(Note: The following is derived from a presentation that Jack McHugh, Mackinac Center senior legislative analyst, gave last fall to the quarterly board meeting of the Michigan Health Insurance Advisory Council, comprised of leaders from health care provider groups, insurance companies, unions and business organizations.)

Health care costs are out of control, customers are dissatisfied and medical professionals are frustrated because of dysfunctions in the system, generated by the fact that both suppliers and consumers are insulated from the market incentives that operate in other sectors of the economy. Injecting into our health care system these market incentives to pursue value, efficiency and innovation will create a consumer-directed system that costs less, improves access and increases customer satisfaction.

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What follows is whirlwind tour that very briefly characterizes various components of the free market movement’s critique of the current health care system, and its recommendations to create a better one by aligning the incentives of providers and consumers with the goals of maximizing value, efficiency and innovation.

Government Regulation of Health Care

Government programs account for 50 percent of all health care spending in the U.S., and the portion that’s accounted for by private-sector payers is subject to mountains of onerous government regulations and other factors (such as tax law and tort law) that grossly distort the entire system. So it should be no surprise that most of the system’s dysfunctions are caused by government, either directly or indirectly. Excessive and often irrational regulations on providers fall into the "direct" category.

". . . the total cost of health services regulation exceeds $339.2 billion . . . after subtracting $170.1 billion in benefits, the net burden of health services regulation is considerable, amounting to $169.1 billion annually (Michigan share $5.6 billion). In other words, the costs of health services regulation outweigh benefits by two-to-one and cost the average household over $1,500 per year."

Health Care Regulation, A $169 Billion Hidden Tax. Cato Institute Policy Analysis, October, 2004.

The Licensure/Scope of Practice "Raj"

For its first several decades as an independent democracy, India strangled its economy in various ways, one of the most pernicious being an onerous system of occupational and business licensure that reduced entrepreneurial activity at every level and in every sector of its economy.

In a similar manner, overly restrictive state government licensure mandates and scope of practice restrictions serve primarily to allow self-interested health care provider groups who lobby hard for them to keep out potential competitors. This raises prices for consumers, lowers value and inhibits innovation.

  • A growing body of evidence indicates that in many cases non-physician clinicians can provide care of equal quality to that provided by physicians

  • States should eliminate "scope-of-practice" regulations and replace licensure by boards that have been granted state monopolies with certification by provider groups and liability insurers.

See Shirley vs. Svorny, "Physicians and Non-Physician Clinicians: Where Does Quality Assurance Come From?" What States Can Do to Reform Health Care, Graham ed., pp. 67–82.

Insurance Mandates

Michigan currently mandates that every health insurance policy include coverage for 26 particular types of health care providers, benefits and patient populations. New mandates are proposed in each legislative session. Individual mandates can add as much as 10 percent to the cost of a policy, or less than 1 percent, but cumulatively their effect is to make insurance unaffordable for ever increasing numbers of families and employers.

"Mandated benefits currently increase the cost of basic health coverage from a little less than 20 percent to more than 50 percent, depending on the state."

Health Insurance Mandates in the States 2007, Council for Affordable Health Insurance (CAHI).

Medicaid Inflexibility – the "attractive nuisance"

Under the current financing system, for every state tax dollar spent on Medicaid (the government health care program for the poor), Michigan gets $1.31 in federal matching funds. This creates a pernicious incentive for legislators and other state policymakers to expand Medicaid spending. The federal government has in effect created an "attractive nuisance" that encourages increased government spending, and fosters increased dependency on government among certain segments of the population.

The solution is to replace the matching funds with a system of federal block grants under which states would have much more flexibility to experiment and devise innovative methods to deliver health care to those whose needs are greatest, and whose ability to provide for their own needs is the least.

"Block grants (to the states for Medicaid) would reduce those costs and encourage states to target scarce resources to the truly needy."

Medicaid's Unseen Costs, Cato Institute Policy Analysis, August, 2005.

Medical Malpractice – the Tort "Lottery"

A variety of proposals have been offered to address this, including caps on "pain and suffering" and punitive awards, specialty "health courts," limits on attorney contingency fees, imposing British-style "loser pays" court rules and more. The current malpractice liability system has aspects of a lottery; it does a poor job of compensating patients who are genuine malpractice victims, and of punishing "bad actor" providers who really should be driven out of business.

At the core of the dysfunction is the refusal by courts to enforce negotiated waiver of liability agreements between providers and consumers. Under this system a provider and a consumer can decide for themselves how much liability the former will assume. Most likely the contents of such agreements would be based on standardized terms devised by groups representing both sides. The most common agreement would probably establish that the basic price of a service makes the provider strictly liable for messing up the thing he is paid to do, but that’s all. However, a consumer who wanted to hold the provider liable for things he "should have done" could pay more. Courts should enforce such agreements.

"The overall expected cost of the medical tort system in 2002 is $113.7 billion, while the expected benefits are $33.0 billion."

Christopher J. Conover, Duke University Center for Health Policy. Figures from draft of upcoming study.
www.hpolicy.duke.edu/cyberexchange/Regulate/CHSR/HTMLs/ MTS1-MedicalTortSystem.htm

Where Are the Innovators in Health Care?

Most of the dysfunctions in the U.S. health care system are generated by the perverse dynamics of a third-party payer system, which distorts the incentives that encourage consumers to economize and producers to maximize value in other sectors of the economy. The system also undercuts the incentives for providers to innovate, and even creates disincentives to innovation.

"When the Duke University Medical Center's innovative new program for people with congestive heart failure so substantially improved patients’ health that hospital visits and usage plummeted (reducing costs by 40 percent), the perverse nature of the payment system meant Duke couldn't benefit from saving its patients’ money. Because the third parties pay providers only for treating sick people, they penalize innovators who make people healthy."

From "Where Are the Innovators in Health Care?" by Regina E. Herzlinger, Wall Street Journal, July 19, 2007. Herzlinger is a professor at Harvard Business School and the author of Who Killed Health Care? (McGraw Hill, 2007).
http://online.wsj.com/article/SB118480794902371108.html ?mod=opinion_main_commentaries

Health Savings Accounts (HSAs) Begin to Restore Proper Incentives

Health Savings Accounts combine insurance policies that have high deductibles (the insured person pays approximately the first $2,500 in annual expenses) with a tax-deferred savings account from which predictable, routine health care expenses are paid until the insurance deductible is reached.

"For two reasons even modest market penetration by HSAs will have positive effects on our health system. On the consumer side, with HSAs economizers benefit from their economizing. Second, when a sufficient number of consumers care about price because they pay the bill, providers who improve efficiency and value will be rewarded, driving down costs throughout the system."

From "MSAs (and HSAs) Increase Freedom and Choice" by Jack McHugh, Mackinac Center.

Employer vs. Individual Insurance Tax Deductions – Level the Unfair Playing Field

Currently, employers can deduct the expense of health care insurance policies they provide to employees, but individuals cannot deduct the cost if they purchase their own health insurance — a growing trend as employers scale back or eliminate altogether this particular fringe benefit. Moreover, there is no cap on the amount an employer can deduct for employee health insurance, which encourages the provision of "gold plated" policies with low deductibles and co-pays; these provide "insulation" from routine, predictable health expenses rather than insurance properly construed, which is protection from unexpected and very large expenses. High-income employees are most likely to benefit from this unfair system.

"The Bush administration has proposed leveling the playing field between self-employed individuals and payroll employees by allowing the former an annual health care expense tax deduction of up to $7,500 ($15,000 for families). These figures are also caps on the deductibility of employer-paid benefits. That would reduce the market distortions of a third party payer system by removing employers’ incentive to offer ‘Rolls Royce’ coverage in lieu of higher wages and salaries."

Jack McHugh of the Mackinac Center in a Detroit News "State of the Union Reaction" feature, Jan. 31, 2007

Be Careful What You Wish For: Government-Run, "Single-Payer" Systems

Proponents of this should be careful what they wish for, because for important cultural reasons such a system in the U.S. is not likely deliver the outcomes they envision.

  • Private health care will not be banned in the U.S. as it (largely) has been banned in Canada.

  • Americans will react viscerally to government-imposed rationing. (When the "Bureau of Prioritization" tells mom that she can’t get a hip replacement because she’s 56 and the system only pays for people 55 and younger to get those, this will not go well.)

  • Such systems also impose rationing in sneaky, dishonest ways such as waiting lists. This too will not sit well with Americans. ("Access to a waiting list is not access to health care," Supreme Court of Canada.)

The outcome will be two health care systems — a good one for the affluent, a mediocre (at best) one for everyone else. Essentially, most of the middle class will be driven into something that looks a lot like the current Medicaid system for the poor. Providers who are essentially ripped off by the current below-market Medicaid reimbursement rates should also be careful what they wish for — many of them are among the proponents of a "single-payer" system. Most displeased by this outcome will be the single-payer system advocates themselves.

Numbers and Costs of Uninsured Exaggerated

"We estimated that uninsured people received $35 billion in uncompensated care in 2001, or about 2.8 percent of total personal health care spending."

"How Much Medical Care Do The Uninsured Use, and Who Pays For It?" Jack Hadley and John Holahan, the Urban Institute.

"The Congressional Budget Office estimates that between 21 million and 31 million people were uninsured for the entire year in 1998. Since then, the number who are uninsured all year probably has not changed substantially."

"How Many People Lack Health Insurance and For How Long?" CBO, May 2003.

One in every four uninsured persons is eligible for Medicaid or SCHIP, but has not enrolled. One in five has a family income in excess of $58,000 and presumably can afford coverage.
(Urban Institute study, no link.)

Socialized Cost, Private Delivery System?

What follows is my personal view only, and is very much a "minority position" in the free market movement community. This plan is not my idea. It was proposed by author Charles Murray in his 2006 book, "In Our Hands: A Plan to Replace the Welfare State" (AEI Press):

For countless excellent reasons free-market defenders will bitterly oppose socializing the health care delivery system, but perhaps they should not resist socializing the cost of health care. An analogy may be seen in this nation’s system of public education.

Starting around 150 years ago, this nation made a decision that we would not allow the ability of parents to pay to determine whether or not an individual acquires an education. I believe that today we are at a similar point with health care.

We made a tragic mistake in public education back then, which was to give the government control of the delivery system in addition to giving it control of the finances. Imagine how different things would have turned out had a decision been made at the start to implement a school voucher system — the government would pay to educate every child, but the education itself would be provided by a school of a parent’s choosing. Such a system could also make sense for health care, given several prerequisites and considerations.


  • The "Scope of Practice/Licensure Raj" were repealed.

  • Negotiable waivers of liability were made enforceable.

  • Decisions were forced early in life about extraordinary end of life procedures, by requiring individuals to begin paying for this option with (expensive) insurance riders.

  • Every person age 21 and older bought health insurance, spreading the cost across the entire population (given the next two components this would be neither an unenforceable imposition nor an infringement of individual freedom).

Then health care costs could be reduced and spread widely enough to allow the following:

  • The cost of a health care insurance policy with a $2,500 deductible would be just $4,000 or less, with universal community rating (everyone would pay $4,000, regardless of age or prior health condition).

  • This is low enough that giving a universal insurance voucher to every adult for such a policy would cost no more (or even less) than the current health care system.

  • This system would be compatible with tax-advantaged HSAs. If they chose, individuals could buy additional coverage beyond the basic policy provided by the voucher, for things like extraordinary end of life care, or lower deductibles. It’s likely that the rational choice would be to stick with the basic policy, and accumulate the savings in an HSA.


Jack McHugh is senior legislative analyst for the Mackinac Center for Public Policy, a research and educational institute headquartered in Midland, Mich. Permission to reprint in whole or in part is hereby granted, provided that the author and the Center are properly cited.

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