The Middle Class Health Benefits Tax Repeal Act of 2019 (HR 748) would repeal an excise tax, that was part of the ACA, on expensive employer-provided health insurance plans. Since the ACA passed, health care costs have decelerated dramatically (while the excise tax has yet to take effect) and the fiscal position of the federal government has strengthened enormously. This means that the revenue gained from the excise tax is not a short-term necessity, and the tax should be largely judged on its policy virtues as a cost-containment device. On these grounds, it largely fails, as it represents a fundamental strategic error in addressing rising health care costs. To put it simply, the tax aims to reduce patients’ utilization of health care. But the glaring problem of U.S. health costs is not excess utilization; instead it is high and rising prices for health care. Smart cost containment policy should address these prices, not seek to ratchet down how much care patients seek.

Congress should pass HR 748 and move on to health reform that more-precisely targets the roots of rising costs—excess market power in health provider and insurance markets. Such a reorientation of policy will make the ACA stronger, not weaker.

Why it matters: Rising premiums, out-of-pocket costs, and public health spending are crowding out income gains and spending on other goods and services. Meanwhile, our health care system ranks low on measures of equity and quality relative to peer countries. Recognizing the role of health care prices in driving health spending is crucial: Efforts to contain costs by controlling use are not only economically inefficient but also dangerous—leading to decreases in medically indicated and preventive care that would improve health outcomes for Americans and that is more cost efficient in the long run.

What can be done about it: Policymakers need to focus on controlling health care prices, not restricting use. While much attention has understandably focused on the ambitious vision of adopting a “single-payer” or “Medicare-for-all” plan, there are steps policymakers could adopt in the nearer term that would allow many of the virtues of single-payer to be realized more quickly and that could serve as useful stepping stones to even more ambitious reform:

• Extend already existing public plans and incorporate a “public option” into ACA exchanges.
• Adopt “all-payer rates”—mandating that the same prices apply regardless of who is paying—to allow private insurers to benefit from the bargaining power of Medicare.
• Pursue policies that would diminish the intellectual property rights monopolies of key health care sectors, like pharmaceutical companies.
• Increase antitrust scrutiny of consolidation of hospitals and physician networks.

Introduction and key findings

Health care remains one of the most salient policy issues on the minds of American households. Polling indicates that people who currently have coverage are generally “satisfied with how the healthcare system is working for [them]” (Auter 2016). This holds true for both public coverage (Medicare and Medicaid) and employer-sponsored insurance (ESI), with unionized workers particularly likely to be satisfied with their ESI plans. On the one hand, this broad-based satisfaction with ESI is good news, as this type of coverage is by far the largest single source of health insurance for American families, with roughly 181 million enrollees. However, another survey stresses that even currently covered Americans realize that there is great pressure on the future sustainability of all forms of health coverage. When asked if they are satisfied about the “total cost of health care in this country,” only 14 percent respond “yes,” with 84 percent saying that they are dissatisfied (CNN/ORC 2017).

This widespread dissatisfaction with health care costs is completely rational; the cost of American health care is exceptionally expensive while its quality is subpar when compared with health care in similarly rich nations.1 Further, the high (and rising) costs of health care have drawn too little attention from policymakers. The Affordable Care Act (ACA) was a major step forward in addressing some key problems with the American health care system. The ACA expanded coverage to millions and established clear and popular rules to eliminate bias against preexisting conditions. Its provisions provided much better protection against personal bankruptcy due to medical costs. These advances notwithstanding, the provisions of the ACA were insufficient for achieving the aim of reining in the fast-rising costs of American health care without sacrificing households’ access to needed medical care.

Worse, since the ACA was passed, the Republican-controlled Congress has done nothing to usefully reform or strengthen the ACA but has instead sought to subvert its gains. A full repeal of even the most popular ACA provisions (like the ban against discrimination on the basis of preexisting conditions) just barely failed in Congress, and the Trump administration has engaged in numerous efforts to thwart the ACA’s effectiveness.2

On the cusp of the 2018 election, this has left the American health care system in limbo. The GOP has undermined the already insufficient reforms of the ACA without offering any alternative plan to provide health security. At the same time, many Democrats have expressed considerable desire to have the United States adopt a “single-payer” health system.3

Doing nothing but undermining an already-troubled American health system should not be a serious policy option. While a single-payer system has large potential benefits, moving toward such a system will almost certainly be a long process that promises little short-run relief for families. Luckily, however, many of the key policy virtues that allow more robust public systems (like Medicare or the health systems of peer countries) to achieve greater cost containment without sacrificing quality can be realized much more quickly and with potentially less political opposition.

These cost-containment strategies would not only make a large public role for health care more plausible, they would also supply needed short-run relief to the private American health care system, particularly the system of employer-provided health care. This ESI system, which provides coverage for American families through the workplace and is paid for with contributions from both employers and employees, is by far the single largest source of health insurance coverage in the United States today.4 This means that the ESI system is where key problems troubling the American health insurance system are most visible to working American families. In the decade before the Affordable Care Act was passed, the ESI system was clearly burdened with the most pressing problem facing the overall American health insurance system: rapidly rising costs. These rising costs in turn led to the rapid erosion of ESI coverage, even during the economic expansion of the early and mid-2000s.5 As costs have slowed a bit in the past decade, ESI coverage rates have largely stabilized. The lesson here is clear: controlling health care costs is vital to the economic well-being of the majority of Americans.

This report highlights trends in health care costs in both ESI and the overall American health system. It demonstrates the various channels through which rising health care costs put downward pressure on the growth of living standards of American families, and it identifies the key sources of rising health costs. Finally, it provides a series of recommendations for policymakers looking to pass reforms to slow the rate of health care cost growth, identifying, in particular, broad approaches that do and do not have merit.

Key findings

• Premium prices in the employer-sponsored insurance system have risen rapidly over the past two decades. The total cost of a family ESI plan rose from $5,791 to $18,142 between 1999 and 2016.6 As a share of average annual earnings for the bottom 90 percent of the workforce, these premium costs rose from 25.6 to 51.7 percent over that same period.

• Fast premium growth did not purchase better protection from health care cost growth for workers. Out-of-pocket costs rose faster between 2006 and 2016 than total costs or costs paid by insurers did. Out-of-pocket costs rose 53.5 percent cumulatively over that time, while total costs rose 49.2 percent and costs paid by insurers rose 48.5 percent.

• The rapid growth in health care costs has led to a rapid increase in total health spending as a share of GDP. This measure has risen from 5.2 percent of U.S. GDP in 1963 to 8.4 percent in 1979 to 17.4 percent in 2016.

• Among industrialized nations, the U.S. has the highest health care costs and below average quality and utilization. When comparing the American health system with the health systems of advanced economy peer countries, American health care spending and prices are by far the highest, while utilization—the volume of health goods and services being consumed—and measures of quality are decidedly below average.

• Policymakers need to focus on controlling prices, not utilization. The weight of the empirical evidence in this report indicates clearly that policies to “bend the health care cost curve” should focus on efforts to control prices, not use. The common root in strategies to contain prices in the health care sector is the need to bring countervailing market power to bear against monopoly-like pricing power currently wielded by health care providers.

• Policy focusing on utilization leads to inefficiency. To date, most efforts to control use of health care services have been poorly tailored because they focus simply on “cost sharing”—or raising the cost of receiving health care across the board. Raising the marginal cost of health in this way does reduce utilization, but patients do not cut back only on low-value care. They also cut back on medically indicated care that could actually be cost-saving in the long run.

• Meaningful policy to address pricing includes public negotiation of “all-payer rates.” The most straightforward way to provide countervailing force against the pricing power of health care providers, as well as to make health care prices informative to consumers, is more robust public negotiation of prices and the extension of this public-sector pricing power to all payers. For example, policymakers should strongly consider setting caps on rates as a tool to slow growth and provide greater transparency and accountability to consumers.

These findings underscore the depth of the challenges that remain to making our health care system more equitable and efficient. They also provide a clear series of steps that policymakers can take to improve this situation. These steps can be part of the groundwork for a more fundamental transformation of the American health system but would also ensure that the current pillar of this system—ESI—will remain strong as new reforms are made.

The canary in America’s health care coal mine: Rising costs for ESI

Table 1 shows one of the most salient trends in American economic life over recent decades—the rising cost of premiums for ESI. It shows employee contributions for these premiums, as well as their total cost, for both family and individual plans. The top panel of Figure A visually depicts the dramatic rise in health care costs as a share of income.

Table 1

The average annual employee contribution to single ESI premiums rose from $318 to $1,129 between 1999 and 2016. This 7.7 percent average annual increase far outpaced the 2.6 percent average annual increase in (nominal) average earnings for the bottom 90 percent of wage earners. This relatively rapid growth of ESI single premium costs led to employee payments for ESI single premiums rising from 1.4 percent to 3.2 percent of average annual earnings for the bottom 90 percent, while employee payments for family plans rose from 6.8 to 15.0 percent of earnings over the same time.

While increased costs of employee contributions to ESI premiums are one of the most salient ways that rising health costs can put pressure on living standards, most economists would agree that in the long run even rising employer contributions to ESI premiums harm potential wage growth.7 The intuition is simple: employers care about the level of employee compensation, not its composition. If workers would rather have more compensation in the form of health insurance contributions and less in cash, employers should in theory be happy to oblige this. This reasoning is why we also show the share of total ESI premiums (both employee and employer contributions) in Table 1 as well. These total premiums have grown slightly slower than just the employee contributions, but still rapidly enough to increase their share of average earnings of the bottom 90 percent in every year. Total ESI premiums for singles rose from $2,196 in 1999 to $6,435 in 2017, and as a share of average annual earnings for the bottom 90 percent, they rose from 9.7 percent to 18.3 percent. For family coverage, total ESI premiums rose from $5,791 in 1999 to $18,142 in 2016, and as a share of average annual earnings for the bottom 90 percent, they rose from 25.6 percent to 51.7 percent.

A straightforward way to interpret the findings shown in Table 1 (looking just at the dollar amounts) is that average annual earnings that could be spent on non-health-care-related goods and services could have been $4,239 higher for those with individual ESI coverage in 2016 but for the rise in ESI premiums. Looking at the change in ESI premiums as a share of annual earnings gives a potentially more realistic description of what the boost in earnings could be had premium price inflation not run ahead of wage growth. Had single ESI premiums simply stayed constant as a share of average earnings, the table shows that this would imply a boost to annual pay of 8.6 percent (or $3,032).8 For those with family ESI coverage, this boost to pay that could be spent on non-health-related consumption could have been $12,350 (as a simple dollar amount), or a 26.1 percent raise ($9,161)9 even if ESI premiums had simply stayed constant as a share of average earnings. Given that nominal annual earnings rose by 54.8 percent cumulatively between 1999 and 2016, this implies that earnings growth for those with single ESI coverage could have been 15.7 percent as rapid, and earnings growth for those with family coverage could have been 47.6 percent as rapid, but for the rising cost of ESI premiums.10

If these rising ESI premiums were purchasing more insulation against health care costs for workers, then perhaps their rapid rise in recent years would have stung less. In other words, if workers were paying less out of pocket when they go to the doctor, then the higher premiums might seem like a good deal. But out-of-pocket costs for health care (that is, costs not paid for by insurance companies even after they have received employees’ premiums) rose rapidly from 1999 to 2016 as well. The bottom panel of Figure A shows the rise of total health costs for those covered by ESI, the rise in costs covered by ESI, and the rise in costs covered by insured households’ out-of-pocket payments (deductibles, copayments, and coinsurance). Between 2006 and 2016, total health costs cumulatively rose by 49.2 percent. Out-of-pocket costs actually rose slightly faster in this period, at 53.5 percent.11 Costs covered by insurance rose by 48.5 percent. This indicates clearly that the rapid growth in ESI premiums paid in this time did not translate into enhanced coverage of total health costs (i.e., reduced out-of-pocket costs for insured households).

Figure A

In short, rising ESI premiums seem to be paying for essentially the same level of protection against health cost shocks as they ever did, with the overall cost of health shocks increasing over time. This implies that the real driver behind ESI premium growth is underlying health costs—an implication that is confirmed in the next section of this report.

Finally, besides their potential role in stifling wage growth, the rapidly rising costs of ESI premiums surely played a role in the rapid erosion of ESI coverage over much of this period. Gould (2013a) documents the erosion in the share of Americans covered by ESI in most of the period between 2000 and 2012. Before 2008, much of this fall was surely driven by historically fast “excess cost growth” (ECG) of health care. (As described in the next section, we define ECG as the difference between the per capita growth rate of potential GDP and the per capita growth rate of health costs.) After 2008, the pace of this excess cost growth relented (at least temporarily), and coverage declines were driven largely by the labor market crisis of the Great Recession. In recent years, ESI coverage has largely stabilized in a post-recession environment, with relatively moderate excess health care cost growth.

The rising cost of health care is a systemwide problem

Given that rising ESI premiums seem to not be paying for more comprehensive coverage, and seem instead to simply be paying for constant protection against steadily rising health costs, it seems likely that trends in premium growth are being driven by overall health costs. The simplest test of the hypothesis that rising health costs are not unique to ESI coverage can be found in Figure B. This figure shows annual growth rates of per capita potential gross domestic product (GDP) and per capita growth rates of health costs, and it also charts the growth in national health spending as a share of potential GDP over time.

GDP is essentially a measure of total domestic income, and potential GDP is a measure of what GDP could be in a given year assuming the economy did not suffer from excess unemployment during that year.12 For health costs, we show average annual growth in national health costs divided by the total population of the United States. The difference between the per capita growth rate of potential GDP and the per capita growth rate of health costs is one version of what is often labeled “excess costs” in health care. Because we are interested in growth rates of health care costs, and because these growth rates are influenced by price changes, neither of these series are adjusted for inflation; instead, we simply track nominal growth in both measures.

Figure B

As the chart shows, the per person annual rate of health care cost growth is substantially faster than annual growth in potential GDP per person over the entire period, by an average of 2.4 percentage points between 1963 and 2016 and an average of 2.1 percentage points between 1979 and 2016. This more rapid growth of health care costs implies that these costs have been rising over time as a share of total U.S. GDP. The figure also charts this evolution, indicating that health care spending has risen from 5.2 percent of U.S. GDP in 1963 to 8.4 percent in 1979 to 17.4 percent in 2016.

Figure C also shows the average annual excess cost growth of health care for the period from 1979 to 2007, just before the Great Recession, and for the period since 2007 (the period during and after the Great Recession). In addition to per capita rates for the entire U.S. population, Figure C also shows ECG rates per insurance enrollee (that is, for just the population that is covered by insurance). Figure C highlights that excess cost growth was quite steady for both of these populations until roughly a decade ago, when it fell substantially.

Figure C

Figure C also shows that between 1979 and 2007, excess costs were slightly higher when calculated with health care costs divided by the share of the insured population rather than the entire population. Unlike nearly every other advanced economy, the United States has allowed a large share of its population to go without access to health insurance each year for decades. Because lack of insurance can make seeking medical care prohibitive on the grounds of cost, this failure to provide universal access to insurance may well have slightly held costs down at the national level. Figure C also highlights that the relative success in containing costs post-2007 is even more dramatic once one accounts for the large increase in the share of population covered in that time; excess cost growth calculated using a measure of cost per insured is far slower post-2007.13 While the recent slowdown in excess health care costs is welcome, policymakers should not be complacent about its durability, for reasons that are discussed in depth in Appendix A.14

Finally, it is worth emphasizing that—as has been documented extensively—the fast pace of health spending growth has not bought high health care quality for the United States relative to other advanced economies. In international comparisons, American health outcomes are decidedly below average when compared with these rich country peers. Figure D shows a comparison of 11 countries’ health systems across a range of measures, based on the findings of Schneider et al. (2017).15 In Schneider et al.’s study, the U.S. is ranked fifth out of 11 in “care process,” 10th out of 11 in “administrative efficiency,” and dead last in “equity,” “affordability,” and “health care outcomes.” The combination of “affordability” and “timeliness” represents a country’s score on “access,” and Schneider has the U.S. ranked last on this measure as well. Finally, the U.S. is also ranked last overall.

The scores in Figure D are normalized so that the weakest performance measured for each criterion is equal to 1. The figure shows the United States’s normalized performance measure alongside the average, minimum, and maximum of the remaining 10 non-U.S. countries. Not shown in Figure D, but worth noting, is the fact that within the “heath care outcomes” ranking, in Schneider et al.’s underlying data, the United States ranks last in the following specific outcomes: infant mortality, the share of nonelderly adults with at least two chronic health conditions, life expectancy at the age of 60, mortality amenable to health care, and the 10-year decline in mortality amenable to health care.16 In short, international comparisons provide no evidence that high U.S. spending buys it a particularly good national health system.

Figure D

How rising health spending puts pressure on growth of living standards

Rising health care costs crowd out household resources that could be spent on other things. In the first section of this report, we highlight one potential channel through which rising health costs could pressure living standards: crowding out potential growth in cash wages as employers put more money into compensation in the form of health insurance premiums for ESI coverage.17 Besides this crowd-out of cash wages, rising health care costs can also pressure living standards by forcing families to spend more of their own money on insurance premiums or on out-of-pocket health care costs like copays or insurance deductibles increase.

Finally, even though the U.S. federal government has a smaller role in providing health care financing relative to most international peers, this does not mean that this role is small relative to other important economic benchmarks. In 2017, for example, the federal government spent more than $1.2 trillion, or about 6.7 percent of total GDP, on Medicare, Medicaid, and the Children’s Health Insurance Program (CHIP) (CBO 2018c). Figure E tracks the role of various financers of health care spending in the United States over time. The most striking finding is that public sources of payment have grown the fastest by far; by 2016, public sources accounted for more than half of all spending.

Figure E

Publicly provided health insurance is funded through a mix of taxes (both general revenue and dedicated revenue sources), user premiums, and increased debt. Dedicated funding sources for these programs include the Medicare portion of the Federal Insurance Contributions Act (FICA) taxes (2.9 percent of wage incomes); a surcharge on high incomes included as part of the ACA (0.9 percent on cash incomes over $200,000); the application of the Medicare portion of the FICA tax to investment incomes over $200,000 per year; and premiums that finance Medicare Parts B and D. In 2015, these dedicated revenue sources raised just under 2 percent of GDP (TPC 2018), leaving almost 5 percent of GDP spent on public insurance programs to be financed by a contribution of general federal government revenue, state revenues (for their contributions to Medicaid), and debt.

In the remainder of this section, we document how each of these direct channels that finance health care spending can lead to pressure on growth in non-health-related spending, and we provide an empirical assessment of how large this pressure might be.

Income pressure stemming from out-of-pocket costs

Figure F shows a sharp long-run decline in the share of total health costs paid out of pocket by households since 1961. However, this decline has done essentially nothing to relieve the pressure that out-of-pocket (OOP) costs puts on household incomes: Figure F also shows the share of household income for the bottom 90 percent of households that went to paying medical OOP costs for each year from 1961 to 2014. Since 1961, OOP costs have fallen from nearly 46 percent to roughly 11 percent of total health spending, yet the share of household income for the bottom 90 percent that must go to OOP costs has not really budged since 1979—averaging roughly 4 percent of income in the years since then.

Figure F

Income pressure stemming from increases in costs for employer-provided health insurance

As discussed above, Table 1 shows the rise in average ESI premiums as a share of the bottom 90 percent’s annual earnings. Figure A provides an illustrative estimate that ESI premium growth since 1999 could have crowded out $4,239 in spending on non-health-care-related goods and services for an employee with single coverage: $811 through higher employee contributions to premiums, and the rest through potentially lower cash wages due to employers’ need to contribute more to premiums instead of cash wages.

Figure G shows employer contributions to ESI premiums as a share of total labor compensation and as a share of compensation for the bottom 90 percent since 1979, using data from the National Income and Product Accounts (NIPA) of the Bureau of Economic Analysis as well as data on comprehensive household incomes from the Congressional Budget Office.18 Between 1960 and 2016, employer contributions to ESI premiums rose from 1.1 to 8.2 percent of total employee compensation. Data for examining the bottom 90 percent are only readily available since 1979. Between 1979 and 2016, employer contributions as a share of compensation rose by 3.9 percentage points overall, but rose by 4.4 percentage points for the bottom 90 percent of earners.

Figure G

If employer contributions to ESI premiums had remained constant as a share of cash wages since 1979, cash compensation could have been $387 billion higher by 2016 for the total labor force, or $327 billion higher for the bottom 90 percent.19 For the bottom 90 percent of full-time-equivalent employees, this would imply cash wages that were higher by roughly $2,740 on average. Appendix B gives some texture to this aggregate analysis by examining the potential crowd-out of cash wages by rising ESI premiums across wage fifths.

Income pressure stemming from rising public costs of health coverage

The rise in spending on public health coverage stems from rising per-enrollee costs of this coverage combined with an increase in the population covered by public insurance. A simple way to hold the latter influence constant is to look at what public spending on health coverage would have been in recent decades had the “excess cost” of these insurance programs been zero. We provide a broad measure of this “excess cost” in Figure B—the growth rate of health costs per capita minus the growth rate of potential GDP per capita. For Figure H, we use the excess growth rates calculated by the Congressional Budget Office (CBO) specifically for the public programs. CBO measures take into account demographic changes within the public programs that may have influenced costs. Figure H charts actual federal spending on health costs versus what federal spending would have been in 2016 had there been no excess costs in health programs since 1987. The figure shows that public spending as a share of GDP in 2016 would have been 1.3 percentage points—or more than $250 billion—lower had there been no excess cost growth in public insurance programs over that time period.

Figure H

Pressure on incomes stemming from rising health costs is projected to rise significantly

As discussed above, by 2016, excess health care cost growth had already caused the employer-provided premium share of total compensation to rise by 3.9 percentage points overall (and by 4.4 percentage points for the bottom 90 percent) since 1979; it had also caused public health spending as a share of GDP to rise by 1.3 percentage points since 1987. But this past performance may understate potential future pressures from health care cost growth. The 30 to 40 years ending in 2016 that saw pervasive excess health care growth saw these costs start from a much more modest base.

Going forward from today, rates of excess health care cost growth in line with the historical averages over the past 40 years would put rapid and large pressure on Americans’ incomes available for nonhealth consumption. Figure I highlights the outcome of such a forecast, showing employer contributions to ESI premiums and spending on public insurance programs as a share of total GDP in two scenarios. In the first scenario, excess cost growth follows the path forecast by the CBO long-term budget outlook for public programs. For employer-paid ESI premiums, we use the forecast of the Social Security Administration (SSA) about the pace of decline in the ratio of earnings to total compensation, a decline that SSA attributes entirely to the rising cost of health care (SSA 2018). In the second scenario, there is no excess cost growth in either public or private health costs.

Under the current projections path, spending on public programs and by employers on ESI premiums reaches 18.1 percent of GDP by 2048, but without excess cost growth, it reaches only 15.6 percent of GDP. The 2.5 percentage-point difference implied by these divergent paths would imply almost $500 billion in additional resources in today’s dollars. Crucially, between 2017 and 2035, a significant portion of the projected rise in public spending is attributable to the baby boom generation aging fully into Medicare eligibility.20 After the baby boomers are absorbed into Medicare, the upward pressure on health spending stemming from pure demographics is expected to slow dramatically, and excess cost growth becomes almost the sole explainer of trends thereafter.

Figure I

Does America overutilize health care? Or is it just too expensive?

The rise in health spending as a share of GDP (shown in Figure B) could in theory stem from either of two influences: a rising volume of health goods and services being consumed (increased utilization) or an increase in the relative price of health care goods and services. Figure J provides evidence suggesting which of these is the prime driver. The figure shows price-adjusted health care spending as a share of price-adjusted GDP (“health spending, real”) and also shows the relative evolution of overall economywide prices and the prices of medical goods and services (“GDP price index” vs. “health care price index”). It shows clearly that health care has risen much more slowly as a share of GDP when adjusted for prices, rising 2.1 percentage points between 1979 and 2016, as opposed to the 9.2 percentage points when measured without price adjustments (“health spending, nominal”). The figure also shows that since 1979, prices for health-care-related goods and services rose more than twice as much as economywide prices.

Figure J

The evidence in this figure argues strongly that prices are a prime driver of health care’s rising share of overall GDP. This finding is important for policymakers to absorb as they attempt to find ways to rein in the rise of health costs in coming years. International comparisons (highlighted in the next section) provide even more reason to think that the primary problem with American health care costs is prices instead of utilization.

International evidence confirms that it is prices, not utilization, that make American health care so expensive

Some researchers have made the claim that quality improvements in American health care in recent decades have led to an overstatement of the pure price increase of this health care in official statistics like those in Figure J.21 On its face, this is a reasonable enough sounding objection—most of us would rather have the portfolio of health care goods and services available today in 2018 than what was available to Americans in 1979, even if official price indexes tell us that the main difference between the two is the price.

But even if official price indexes understate the increase in health care quality made available to U.S. households in recent decades, this should not cause policymakers to be complacent about the pace of health care price growth. A look at the U.S. health system from an international perspective reinforces this view. The first finding that leaps out from this international comparison is that the United States spends more on health care than other countries—a lot more. Table 2 shows the share of health care spending in 2017 normalized by overall GDP for a group of 21 advanced country peers. The 17.2 percent figure for the United States is almost 30 percent higher than the next-highest figure (12.3 percent, for Switzerland). It is almost 80 percent higher than the group average of 9.7 percent. Table 2 also shows the average annual percentage-point change in the health care share of GDP, as well as the average annual percent change in this ratio over time.22

A particularly striking finding from this table is that not only did the United States spend more on health care as a share of the overall economy than any of its peers in the first year for which data is available, it has also generally pulled away from these peers in subsequent years. When growth in health spending is measured as the average annual percentage-point change in health spending as a share of GDP (using earliest data through 2017), the United States has seen unambiguously faster growth than any other country in recent decades. When growth in health spending is measured as the average annual percent change in this ratio, the United States has seen faster growth than all other countries except Spain and Korea (two countries that are starting from a base period ratio of half or less of the United States).

Table 2

Examining data on utilization and prices separately shows clearly that it is high prices that drive the U.S. position as an outlier in health care spending. Figure K shows the utilization of physicians and hospitals in the United States compared with the median, maximum, and minimum utilization of physicians and hospitals among its OECD (Organisation for Economic Co-operation and Development) peers. The United States is well below typical utilization of physicians and hospitals among OECD countries.

Figure K

While utilization in the United States is typically lower than utilization levels for its industrial peers, prices in the United States are far above average. Figure L shows the findings of the latest International Federation of Health Plans Comparative Price Report (CPR). The CPR shows the prices of various medical goods and services in the United States compared with prices for the same goods and services in a number of other advanced countries.

Figure L

For the 21 goods and services surveyed in the CPR, average prices in the United States are higher than the non-U.S. average for all 21 and are the highest among all the countries (that is, the U.S. average exceeds the non-U.S. maximum) for 18. Averaged across the non-U.S. mean prices, prices in the United States are more than twice as high as prices in peer countries. And even when averaged across the non-U.S. maximums, average U.S. prices are more than 40 percent higher. Notably, a number of these goods and services are highly tradeable—particularly pharmaceuticals. The fact that international tradeability has not eroded enormous price differentials between the United States and other countries should be a red flag that something strikingly inefficient is happening in the U.S. health care market.

Figure M shows some specific measures of utilization that correspond to the price data highlighted in Figure L: the incidence of angioplasties, appendectomies, cesarean sections, hip replacements, and knee replacements, normalized by the size of the country’s population. On two of the five measures, the United States has either a typical (angioplasties) or relatively low (appendectomies) utilization rate relative to other countries’ averages. On two more measures (C-sections and hip replacements), the average of other countries’ utilization levels is roughly three-quarters of the United States’s utilization level. For all four of these measures, the United States is well below the highest utilization rate. The United States is only the highest-utilization country—by a small margin—when it comes to knee replacements. In short, if one were looking only at the data charting health care utilization, one would have little reason to guess that the United States spends far more than its advanced country peers on health care.

Figure M

Figure N shows another set of international comparisons of health care inputs and prices, from Laugesen and Glied (2008). Laugesen and Glied compare physician services’ utilization and salaries in Australia, Canada, France, Germany, and the United Kingdom with those in the United States (in the figure, the U.S. level of each is set to 1). They find that utilization of primary care physicians by patients is higher in all of these countries, by an average of more than 50 percent. Yet salaries of primary care physicians are higher in the U.S., by roughly 50 percent. The utilization measure they use for orthopedists is hip replacements. Hip replacements (normalized by the population) are a bit rarer in Canada than the United States, with Canada undertaking 74 hip replacements for every 100 in the United States. They are roughly as common in Australia (94 to 100) and the United Kingdom (105 to 100), and they are more common in France and Germany. Orthopedist salaries are much higher in the United States than in any peer country—more than twice as high on average.

The salary comparisons in Figure N are net of doctor’s debt service payments for medical school loans, so this common explanation for high American physician salaries cannot explain these differences.

Figure N

As we have noted, many rightfully argue that most Americans would not want to trade the health care available to them today for what was available in decades past, even as official price data indicate that all that has changed is the price. However, the international evidence indicates clearly that most Americans should be willing to trade the health care available to them today for what is available to the residents of most other advanced economies. This health care available abroad is far cheaper and yet of at least as high quality. The relatively low level of utilization and very high price levels in the U.S. provide suggestive evidence that the faster rate of health care spending growth in the United States in recent decades has been driven on the price side as well. This inference is supported with some more specific evidence in Appendix C, which provides indirect estimates of the rise in hospital prices across countries over time.

The appropriate policy focus going forward: Price, not utilization

It is clear that the United States is an outlier in international comparisons of health care costs. It is also clear that the United States is an outlier not because of overuse of health care but because of the high price of its health care.

As discussed above, the United States is decidedly unremarkable on health outcome measures (see Figure D) and is even toward the low end of many crucial health measures.23 On measurable utilization of health care, consistent with our findings, most studies similarly find the United States to be below average on broad measures of utilization when compared with its advanced country peers.24 Finally, the indirect evidence on hospital prices presented in Appendix C suggests that prices have likely been rising faster in the U.S. than in the vast majority (18 of 21) of peer countries. All of this evidence strongly indicates that getting U.S. health care prices more in line with international peers could have significant success in relieving the pressure that rising health care costs are putting on American incomes.

Attacking utilization is a dangerous strategy

Even though many health researchers have noted that price—not utilization—is the clear source of the dysfunction of the American health system, it is striking how much attention has been paid to reducing utilization, rather than reducing prices, when it comes to making health policy in the United States in recent decades.

In the years leading up to the passage of the ACA, many policymakers cited the Dartmouth Atlas of Health Care and its research spinoffs (e.g., Skinner et al. 2009) to claim that up to a third of American health spending was wasteful; hence, they concluded, great opportunities abounded to squeeze out this waste by targeting lower utilization. These findings were a great source of temptation for policymakers, and they were incredibly influential in the American policy debate in the run-up to the ACA. The problem is, even if the Dartmouth research was entirely correct, it was always going to be hard to figure out how to operationalize these findings for policy. The most obvious complication was how to construct policy levers to precisely target which third of health care spending was wasteful.

Further, subsequent research in recent years has highlighted additional reasons to think that the Dartmouth findings would be difficult to translate into policy recommendations. The earlier Dartmouth Atlas findings were largely gleaned from looking at regional variation in spending by Medicare. The Atlas found large regional variations in costs and found that high-cost regions did not seem to produce better health outcomes. The authors of the Atlas hypothesized that regional differences in physician practice drove price differentials that were not correlated with quality improvements. Policymakers and analysts have often made the argument that if the lower-priced, but equally effective, practices of more efficient regions could be adopted nationwide, then a large chunk of wasteful spending could be squeezed out of the system. However, research by Doyle (2011) and Sheiner (2014b) indicates that the noncorrelation between spending and outcomes found in the Dartmouth research may well be driven by a failure to fully control for the socieoeconomic and health characteristics of patients. Further, Cooper et al. (2018) study the regional variation in spending on privately insured patients and find that it does not correlate tightly at all with Medicare spending. This finding casts doubt on the hypothesis that regional variation in practice is driving trends in both spending and quality, as these type of region-specific practices should affect both Medicare and private insurance payments.

Policies to increase cost sharing are a cost blunderbuss—A scalpel is needed

The evidence reviewed above casts doubt on the potential to rein in health costs on the utilization side. And it’s certainly not possible to eliminate wasteful and unproductive care simply by raising the patient cost of care across the board, as we show below. Yet this blunderbuss approach of increasing “cost sharing” indiscriminately is by far the most common theme in policy proposals aimed at reducing the growth rate of health spending.

On the conservative side, the last couple of decades have seen much writing from policy analysts about “consumer-directed health care” and efforts to put health care consumers’ “skin in the game” as a strategy to constrain costs.25 The rhetoric from the center left rejects this view, but their actions tell a different story: Perhaps the single most-trumpeted cost-containment device included in the ACA was the so-called Cadillac Tax, which seeks to contain costs precisely by forcing health care consumers to face a higher share of marginal costs. This excise tax would be levied on employer-provided health benefits above set limits, thus incentivizing employers to offer less expensive health plans, which would in turn translate into higher out-of-pocket costs for workers.26

The logic of forcing health consumers to face higher marginal costs of buying health care is based in the economics of moral hazard: If people do not face the marginal cost of undertaking a behavior, they’ll do more of it. In the case of health care, insured consumers pay fixed premiums every month regardless of whether or not they visit a doctor. Then, when they do visit a doctor’s office or go to the hospital, insurance pays for some (often even most) of the marginal cost of this visit. Once the fixed cost of paying a premium is met, each subsequent visit to a health provider is then partially to fully subsidized by the insurance company, and this means that the patient does not face the full marginal cost of the decision to obtain health care.

Even the most dogmatic proponents of solving moral hazard would not, of course, endorse outlawing insurance as a means of containing costs. Instead, they would argue that most Americans are simply overinsured and that more health care spending should be financed out of pocket until those costs become prohibitive, at which point insurance would then properly kick in.27 Being overinsured and not facing the full marginal cost of each new visit to a health care provider is thought to make Americans overconsume health care, potentially using resources (i.e., money paid out by their insurance companies) to obtain treatments that they would not have sought had these treatments’ full marginal cost been faced (that is, had they been required to pay the costs themselves).

However, this focus on increasing patient cost-sharing is poorly designed for smart cost containment and could do significant harm, for a number of reasons. First, unless one is willing to increase cost sharing even for truly catastrophic medical costs, such measures will miss the primary cost drivers in the U.S. health care system. Eighty percent of health dollars are spent on just 19 percent of health consumers, and 50 percent of health dollars are spent on just 5 percent—presumably the sickest patients (Gould 2013b). In other words, encouraging relatively healthy people to cut back on health care simply misses the vast majority of health care costs, and no one would suggest that expensively sick patients should be required to pay more than they already do (which is likely already too high relative to their resources in many cases).

Second, the assumption that all moral hazard results in economically inefficient overconsumption of health care may well be wrong. Nyman (2007) directly questions this theory by arguing that a large portion of moral hazard represents health care that sick consumers would not otherwise have had access to without the income that is transferred to them through insurance. This portion of moral hazard—the transfer of income—is efficient and generates a welfare gain. Take the example of an adult who has lost front teeth in a bicycling accident. Having missing teeth is obviously not life-threatening, but it is quite likely that if insurance gave the cash-equivalent cost of replacing the teeth to this person, they would opt to do precisely this and not spend the cash on other goods and services. As long as the income transfer made possible by insurance was spent buying health care and not something else, then this portion of the moral hazard caused by insurance is efficient.

This recognition that not all moral hazard is economically inefficient is becoming well understood in other branches of economics. Chetty (2008) makes similar arguments in the context of unemployment insurance, focusing on the fact that unemployment insurance benefits solve a liquidity problem rather than creating a disincentive to look for work. His research differentiates the moral hazard effect from the relief of liquidity constraints by comparing households that can and cannot smooth consumption through a spell of unemployment with assets or income from other sources, such as a working spouse or accumulated wealth. He finds that higher-than-average unemployment insurance benefits increase unemployment duration only for workers with no liquid wealth. This suggests strongly that it is the relief of liquidity constraints and not the disincentive to work—stemming from reductions in the “cost” of leisure (i.e., the loss of income) spurred by the receipt of UI—that drives responses. Chetty explicitly notes that this analysis could apply even more strongly to the case of liquidity constraints in the purchase of health care. This would be particularly true in the case of individuals with serious illnesses who require expensive treatments, as the liquidity demands imposed by contracting such an expensive illness would dwarf those needed to finance a short spell of normal consumption while unemployed.

Third, short-run cutbacks in the consumption of health care can end up being “penny wise and pound foolish.” If increased cost-sharing leads some patients to cut back on medical spending, they may end up cutting back on medically indicated treatment that could save money in the long run, especially for vulnerable populations and those with chronic conditions. Goldman, Joyce, and Zheng (2007) find that cuts in plan generosity can lead to reduced compliance with drug therapies for chronic disease, and Buntin et al. (2011) find that enrollment in high-deductible health plans leads to reductions in the use of preventive care. Both Gruber (2006) and Hsu et al. (2006) demonstrate that higher cost sharing is detrimental to the health of the chronically ill.

McWilliams, Zaslavsky, and Huskamp (2011) find that cuts in plan generosity can lead to higher overall medical spending. Chandra, Gruber, and McKnight (2009) find that there are substantial “offset” effects to broad increases in cost-sharing rates for physician visits and prescription drugs; spending on these categories fell with higher cost sharing, but hospitalization costs rose substantially. In one related study, Goldman, Joyce, and Zheng (2007) find that higher cost sharing for pharmaceuticals is associated with an increased use of overall medical services, particularly for patients with greater needs (e.g., heart disease, diabetes, or schizophrenia).

Similarly, lower cost sharing is associated with a reduction in overall health spending, particularly for those with chronic diseases. For instance, Chernew et al. (2008) demonstrate that cost sharing with lower costs for those for whom the intervention would be most cost effective (generally the chronically ill) leads to higher compliance. Furthermore, Muszbek et al. (2008) find that increased compliance with drugs for hypertension, diabetes, and a series of other ailments will lead to higher drug costs but lower nondrug costs, leading to overall cost savings. Mahoney (2005) also finds that lowered cost sharing for diabetes patients reduces health costs per plan.

The most recent, and perhaps the most persuasive, study of the effect of increasing cost sharing comes from Brot-Goldberg et al. (2017). In this study, the authors examine the response of employees covered by ESI when the insurer imposes a number of changes to cost sharing. The entire firm being studied (the name of the firm is kept anonymous) switched from a plan that provided essentially free health care to one with a large deductible. The switch led to large reductions in medical spending, but the changes all came from reduced utilization, and the goods and services sacrificed to higher health costs were not low value; instead, they were essentially random. Perhaps most strikingly, Brot-Goldberg et al. “find no evidence of consumers learning to price shop after two years in high-deductible coverage. Consumers reduced quantities across the spectrum of health care services, including potentially valuable care (e.g., preventive services) and potentially wasteful care.” The findings on preventive care are particularly shocking. Facing a deductible, the firm’s employees cut back on preventive care at essentially a comparable rate with their cutbacks on other health care services. Yet even under the new health plan, preventive services were all free!

Finally, Swartz (2010) points out that it is often the health care providers and not the patients themselves who are the drivers of high health care spending. To the extent that moral-hazard-induced overconsumption of health care is a significant problem, patients already active in the health care system (e.g., under the care of a physician) may be less sensitive to cost sharing. Under a physician’s care, the amount of health services consumed is more likely to reflect the decisions made by providers. At that point, patients exercise little control over the medical care they receive. The corollary is that those less active in the health care system may be more sensitive to prices, meaning they are more likely to forgo expensive care if they believe there is less of an immediate medical need for it.

The sweep of this evidence is clear. To the extent that consumers do cut back on care in response to increased cost sharing, they cut back essentially randomly, even on medical spending that is cost effective in the long run. Proponents of increased cost sharing often implicitly suggest that consumers would only be forced to cut back on luxury items (e.g., designer eyeglasses) or medical care that has little or no long-term health effects (e.g., treating a minor skin condition). But a growing body of research indicates that this is not true; increased cost sharing does indeed often crowd out health-improving and cost-effective medical interventions.

In the end, markets for health care goods and services in the United States just do not provide consumers the ability to make efficient decisions. Health care prices are dominated by monopolization and consolidation, and price rarely, if ever, matches marginal cost (a key condition for prices to allow consumers to make efficient decisions). Efforts to cut utilization without harming patient care are going to have to be led by payers and by health care providers who are hemmed in by a system that incentivizes them to provide efficient information. This is a heavy policy lift. Experiments on how to do this can certainly be undertaken, but this is certainly not the low-hanging fruit in the health care cost policy world that too many in the past have claimed it to be.

It is almost certain that no country in the world has managed to make health care prices good enough conveyors of information to rely on market-based decisions to efficiently constrain costs. Instead, other countries have largely tried to use the monopsony power of large public insurance plans to provide countervailing force against health care providers’ monopoly position. In addition, public plans in both the U.S. and abroad try to provide information on what health care goods and services provide good value based on which health care interventions are covered by insurance and which are not. This is clearly an imperfect approach, as occasionally medical interventions that might improve health outcomes for a small number of people might not get covered on the basis that for most people in most circumstances, they are “low value,” or interventions that cutting-edge research shows are low value might be hard to take away from patients who are used to receiving them without cost. But the economics of health care are complicated enough that we will never be in an optimal world, and we should take as given that policy will need to proceed under the “theory of the second best.”28

How can we use policy to restrain provider pricing power in health markets?

The recent political momentum for ambitious further reform of American health care (calls for either single-payer- or Medicare-for-all-type plans) did not spring from nowhere. Despite the large strides made by the ACA toward securing a fairer and more efficient system, there remains much work to be done, and much of this work needs to focus on locking in and extending the cost slowdowns of recent years, but in ways that do not harm health care quality.29

While a single-payer system is a worthy goal to pursue for many reasons, not just cost control, such root-and-branch reform will likely require an extended political process. That is, it is unlikely to happen quickly. However, there are incremental, but still ambitious, reforms that could be undertaken that would allow many of the virtues of single-payer to be realized more quickly. In this section, we talk about some broad reforms that could help with cost containment. These include increasing the scope of strength of already existing public programs (Medicare, Medicaid, and the ACA exchanges); adopting measures to help private payers leverage the bargaining power of the large public programs; revising the law to allow Medicare to negotiate drug prices, and pursuing other policies to diminish the intellectual monopoly power of pharmaceutical companies; and using robust antitrust enforcement to keep consolidation of medical providers like hospitals and physician practices from pushing up prices. Below we provide a short discussion of each of these.

Extend already existing public plans and incorporate a “public option” into ACA exchanges

The most obvious reform to provide countervailing power against the ability of monopoly providers to mark up health care prices is to increase the role of public insurance. Medicare (the large sort-of-single-payer program that provides universal coverage to Americans 65 and older30) is often presented as being a problem because it is projected to see costs rise and increase federal spending in coming years. However, Medicare costs have actually risen more slowly than costs in the American private insurance market in recent decades. This largely reflects the fact that Medicare’s size gives it enormous power to set the reimbursement rates it will pay health care providers. Medicare’s enrollment is now well over 50 million, and its enrollees are the highest-spending part of the population (health care spending rises with age, and Medicare provides coverage largely for the over-65 population). This gives it enormous price-setting power that no private insurer—even those that are well-managed and efficient—can match. Figure O shows the growth in per-enrollee costs for Medicare and for private health insurance, for similar benefits.

Figure O

The implications of this figure are staggering for the 181 million Americans with ESI coverage. If ESI per-enrollee costs had grown at the same rate as per-enrollee costs for Medicare since 1970, a family insurance plan that costs $18,000 today would cost roughly 48 percent less, giving workers the potential of $8,800 in additional income to spend on non-health-related goods and services.31 This is serious money.

More suggestive evidence that cost control is aided by a strong public role in providing health insurance is seen in Figure P. This figure displays data across a range of countries. For each country it shows the average annual growth in overall health spending as a share of GDP, as well as the share of GDP represented by public health spending in the first year in the data. The latter variable is meant as a stand-in for the country’s commitment to using the public sector’s monopsony power as a brake on cost growth. In theory, we could have used the growth in public spending instead, but this is obviously endogenous to growth in overall spending (i.e., fast cost growth could have spurred countries to adopt larger public systems as a cost-containment device). The scatter plot shows a clear negative relationship—large public sectors in the beginning of the data series are associated with significantly slower increases in health care costs thereafter.

Figure P

The observation that more robust public roles in health care financing are associated with more success in restraining costs lies behind much of the recent political enthusiasm expressed for single-payer proposals. The impulse that a large public role can ameliorate many ills is clearly correct. One way to start a process leading to a much larger role is fairly straightforward: add a “public option” to the health care exchanges that were established under the ACA. This public option would allow households the choice to enroll in a public plan (comparable to Medicare) instead of a private plan. They would pay actuarially fair premiums (with the income-related ACA premium subsidies in force) and receive insurance coverage. The ACA architects largely thought that a public option was always meant to be included (a public option, for example, was part of the bill that passed out of the House of Representatives). The Congressional Budget Office has estimated that including a public option would save roughly $140 billion in federal spending over a decade, due to the downward pressure on premium prices it would exert (CBO 2016). Further, introducing a public option would increase competition in many counties around the United States where private insurers have largely abandoned the ACA exchanges. In 2017, 47 percent of counties had fewer than three insurers offering plans in the ACA exchanges (CMS 2018). This is a prime example of health insurance markets consolidating and robbing consumers of the potential benefits of competition. Adding a public option to the ACA exchanges would go a long way toward remedying the lack of competition, and if it attracted enough enrollees, it would be able to use its market power to bargain to keep payments to providers from growing excessively fast.

Besides providing a public option for the insurance exchanges set up by the ACA, another straightforward way to introduce a more robust public-sector involvement in health care would be to expand eligibility for the existing large public programs—Medicare and Medicaid. Allowing Americans 55 and over to “buy in” to Medicare at actuarially fair premium rates is an idea with a long pedigree. This would not only expand Medicare’s enrollee pool and boost its bargaining power with providers, but it would also provide a crucial window of health security at a time in Americans’ lives when they are often most vulnerable to an unexpected employment shock leading them to lose access to affordable health care. Similarly, one could expand eligibility for Medicaid. Currently, this eligibility requires household incomes of less than 138 percent of the federal poverty line (FPL), but there’s nothing particularly magical about this threshold—there’s no particular reason why this could not be raised to 200 percent of the FPL. Essentially, policymakers eager to claim the policy virtues of single-payer systems should seize on any chance they can get to expand existing public programs, even if this must be done incrementally.

Adopt “all-payer rates” to help private payers draft in the bargaining power of Medicare

It has often been observed that the large public programs, and Medicare in particular, can serve to set pricing benchmarks that private insurers can use in their own bargaining with providers. However, even if Medicare reimbursement rates provide useful information to private insurers, this latter group’s success in achieving the same bargain Medicare strikes with providers will depend on raw market power. As a recent landmark study of the private insurance market (Cooper et al. 2018) put it, “The results paint a consistent picture of bargaining power. At least descriptively, when hospital markets are concentrated (and/or insurer markets are fragmented), hospital prices are higher and hospitals are able to obtain contracts that shift more risk on to insurers.”

These findings suggest a clear policy recommendation: Besides having large public programs with pricing clout cover more Americans directly, we can use policy to allow private payers to draft in the price-setting power of public plans.

One obvious way to help the pricing benchmarks set by Medicare apply more tightly to all private payers (even those not large enough to wield considerable bargaining power on their own) is to establish all-payer rates. All-payer rates, much like they sound, simply require that health care providers charge the same price for a given procedure regardless of who is paying for it. Wide variance in rates charged for the same procedure—even for the same procedure undertaken in the same hospital in the same month and year—is a notable feature of the American health care market (Cooper et al. 2018). It is hard to see how this variance helps efficiency, and careful research has concluded that it is largely the outcome of differential bargaining power wielded by different health care payers.

Setting all-payer rates effectively lets the payer with the most bargaining power set rates for everybody. It therefore replicates much of the monopsony power of large public systems. Currently, Maryland is the only state with all-payer rates, and they apply only to the hospital sector. Murray (2009) has documented that hospital prices in Maryland have risen far more slowly than in other states in recent decades, indicating some beneficial effect of all-payer rates.32

Erode the intellectual monopoly of key health care sectors (e.g., pharmaceuticals)

A growing share of health costs in recent decades is accounted for by increased spending on pharmaceuticals. These drugs are generally developed and tested by private companies that are given intellectual property rights, which in turn give them substantial monopoly pricing power.33 As shown in Figure M, the price of drugs in the United States is often orders of magnitude higher than in other advanced countries. This suggests strongly that other countries—again, often with the help of more robust public roles in health financing—use their purchasing power to cut down the pharmaceutical company markups on drugs. Strikingly, Medicare was explicitly barred from effectively negotiating for lower drug prices when the 2003 law that expanded Medicare coverage to include pharmaceuticals was passed.34 Affirming Medicare’s responsibility to strike better bargains for taxpayers when purchasing from pharmaceutical companies should be seen as low-hanging fruit in the struggle to control costs. Baker (2013), for example, notes that having Medicare bargain for lower drug prices could save $40–60 billion annually.

Baker (2008) would go even further than simply having the government bargain for lower prices when serving as a direct purchaser. He suggests having clinical trials for new drugs be publicly financed. He notes the many economic conflicts of interest that arise when drug companies themselves undertake and report on the results of clinical drug trials. There are obvious incentives to overstate a drug’s effectiveness and understate any risks. Baker recommends that the cost of setting up publicly financed drug trials be recouped (and then some) by having the intellectual property resulting from new discoveries be placed in the public domain. This would result in far lower prices charged for pharmaceuticals.

Finally, the enormous price differences across countries (even those that share a border) for the exact same brand of drug suggests one obvious potential strategy for reducing drug costs in the United States: Allow these drugs to be bought in other countries and reimported into the United States. Economists for decades have evangelized about the benefits of free trade and have been nearly unanimous in advocating for trade treaties like the North American Free Trade Agreement (NAFTA) that cut tariffs for apparel and textiles and other goods. Yet these same trade treaties have almost always forbidden such drug reimportation and even demanded extension of U.S. levels of intellectual property protections to trading partners as a precondition for access to the U.S. market. This is a truly odd oversight on the part of the profession—free trade in pharmaceuticals would actually solve a pressing economic pressure on the budgets of millions of American families.

Increase antitrust scrutiny of consolidation in health care markets

We have noted many times in this report that providers of health care goods and services have substantial market power. The most intuitive way sellers in a market can wield power is when the market is relatively concentrated, with too few sellers to provide meaningful price competition. This lack of competition is an obvious feature of those corners of the health care market that are explicitly protected by patents (pharmaceuticals and medical instruments, mostly), as described above.

However, recent decades have seen another trend leading to degraded competition in a crucial sector of the American health system: consolidation of hospitals. This consolidation has been both horizontal and vertical. Horizontally, the number of hospitals (or hospital companies) in any given region is falling on average over time, and this fall has restricted price competition. Vertically, hospitals have affiliated with other providers (often networks of physicians) to extend pricing power.

The year 2017 saw a record number of hospital mergers and acquisitions (115), and 2018 saw 30 such mergers and acquisitions in the first quarter alone. This extends a pronounced trend in hospital consolidation over the past decade. In 2007, 53 percent of community hospitals belonged to a larger system. By 2017, the share was over two-thirds (66.8 percent). Similarly, between 2009 and 2015, the share of hospital-employed physicians grew from 40 to 48 percent.35

Research indicates that hospital mergers increase the price charged for services by 10–17 percent. In already consolidated markets, mergers between close competitors can raise prices by as much as 50 percent. Other research indicates that when hospitals acquire physician practices, prices for physican services increase by 14 percent.

A growing literature has documented potential increases in market concentration across a range of sectors and geographies. This wider literature makes a powerful case that enhanced antitrust protection should be a key priority of economic policymakers in coming years. It is hard to imagine a sector besides health care where this is a more pressing priority.

Conclusion

Nobody who was clear-eyed about the deep problems in the American health system in 2009 thought that the Affordable Care Act should be the last ambitious reform undertaken. While the ACA was a major step forward in addressing some key problems—like the lack of insurance coverage among a large share of the population—it was clearly insufficient to serve as a comprehensive cure for what ailed the American health system. The clearest goal for post-ACA policymakers is reining in the fast-rising costs of American health care without sacrificing households’ access to needed medical care.

American health care is singularly expensive among industrialized nations, and other nations with a stronger public role in health provision spend far less while achieving at least comparable (and often superior) health outcomes. This insight is what lies behind the considerable political desire to have the United States adopt a “single-payer” health care financing program. Single-payer is clearly a worthy policy goal, but moving toward it could be a long process, and it would take some time before full implementation of such a system could be achieved. Luckily, however, many of the key policy provisions that allow more robust public systems to achieve greater cost containment without sacrificing quality can be adopted quite early in any march toward single-payer. These cost-containment strategies would not only make a large public role for health care more plausible, they would also supply much-needed relief in the short run to the private American health care system, particularly the system of employer-provided health care.

Crucially, the class of reforms highlighted in this paper will enable many of the virtues inherent in a single-payer system to be realized without radically disrupting the ESI system that currently covers the majority of Americans. These households with ESI plans have shown themselves to be (understandably) quite leery about major reforms that threaten to disrupt this system before a proven alternative is demonstrated. As this report shows, however, there are significant reforms we can enact that would both pave the way for single-payer reform in the long run and, in the short run, provide enormous benefits for those families who currently have ESI coverage.

Acknowledgments

The author gratefully acknowledges the help of Elise Gould, Jessica Schieder, and Julia Wolfe in preparing the report, and Zane Mokhiber for help with figures and tables. I also thank Krista Faries and Lora Engdahl for editing assistance. Large portions of the section detailing the dangers of policy measures to attack utilization are lifted from Gould 2013, which in turn draws heavily on previous joint work.

About the author

Josh Bivens joined the Economic Policy Institute in 2002 and is currently EPI’s director of research. His primary areas of research include mac­roeconomics, social insurance, and globalization. He has authored or co-authored three books (including The State of Working America, 12th Edition) while working at EPI, edited another, and has written numerous research papers, including for academic journals. He appears often in media outlets to offer eco­nomic commentary and has testified several times before the U.S. Congress. He earned his Ph.D. from The New School for Social Research.

Appendix A

Recent cost slowdown is welcome but should not breed complacency

While the forecast of future income pressure stemming from rising health costs implied by Figure I is disquieting, it is perhaps more hopeful to note that the rate of excess cost growth has dropped significantly over the past decade (as can be seen in Figure C). The precise sources of this drop in excess cost growth remains not well understood.36 There is some evidence that the Great Recession had something to do with it. The recession saw enormous drops in spending on all goods and services economywide, so it is perhaps not shocking that this included the health care sector as well.

Some have conjectured that the ACA had something to do with it.37 The ACA created an Independent Payments Advisory Board (IPAB), a board that was empowered to change provider reimbursements from the public insurance programs if excess health care cost growth continued. The ACA also provided funding for experiments in payment reforms for the public insurance programs meant to better peg value and money spent on health care. A key thrust of those reforms was moving the public insurance systems away from payment models characterized by “fee for service” (FFS), where each medical intervention for a patient is billed and reimbursed by a provider. FFS carries an obvious incentive to provide more medical interventions for that patient. To break this incentive, some proposed payment reforms reimburse diagnoses and medical management rather than discrete procedures.

One key example of the policy thrust toward moving away from FFS reimbursement and toward “paying for quality” was an effort to reduce readmissions to hospitals following treatment. Hospital readmissions are too often a sign that care has been suboptimal in the first contact between patient and hospital. Readmissions are also quite costly in resource terms. But from the strict perspective of hospitals and doctors being paid on a fee-for-service model, they represent income gains. Efforts have been made to break this perverse incentive by penalizing readmissions or not reimbursing for multiple admissions related to a single diagnosis. The ACA specifically created a Hospital Readmission Reduction Program (HRRP) in 2012. The HRRP financially penalizes hospitals that have higher-than-expected readmission rates for a range of illnesses.38

It has been speculated that, in anticipation of IPAB decisions and widespread adoption of payment reforms, providers undertook cost-saving modifications of their own practices.

Whether these speculations are true or not, it seems clear that the recent slowdown in excess health care cost growth is not fully understood, and there is no guarantee that it rests on solid ground. Worse, some of the policy reforms that may have contributed to the recent slowdown have been significantly weakened. The IPAB was abolished as part of the Republican tax cut passed at the end of 2017, and the Trump administration Department of Health and Human Services seems far less interested in cost-saving reforms than its predecessor. If anticipation of the effect of IPAB and payment reform really was driving efficiency-seeking behavior of medical providers over the past decade, the removal of these cost-disciplining institutions could threaten to unleash faster excess cost growth in coming years.

In short, while we should not take the more dire forecasts embedded in Figure I as set in stone and immovable, nor should we take recent years’ slowdown in health costs as inevitable and obviously durable. Instead, policymakers should realize that health care costs are starting from a very high base, so any excess cost growth in coming decades will do substantial damage to possibilities for nonhealth consumption of goods and services. This argues strongly for noncomplacency and the need for aggressive measures to lock in the recent decade’s excess cost slowdown and to build on it.

Appendix B

How rising ESI costs pressure wages across the distribution

Figure G provides evidence on how wages overall (and wages for the bottom 90 percent) have been potentially crowded out by the rising cost of ESI premiums. Appendix Table B1 gives some more texture to this discussion by showing how much rising employer contributions to ESI premiums affected workers at different wage fifths.

The first set of rows (“Hourly wage, nominal”) shows the median hourly wage within each wage fifth for three separate years: 1979, 2007, and 2016. In 2016, this ranges from $9.54 for the lowest fifth to $44.79 for the highest fifth. The second set of rows (“ESI coverage rate”) shows the share of workers in each fifth who receive ESI coverage through their own job. These rows show that in 2016, 53.1 percent of workers overall received ESI coverage from their own job, down from 69.0 percent in 1979. The next set of rows (“Cost of employer contributions”) show an estimate of the average cost to an employer of providing ESI coverage, expressed as a share of the median wage in each fifth. These rows show that in 1979, employer contributions for the average ESI plan were equal to 16.8 percent of the median wage for the bottom fifth and 4.7 percent of the median wage of the top fifth. The next set of rows (“Hourly wages plus employer contribution”) show the sum of the hourly wage plus employer contributions to ESI premiums for an employee at the median of each fifth, accounting for the fact that not all workers receive this ESI coverage. The next set of rows (“Hourly wages plus employer contributions, counterfactual”) provides this same measure but holds the cost of providing the average ESI plan constant at its 1979 share of median hourly wages in each fifth. Finally, the last two sets of rows show the difference between the actual measure of hourly wages plus employer contributions to ESI per wage fifth and the counterfactual measure (by dollar amount in the first set and by percent of wages in the second set). This difference shows the potential crowd-out of hourly wages by the rising cost of ESI premiums. By 2016, this difference was $2.15 on average, with the crowd-out ranging from $0.99 per hour for the lowest wage fifth to $2.47 for the fourth fifth.39

Appendix Table B1

It should be noted that these calculations may understate the damage that rising health care costs have done to workers in the bottom two-fifths of the wage distribution. We should be clear that this damage has been substantial, for a number of reasons. First, the crowd-out of wages from rising ESI premiums has actually been larger than average for the bottom two-fifths, measured in percentage terms (as seen in the last row of the table). Second, while this chart shows the crowd-out of wages taking ESI coverage erosion into account, for those workers who continue to receive ESI, the wage crowd-out stemming from rising ESI premiums (not shown here) is much higher in percentage terms for workers in the bottom two-fifths than for other workers, for the simple reason that ESI premiums constitute a much higher share of these workers’ wages. For the same reason, conditional upon receipt of ESI, the benefits of the tax exclusion of ESI premiums are also greatest for lower-wage workers.40 Finally, the table shows clearly that ESI coverage has eroded most dramatically for workers in the bottom two-fifths of the wage distribution (as seen in the second set of rows, “ESI coverage rate”). This erosion is surely related to the fact that growth in ESI premiums relative to these workers’ wages has been extreme. In a real sense, the stakes for these workers in slowing health care costs are the greatest: To keep coverage in the face of rising costs, they must suffer the largest wage declines or else have coverage become so completely unaffordable that they must go without it.

Appendix C

American health care today is expensive relative to its international peers—but have prices in the U.S. actually grown faster than prices in peer countries?

Figure J provides a look at American health care prices over time, and Figure L provides comparisons of the U.S.’s and other countries’ health prices at a single point in time. Unfortunately, there is no reliable set of comparative price indices across countries that would allow one to make easy comparisons about the pace of health care price growth.41

We can, however, take a suggestive look at one particular slice of health care—hospitalization. The Organisation for Economic Co-operation and Development has a rich data set (OECD Health Statistics, or OHS henceforth) on health care financing and utilization across countries (but again, unfortunately, no cross-country set of health care deflators over a long period of time). For hospitalizations, the OHS provides national spending per capita as well as volume-based measures of utilization—the number of hospital discharges normalized by population size, as well as the average length of stay in hospitals. By looking at the trend in purely volume-based hospitalizations and comparing it with the rise in spending (which is the product of volume and prices), one can infer a rough trend for the price of hospitalizations. If, for example, a country has seen a 10 percent increase in hospital spending per capita but only a 5 percent increase in the volume of hospitalizations per capita, this implies that hospital prices have likely risen by 5 percent over that time as well.

Appendix Table C1 shows the trends in hospital spending and trends in hospital utilization for a range of OECD countries. Unfortunately, the United States does not show up in the OHS for a key measure of hospital utilization—hospital discharges. But independent sources do provide such a measure for the U.S. Potentially reassuringly, the trend from the independent U.S. sources displays the same nearly universal downward slope experienced by other OECD countries in recent decades.

Appendix Table C1

Taking the simple difference between the average annual growth rate of hospital spending (the second column of the table) and the average growth rate of hospital utilization (the first column) provides our inferred measured of hospital prices (the third column). Finally, to account for differences in overall price growth between countries, we subtract overall price inflation (the fourth column) from the constructed measure of hospital price to get a measure of “excess hospital price growth.” This last measure shows that this excess price growth in the United States for hospital services was indeed notably faster than the OECD average, with only three of 21 countries seeing faster excess price growth over this time. Most fundamentally, this table shows that hospital spending in the U.S. is quite high relative to OECD peers but hospital utilization does not appear to be, given that hospital utilization rates have been declining in the U.S. at a faster rate than in most other countries.

Endnotes

1. The degree to which the United States is an outlier in costs is well established, and later sections of this report provide the documentation. The middling-at-best performance of the United States health care system from an international perspective is almost as well established, with Sawyer and Gonzales (2018) providing a good recent rundown of the evidence.

2. See Center on Budget and Policy Priorities 2018 for an excellent overview of the administrative undermining of the ACA.

3. “Single-payer” is not a particularly specific term. It is often used interchangeably with “Medicare for All,” but the current American Medicare system allows private payers in and so is not, strictly speaking, a single-payer system. Further, some have interpreted “single-payer” to mean that no individual contributions to health care costs (e.g., deductibles or copays) are required. But no other country, including those often described as having a “single-payer” system, has a public insurance plan that pays for 100 percent of medical costs. In the end, “single-payer” should generally be taken to mean universal coverage that is achieved with a large public plan that covers a large portion of health care costs.

4. See Barnett and Berchick 2017 for information on sources of insurance coverage.

5. Gould 2013a documents this rapid erosion in ESI coverage following the 2001 recession.

6. Family plans include all plans that provide coverage for more than one person. KFF (2017) averages across family plans to yield an overall family plan cost.

7. For this argument, and some evidence validating the long-run trade-off between health insurance premiums and earnings, see Baicker and Chandra 2006.

8. The percentage-point difference between the 1999 share and the 2016 single premium share of earnings (8.6 ppt.), shown in the last column of Table 1, corresponds to the percent boost in annual pay (8.6 percent) that could have occurred had the premium stayed constant as a share of earnings. If this correspondence is not obvious, another way to calculate the percentage boost in annual pay is to assume that the single premium’s share of annual earnings in 2016 is still 9.7 percent, as it was in 1999—this makes the dollar amount of the 2016 premium $3,403 instead of $6,435, or $3,032 less, which represents an implied boost to pay of 8.6 percent ($3,032/$35,083) if that amount is redirected into cash wages.

9. This is indicated by the 26.1 percentage-point difference shown in the last column. If we assume the 2016 family premium remains at 25.6 percent of annual earnings, as in 1999, then the dollar amount of the 2016 premium becomes $8,981 instead of $18,142, for a potential boost in pay of $9,161, or 26.1 percent ($9,161/$35,083).

10. For single coverage, take the 8.6 percent increase in earnings that could have occurred had ESI premiums remained constant as a share of annual earnings, and divide by 54.8 percent to get the 15.7 percent figure. For family coverage, the relevant numbers are 26.1 percent and 54.8 percent.

11. The Kaiser Family Foundation Employer Health Benefits Survey (KFF 2017) finds that the composition of out-of-pocket costs changed dramatically over this period. Copayments (fixed costs associated with each visit to a provider), for example, fell 37.8 percent. Coinsurance (out-of-pocket costs that are charged as a share of the total provider cost) rose by 67.1 percent. Deductibles (out-of-pocket costs that fully cover provider costs up to a threshold above which insurance payments kick in) rose most rapidly of all, by over 176 percent.

12. Potential GDP is used instead of actual GDP in measures of excess health care cost growth because one doesn’t want the measure of excess health cost growth to be infected by economic recessions and booms. For example, measured relative to actual GDP growth, excess costs would have skyrocketed during the Great Recession, yet nobody would think this was a meaningful change.

13. Some of this rapid slowdown in excess cost growth per enrollee relative to growth per capita is likely compositional: Many of those who were newly insured following the implementation of the ACA were likely relatively healthy and cheap to cover, pulling down average costs.

14. Sheiner (2014a) provides a good overview of cost trends and a good discussion about how to think about the recent slowdown in health care cost growth, noting that “…it seems premature to either declare a turning point or to decide that nothing has changed. There remains much uncertainty about the likely trajectory of future health spending.”

15. The 11 countries are Australia, Canada, France, Germany, the Netherlands, New Zealand, Norway, Sweden, Switzerland, the United Kingdom, and the United States.

16. Mortality amenable to health care is a measure of population health that estimates deaths that are potentially preventable with timely and effective health care and hence attempts to separate mortality changes due to influences outside the control of health care changes.

17. Again, this presumes that even employer contributions to rising ESI costs are, in the long run, financed by slower potential growth of cash wages. Over the long run, this seems like a safe assumption.

18. The virtue of including this measure, as well as those from the previous section, is that the measures in Table 1 and Figure A essentially show the potential crowd-out of cash wages stemming from rising ESI premiums conditional on workers receiving ESI. It is possible that some employers respond to rising ESI premiums by no longer providing coverage, and this could reduce the crowd-out of cash wages systemwide. The NIPA data examined in this section essentially show the unconditional rise in total compensation accounted for by rising health costs—including the potential effect of employers reducing coverage.

19. The overall number is derived by multiplying the change in the share of total compensation accounted for by employer contributions to ESI premiums since 1979 by total compensation as measured by Bureau of Economic Analysis (BEA) NIPA Table 1.10. For the bottom 90 percent, we multiply the change in the share of total compensation accounted for by employer contribution to ESI premiums by the change in the bottom 90 percent’s total compensation, which is the product of total compensation from BEA NIPA Table 1.10 and the measure of the bottom 90 percent’s share of total compensation provided in CBO 2018c.

20. This fact is highlighted most usefully in some earlier versions of the Congressional Budget Office’s Long-Term Budget Outlook (CBO 2007).

21. See Aizcorbe et al. 2013 for a good overview of this argument.

22. One might argue that because the United States is starting these comparisons from a higher base ratio of health spending relative to GDP, a larger percentage-point change does not necessarily imply less success in constraining the growth of costs. Highlighting the average annual percent change in the ratio accounts for the higher base level of the United States.

23. See Sawyer and Gonzales 2018 for U.S. outcomes in comparative perspective.

24. See Papanicolas, Woskie, and Jha 2018 for more on cross-country comparisons of utilization measures.

25. See Davis 2004 for a good overview of the theory and evidence regarding consumer-directed health plans.

26. For a critical review of the effect of the excise tax on expensive health plans, see Bivens and Gould 2015 and Gould 2013b.

27. To be fair, many proponents of increased cost sharing for the first dollar of health spending would readily concede that tens of millions of Americans are underinsured as well.

28. The “theory of the second best” says that if markets are characterized by even one deviation from the perfectly competitive optimum, then it is possible that welfare improvements may happen only by moving further away from this competitive optimum, not closer.

29. Further cementing the need for future reforms, of course, is the intentional campaign to weaken the ACA undertaken by Republicans in Congress, the White House, and the courts since the day it was passed. The combined effect of these campaigns have succeeded in significantly reducing potential enrollment in both Medicaid and the ACA exchanges.

30. Medicare also provides coverage to some Americans under age 65 who qualify due to a disability.

31. This number is derived by taking the cost of a family ESI plan today, as estimated by KFF (2017), and backcasting its cost growth from the private health insurance costs in Figure P. Once its 1970 value is derived from this backcast, we then let it follow the cost path taken by Medicare costs and compare this counterfactual 2016 cost with its actual cost.

32. At the same time, overall hospital utilization in Maryland over the same period has risen significantly faster than in other states. This could be random luck, or it could be providers with market power using another margin of this power—increasing recommended medical utilization—to preserve revenue in the face of price controls. Finally, it could be simply that demand for hospital services is relatively price elastic, and the subdued price growth in Maryland has moved potential patients down the demand curve relative to other states, leading to higher rates of utilization.

33. It should be noted that much of this argument applies to medical devices as well as to pharmaceuticals. Payments for devices, however, are harder to separate in the data than payments for pharmaceuticals, so the data do not provide as clean a basis for how much we spend on devices.

34. Medicare Prescription Drug, Improvement, and Modernization Act of 2003, 117 Stat. 2066.

35. Statistics on consolidation taken from congressional testimony of Martin Gaynor (2018).

36. Again, Sheiner (2014a) remains a good documentation of competing explanations.

37. Cutler and Sahni (2013) provide the most forceful argument that the ACA should be expected to have had relatively immediate effects in restraining cost growth.

38. These hospital readmission rates were risk adjusted to account for different patient populations handled by different hospitals. McIlvennan, Eapen, and Allen (2015) provide an overview of the HRRP.

39. These estimates rely on the assumption that covered workers face the same premium prices regardless of which wage fifth they are in. This could certainly be incorrect, but it is not obvious which way the bias would run. On the one hand, low-wage workers might be given substandard plans that provide less protection and are hence cheaper. On the other hand, smaller employers tend to pay lower wages yet face significantly higher costs for health insurance.

40. See White 2017 for a detailed discussion of these points.

41. The OECD Main Economic Indicators does provide data on the consumer price index for medical care, but the data are too spotty for too many countries to provide a good comparison. For example, the data for the United States in these statistics only begin in 2004.

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Fixing the problem of too-high exposure to out-of-pocket costs is straightforward: the exchange subsidies for premiums and cost-sharing could be increased. There would be plenty of members of Congress—mostly (or exclusively) Democratic—who would sign onto this. The obvious objection to this is that it costs taxpayer money. This, in turn, begs the question of are there any policy changes that could both lower the cost of health care to consumers and also the tax bills of households?

Luckily, there are such policies. Senator Bernie Sanders and co-sponsors are introducing the Affordable and Safe Prescription Drug Importation Act. This would instruct the HHS Secretary to put forward regulations allowing the importation of qualifying prescription drugs from Canadian sellers. In two years, importation from other advanced countries would also be allowed. The bill sets high standards to insure that only safe and effective prescription drugs could be imported, and there would be strict controls following the drugs into the United States to insure their proper dispensing.

The theory behind this bill is simple: drug prices in our advanced peer countries are substantially cheaper than in the United States, so we should leverage the ability of free trade to lower prices in the United States. Our failure to allow this today is surely the most costly form of protectionism (in goods trade, anyhow) still plaguing our country today, and yet it is never addressed by those in charge of our trade policy.

Prescription drug prices in the United States are needlessly high, and the economic stakes are large: U.S. patients consume more than $300 billion worth of prescription drugs annually, with the government picking up more than a third of the tab. The beneficiaries of high drug prices are shareholders and corporate managers of pharmaceutical companies, some of the most profitable corporations in the world. The losers from these high drug prices are America’s working families. It is time to introduce some genuine economic competition into this highly protected industry.

Will this bill alone solve all of our health care cost and access problems? Of course not. There is no silver bullet here, and further progress will have to be made. One obvious next step would be legislation requiring the federal government to bargain aggressively with pharmaceutical providers for the tens of billions of dollars we spend as taxpayers through the Medicare prescription drug program. But the Affordable and Safe Prescription Drug Importation Act is an excellent start. It aims to find genuine efficiencies in our wildly dysfunctional health system, and it can lower costs for both patients and taxpayers.

First, some economics, and then on to some politics.

Jared and I are roughly on the same page regarding the wage/health care trade off issue. As the excise tax is imposed on plan costs above a certain threshold, this will encourage people to shift into plans with lower upfront premiums. But these lower upfront premiums mean that more health costs are shifted onto households in the form of higher co-pays, deductibles, and co-insurance. The good news of lower premiums, however, is that this frees up money for employers to give more compensation to workers in the form of cash wages rather than health premiums. Elise Gould and I have argued in the past that this wage boost stemming from less-generous health plans is likely to be a long time coming, particularly if labor markets remain slack. Jared agrees. He argues this trade off likely will happen in the longer run. I agree (though I’m not 100 percent sure, and am troubled by the lack of robust empirical support in the research literature on this). My beef has mostly been with people who simply state that the excise tax will lead to a “raise” for American workers. That’s bunk. It will change the composition, not the level, of employee compensation. And it will increase total taxes on this compensation, hence cutting their take-home pay.

We have argued that the real problem with the tax is that the increased cost shifting will indeed cause people to cut back on health care spending, but because the American health system is opaque and uncompetitive, there will be no good information to tell consumers what they should cut back on first. So, they will cut back across the board, making decisions that are bad for health and do nothing to boost dollar-for-value in health spending. Recent research provides further confirmation of the destructive impact of the sort of scattershot cost shifting that the excise tax will result in.

Jared thinks we overstate this, and references the fact that in the beginning years of the tax, few plans (and fewer health care dollars) will be affected. But the tax is designed to grow over time, and you can’t really claim that this is a vital revenue raiser and then claim that it won’t affect many people or many health care dollars. If it’s not impacting anybody, it is by definition not raising any revenue either. Further, if the claim is that the tax really won’t do much at all to change people’s behavior in consuming health care and hence our concern is exaggerated, then Jared is in a sense conceding our point on the lack of any inherent policy virtue of the tax. That is, if it does not result in people cutting back on health spending, all it’s doing is raising revenue, and we can then choose an equivalent revenue raiser with fewer problems (which would bring us to his political objections, which I wrestle with below).

Jared references some recent arguments made by excise tax proponents that its imposition will actually not lead to thinner plans with higher co-pays, deductibles, and co-insurance. The argument runs that firms and workers will begin pressuring health insurance providers to find efficiencies in insurance and health care provision and obtain lower-cost care of equivalent quality through these efficiencies. This really strikes me as magical thinking. If such efficiencies exist today, why aren’t firms and workers demanding them? Yes, the excise tax provides a tiny bit larger incentive to demand these, but an awfully big incentive is sitting out there today. A quick example—I pay about $10,000 each year directly for family health insurance premiums through my employer-provided plan. Does anybody really think I wouldn’t really, really like to pay less than this? Or does anybody think EPI (my employer) wouldn’t love to lower what it pays in its contribution to health care premiums for employees? What is lacking here is not will or incentive on the part of workers and firms, it’s a mechanism that links employees’ and firms’ desire for cheaper, more efficient health care to insurers’ and providers’ ability or motivation to provide it. The excise tax doesn’t change any of this.

In the end, the meat of Jared’s argument is political—we have a tax on the books today, Congress is deadlocked by anti-tax zealots today, so we should not give away this precious revenue. It’s a good argument. We will eventually almost surely need more revenue to maintain projected spending levels on valuable social insurance programs (including the ACA, but also Social Security, Medicare and Medicaid), public investment, and generally functional government.

But I do think two recent economic developments make the need for revenue less pressing in the near-term.

First, health care cost-growth has decelerated significantly over the last decade, with the slowdown preceding the Great Recession. This makes the need for more revenue in the medium-term much less pressing. The projected future budget deficits that are so often breathlessly reported by DC policy types are driven entirely by rising health care costs. As these costs have risen more slowly recently, the size of projected future budget deficits has declined as well. Can we bank on tame health care cost growth forever? No, but it does buy us time.

Second, when discussing macroeconomics, many of us (Jared included, I believe), take seriously the worry that we’ve entered an era where advanced economies may have chronic shortfalls of aggregate demand for years to come. Basically, a range of factors (rising inequality, a global savings glut, the declining cost of capital goods, who knows what else) seem to have conspired to keep households, businesses, and governments from spending enough to keep the labor force fully employed. In the jargon, this is sometimes referred to as secular stagnation. A key policy conclusion from this is that we can and should run larger government deficits than would’ve been considered desirable in earlier eras. These deficits spur demand, and the traditional downside of deficits run during times when the economy is near full-employment (high and rising interest rates) do not materialize.

Again, will the age of secular stagnation be with us forever? Probably not, but this again buys time against when we will need more revenue.

And this time is crucially important. Surely we can’t make all possible policy decisions today based on the premise that we’ll never have a reasonable Congress again. This would argue for striking a deal, any deal, that preserved any piece of currently scheduled Social Security benefits because under current law more revenue will be needed to keep these benefits from falling significantly 20-something years from now.

I do wish we weren’t debating whether or not to give back some revenue legislated as part of the ACA. But I also wish we had adopted a better revenue source back then. And, in some sense the good-faith debate over a laser-focused change in the excise tax is a healthy normalization of health policy debates. Nobody—not even fervent proponents like us—thought that the 2010 passage of the ACA solved all U.S. health care problems forevermore. The ACA and Medicare and private insurance will need to be tweaked and adapted in coming years. For the past six years, the health care debate has been entirely hijacked by anti-ACA obsessives in Congress. Having a substantive policy debate driven by people who like the ACA writ large but want a minor course adjustment should be seen as a return to policy normality.

Beginning in 2018, the tax will be levied on the cost of single plans in excess of $10,200 a year, and non-single plans in excess of $27,500. The point of the tax is to nudge workers into taking thinner health plans—those with lower premiums that stay under the threshold for the tax. But choosing plans with lower premiums will generally lead to higher out-of-pocket costs – higher deductibles, co-pays and/or other forms of cost sharing. This increased cost-sharing is the point of the tax, not a byproduct. By boosting the marginal cost of each new episode of obtaining health care, the theory is that health consumers will shop more wisely and cut back on unnecessary care. We have strong reservations about leaning on this dynamic as effective cost containment, but for now I’ll focus on a side claim made by defenders: that a happy consequence of accepting plans with lower premium costs is that workers will see higher wages.

The theory for this is that if employers cut back on contributions to health insurance premiums as workers choose thinner plans, more money will become available to boost non-health care compensation—wages or other fringe benefits. This presumed increase in wages actually accounts for a significant share of estimated revenue that will be raised by the tax. (I should note that if the compensating wage boost stemming from lower employer premium payments does not happen, this does not necessarily mean that the tax won’t raise money. Lower premium costs and unchanged wages paid by employers imply a rise in business income or profitability, and this higher profitability should mean higher tax payments by employers.)

This potential boost to wages is what leads many of the tax’s defenders to call it a “pay increase.” But of course, even if wages rise in response to cutback s in employer premium contributions, the level of pre-tax pay (where pay includes both wages as well as other employer-provided benefits) won’t increase at all—instead its composition will simply shift, with employer premium payments falling and wages rising. Further, because wages are taxed and employer premium payments are not, this means that the total tax bill on the worker’s overall compensation will have unambiguously increased. So, post-tax compensation is lower with the excise tax, period. It is a take-home-pay cut.

We know that, all else equal, average out-of-pocket costs will rise in line with the average reduction in premiums as firms and workers shift to thinner health plans. If out-of-pocket costs rise one-for-one with the reduction in premiums, this implies that all of the increased wages stemming from this compensation shift will simply be forked over to doctors and other health providers. This would mean that even wages that were pre-tax but post–health-care expenses (PTPHCE) would be no higher after the tax. If the increased cost-sharing (higher out-of-pocket costs) spurred by the tax instead led to workers deciding to consume less health care, then workers’ PTPHCE wages would rise. But their total compensation would remain lower than it was before the excise tax, and their wage increase would be driven by their decision to forego health care.

How confident should we be that wages will rise in response to a cutback in employer premium payments in an effort to avoid the tax? I’ve been indoctrinated enough as an economist to think this will likely be the case over the long run. However, the ability of workers to demand wages as recompense for accepting thinner health plans and lower employer premium contributions will depend on many things, including how close the economy is to full employment. The U.S. economy has spent many long periods of time away from full employment in recent decades, so it is no guarantee that these compensating wage-gains will come quickly. This necessary ingredient for effective workers’ bargaining power and its frequent absence in the U.S. labor market may be a reason why the compensating wage gains stemming from rising health costs has been hard to definitively pin down in the research literature.

Despite many references to a wage/health care benefits trade-off being a completely settled topic in empirical economics, it’s actually far from a robust finding. There are high-quality studies that find a wages/health care cost trade-off, and high-quality studies that don’t. Further, this is a topic where one needs to be worried about publication bias—the possibility that studies failing to find this trade-off are just not published. This has been a real problem in previous economic debates , like that around the disemployment effect of the minimum wage.

An illustration of the importance of labor market conditions on whether we see compensating wage gains is the past eight years. Since 2007, health care costs have decelerated rapidly. This should have opened up a lot of room for faster wage gains in the post-2006 period. Yet inflation-adjusted wages after 2007 have fallen for the vast majority of American workers.

In the end, I do think that wage gains will eventually come if we incentivize thinner health plans, but it could be quite a while, and it doesn’t change the fact that the excise tax remains an unambiguous pay cut for American workers.

The Affordable Care Act took enormous strides toward providing access to health-care coverage to the tens of millions of uninsured Americans and reining in the skyrocketing costs of health care that heavily pressured households and public budgets, addressing what we consider the most glaring shortcomings of the U.S. health system. When it comes to cost control, however, the policy virtue of one provision of the ACA–the excise tax on high-cost employer-sponsored health insurance plans, frequently called the Cadillac tax–is often overstated.

This provision levies a 40% tax on the cost of insurance plans that exceed $10,200 for individuals in 2018 ($27,500 for non-single plans). The policy goal of this tax is to nudge workers into opting for plans that charge lower premiums. Lower premiums in turn imply higher co-pays, deductibles, and cost-sharing. To be clear, these higher out-of-pocket costs are the point of the tax, not a byproduct. The theory is that as each new episode of obtaining care becomes more expensive households will cut back on health spending and this will help contain costs.

We think this is roughly true. Evidence shows that making health care more expensive does induce people to consume less of it. But the same evidence shows that people do not cut back only on care that is ineffective or somehow luxurious; instead, they cut back across the board. Expecting sick Americans to decide on the fly in an opaque and uncompetitive marketplace what health care is cost-effective–and what is not–is an unrealistic and unfair approach to containing costs.

While overall costs may be pushed down by the excise tax, this is a good outcome only if one believes that the health care squeezed out is merely the ineffective kind. But a lot of welfare-improving care may also be a casualty, and for some patients, cutting back on medically indicated care because of the increased cost-sharing could increase their overall spending. For example: some patients who cut back on low-cost pills to contain cholesterol end up in emergency rooms.

Cutting utilization is also a limited cost-containment strategy. Americans’ extraordinarily high health spending compared with our international peers is not driven by profligate utilization of health care but, instead, by much higher prices per unit of care. Studies have not shown cost-shifting to do anything to the price side of the equation. The excise tax is not aimed at nor will it reduce health-care prices.

Defenders of the tax say that because firms will be induced to push down premium costs, this gives space for employers to increase cash wages. As economists, we think this is likely correct in the long run if the economy returns to full employment. But the U.S. economy has spent a lot of time away from full employment in recent decades, so for many workers the compensating wage increases might be a long time in coming. Further, much of these higher cash wages will, on average, be forked over to health-care providers to pay higher out-of-pocket costs. Some defenders of the tax call the outcome of higher wages a “pay increase” or say it will “boost incomes” for workers. This is absurd; the tax reduces total after-tax compensation for workers.

The “Cadillac tax” label grates because the tax is not aimed at “Cadillacs”–plans that shield workers even from discretionary health purchases such as, say, designer eyeglasses or hot-stone massages. Simply put, “expensive” does not equal “good” insurance. Health insurance plans can be expensive because they’re in high-cost states, or because firms are small and lack bargaining clout with insurers, or because the workforce of a given employer is older than average. Pre-ACA research indicated that as little as 4% of the variation in health insurance premiums was driven by generosity of coverage. Further, the tax is designed to, over time, scoop up more and more of the employer-sponsored plans in the U.S. economy.

There are other, less damaging ways to limit the tax preference for employer-sponsored premium payments. The president’s proposed budget recommends capping the income tax preference for all tax deductions (including employer-sponsored health insurance) at 28%. This would leave more than the bottom 95% of workers’ exclusion untouched but would still raise considerable revenue. Best, the targeting of those being nudged into higher out-of-pocket costs would be based on these households having high incomes–and not based on these workers having a high-cost health plan that they obtained through the roulette of the U.S. health insurance market.

It is understandable why, in 2009, architects of the ACA sought to insert all manner of cost-control devices into the legislation: Health-care costs had risen more rapidly than overall economic growth for decades and had climbed particularly swiftly in the early 2000s. Since 2006, however, the rate of growth of health costs has decelerated significantly. Research indicates this is not just an outcome of the Great Recession. This cost-growth deceleration is so rapid that between 2011 and 2014, the Congressional Budget Office estimate for federal spending on health care in 2021 declined by roughly $300 billion. This slowdown in cost growth gives time to ensure that policy strategies for cost containment focus on not just less spending but also better value for money. The excise tax is a shotgun blast. But what’s needed for cost containment is a scalpel.

Reinhardt suggests that inducing patients to shop around for cost-effective health care is “about as sensible as blindfolding shoppers entering a department store in the hope that inside they can and will then shop smartly for the merchandise they seek.” The problem, he argues, is that health care has been historically “delivered behind the secure walls of a fortress that kept information on the prices charged for health care and the quality of that care opaque from public view.”

This is one of the reasons why I (in a far less humorous fashion) have argued that increasing health care cost sharing, whether in the form of premium support in Medicare or the thinning out of plans as a result of limiting the tax exclusion, may do little to rein in health care costs and will have the unfortunate downside of simultaneously burdening the patients who need care the most. I wrote earlier this year, “prices of health care services faced by consumers bear very little relation to providers’ cost to supply these services. Hence, these prices provide little to no information for consumers looking to judge the relative efficacy of various health care interventions.” I’m happy that the lack of price transparency is getting the attention it deserves.

Reinhardt makes the additional point that those providers clamoring for little government intervention in the “free” market for health care may be just the thing that breaks down the barriers to true price competition by increasing transparency in prices and costs. On that margin, perhaps, effective health policy can concentrate on lowering costs, rather than on the backs of the most vulnerable.

This brief argues that this is a flawed strategy for health care cost containment. The health care market is unlike other markets; thus, forcing increased cost sharing on American households is a deeply inefficient strategy for trying to contain health care costs. Forcing Americans to pay a higher share of health costs will not induce them to shop around and compare prices when they are experiencing chest pains or their child is suffering from an asthma attack. Further, consumers of health care are in no position to second-guess their doctor when she tells them an MRI is better than an X-ray (and hence worth the higher price) to diagnose a condition. Lastly, unlike other markets, prices of health care services faced by consumers bear very little relation to providers’ cost to supply these services. Hence, these prices provide little to no information for consumers looking to judge the relative efficacy of various health care interventions.

In addition, increased health cost sharing is unlikely to make American health care more affordable to those currently unable to afford it, and will instead likely place the largest burdens on those who need care the most.

Besides being flawed in conception, most concrete policy tools used to increase cost sharing also have serious problems of implementation. This brief discusses a couple of real-world policy proposals to increase cost sharing, such as changing the tax treatment of employer-sponsored health insurance or changing Medicare’s premium structure.

This paper’s main findings include:

• Most cost-sharing proposals lead to higher out-of-pocket medical costs, hitting those who require a high degree of medical care especially hard.
  • The short-term cost savings achieved as patients respond to increasing out-of-pocket burdens may be realized by reducing medically necessary health care—a penny-wise, pound-foolish result.
  • Cost sharing increases the likelihood of future financial risk.

• Most cost-sharing proposals are poorly targeted for containing overall system costs.
  • They miss the expensive cost drivers.
  • They may lead to consumption of less-effective care and therefore increase overall health care spending.
  • Any cost containment would be driven by reduced medical care, not reduced prices.

• The Affordable Care Act’s (ACA) excise tax on high-priced health insurance plans is not well targeted.
  • Health insurance premiums are driven by a variety of influences (e.g., firm size, age of workforce, location, etc.) unrelated to the generosity of health plans.
  • Because the tax is triggered by high premiums, the tax will hit many workers with ordinary, not exceptionally generous health plans.
  • Because the threshold is indexed in future years at a growth rate that is expected to be slower than the growth of medical costs, in the future it will capture more typical health plans.
  • Any increase in wages that employers may offer to compensate workers for employers’ reduced premium contributions to less generous coverage will still lead to a fall in total after-tax compensation, which will increasingly need to be spent on higher out-of-pocket medical costs for those who need care.

• Many proposals to restructure Medicare could increase the financial and health risks faced by the vulnerable elderly.
  • Turning Medicare into a premium-support system—with a voucher set arbitrarily at the value of the second-least-expensive insurance plan—would shift costs to elderly households.
  • Increasing the Medicare eligibility age from 65 to 67 (while simultaneously repealing the ACA’s insurance market reforms) will leave many Americans ages 65 and 66 without insurance. Thus, many will put off needed care, costing both their health and financial well-being more in the long run.
  • While cost shifting may lead to workers’ wages increasing to compensate them for a loss in employer health insurance contributions, there is no such trade-off for the elderly when it comes to Medicare cost shifting. Additionally, a greater share of elderly Americans’ fixed income will have to go toward health care.

Policy background

A number of proposed health policy interventions—such as taxing employer-sponsored health insurance benefits and restructuring Medicare into a premium-support program—share a key policy feature: They aim to shift health care costs from government and insurance companies onto households. The stated policy benefit of this shift is often short-handed as increasing American households’ “skin in the game.” The “game” is the purchase of medical care; the “skin” is that Americans will shoulder more of the costs. In other words, Americans will directly face a higher share of total health spending. The theory behind this idea is that people will become more careful consumers of health care and will forgo unnecessary care that they only consumed because insurance reduced its cost to them, all of which will bring down overall health costs.

Increased cost sharing can take many forms. Both taxing employer-sponsored benefits and decreasing government payment of Medicare premiums will encourage the purchase of less expensive health plans in either the employer system or in Medicare. All else equal, fewer dollars toward premiums translates into less comprehensive coverage.

Various particular policy proposals have worked to increase cost sharing. Several increase the taxation of employer-sponsored health insurance benefits. Specific examples include the Affordable Care Act’s excise tax, which levies a 40 percent tax on high-priced health plans; the tax exclusion cap set forth by the 2010 National Commission on Fiscal Responsibility and Reform (i.e., the Bowles-Simpson plan); former President Bush’s 2005 Tax Reform Panel’s recommended cap on the tax exclusion for employer-sponsored premiums; and many other proposals over the years. This brief discusses the specific case of the excise tax in the Affordable Care Act, which creates a strong incentive for employers and workers to purchase less expensive—and hence less generous—coverage to avoid the tax.

Another avenue of increased cost sharing is found in proposals to restructure Medicare. This paper focuses on one such proposal: House Budget Committee Chairman Paul Ryan’s 2014 budget, which replaces Medicare’s current health coverage guarantee with a premium-support payment, in essence creating a voucher for the purchase of health insurance. As with the excise tax, the voucher loses value over time, causing the Medicare population to choose between spending more out-of-pocket on health insurance or more out-of-pocket on purchasing health care.

Both of these avenues of reforming health insurance provision will increase out-of-pocket costs, particularly for enrollees who frequently require health services. As a result, consumers are either burdened with paying higher medical costs, or they may respond to increasing out-of-pocket costs by cutting back on care, some of which may be medically indicated.

This brief argues that these poorly targeted interventions to boost cost sharing are a fundamentally misguided answer to high and rising health costs. The next sections explore these arguments in detail, but in short, pushing costs onto consumers is not a very effective cost-containment device. While these policy measures will undoubtedly reduce the federal government’s health expenditures, they will not do much to reduce total system health spending. Unless one is willing to increase cost sharing even for truly catastrophic medical costs, such measures will miss the primary cost drivers in the U.S. health care system—80 percent of health dollars are spent by just 19 percent of (presumably the sickest) health consumers, and 50 percent are driven by just 5 percent of the population (author’s analysis of MEPS 2010). In other words, encouraging relatively healthy people to cut back on health care simply misses the vast majority of health care costs. If these less healthy patients driving overall spending (particularly those with chronic diseases) respond to across-the-board increases in cost sharing by cutting back on all medical care—some of which is extraordinarily cost-effective in the long run—they may actually increase overall health costs in later years. In addition, research has shown that cost containment from increasing cost sharing is generally driven by reduced volumes of medical care consumed, and not by reduced prices (Anderson et al. 2003). Since it is the high prices of American medical care that make us such an outlier in international comparisons, it seems that increased cost-sharing focuses on the wrong problem. Serious solutions to contain health costs may be found elsewhere (e.g., value-based insurance design, all-payer rates, and better care coordination).

The economics and evidence on how cost- and risk-shifting may lower coverage and care

Forcing people into less-comprehensive plans exposes them to higher out-of-pocket costs and greater health-related financial shocks. People value insulation from these shocks—this is the reason people purchase insurance—so forcing them into less-insulating plans has a cost. Shifting health insurance costs onto workers, seniors, and their families may hamper their ability to maintain and secure affordable health care. Such costs have already risen in recent years, resulting in increased out-of-pocket burdens and difficulty in paying medical bills (Collins 2013).

Cunningham (2010) finds growing financial burdens of health care across the socioeconomic distribution, not simply among the poor and uninsured. Himmelstein et al. (2009) find a striking growth in bankruptcies associated with medical costs, even for those households covered by health insurance. Pushing insurance plans to be less comprehensive has the potential to make these financial problems worse.

Not all moral hazard is inefficient

The movement of people into less-comprehensive coverage is often identified as a policy benefit—under the theory that when people have more “skin in the game” (i.e., face a higher share of total health spending) they will become more careful consumers of health care and will forgo unneeded care only previously purchased because they were not facing its full cost. Among economists, this problem is called moral hazard. This theory implies there is an optimal level of cost sharing and some of the additional health care purchased by the insured represents economic inefficiency. Nyman (2007) directly questions this theory by arguing that a large portion of moral hazard represents health care that sick consumers would not otherwise have access to without the income that it transferred to them through insurance. This portion of moral hazard—the transfer of income—is efficient and generates a welfare gain.

Nyman illustrates this phenomenon through a useful example of a woman who has just been diagnosed with breast cancer. Without health insurance, she would not be able to afford both the mastectomy and the breast reconstruction needed to correct the disfigurement caused by the mastectomy. With health insurance, she can afford both. One might argue that insurance is inefficient (causing moral hazard) because the breast reconstruction was not medically indicated and she only chose to have that procedure because it was made inexpensive by her insurance. In a social experiment, one could theoretically transfer to her the full cost in dollars (of both procedures) and then view whether she spent it on the mastectomy and the breast reconstruction to determine if it is just the price reduction from insurance that provides the incentive or the income transfer from insurance that drives her decision-making. If she still purchases both procedures with the cash transfer that she could have used to purchase other goods and services, then this would show that insurance, by relieving a liquidity constraint, leads to efficient decision-making and that presumed inefficiencies from insurance’s price distortion are overstated.

This recognition that not all moral hazard is economically inefficient is becoming well-understood in other branches of economics. Chetty (2008) makes similar arguments in the context of unemployment insurance, focusing on the fact that unemployment insurance benefits solve a liquidity problem rather than creating a disincentive to look for work. His research differentiates the moral hazard effect from the liquidity constraint by comparing households that can and cannot smooth consumption through a spell of unemployment with assets or income from other sources, such as a working spouse. Chetty suggests his analysis could apply even more strongly to the case of liquidity constraints in the purchase of health care. On net, it is conceivable that the welfare gain from efficient moral hazard outweighs in both size and importance the welfare loss from excessive medical care. This would be particularly true in the case of individuals with serious illnesses who require expensive treatments.

If policymakers remain determined to make cost sharing a part of a health policy package, the above arguments suggest that taxing health benefits or reducing Medicare premium contributions for only high-income households might reduce some of these negative consequences for those at the lower end of the income scale while still raising revenue and reducing spending. This assumes both that the high-income are less likely to be liquidity constrained and that such policies only genuinely hit the high-income.

Cost sharing can lead to medically and economically inefficient decisions

By increasing cost sharing, consumers will be faced with higher out-of-pocket costs when deciding whether to seek medical care. This effective price increase may lead some to cut back on medical spending. For vulnerable populations and those with chronic conditions, many interventions that are avoided may turn out to be health-improving. Research has shown that higher cost sharing could lead families to cut back on medically indicated and effective health care. Goldman, Joyce, and Zheng (2007) find that cuts in plan generosity can lead to reduced compliance with drug therapies for chronic disease, and Buntin et al. (2011) find that enrollment in high-deductible health plans leads to reductions in the use of preventive care. Both Gruber (2006) and Hsu et al. (2006) demonstrate that higher cost sharing is detrimental to the health of the chronically ill.

Overall, the evidence shows that an optimal cost-sharing design may better serve consumers and the health care system when it takes into account all the considerations raised by different patient populations, therapies, and conditions. Consumers simply do not have the necessary information or wherewithal to make many health decisions, and various factors may keep prices from accurately signaling quality or effectiveness. Patients in emergency situations are simply not able to assess hospital quality or direct their own treatment regimen. Patients, in both emergency and non-emergency situations, trust medical professionals to offer the best information and care, unlike sellers in the general marketplace.

Efficient cost-sharing designs cannot be one-size-fits-all. A universally applied excise tax on health benefits or reduced premium contributions to Medicare do not create the right incentives for the creation of the most efficient insurance policy; in fact, one might argue that they are blunt instruments that create no incentives except to purchase less expensive policies. In doing so, they shift costs onto workers, seniors, and their families, hitting those requiring high levels of medical care especially hard.

Cost sharing is a poorly targeted cost-containment device

Many health policy experts have claimed that both taxing employer-sponsored health benefits and restructuring Medicare into a premium-support system could be powerful tools in restraining the overall growth of American health care costs without exposing Americans to much greater financial or health risks. Given that rapidly growing health costs exert real strains on both government budgets and family incomes, curbing them seems to be a worthy policy goal. As it turns out, these policies have less reach in driving significant cost containment than is commonly recognized.

Decreasing first-dollar coverage through higher deductibles and the like will probably miss many of the most expensive costs in the health system. As previously noted, the sickest 19 percent of the population in any given year accounts for 80 percent of total health spending. This includes people with chronic conditions, acute care needs, end-of-life care needs, etc. An increase in cost sharing among the big-ticket items such as transplants, major life-saving surgeries, or the management of chronic diseases such as diabetes has not been explicitly suggested and is universally recognized to be bad policy.

Swartz (2010) points out that it is often the health care providers and not the patients themselves who are the drivers of high health care spending. To the extent that moral hazard–induced overconsumption of health care is a significant problem, patients already active in the health care system (e.g., under the care of a physician) may be less sensitive to cost sharing. Under a physician’s care, the amount of health services consumed is more likely to reflect the decisions made by providers. At that point, patients exercise little control over the medical care they receive. The corollary is that those less active in the health care system may be more sensitive to prices, meaning they are more likely to forgo expensive care if they believe there is less of an immediate medical need for it. Efforts to “bend the cost curve” via increasing costs paid by consumers would be limited to the relatively small share of total health spending borne by this population (akin to the 20 percent of health dollars consumed by 81 percent of the population).

To the extent that consumers do cut back on care in response to increased cost sharing, we noted before that they may well cut back on health-improving medical spending. But they may even cut back on medical spending that is cost effective in the long run. Proponents of increased cost sharing often implicitly suggest that consumers would only be forced to cut back on luxury items (e.g., designer eyeglasses) or medical care that has little or no long-term health effects (e.g., treating a minor skin condition). But a growing body of research indicates that this is not true; increased cost sharing does indeed often crowd out health-improving and cost-effective medical interventions.

McWilliams, Zaslavsky, and Huskamp (2011) find that cuts in plan generosity can lead to higher overall medical spending. Chandra, Gruber, and McKnight (2009) find that there are substantial “offset” effects to broad increases in cost-sharing rates for physician visits and prescription drugs; spending on these categories fell with higher cost sharing, but hospitalization costs rose substantially. In one related study, Goldman, Joyce, and Zheng (2007) find that higher cost sharing for pharmaceuticals is associated with an increased use of overall medical services, particularly for patients with greater needs (e.g., heart disease, diabetes, or schizophrenia).

Likewise, lower cost sharing is associated with a reduction in overall health spending, particularly for those with chronic diseases. For instance, Chernew et al. (2008) demonstrate that cost sharing with lower costs for those for whom the intervention would be most cost-effective (generally the chronically ill) leads to higher compliance. Furthermore, Muszbek et al. (2008) find that increased compliance with drugs for hypertension, diabetes, and a series of other ailments will lead to higher drug costs but lower non-drug costs, leading to overall cost savings. Mahoney (2005) also finds that lowered cost sharing for diabetes patients reduces health costs per plan.

The sum of this important research suggests that increased cost sharing in certain areas (e.g., prescription drugs or primary care) can lead to higher overall costs due to increased health service utilization in other areas (e.g., hospitalization), and that the optimal cost-sharing rate for many chronic conditions and large classes of prescription drugs is very low or even zero. By not differentiating among medical goods and services based on effectiveness research, increased cost sharing stemming from overly blunt policies such as the excise tax or Medicare vouchers may be an ineffective and potentially harmful tool in making efficient cuts to health care utilization. A careful examination of the growing value-based insurance design literature may produce a more effective policy response.

To the extent that consumers do respond by cutting back on medical care, it becomes clear that any cost containment from these policies is driven by the reduced quantity of medical care consumed, not reduced prices. That is, if increased cost sharing contains costs to any significant extent, it does so by encouraging people affected by it to buy less health care. Anderson et al. (2003) suggest that high medical spending in the United States, as compared with its industrial peers, is actually driven by high prices and not high utilization. To the extent this is true, policies that shift costs onto consumers are not likely to remedy this problem.

Besides problems in conception, specific policies that increase cost sharing also suffer significant problems in the way they are applied. The remainder of this paper looks at two such policies—the Affordable Care Act’s excise tax and Rep. Paul Ryan’s plan to restructure Medicare—and some of the unique problems their implementation would present.

Excise tax is not well targeted

In March 2010, President Obama signed into law the Affordable Care Act (ACA), commonly known as health reform. As part of health reform, beginning in 2018 a 40 percent excise tax will be levied on health insurance policies with premiums in excess of $10,200 for individual policies and $27,500 for family coverage. The tax applies to the portion of premiums between the threshold and the total cost of the insurance policy. The premium thresholds are adjusted for workers in high-risk industries and for the age and gender of the workforce. In 2019 and beyond, the threshold above which premiums are taxed is indexed to the overall inflation rate plus 1 percentage point, not to the growth of medical costs, which is expected to be higher.

Currently, employer contributions to health insurance premiums are excluded, without limit, from workers’ taxable income. Employee contributions are excluded if the employee works at a firm with a cafeteria plan, a plan that allows employees to choose between taxable and nontaxable fringe benefits (e.g., plans that offer flexible spending accounts). Subsidizing compensation paid in the form of health insurance encourages employers to offer health insurance, increasing the number of insured workers. Nevertheless, some argue that limiting this tax exclusion would provide incentives for cost containment because it would make consumers more price sensitive, thereby leading to reduced health expenditures, and it would raise tax revenue that could be used in part to pay for coverage expansions.

In response to the excise tax, a Mercer survey (2009) finds that nearly two-thirds of employers plan to cut health benefits to avoid the tax and a full 7 percent would eliminate their health plan altogether. The Joint Committee on Taxation (2009) revenue estimates assume that only a small share of revenue would actually come directly from the excise tax (as opposed to the large share of revenue from taxed wages), implying that employers and employees alike will shy away from the more expensive plans. Among workers at firms that drop insurance coverage altogether, some workers will become eligible for subsidized coverage in the state health exchanges established by the ACA.

Taxing benefits is often mistaken as a way to get rid of overly generous, or “Cadillac,” coverage. However, expensive plans are not necessarily more generous plans. Many health plans are expensive because the employee population is older or sicker than average, and not because they provide more generous coverage. Gould and Minicozzi (2009) have shown that some of the most powerful predictors of a plan’s high cost are the size of the firm and the age of its workers. Small firms and firms with older workforces tend to have less bargaining power with insurance companies and face higher administrative costs. All else equal, this leads to higher prices for insurance coverage, which may be no more comprehensive than lower-priced coverage for larger firms or those with younger workers. Gabel et al. (2006) have shown that small firms pay premiums 18 percent higher than large firms pay for equivalent health coverage.

Another way to measure plan generosity is to use a health plan’s actuarial value, that is, the share of average medical expenditures paid for by the insurance company (instead of by the policyholder). Using actuarial value as a proxy for plan generosity, Gabel et al. (2010) find that only a small share (3.7 percent) of the variation in premiums for family plans is determined by a plan’s generosity. Other factors include type of plan (e.g., HMO), industry, and variation in medical costs across the country. Even after including these factors, much of the variation in premiums is left unexplained by plan features. This reinforces that plan prices do not reflect plan value.

To some extent, the health reform law acknowledges this reality and specifically raises the threshold of the excise tax for selected small groups of workers explicitly on the grounds that high cost is not synonymous with high value. For instance, it increases the threshold for health plans covering high-risk professions. However, it does not go far enough to account for the high prices some pay for coverage that is still far from a “Cadillac” standard. Dorn (2009) recognizes this problem and proposes an alternative solution to more clearly target the tax to high-value plans by using actuarial value to measure benefit generosity. One solution he outlines taxes plans above the 75th percentile of actuarial value among all enrollees in employer-sponsored insurance plans, and indexes this threshold to overall inflation over time. This policy prescription still ignores the fact that more comprehensive coverage benefits the least healthy the most.

As previously noted, in 2019 and beyond, the threshold above which premiums are subject to the ACA excise tax is indexed to the overall inflation rate plus 1 percentage point (CPI+1). For instance, if overall inflation grows at an average rate of 2.5 percent while medical care costs rise at 4.0 percent, a growing wedge will be created between a CPI+1 of 3.5 percent and the growth of medical costs. The result is that more and more insurance plans would be subject to the excise tax, leading more employers and workers to demand lower-priced and less comprehensive coverage. As in the past, this growth rate is expected to be lower than the growth of medical costs, thereby capturing more and more health plans in the future—an increasing number of which by any measure would not be considered “Cadillac.”

Other policy virtues of the excise tax often overblown

Additionally, proponents of taxing employer-sponsored health insurance benefits often note that if it encourages workers to take less compensation in the form of health insurance premiums, then this could raise other forms of compensation, especially cash wages. Given that in the long run the excise tax will indeed likely lead to non-trivial cuts in employer contributions to insurance premiums, it is certainly possible that cash wages may rise as employer contributions to premiums fall. However, the large majority of these wage increases will simply be absorbed by higher out-of-pocket medical costs incurred with less generous coverage. Given the large variation in annual health spending (i.e., many families spend next to nothing on health costs in a given year while some spend large amounts), many workers could face increases in out-of-pocket costs that far exceed the potential addition to cash wages that accompanies the imposition of the excise tax. On average, after-tax, after–health care wages will rise much less than proponents often claim. Finally, characterizing the potential for cash wages to rise in response to the tax as simply “a raise” for American workers is not correct. Even if cash wages rise in response (however doubtful in the current economy), these rising wages only come as other forms of compensation are falling. Further, because some compensation that was previously being subsidized through tax policy is now being taxed, the result is an unambiguous cut, not a raise, to total after-tax compensation.

Lastly, because better-paid workers are generally more likely to have employer-sponsored insurance (ESI), and because the tax benefit to having ESI rises with income, anything that reduces this ESI-related tax benefit is often described as a “progressive” tax increase. However, McIntyre (2009) makes the additional point that, as a share of income, taxing ESI does not unambiguously increase the progressivity of the tax system across every segment of the income distribution. While many low-income households do not enjoy access to ESI, high-income households are required to contribute only a small share of their income to pay the tax because there is a limit to how much any household would want to take income in the form of health insurance. For instance, compared with the home mortgage interest deduction, the tax advantage given to health insurance is more tightly distributed, as house prices vary more widely than do health premiums. McIntyre calculates the marginal federal income and payroll tax rate on converting a portion of tax-exempt wages (in this case, health insurance) into taxable wages. He finds that if health premiums were taxed as wages, the tax rate (including the payroll tax) would be relatively flat across income groups. Given the tight distribution of health premiums and relatively flat marginal tax rates, McIntyre estimates that the excise tax, as a share of income, would be 10–20 times as high on middle-income families as on the rich, reducing the overall progressivity of the tax system.

Medicare restructuring according to Paul Ryan’s 2014 budget

House Budget Committee Chairman Paul Ryan’s 2014 budget proposes several changes to Medicare in an effort to increase competition and stem the program’s growth rate (Ryan 2013). His plan restructures traditional Medicare into a system where the government pays a set rate and seniors shop for their plans in a competitive Medicare Exchange. The government contribution is set at the lesser of the second-least-expensive private plan or traditional Medicare. So in the first year, those wishing to remain in traditional Medicare will be able to with no additional costs.

However, in future years, the value of the voucher will be set according to a competitive-bidding process and (more importantly) cannot see its growth exceed growth in overall GDP plus 0.5 percentage points—a rate likely to be slower than actual health cost growth. Given the wedge between the increase in health costs and government contributions to premiums, over time the voucher will lose value relative to desired health plans for purchase. Van de Water (2013) argues that the only way to keep Medicare cost growth within the target spending level under the Ryan proposal is to limit the annual increase in the amount of the voucher. Over time, this pushes both the cost of health insurance and the cost of health care onto seniors.

While an argument can be made that workers who face a loss in employer contributions to health insurance will see higher wages to compensate, in the case of Medicare, seniors will clearly experience a welfare loss. There will be no increase in Social Security to offset the increased cost sharing as a result of premium support that refuses to keep up with medical inflation. Forcing cost sharing on seniors will increase their economic and health vulnerability without any offsets that increase their financial well-being. Any increases in out-of-pocket spending as a result of less generous plans will lead to a higher share of the elderly being financially insecure. Cooper and Gould (forthcoming) find that a 50 percent increase in medical spending on premiums and out-of-pocket medical care among the elderly Medicare population will increase the share of the economically insecure elderly by nearly 10 percent, from 48.0 percent to 52.6 percent.

Furthermore, in its analysis of a similar plan Rep. Ryan proposed two years ago, the Congressional Budget Office (CBO) estimates that replacing traditional Medicare with a premium-support model would not yield the touted cost containment (CBO 2011). CBO points to two major factors: Private plans have higher administrative costs and profits than Medicare, and payment rates to providers are higher in private plans because they have less negotiating power than does Medicare. Not only will seniors bear more of the health cost burden, but the overall burden may increase as Medicare loses its comparative advantage in the health care marketplace.

Ryan’s plan also raises the eligible age for Medicare from 65 to 67 by 2035. As his plan also proposes to repeal many of health reform’s provisions, increasing the Medicare eligibility age will cause many to put off needed care, costing both their health and financial well-being more in the long run (McWilliams et al. 2007). Without a regulated insurance market that assures those ages 65 and 66 an alternate source of affordable coverage, they may enter the ranks of the uninsured with all the problems that ensue from that status, particularly the inability to receive necessary care when needed.

Conclusion

Both the excise tax on high-cost employer-sponsored health insurance plans and restructuring Medicare into a voucher system will shift costs onto workers, seniors, and their families. For those who require extensive medical care, such policies may result in financial stress and/or medical sacrifice. They may lead some to be even more costly consumers of health care. For that price, these policies may ease the federal budget, but research shows that they will do little to contain overall health spending. Furthermore, they put all the burden of cost containment on consumers without giving them the tools to make more fully informed medical decisions.

Serious solutions to contain health costs may be found elsewhere. Experts are required to make these decisions, and such methods can be instituted, for instance, by the Independent Payment Advisory Board established by health reform to restrain Medicare cost growth without sacrificing coverage or quality of care. Among a series of alternatives Holahan et al. (2011) estimate to contain health system costs, the one with the greatest effect is the establishment of an all-payer rate setting system, a system that would ensure that rates were controlled for all, regardless of how they received insurance. Laugesen and Glied (2011) offer ways to create incentives for the consumption of more medically effective and cost-effective care by reducing the payment disparities between physicians and specialists. Buntin and Cutler (2009) explore alternative savings mechanisms such as investments in health information technology and payment system reforms. If policymakers are determined to increase cost sharing, careful research (including research that has yet to be conducted) should be consulted to avoid increasing cost sharing where it would be destructive to health or economic security. Doing so, rather than using the blunt tool of a tax on high-priced plans, may provide a more effective incentive to rein in the high costs of the U.S. health care system.

— Elise Gould joined the Economic Policy Institute in 2003. Her research areas include employer-sponsored health insurance, inequality and health, poverty, mobility, and the employer tax exclusion. She has published her research in a range of venues from academic journals to general audience periodicals, been quoted by various news sources, and testified before the U.S. Congress. Also, she teaches health economics and econometrics to graduate students at Johns Hopkins University and The George Washington University, respectively. She holds a master’s in public affairs from the University of Texas-Austin and a Ph.D. in economics from the University of Wisconsin-Madison.

— The author thanks Natalie Sabadish for her clever research assistance and Josh Bivens for his valuable comments.

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There are two points they make abundantly clear. First, yes, the excise tax on high cost health plans will generate revenue. Second, it’s not going to do much to contain long term health cost growth.

The first point is indisputable.  The second runs contrary of conventional wisdom about how effective taxing benefits will be in driving consumers to purchase less expensive plans. All else equal (firm size, region, age of workers at firm, etc.), less expensive plans require consumers to pay more when they seek care – higher coinsurance rates, higher deductibles, or the like. When consumers have to pay more, they will consume less. Voila!  Rising health cost growth halted and we are saved.

Holahan and co-authors say it’s not so simple because spending on health care is not evenly spread across the population. And, I quote:

“Those least likely to be involved in the health care system—those with the lowest health care needs—will be most likely to be affected by increased cost-sharing. Given the strongly skewed distribution of health care spending, with 65 percent of total spending accounted for by only 10 percent of the population, significant health savings will not be achieved unless the highest spenders are affected as well.”

It sounds so convincing and reasonable to me, perhaps because I tried to make similar arguments during the health reform debate. It’s not that I had unusual foresight, but it’s just common sense when you look at the data. Back in March 2009 I argued:

“But the potential gains in cost containment from taxing health benefits are wildly overblown. We know that 80% of health costs are borne by 20% of the population. Serious cost containment measures should deal with bringing down the costs of the most expensive cases in our system (e.g., managing chronic diseases) rather than arguing over the much smaller amounts spent by the rest of the population. Policies fixated on reining in the first few hundred dollars of health spending do not effectively or efficiently deal with what is driving the high costs of the U.S. health system.”

However, as the health reform debate progressed, the policy virtues of taxing insurance benefits became exaggerated. And another set of prominent economists even identified the tax on expensive health insurance plans as one of just four critical elements of reform.

To sum up the Urban study’s main points that are consistent with those I raised two years ago:

1. Taxing benefits will have little impact on reining in health care spending because the distribution of health spending is skewed with few spending the vast majority of health dollars.
2. Increased cost sharing could lead to increased costs if patients respond to increased cost-sharing by substituting other services or delaying care until more expensive medical interventions are necessary.
3. Increased cost sharing could have significant negative health outcomes for people who have chronic conditions or are poor.

I might (and did in 2009) make another point: “high-cost” plans aren’t the same thing as “Cadillac” plans. The excise tax was often sold as taxing only those workers lucky enough to have lavish health coverage that demand minimal cost-sharing relative to normal plans (hence they were “Cadillac” plans). But in the market for health insurance, plans are expensive for a number of reasons (firm size, age of workforce, location, etc.) besides how much cost-insulation they provide. Further, as the excise tax threshold rises slower than health care inflation, it can no longer legitimately be called a tax on high-cost plans, unless the definition of what are high-cost plans is altered to mean all plans.

Why is this still a live question?  Various proposals to even further erode the tax-preference for health insurance continue to pop up in the debate over budget deficits. So, it should be pointed out again that the excise tax (or taxing benefits through a tax exclusion cap or the like) is simply “not well targeted” (pg. 10) and does not create the right incentives for the creation of the most efficient insurance policy; in fact, it is a blunt instrument that creates no incentives except to purchase cheaper policies.

In the end, health care cost control should not come about by forcing consumers to figure out what they’re going to sacrifice – our health system just does not provide them the information they need to do this. The rest of the Holahan et al paper describes some better ways to contain costs.

The top line numbers alone are fairly shocking. Average family health insurance premiums rose from $13,770 in 2010 to $15,073 in 2011, up 9 percent. In 2010, total family premiums had only risen 3 percent, but the leading story then was about how employees were paying an increasing share of the total premium, on average 30 percent for family plans.

To put these numbers in perspective, Kaiser/HRET compares both total health insurance premiums and the portion of premiums paid for by workers to workers’ earnings and overall inflation from 1999 to 2011. Their figure, displayed below, illustrates how premiums have risen over three times faster than workers’ earnings and four times faster than overall inflation.

Click figure to enlarge

Given the high cost of employer-sponsored health insurance, it comes as no surprise that the share of non-elderly Americans with such coverage fell from 2000 to 2010, as shown in the Census data released earlier this month. The combination of a bad economy, general lack of bargaining power among workers, and steeply rising health insurance prices in 2011, as shown in today’s release, will surely lead to lower coverage rates, when the Census data on health insurance coverage comes out next year.