Health Care and Tribalism

I wanted to touch on Brad DeLong’s post on health care that Dave Schuler pointed too a few days ago, but I was a bit busy at the time.

First off, I think DeLong, or more accurately his graduate student, is setting up two fallacies. First there is the either/or fallacy. Either you belong to this tribe, or you belong to that tribe. I don’t think this is really accurate in that I’m quite willing to buy into both “tribes” or more accurate explanations. I’m perfectly willing to accept that both moral hazard and adverse selection are problems. Basically, there is nothing that says these two issues are mutually exclusive. Further, I’m also willing to accept Dave Schuler’s “tribal” explanation that Gammon’s Law is at work (see here for more discussions on this by Dave Schuler, and also here for Milton Friedman). So this notion that you have to belong to a tribe is, in my view, simply not all that helpful.

This is why I think President Bush’s plan is so good. Now mind it isn’t great, and it does have its warts, but it would be a step in the right direction in regards to the probelms of moral hazard and adverse selection. With moral hazard, is that because so many Americans have pretty extensive health insurance they use it for lots of things that ideally they shouldn’t. Insurance markets usually develop for events that are both rare and costly. Think of auto insurance and collisions. These events are generally fairly rare for any given driver. Auto insurance covers the cost associated with a collision, but they don’t cover routine maintenance like oil changes or even large expenses like overhauling a transmission or something like that. Could the fact that we buy health care with dollars that have already been taxed be part of the explanation?

Why should the tax exempt statust of health care matter? I go through the nitty gritty details over here, but the bottomline is that Bush’s proposal creates an incentive not to go for the more extensive plans that cover things that should be covered such as lasik eye surgery, infertility treatments/testing, or even just standard doctor’s visits for minor illnesses. Basically, the tax exempt statust of health care benefits for many employees creates an incentive to “hide” income from taxation by getting that income in-kind. By changing the tax status from “all employer provided benefits are exempt” to “there is a deduction for health care benefits upto a certain limit anything over that limit is taxed” helps remove this perverse incentive.

The President’s plan also helps with adverse selection. In DeLong’s story the problem is relatively healthy people with few financial assets might see health insurance as a sucker’s game. If they get hurt they will still get treatment. If they can’t pay, there isn’t all that much that can happen to them. Sure you can file various claims against them and start collection proceedings and screw up their credit, but all that will do is make sure that they don’t aquire any financial assets for you to collect on. The tax deduction that President Bush is proposing will also make health care basically lowers the price of insurance to these people. Now the people in this catagory will have less incentive to skip buying health insurance. This will lead to more people purchasing insurance as anybody who is even slightly familiar with demand curves will tell you.

Now, the plan could be made better, in my view. I agree with Burman, Furman and Williams (and these guys are not conservative lap dogs) in making the tax deduction a tax credit with a sliding scale linked to income (i.e. as one’s income rises the tax credit declines). Also, there will likely be problems with some employers who are on the margin in supplying health insurance benefits who will drop this benefit. Transition costs/problems will have to be watched and if possible something will be done to minimize them. And the proposal wont solve all the problems and get 40 million or even 20 million people covered by health insurance. But it is at least a start and a sensible one.

The reason it is a start at addressing the problem is that I have been growing more and more convinced that Dave Schuler is right that Gammon’s Law is also at work here in the U.S. Gammon’s Law can be crudely, yet briefly, summarized as: bureaucratic aspects of provision of the good grow to absorb more and more of the spending leaving less and less for the actual provision of the good in question. Gammon himself called his theory, the theory of bureaucratic displacement. The article by Milton Friedman gives us this explanation,

In [Gammon’s] words, in “a bureaucratic system . . . increase in expenditure will be matched by fall in production. . . . Such systems will act rather like `black holes,’ in the economic universe, simultaneously sucking in resources, and shrinking in terms of `emitted production.'”

Think of the DMV. When I go in there I see a fraction of the people waiting on “customers” and many more doing paper pushing jobs. Friedman also points the public school system here in the U.S. How many school districts have bloated and expensive bureaucracies? And the evidence that Friedman and Schuler point too is pretty persuasive.

But we can see the solution here as well. The problem is too much bureaucracy, so the solution is less bureaucracy. To put it crudely, and in a way that will annoy some, we need health insurance more like car insurance. That is we want some government intervention with say mandates that people buy insurance. If you don’t buy insurance you face stiff penalties maybe even jail time. Further, the tax exempt status of health expenditures are eliminated. And I’d even be willing to go down the road of the government providing a voucher (possibly on a sliding scale linked to income and also possibly health status–and here people were worried about Bush looking at their library records!) for people to purchase health insurance. And the health insurance that everyone has to buy is essentially catastrophic health insurance. That is, it covers the big rare things, but for most people if you want additional coverage you are on your own. This would be a major shift in the way people think health care should be rationed. Many recoil at the notion of letting the price ration health care. But health care is like all other goods: the resources going into supplying health care are limited. As such there will have to be some kind of rationing mechanism, and if isn’t price it will be something else. Government rationing has a very poor track record. In fact, that is part of the problem. Gammon lives in England where the government controls health care. I’d be a bit surprised to find out if Gammon’s theory wasn’t at work in other countries like German, Canada, etc.

As for the other problem noted by DeLong, bad life-style choices, his prescription is rather disquieting. Not because I don’t want to see lectures on television by the Surgeon General (I don’t watch broadcast television save by DVD). My fear is that it wont end there…heck it wont even start there. My fear is that many politicians will automatically take it to the next level where things will simply be banned. We see it now. Smoking is becoming prohibited in more and more places. In Santa Monica you can’t even smoke outdoors anymore. There have been rumblings about transfats, school lunches and so forth. We already have the War on Drugs to help establish legal precedent, so a War on Fat, Sugar, Booze, etc. wouldn’t be all that hard. Eating a donut might not simply be an occasional pleasure, but something that could land you in serious trouble with the criminal-justice system.

“Do you know what kinds of costs you are imposing on your fellow citizens Mr. Verdon?”

“But it is only a maple bar your honor!”

Here’s a thought. Why don’t we simply reduce incomes. Obesity has become a problem only fairly recently. We’ll reduce incomes back to say the 1950’s levels and see if that does it. I wonder if DeLong would like this solution, after all his position strikes me as being rather utilitarian.

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Steve Verdon
About Steve Verdon
Steve has a B.A. in Economics from the University of California, Los Angeles and attended graduate school at The George Washington University, leaving school shortly before staring work on his dissertation when his first child was born. He works in the energy industry and prior to that worked at the Bureau of Labor Statistics in the Division of Price Index and Number Research. He joined the staff at OTB in November 2004.


  1. Dave Schuler says:

    One more amplification: government isn’t the only source of bureaucracy. Big companies including medical conglomerates have enormous bureaucracies, too, indeed, I think that once any organization reaches a certain size the development of a bureacracy is inevitable.

    So size matters as well as government involvement.

  2. Steve Verdon says:

    I agree Dave, but for you to make the case that private sector bureaucracy is a significant part of the problem I’d like to see evidence supporting Gammon’s Law without serious government intervention. For example, how about auto insurance? Is it at work there?

  3. Edgardo says:

    Indeed, as we teach in microeconomics, moral hazard and adverse selection are not mutually exclusive problems. DeLong, however, may be right that the debate about health care reform has led to two groups, each one emphasizing one of the two problems.

    Then you focus on moral hazard as if we were dealing with an insurance problem. With Arnold Kling I believe that the US current system is not an insurance scheme but what he calls “insulation” plan. Here in Chile we have a system that appears to be different from yours but it is also an “insulation” scheme: employees and retirees are required to contribute 7% of their income to fund a plan of their choice (there are several alternatives but the information is terrible so you never know ex ante what you have chosen). Each plan promises to pay for some “routine maintenance”, “emergency” and “collision” expenditures but actual payments are arbitrarily determined by the managers of regulated companies or the government agency. Thus, we are “insulated” but not “insured”. Actually, we can buy “additional” insurance to cover expenditures not paid by the official system, and this is really insurance because you never know what you are going to be paid. Therefore, the application of the concept of moral hazard to health care system in the US and Chile is misleading.

    Although I’m a research economist, my assessment of how the Chilean system works is based on my personal experience with the system.