Amitabh Chandra on Health Care Reform: An Economic Perspective

November 20, 2008

Testimony by Amitabh Chandra to the United States Senate Finance Committee, Hearing on Health Care Reform: An Economic Perspective

November 19th, 2008

Chairman Baucus, Senator Grassley, and members of the Committee, thank you for inviting me to Washington to testify.

My first point this morning is to note that cost-growth in healthcare has reduced wages, and increased the numbers of the uninsured. My second point is that the Medicare program encourages the adoption of new medical technologies, some of dubious marginal value. It also rewards the full utilization of existing capacity. Yet, because physicians treat their over 65 and
under 65 patients similarly, Medicare’s incentives encourage the intensive treatment of the under 65 which raises their premiums. My third goal is to elaborate on reform options.

Let me start by discussing the effects of cost-growth in healthcare on labor markets. Despite what is commonly believed, workers who receive health insurance benefits are paying for them in the form of lower wages, and consequently, have less money for gasoline, food, and holiday presents. Recognizing this tradeoff, some workers decline health insurance.

But firms have limited ability to offset increases in the price of health insurance through lower wages. They certainly can’t do it for workers who’re retired. For employees whose compensation cannot be reduced, firms will reduce employment or move workers into part-time jobs without health benefits. Dr. Katherine Baicker and I estimate that a 20% increase in premiums (which is a third of what they have grown since 2000) results in an employment loss of 3.5 million workers, with another 3-4 million moving from full-time to part time jobs without health insurance. Firms may also respond by avoiding areas of the United States where there is large cost growth. For workers in these areas, there will be no jobs and no health insurance.

Because of our peculiar choice of tying health benefits to employment, Americans lose insurance when they lose their jobs. Some respond by being more reluctant to switch jobs because they don’t want to lose their insurance and be exposed to the threat of medical bankruptcy. But such switching is key to revitalizing our economy, as workers should leave failing firms and move to more exciting opportunities.

All this said, there is no reason to believe that simply because something is expensive it’s not worth it. But we now know that 30 percent of medical spending in the United States confers no medical or therapeutic benefit. The United States spends over 2.1 trillion dollars a year on healthcare and 30 percent of that is 700 billion dollars annually—a number that has particular significance today. It is surely possible to offer more affordable health insurance policies that don’t cover this 30 percent of wasteful spending. So what can we do?

In the short run, Congress may consider increasing the portability of insurance, and the expansion of existing programs. These will be costly. Permanent largescale insurance expansions will increase provider’s incentives to expand capacity, which will then be fully utilized in all Americans, driving up their premiums further. Expansions will also encourage some employers to drop coverage, thereby increasing costs and reducing benefits of this policy.

Permanent expansions will also weaken the Federal budget situation.

Reforming the individual health insurance market through regulatory reform is another coverage option, and one that will eventually pave the way for the delicate task of decoupling insurance from employment. At present, insurers have an incentive to shed their sickest enrollees. Nor are insurers held responsible when inadequate coverage raises the costs for a future insurer, such as Medicare. The problem of geographic variation in how medicine is practiced will mean that premiums in Hanover, New Hampshire will be substantially higher than those in McAllen, Texas. Simply deregulating insurance markets does nothing to address these concerns.

We should also acknowledge that efforts to insure the uninsured will not check subsequent premium growth. Moreover, insuring the uninsured will give them access to the sort of health care that everyone else receives, which is a combination of valuable care, the overuse of costly care with little proven benefit, and underuse of some vitally important therapies. It is not fundamental reform.

More challenging to achieve, but also more fundamental, is to address the source of uninsurance, which is cost growth in healthcare. This is not a uniquely American phenomenon, but Medicare’s perverse incentives aggravate this situation by encouraging the adoption of innovations that are beneficial in some patients, but offer great scope for overuse in others. Physicians do not practice medicine in a vacuum—because of malpractice and practice norms, how they treat Medicare patients, is how they treat non-Medicare patients. But these spillovers can also be leveraged to engineer reform. Medicare reforms that promote value-based reimbursement will affect everyone, thereby extending the reach of both public and private dollars. Private insurers will be able to offer more affordable policies if they know that they don’t have to cover the 30 percent of useless spending that Medicare currently covers. Indeed, cost savings from Medicare reform could be used to finance other health reform efforts.

How exactly to reform Medicare is a topic for another hearing, but I have many ideas that I would be delighted to share with you. The key to reform is the realization that we must measure all costs, and not only costs at the level of discrete episodes of illness. We must reimburse for value, and ensure that the care that patients receive is congruent with their preferences. The Accountable Care Organizations championed by the Dartmouth Institute offer the greatest promise. But they need to be rigorously tested.

In summary, reforming the individual insurance market, followed by decoupling insurance from employment, and addressing cost-growth in healthcare will increase wage growth and consumption, reduce uninsurance and unemployment, and encourage voluntary turnover. It will prevent Medicare from taking over the entire Federal budget. And it will have the bonus effect of improving the nation’s health. There is no better time to initiate such reform.

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