Health Care, Taxes, and Debt

As we move more into the legislative agenda of the Obama administration, rather than the triage period of economic recovery, several inter-related issues become very prominent. Obama wants to shift the emphasis of health care towards universal coverage, but has to accomplish this against a very strong headwind: the Reagan/Bush legacy of national debt.

The problem is simple: any attempt to provide universal health care coverage, in other words the move from regarding health care as a ‘benefit’ or a ‘consumable product’ towards a basic ‘service’ akin to a utility will cost serious money. Most estimates put the price tag in the range of $150 billion a year. In the context of the Federal Budget this is a very significant addition to the deficit, although it is trivial when set against the cost of bailing out the banks.

The original Obama budget used a variety of methods for financing this cost: mainly the termination of the Bush tax cuts at the high end of incomes, and the implementation of much needed cost reductions in the health care industry.

The problem of cost reduction is of paramount importance. The US system is extremely expensive to run. It absorbs about twice of our national annual income, as measured by its percentage of GDP, than any other health care system in the world. The next most expensive is the French system, which delivers excellent service at half the price. Indeed the French system is arguably superior since it provides more effective basic service to the entire French population, unlike the American system which fails to cover about 45 million people here.

The problem with the US system is is that its fragmentation amongst a vast number of carriers, insurers and other providers dissipates buying power so costs of things like drugs are not forced down. Yet at the same time it is replete with duplicated costs: all those insurance companies carry large administrative overheads and at the front line of care the lack of automation in doctor offices is extraordinary. By any objective standard the system is horribly inefficient.

To those who advocate a totally private system this must be a source of frustration: market forces are supposed to drive out costs because doctors and hospitals should be competing on price as well as service. In fact price should dominate the provision of the basic services since most doctors, within their specialties, have little opportunity to differentiate sufficiently to maintain a higher price service. There will always be niches for very high end services, but those are commonplace the world over even in nationalized systems. The problem here is that the typical market forces that should eliminate waste simply don’t work. Consumers do not look at health care as a ‘consumable item’ except for fringe services like cosmetic plastic surgery. And sick people have very little incentive to search for a ow cost provider: they simply go to their regular doctor or head to the emergency room.

In the American system the true locus of efficiency inducing market forces should be in the cost of purchasing insurance. This is where consumer choice should enter into the equation. But, again, consumers are effectively shielded from the true cost of their choices by the employer provided nature of the service. Because employers provide health care coverage as a ‘benefit’ they find it acceptable to absorb some of the cost. So consumers who get their insurance through the workplace, and that is a large percentage of Americans, do not face the real cost. Thus they have no incentive to demand cost reductions from doctors or insurance companies.

Couple this lack of effective market force with the unique effects of the American litigious process which adds to overhead costs and the end result is a system that is neither market efficient nor universal. It has none of the benefits of being truly ‘privatized’ and none of the benefits of being truly ‘nationalized’. So it exists as a wildly inefficient hybrid absorbing an increasing amount of our wealth while not producing an equivalent level of excellence: the US ranks very low in most of the basic services that the United Nations uses to measure the effectiveness of health care around the world. This is a scandal given the amount of money we collectively spend on it.

So a fix is urgently required before we are swamped by the system’s cost and it squeezes out other more productive and wealth generating activities from the economy.

Hence the need to look at debt loads and taxes.

I have mentioned here many times that the massive expenditure to save the economy was unavoidable. Deficit spending, while distasteful to those of us who are fiscally conservative, is a necessary evil. It is the only method we have for keeping ourselves from plunging full bore into another Depression. And it seems to be working, although there is growing feeling amongst economists of all political stripes that the stimulus may need another round of spending before we are assured of success. Even Martin Feldstein, hardly a left winger, gets in on the act of advocating more spending. Only the hard core ‘New Classicists’ remain berating the Keynesian drift of economic policy, mainly because the current crisis is an indictment of their theory.

But, given the mess that three decades of Reagan/Bush profligacy have created, notwithstanding the entirely accidental Clinton surpluses, we are facing almost historic debt levels as a result of the current ‘triage’ approach. And already that is causing nerves to crack in the bond market. The prices of US treasury bonds are dropping at the moment for a variety of reasons:

• faster economic growth will engender inflation. Bonds will fall in anticipation of inflation: interest rates will climb to compensate for inflation. Higher interest rates means fixed rate US treasury bonds are worth less, hence the decline in price of bonds.
• the enormous amount, some would say ‘glut’, of bonds being flooded onto the market by the US as it tries to bail itself out needs to be maintained in the market. This is a simple matter of supply and demand. Greater supply of bonds will reduce their price. The result: lower bond prices and higher interest rates.
• now add in the expectation of funding needed for the Obama agenda, and the supply of bonds seems to grow even more. The result: lower bond prices and higher interest rates.
• lastly, foreign investors will start to unwind their holding of US bonds, as their respective domestic markets recover and offer higher yielding opportunities for investment. The result: lower bond prices, and higher interest rates in the US in order to maintain foreign investor involvement in the market.

There seems to be a theme here.

Even with the Federal Reserve Board’s efforts to reduce the supply of bonds through purchases most estimates put the Treasury’s bond issuance requirements at around $2 trillion this year alone – it has already issued about $900 billion this year.

In other words fiscal policy is a mess and we need to start to plan to tighten it back up in order to prevent a massive bond market revolt against the US. The jitters last week when Standard and Poor’s threatened to downgrade the UK debt from its AAA status was a strong shot across the bows here as well.

So what to do?

Raise taxes.

There seems to be little appetite for expenditure cutting in Washington. And in truth there is little that can be done in any case. The largest chunks of the budget are each sacrosanct: I doubt, for instance, that defense spending will be reduced substantially any time soon even though it is egregiously high when compared to other nations. The US spends as much on defense [or more properly ‘offense’] than the next ten countries in the world combined, and it is wedded to defense systems that have no place in the post-Cold war era. Yet cutting defense spending seems politically infeasible. Likewise reducing or eliminating entitlement spending: even the supposedly anti-government ideologues like Reagan and Bush balked at that. In fact they added to the spending. The American middle class likes its perks, but doesn’t want to pay for them.

So in the absence of cost cutting we will have to raise revenues. This means taxes. I have already alluded to the elimination of the upper end Bush tax cuts, but that alone won’t be enough. US corporate taxes are already among the highest in the industrial world and probably need cutting rather than raising – but only if the loopholes are also done away with. This leaves other taxes such as excise and sales taxes. I would wager that the US will end up with a European style Value Added Tax [‘VAT’] in the not too distant future. Given our need to shift our priorities more towards savings, a larger emphasis on consumption taxes surely has to be in the offing.

But. Lingering in the background of the health care debate is a massive tax opportunity. One that Obama has now begun to turn to, even though he hammered McCain during the election for raising it. Resolving the employer tax exclusion could free up more than enough money to pay for the entire edifice of universal health care – some estimates put the extra revenue that abolishing this loophole would provide at $300 billion a year. Serious money . Huh? I can hear you all asking. What is that? It seems that way back during World War II the government put a lid on wages in order to control costs and it simultaneously introduced a ferocious tax on ‘excess profits’. After the war businesses that started to make good money again were faced with rising profits and no ability to raise wages. So they turned to giving away health benefits in lieu of wages. Why? Because the wartime legislation also excluded the cost of employer health care coverage from taxes. So providing health care was subsidized by the tax exclusion. And, as usual, the continuance of a tax subsidy distorts the market: decades later we have a mangled health care system because businesses can reduce their tax bill by offering health care as a ‘benefit’.

So there you have it: our fiscal constraints will dictate in large part the next phase of the Obama agenda. The costs of unwinding the Reagan/Bush binge are enormous and threaten to undermine any attempt to rationalize our health care system. With some imagination and a little political courage we can accomplish both at the same time. Indeed I see them as firmly intertwined. We spend too much on health care, and we ned that money to get our house back in order.

Welcome to the era of change: cost cutting and fiscal responsibility. That’s very conservative. And it’s a huge change from the past three decades of waste and illusion.

Change we can believe in? Or simply change we need?