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Do We Need An Individual Mandate?

May 10th, 2010

Should everyone be required to have health insurance? The short answer is no. There is nothing that can be achieved with a mandate to buy health insurance that cannot be better achieved by a carefully designed system of tax subsidies. Beyond that, a requirement that everyone obtain insurance (as the new health reform law dictates) creates problems greater than the problem it is designed to solve.

The most common argument for an individual mandate is based on the free rider problem. Jonathan Cohn made this argument in the New Republic the other day. Similar thinking can also be found on the political right.

So what is the free rider problem?

Imagine a community in which everyone dutifully pays health insurance premiums every month, except Joe — who spends his money instead on other consumption. Then one day Joe gets sick and finds that he cannot pay the full costs of his medical care. So the rest of us — being compassionate sorts — chip in and pay for the remainder of Joe’s care. Upshot: When he was healthy, Joe got to consume all his income instead of paying premiums and after he got sick he managed to “free ride” on everyone else’s generosity. You can think of this as both an ethical problem and as an economic problem. Ethically, Joe is getting an undeserved benefit paid for by others bearing an undeserved cost. Economically, Joe is imposing an external cost on others. If we let Joe get away with not paying his own way, others might emulate his example, and the cost could grow through time.

The “Mandate Solution”: A Case Of Overkill

Turning to the “mandate solution,” let’s add a bit of realism here. On the average, people without health insurance consume only about half as much health care as everyone else — after adjusting for other characteristics; and of the amount of care they consume, they pay for about half from their own resources. So, roughly speaking, the “free ride” for the average uninsured person is equal to about one-fourth of what everyone else spends on health care.

With these facts in mind, it should be clear that forcing Joe to buy insurance that pays for the same amount of care everyone else gets would be overkill. It would be overkill four times over. To get Joe to pay his own way, we need to take from him an amount of money equal to one-fourth the average health care spending of insured people and either distribute it to everyone else or put it in a fund to pay for uncompensated care required by Joe and others like him.

How could that work? Let’s say that $X is the average health care spending by insured people. Then, one solution would be to make Joe pay $X/4 in extra taxes each year. Or, we could achieve an equivalent outcome by giving everyone who has insurance a tax break equal to $X/4, but deny the break to Joe and everyone else who is uninsured.

Alert readers will realize that what I am describing is not all that different — at least in principle — from the current tax system. For people who get insurance at work, the employer’s premium payments avoid income and payroll taxes, unlike the payment of wages. For a broad stretch of middle-income earners, that means avoiding a 15% FICA tax and a 10% federal income tax. If there are state and local income taxes, the subsidy is greater than 25%.

By contrast, families with similar incomes who are uninsured (and, therefore, receive extra compensation in the form of taxable wages rather than nontaxed health insurance) will face a tax bill that is higher by an amount roughly equal to one-fourth of the cost of employer-provided insurance.

Designing  A Better Solution

If we want to build on this structure to create a much fairer and equitable answer to the free rider problem as well as one with better incentives, however, there are three fundamental flaws that need to be corrected.

First, although the subsidy/penalty system seems to be broadly adequate for the middle-class, it is far less so for the rest of the population. For the upper middle-income families, the subsidy for employer-provided health insurance approaches 50%; whereas for lower-income families it is as low as 15%. Generally speaking, we are over-subsidizing the health insurance of the wealthy and undersubsidizing it for the poor. A fixed-sum tax credit — essentially giving everyone the same subsidy, regardless of income — would solve this problem once and for all.

Second, there is no connection between the penalties and the subsidies. That is, the extra taxes paid by the uninsured for the most part go to Washington, while the uncompensated care must be delivered locally. In terms of our example, even though Joe is paying an appropriate penalty for being uninsured, his penalty is being spent on other things by another political jurisdiction. His neighbors will have to cough up additional amounts if he needs free care.

Third, although we subsidize employer-paid insurance — in some cases very generously — there is virtually no subsidy for people who obtain insurance on their own. Whereas employees through their employers can buy insurance with pretax dollars, people on their own must pay with aftertax dollars. (The self-insured get a partial subsidy.)

Now let’s stop and take stock. We began with the free rider problem, which can generally be described as some people reaping benefits and other people bearing costs which are undeserved. Then, in thinking about how to solve this problem, we discovered that the health care system is riddled with undeserved benefits and undeserved costs. Fortunately, sensible reform can solve all these problems in one fell swoop.

Recently Passed Health Reform Legislation Makes Things Worse

But…and this will come as a surprise to some…the newly enacted health reform leaves intact all three flaws discussed above. Plus, it adds a new dimension — a bizarre system of new subsidies that give a whole new meaning to the idea of undeserved costs and benefits. As previously explained:

  • A $30,000-a-year worker with family will be forced to take a $14,000 health plan instead of wages (overkill four times over) and get a tax subsidy of little more than $2,000.
  • Someone at the same income level in a health insurance exchange, however, will get an identical plan almost completely paid for by Uncle Sam, plus reimbursement for most out-of-pocket expenses for a total subsidy in excess of $19,000.
  • A $60,000-a-year family getting insurance in the exchange will get a subsidy twice as large as a family earning half as much income ($30,000).

Thus, although the law has an individual mandate, it does not solve the problem of the undeserved benefits made possible by free-ridership. Instead, it creates even more undeserved costs and benefits — creating far more inequities than were there before.

Even more bizarre, it may not even reduce the number of uninsured. As Marty Feldstein has pointed out, the penalties are low and enforcement may be weak. We may end up with more free-riding uninsured people than ever before.

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6 Responses to “Do We Need An Individual Mandate?”

  1. John Goodman Says:

    Response to lotusrising: We do not have to let Joe wait until he gets sick and then buy insurance for the same premium everybody else pays. In fact, this would be a very foolish thing to do. It would encourage Joe and many others to remain uninsured while healthy and only buy insurance during times when they needed medical care.

    The better strategy is the one I suggested. Give Joe a reasonable subsidy to buy insurance while he is healthy. If he rejects the offer, put the money in a fund from which to pay his medical bills — but only after he has exhausted his own resorces.

    By all means allow him to buy insurance after he gets sick, but only if he is willing to pay actuarialy fair, free market premiums that reflect his expected health care costs.

  2. Heather Fell Says:

    The difference here is that guaranteed issue by insurance companies means that “Joe” can purchase insurance when he gets sick, and the insurance company will have to provide coverage without any exclusions for pre-existing conditions.

    Essentially, it’s like letting people buy fire insurance when they smell smoke. Without an individual mandate / social norms requiring everyone to carry health insurance, the free rider problem will be exacerbated by reform.

    Monkeywrench, on what basis do you believe that the British NHS has led to higher costs and lower quality compared to the US system? In the US, our life expectancy is lower, infant mortality higher, and healthcare costs higher (per capita, and as percent of GDP) than in the UK.

    Health Care Costs Around the World

    I think that there is a real misperception about how “good” our healthcare is in the US. People with good insurance coverage may experience some of the best healthcare here – Cleveland Clinic, Mayo, etc. There is no argument that the US has some of the best and most innovative healthcare practitioners in the world. But that doesn’t translate to our system being better than others. How good is the quality for the working, uninsured poor person who can’t afford primary care and ends up finding out they have cancer too late to do anything about it?

    I think that we should view reasonable health care coverage as a public good, and everyone should contribute on an income-adjusted basis. From a pure economic perspective – a healthy population is a productive population. From a humanitarian perspective – I believe that basic healthcare is a human right, and something that the most developed and successful nations like the US should provide.

    In fact, almost every other developed and successful nation in the world does provide basic healthcare to all its citizens. Let’s apply some good old-fashioned American ingenuity to this problem, and figure out how we can provide healthcare to all Americans without bankrupting our nation – which the pre-reform system was on pace to do!

  3. Catherine Says:

    I agree with Brian. The incentives are all wrong with the new plan. I know from two years of managing my own HSA that I am a much more efficient patient now. I weigh cost vs. benefit on every expense. It’s a totally different mindset than the years I spent with one flat co-pay and no interest in what anything cost. The worst-case scenario to me is letting the government decide what is beneficial and what my costs will be.

  4. Pam V. Says:

    Not to mention, a mandate will not likely make a difference in getting more people to buy insurance, particularly due to the fact that the insurance cost will likely be worse than the penalty. This has been shown with auto insurance. In that case there is a social cost that is not internalized by the uninsured. Those around the uninsured driver carry “uninsured motorist” coverage. The uninsured driver likely drives a clunker that he will not bother getting fixed, the care he gets in the ER that he can’t pay for will just be written off as a loss to the health care provider, and if he is liable…well, you can’t get blood from a turnip.

  5. Devon Herrick Says:

    People often used the “free-rider” argument in support of requiring an individual mandate. However, I believe the primary reason proponents pushed for an individual mandate was to more easily compel young, healthy people into cross-subsidizing older, sicker enrollees. (If proponents were truly only concerned about free-ridership, they could have mandated high-deductible plans with limited lifetime benefits. That would have been sufficient for 98% of the population)

    The only way to enforce a system of cross-subsidies that finance generous, first-dollar coverage for those with pre-existing conditions is to force those currently paying little (or nothing) for medical care to pay far more than their expected costs.

    I’ve heard this fiction repeated numerous times… “health coverage will only be affordable when everyone is covered.” An individual mandate does not magically make coverage affordable. It merely subsidizes those with the highest medical bills by making younger colleagues chip in more of their earnings.

  6. Brian R Williams Says:

    Problem: Somewhere between 30-50 million people lack health insurance.

    Solution: Make it illegal to be uninsured. Everyone must purchase health insurance, under penalty of law. Problem solved.

    If the individual mandate is viewed as a viable solution to the uninsurance problem, what other problems can the government “solve” with an individual mandate? Can the government tackle obesity by requiring everyone to purchase a health club membership? Can the government combat homelessness by requiring all Americans to buy a home?

    I fear the individual mandate will not only fail to solve the problem, I fear it gives government more power over our personal lives.

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