Government Regulation and Intervention Part 1 Vivian Ho Health Economics This material draws heavily from Santerre & Neun: Health Economics, Theories Insights and Industry Studies, Southwestern Cengate 2010 Introduction Causes and consequences of government intervention in health care. Types of government intervention. Case studies – Cigarette taxes. – Price ceilings on health care services. – Hospital antitrust litigation. Criteria for perfect competition All firms and consumers are price takers. Consumers and firms have perfect information. All firms produce an identical product. Firms can freely enter an exit an industry. Market imperfections may lead to inefficient or inequitable distribution of resources. Imperfect consumer information Monopoly Externalities Government intervenes to restore efficiency and/or equity. • “Public interest theory.” An opposing theory: The amount and types of government intervention are determined by supply and demand. Vote-maximizing politicians “supply” legislation. Wealth maximizing special interest groups are the buyers. Successful politicians stay in office by satisfying special interest groups. “Special interest group theory” Examples: Extended patent protection for brand name drugs. Rejection of national health insurance in favor of private insurance companies. Special interest group theory claims that special interest groups gain at the expense of the general public. Consumers are diverse, fragmented, more costly for them to organize. Inefficient, inequitable resource allocation by government. Which theory do you believe? C-B analysis is needed to identify winners and losers. Types of Government Intervention Provide public goods. Fund medical research. Correct for externalities Tax cigarettes, pollution. Impose regulations. Enforce antitrust laws. Sponsor redistribution programs. Operate public enterprises. FDA Bar hospital mergers. Medicare and Medicaid. VA hospitals Public Goods >1 individual simultaneously receives benefits from the good. i.e., no rivalry in consumption. Costly to exclude nonpayers from consumption of the good. Private firms unwilling to produce and sell public goods. Are most medical services public goods? Externalities Definition: An unpriced byproduct of production or consumption that adversely affects another party not directly involved in the market transaction. Cigarette smoking Pollution Medical treatment for cyclists who don’t wear helmets Drunk drivers Demand-side externality: Marginal Social Benefit Marginal Private Benefit Supply-side externality: Marginal Social Cost Marginal Private Cost Cigarette smoking is an example of a (negative) demand-side externality. Smokers impose work-related costs on nonsmokers. Health insurance, pensions, sick leave, disability, group life insurance financed collectively by smokers and nonsmokers. But smokers, die earlier, pay less taxes, premiums. Smokers also impose health care costs on nonsmokers. Smokers usually incur higher health care costs. But nonsmokers die prematurely from passive smoking, smoking-related fires. The total external costs of cigarette smoking are estimated to be 15¢ per pack. (Manning et al., 1991) Keep in mind: The problem which calls for government intervention is external costs, not internal costs. The full extent of external costs must be measured using a lifetime approach. Manning et al.’s methods Lifetime external costs 154 # packs smoked Numerator takes into account life expectancy for smokers and the costs (savings due to early death) incurred each year. External Cost Components Covered medical costs. Covered work loss and disability. Group life insurance. Widow’s social security bonus. Covered nursing home costs. Pensions. Taxes on earnings. Fires. $ per S=MPC=MSC pack MSC0 D=MPB MSB0 MSB Q1 Q0 Cigarette Packs At Q0 MSC0 > MSB0 Cigarettes are being over-consumed. Government can use taxes and subsidies to alter economic incentives, correct for externalities. Charge a tax on cigarettes that reduces consumption to the socially optimal level Q 1. Levy a per-unit tax T on cigarette makers equal to vertical distance between MPB and MSB at Q1. $ per pack MPC0+ T MPC0=MSC P1 P0 P2 D=MPB MSB Q1 Q0 Cigarette packs With tax: Market price of cigarettes = P1 Cigarette manufacturers receive P2 per pack. Tax burden Consumer pays P1 - P0 Seller pays P0 - P2 The relative tax burden on consumers vs. producers depends on price elasticities for supply and demand. If demand for cigarettes is inelastic, consumers bear a larger?/smaller? Share of the tax burden. Further issues The current tax per pack exceeds external costs. Is this “OK”? Should smokers or cigarette companies be responsible for the external costs of smoking? “Thank you for smoking.” Is this moral?? Regulations Government can attempt to control price, quantity, or quality of health care products. Example: Price Ceilings in The Canadian Health Care System. – Consumers are fully insured by the government. – The government fixes the price the physician receives for each visit. Regulations Because consumers are fully insured, they will demand the number of visits as if the price per visit = 0. Assume that the government sets a reimbursement rate for physician visits equal to PC. Price S PC D QS QD Physician visits With full insurance, consumers want QD visits. But the government has fixed the price of visits at PC. – Only QS visits will be provided. Shortage of physician visits = QD - QS. Consequences 1)Physicians may treat patients on 1stcome, 1st-served basis, regardless of severity/urgency. 2)Patients will have to queue for care/not receive care. 3)Unethical doctors may take bribes from patients trying to jump the queue. Lesson: There is no free lunch under cost containment. Price ceilings can lead to: 1) Shortages. 2) Longer waiting lines. 3) Nonprice rationing. 4) Poorer health outcomes. Antitrust: Sherman Antitrust Act Section 1: Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several states or with foreign nations, is hereby declared illegal. Section 2: Every person who shall monopolize, or conspire with any other person or persons to monopolize any part of the trade or commerce among the several states, or with foreign nations, shall be guilty of a misdemeanor. The Act prohibits anticompetitive business practices that promote inefficiency and inequity in the marketplace, such as: Price fixing - when business rivals enter a collusive agreement to refrain from price competition; fix the price of a good or service. Hospitals in a given city cannot jointly establish the price of various hospital services. Boycott - agreement among competitors not to deal with a supplier or a customer. Physicians in an area can’t collectively agree to deny services to a particular managed care organization. Market allocation - when competitors agree to compete with one another in specific market area. Hospitals in the same city can’t collectively set geographic service boundaries. Price fixing, boycotting, and market allocations are illegal per se. The plaintiff must only prove these actions took place for the defendant to be in violation of the Act. In contrast, rule of reason doctrine is used to evaluate horizontal mergers under the Act. While horizontal mergers may force price above the competitive level, they may also create benefits which could be passed on to the customer. Redistribution The government often taxes one group and uses the revenues to subsidize another. Why? Interdependent utility functions. Donors get utility from increasing the welfare of recipients. Why is the government involved? “free rider” problem. Two notions of equity in redistribution programs Vertical equity “Unequals should be treated unequally.” People who earn more should pay higher taxes. Horizontal equity “Equals should be treated equally.” Two persons with the same income level should pay the same in net taxes. Vertical equity in practice How much more in taxes should higher income people pay? Suppose high income households pay $4,000 in taxes on average, and low income households pay $2,000. Is this equitable? If the high income household makes $100,000, they pay a 4% tax. If the low income household makes $10,000, they pay a 20% tax. The notion of equity in taxation depends not just on total tax revenues, but on income levels and tax rates as well. In practice, vertical equity is achieved when the net tax system is sufficiently progressive. Taxes as a fraction of income rise with income. Federal income tax system. Other forms of redistribution Proportional. The fraction of income going to taxes is constant as income rises. The Medicare tax is a fixed % of payroll income. Regressive. The fraction of income going to taxes falls as income rises. Sales tax Implementing redistribution Supply-side subsidies Government funding aimed at reducing the costs of producing a consumer good or service. Subsidy to a public hospital. Tuition for nurses or doctors. Potentially violates notion of vertical equity if all persons have equal access to the subsidized product. Demand-side subsidies - government funding for consumers. In-kind: vouchers or reimbursements for specific services. Food stamps, Medicare, Medicaid Cash: government-provided income that people can use at their own discretion. AFDC, Supplemental Security Income Keep in mind: It is difficult to guarantee horizontal equity with multiple programs in operation. Consumer Groups Accuse U.S. of Negligence on Food Safety – The New York Times, October 15, 2002 Back to the Start Does government intervention correct for market imperfections, or is it ruled by special interest groups? A Final Caveat Market failure is a necessary, but not sufficient condition for government intervention. It may cost the government $10m to correct a problem in the marketplace, which imposes $8m in damages. While markets may fail and impose societal costs, the costs of government intervention may be greater.