1. Copyright © 2002 by Thomson Learning, Inc. Chapter 9 Government and Health Care Copyright © 2002 Thomson Learning, Inc. Thomson Learning™ is a trademark used herein under license. ALL RIGHTS RESERVED. Instructors of classes adopting PUBLIC FINANCE: A CONTEMPORARY APPLICATION OF THEORY TO POLICY, Seventh Edition by David N. Hyman as an assigned textbook may reproduce material from this publication for classroom use or in a secure electronic network environment that prevents downloading or reproducing the copyrighted material. Otherwise, no part of this work covered by the copyright hereon may be reproduced or used in any form or by any means—graphic, electronic, or mechanical, including, but not limited to, photocopying, recording, taping, Web distribution, information networks, or information storage and retrieval systems—without the written permission of the publisher. Printed in the United States of America ISBN 0-03-033652-X

2. Copyright © 2002 by Thomson Learning, Inc. Government Health Care Spending  Government represents 45.5% of the $1.1 trillion spent on Health Care.  19% of the Federal Budget is devoted to health care issues.

3. Copyright © 2002 by Thomson Learning, Inc. Figure 9.1 U.S. Health Expenditures as a Percentage of GDP 1960-1998 Percent Year 25 20 15 10 5 0 196519601970197519801985199019952000

4. Copyright © 2002 by Thomson Learning, Inc. Why Health Care is Different  Uncertainty:  People do not typically know what their health care expenses will be.  Insurance:  Because of uncertainty people typically buy health insurance.  This means that people do not typically pay the full marginal cost of their health expenses.

5. Copyright © 2002 by Thomson Learning, Inc. Health Insurance Coverage  82% of Americans are covered.  44 million are uncovered.

6. Copyright © 2002 by Thomson Learning, Inc. Figure 9.2 Financing Health Care Expenditures in the United States, 1998 Individual Out-of-Pocket 17% Private Health Insurance 33% Private Charity and Other 5% Governments 45%

7. Copyright © 2002 by Thomson Learning, Inc. Figure 9.3 Health Insurance and the Market for Health Care Price (Dollars per Unit Service) P2P2 P2P2 P2P2 Q*Q*Q1Q1 B A C Loss in Net Benefits Supply = Marginal Social Cost Demand = Marginal Social Benefit

8. Copyright © 2002 by Thomson Learning, Inc. Problems with Health Insurance  Asymmetric Information:  Sellers know more about the health care needs than buyers.  This can lead to over-consumption.

9. Copyright © 2002 by Thomson Learning, Inc. Problems with Health Insurance (continued)  Adverse Selection  People at greater risk for high health expenses will purchase health insurance even at very high premiums.  At those higher premiums people who are healthy may opt to go without insurance leading to a situation where insurance companies must raise rates.  This problem can create a vicious cycle that drives insurance companies out of business and leaves people without health insurance.

10. Copyright © 2002 by Thomson Learning, Inc. Problems with Health Insurance (continued)  Third-Party Payments  Neither the insured nor the physician has incentive to keep costs down.  This leads to over-consumption.  Patients evaluate the benefits of a procedure against only a fraction (their coinsurance rate) of the cost.

11. Copyright © 2002 by Thomson Learning, Inc. Figure 9.4 Government Health Spending, 1965-1998 in billions (Selected Years) Year $400 $300 $200 $100 $0 $500 1965197019751980198519891991 $8.3 $27.6 $45.3 $105.1 $174.6 $253.1 $330 19951998 $456 $500.4 Government Health Spending (Billions of Dollars)

12. Copyright © 2002 by Thomson Learning, Inc. Problems with Health Insurance (continued)  Moral Hazard  People with insurance often behave in ways that cause them to need the insurance.  People may fail to eat right and exercise knowing that they have health insurance to help defray the monetary costs of such a decision.

13. Copyright © 2002 by Thomson Learning, Inc. Other Features Contributing to Inefficiency and High Cost  Malpractice Insurance: Doctors must pay high malpractice insurance premiums. These costs are passed on to health insurance companies and then on to patients in the form of higher insurance premiums.  Uninsured Patients: Doctors and hospitals that accept Medicaid patients are not able to deny service to patients based on their ability to pay.  Technological Advance: Third-party payments encourages over-consumption of health care services which leads to over-development of health care technology.

14. Copyright © 2002 by Thomson Learning, Inc. Governments and Health Care: Compensating for Market Failure Market ImperfectionGovernment Reaction Asymmetric InformationFDA drug approval Adverse Selection with the retired population Medicare Income InequalityMedicaid Public HealthVaccinations and Research

15. Copyright © 2002 by Thomson Learning, Inc. Why Worry About Growth in Health Care Costs  An increasing share of income is devoted to health care which implies other priorities lose out.  High health insurance costs for employers cause them to hire contract labor.  Employees with a poor health history can be inefficiently locked into particular jobs.

16. Copyright © 2002 by Thomson Learning, Inc. ProgramSpending in Billions Medicare216.6 Medicaid170.6 Other113.2 Government Health Insurance

17. Copyright © 2002 by Thomson Learning, Inc. Medicare  65 and older  38 million covered  Part A: Hospitals  Part B: Doctors  Prescription Drugs and Long-Term care are not covered

18. Copyright © 2002 by Thomson Learning, Inc. Cost Containment in Medicare  Prospective Payments and the DRG  The Diagnosis Related Group is a broad type of illness.  Payments to hospitals are made based on the DRG and are the same regardless of actual costs.  This creates an incentive for hospitals to control costs because if they succeed they get to keep the savings.

19. Copyright © 2002 by Thomson Learning, Inc. Medicaid  Medicaid is health insurance coverage for the poor.  Eligibility is tied to the income of the household.  Children of low income people can be eligible even when their parents are not.

20. Copyright © 2002 by Thomson Learning, Inc. Indirect Government Subsidies of Health Care  Because employer-paid health insurance premiums are not subject to the income tax, this constitutes a substantial subsidy to health insurance.

21. Copyright © 2002 by Thomson Learning, Inc. Figure 9.5 The Effect of Preferential Tax Treatment of Employer-Provided Health Insurance Cost to Workers of Health Insurance (Dollars per Month) Taxable Income Lost to Governments 225 150 0 Q1Q1 Q2Q2 Demand for Health Insurance Quantity of Health Insurance

22. Copyright © 2002 by Thomson Learning, Inc. The Impact of Coinsurance on the Price of Health Care  Low coinsurance rates cause patients to ignore health care costs.  This increases demand and encourages an inefficiently high level of consumption.

23. Copyright © 2002 by Thomson Learning, Inc. Figure 9.6 How an Increase in Coinsurance Can Reduce Health Care Spending and Improve Efficiency in the Market for Health Care Services Price (Dollars per Unit if Service) P4P4 Q1Q1 Q*Q* P3P3 P2P2 P1P1 Demand Supply A B A’ B’ E Health Care Services per Year

24. Copyright © 2002 by Thomson Learning, Inc. Controlling Costs Through Managed Care  HMOs (Health Maintenance Organizations) are forms of insurance that pay a “capitation” or a fixed amount of money for every patient in their care. This puts pressure on HMOs to control costs.  PPOs (Preferred Provider Organizations) are forms of insurance that negotiate a reduced fee structure for participating physicians.

25. Copyright © 2002 by Thomson Learning, Inc. Controlling Medicare and Medicaid Expenses  Medicare: Prospective payments for DRGs.  Problem: encourages early discharge and low levels of service.  Medicaid: low reimbursement rates reduce doctor incentives to provide service.  Problem: reduces access to quality care in many places.

26. Copyright © 2002 by Thomson Learning, Inc. Universal Coverage  The U.S. has more than 40 million uninsured.  It is one of only a few countries without universal health insurance guaranteed by government.

27. Copyright © 2002 by Thomson Learning, Inc.  Gaps in Coverage  The U.S. has more than 40 million uninsured.  It is one of only a few countries without universal health insurance guaranteed by government.  No long-term coverage. Universal Coverage

28. Copyright © 2002 by Thomson Learning, Inc. U.K. System  National Health Service  Capitation paid to general practice physician  Universal coverage  Specialists difficult to see  Waiting lists for common operations; low cancer survival rates  Capital expenses budgeted by a national board

29. Copyright © 2002 by Thomson Learning, Inc. Canadian System  Provincial governments administer the system.  Costs shared by national and provincial taxes.  Waiting lists and shortages cause the wealthy to go to U.S. for service.