The role of government in
health care
Today: Reasons for having
government-provided health care;
Medicare; Medicaid; Reform efforts
Last week…

We saw that health
care costs (as a
percentage of GDP)
have rapidly increased
over the last 50 years
Health care insurance

Advantages and
disadvantages
Figure 9.1: US expenditures of selected goods and services as share of Gross Domestic Product (19602004)
18
16
14
Percentage of GDP

12
10
8
6
4
2
0
1960
1964
1968
1972
1976
1980
1984
1988
1992
Year
Health
Food
Clothing and Shoes
Housing
1996
2000
2004
Today

Government-provided health care


Programs



Why should government provide health care?
Medicare
Medicaid
The government’s role in health care reform
Why should gov’t provide health care?




Adverse selection
Moral hazard
Paternalism
Income too low for some people
Adverse selection


Recall adverse selection
problem (see example to
the right)
The government could force
everyone into the same
health care plan


Pro: Adverse selection
problems go away
Con: Low-risk people
subsidize high-risk people



Example: 6 people at a firm
Spending if sick: $10,000
3 people have a high risk of
getting sick


3 people have a low risk of
getting sick


10% each
5% each
With no employer
contribution, some at low
risk do not buy insurance
Moral hazard

Some activities are
more likely to occur to
an insured person






Bungee jumping
Mountain climbing
Skydiving
Smoking?
Bad eating habits?
These activities lead to
inefficient outcomes

The government can
intervene to try to
discourage these things
from occurring




Anti-smoking campaigns
Commercials promoting
good eating habits
Prohibiting certain very
dangerous activities
Withholding care due to
dangerous activities
Paternalism



A paternalist would argue that some people
“don’t get it right” when it comes to health
insurance
These people would say that everyone
should be forced to have a minimum level of
health care
Much of the 2008 presidential debate
involved paternalistic arguments
Income too low for some people

Some people do not
make enough money to
afford health care



Downward spiral


Problem made worse by
increasing health care
cost (see “Downward
spiral” at right)
Young adults and
noncitizens make up a
substantial fraction of
the uninsured in the US
Health care costs go up
More people are unable
to afford health insurance


These people must use
the Emergency room,
driving up premiums for
those insured
When premiums go up
due to increased
numbers in the
Emergency room, the
cycle repeats
What does the government do?


The government provides over 45% of health
care funds in the United States
Two main programs of government-provided
health care

Medicare



People 65 and older
Disabled people
Medicaid

Poor people
Refer again to Figure 10.2, p. 207: Source of health care funds in the US
Medicare


Enacted in 1965
Second largest domestic spending program

Funded by a 2.9 percent tax on earnings of
current workers


Tax split evenly between employers and employees
Provides health insurance to seniors and the
disabled, primarily through the private sector


Seniors must have worked and paid payroll taxes
for at least 10 years
About 35 million seniors enrolled
Medicare: Overview
Figure 10.3: Medicare expenditures (1966-2004)
350
3
2.5
250
2
200
Expenditures on
Real
Medicare as a
expenditures
Share of GDP
150
1.5
1
on Medicare
100
0.5
50
0
0
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
Year
Expenditures (Billions $)
SOURCE: Centers for Medicare and Medicaid Services [2005a].
Expenditures as % of GDP
1996
1998
2000
2002
2004
Expenditures as % GDP
Real Expenditures (2004 $ Billions)
300
Different aspects of Medicare

Parts A and B of Medicare are the largest
components



Part A: Hospital insurance
Part B: Supplementary medical insurance
New Medicare component: Part D

Prescription drug benefit
Part A


Hospital insurance
Structure for 2008

Monthly premium $423 per month




Covered for people that have 10 years of contributions into
FICA taxes
Must also enroll in Part B if enrolled in Part A (typically)
States may be able to help low-income enrollees
Various benefits covering
 Blood
 Home health services
 Hospice care
 Hospital stays
 Skilled nursing facility care
(Source: http://www.medicare.gov/Publications/Pubs/pdf/10050.pdf)
Part B

Supplementary medical insurance

Sometimes optional, depending on whether or not you
receive Social Security benefits


Enrollment is automatic if you receive Social Security benefits
Structure for 2008


All but high income people pay $96.40 per month
Benefits



Medically-necessary services
Preventive services
Coinsurance and deductibles may apply, depending on the
benefit
Part D

Prescription drug benefit



Benefits began in 2006
Different plans offered
Some numbers for the plan in 2006

Expected premium: $386 per year


Low-income earners can qualify for lower premiums
Benefit structure




$250 deductible
Beneficiary pays 25% of cost for next $2,000
Beneficiary pays 100% of cost for next $2,850 (“donut hole”)
Beneficiary pays at most $5 or 5% thereafter per prescription
Cost control measures for Medicare

Before 1983, Medicare reimbursement was
retrospective for Part A



Compensation is made after services are completed
Little incentive to economize on costs
Since 1983, this changed to a prospective payment
system (PPS)

Compensation level is set before services start


500 diagnosis related groups exist for the prospective
payment system
This gives incentives to economize on costs
Cost control measures for Medicare


Recall DWL that occurs
when MB is low
PPS appears to have
decreased DWL


Average stay for
Medicare patients in
short-stay hospitals
decreased from 10.5
days in 1981 to 8.5 days
in 1985
The decrease in stay
appears to have no effect
on health outcomes
Cost control measures for Medicare

To keep costs down for Part B, a resourcebased relative value scale system is used

Fees are set per service provided


Does not necessarily keep down number of services
If fees are set too low, many medical practices will not
accept Medicare patients

Medicare patients would then get low-quality care
Cost control measures for Medicare

Managed-care options

Since 1985, Medicare beneficiaries could enroll in
HMOs

Originally, the HMO received 95% of the average
amount that the average patient would require

Problem: Adverse selection… Healthier patients enrolled
in HMOs  The government was overpaying the HMO
Cost control measures for Medicare

Solution to adverse selection problem: Riskadjusted payments to HMOs


Reduced HMO enrollment
New methods are being tested to try to
increase HMO enrollment and decrease
costs simultaneously
Medicaid: Overview
Figure 10.4: Medicaid expenditures (1966-2004)
3
300
2.5
250
2
200
1.5
150
1
100
0.5
50
0
0
1966
1968
1970
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
Year
Expenditures (Billions $)
Expenditures as % GDP
1996
1998
2000
2002
2004
Expenditures as % GDP
Real Expenditures (2004 $ Billions)
350
Medicaid eligibility


1965: Health insurance for recipients of cash
welfare payments
1980s: Children of low-income two-parent
families became eligible


“Children” can include care to pregnant women
1997: State Children’s Health Insurance
Program

Allows states to get additional money from federal
government to reduce number of uninsured kids
Financing and benefits

Federal and state governments share the
cost



Poor states get higher matching rates than rich
states
Federal government contribution comes from
general revenues
States must offer major services with
Medicaid

Hospital stays, physician visits, prenatal care,
vaccines for children
Financing and benefits

States have some flexibility in program
administration

Example: Capitation-based reimbursement is
allowed


Recall that health care provider receives annual
payment per patient in their care, independent of
services rendered
Some empirical evidence (Duggan 2004) shows that
forcing people into managed care increased Medicaid
costs

Questionable if this is actually true
Medicaid stigma

Many people do not
enroll in Medicaid




Guilty feelings
Stigmas
Uninformed about
benefits
Public service
announcements help to
get more eligible
children on Medicaid
Person who
values private
insurance
relatively highly
F
A
Person who
values private
insurance
relatively lowly
F
A
Amount of publicly
provided insurance
F
B
C
M
Person who is
uninsured
before public
insurance
A
B
B
0
Quantity of all other goods
Quantity of all other goods
Quantity of all other goods
Does Public Insurance Crowd Out Private
Insurance?
C
0
M
Health insurance
Amount of publicly
provided insurance
C
0
M
Health insurance
Amount of publicly
provided insurance
Health insurance
Are Medicaid expansions effective?

Unclear for two reasons




How much is due to crowding out?
Many eligible people do not enroll in Medicaid
Cutler and Gruber (1996) estimate that about half of
new Medicaid enrollment previously had private
insurance
Card and Shore-Sheppard (2004) estimate that
crowding out occurs less than Cutler and Gruber
estimate

They also find that take-up rates due to expansion are low
Health care reform

Two factors are leading to more talk about
health care reform


Increased costs
Significant portion of population without insurance

Increases cost to others
Health care reform

Some proposals to try to solve the health
care problem

Mandating everyone to have insurance


Catastrophic insurance



Hot topic in the 2008 Presidential race
Only provides payment when expenses become large
Health Savings Accounts can be used to pay for this
type of insurance
Nationalized health care…
Nationalized health care

Pros

Everybody is covered




Cons

Commodity
egalitarianism
No adverse selection
problems
Government can use
cost-cutting measures to
prevent care with low MB




Predetermined budget
may lead to a suboptimal
amount of health care
provided
Long lines in some cases
Government determines
what is “medically
necessary”
New technology may not
be adopted quickly
Moral hazard problems
Is there a solution?

Is there a solution to the health care
problems presented over the last week?

There will probably never be a complete solution


Security and efficiency will be “at odds” with each other
Some people will always choose NOT to have
insurance unless forced to

Current trend: More middle-class Americans are
deciding to have little or no insurance 
This increases health care insurance premiums for
those that remain insured 
Downward spiral
Is there a solution?

What if we are willing to accept new ways for
health care and insurance to be
administered?



We will likely be able to increase security without
giving up efficiency
Catastrophic insurance may be most important at
reducing risk
Higher deductibles, co-payments, and coinsurance rates can decrease loss of efficiency
Is there a solution?

Is prevention the key?

Should people be encouraged to eat healthy?




Should healthy food be subsidized?
Should unhealthy food be taxed?
Are taxes on smoking and alcohol set at the
optimal level?
Should some drugs be legalized, taxed, and
regulated?

Tax money can be used for health care costs
Summary

The government provides health care
insurance for millions of Americans through
Medicare and Medicaid



Some believe that every person should be able to
access needed health care
Adverse selection and moral hazard are
significant problems
Future health care reforms can try to balance
paternalistic views and efficiency
Next lecture

Social Security

Chapter 11





Read pages 228, 232-236, and 240-251
History
Current structure
Long-run problems due to the graying of America
How people’s decisions differ with and without
Social Security
Problem

Timothy has the following utility function




U(x, y) = x + (10,000y)½
x denotes Timothy’s consumption on everything
except health care
y denotes Timothy’s consumption on health care
Note: We assume no disutility from work
Problem

Timothy is currently working 1,500 hours per
year



Hourly wage is $10
He also receives government health care, valued
at $3,000 per year
Timothy could work a second job for 700
hours per year


Hourly wage is $8
With the second job, Timothy would make too
much money for government health care
Problem

What should Timothy do?


We need to find Timothy’s highest possible utility
working one job
…working both jobs
Problem: Working one job




Total wages: $15,000
Total government health care: $3,000
Total benefits: $18,000
How does Timothy maximize utility if he has
$18,000 in total benefits?


Note that at least $3,000 must go to health care
Maximize x + (10,000y)½ subject to x + y = 18,000
and y ≥ 3,000
Problem: Working one job

Maximize x + (10,000y)½ subject to
x + y = 18,000 and y ≥ 3,000


For now, ignore y ≥ 3,000
Maximize x + (10,000y)½ subject to
x + y = 18,000


Equivalent to Maximize 18,000 – y + (10,000y)½
First order condition



–1 + 10,000½ / 2y½ = 0
y = 2,500
Since Timothy would only want $2,500 in care, he is
constrained to take at least $3,000
Utility from working one job

Utility when x = 15,000 and y = 3,000

15,000 + (10,000 * 3,000)½ = 20,477
Working two jobs

Wages



$15,000 from first job
$5,600 from second job
$20,600 total
Working two jobs

Timothy’s maximization problem

Maximize x + (10,000y)½ subject to x + y = 20,600


Notice that x and y only need to be nonnegative here
Maximize 20,600 – y + (10,000y)½


First order condition is the same as with one job
y = 2,500
Working two jobs

What is Timothy’s utility if he works both
jobs?



He spends $2,500 on health care
He has $18,100 left for everything else
Utility is 18,100 + (10,000 * 2,500)½ = 23,100
What should Timothy do?



Utility from one job: 20,477
Utility from both jobs: 23,100
Timothy should work the second job and give
up his government health care