Feldstein Chapter 1: Rising Health $ in US
Two questions:
1. How much?
2. Why?
Background:
1. What are some of the reasons for the increased demand for medical services since 1965?
A. More government insurance:
 Pre 1965, most healthcare paid privately (80%) and out of pocket (53%). Government
paid just 20% (see slides) . Average spending = $210 @ 5.5% of GDP.
 % w/o health insurance is stuck around 17% today.
 Post 1965 comes Medicare and Medicaid programs enacted in 1965. These programs
reduced out-of-pocket expenses for the aged and the poor; as a result, demand for hospital
and physician services dramatically increased. Hospitals had to spend more to meet the
growing demand for services, which led to rapid rises in expenditures.
 By 2014 Federal & State spending = 48.3% of total health care. Spending now = $8700 per
person at 17% of GDP.
 Obamacare will increase spending further, with $ expected to double by 2020.
 Insured not concerned with total cost of care, just out of pocket cost.
 The growth in health care spending has consistently been much higher than general inflation
(see 2.2), so health care takes a bigger and bigger share of total GDP.
B. Advances in medical technology also increased the demand for medical treatment. New methods
of diagnosis and treatment were developed, so those with previously untreatable diseases could now
have access to technology that offered hope of recovery.
C. Aging of population, e.g. elderly just 13% of population but fill 40% of hospital beds.
D. Rising incomes lead to increased demand (normal good) for health care and health insurance
E. Private employer-paid health insurance has excess demand because:
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Buying in group better than individual
Employer-paid insurance not subject to federal income tax. When employees receive
additional income in the form of wages, they pay federal, state, and Social Security taxes and
are left with less disposable income. Instead of having their employer pay wage increases in
after-tax cash, employees prefer to have their employer spend those same dollars, before tax,
to buy additional health insurance. Thus employees can have their out-of-pocket medical
expenses paid with before-tax dollars rather than after-tax dollars. This tax subsidy for
employer-paid health insurance has stimulated the demand for medical services in the private
sector and further increased medical prices.
Rising incomes, high marginal tax rates (up to 70%) and inflation increase demand for health
insurance as compensation vs. wages
Insured not concerned with total cost of care, just out of pocket.
2. How did insurance rules promote inefficiency?
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In the 1960s and 1970s hospitals were paid their costs plus 2 percent for serving Medicare
patients. Private insurers paid in a similar manner. Because hospital costs were reimbursed,
there was no incentive to be efficient and reduce expenditures. On the contrary, hospitals
actually had an incentive to increase costs. They expanded their capacity, invested in the
latest technology, and duplicated facilities and services available in nearby hospitals.
Hospital prices rose faster than any other medical service during this period.
HMOs & managed care insurers faced barriers in the 1960s and 1970s?
o When Medicare and Medicaid were enacted, federal law prohibited Medicare and
Medicaid from contracting with HMOs.
o Providers could only be paid fee-for-service. HMOs, such as Kaiser, also were paid
fee-for-service, not an annual capitated amount per Medicare and Medicaid enrollee.
o The government, under Medicare and Medicaid, was not permitted to enroll Medicare
or Medicaid beneficiaries in HMOs; enrollees in these two programs had to have free
access to any provider.
o The AMA had lobbied for these provisions and others limiting HMOS (prepaid group
practices): HMOs could not advertise, they had to be nonprofit, and a majority of the
Board of Directors of an HMO had to be physicians. The purpose of these restrictions
were to prevent HMOs from competing with fee-for-service physicians.
3. Federal efforts to reduce Medicare spending
 Medicare Part A was funded by a special payroll tax, and the amount collected was
insufficient to pay for Medicare hospital expenditures, which rose faster than expected.
 Feds faced with the following options: increase the payroll tax and the wage base to which it
applied, pay hospitals less for treating Medicare patients, or increase fees to Medicare
patients. Tried first two options were politically less costly than increasing the burden on the
aged.
 Additional regulatory approaches were also used by federal and state governments to control
these rapidly rising expenditures. Medicare utilization review programs were instituted, and
controls were placed on hospital investment in new facilities and equipment. However, these
government controls proved ineffective; hospital expenditures continued their rapid rise
throughout the 1970s.
4. 1980s medical services becomes much more price competitive
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Reagan efforts to achieve savings in Medicaid
o In 1981 removed the “free choice of provider” requirement for Medicaid enrollees;
states were able to require their Medicaid population to participate in closed provider
panels, enabling them to contract with HMOs and accept bids from hospitals for care
of their Medicaid patients.
o The “free choice” requirements remained in place for Medicare until the mid-1980s,
at which time enrollees were permitted to voluntarily join HMOs.
o In 1983, a new Medicare hospital payment system was phased in. Hospitals were no
longer paid according to their costs; fixed prices were established for each diagnosticrelated-group (DRG) admission, and each year Congress set an annual limit on the
increase in these fixed prices per admission. Since hospitals could keep the difference
between their costs and the fixed DRG price, they now had an incentive to reduce
their costs for caring for Medicare patients and discharge them earlier. The length of
stay per admission fell, and occupancy rates declined.
o In 1992 Medicare went to prospective payment for MDs.
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In the private sector, businesses struggling to survive the recession of the early 1980s focused
on reducing labor costs. Because health insurance was the fastest-growing labor expense,
businesses put pressure on health insurers to better control both the use and cost of medical
services. This led to more outpatient surgery, increases in deductibles and copayments, priorauthorization restrictions, and utilization reviews to reduce costs. These actions greatly
reduced hospital admission rates. Between 1970 and 1998, hospital admissions per 1,000 in
Blue Cross plans declined from 127 to 71.
Physician supply, which increased as a result of the 1960s federal support to medical schools,
resulted in physicians having excess capacity and a willingness to join closed provider
panels. With excess capacity among suppliers, and demanders determined to reduce
employees’ medical expenses, the preconditions for price competition were in place.
The applicability of the antitrust laws to healthcare, upheld by the US Supreme Court in
1982, removed any anticompetitive barriers to price competition.
Consequences of 1980s changes:
o Traditional physician-patient relationship disrupted
o Utilization review, limited panels, case management, mandatory use of cheaper
substitutes (providers, outpatient, generics)
o Big drop in hospitalization & big discounts from providers to insurers
o Big increase in competition between insurers. Compete for employer business via
price & reputation of networks.
o Managed care insurance became dominant (20% of Medicare today, most Medicaid
and nearly all private employer plans)
5. 1990s and on starts a new escalations
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Backlash: public wanted greater access to care, and politicians respond with restrictions
on managed care organizations—mandating minimum lengths of stay in the hospital for
normal deliveries, for example.
The population is aging, technological advances are improving early diagnosis, and new
methods of treatment are becoming available, all of which result in higher demand for
costly medical services. Costs are also driven up by government regulations at the state
and federal levels that mandate minimum care requirements and freer access to
specialists. New technology is believed to be the most important force behind rising
expenditures. More highly trained medical personnel are needed to handle this
technology, and wages must be raised to attract more nurses and technicians to the
medical sector.
In response to consumer demands for easier access to providers and specialists, health
plans have broadened their provider networks, thereby decreasing their ability to
negotiate large provider discounts. Hospital mergers that have lessened competition have
also enabled these hospitals to increase their prices to health plans.
6. The Affordable Care Act (ACA) briefly
Decreased the number of uninsured by expanding Medicaid, offering individual subsidies, and
mandates for companies and individuals. Before (2013) ACA, 40-45 million (15%) Americans
uninsured. ACA expanded Medicaid eligibility from 100 to 133 percent of the federal poverty level
(FPL). Subsidies for people who bought on state & federal exchanges (from 133 to 400 % of FPL).
Larger companies must also provide full-time employees coverage. Today 30 million uninsured and
uninsured % decreased to 9.2%. Note: most “Red” states did not expand Medicaid.