Where did our health care crisis come from?

One of the most important questions that never gets asked is "where did the health care 'crisis' come from?". As a student of George Stigler who won the 1982 Nobel price for economics in part for answering this question, I have a point of view. There was a French economist named Frederic Bastiat who coined the phrase "Things seen and things unseen" - his basic message was that the effects of an economic policy include the intended ones and the many unintended ones and to fully understand the consequences of any economic choice, one must understand all of them. This means that both the intended 'first order' effect and the unintended 'second, third, fourth and so on order effects' need to be taken into consideration before evaluating the efficacy of any policy.

By coincidence, the current health care crisis derives from a Bastiat unintended consequenc of another progressive policy innovation from the Great Depression: income tax 'reform'. In the twenties, the Federal income tax was 15% of only the highest earners' incomes. When the Great Depression hit, Hoover inexplicably raised it to 60% of a much broader group of earners. Not to be outdone in perversity by that Republican piker, FDR raised it to 70% and then even 79% for a time. Aside from pure vindictiveness it is hard to see what FDR sought to accomplish by this. Indeed the 'first order' effect of this policy was to contribute mightily to the 'capital strike' which defined the Depression, ensuring that almost 20% unemployment persisted right up to WW2.

But there was a second order effect. With high marginal rates, 'progressive' politicians had a 'product' to sell. Any industry or business who could get a deduction or exemption written into the tax code for what they were selling could make a fortune. And they would share that largesse with the politicians and parties who made it happen. One of these industries was health insurance/health care. They persuaded the New Dealers to make health insurance premiums paid for by companies on behalf of employees exempt from personal income tax. As a result, company provided health insurance exploded. It's not hard to see why: pay me an incremental $1 I pay most of it to the government. Pay my health insurance and I keep all the benefits.

The second order effect of the employee benefits exemption led to a third order effect. Historically 'health insurance' had been sold only to individuals and only as a catastrophic policy. The great majority of health care expenses were paid out of pocket by consumers or financed by providers. But now, given confiscatory rates, it made tax sense to provide employees not with insurance but with 'prepaid health care' to sweep as much of the costs into the tax exempt bucket. So almost all healthcare expenses became "third party" expenses.

And this led to a fourth order effect: a radical change in consumer behavior. Bear with me for a minute while I provide an analogy of what happened using a commodity that we are all familiar with:

What if your company gave you 'first dollar' Food and Drink insurance? In other words, your food and beverages are part of your compensation. When you're hungry, you whip out your insurance card and for free or a de minimis charge at the point of delivery, you can order whatever you want. How would your behavior change? Three ways:

First, you would consume more food. After all, taking a second loaf of bread to make sure we don't run out doesn't cost anything. Some of it will be wasted, yes, but that would be no skin off of your nose. Can't decide between the triple chocolate tort and the blueberry ice cream? Order 'em both.

Second, you'd 'class up', replacing Two Buck Chuck with Ten Buck Charles. I mean why starve yourself of the finer things in life? Particularly when someone else is picking up the tab?

Third, you would no longer waste time on all that 'good consumer' activity: price comparing, looking for 'deals', stocking up, clipping coupons, going to mega discount chains, bagging your own groceries. Essentially we would become a nation of Bluto Blutarskys of Animal House fame: "Want a beer? Don't cost nuthin"

And the food retailing industry would quickly get the message. You want a lot? We'll give you bigger package sizes. You want class? We'll cut the discount stuff and line the shelves with 'super premium' product. You don't care about price? We'll raise it through the roof. They'll also pour money into facilities and amenities that can be tied to food. WalMart will cover its floors in terrazo and will win an award for the best complimentary valet parking service in food retailing. Just like hospitals do today. And the per capita cost of food will explode. So long as the company is willing to pay more each year, that is.

Get the picture?

This is what happened to healthcare starting in the '30s and accelerating in the 40s and 50s. In many respects it was a golden age because you had great health coverage. If you had employer provided health insurance, that is. For the poor and the elderly it was a dark time. Up until then, healthcare had largely been an out of pocket consumer purchase. As a result it wasn't that expensive to go to the doctor or pay for a whole range of procedures. And all the panoply of price shopping and competition was in full flower. But with the Blutarskys driving the healthcare Lincoln (the fourth order effect) and the healthcare industry rapidly restructuring itself to a third party payor model (the third order effect), they found themselves increasingly priced out of the market. The elderly in particular were hit. Because they use the most and the most expensive healthcare, they suffered first. They were the canary in the coal mine and by 1965 they were tweeting to their representatives at top volume.

So the best and brightest were pulled together. Flights from Boston were packed with brainy looking characters, their briefcases bulging with scholarly papers and 'therapeutic' visions. They all got together and said: you know what? Our policy of vindictively high tax rates coupled with an exemption for health insurance has provoked a roaring inflation that is sinking the elderly. Lets reverse course and relink healthcare price and value - deemphasizing third party payment. Lets put the people back in the driver's seat, not the large corporate interests. That makes sense, doesn't it? I mean we're the party of the People aren't we?

Well sadly, that scenario only happens in my dreams. In fact they used their impressive credentials and swollen crania to take the clearly bad existing third party driven system and made it infinitely worse. Old system provided tax subsidies? We'll provide massive cash subsidies. Old system stuck it to private companies? We'll make it a tax and stick to to our kids and grand-kids. Old system incented the insured to overconsume? We'll do that for a group that has a virtually unlimited demand for end stage healthcare exotica.

Washington is not completely bereft of people with brains that are loaded with logic software and some of them, most notably that right winger, The Monster Barry Goldwater asked some hard questions. Questions like: "so how much is all this hope and change gonna cost?" (they didn't actually say H&C, but they thought it). The boffins of the CBO, the OMB, the Accounting Firms, the Actuaries and half the faculty of Harvard dutifully trooped in and divided one number by a bunch of other numbers, carried the remainders, summed whole columns of historical numbers congealed from other numbers with out making a single arithmetical error and announced portentiously: "The Great Society has created a balm for the elderly everywhere. This program shall not cost 10.7 billion over 24 years, neither will it cost 14.098 Billion over 32 years. But verily we say unto you it will cost precisely 12 Billion shekels over 25 years." And Henry Wallace looking down from heaven pronounced it 'Progressive' and there were signs and wonders throughout the land: Watts, Detroit, Harlem were burned to the ground by a righteous God - wait, no, wrong testament.

And now we come to my point. George Stigler was a young economist at Chicago fascinated by 'hope and change' projects. He took a look at the precise cost estimates provided by the Wise Men of Washington and Boston and wrote a brief little paper. He told me later that he almost didn't even put any numbers or equations in the paper, so simple was the concept, but he was sending it to an economics journal and they like gobbledy gook, so he threw some in. Essentially what he said was this: "My Momma taught me that when you git somethin' you don't pay for, you waste it. This program will cost at least ten times what the experts say it will." And it did and in 1982 little Georgie Stigler won the Nobel Prize for Economics in part for channeling his Momma.

You see all the actuaries and newspaper editors and university professors and accountants and assorted analysts failed to recognize that the implementation of the Medicare "reform" would radically change the behavior of consumers and providers in ways that would make nonsense of all of their carefully tabulated numbers. Because of course, all of their equations and relationships and models were based on historical consumer and economic logic. Change the logic and all bets are off. They failed to realize this despite the fact that the reason they had passed this 'reform' was to cope with the previous mess that had been caused by the same policies that they were now implementing again in more extreme form. Thus the most brilliant experts in the field that the world had ever seen boldly marched into the Slough of Intellectual Despond and sank without a trace.

And now fast forward to Hope 'n Change 2010. The same portentous progressive experts are proposing the same sorts of radical changes to economic arrangements and the same "wise men" are providing precise estimates based on an old reality that the new policy sweeps away. One wonders why they don't just wheel out the 1965 numbers and add a zero.

And Bastiat's long stupid arm of past policy blunders reaches its bony hand towards us motioning as if to say: I have only just begun to screw with you.