Friday, June 19, 2009

Healthcare Reform Could Push The US Over The Edge

Kenneth Rogoff, Harvard professor and former chief economist of the International Monetary Fund, warns that expensive healthcare reform could lead to a financial crisis worse than we are currently experiencing. However, University of Oregon economics professor Mark Thoma disagrees with the assumption that reform would necessarily increase costs. See the following for a summary of Rogoff's commentary and Thoma's response in the following post from The Economist's View.

Kenneth "The Hawk" Rogoff:
America should also look to its fiscal health, by Kenneth Rogoff, Commentary, Financial Times:
America desperately needs a better framework for providing healthcare and Barack Obama’s administration is right to press on for change... Yet given the explosion of the federal debt, it is extremely important to craft a plan that will not excessively risk the government’s own fiscal health. The risks cannot easily be overstated.

The US government is already entering a prolonged period where it is extremely vulnerable to a loss in investor confidence from the Chinese and other main holders of its Treasury securities. Foreign investors are rightly concerned about the deeply ingrained reluctance of Americans to tax themselves. The last thing the US needs is to be viewed as one giant California, rich but unwilling to pay enough taxes to fund the services its citizens demand. A sharp rise in taxes to pay for healthcare initiatives could potentially weaken the credibility of the government’s promise to raise taxes as needed to pay off debtors. ...

[I]n principle, fixing the imbalances in the Social Security and, especially, the Medicare programmes could provide a powerful offset to the huge increase in debt burdens visited by the financial crisis.

Unfortunately, the idea that healthcare reform will alleviate debt problems rather than exacerbate them is far-fetched..., many proposed healthcare reforms are more likely to worsen the government’s budgetary health than to improve it. This should hardly be surprising, given that a main purpose of reform is to help provide better care for Americans who cannot afford insurance.

Higher taxes to pay for healthcare are also likely to reduce US growth, making it far more difficult to escape the debt trap. This comes at a time when other policy initiatives, such as tackling environmental degradation and income inequality, are also likely to imply higher tax burdens... In addition, the continuing weakness of the financial sector weighs on growth, and it is by no means clear yet when and how some semblance of normality will be restored. ...

All of these considerations appear to underscore the importance of finding ways to keep the new health plan from being overly burdensome, and to avoid unduly optimistic projections on efficiency savings. Healthcare reform is no substitute for finding a credible path to fiscal sustainability. ...

Make no mistake, the US and much of the developed world is in a frighteningly precarious fiscal state. ... It is a disgrace that the world’s richest country cannot provide reliable basic care for its poorest citizens. But if the politics of reform produces too extravagant a plan when the nation’s fiscal health is already so weak, the US may experience a form of financial crisis even more virulent than the one it is recovering from. Any healthcare plan would then be dead on arrival.

Setting the fear mongering about the future aside - and there's no evidence in long-term interest rates that financial market participants are worried about these issues - here are a few things to keep in mind when thinking about health care reform First, it is not a demographic problem. This graph is from a CBO presentation on this point, and is fairly self-explanatory:

Second, rising health care costs is not just an issue for Medicare and Medicaid, the same rise in costs is also projected to hit private sector health care. Again, from the CBO:

Projected Spending on Health Care Under an Assumption That Excess Cost Growth Continues at Historical Averages (Percentage of GDP)

Going back to the question of the effect of health care reform on the long-run budget, though expanding coverage will expand increase the total amount of medical care that is provided, and hence increase costs, there seems to be some confusion between expanding overall coverage and simply moving the dividing line between the public and private sectors upward so that the public sector expands and the private sector contracts by the same amount. Changing the dividing line, all else equal, simply changes how the bills are paid, it has no effect at all on the overall health care burden that people face (it moves the dividing line in a graph like the one above showing the public and private sectors explcitly without changing the total area). So it's hard to see why higher taxes driven by this type of a change would have the negative economic effects Rogoff is worried about.

But he is more worried that expanding the size of the public sector both by moving the dividing line up and by including more people - the latter in particular - will increase increases health care costs and add to the debt burden, which in turn would require higher taxes. Is that true? It would if the only effect of the expansion of the public sector was to increase the number of people receiving care, and his claim that costs won't fall, or at least not by much, presumes this is how it will work. But when we look at other countries that have substantially expanded the public sector we see lower costs - on the order of 50% lower - and no reduction in the quality of the care that people receive. That's a huge reduction in costs, a reduction large enough to allow a significant expansion of coverage without increasing costs at all. I don't think we'll reduce costs by that magnitude, 50% seems like a lot to hope for, but it does imply that it's possible to reform the system without compromising quality or experiencing the dire consequences Rogoff fears.

This article has been reposted from the Economist's View. The full post can also be viewed on the Economist's View.

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