Monday, March 05, 2012

A Classic Milton Friedman Essay on Health Care

From a classic 2001 article by Milton Friedman, "How to Cure Health Care":

"Two simple observations explain both the high level of spending on medical care and the dissatisfaction with that spending. The first is that most payments to physicians or hospitals or other caregivers for medical care are made not by the patient but by a third party—an insurance company or employer or governmental body. The second is that nobody spends somebody else’s money as wisely or as frugally as he spends his own.

No third party is involved when we shop at a supermarket. We pay the supermarket clerk directly: the same for gasoline for our car, clothes for our back, and so on down the line. Why, by contrast, are most medical payments made by third parties? The answer for the United States begins with the fact that medical care expenditures are exempt from the income tax if, and only if, medical care is provided by the employer. If an employee pays directly for medical care, the expenditure comes out of the employee’s after-tax income. If the employer pays for the employee’s medical care, the expenditure is treated as a tax-deductible expense for the employer and is not included as part of the employee’s income subject to income tax. That strong incentive explains why most consumers get their medical care through their employers or their spouses’ or their parents’ employer.

We have become so accustomed to employer-provided medical care that we regard it as part of the natural order. Yet it is thoroughly illogical. Why single out medical care? Food is more essential to life than medical care. Why not exempt the cost of food from taxes if provided by the employer? Why not return to the much-reviled company store when workers were in effect paid in kind rather than in cash?

The revival of the company store for medicine has less to do with logic than pure chance. It is a wonderful example of how one bad government policy leads to another. During World War II, the government financed much wartime spending by printing money while, at the same time, imposing wage and price controls. The resulting repressed inflation produced shortages of many goods and services, including labor. Firms competing to acquire labor at government-controlled wages started to offer medical care as a fringe benefit. That benefit proved particularly attractive to workers and spread rapidly.

Initially, employers did not report the value of the fringe benefit to the IRS as part of their workers’ wages. It took some time before the IRS realized what was going on. When it did, it issued regulations requiring employers to include the value of medical care as part of reported employees’ wages. By this time, workers had become accustomed to the tax exemption of that particular fringe benefit and made a big fuss. Congress responded by legislating that medical care provided by employers should be tax-exempt.

The tax exemption of employer-provided medical care has two different effects, both of which raise health costs. First, it leads employees to rely on their employer, rather than themselves, to make arrangements for medical care. Yet employees are likely to do a better job of monitoring medical care providers—because it is in their own interest—than is the employer or the insurance company or companies designated by the employer. Second, it leads employees to take a larger fraction of their total remuneration in the form of medical care than they would if spending on medical care had the same tax status as other expenditures.

Employer financing of medical care has also caused the term insurance to acquire a rather different meaning in medicine than in most other contexts. We generally rely on insurance to protect us against events that are highly unlikely to occur but that involve large losses if they do occur—major catastrophes, not minor, regularly recurring expenses. We insure our houses against loss from fire, not against the cost of having to cut the lawn. We insure our cars against liability to others or major damage, not against having to pay for gasoline. Yet in medicine, it has become common to rely on insurance to pay for regular medical examinations and often for prescriptions.

If the tax exemption for employer-provided medical care and Medicare and Medicaid had never been enacted, the insurance market for medical care would probably have developed as other insurance markets have. The typical form of medical insurance would have been catastrophic insurance (i.e., insurance with a very high deductible)."

HT: W.E. Heasley

23 Comments:

At 3/05/2012 10:16 PM, Blogger ws4whgfb said...

Why single out medical care? Food is more essential to life than medical care. Why not exempt the cost of food from taxes if provided by the employer?

Because the way insurance works they give a discount if you are part of a large group. It spreads the risk making the cost per person less. It is natural for one company to put all its employees in a group so they can all get insurance at a reduced cost than if they bought insurance as individuals.

 
At 3/05/2012 10:19 PM, Blogger ws4whgfb said...

Why single out medical care? Food is more essential to life than medical care. Why not exempt the cost of food from taxes if provided by the employer?

It's a way of forcing healthy young people to pay for insurance they might not otherwise purchase individually, so you can insure sick older people at a reduced cost?

 
At 3/05/2012 10:20 PM, Blogger Mark J. Perry said...

Why don't employers then provide car insurance and homeowner's insurance for their employees? And food, clothing, electronics, autos, etc. all at group discounts?

 
At 3/05/2012 11:08 PM, Blogger Ron H. said...

ws4whgfb: "It's a way of forcing healthy young people to pay for insurance they might not otherwise purchase individually, so you can insure sick older people at a reduced cost?"

Do you believe young people should be forced to subsidize older sick people?

 
At 3/06/2012 12:22 AM, Blogger Seth said...

ws4whgfb - Re: Your second statement -- Prior to Obamacare, employers did not force their employees to purchase health insurance, at least none of my employers did. So, that's not it.

Re: Your first statement - Why wouldn't you expect other groups to emerge to go after such discounts? What's so special about work groups? Why wouldn't church groups emerge to buy group health plans, or just about any other human association.

 
At 3/06/2012 6:17 AM, Blogger Larry G said...

both the GOP and the Dems have, at various times suggested that employer-provided health insurance be taxed as compensation and that people have choice as to where they buy their insurance (or not).

In terms of subsidizing sick old people - there are also a good number of sick young people and you're caught in a conundrum in most industrialized countries including the US where the majority of people in elective representative govt will not let people without insurance die without medical care.

If insurance became less and less purchased but the govt (a majority of taxpayers) would not let sick people die, wouldn't that invetiably drive the system to a de-factor single payer system?

 
At 3/06/2012 7:26 AM, Blogger geoih said...

Quote from Larry G: "If insurance became less and less purchased but the govt (a majority of taxpayers) would not let sick people die,"

The question is would YOU let them die? Rather than worrying so much about what other people would do, and trying to spend their money on things you think are important, what would you do with your money?

If helping others is such a great idea and so important to 'society', then I would expect there will be plenty of giving people like yourself to provide for the less fortunate. If you think that will only happen if people are forced at the point of a gun, then you have a very low opinion of other people indeed, and are sadly mistaken if you think doing so makes for a better 'society'.

 
At 3/06/2012 7:58 AM, Blogger Larry G said...

" If helping others is such a great idea and so important to 'society', then I would expect there will be plenty of giving people like yourself to provide for the less fortunate"

but you would "expect" wrong for the majority of voters in this country.

they believe in:

1. - all taxpayers helping to not let people die from a lack of health care

2. - individual mandates like payroll taxes and mandatory insurance (like auto insurance) to be financially responsible for their needs.

and we are not the only country.

we are but one of every single industrialized country in the world, where their citizens have also support that concept.

I'm not disagreeing with the premise. I'm pointing out that there are no real world examples of it except in 3rd world countries.

 
At 3/06/2012 8:49 AM, Blogger Aiken_Bob said...

The point of the old essays was how we got into this mess we call 'medical insurance'. If we know how we got there then maybe we can find a way out of the problem. The key is that we got into this problem because companies had to get around a stupid (in hindsight for most) policy. One way to solve it is to simply undo what was done in the 1940's, make company medical expenses part of an individual pay. I have enough faith in the free market that this 'problem' would be solved quickly, it maybe an ugly solution but it would be solved.

 
At 3/06/2012 9:56 AM, Blogger Larry G said...

If employer-provider health care was no longer tax-free OR if ANY insurance purchased by anyone on the open market - was not taxed - then many folks might well obtain something other than what the employer provides - as long as they could still buy insurance.

Unfortunately, many people would not be able to obtain insurance in the open market. Anyone with expensive-looking conditions included age would end up going "bare" and then depend on EMTALA and MedicAid.

If not mistaken, not only is employer-provided insurance not taxed but it is also written off as an expense by the company.

 
At 3/06/2012 11:36 AM, Blogger Seth said...

Larry G. - Written off as an expense is how it is not taxed, as companies pay taxes on their net income.

You may have a point for a transition period back to a freer, employer-decoupled market. But, I wouldn't assume this (not being able to get or afford) is true for the majority.

But, you could address those in a targeted fashion, like food stamps (e.g. medical stamps), rather than changing the system for everyone.

 
At 3/06/2012 12:56 PM, Blogger geoih said...

Quote from Larry G: "we are but one of every single industrialized country in the world, where their citizens have also support that concept."

Is that the depth of your thinking, what everybody else thinks? There was a time when the majority of everybody thought that slavery was a fine institution, or that women should not have rights, or that human sacrifice was good.

Does democracy make everything right?

 
At 3/06/2012 1:24 PM, Blogger Ron H. said...

Geoih: " If helping others is such a great idea and so important to 'society', then I would expect there will be plenty of giving people like yourself to provide for the less fortunate"

Larry: "but you would "expect" wrong for the majority of voters in this country.

they believe in:

1. - all taxpayers helping to not let people die from a lack of health care

2. - individual mandates like payroll taxes and mandatory insurance (like auto insurance) to be financially responsible for their needs.
"

If I understand this correctly, you agree with Geoih that a majority of people, you included, feel a moral obligation to help those in need, and will do so voluntarily.

But, in addition, you believe that anyone who doesn't agree with the majority, should be forced at gunpoint to contribute also.

Is that about it?

Or, does "but you would "expect" wrong for the majority of voters in this country" mean that you believe a majority would NOT be so generous, so that everyone must be forced by some authority to pay for those less fortunate?

 
At 3/06/2012 1:38 PM, Blogger Ron H. said...

"Unfortunately, many people would not be able to obtain insurance in the open market. Anyone with expensive-looking conditions included age would end up going "bare" and then depend on EMTALA and MedicAid."

The reason people buy insurance is to protect themselves against financial losses due to unforeseen events, including those for high dollar medical expenses.

Once the "bad thing" has happened, it's a little late to consider insuring against it.

"If not mistaken, not only is employer-provided insurance not taxed but it is also written off as an expense by the company."

That's what "not taxed" means, Larry.

 
At 3/06/2012 2:17 PM, Blogger juandos said...

Nice strawman argument larry g: '(like auto insurance)'...

Guess what, auto insurance is NOT mandatory...

There are many thousands of if not millions of people in this country that don't have it...

They don't have vehicles...

 
At 3/06/2012 2:50 PM, Blogger Paul said...

Juandos,

Moreover, auto insurance is mandatory in states mainly because of the damage that can be done to other vehicles and people. Also, the auto insurance mandate is done at the state level. In short, apples and oranges.

 
At 3/06/2012 5:23 PM, Blogger Ron H. said...

Paul,

"Moreover, auto insurance is mandatory in states mainly because of the damage that can be done to other vehicles and people. Also, the auto insurance mandate is done at the state level. In short, apples and oranges."

Apples and oranges is right! Most states have "financial responsibility" laws that require you to show evidence that you are financially capable of handling liabilities you might incur by operating your vehicle, up to certain limits.

Most people buy insurance to cover that requirement, but that is only one way to do it.

 
At 3/06/2012 6:46 PM, Blogger Larry G said...

"


Apples and oranges is right! Most states have "financial responsibility" laws that require you to show evidence that you are financially capable of handling liabilities you might incur by operating your vehicle, up to certain limits.

Most people buy insurance to cover that requirement, but that is only one way to do it"

actually, that's the basis of the payroll tax ... to be financially responsible ..for your retirement and your hospitalization in the future.

Virtually every industrialized country is the world also requires this financial "responsibility".

 
At 3/06/2012 7:19 PM, Blogger Ron H. said...

"actually, that's the basis of the payroll tax ... to be financially responsible ..for your retirement and your hospitalization in the future."

No, Larry, it's nothing like that.

"Virtually every industrialized country is the world also requires this financial "responsibility"."

As Geoih asked: "Is that the depth of your thinking, what everybody else thinks? There was a time when the majority of everybody thought that slavery was a fine institution, or that women should not have rights, or that human sacrifice was good.

Does democracy make everything right?"

That's a good one. It's an important question. Give it some serious thought.

 
At 3/06/2012 10:03 PM, Blogger NormanB said...

The only,yes only, way to bring medical costs in line with needed usage is to keep the spending decisions in the hands of the users so that they benefit or lose from those decisions themselves. So far, only Health Care Savings plans accomplish this. To blend all political viewpoints the government should provide medical stipends to everyone to put into their HCSs and let the system work.

 
At 3/06/2012 10:37 PM, Blogger Ron H. said...

NormanB,

I was right with you until you wrote "...government should provide..."

 
At 3/07/2012 7:11 AM, Blogger hal said...

Medical school shortage!
Medical schools don't act like businesses, and expand to meet demand for medical education.
Therefore, there is a bottleneck in the delivery of services to patients, Because there is an artificially low number of doctors practicing, which jacks up costs.

Government intervened in healthcare originally because doctors complained that they were paid too little.

 
At 3/07/2012 8:55 AM, Blogger Paul said...

"actually, that's the basis of the payroll tax ... to be financially responsible ..for your retirement and your hospitalization in the future."

And in the interim that money goes to the US Treasury, one of the most financially irresponsible entities in history. We've traded a few generations of artificial "retirement" for long-run financial doom. I never even got to vote on this deal.

 

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