1. Opinion

Curbing health care costs is key step toward budget solution

The Congressional Budget Office shows that there is a manageable path to a sustainable federal budget. With a return to normal growth and the expiration of the Bush tax cuts, currently scheduled for Dec. 31, the CBO projects that the ratio of debt to gross domestic product will level off at about 80 percent of GDP and remain so until about 2021. This projection, of course, also assumes no more unfunded wars, bailouts or recessions.

Beyond 2021, however, deficits are projected to rise substantially once again. Why? Health care costs.

With the huge exception of health care costs, all of the other components of government expenditure, including Social Security, are shown to be constant as a function of GDP. If we are to control the federal budget, we must get health care expenditures under control. This is the stated aim of the Paul Ryan/Ron Wyden plan.

Unfortunately, their plan achieves a balanced federal budget not by cost containment but by shifting costs to the elderly. The CBO estimates that total cost of providing health insurance to the elderly — costs paid by the elderly plus costs paid by the government — will rise 30 percent under their plan. While they address government's share of health-care costs, they make total health care costs worse.

The cost of an insured-against event is the main determinant of the size of the premium charged. For example, if the cost of car repairs is rising at 10 percent per year, then auto insurance premiums must also rise at 10 percent per year. Insurance premiums rise not because the insurers have become less efficient or less competitive, but because the cost of the insured-against event is itself rising. That cost must be passed through in the form of higher premiums.

While it may look as if Medicare and Medicaid are out of control, the reality is that health care resources are being drawn from the rest of the economy at an increasing rate. It is this shift of resources that is at the heart of the economic problem posed by excessive health care costs. This is true whether the insurance is private or public. The CBO warns that only through cost containment measures will we address the underlying costs of health care and the amount of resources that it requires as a fraction of GDP.

The question then turns to how best to insure against health care costs in ways that are compatible with cost containment. In an economic system that is primarily market driven, the usual presumption is that markets allocate resources better than government. But this is a "rebuttable" presumption; the rebuttal in the case of health insurance rests on whether the insurance can be provided more cheaply by government or by the private sector. Both on grounds of economic principle and on empirical grounds, the government seems to have the advantage.

Professor Kenneth Arrow, a Nobel Prize winner in economics, demonstrated that when the goal is universal coverage, the government can provide basic insurance for less. One reason is the enormous economies of scale in the bearing of risk. Another is the large amount of market power that the government brings to bear when purchasing pharmaceuticals and negotiating rates with health providers. The CBO estimates that these advantages yield a 30 percent cost advantage to the government over competitive private insurance companies which lack similar economies of scale and bargaining power.

Our choice is either to pay taxes for Medicare and Medicaid or, if smaller government is preferred, to pay insurance premiums 30 percent higher than those taxes would have been. The debate should focus on cost. If the CBO is correct, the government is the less expensive alternative.