In March 2009, President Barack Obama said,“If there is a way of getting this done where we’redriving down costs and people are getting healthinsurance at an affordable rate, and have choiceof doctor, have flexibility in terms of their plans,and we could do that entirely through the mar-ket, I’d be happy to do it that way.” This paperexplains how letting workers control their healthcare dollars and tearing down regulatory barriersto competition would control costs, expandchoice, improve health care quality, and makehealth coverage more secure.First, Congress should give Medicare enrolleesa voucher and the freedom to choose any healthplan on the market. Vouchers would be means-tested, would contain Medicare spending, and arethe only way to protect seniors from governmentrationing.Second, to give workers control over their healthcare dollars, Congress should reform the tax treat-ment of health care with “large” health savingsaccounts. Large HSAs would reduce the number of uninsured Americans, would free workers to pur-chase secure health coverage from any source, andwould effectively give workers a $9.7 trillion tax cutwithout increasing the federal budget deficit.Third, Congress should break up state monop-olies on insurance and clinician licensing. Allow-ing consumers to purchase health insurancelicensed by other states could cover one-third of the uninsured without any new taxes or govern-ment subsidies.Finally, Congress should reform Medicaid andthe State Children’s Health Insurance Programthe way it reformed welfare in 1996. Block-grant-ing those programs would reduce the deficit andencourage states to target resources to the truly needy.The great advantage of a free market is thatinnovation and more prudent decisionmakingmeans that fewer patients will fall through thecracks.

Yes, Mr. President

A Free Market Can Fix Health Care

by Michael F. Cannon

_____________________________________________________________________________________________________

Michael F. Cannon is director of health policy studies at the Cato Institute and coauthor of

Healthy Competition:What’s Holding Back Health Care and How to Free It

Executive Summary

No. 650October 21, 2009

Introduction

In March 2009, at the outset of his effort tooverhaul America’s health care sector, Presi-dent Barack Obama told a White House sum-mit:If there is a way of getting this donewhere we’re driving down costs and peo-ple are getting health insurance at anaffordable rate, and have choice of doc-tor, have flexibility in terms of theirplans, and we could do that entirely through the market, I’d be happy to do itthat way.

This paper explains how a free market can andwould control costs, expand choice, improvehealth care quality, and make health coveragemore secure. The key steps that would move America toward a free health care market areMedicare, tax, and regulatory reforms thatgive consumers control over their health caredollars and free them to choose from a wide variety of providers and health plans. At present, America’s health care sector isfar from a free market. Government directly controls nearly half of all health care spend-ing, and indirectly controls most of theremainder.

Government controls more thanhalf of the nation’s health

insurance

dollars(through Medicare, Medicaid, and other pub-lic programs), and delegates control overanother third to employers through the pref-erential tax treatment granted to employer-sponsored health insurance.

The federalgovernment imposes an average tax penalty of more than 40 percent on the one marketthat offers a wide range of health plans andseamless coverage between jobs: the “individ-ual” market, where consumers purchase cov-erage directly from insurers. (Indeed, that taxpenalty may explain much public dissatisfac-tion with the individual market.

) More thanhalf of U.S. health care spending takes placeunder government price and exchange con-trols. As President Obama’s economic advis-er Larry Summers reminds us, “Price andexchange controls inevitably create harmfuleconomic distortions. Both the distortionsand the economic damage get worse withtime.”

That is to say nothing of the countlesscounterproductive regulations that govern-ment imposes on clinicians, insurance, med-ical products, and health care facilities.

As health economist Victor Fuchs ex-plains, most leading health care reforms “aimat cost shifting rather than cost reduction.”

Whereas the legislation that President Obama is shepherding through Congress attempts tocover the uninsured by pouring more re-sources into health care, a free market wouldget more out of America’s health care sector.Letting Americans control their health caredollars and breaking up the states’ monopo-lies on insurance and clinician licensing (with“regulatory federalism”) would put access tohealth care within reach of millions of Americans by putting downward pressure onhealth care prices and health insurance pre-miums. Those reforms would also dramati-cally improve quality by allowing varioushealth plans, with various payment systemsand delivery systems, to compete on a levelplaying field.

Controlling Costs

Health care spending is growing unsus-tainably. Over the past 30 years, health carespending has grown more than 2 percentagepoints faster than the economy overall,

andnow stands at 18 percent of GDP.

That would not be a problem if we weregetting our money’s worth. The most credi-ble estimates, however, suggest an alarmingone-third of health care spending does noth-ing to make patients healthier or happier.

In 2009, Americans will waste more than$800 billion—about 6 percent of U.S. GDP—on medical care that provides zero benefit topatients. Americans will waste additional bil-lions on services whose benefits are notworth the cost. That wasteful spending re-sults in higher taxes, higher health insurancepremiums, and more uninsured Americans.

WhereasPresident Obamaattempts to pourmore resourcesinto health care,a free marketwould get moreout of America’shealth care sector.

Government Failure

Government is largely incapable of elimi-nating wasteful health care spending, becausenobody spends other people’s money as care-fully as they spend their own. Government taxand entitlement policy denies patients owner-ship of their health care dollars, and thereby strips them of any incentive to control costs.Due to federal tax policy, for example, Stan-ford University health economist Alain En-thoven estimates that “less than 5 percent of the insured workforce can both choose a health plan and reap the full savings fromchoosing economically.”

Indeed, consumersresist efforts to eliminate wasteful spending,and with good reason. Since they are enjoyinghealth insurance that is effectively purchasedwith other people’s money, consumers receiveno direct financial benefit from eliminatingwasteful spending, whether through cost-shar-ing or care management. When Medicare triesto eliminate coverage of low-value services or toreduce excessive provider payments, seniorsexperience nothing but pain. Workers perceiveincreased cost-sharing or managed-care con-trols as cuts in their compensation. Eventhough these steps should ultimately lead tohigher wages and lower taxes, those benefitsare not salient to seniors and workers.

That lack of cost-consciousness createswhat author David Goldhill describes as “anaccidental collusion between providers bene-fiting from higher costs and patients whodon’t fully bear them.”

Former SenateMajority Leader Tom Daschle writes that thisresults in a politically powerful “patient-provider pincer movement” that blocks effortsto reduce wasteful spending.

The patient-provider pincer movement prevents Medicarefrom considering cost-effectiveness whendeciding whether to cover particular services;repeatedly eliminates funding for federalagencies that conduct comparative-effective-ness research;

preserves excessive Medicarepayments for specialists, insurers, and proce-dures; blocks competitive bidding for durablemedical equipment in Medicare; has made a joke out of the scheduled “sustainable-growth-rate” cuts to Medicare physician pay-ments; and even curtails private-sector effortsto eliminate wasteful spending with managed-care controls.The end result is that both government-and employer-sponsored insurance wastemoney in ways that consumers spending theirown money never would. If the health reformlegislation currently before Congress becomeslaw, politicians and employers will continue tocontrol Americans’ health care dollars, andthis government failure will persist.

The Free-Market Alternative

A free market, in contrast, would eliminatewasteful health care spending. Individualswould control their own health care dollarsand would therefore benefit directly fromreducing waste. A less-regulated market wouldalso free Americans to choose from a wide variety of health plans and providers.When consumers own and control theirhealth care dollars—in particular, the money that purchases their health insurance—the self-interest of hundreds of millions of Americanswill lead them to choose health plans thateliminate wasteful spending, whether throughcost-sharing or care management, in exchangefor lower premiums. Peter Orszag, PresidentObama’s director of the Office of Managementand Budget, testified before Congress on thepromise of individual ownership:Workers may demand less efficiency from the health system than they would if they knew the full cost thatthey pay via forgone wages for coverageor if they knew the actual cost of theservices being provided.

[I]magine what the world would belike if workers [understood] that today it was costing them $10,000 a year intake-home pay for their employer-spon-sored insurance, and that could be$7,000 and they could have $3,000more in their pockets today if we couldrelieve these inefficiencies out of thehealth system. Making those costs more

Government islargely incapableof eliminatingwasteful healthcare spending,because nobody spends otherpeople’s money as carefully asthey spendtheir own.