Paul Krugman: Additional Notes on Gold-Plated Indifference

Paul Krugman emails more background on his column today. This appears in his Money Talks column and explains some of the economics behind his opposition to the Bush proposal:

Additional Notes on 1/22 Column, "Gold-Plated Indifference": As is often the case, I couldn't fully explain my views in the space available. So I'd like to explain at a bit more length why I'm so opposed to the direction Bush is going.

Basically, everyone agrees that health care is a messed-up sector. But there are two opposing doctrines about what the problem is.

I believe - and the evidence, I think, supports this belief - that the big problem is "adverse selection." An insurance plan offered to everyone at the same rate would be a great deal for relatively sick people, a poor deal for the healthy. So one of two things happens to private insurance. Either plans go into the "adverse selection death spiral," as sick people flock in, driving up rates, driving out more healthy people, and so on. Or insurance companies spend a lot of the money they receive in premiums screening out "high-risk" clients, so that the system has huge overhead and the neediest cases are excluded.

The clean solution to this problem is for the government to provide insurance to everyone. Other rich countries do that. So do we, for older Americans, veterans, and others. Actually, government health insurance is already bigger in America, in dollar terms, than private insurance - it covers fewer people, but that's because the elderly, who cost more, are handled by the government.

Employment-based insurance is a distant second-best, but better than nothing. Large employers, in particular, can spread risk widely, creating the kind of risk pool that dies from adverse selection in the individual market. And the tax preference for employer-based care, more or less by accident, has helped sustain this imperfect fix - which is why I'm highly skeptical of anything that might erode that preference.

What conservatives in the "consumer-directed" health movement believe, however, is that the big problem is "moral hazard" - people consume too much medical care, because someone else pays for it.

Now, this isn't entirely wrong. People probably do undergo expensive surgery with questionable effectiveness, and so on, because it's not out of pocket. Curbing that was supposed to be the point of managed care. But managed care didn't deliver, because people - rightly - don't trust private HMOs to make life and death decisions on their behalf. Successful managed care only takes place in institutions like the VA where there's more trust in the institution's motives.

The whole consumer-directed thing is, in my view, just an attempt to avoid facing up to that failure. Rather than admit that private-sector institutions aren't any good at rationing, conservatives now say that patients should be induced to ration their own care by being forced to pay more out of pocket. And that's where Bush's attack on gold-plating comes from: reduce the tax advantage of employer-based care, and deductibles and co-pays might go up.

The trouble is that the big money is in stuff like heart operations - areas where (a) people can't pay out of pocket in any case - they must have insurance or go untreated - and (b) people really aren't sufficiently well-informed to make the decisions. Yet the whole focus of consumer-directed doctrine is on things like routine visits to doctors' offices and annual dental checkups. It's going where the money isn't - because the advocates just can't believe that markets aren't always the answer.

Now here's the thing: in the name of consumer-directed health care theory, Bush is proposing changes that would essentially encourage people to move into the individual market - which wastes a lot of money, and doesn't and can't work for those most in need - while undermining the employer-based system, which isn't wonderful but is still essential. In particular, healthy high-income people would be encouraged to drop out of employment-based plans, leaving behind a sicker risk pool, driving up rates, and pushing employer-based care in the direction of an adverse selection death spiral. The plan we're supposed to learn about tomorrow doesn't sound big enough to have catastrophic effects, but it's a step in the wrong direction.

Update: Tyler Cowen comments on Krugman's follow-up.