Wilson H. Taylor Scholar Joseph Antos

The presidential campaign has helped crystallize the discontent that many Americans have with our health system. It appears that most people are willing to consider significant health system reforms. However, we should be wary of grandiose campaign rhetoric: the next president will have less maneuvering room than he or she might now claim. Instead of sweeping changes, we are likely to see more modest, but in some ways more meaningful, policies that can form the basis for real improvements in American health care.

An Ailing System

The problems of the US health system are well known. Our health costs are the highest in the world, exceeding $2 trillion annually or 16% of the economy. Despite that enormous expenditure, 47 million Americans are uninsured and there are growing concerns about the quality of care. These issues have steadily worsened. Between 2000 and 2006, national health spending rose 33% while gross domestic product grew 15%. Over the same period, the uninsured population grew 22%.

Some activists argue that universal coverage is a prerequisite to reform. While that stance may energize the Democrats' political base, it confuses cause and effect. Rising cost drives up insurance premiums, putting health insurance out of the reach of more families. Without solving the cost problem, we will not be able to solve the uninsured problem.

Third Party Payment and the Tax Code

More of US health spending is covered by insurance than in other developed countries. Americans pay only 13% of the cost of care directly out-of-pocket, while the Organization for Economic Cooperation and Development average is 20%. Third parties (private insurers or public programs) pay the rest. Consequently, patients are little aware of the full cost of health care, and act accordingly. Lack of cost consciousness encourages the greater use of health services (including services offering little value to the patient), and the virtual certainty of payment through private and public insurers ensures that health care providers will prescribe those services.

Generous tax subsidies have given a strong boost to the private insurance market over the past 6 decades. Employers' premium contributions are excluded from employees' taxable income; in this way, $1 of health benefits is worth more than $1 of wages. This tax break is not available to those who purchase health insurance in the individual market. In 2006, 177 million people--70% of the insured--purchased coverage through an employer, with the tax subsidy exceeding $200 billion.

Although the tax exclusion promotes insurance coverage, it has had a perverse impact on the health system in other ways. The exclusion:

• Promotes regression, providing a larger subsidy to people with higher incomes.
• Creates discrimination, providing different subsidies (depending on where health insurance is purchased) to people who have the same incomes, health needs, and other circumstances.
• Promotes cost growth, by encouraging the purchase of generous coverage that pays for nearly the entire cost of care.
• Increases the uninsured, by increasing the cost of care and the cost of insurance.
• Limits choice of insurance, because the employer (not the worker) decides what types of policies are offered.
• Creates job lock, causing workers to remain in jobs for fear of losing coverage.

Reform and the Election

Despite well-publicized differences, Democratic Senators Hillary Clinton and Barack Obama offer similar reform plans. They stand for universal coverage backed by mandates, subsidies, Medicaid expansion, and regulations on private insurers. They would give people access to a purchasing arrangement similar to the Federal Employees Health Benefits Program and create a new public sector insurance plan.

The Republican approach to health reform is less interventionist. Senator John McCain argues for universal access to insurance, but rejects a mandate on individuals to buy coverage. He emphasizes greater competition, improved financial incentives, more informed individual decision-making, and a focus on the sickest patients who use the most care. He would revamp the tax code to make it more equitable and more efficient.

Democrats view health care as a social responsibility, and their policies would strengthen the role of government. Republicans view health care as an individual responsibility, and their policies would free up market forces.

Would Mandates Work?

The Massachusetts health reform provides insight into the effect of an individual insurance mandate. Under the reform, every resident of the state is required to have coverage, subject to a penalty up to $912 in 2008. Lower income people are eligible for state subsidies. The state-run Connector Board provides residents one-stop insurance shopping.

By some measures, the program has been successful. Enrollment in subsidized coverage has been stronger than expected. As a result, the program has a $150 million deficit this year. However, enrollment in unsubsidized coverage has lagged, and the state exempted 60,000 people from the mandate because they would not be able to afford the premiums.

Massachusetts' reform has raised awareness among state residents about the need to have health coverage. The mandate led some people to buy insurance coverage who otherwise would not, but other factors (including widespread publicity, the new subsidies, and the availability of alternative insurance packages through the Connector) also encouraged enrollment. Penalties for noncompliance were not enforced in 2007, but it is clear that enforcement will be difficult. A lower income person who is not eligible for a subsidy may find that the penalty is less costly than the insurance premium, and probably would receive at least emergency care from safety net providers.

The mandate by itself does nothing to lower the cost of health care. Total health spending is likely to rise if the newly insured have better access to services without improving the efficiency and effectiveness of the delivery system. The mandate also cannot improve the quality and appropriateness of health care. Other reforms are needed to address those issues.

Would Tax Changes Work?

Senator McCain proposes to replace the current tax exclusion with a refundable tax credit worth $2500 for an individual and $5000 for a family. That credit would be available to everyone, whether they purchased insurance through an employer or on the individual market. This would reduce the tax subsidy for high-income people and those who purchase very expensive insurance while increasing the subsidy for low-income individuals and those who do not have access to employer coverage.

The credit would be the same amount whether someone purchases high-cost or low-cost health insurance. Consequently, the decision about how much coverage to purchase would not be biased as it is under the current tax incentive, which favors high-cost policies. Under the proposed credit, anyone wishing to buy additional coverage could do so, paying the full additional premium themselves without help from taxpayers.

Rather than being locked into high-cost insurance, many individuals likely would buy plans with lower premiums and higher cost-sharing. Republicans argue that this would increase consumer cost awareness and put pressure on the health system to find more efficient ways of delivering care.

However, sizeable subsidies would be necessary to encourage most of the uninsured to buy coverage. A fixed tax subsidy would disadvantage higher-need patients facing higher premiums for a given package of insurance benefits, or low-income people not eligible for Medicaid. Risk-adjusting the credit may help resolve this problem, along with additional state subsidies for such individuals.

Reshaping the Health Sector

The Democratic and Republican presidential candidates would push the health sector in different directions. As reformed by Democrats, the health sector would gradually shift from private to public insurance. As reformed by Republicans, the health system would gradually shift toward individually purchased coverage and a wider array of choices in the employer market.

The Democrats' proposals build on the existing private-public system but impose new regulations that would deter private insurers and discourage employer coverage. Guaranteed issue and community rating would increase coverage for those who have high health needs, but rising premiums would discourage healthier people from buying coverage. Despite the individual mandate, many would likely see their premiums increase. Employers would reduce their financial risks by encouraging workers to enroll in the "Medicare-like" plan run by the government, likely resulting in a shift over time to a fully federalized system.

The Republican proposals would promote more competition and individual ownership of insurance. The tax credit would be available to everyone, causing some migration out of employer-sponsored coverage. Insurers would be allowed to sell plans in any state, and churches, clubs, and other groups could also sponsor insurance. Employers who use insurance to recruit and retain workers would continue to offer coverage.

What Will the Next President Do?

No "big bang" health reform is in our immediate future. The next president will face a deteriorating economy and tight budget, leaving little room for system-wide health reform. The public and the health industry are averse to the disruption of major reform. A more deliberative reform process will be pursued, with targeted investment in knowledge, delivery system improvements (including health information technology, better care management, and smarter purchasing by public and private plans), and modest expansion of federal subsidies to improve access to care.

Joseph Antos is the Wilson H. Taylor Scholar in Health Care and Retirement Policy at AEI.