Obama's Health Cost Illusion

The President's main case for reform is rooted in false claims and little evidence.

The main White House argument for health-care reform goes something like this: If we spend now on a hugely expensive new insurance program for the middle class, we can save later by reducing overall U.S. health spending. This "tastes great, less filling" theory could stand some scrutiny, not least because it is being used to rush through the greatest social spending program in American history.

What if this particular theory turns out to be a political illusion? What if the speculative cost savings never report for duty, while the federal balance sheet is still swamped with new social obligations that will be impossible to repeal? The only possible outcome will be the nationalization of U.S. health markets, which will mean that almost all care will be rationed by politics Since Medicare was created in 1965, U.S. health spending has risen about 2.7% faster than the economy and on current trend would hit 20% of GDP within a decade. Every public or private attempt to arrest this climb has failed: wage and price controls in the 1970s, the insurance industry's "voluntary effort" in the '80s, managed care in the '90s.

Now the White House -- especially budget chief Peter Orszag -- claims there is new cause for hope. The magic key is the dramatic variations in per patient health spending among U.S. regions. Often there is no relationship between spending and the quality of care, according to a vast body of academic research, most of it coming out of Dartmouth College. If the highest spending areas could be sanded down to the lowest spending areas, about 30% in "waste," or $700 billion each year, would be saved. More than enough to pay for ObamaCare. Or so the theory goes.

But -- how? Mr. Orszag's ideas include more health information technology; emphasizing prevention and healthy living; rejiggering reimbursement policies so doctors and hospitals are paid more for quality care; and funding federal research that compares the effectiveness of medical treatments. These are the lovable bromides of all politicians, and some of them may or may not improve health overall. But there's scant evidence that any of them will ever save real money. There's a reason the Congressional Budget Office can't score them.

Think about comparative effectiveness. Why is low-cost, high-quality Minnesota, say, already making more rational decisions than high-cost, lower-quality Texas? It's ridiculous to suggest that doctors in Rochester have access to clinical information that isn't available in Houston. If it's because the former are simply better physicians, well, medicine isn't Lake Wobegon, where everyone is the Mayo Clinic.

The reality is that after three decades of economic research, the reasons that spending varies are still highly uncertain. As in politics, everything is local in health care. Most of the variation is due to the use of services and mix of care that patients receive, while some relates to labor costs and local prices. The abiding mystery is why practice patterns oscillate so widely, even among hospitals in the same city.

Not surprisingly, variation is greatest when doctors don't agree on the best treatments -- as with back injuries, for example. Another part is technology. New therapies are developed at an astonishing pace. Consider the stent, which props open arteries after a heart attack and was barely used in 1994. By 1998 stents were used in a majority of coronary surgeries. Constant innovation means that there must be trial and error, and thus regional spending variation.
* * *

Such technological change is the most important driver of health spending. Modern medicine can do so much more than it could in the past, but this costs a lot even as it has bought a lot in extending and improving lives. In a 2001 study, David Cutler (an Obama adviser) and Mark McClellan (a Bush adviser) found that the benefits of lower infant mortality and better treatment of heart attacks "have been sufficiently great that they alone are about equal to the entire cost increase for medical care over time."

No less an authority than Mr. Orszag admits that stomping out regional variation means constraining this experimentation. "Future increases in spending could be moderated if costly new medical services were adopted more selectively in the future than they have been in the past and if the diffusion of existing costly services was slowed," Mr. Orszag told Congress last year, when he was CBO director. He was careful to note that "savings are possible without a substantial loss of clinical value," but how does he know? Even if health planners in Washington could arbitrarily reduce spending in high-cost areas, low-value treatments may not be what go over the side.

Another complication is that the Dartmouth research shows spending variation in Medicare, for which uniform, common data are available. But similar data don't exist for the entire health system. Richard Cooper, a professor of medicine at the University of Pennsylvania's Wharton School, has studied regional variation in aggregate health spending, rather than Medicare-only. He found that the areas with the highest quality spend the most on medicine, whatever the mix of private and government funding. Areas with disproportionately high Medicare spending, generally in the South, correlate with the lowest quality -- but at the same time, with very low private spending.

Mr. Cooper's assault on the Dartmouth Atlas is controversial but compelling. He argues that the less-is-more theory is based on the flawed premise that when a region's outcomes did not improve as spending increased, the difference is simply classified as "waste" -- even if it isn't. That's the 30% figure Mr. Orszag likes to cite.

In any case, Medicare reflects the entire practice of medicine only as a funhouse mirror. It simply fixes the prices for thousands of services and procedures, usually well below those of private payers. There is no way of knowing if these administered prices are the "right" level, and, either way, marginal costs adapt to what is paid, creating perverse incentives of their own. Congress also regularly uses Medicare to skew the distribution of medical resources, such as extra payments to teaching hospitals or rural areas.

Above all, Medicare is an ocean of money surrounded by people who want some. It is not only an entitlement to beneficiaries, but a de facto revenue entitlement to hospitals, physicians, nursing homes, durable medical equipment suppliers and the rest. Even a tweak to the Medicare fee schedule is the small-scale equivalent of closing a military base or trimming farm subsidies. The system will never be as rational as Mr. Orszag desires unless it is severed from politics.
* * *

A far better alternative is to increase individual responsibility for medical decisions. In 1965, the average American paid more than half of his health care out of pocket. Spending has since increased sevenfold, but the amount that consumers pay directly hasn't even doubled. When people aren't exposed to the true cost of their care -- though it is paid in foregone wages and higher taxes for public programs -- they consume more care. The research of MIT economist Amy Finkelstein suggests that roughly half of the real increase in U.S. health spending between 1950 and 1990 is due to Medicare and the spread of third-party, first-dollar insurance.

Increasing cost-sharing would discipline the health spending curve and give it a more rational bent. As societies grow richer, it makes sense that people will invest more in their own well-being. Health is a superior good, while the utility of wealth is fairly low if you're dead. The U.S. health cost "crisis" is that we spend so much without incentives to weigh the costs against the benefits.

Yet the entire Obama agenda is about increasing political, rather than individual, control of the health markets. Ted Kennedy's draft health-care bill offers insurance subsidies up to 500% of the poverty line -- for a family of four, that's $110,250. In that kind of world, all costs will climb even higher as people use far more "free" care and federal spending will reach epic levels. Bureaucrats watching the bottom line will try to ration care while simultaneously locked in a death match with interest groups guarding their turf. Congress will join the fray and make things worse, as it always does. Caught in the political crossfire will be patients, as they always are.
* * *

None of the complexities surrounding regional health spending variation would matter as much if the Obama Administration were merely trying to defossilize Medicare and save the federal fisc. But instead it is exploiting the looming bankruptcy of our current entitlements as a pretext to pass the largest entitlement expansion since 1965. And it is selling this agenda with a phony cost-control "plan" that doesn't even exist.

The now-famous Obama-Orszag mantra -- "entitlement reform is health-care reform" -- really means that when they're done, all health care will be an entitlement.


Printed in The Wall Street Journal, page A13