Efficency or Rationing?

Managing the cost of health care is essential for covering the uninsured, which is in turn essential to solving the problem of emergency services failure. The cost of providing health insurance for the uninsured is not trivial, but it amounts to less federal money than is spent on any other single federal program or industry subsidy. Added to what is already spent on the uninsured by hospitals, doctors, the public, and the uninsured themselves, one estimate is that the US could cover them for $73-100 billion in 2004 dollars.(1) To put this figure in perspective, the US spent $2 trillion on health care in 2004; less than four percent of that would be sufficient to cover all of the uninsured. The cost is less than the federal portion of Medicare, of Medicaid, and less than half the tax subsidy for employer-based coverage. (2)(3)(4)

But using federal money to cover the uninsured is a fiscal time bomb if it is not combined with a serious effort to reduce health care costs. The current method of controlling health care spending by cutting prices in fee-for-service medicine is not effective.

The periodic reduction of payments by Medicare and private insurers without constraints on utilization has not controlled US health care costs. There are only two other ways to control health care spending: 1) price controls with rationing of resources (the method used in most industrialized countries) or 2) increased efficiency (not used in medicine in any country). The US has to choose one of the two because there will be no moderation of health care costs without reducing utilization. Most industrialized countries combine rationing of resources and price controls to manage cost. Even these countries are now faced with US-style health care cost escalation, though they their rate of health care growth is from a much lower unit cost than the US.

The definition of rationing is providing, a fixed amount of anything for a certain amount of time.(5) When applied to medicine, the word implies the limiting of needed services.

Rationing is risky business when no one can separate essential from superfluous services, because both kinds may be limited. Americans think that rationing is un-American, but American society does it all the time to the uninsured. I am not the only one who thinks that the insured are in for rationing, too, if another way of managing health care costs cannot be implemented in the US.

David Cutler, the Otto Eckstein Professor of Applied Economics at Harvard University, has studied the US health care system for his seventeen year career. He succinctly expressed the US consumer 's choices:

The issue of efficiency improvement is fundamental to any health care reform. Without explicit rationing, it is the only hope we have of saving money in medicine.(6)

Figure 1 shows that price cutting in fee-for-service medicine never controls health care costs for long. It graphs the annual escalation in private insurance spending for a period of forty-two years.

Figure 1 Annual Changes in Private per Capita National Health Spending with Federal Actions

Source: Trends and Indicators in the Changing Health Care Marketplace, Exhibit 1.4, Publication 7031. Health Care Marketplace Project, Kaiser Family Foundation, May 2005

The first decrease in private spending came with the creation of Medicare and Medicaid in1965 in Lyndon Johnson 's administration. Private health insurance spending fell because businesses no longer bore the full costs of their retirees ' health care. In 1971 Medicare and private insurance costs decreased when the Nixon administration applied price controls to the broad economy. Except for World War II this was the only time that economy-wide price controls were ever applied. The controls lasted until 1974 and the reduction in health care cost escalation lasted only that long. The hospital industry implemented The Voluntary Effort in 1979 to avoid National Health Planning during the Carter administration. The hospital industry dismantled its self-imposed spending constraints in the 1980s and health care inflation rapidly escalated.

The government 's next initiative came during the administration of President Bill Clinton and was an effort to implement federally-mandated use of managed care coupled with mandated insurance coverage of the entire US population. The Health Security Act was a creature of health care economists who estimated that health care costs could be reduced by thirty percent if they were managed. Of course, they were right, but the Health Security Act did not become law because of Republican opposition, political mismanagement, a fifty-million-dollar advertising campaign by the health insurance industry, physician opposition, business opposition, and public fear of a new, unresponsive federal bureaucracy managing their health care. Still, it had sweeping effects on the private insurance market by stimulating the rush to cut health care prices in the name of managed care. Health care prices were muted for only a few years, however.(7)

The graph of Medicare cost growth can almost be superimposed upon this graph of private health care cost growth. The principles are the same for both programs. The reason that price cutting does not work for long is that doctors just increase the volume of their services to maintain their incomes and also because new technology is continually developed, much of it insufficiently evaluated.

Price Cutting Increases Volume

Health economists calculate that a reduction in Medicare fees results in only fifty percent of the expected decrease in Medicare revenue to physicians. The reason is that doctors perform more procedures and choose more complicated procedures to make up for the lost revenue from the fee reductions.(8) The phenomenon even applies to major surgery. For example, reducing the fees for orthopedic surgery, thoracic surgery, and obstetrics/gynecology only yields twenty-five percent of the expected savings because surgeons perform more procedures in response.(9) Since price cutting in fee-for-service medicine does not work, our choices to manage health care cost are either efficiency or rationing.

1. Jack Hadley and John Holahan, “Covering the Uninsured How Much Would It Cost?”
   Health Affairs Web Exclusive, June 4, 2003.
2. Thomas M. Selden and Bradley M. Gray, “Tax Subsidies for Employment-Related Health
   Insurance: Estimates for 2006,” Health Affairs (November/December 2006): 1568-1579.
3.  “2006 Annual Report of the Boards of Trustees of the Federal Hospital Insurance and
   Federal Supplementary Medical Insurance Trust Funds.”
4. “National Health Expenditures by Type of Service and Source of Funds CY 1960-2005,”
   Centers for Medicare & Medicaid Services (CMS).
5. Webster’s Dictionary of American English, Ed. Gerard M. Dalgish (New York: Random
   House, 1997).
6. David M. Cutler, “Making Sense of Medical Technology,” Health Affairs Web Exclusive,
   February 7, 2006.
7. Peter P. Budetti, “10 Years beyond the Health Security Act Failure: Subsequent
   Developments and Persistent Problems,” JAMA 292, no. 16 (October 27, 2004): 2000-2006.
8. “Physician Volume and Intensity Response,” Memorandum, Centers for Medicare and
   Medicaid Services, August 13, 1998. Accessed online 2007:
   http://www.cms.hhs.gov/ActuarialStudies/downloads/PhysicianResponse.pdf
9. Stephen Zuckerman, Steven A. Norton, Diana Verilli, “Price Controls and Medicare
   Spending: Assessing the Volume Offset Assumption,” Medical Care Research and Review 55,
   no.4 (December 1998): 457-478.