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Health Care Economics 101 And The Supreme Court



May 23rd, 2012

Editor’s note: Kathryn Gilbert, a J.D. candidate at the University of Michigan Law School, is a coauthor of this post, in addition to Jill Horwitz and Helen Levy (photos and linked bios above).

The case that will decide the fate of the most important piece of health care legislation in the past fifty years has, perhaps unsurprisingly, broken a number of records.  The Supreme Court allowed six hours of oral argument in the case, the longest since 1967.  Friends of the court also filed a record 152 briefs.  Of these, the two that garnered the most interest from the Justices were drafted by economists, not lawyers.  These briefs, particularly the one favoring the respondents (sponsored by the American Action Forum, the “AAF”), figured prominently in the oral arguments and are likely to show up in the opinion.  But we hope that the Justices won’t repeat the economic and policy misunderstandings, discussed below, that pervade the economists’ brief for the respondents and were reflected in the arguments.

Here we focus on two key misunderstandings from the AAF brief, each repeatedly raised by the conservative Justices.  The first has to do with the uniqueness of health care markets, and the second has to do with the idea that it is unfair to require young adults to buy health insurance that is not a “good deal” for them.

Health Care Markets Are Indeed Unique

We begin with a claim raised in the AAF brief, that the economic nature of health care markets is not unique and, therefore, cannot serve as a limiting principle for exercise of the commerce clause.  Some of the Justices repeated the mistaken idea that if the court upholds the individual mandate, Congress will be able to force individuals to buy other not-very-special goods, such as broccoli or cars.  Regardless of any legal differences between broccoli and cars on the one hand and health care on the other – differences that do not need to relate to the unique nature of health care markets for the court to find that a limiting principle applies sufficient to uphold the mandate – there are significant economic differences between health care and the list of goods the amicus brief and some of the Justices cited.  However the Court rules, it should not base its reasoning on the misperception that such economic differences do not exist.

From an economic perspective, the market for health care is characterized by multiple and substantial departures from the assumptions of perfect competition.  As Kenneth Arrow explained in a seminal 1963 article, the most salient of these are uncertainty about the demand for care, which gives rise to the market for insurance, and information asymmetries in the market for insurance that result in adverse selection.  These departures from perfect competition result in inefficiency.

The key insight from economics is that in the presence of these significant market imperfections, appropriately structured government intervention — which in this case means guaranteed issue, community rating, and an individual mandate — can actually promote efficiency, solving the problem of market failure and making the pie bigger for everyone.  This is never the case in perfectly competitive markets, where government intervention may be desirable for other reasons, such as redistribution or the imperative to raise revenue, but cannot improve the efficiency of the market.  Markets for cars or broccoli, unlike the market for health insurance, are very close to the ideal of perfect competition.  Intervention in these markets – for example, forcing people to buy American-made cars to shore up the financial position of the automakers – is unambiguously inefficient.

The distinction between competitive markets and the health insurance market, which is filled with failures, was absent from the oral arguments.  Instead, some Justices, relying on the AAF brief, asked questions suggesting that health insurance markets function just like other markets.  Justice Scalia, for example, explained to General Verrilli that, “if people don’t buy cars, the price that those who do buy cars pay will have to be higher.  So you could say in order to bring the price down, you are hurting these other people by not buying a car.” (Transcript, 19).  Mr. Clement, arguing for the respondents, drove the point home when he said, “When I’m sitting in my house deciding I’m not to buy a car, I am causing the labor market in Detroit to go south.” (Transcript,  69).

Forcing people to buy cars would address no market failure and would redistribute resources (from consumers to car producers) in a way that is inefficient.  Congress may want to intervene in the market for cars for unrelated policy reasons, perhaps to achieve some redistributive goals.  But economists and policymakers interested in the efficient functioning of markets would not wish to do so.  (Indeed, this is why the economists’ brief for the petitioners, to which coauthor Jill Horwitz was a signatory, did not make claims about negative externalities, but focused on adverse selection.)

In addition, some of the Justices not only asked questions implying health insurance markets are like other markets, but also that health care goods are just like other goods.  But the only way to turn health care into a not-so-special good is to conceptually dismantle it, characterizing each attribute of the market as non-unique rather than considering together the multiple features that fill health care markets with failure. So, for example, health care isn’t so uniquely unavoidable – everyone has to buy food, too.  Or, the unpredictable timing of your need for health care isn’t particularly unpredictable: look at other insurance markets like fire insurance.  But the health care market has many, interrelated features, each of which leads to failure.  Compounded, they set the health care market apart in type and, most significantly, in degree from all other markets.

Consider the claim that health care’s unpredictability is not unique: you can’t guess when you’ll get hit by a bus and need catastrophic care, and you also can’t guess when your home will flood or burn down.  But the unpredictability claim is a microcosm of the fundamental problem with the AAF brief’s ceteris paribus approach:  healthcare is unpredictable in many ways, including its costs, timing, and duration.  When, during oral arguments, Justice Roberts asked whether the government may mandate the purchase of a cell phone to facilitate emergency phone calls, he asked only about temporal unpredictability.  (Transcript, 6)

(As an aside – Justice Roberts focused on the wrong market in any event.  He said that the comparison was apposite because one doesn’t know when one will need an emergency response, but when you do, the government covers that need.  But consider how this comparison is really one that supports the mandate.  The government has a monopoly over emergency response, because it’s so unpredictable and would otherwise fail that it needs to be heavily — indeed, entirely — regulated.  So it’s kind of hard to address the “market” comparison, since the market seems to be for emergency services!  The cost of the cell phone is entirely predictable.)

Or take the idea that the inevitability of health care is nothing special since, as Justice Scalia reminded us, we all need to eat.  (Transcript, 13).  Again, while the food market shares this one attribute, it is different in other crucial ways.  In particular, the timing and costs of food purchases are both very predictable.

Likewise, everyone dies.  To that end, Justice Alito asked whether the government can mandate purchase of burial insurance. (Transcript, 7-8)  Burial insurance indeed shares some important attributes with health insurance.  After all, this is an insurance market that has quite a bit of adverse selection, and the government is left holding the bag when people are uninsured and have no relatives who will pay their burial costs. But burial is a one-time event for everyone, unlike the uncertain and continuously evolving need for health care.

Moreover, the stakes are low.  This country is not wracked by a burial insurance crisis.  Burial has neither excessive nor (in the long run) unpredictable costs.  Even if all of the approximately 2.4 million people dying in a given year left no provision for the disposal of their remains, the total cost to the government would not be more than $2.4 billion, assuming cremation cost of $1,000.  But if those costs were considerably higher, like those of health care, then the answer to Justice Alito’s question should be yes – with the important qualification that such a requirement would promote efficiency by addressing a market failure.

The ACA Does Not Unfairly Force The Young And Healthy To Subsidize The Old And Sick

Justices Alito and Scalia also raised questions echoing a second mistaken claim found in the AAF brief.  In effect, they ask whether it is unfair to force young, healthy people to buy insurance that is not a good deal for them simply to subsidize old, sick people.  (Transcript,9 -10, 33, 35)  If this is what the ACA did, this might be a good question  (although, as Justice Ginsburg noted, the design of Social Security implies a similar pattern of subsidies (Transcript, 57).  But this is not what the ACA does.

Contrary to assertion in the AAF brief (AAF Brief 8, 25), the Act does not impose pure community rating – which would indeed entail substantial transfers from young to old – but rather, it employs community rating with variation in premiums for age, geographic location, family size, and smoking status.  In fact, it allows quite a bit of adjustment for age.  Insurers may set premiums for older individuals as much as three times as high as those for younger individuals. There was no mention of this feature of the law in the AAF brief or during the oral arguments; no acknowledgement that the higher average spending of older people would be reflected in their higher premiums.

The three-to-one “age band” in premiums is the same as the ratio of average medical spending for 45 to 64 year olds to spending for 18 to 24 year olds, according to data from the 2009 Medical Expenditure Panel Survey. Moreover, the ACA also offers young adults up to age 30 the opportunity to purchase catastrophic policies that are not available to older adults.

Taking these two features of the law into account, it is not clear there will be much redistribution from young to old as a result of the ACA at all. There will, within each age group, be pooling of good and bad risks; by definition, this is how insurance works, and as noted above is a more efficient outcome than one in which markets do not exist because of adverse selection.  But subsidies from young to old are a red herring.

EMTALA Codified An Existing Imperative To Provide Emergency Care

In closing, we note that the AAF brief (pg. 32 et seq.), makes a striking claim that is not about economics at all.  It suggests that health care isn’t uniquely inefficient, because its inefficiencies stem from federal legislation.  Following the brief, Justices Alito and Scalia (Transcript 20, 37, 86) pointed to the cost-shifting associated with the Emergency Medical Treatment and Active Labor Act (EMTALA), which requires hospitals that accept Medicare patients (as nearly all do) to stabilize everyone who comes to their emergency rooms if they have an emergency condition or are actively in labor, regardless of their ability to pay for that care.

But EMTALA didn’t create the moral and legal imperative to provide emergency care; it codified that imperative.  As the economists’ brief in favor of the mandate notes, a majority of hospitals provided this type of care well before EMTALA was born.  Many states had statutory or common law rules to the same end.  EMTALA and the ideals and rules it embodies are thus yet one more unique feature of the healthcare market, not an artificially imposed inefficiency.

The “tradition of assuring the availability of some minimal level of treatment to all Americans without regard to ability to pay reflects a collective decision that we are, as a Nation, generally unwilling to see others come to great harm for lack of access to medical care.” (Economic Scholars Brief in support of Petitioners, 10-13).  In oral arguments, Justice Sotomayor asked whether Americans would be willing to accept the death of a child turned away from an emergency room because of an inability to pay. (Transcript, 97-98)  The final unique feature of the health care market, one of a complex set that we hope the court considers carefully, says that the answer is no.

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2 Responses to “Health Care Economics 101 And The Supreme Court”

  1. markus narath Says:

    What is peculiar about the duck-billed platypus?

    “The method of reasoning that you employ here is not adequate to sustain the conclusions that you draw, in fact the conclusion is itself a non sequitur. What you do is consider various characteristics of medical care…and you show that each of these in turn is to be found in some other (non-collective) good or service. You then draw the quite unwarranted conclusion that medical care is not markedly different…This conclusion is unwarranted because what you need to show…is that there are ‘other goods in the market’each of which exhibits all of these characteristics. Let me illustrate my point by analogy. What is peculiar about the duck-billed platypus? It has a duck-type bill, a furry body like a mole, it lays eggs, and it suckles its young! Now the type of analysis you have employed would run as follows…many birds have duck-type bills, and lots of animals have furry bodies, and as for laying eggs, this is common among birds and reptiles, and all mammals suckle their young, therefore the duck-billed platypus ‘would appear to have no characteristics which differentiate it sharply from other…’etc. I hope my point is clear.”
    Alan Williams, in a letter to Dennis Lees, November 1961

    Economics of health care financing : the visible hand / Cam Donaldson and Karen Gerard ; with Stephen Jan, Craig Mitton, and Virginia Wiseman. 2nd Ed. Palgrave Macmillan, 2004. p.31

  2. emt22 Says:

    Two comments: 1) Although Arrow posits that uncertainty may give rise to insurance, there is no indication that insurance should compose the entire payment market for medical goods. That is, why is the relevant market the health insurance market, rather than market for medical services of which insurance (probably catastrophic) would only be one payment option including others such as paying out-of-pocket?

    2) Regarding subsidies, your argument does not knock down the assertion that the young will be subsidizing the old: The fact that average spending in the 45-64 cohort is 3 times that of in the 18-24 means little; this because they are not in the same pool, and expenditures are based on aggregate expenditures, not average expenditures. Thus, at least some youth will be subsidizing based on the distribution.

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