The Economic Case for Health Care Reform

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The Council of Economic Advisers (CEA) has undertaken a comprehensive analysis of the economic impacts of health care reform. The report provides an overview of current economic impacts of health care in the United States and a forecast of where we are headed in the absence of reform; an analysis of inefficiencies and market failures in the current health care system; a discussion of the key components of health care reform; and an analysis of the economic effects of slowing health care cost growth and expanding coverage.

The findings in the report point to large economic impacts of genuine health care reform:

  • We estimate that slowing the annual growth rate of health care costs by 1.5 percentage points would increase real gross domestic product (GDP), relative to the no-reform baseline, by over 2 percent in 2020 and nearly 8 percent in 2030.
     
  • For a typical family of four, this implies that income in 2020 would be approximately $2,600 higher than it would have been without reform (in 2009 dollars), and that in 2030 it would be almost $10,000 higher. Under more conservative estimates of the reduction in the growth rate of health care costs, the income gains are smaller, but still substantial.
     
  • Slowing the growth rate of health care costs will prevent disastrous increases in the Federal budget deficit.
     
  • Slowing cost growth would lower the unemployment rate consistent with steady inflation by approximately one-quarter of a percentage point for a number of years. The beneficial impact on employment in the short and medium run (relative to the no-reform baseline) is estimated to be approximately 500,000 each year that the effect is felt.
     
  • Expanding health insurance coverage to the uninsured would increase net economic well-being by roughly $100 billion a year, which is roughly two-thirds of a percent of GDP.
     
  • Reform would likely increase labor supply, remove unnecessary barriers to job mobility, and help to "level the playing field" between large and small businesses.
     

WHERE WE ARE AND WHERE WE ARE HEADED

Health care expenditures in the United States are currently about 18 percent of GDP, and this share is projected to rise sharply. If health care costs continue to grow at historical rates, the share of GDP devoted to health care in the United States is projected to reach 34 percent by 2040. For households with employer-sponsored health insurance, this trend implies that a progressively smaller fraction of their total compensation will be in the form of take-home pay and a progressively larger fraction will take the form of employer-provided health insurance.

The rising share of health expenditures also has dire implications for government budgets. Almost half of current health care spending is covered by Federal, state, and local governments. If health care costs continue to grow at historical rates, Medicare and Medicaid spending (both Federal and state) will rise to nearly 15 percent of GDP in 2040. Of this increase, roughly one-quarter is estimated to be due to the aging of the population and other demographic effects, and three-quarters is due to rising health care costs.

Perhaps the most visible sign of the need for health care reform is the 46 million Americans currently without health insurance. CEA projections suggest that this number will rise to about 72 million in 2040 in the absence of reform. A key factor driving this trend is the tendency of small firms not to provide coverage due to the rising cost of health care.

INEFFICIENCIES IN THE CURRENT SYSTEM AND KEY ELEMENTS OF SUCCESSFUL HEALTH CARE REFORM

While the American health care system has many virtues, it is also plagued by substantial inefficiencies and market failures. Some of the strongest evidence of such inefficiencies comes from the tremendous variation across states in Medicare spending per enrollee, with no evidence of corresponding variations in either medical needs or outcomes. These large variations in spending suggest that up to 30 percent of health care costs (or about 5 percent of GDP) could be saved without compromising health outcomes. Likewise, the differences in health care expenditures as a share of GDP across countries, without corresponding differences in outcomes, also suggest that health care expenditures in the United States could be lowered by about 5 percent of GDP by reducing inefficiency in the current system.

The sources of inefficiency in the U.S. health care system include payment systems that reward medical inputs rather than outcomes, high administrative costs, and inadequate focus on disease prevention. Market imperfections in the health insurance market create incentives for socially inefficient levels of coverage. For example, asymmetric information causes adverse selection in the insurance market, making it difficult for healthy people to receive actuarially reasonable rates.

CEA’s findings on the state of the current system lead to a natural focus on two key components of successful health care reform: (1) a genuine containment of the growth rate of health care costs, and (2) the expansion of insurance coverage. Because slowing the growth rate of health care costs is a complex and difficult process, we describe it in general terms and give specific examples of the types of reforms that could help to accomplish the necessary outcomes.

THE ECONOMIC IMPACT OF SLOWING HEALTH CARE COST GROWTH

The central finding of this report is that genuine health care reform has substantial benefits. CEA estimates that slowing the growth of health care costs would have the following key effects:

  1. It would raise standards of living by improving efficiency. Slowing the growth rate of health care costs by increasing efficiency raises standards of living by freeing up resources that can be used to produce other desired goods and services. The effects are roughly proportional to the degree of cost containment.
     
  2. It would prevent disastrous budgetary consequences and raise national saving. Because the Federal government pays for a large fraction of health care, lowering the growth rate of health care costs causes the budget deficit to be much lower than it otherwise would have been (assuming that the savings are dedicated to deficit reduction). The resulting rise in national saving increases capital formation.
    Together, these effects suggest that properly measured GDP could be more than 2 percent higher in 2020 than it would have been without reform and almost 8 percent higher in 2030. The real income of the typical family of four could be $2,600 higher in 2020 than it otherwise would have been and $10,000 higher in 2030. And, the government budget deficit could be reduced by 3 percent of GDP relative to the no-reform baseline in 2030.
     
  3. It would lower unemployment and raise employment in the short and medium runs. When health care costs are rising more slowly, the economy can operate at a lower level of unemployment without triggering inflation. Our estimates suggest that the unemployment rate may be lower by about one-quarter of a percentage point for an extended period of time as a result of serious cost growth containment.
     

THE ECONOMIC IMPACT OF EXPANDING COVERAGE

The report identifies three important impacts of expanding health care coverage:

  1. It would increase the economic well-being of the uninsured by substantially more than the costs of insuring them. A comparison of the total benefits of coverage to the uninsured, including such benefits as longer life expectancy and reduced financial risk, and the total costs of insuring them (including both the public and private costs), suggests net gains in economic well-being of about two-thirds of a percent of GDP per year.
     
  2. It would likely increase labor supply. Increased insurance coverage and, hence, improved health care, is likely to increase labor supply by reducing disability and absenteeism in the work place. This increase in labor supply would tend to increase GDP and reduce the budget deficit.
     
  3. It would improve the functioning of the labor market. Coverage expansion that eliminates restrictions on pre-existing conditions improves the efficiency of labor markets by removing an important limitation on job-switching. Creating a well-functioning insurance market also prevents an inefficient allocation of labor away from small firms by leveling the playing field among firms of all sizes in competing for talented workers in the labor market.
     

The CEA report makes clear that the total benefits of health care reform could be very large if the reform includes a substantial reduction in the growth rate of health care costs. This level of reduction will require hard choices and the cooperation of policymakers, providers, insurers, and the public. While there is no guarantee that the policy process will generate this degree of change, the benefits of achieving successful reform would be substantial to American households, businesses, and the economy as a whole.

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