An Economic Perspective: Health care reform

Our current health insurance system is a relic of World War II.

Wage controls prevented businesses from increasing worker salaries. Benefits, like health insurance, were given to employees to increase total compensation. Health insurance is tax exempt and creates an incentive for individuals to receive insurance from their employer.

Health insurance is not a perfectly competitive market. Only 13 percent of payments are out-of-pocket, the rest come from private and public insurance agencies. This creates an incentive for people to demand more health care than can be efficiently allocated, clearly a market failure that needs correction.

Health care providers are receiving a profit at the cost of society. Trying to change this would be akin to removing tenure from teacher unions. No wonder 85,000 physicians are against reform!

According to Milton Friedman, in a most efficient system, either every individual would buy his own health insurance or the government would provide insurance for everyone. Both options would eliminate labor market rigidity and allow workers to move between jobs without fear of losing benefits.

This principle applies to small businesses today. The system right now creates a bias in favor of larger firms. Large firms are able to pay less per worker for insurance and give employees more benefits. If small firms are able to enjoy the same insurance rates as large firms through co-ops, they will become more competitive and create jobs.

Due to political entrenchment, we cannot have an efficient health insurance market; there are, however, four basic steps toward making our current system more efficient.

First, we need community ratings. Insurers will charge everyone the same rate regardless of medical history. This decreases administrative costs involved with examining patients to determine risk. It also prevents insurance companies from spending money to rescind coverage to current beneficiaries.

Second, we need mandated coverage. Individual coverage, where each person pays based on his own risk, is incredibly inefficient. It creates an incentive for healthy people to avoid buying insurance. This increases the cost for everyone else. A negative feedback loop exists where insurance costs constantly increase.

Third, we need subsidies for low-income families. This will not significantly increase costs because the government already subsidizes the poor through Medicaid. Without subsidies, poor families will try to evade coverage.

Fourth, we need private-public competition. Private insurance companies have astronomically high administrative costs; government insurance has very low administrative costs. In the late '90s, the private sector began providing Medicare insurance. It quickly became apparent that the private sector was less efficient than the public sector. If a public option is less efficient, it will not be used and health insurance will remain private.

The program I have outlined was implemented in Massachusetts by former Gov. Mitt Romney. It was also implemented on the federal level, without the public option, in 2010.

Currently we spend the most globally on health care but are 37th in the world in life expectancy. The key to improving our system is maintaining an efficient market that maximizes benefits. The president's plan is one step in that direction.

This article is the work of the Economics Society and reflects the views of its author. The views of the Economics Society are not necessarily represented in this article's content.