With the Supreme Court close to a decision on the Affordable Care Act, it’s worthwhile to explore the economic problems with the bill. One potential outcome is the court will strike down the individual mandate requiring Americans to purchase health insurance but leave the rest of the bill intact. That might be a minor victory for opponents of health care reform, but one consequence would be that supporters of the law could try to use it as a scapegoat for health care reform’s eventual failure to work. Yet the reason the overhaul ultimately will fail will have little to do with the mandate or lack thereof and a lot to do with its most politically popular attributes regarding pre-existing conditions and price discrimination.
Insurance, at its most basic level, is a product meant to help people stabilize their cash outflows. Health care costs are lumpy by their nature. Over a 10-year period, an American may have eight years with about $1,000 in health care expenses and two years with $10,000 in expenses. If you average it out, our hypothetical American has an average yearly expense of $2,800, but those two lumpy $10,000 years end up being problematic. It’s easier to pay $2,800 per year than to try to pay $10,000 at once. This is why we have insurance.
The Medicare system distorts this traditional relationship, and the Obama health care overhaul makes it even worse. The law attempts to redefine insurance so that instead of being a product to stabilize our cash flows, it becomes a redistributionary welfare system. If you consume little health care, your tax monies are redistributed to someone who will use much more health care. The theory behind this is that we’ll consume less when we’re younger and more when we’re older and everything will even out in the end.
Unfortunately, it’s more complicated in reality. For one, younger people have difficulty paying the burden for older people. The problem is that younger adults generally don’t earn that much. The prime income-earning years for most Americans come during middle age and prior to retirement - the 40s, 50s and 60s - not the 20s. While older Americans have higher health care expenses, they also typically have more resources to pay for those expenses.
The other problem, and perhaps the even bigger issue, is that when everyone is forced to pay the average health care cost regardless of consumption, the incentive then becomes to consume as much as possible. If you examine the U.S. health care system, this appears to be our biggest issue since the advent of Medicare. We consume much more health care than the rest of the developed world, yet we don’t appear to achieve noticeably superior results. This suggests that we are simply wasting a lot of resources that might not be expended if we were all held a bit more accountable on our health care consumption.
While the individual mandate is a gross invasion of liberty, it’s very weak from an economic standpoint. The $695 tax an individual would incur for not buying health insurance is roughly 2.3 percent of the gross income for an American earning $30,000 per year. It seems high until you consider the alternative option of purchasing insurance under the new law. The average health care insurance cost is more than $8,000 per person in the United States. Yet a typical young, healthy adult might average less than $1,000 in health care costs each year. That’s a rather wide discrepancy. If you are scraping by on $30,000 per year, would you rather pay the $695 tax, plus your $1,000 in health care expenses, or would you rather pay $8,000 per year? Certainly, many Americans are willing to pay some price for stability, but the price for that luxury is becoming very steep.
Adding more fuel to the fire: Because the overhaul tries to eliminate pricing differences, it’s likely that those who buy in will be the heaviest consumers, while those who opt out will be the lightest users. This will cause the systemwide costs to soar, resulting in higher premiums.
Mandate or no mandate, the health care overhaul will fail because it distorts incentives and encourages Americans to overconsume. Meanwhile, if insurers are prevented from serving their traditional function, many consumers will simply decide to abstain from buying in. The mandate and the $695 tax could not conceivably fix these issues.
Jake Huneycutt is an investment manager in Atlanta.