Characteristics Of An Ideal Health Care System

Health | Policy Reports

No. 242
Monday, April 30, 2001
by John C. Goodman

Executive Summary

Why should government be involved at all in our health care system? Aside from providing care for low-income families, the most persuasive argument is that in the absence of coercion people will have an incentive to be uninsured "free riders." In our society, people who choose not to pay for insurance know that they are likely to get health care anyway - even if they can't pay for it. The reason is that there is a tacit, widely shared agreement that no one will be allowed to go without care. As a result, the willfully uninsured impose external costs on others - through the higher taxes or higher prices which subsidize the cost of their care.

What evidence is there that free riders are a problem? One piece of evidence is the number of uninsured:

  • According to the Census Bureau, in 1999 there were 42.6 million people who were uninsured at any one time, a larger percentage of the population than a decade ago.
  • The rise in the number of uninsured has occurred during a time when per capita income and wealth, however measured, have been rising.

Although it is common to think of the uninsured as having low incomes, many families who lack insurance are solidly middle class. And the largest increase in the number of uninsured in recent years has occurred among higher-income families:

  • About one in seven uninsured persons lives in a family with an income between $50,000 and $75,000, and almost one in six earns more than $75,000.
  • Further, between 1993 and 1999, the bulk of the increase in the number of uninsured was among the households earning more than $50,000.
  • By contrast, in households earning less than $50,000 the number of uninsured decreased by about 5 percent.

In deciding to be uninsured by choice, many healthy individuals are undoubtedly responding to perverse incentives created by government policies.

  • On the one hand, we make an enormous amount of free care available to the uninsured; in Texas, for example, it totals $1,000 per uninsured person every year, on the average.
  • Also, federal and state laws are making it increasingly easy for people to obtain insurance after they get sick - thus removing the incentive to buy insurance when they are healthy.
  • Finally, although the federal government generously subsidizes employer-provided insurance, most of the uninsured are not eligible for an employer plan, and they get virtually no tax relief when they buy insurance on their own.

Far from solving the free rider problem, most government interventions these days are making the problem worse. Indeed, we might be better off under a policy of laissez faire.

If we accept the free rider argument, however, what policy implications logically follow from it? One commonly proposed solution is to have government require people to purchase insurance. However, this is neither necessary nor sufficient. Instead, a complete solution would have 10 characteristics. Adhering to each of them would lead to a system that provides a reasonable form of universal coverage for everyone without adding to national health care spending and without intrusive and unenforceable government mandates.

1. We should subsidize those who insure and penalize those who do not. Since we have a social interest in encouraging people to have health insurance, we should subsidize its purchase - say, with tax credits. The penalty for not being insured would be the absence of the subsidy. Why not simply require people to purchase insurance without any subsidy? Because the only practical way to enforce such a mandate is by fining people who disobey it. And, since a fine is a penalty, the absence of the penalty is a subsidy to those who purchase insurance. A penalty/subsidy system, in other words, is all the leverage that is needed or desired.

2. The subsidy for private insurance should equal the value society places on insuring individuals, at the margin. We should decide how much we care (in money terms) whether a person is insured, and that should determine the size of the subsidy/penalty.

3. The revealed social value of insurance is the amount we spend on free care for the uninsured. Since none of us is a mind reader, how do we know how much it's worth collectively to insure a given individual? If we are willing to take the political system as dispositive, it's the amount we expect to spend on free care if the person is uninsured.

4. The penalties paid by the uninsured should be used to compensate those who provide safety net care. What should be done with the penalties (extra taxes) paid by those who continue to elect to be uninsured? These funds should be made available to those who operate the health care safety net in the community where each uninsured person lives. In this way, the uninsured would help finance their own "free" care.

5. The subsidy for each newly insured should be funded by reducing the expected amount of spending on free care for that person. If every uninsured person suddenly obtained insurance, we would no longer need to fund our nation's very expensive health care safety net. Further, money that was previously funding the safety net could then be used to subsidize health insurance for the newly insured. In this way, people who cease being insured free up the funds that subsidize their choice. In general, as individuals move from uninsured to insured status, we should reduce safety net spending and use the newly freed-up money to help subsidize the newly acquired insurance.

6. Subsidies for being insured should be independent of how the insurance is purchased. The social value of insurance is independent of how it is purchased. Accordingly, the subsidies for private insurance should be the same, whether purchased individually or through an employer. On a level playing field, the role of the employer would be determined in the marketplace - not by tax law.

7. The optimal number of uninsured is not zero. The social goal is to reach a point at which the additional cost (in terms of subsidy) of the last person we induce to insure is equal to the additional benefit (in terms of the reduction in cost of free care). At this point, there will almost certainly be some people who remain uninsured by choice.

8. The principles of reform apply with equal force to all citizens, regardless of income. People who earn $100,000 a year can incur medical bills they cannot pay almost as easily as people who earn only $30,000. For that reason, the social interest in encouraging insurance is largely independent of income. Accordingly, health insurance subsidies should be independent of income.

9. Health insurance subsidies need not add to budgetary outlays. Getting all the incentives right may involve shifting around a lot of money by reducing subsidies that are currently too large and increasing subsidies that are too small. But there is no reason to believe our health care system spends too little money right now. Nor is it necessary to add new money in order to adhere to the 10 characteristics described herein.

10. The federal government's role should remain strictly financial. From an interest in encouraging catastrophic insurance, there is no social reason why government at any level should dictate the content of health insurance plans. Although federal subsidies for private insurance exceed $141 billion a year, currently the federal government places very few restrictions on the content of insurance plans. And except for certain portability requirements, federal law is silent about the conditions under which insurance is bought and sold. The federal role is largely a financial one. It should remain so.

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