Heritage Foundation Leadership for America

See Stuart M. Butler and Edmund F. Haisimaier, eds., A National Health Systemfor Ainerica (Washington, D.C.: The Heritage Foundation, 1989); Stuart M. Butler, "Using Tax Credits to Create an Affordable Health System," He mage Foundation Backgrounder No. 777, July 20, 1990; Stuart M. Butler, "A Tax Reform Strategy to Deal With the Uninsured," The Journal of the Anwrican Medcal Association, Volume 265, huy 15,1991.

Consider this fact: In ours ard every developed society, there has grown, in recent yaars, a very large industry based upon the simple premise that a person who can defer the payment for a good or service will purchase mom of those goods or services. I confidently predict that almost everyone in this room has one or more credit cards in their pocket. It is a large and very successful industry, which operates on that simple premise: If we can defer payment, we will buy more of things. In fact, we do. Imagine then, the effect on attitude if another person believes that they do not have to pay at all. If their attitude is, I am not paying anything for this, we readily, of course, are prepared to purchase more. To some extent-and it ought not to be exaggerated-but to some extent, that is a factor in overutilization and the volume of services provided today. ... I think We have to begin to change attitudes and convince every American that they are paying because, in fact, they are. Senator Nfitchell has, in my opinion, clearly identified the driving force behind many of the current problems with America's health care system, namely that the current system largely di- vorces the payment for health care from the receipt of health care services. One group-beneficiaries-are concerned primarily with the receipt of health care services. But because they are insulated from the true costs of those services, they have little interest in those costs. Another group, businesses and governments, are concerned primarily with paying for health care. Since businesses and governments are merely legal entities, they do not use health carp' services, and thus have little natural interest in the quantity or quality of those ser- vices delivered to patients. At the same time, under this system, providers naturally offer more services and seek to charge more for them. Normally, in the rest of the economy, this tendency would be constrained by con- sumers demanding the highest benefits at the lowest cost. But health care providers function in a very different environment from that faced by providers of goods or services in other areas of the economy. Providers elsewhere must constantly try to keep down the prices they charge if they are to survive. That does not happen sufficiently in health care because consumers generally have little incentive to challenge cost. What is missing, then, from the current health care system is any effective mechanism for bal- ancing costs with quantity and quality. There is simply no mechanism for seeking or obtaining good value-that is, the best quantity and quality at the best price-for either Americans as indi- viduals or society as a whole. Two Remedies. This fundamental defect in the existing system can be remedied in one of only two ways. Either the system must be changed to give those who benefit from health ser- vices direct control over the funds used to pay for those services-a consumer-led model-or it must be changed in the opposite direction by eliminating the ability of consumers to demand ser- vices without regard to cost. This latter result is accomplished by giving control over the supply of health care completely to government officials who can ignore the excessive or inefficient de- mands of consumers. These are the only two ways effectively to solve current problems in the health care system. A hybrid system, epitomized by play or pay proposals such as' Senator Nfitchell's bill, is not in fact a compromise between these alternatives. In practice it would com-

bine the worst features of each approach Paid would be economically damaging as well as polliti- cally unstable. The first approach I mentioned-i "lie consumer model-necessitates sweeping-reforms based on consumer choice and market principles to give individual Americans and their families direct control over the funds used to buy th,-,L- medical care and health insurance and the incentive to use funds efficiently. Such reforms would be accompanied by some structure of direct subsidies, through the tax code or direct assistance, to provide lower-income or chronically sick individuals with the extra funds they require to purchase needed medical care and health insurance roughly equal to that of the rest of the population. This is the approach which 1, among others, advocate. The second approach also necessitates sweeping changes to eliminate the problem that con- sumers, facing perverse incentives, are not encouraged to use health resources efficiently, or even effectively. These changes would grant government complete and direct control over the system, including the key economic levers of price, quantity, and quality, throug@ a national health insurance program. Such a program could be structured along the lines of either a public service model, such as the British system, or along the lines of a closely regulated public utility model, such as the Canadian system. Various 'individuals, including some members of Congress, advocate this type of approach. I do not agree with this approach, but it is the only logical alterna- tive to a consumer-based sysItem. No Third Choice. I do not see any third choice. Specifically, I do not see how pursuing any course of reform, other than the two choices I have described, will result in a system that is politi- cally or economically workable. Trying to pursue a third way that is based on neither of these fundamental options, or is an attempted combination of the two, will only create a more unstable and ineffective system-leading to eventual reform in one of the two directions I have outlined. The effect of such a measure will be only to delay the inevitable day of final decision. Unfortunately, Senator Mitchell -and others, including the Chairman and some members of this committee, have chosen to pursue that unworkable third approach in S. 1227.

The basic elements of S. 1227 are: 1) The establishment of a federally-defined basic minimum package of health insurance ben- efits for all Americans. i 2) A requirement that employers either purchase health insurance coverage for their workers and dependents from private insurance companies, which meets or exceeds the federally- defined minimum, or pay a new payroll tax to fund government-provided health insurance for their workers and dependents. 3) Strong anti-discrimination measures to stop employers who offer insurance from firing or refusing to hire individuals whose families might mean high costs for the firm's health plan. 4) The replacement of Medicaid with a new public assistance program providing health care coverage to all Americans lacking private, employer-provided insurance. 5) A new set of regulations and restrictions on how private health insurers write policies and conduct business.

6) The creation of a new mechonism of govemment-sponsored negotiations and govern- ment-imposed regulations designed L0 control the quantity, quality, and cost of health care services throughout the wtire system. While there are differences in the details, S. 1227 is no different in basic structure from other proposals based on the concept of health care reform commonly known as the "play or pay" ap- proach. Rather than presenting a detailed analysis of S.1227, I will, in the rest of my testimony, com- ment on what I see- as -the major flaws of this legislation and of all similar play or pay proposals. I do this because over--the long haul the details -of wparticular bill actually are of marginal signifi- cance. The eventual outcome will be driven by powerful pressures emanating from the fundamental dynamics of play or pay. The premise of the play or pay approach is -that because the majority (over 80 percent) of American workers and their dependents currently receive health insurance coverage through the work place, the ideal way of creating a universal health care system would be for those who cur- rently lack health insurance to receive coverage in the same manner. The conclusion, based on this reasoning, is that employers not now providing these benefits should be forced either to pro- vide coverage by private means (that is, "play"') or fund the cost of government-administered coverage (that is, "pay"), for uninsured workers and their dependents. Major Consideration. Some lawmakers and policy makers assume that the abience of univer- sal employer-sponsored coverage is due to a desire to freeload on the part of some employers. This is largely wrong. Surveys show that workers consider the existence or absence of employer- provided health insurance to be a majorconsideration. when choosing a job, and t@fiat employers feel competitive pressure to offer health insurance as a means of attracting or retaining workers. The main reason most uninsured Americans lack health care coverage is that they and/or their employers are unable to pay the cost of a reasonable health benefits package. One major reason for this is that the current tax policy designed to give an incentive for employers to provide insur- ance is inequitable and contains highly perverse incentives that push up costs. For employees, the only kay to obtain significant assistance towards health care costs, short of going on welfare, is through the exclusion for company-provided plans. This provides generous tax relief to employees in high tax brackets and least help to workers in the lowest bracket. If the employee works for a small firm without a plan, he or she usually must pay for insurance or care in after-tax dollars. Thus the design of assistance is exactly the reverse of the principle of provid- ing most help to those who need it most. In addition, many workers see employer-provided coverage as "free' to them and have little incentive to economize, especially if it is first-dollar coverage. And insurance at the place of work means that the coverage is not portable-thus many employees with medical problems either are unable to move to a better job or face a finan- cial catastrophe if they are without work even temporarily. For businesses, the cost of covering employees includes not only the cost of insurance premi- ums but also the substantial, hidden administrative costs imposed by government regulation of employee benefits plans. These administrative costs explain why some businesses do not offer in- surance to short-term employees, even if they are otherwise highly compensated. It is also a major deterrent to small businesses (where most uninsured workers are employed) offering insur- ance. Furthermore, group insurance through the place of work means higher overhead costs for small businesses. The effect of a play or pay scheme, such as that in S. 1227, thus would be to force employers or workers who cannot afford health insurance to buy it anyway (either privately or through the government), with money they must take from somewhere else.

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In other words, I believe the play or pay model is politically unstable, and likely will evolve into one of the polar alternatives I discussed at the beginning of my testimony. 3) Play or pay will require steadily tighter and more sweeping price and volume con- trols, leading to a system i n1distinguishable from a government-operated national health system. By legislating an arbitrary minimum benefit package that employers must provide, and an equally arbitrary tax they mulst pay if they fail to provide those benefits, the government would force firms that have kept their health care costs under the tax level to make up the difference or drop their coverage. Thus the system would punish--the fins that-have done the best job in con- trolling costs. Nor do I think that the cost control provisions contained in S. 1227 will prove effective. With- out digressing into a lengthy and -technical discussion of the likely effects of those provisions, I will simply observe that the present Medicare system has even more stringent price-setting au-' thority than that proposed in S. 1227 and yet it has not been able to control cost escalation. Thus I believe once again the health system envisioned in S. 1227 is inherently unstable and will evolve into something else, most probably a system more like the Canadian or British sys- tems. As limited.price-setting authority is found to be ineffective, the tendency will be for increasingly stronger price controls-and for steps to be taken to draw more aspects of the health system under government control, in order to avoid adverse selection against the govern- ment. 4) The "basie' benefits package will expand, raising the taxpayer cost of the public pro- gram and blunting current business-led efforts to control costs. Mandating any minimum benefit package on employers would result in enormous constitu- ency pressure on Congress to add more and more services under the mandated minimum benefit package, and to reduce its cost-sharing requirements on beneficiaries. This pressure would come from consumers desiring more "free" or "lower cosf ' services. Medicare offers a good example of this kind of behavior. When the program was created in 1965, the out-patient deductible was set at $50. It has been increased only three times since then to its present level of $ 100. Yet, had the deductible kept pace just with general inflation it would today be $220. 1 strongly doubt that the provisions in S. 1227 stipulating annual inflation adjust- ments in deductibles would last long under pressure from constituents to freeze or lower them. Pressure would also come from providers initially excluded from the system. Havin the gov- 9 ernment require people to buy your services is a great way to guarantee your income. There can be little doubt that Congress would also bow to this pressure. State legislators have already done so, enacting over 800 laws in the past fifteen years requiring insurers to cover specific providers or services-even when consumers expressed little or no interest in the benefits. The political and economic problem of state insurance mandates, which artificially increase the cost of insur- ance and medical care, would simply be transferred to the federal level. These pressures would combine to undermine the current efforts of businesses to hold down costs by negotiating with organized labor and by redesigning health packages. Organized labor, perhaps understandably, wo uld have the incentive to achieve increases in benefits through the po- litical process rather than at the bargaining table. And provider groups similarly would turn to the political process when they feel excessively squeezed by employers trying to curb costs. Some large businesses, with well paid workers and generous benefit plans, on the other hand view play or pay as a way to lower their own health care costs. Those businesses argue that their

health insurance costs are unnecessarily high because providers increase charges to their insured workers to cover the cost of providing free or low-priced care to the uninsured. They believe a play or pay system would -shift those costs -back to the employers who do not prqvide insurance. Eliminating current health care cost-shifting in which the cost of treating the uninsured is added to medical bills paid by the insured is not, contrary to the arguments of son@e large busi- nesses, a valid reason for adopting a play or pay system. If employers themselves paid for health insurance, there might be some justification to this argument. But they do not-employees pay for health insurance. Employee compensation equals cash wages, plus non-cash fringe benefits, plus payroll taxes paid by employers. Employees with tax-free employer-sponsored health bene- fits generally earn much more than workers without such benefits. Thus, despite the inefficiencies of a system in which those with employer-provided health benefitspross-subsidize those without such benefits, in reality it is a far more progressive "solution" than imposing an ad- ditional payroll tax on the uninsured, which would cut the cash wages of lower-paid workers. 5) Play or pay is regressive. While the current tax exclusion for employer-provided insurance is regressive, with the bene- fits accruing disproportionately to the more affluent, that regressivity is partly offset by the informal system of cross-subsidies which funds uncompensated cam for the low-income unin- sured, who receive no tax breaks on their medical care. Replacing those cross-subsidies with a new payroll tax on low-income workers, as S. 1227 would do, may be even more regressive since it would have the effect of reducing the compensation package for many workers and their fami- lies who now receive uncompensated care. I do not believe it is the intention of this committee or of Congress to fund America's health care system by taxing the poor. Yet, that is precisely what S. 1227 would do.

sessment of value of benefits. However, there is no inherent logic to an employer-based system or to a play or pay system of employer mandates. As Senator Mitchell noted, our present system is the product of historical accident and not de- sign. In light of the problems it has generated, Congress should avoid extending this system through a play or pay system. There is every reason to replace it with one or the other of the two fundamental systems I have described. I urge this committee and Congress to make that funda- mental and necessary choic6 now, rather than later.