are most likely unsustainable. Here I investigate a one-sided solution that imposes all the cost on the elderly. Rather than making the young pay through taxation, I show the premi­ ums that would be required if we make the eld erly pay. As an aside, I will discuss the impact of either solution on the generational distribution of who pays, the retired generation or the working generation.

Increasing Medicare Parts Band D Premium to Pay for Projected Deficits

As I did in the discussion of the level of taxation required to fund projected Medicare, the premium calculations are designed to leave the non-elderly federal budget unaffected by Medicare deficits. I will treat each part of Medicare separately and begin with Medicare Part B. To leave the non-el­ derly federal budget unaffected by future Medicare Part B, I assume that the general revenue transfer to Medicare Part B remains fixed at its 2006 share of GDP.6 Medicare Part B premiums are the same across all aged beneficiaries and are set in the Fa ll of each year at 25 percent of expected per-capita Part B expenditures.? A further complication comes from the Medicare Modernization Act's introduction of limited means testing that is projected to provide a small increase in the revenue contribution of Medi­ care Part B premiums.8

Figure 7 shows the premiums that must be imposed to fund the Medicare Part B deficits projected by the Trustees when we fix the Medicare Part B general revenue transfer as a share of GDP at its 2006 level. The required level of premiums rise rapidly from their 2006 level of 25 percent of the per-capita cost of Medicare Part B. By 2020, the share of all Medicare Part B expenditures paid by beneficiaries in the form of premiums will reach to 42 percent of expenditures and the general revenue financing of Medicare Part B will in 2020 have fallen from its current share of 75 percent to 58 percent. Beneficiaries will be paying for more than one-half, 57.2 percent, of all Medicare Part B expenditures in 2030, and in 2040, beneficiaries will be paying for almost two-thirds, 65.1 percent, of Medicare Part B expen­ ditures. Finally, at the end of the Trustees 75-year projection periond, Medicare Part B beneficiaries will be paying for almost three-fourths, 74.2 percent, of Medicare Part B expenditures, essentially reversing the current- law participant, general revenue shares. I' I' I'

6. Thus, the general revenue transfer is allowed to grow at the same rate as GOP. Because health care growth exceeds GOP growth, the required transfers grow faster than GOP. 7. There is the small matter of the Medicare Part B Trust Fund. The Trust Fund is managed through the level of premiums and exists to allow for the payment of benefits should the fore­ cast of expenditures be well below actual costs. 8. The 2004 MMA introduced a limited means testing of premiums. However, the level of the means testing threshold, $80,000 means adjusted gross income for an individual and $160,000 adjusted gross income for a couple, means the impact on the share of Part B expenditures covered by premiums is projected to rise only slightly from its curren! level of 25 percent.

39 F igure 7 P l'emiums as a Shal'e orTolal Medical'e Pal'l B Expenditul'es ParI B Tr{/I/.~li:r .S'harl· NOI1-Elllir/elllc11l P't.'derll/ /le l 'CHlle.'; Fi.w cl

&u.------~----,-----.------~

70 6S. l%

GO

50 ./ " 42'()% ,.' 2040 /' 2030 30

10

IU

O~~~~~~~~~~~~~~~~~~~~~ 2005 20 1r5 2025 20 35 2045 2055 2065 2075 Calenda,' YeaI'

Because the full implementation of the Medicare Part D prescription drug benefit is in its first year in 2006, the future of this program is still highly uncertain. However, for purposes of the required premium estimation, I will treat the estimates presented in the 2006 Medicare Trustees Report as having the same level of reliability as the Trustees estimates of Medicare Part B, which has a long history. Figure 8 shows the Medicare Part D pre­ mium required when we limit the general revenue transfer to Medicare Part D as a share of GDP to its 2006 level as projected by the Trustees.

F igul'e S P l'emiuJIls as a Shm'e oflHedicm'e P ad D E xpeuditures Pan [) Trellls/"r ,S'llare ,!/'NolI-Elllillelllell f Federal Revelllles Fixed

100 .------~----.---~,------~

90 81.4% 80 77.7%

7U 66.8% ./ ,/ " 60 2040

" 50 2030

40 2020 30 . 20 10

0 2005 20 15 2025 2035 2045 2055 20G5 2075 Calenuar Ye!l l'

Given that we have no history for the Medicare Part D premium share of Medicare Pali D expenditures, I use the Trustees estimate that by 2015 these premiums are expected to account for 22,8 percent of expenditures,

40 as my 2006 starting point.' The ri se in th e premium share of total projected Medicare Part D expenditures is even more rapid than was th e case for Medicare Part B. By 2020, the pre mium-financed share of Medicare Part D expenditures account for two-thirds, 66.8 percent, by 2030, premiums would account for more than three-fourths, 77.7 percent, and by 2040, more th an four-fifths, 81.4 percent. Fin all y, at the end of th e Tru stees 75- year projection period, 86.5 percent of all Medica re Part D expenclitures will be paid by beneficiaries.

Using Premiums to Pay for Projected Medicare Part A Deficits

A full transfer of th e cost of fu tu re deficits of Medicare to the elderly re­ quires that I estimate the level of premium s that would be necessary to pay for th e projected Medicare Part A deficits. Figu re 9 shows th e share of projected Medicare Part A expenditures that would be paid with prem iums if th e cu rre nt Medicare payroll tax rate remains at its curre nt 2.9 percent leve l. Medicare Part A was essentially self-supporting in 2005, so premiums would be zero. However, beginning in 2006, th e Trustees project th at Medi­ care Part A will be in deficit. Since there have been no general revenue transfers to Medicare Part A, I have estimated the Medicare Part premiums at levels to cover all future projected deficits.

1

70.('0/. 7U 1

Go 56.3%

.> 11>1..1'" I ' t' 204()

2 J . 9~. 2u30 20

10 o ~ 2005 2{) 15 2025 2U.15 2u-l 3 "''' 2uGS 21175 CrliC I1t1 flf YCIl I'

Because Medicare Part A goes into deficit immediately, premiums would be positive in 2006 and would ri se rapidly as th e Med icare Part A deficits grow. By 2020, Medica re Part A premiums wou ld account for almost one-fourth of Med ica re Part A expenditures , IlY 2030, more than 40%, and by 2040 well more th an one-half of all Medica re Part A expenditures. Finall y, at the end of th e Tru stees 75-year projection period , Medicare Part A premiums would account for more th an 70 percent of Medicare Pari A expenditures.

9. The premIum revenue for Medicare Part 0 comes from two sources: premiums from par­ ti cipants WllO are not eligible for Med icaid. For those eligible for MedicaId, tha dual eligibles, th e State's are expected to return to the fede ral treasury somo or all of th e savings they incur because of tile federal su bsidy to these beneficiarie s. Tile projections we have assume th at th ese trans fers actually ocCur. Also, our projec ti ons fall to acco unt for the fact th at th e transfers from the States to th e federal government may Im ply a lax burden on th e cItizens of Ih e vari­ ous States,

41 The Total Premium Burden on Elderly Income

The shifting of the burden of funding the projected Medicare deficits from the young to the elderly results in the elderly paying for from 70 to 86 percent of all Medicare Parts A, Band D expenditures by the end of the 75- year projection period. The level of premiums required will place a substan­ tial burden on elderly income. One way to think about the future income of the elderly is the level of Social Security ben efits as projected by the Social Security Trustees. Figure 10 shows the total Medicare premium burden as a share of projected Social Security benefits for scaled medium and high career earners who retire at the normal retirement age, as specified by the current Social Security law.

From the 2006 Medicare Trustees Report, the Trustees estimate current Medicare premiums will consume 7. 4 and 9.8 percent respectively of the High and Medium earners' Social Security benefit in 2006. If the general revenue transfers to Medicare are fixed at their projected 2006 share of GDP, the required increases in premiums to cover the projected revenue shortfalls for all parts of Medicare as a share of retirees' Social Security benefit checks will rise rapidly. These premiums will consume 23.4 of a High earner's Social Security benefit and 31.1 percent of a Medium earn­ er's benefit check as early as 2020. By 2030, these shares will have risen to 38.0 percent and 50 .5 percent respectively. Then by 2040, the required premiums will consume more than one-half, 51 .2 percent, of a High earn­ er's Social Security benefit and more than two-thirds, 67.9 percent, of a Medium earner's Social Security benefit. Finally, at the end of the Trustees 75-year projection period, the required Medicare premiums will consume more than three-fourths of High earner Social Security benefits and more than 100 percent of Medium earner benefits.

FigllJ'e 10 Pnl'ls A, B, 0 Premium s as a Shnre of Projt!c tcd Social Scrurity Be nefit s .\/,'dicor.' Trnll!.f~'r ;.! (/ Cvwrllllf SIIIII",' a/Fed,1m' NOII·Elllilh'lIIl'IIf R.'wl//I.'j fart A PII,ITON T(/\\'s [(.'III(J;IIIII Cllrrl'lIf LI!\\ "

120.,.---,--,,.--,------, '00 ...... [~ S ...... ~ . ::, . '~t" Moo;" • • ~,

SII ...... •.. .•. 2020 ...... •r...... ~:.:.... :.;; ~ ig h Earner 78.1')' 67.9% " 60 ...... "(' ...... ; ... , ...... 50.5% i' ,./ ·111 ·· · ········ · ~·; :·; ;X. ! ·;:;i'~ .,.; ... ·~ I ·.-2-~{ ......

• f·' ". 3S.0o/' 20 ...... !~. . . !', ...... •.•.•. ••••• • ...... •. • .•...... 23 ..1 %

o~~~~~~~~~~~~~~~ 20 15 2015 21125 2!)35 2(J~5 2(155 2065 2075 C:tl eud ar Year rmosf

42 Summary

As the above estimates mal(e clea r, the solution to fin ancing the projected Med icare deficits will require a combinati on of taxes on the yO~lI1 ge r gen­ erati on, premium payments by the older generation, and perl1 aps even expenditure cuts by Congress . Requiring the young to cover th e looming defi cits through increased taxati on implies an almost doubling of th e total tax burden from its current level of 14.4 percent of personal incom e to 23 .1 percent. Expressed in term s of payroll , the tax rate at the close of th e Tru st­ ees 75-year projecti on peri od must be almost 20 percent, a seven-fold in­ crease from th e current 2.9 percent HI payroll tax rate. When one considers th at th e Social Security Trustees estimates that th e tax rate required to pay projected Social Security benefits in 2080 will be 18.6 percent of payroll , it is clea r that such tax rates are beyond any real possibility.

By the same tol

References

Th e Board s of Tru stees, Federal Hospi tal and Federal Supplementary Medica l Insura nce Trust Fund s, The 2006 Annual Raport of Ihe Boards of nustees of Ihe Federal Hospilallnsurance and Federal Supplemenlary Medicare Insurance Trusl Funds, US Government Printin g Oftice , Was hington, 2006.

The Boa rd or Trustees , Federal Old-Age and Survivors Insurance and Federal Dis­ abi lity Insurance Trus t Funds, TI)e 2006 Annual Report of lI,e Boarel of 7i'uslees of the Federal Old·Age and Survivors Insura nce and Federal Dlsabl/lly Insurance Trust Funds, US Government Printing Office, Was hington, 2006.

Retlenmaier, Andrew J. and Thomas R. Saving, The Diagnosis and Treatmenl of Medicare, fo rthcoming, AE I Press.

Tab le 2.3 Receipts by Source as a Perce ntage of GDP 1934-2011 , in Budget of the United States Government, Fiscal Yea r 2007, available at, <11t1p:llwww.wI1ite l1ollse.gov/omb/budgetlfy2007/hi st. html> l1ttp :IIwww. wl1 itehouse. gov/omblbudgeUfy2007/hi st.html

43 • r. •

fundamental tax reform • • •

Health care spending is the United States' leading economic and social policy challenge. In 1970, national health expenditures were $1300 per person and consumed 7 cents out of every national dollar - 7 percent of Gross Domestic Product (GDP). Over the past three decades, spending per capita grew on average 2.5 percent faster every year than did income per capita. The upshot of this phenomenon - which I will refer to as "ex­ cess cost growth" - is that in 2004 spending per capita rose to $6300 and health spending constituted 16 percent of GOP.

What happened? While most of the recent attention has been paid to spending on drugs - which grew at an annual rate of 14 percent between 1997 and 2002 - this misses the bigger picture. Pharmaceuticals are still only 10 percent of the health care bill. Instead, the rising spending comes from several sources. The first is an aging population in which a larger fraction of the population is in high-spending parts of the lifecycle. Along with this has come rising incomes and increased health insurance cover­ age. The former increase the ability and the latter increases the incentives to purchase more health care. At the same time, the tort system has likely contributed to excessive testing and other forms of defensive medicine, although the exact scale is far from clear.

However, most analysts agree that a dominant characteristic of rising health spending has been the innovation, adoption, diffusion, and utilization of new technologies. While in some cases these new technologies held out the promise of comparable cost-savings elsewhere - think, for example, of cholesterol medications reducing the utilization of heart bypass or angio­ plasty - thus far such savings have not been realized . And in many cases,

44 innovation simply permitted the treatment of previously-untreated chronic conditions ranging from pain to erectile dysfunction to heartburn.

These trends cannot continue. To see this, focus for a second on the US federal government budget.1 At present, the ratio of debt (in the hands of the public) to GOP is roughly 40 percent. This ratio has two desirable char­ acteristics as an indicator of the long-run sustainability of current policies. First, the numerator reflects any cumulative mismatch between the outlays of the government and its tax receipts, which is the core concept of sustain­ ability. Second, the denominator reflects the scale of the national economy that could, in principle, be devoted to the imbalance. Moreover, to the ex­ tent that there are pro-growth policies that might worsen the numerator but sufficiently augment economic growth, then the indicator will decline. This is exactly the type of sustainability barometer that one should examine.

Using this, let us examine the political and policy mechanics of trying to sustain something close to current federal budget practice. At present, the federal government raises about 18 percent of GOP in receipts - essen­ tially the postwar average. (Business as usual in the United States is that the federal government spends 20 cents out of every national dollar, raises 18 cents in revenue, and borrows the remainder. This is nearly identical to how the federal government will close the books for 2006.)

On the spending side, let us assume that Social Security reform remains unrealized and the benefits are paid as currently scheduled. That implies that outlays for Social Security will rise with the retirement of the baby­ boom generation from about 4.5 percent of GOP now to 6.5 percent of GOP in 2030, and then continue to drift north to about 7 percent of GOP.

Of course, this will require a bit of belt-tightening, so let us adopt the Administration's strategy of holding non-defense discretionary spending flat in nominal terms. But instead of holding it for five years, assume that the political will exists to hold it flat for five decades. At the same time, cut defense discretionary spending by about 25 percent and hold it flat for 50 years. This is a dramatic reversal of the cost of current policy in both the supplemental (Iraq, Afghanistan, etc.) and base defense budgets and will carry comparably dramatic political costs.

Is this fiscal policy sustainable? Not yet. Having succeeded in 50 years of annual political self-control , the only element missing to keep a stable debt-to-GOP ratio is .... a miracle! Specifically, the rate of excess cost growth must fall to: zero. If excess cost growth continues at historic rates, Medicare and (the federal share of) Medicaid will raise from 4 percent of GOP to 22 percent of GOP in 2050, or larger than the entire federal bud­ get. Conventional assumptions (such as those of the Medicare trustees) are that excess cost growth will moderate to 1 percent. With this assump­ tion, Medicare and Medicaid will still triple in size to 12 percent of GOP and debt-to-GOP will still grow explosively.

1. This discu ssion is ba sed on th e Congressional Budget Office, Th e Long-Term Budget Out­ look, December 2005.

45 Future health care costs are of such magnitude that even if the "good news" scenario of 1 percent excess cost growth prevails and taxes are also raised to 25 percent of GOP, fiscal policy is likely unsustainable. More­ over, the detrimental economic growth consequences of that size increase in taxes would reduce GOP enough to make the problem even harder to solve. Put bluntly, we cannot tax our way out of the fiscal implications of growth in federal health programs. We cannot grow our way out - a sustained increase in productivity growth of a full percentage point is both unimaginable and inadequate.

But the future of the federal government budget is not the most important reason why things must change. A bigger issue is the macroeconomic consequences of these trends. If left unchecked, these programs' enor­ mous appetite for spending will attack the three pillars of post-war eco­ nomic success.

First, US economic success is largely due to the strength of the private sector. The mirror image of reliance on private markets is commitment to a government sector that is relatively small (granted, "small" is in the eye of the beholder) and contained. Growth in spending of the magnitude prom­ ised by current laws guarantees a much larger government.

Second, the small US government has been financed by taxes that are relatively low by international standards and interfere relatively little with economic performance (the same caveat applies to "low" and "little"). Spending increases of the type currently promised guarantee higher taxes and impaired economic growth.

Finally, a hallmark of the US economy has been its ability to flexibly re­ spond to new demands and disruptive shocks. In an environment where old-age programs consume nearly every budget dollar, to address other policy goals politicians may resort to mandates, regulations, and the type of economic handcuffs that guarantee lost flexibility. Why should the govern­ ment book the costs of homeland security, or worker training, or new initia­ tives when it can demand that the private sector do it "free"?

In short, addressing health care spending and fiscal sustainability is essen­ tial to sustaining overall economic growth in the United States.

In doing so, it is important to recognize that the problem is not necessarily the structure of federal programs. While they are large-scale customers and have a significant influence, the focus should be on the rising spend­ ing on health care - excess cost growth exists in federal programs, state programs, and the private sector. However, the biggest problem is not how to cut health spending. The biggest problem is that we have no idea what we're getting for our money.

Does higher spending reflect better quality? Does it reflect market power or even predatory prices? Is it driven by overuse of new technologies, or underutilization of preventive care that would avoid the need for expensive therapies? Is it an artifact of paper filing systems? Until the causes of the relentless rise in spending are more completely diagnosed, it will be difficult

46 to undertake effective reform s. In the absence of solid understanding, sen­ sible reform s are impossible. Given curren t trends, in the future th e gov­ ernment will find a way to devote fewer resources to health programs, but without beUer Imowledge it will be easy to fear that any increased spending is waste, and any cu ts in oullays co me at the expense of needed care. In th at politica l environment, real reform will be impossible.

The sooner th e reform process begins, th e more beneficial the lil

Meanwhile, the same pressure on costs in the public sector wi ll lil

If left to thi s path, the most likely responses will be the ones easiest to di­ rectly "solve" th e problem. On the insurance front, there will be tremendous pressure to expand Medicare eligibility. (There are earl y indica tions of the shape of such a response in Congressman Oingell's Medicare for All Act (H .R. 4863) that would dramatica ll y expand fee-for-service Medicare.) On the health care cost side of the ledger, there will be simultaneous pressures to control prices and raise taxes to cover costs.

Less dramatic actions wi ll si mply pale compared to the problem. For exam­ ple, raising the part B premium from 25 percent to 50 percent of outpatient care costs would reduce Medicare by on ly 0.7 percent of GOP in 2050. In short , failing to change course soon raises the odds of a future of higher ta xes, greater government insurance , and more governmen t price controls in health ca re.

What's a beUer solution? I think th e US w ill need to "ely on marl

The first step is to begin to separate the markets for health ca re and health insurance. Heallh care is about getting the highest quality, lowest-cost bang for the buck as patien ts and doctors choose therapies. Health insurance is

47 about making sure that family finances survive the economic consequenc­ es of episodes of bad health. At present, insurance and care are too inter­ mingled in the United States. Reforms should target the two separately.

To improve private health insurance markets, it is important to recognize that catastrophic and chronic costs are not the same. Insurance markets easily spread the costs and make affordable the high cost of infrequent episodes of bad health. But the ongoing high cost of chronic bad health is not insurable. At present, it is too difficult to identify these costs; the result is that insurance companies fear selling to individuals out of fear that they may turn out to be a chronic drain on profits. To support broad, private markets tax policy should eliminate the preferred status of employer-provid­ ed insurance. And, to the extent necessary, government high-risk pools or reinsurance should help to separately pay for chronic care. These reforms - coupled with sensible regulations and tort laws - promise to broaden insurance pools and support making affordable insurance for the currently uninsured.

However the heart of the reforms needed is to make health markets work more like other markets. To begin, the United States has to establish a locus of decision-making that is conscious of costs and capable of evaluat­ ing benefits. Who will that be? Operating by process of elimination, it will not be insurance companies. Insurance companies shouldn't be in the business of micromanaging ordinary care, and the widespread discontent with Health Maintenance Organizations (HMOs) in the 1990s suggests they won't be. Similarly, it does not seem likely that Americans will place doc­ tors at the controls of both care choices and costs. Finally, I do not envis­ age the public accepting government as the decider of care decisions and a full payer of health costs.

That leaves the US family as the locus of decision-making. In a better­ function market for health care, families would decide benefits in rec­ ognition of their costs. The result would be health decision-making that endorsed spending that is "worth it" - it might involve spending more as incomes and ages rise, but it would be efficient in its use.

The problems in fulfilling this vision exist in the cultural, benefits, and costs dimensions. Culture might be the hardest. At present, families do not ex­ pect to be in charge of health decisions and changing the culture from one in which people "visit" the doctor to one in which they "buy doctor services" is an enormous undertaking.

Moreover, even if the culture shifted instantly, there is much to be done in other areas. At present, too little is known about the benefits of alterna­ tive therapies to support good decision-making. As with other complicated consumer activities - homes, colleges, computers and cars come to mind - greater production and dissemination of information, evaluation and rank­ ings must become routine.

On the cost side, it is similarly unimaginable that families could immediately shoulder the full burden of non-catastrophic health costs. However, moving to greater cost-exposure over time will give providers incentives to operate

48 more efficiently and identify costs with better pricing. The large results will likely derive from more sensible technology adoption. Faced with regular evaluation of benefits and a clear importance of costs, technology adopti on wi ll satisfy an economic test and not just a health care hurdle.

A large of array of supportive changes could help to ensure success - tort refo rm , better physician training and best practice protocols, cross-state Insurance portabili ty, etc. - but government programs sl10uld talle a lead in supporting reform . Medicare and Medica id are on tracll to swamp th e federal budg et, which is reason enough for changing th ese programs. But changes should support reforms of the broader hea lth sector - programs should provide information about quality, harness market forces in care de­ cisions, and separately address catastrophic and chronic care. States face bu dget pressures, but corresponding ince ntives to innovate in providing low-income insurance - experim entation of this sort are a good thing.

Health care reform is a volatile, two trillion doll ar brew of equipment, techni­ cians, providers, patients, and insurers. Because there is no sing le magic bullet, a long series of adjustments will ultimately be required to ensure that the United States does not overspend on health care. The odds of getting all those changes rig ht in one fell swoop are essentiall y zero , so a better approach is to begin now and malle sustained, incremental improvements in the functioning of Iley markets.

Why should the United States engage in broad reform of its health care? Because it must. When should health care reform begin? Yesterd ay would be best, but today for sure. And how should reform be done? It should focus on continuous incremental changes to the cultural, legal, and regula­ tory environment th at improve th e capacity of health care markets. .

'k9 I'm delighted to be a part of this very special event.

When I look at my distinguished fellow panelists, I recall a comment Mark Twain once made when he found himself sharing the podium with a famous educator.1

"Between us," he said, "we cover alll

Seriously, the breadth and depth of the group you've assembled today is unusual. Together, we may not cover all knowledge. But we should be able to provide some interesting perspectives on health care in the US.

Also, your timing couldn't be sharper. Problems in our health care system, and proposals to solve them, are very much top of the news now.

In fact, I'd like to use as my point of departure the latest health care reform proposals from the Bush administration. 2

This paper is based on remarks prepared for the Indiana University Business Conference sponsored by the Indiana University Kelley School of Business, March 8, 2006, in Indianapolis, Indiana. Copyright 2006 Eli Lilly and Company. Used by permission. 1. The other panelists were: Michael B. McCallister, President and CEO of Humana Corporation; Larry C. Glasscock, Chairman, President and CEO, WeliPoint Inc.; Daniel F. Evans, Jr., President and CEO, Clarian Health Partners; and Ralph F. Hake, Chairman and CEO, May tag Corporation . 2. See Office of Management and Budget (2006).

50 In his current budget, th e presidenl is asking for new leg islation in several Imyareas.

He wants to expand the use of his new Health Savings Accounts by maIl­ ing premiums tax ded uctible and employee contribu tion s exempt from the payroll tax.

He wants to offer th ese accounts to many who are now uninsured by creat­ ing a refundable tax credit for low-income workers to purchase HSAs.

He is as lling for new leg islation to enable consumers to shop for th e best health insurance va lues in a nationwide marllet.

He is asl

And finally, he wants to accelerate th e adoption of information technology in health care, including creating electronic medical records for most Ameri­ cans by 2014.

Thi s is, to put it mildly, a far-reaching agenda, with enormous consequenc­ es for our society. Ultimately, to be able to evaluate th ese remedies, we need to better understand what ill s they are trying to cure.

So what t want to do today is go a bit deeper and try to layout some of the reasoning behind the proposals.

If I can push the disease analogy a bit further, I would say the US health care system suffers from three seri ous aliments--a metabolic disorder, an autoimmune disorder, and a cog nitive disorder.

The metabolic disorder is really an economic problem. As th e intake and utilization of food drives the performance of th e human body, so does the intake and utiliza tion of funding drive th e performance of a health care system.

People with certain metabolic di sord ers may overeat, beca use th e chemica l signals that usually tell the brain when to eat and when to stop are out of balance.

A similar malfunction is at th e heart of th e endless cost spiral in US health care. Th ere is a breall down in th e economic signals between buyers and sell ers where, no rmall y, price is the balancing mechanism. In health care that exchange never happens because one party--the patient--needs and consumes th e medical servi ce, wllile anotller party--the government, or my employer, or tile insurance company--appears to pay for it.

I say "appears," because economists would arg ue that, in one way or another, co nsumers do bear the cost. But, because we thinll of it as "some­ body else's money," we fee l little inh ibition about spending it. "Feed me," the consumer says.

5] Conversely, the payers are driven to focus on costs above all else and can­ not fairly or fully balance their concerns with consideration of the long-term benefit to the patient. "Stop eating!" is their message.

The sellers--doctors, hospitals, drug companies, and all the other suppli­ ers--are caught between these conflicting signals. But still, they are the sellers, and so, in general, they will try to provide what the patient requests. Consequently, like the compulsive overeater, we as a society cannot seem to check our consumption.

The side effects of this fundamental economic dislocation are perva- sive. Harvard's Michael Porter argues that competition in health care has become a zero-sum game in which, "the system participants divide value instead of increasing it." He describes how, instead of competing to in­ crease value to consumers, health care payers and providers compete to avoid costs to themselves. So what we see is an endless cycle of cost shifting. Thus "gains for one participant come at the expense of others--and frequently with added administrative costS."3

It's obvious how such behavior powers the upward spiral of costs. It's also obvious that the root of it lies in the fracture that separates patient from payer.

When I say that another key pathology in our system is like an autoimmune disorder, I'm thinking of the impact of various kinds of government involve­ ment.

The immune system's function is to protect the body, mainly by detecting and neutralizing harmful intruders like viruses and bacteria. But sometimes, the immune system runs out of control and begins attacking the body itself­ -that's the essence of an "autoimmune" disorder.

Most government regulations in our economic system are designed to protect citizens from potentially harmful practices. But in the case of health care, massive over-regulation--while surely intended to protect us--has instead created a great deal of economic "friction"--tremendous waste and inefficiency--that is crippling the system as a whole.

Recently, one group of scholars attempted to compute the total economic impact of all the regulatory complexity in our system. Subtracting total ben­ efits from total costs, they concluded that regulation in our current system imposes excess costs of at least $169 billion per year.4

In health care, sometimes even the best-intentioned acts of government intervention can have unintended and undesirable consequences.

The split between patients and payers can be traced to a quirk of policy expediency during World War II, when the Roosevelt administration allowed employers to skirt temporary wage and price controls by offering health benefits to workers in lieu of higher wages.

3 See Porter and Teisberg (2004). 4 Se e Conover (2004).

52 What really locked this system in place, and greatly amplified the economic dislocation it causes, was the subsequent decision by the government to exempt these benefits from taxation.

All of us who receive our health care through our employers are dependent on this break, but it has pernicious consequences. In effect, it inflates our currency for buying health care insurance, and thus compounds the third­ party payer problem in weakening the price signal in health care transac­ tions. Consumers who enjoy this invisible subsidy are less sensitive to the true consequences of price and, therefore, so are suppliers. This is one of the keys to the perpetual rise in health costs.

And of course, it's a key to the problem of the uninsured. If you don't get health coverage through your employer, you don't get this significant dis­ count. You have to pay full fare, and many simply can't afford that.

This is not to say that all of the wasteful "friction" in the system can be laid at the door of government. A significant part of it arises from the third systemic disorder, which I compare to a cognitive disorder. Our health care system seems to be plagued by a strange pattern of willful ignorance.

Many of the deadly medical errors and other quality problems that plague US health care can be traced to a gap in the flow of necessary information. Too often, vital information is not available not because it doesn't exist but because we do not allow ourselves to see it, share it, and act upon it.

"Exhibit A" is the general failure to fully adopt and implement the advan­ tages of modern information technology. Though it's starting to change, too many people in health care are still living in a world of paper charts and hand-scrawled prescriptions. We need a world in which our doctors have instant electronic access to our complete medical records.

And, for consumer-driven care to work, we need a world in which consum­ ers can go online and get reliable information about price and performance for health care products and services.

Now, with this background, take another 1001< at the president's propos­ als. You can see that these are not just a few random "good ideas." Each of them is intended to address one or more of these structural problems. Together, they constitute an action plan for comprehensive health care reform.

To tal

Second, the proposals to reform medical liability and health insurance laws would address two of the biggest sources of economic friction in our sys­ tem. Medical torts now impose a net cost of about $80 billion per year on ' the US system. Some kind of rational reform is long overdue.

53 As for deregulating insurance markets, I'll defer to my colleagues here. But I can't see any virtue in having 52 separate markets defined by state governments. Some refer to the reform concept as "ERISA for all," mean­ ing, in essence, let's let everyone have what large corporations have in this country: freedom from state regulation of health insurance. Let's all enjoy the efficiencies of a national market.

But the measures that have the greatest potential for creating true health care reform are those that would improve and expand the Health Savings Accounts that Congress authorized in the Medicare Modernization Act.

These HSAs are designed to be combined with high ~ deductible catastroph­ ic insurance coverage, so that people first meet medical expenses and premiums from the HSA up to the deductible limit, after which the coverage kicks in. This structure can dramatically reduce the cost of the insurance coverage. But the real point of it is to put purchasing power back into the hands of the consumer.

In order to instill a sense of personal ownership and to break the endless cycle of expanding costs, we need to heal the economic fracture at the heart of our present system. That will never happen as long as people con­ tinue to think of health care as "free," or as something paid for by someone else.

Finally, the proposal for a refundable tax credit really could shrink the ranks of the uninsured. The credit would be targeted to help low-income Ameri­ cans buy an HSA-compatible high-deductible health plan.

Now, I don't want to suggest that these proposals can't be improved upon or that they will solve every single problem in US health ca re.

For my part, I'd like to see HSAs expanded to make them even more ap­ pealing--for example, by permitting employees to convert current Flexible Spending Accounts into HSAs. And I'd like to see these new plans focus on what works best for patients. For example, I believe they should be struc­ tured to encourage preventive care.

I like the idea of offering tax credits to help low-income workers buy cover­ age. But ultimately, it would make the most sense to extend this credit to everyone, provided it is used to purchase some form of health coverage. This would be a much more equitable alternative to the current tax exclu­ sion for employer-based benefits.

And there are some other needs that aren't addressed in the president's proposals.

Still, this said, it's important to acknowledge th at behind these new initia­ tives is a remarkable vision for health care reform in this country--the first in my lifetime to try to harness the power of markets rather than government mandates.

54 Make no mistake; maintaining the status quo is not an option. The current system in the US must undergo dramatic change as the Baby Boomers retire and overwhelm the current entitlements structure. The alternative to the free-market approach is some version of the government-centered ap­ proach used in Canada and Europe. That concept still has plenty of power­ ful supporters in this country, and they believe their "turn at bat" is coming in the next election cycle.

I have lived and worked under several of these centralized systems, and I believe they all have serious flaws.

The reforms the administration is proposing will not be easy for my industry to adapt to. But I'd much rather take my chances in a true, transparent, free market system ruled by consumer choice than in a command-and-control system, driven by the winds of politics.

I have to believe that most people who have seen the incredible benefits that a market economy has built in this nation, the miracle that is America, will make the same choice.

Conover, Christopher J., "Health Care Regulation: A $169 Billion Hidden Tax", Cato Institute Policy Analysis, No.527, Oct. 4, 2004.

Office of Management and Budget, Budget of the United States Govern­ ment, Fiscal Year 2007, US Government Printing Office, February 6, 2006.

Porter, Michael E. and Elizabeth Olmsted Teisberg, "Redefining Competi­ tion in Health Care" Harvard Business Review, June 2004 82(6): 64-76, 136.

55 NOTES

56 © 2006 Networks Financial Institute