Bending the cost curve in the wrong direction

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President Obama repeatedly promises that his version of health-care reform will “bend the cost curve,” saving money for patients and taxpayers. The problem is, most provisions in the health-care bills would bend that curve the wrong way. The cost of individual health-care services, premiums and total health care spending would grow faster, not slower.

No one disputes that health-care spending is rising rapidly. In 2008, total health-care spending in the United States was $2.34 trillion, or 16.2 percent of GDP, up 4.4 percent from the previous year. The Congressional Budget Office forecasts that if present trends continue, health care spending would account for 25 percent of GDP by 2025 and continue climbing rapidly.

Commonly proposed explanations include unhealthy lifestyles, expensive new health-care technologies, wasteful spending in part due to worries about malpractice lawsuits, and a third-party payment system that insulate decision-makers from costs.

All of these factors contribute to the problem. Today’s health-care system is fraught with perverse incentives that generate artificially increased spending. But nothing in the House- and Senate-passed health bills, or in the president’s plan, would reduce these incentives. And some provisions would make them worse.

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In most fields, such as computers and cell phones, new technology usually increases quality and reduces prices. Health care prices, though, often go the opposite way. Not always; drug prices drop when generics replace brand-name drugs, and expensive drugs sometimes replace even-more-expensive surgical interventions. But often, new health technologies increase prices. Why? Health-care prices are determined by a bureaucratic process that prevents competition from driving prices down.

Once Medicare or an insurer approves a new medical device (or device-based procedure like MRI), the manufacturer has little incentive ever to reduce prices – even when its manufacturing costs go down. And unlike goods sold in “normal” markets, the next model will come at a higher, rather than a lower price, since the improvements can be used to “justify” a higher price.

Some blame the increased spending on frivolous malpractice lawsuits and excessive malpractice insurance premiums. The direct cost of malpractice amounts to less than 2 percent of total health-care spending, according to the CBO. (It is higher for certain specialties and certain states.) The much larger problem is the tendency of physicians to prescribe additional tests and treatments out of the belief that they will forestall lawsuits. A study by PricewaterhouseCoopers estimated that this “defensive medicine” accounts for 10 percent of total health-care spending.

These factors are exacerbated by a payment system that makes the physician and patient insulated from – even unaware of – the costs of various treatment options. Often, the patient pays the same regardless of which treatment is chosen, with any difference passed along to the insurance company, Medicare or Medicaid. One might think that these “third-party” payers have an incentive to ensure that resources are used efficiently, but ultimately they don’t pay the price either: Insurers pass on increased spending to patients (and their co-workers) through increased premiums. Government programs, meanwhile, pass spending increases along to taxpayers.

When Medicare was created in 1965, patients paid 52 percent of health-care expenditures out of pocket, on average. This fell to only 15 percent by 2005. As third-party payer spending has risen as a percentage, so has total spending on health care; since 1965, inflation-adjusted per capita expenditures have increased approximately sixfold. This is no coincidence. Both the Senate and House bills, and the president’s plan, contain provisions that would magnify this problem. They would force private insurance premiums to increase by putting strict limits on all patient “out-of-pocket” payments except premiums. They would even require insurance companies to give rebates if they don’t spend “enough” on health care, and prohibit premiums based on lifestyles or health status.

The plans would transfer millions into Medicaid, which encourages the use of expensive emergency rooms by underpaying primary care physicians and prohibiting even nominal payments by patients. In addition, the plans impose new taxes on medical devices, prescription drugs, and health insurance itself. These taxes would be passed on to patients through higher prices and higher premiums. The president’s plan includes a 40 percent excise tax on high-premium plans, which would bend the premium cost curve upward unless benefit packages for those plans are cut. Indeed, the extra taxes and other regulations might make those cuts impossible.

The House- and Senate-passed bills, and the president’s plan, would make the health care system even more inefficient and costly. They would saddle an already burdened system with more mandates, higher taxes and less flexibility. They would indeed bend the curve – but upward, not downward.

Jason D. Fodeman is a former health policy fellow in the Center for Health Policy Studies at The Heritage Foundation. Robert A. Book is a senior research fellow in Heritage’s Center for Data Analysis.

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