The Center for Popular Economics : Economics for People, Not Profits

Testimony to Massachusetts General Court, December 15, 2011

My name is Gerald Friedman.  I am a Professor of Economics at the University of Massachusetts at Amherst.  I have lived in Massachusetts since August 1978 when I moved to Cambridge to attend Harvard, where I was awarded a PhD in Economics in 1986.  Since 1984, I have taught at your state University at Amherst where I have specialized in Labor Economics, public policy, and Economic History.

Before studying Economics at Harvard, I was a History major at Columbia and my first book, State-Making and Labor Movements, is a historical study of the origins of the labor movement in France and the United States 1870-1914; my latest book, Reigniting the Labor Movement: Restoring Means to Ends in a Democratic Labor Movement, addresses union growth and decline in 16 advanced economies since the late 19^th century.  I am a big picture guy and, as such, I do not envy your responsibilities because the big picture is grim: spending on health is swallowing the economy even while growing numbers are receiving inferior care.

This is not to dismiss your very real accomplishments, of which you should be proud.  With some help from Governor Patrick and former Governor Romney, you developed a health care program that has extended health insurance to most of our citizens even while insurance has become increasingly unavailable outside of Massachusetts.  Today, fewer than 5 percent of Massachusetts residents are uninsured, a rate barely a third that of the rest of the United States.  This is a signal accomplishment that dramatically improves life for hundreds of thousands of people.

Much of the expansion in health insurance coverage has been achieved through the Massachusetts Health Reform Law, Chapter 58 of 2006.  A compromise between reform advocates, Governor Romney, and various industry groups, the bill did less to reform health care in Massachusetts than to expand access by “plugging gaps” in existing insurance programs.  As such, it has done little to slow the seemingly inexorable rise in health care costs, and the resulting squeeze on the budgets of Massachusetts families, businesses, and governments.  Back in the days when Governor Dukakis tried to slow health care inflation, health care spending equaled 12 percent of the Massachusetts economy; today it is over 17 percent.  This increase, 5 percent of our income, is about $3,000 per person that we do not have to spend for other things because of rising health care costs.  If we continue the way we are going, we will be giving up thousands more over the next two decades.

While some of the increase in costs reflects improvements in care and is a consequence of rising life expectancy, most in Massachusetts, as throughout the nation, is due to waste within the health insurance and health care industries.  Compared with other industrial economies, the United States is peculiarly inefficient in our health care system. We spend more but receive relatively poor health care; compared with other affluent economies (members of the Organization of Economic Cooperation and Development), we spend thousands of dollars more per person to achieve life expectancy lower than 49 other countries (see Figure 1).  If we are only to have the life expectancy of Portugal, then we should be able to spend over $4000 less per person; or if we are to maintain such high spending, then we should have 4 more years of life expectancy (see Figure 1).

Figure 1.  Female life expectancy and health care spending, US and other OECD members, 2006.

Some of our poor performance may reflect intrinsic differences between the United States and other countries.  Standard practice among economists addressing such intrinsic effects is to compare the change-over-time in different countries.  Here the picture is even worse because health care costs have been rising much faster in the United States than elsewhere even though there has been less change in our health care outcomes (see Figure 2).  In Figure 2, the length of the horizontal line indicates the increase in spending per person from 1971 to 2008 while the vertical distance is the increase in life expectancy; the higher the vertical and shorter the horizontal the better because this indicates more gain for less cost and, on this measure, the United States does peculiarly badly.  To highlight one case: in 1971, when Canada established its single-payer provincial Medicare system, life expectancy and health care spending were roughly similar in the United States and Canada.  Since then, however, Canada has gained 6.6 years of life expectancy for an increase in spending of $3,785, or $573 per year of life expectancy gained.  Health care spending in the United States, by contrast, has risen almost twice as fast for a smaller increase in life expectancy, $7,182 for only 5.4 years of life expectancy, for a cost per year of $1,330.  Had our efficiency, years gained per dollar, been the same as Canada, we would be saving over $4,085 per person, or we would have gained 12.5 years of life expectancy, 7.1 more years of life for each American.

Figure 2.  Changes in health care spending and life expectancy, 1971-2008, US and other OECD countries.

Rising costs threaten our economic viability and our health care reform effort.  Rising health care costs threatens the viability of every responsible business that tries to do the right thing and provide insurance for its employees.  Rising health care costs makes it harder for the unemployed to find work, especially older workers and those with health problems, and it threatens the budgets of local and state governments. By making adequate insurance unaffordable, rising health care costs is forcing employers and individuals to gamble on reduced coverage leading to the growing phenomenon of inadequate insurance.

If health care cost inflation threatens health care reform this problem should not be seen as an accident because waste is built into the private health insurance system and, thus, into the foundations of Chapter 58.  The market for health insurance is different because companies do not profit by selling more but rather by screening their customers so they sell less to people who need insurance.  In his coffee business, for example, my father tried to provide quality coffee because he his profits grew when he sold more coffee to more people.  Health insurance companies, however, increase their profits by reducing their sales, by identifying those likely to be sick and denying them coverage.  Over 70 percent of what insurers call their medical “losses,” payments made to providers, go for as few as 10 percent of people covered. This creates a powerful incentive for insurers to identify those people and get them to drop their coverage or change insurers. If you can do this, if you can “cherry pick” and “lemon drop,” you can dramatically lower your “losses” (what we call insurance benefits) and increase profits.  Expensive practices, like clinical review and requirements for prior authorization, practices that demean the sick and needy while wasting valuable provider time and insurance resources, are not accidents or mistakes but are practices designed to lower insurance company costs by driving away those who may need insurance the most.

Bureaucracy and waste are fundamental to a private insurance system  because profits are made not by providing quality coverage but rather by selecting customers and driving out those who will need services.  I am not suggesting that there is any ill will or maliciousness on the part of insurers whose business depends on driving out the needy.  Companies that fail to screen their enrollees risk plunging into an “insurance death spiral” where a less-healthy population leads to rising costs and higher premiums that discourage the healthy from buying coverage making the population enrolled less healthy, raising costs further and requiring higher premiums.

The drive for profitability through screening contributes to the higher cost of coverage for private insurance in the United States as well as raising the costs of billing and insurance in provider offices.  Administrative expenses throughout raise the cost of health care in the United States are driving rising health care costs in Massachusetts and throughout the United States. Administrative costs have risen in the United States at a rate of over 11 percent a year since 1971, rising from 1.5 percent of GDP to 5.0 percent.  Returning to the comparison with Canada’s single payer system, administrative cost increases account for two-thirds of the excess increase in our health care costs relative to Canada’s. Perhaps most revealing, there is no difference between the cost increases in Canada’s Medicare single-payer system and our Medicare single-payer-system for the elderly; had all of the US health care system behaved like our Medicare system, we would be spending little more than does Canada.

Rising administrative costs are price we pay for a broken system of private health insurance, a system designed to increase industry profits even while denying adequate health care to growing numbers of our citizens.  Fortunately, we have an alternative to this bloated and inefficient system.  A single-payer health insurance system would dramatically lower costs by eliminating much of the administrative burden both within health insurance companies and within provider offices’ billing and insurance operations.  Combined with savings to be realized by reducing administrative costs in the operation of Medicaid and by reducing market power in areas like prescription drugs, Massachusetts could reduce health care costs by nearly $13 billion or 19 percent by establishing a single-payer health insurance system (see Figure 3).  Even after expanding coverage to all Massachusetts residents, this would leave savings of over 17.6 percent of current expenditures.

Figure 3.  Savings (in millions) from single-payer health system, Massachusetts 2010

A single-payer system would benefit all residents of the Commonwealth with the greatest benefits for the poorest.  Replacing flat insurance premia with income- or payroll-based taxes and out-of-pocket spending with an income based tax of 7.5 percent on payroll and 7.5 percent on unearned income would raise income after-taxes and health-care expenditures for the poorest by over 30% with savings for over 80% of Massachusetts residents.

Businesses would also benefit because the payroll tax of 7.5% is nearly 2 percentage points below the current share of payroll paid by Massachusetts employers.  When added to significant administrative savings within companies, the single-payer system would dramatically enhance the competitiveness of Massachusetts companies.  A conservative estimate would be that these savings would lead to an expansion in sales and production that would increase employment in the state by over 3 percent, or nearly 100,000 additional jobs.

Because health insurance is an especially large share of local government expenditures, the Commonwealth’s cities and towns would be among the biggest winners from adopting a single payer health program.  Applying the 17.6 percent savings to municipal health expenditures suggests a bonus to local governments of over $350 million, equivalent to an 8% increase in local aid or a 3% increase in property tax revenues (see Table 1).

Table 1. Effect of single-payer on selected local governments.

Economists are not known for their humor, but we do have a few jokes within the profession.  One of the most famous is told about the late- great-Chicago conservative George Stigler.  It is said that Stigler was walking down the street with a graduate student when the student spied a $20 bill on the sidewalk.  When the student ran to pick up the money, Stigler rebuked her saying that “if the money was real, someone would have picked it up already.”  While economists like to assume that any efficiency gains have already been captured, historians and others devote their time to identifying the mistakes that people make and the bad institutions that persist.  Our system of private health insurance is one such mistake, one that has been entrenched by Chapter 58.  It is time to bend down and pick up the billions of dollars that we have left on the sidewalk.

Figure 4.  Effect of single-payer financed with 7.5% payroll tax and 7.5% tax on unearned income.  Effect on income by quintile.