Any Economics 101 course will tell you that the price of a good or service is determined by supply and demand. We’ve seen everyday examples of this in the recent COVID-19 pandemic: when the supply of toilet paper is low and the demand is high, the price goes up — even if that’s through resale on an online marketplace. Another example is when the demand for airline tickets plummets, but the supply remains the same, prices drop.
A market system functions, with few hiccups, largely in accordance with these invisible laws. Start interfering in the processes, however, and things can go awry quickly. In the United States, perhaps no industry better illustrates this point than healthcare. Layer upon layer of regulations, built through decades of federal and state interventions, have left the US with a healthcare industry that can no longer be called a “free market.”[i]
Through government intervention, the US has managed to simultaneously apply two sources of upward pressure on healthcare prices through artificially inflating demand and suppressing supply.
Some North Carolina Context
Before jumping into the discussion of how government drives higher healthcare costs, it is helpful to review some figures on healthcare spending in North Carolina.
In 2014 (the most recent year available), North Carolina had the ninth lowest per capita healthcare spending among states and DC at $7,264.[ii] Alaska had the highest per capita expenditures at $11,064 (besides DC, which came in at $11,944). Utah had the lowest, at $5,982 per capita.
All resources are limited. That means every spending decision consumers make is a tradeoff. Purchasing clothes or entertainment leaves less money for groceries or gas. When it comes to healthcare, though, most people are insulated from these choices by a third-party payer system.
According to the Centers for Medicare and Medicaid Services (CMS), the major payers in our healthcare system are Medicare, Medicaid, and Private Health insurance.[iii]
Patients actually pay relatively little of the costs of their healthcare. A 2017 research brief from the Mercatus Center at George Mason University found that only 11 percent of healthcare spending is direct spending between patients and healthcare providers.[iv] Third party payers are responsible for 89 percent of all healthcare payments.
For example, North Carolina’s per capita expenditure translates to a family of four having annual health expenditures upwards of 29 thousand dollars. If families are responsible for 11 percent, out of pocket expenses would be around $3,100 per family. Of course, we can reasonably hypothesize that expenditures have increased in the past 6 years since that data is from 2014. This is a simplistic data point, for many reasons;[v] however, it is helpful as a point of reference.
How does this third-party payer system drive up prices? As mentioned, it insulates patients from the true costs of the healthcare they consume. This often leads to an overconsumption of care and a lack of consideration of cost in care decisions. If a family of four had an annual healthcare bill of $29,000 instead of $3,100, their healthcare consumption capacity would be vastly different.
Let’s use a non-healthcare consideration to illustrate this point. Suppose that you are in the market for a new car. You have three options – a very affordable older used car with high mileage, a mid-priced used car of a nicer make with moderate mileage, or a brand-new luxury car. If you knew that someone else would be footing the bill, or the vast majority of the bill, why not pick the best option, regardless of costs? In the real world, however, each car buyer has to weigh the pros and cons of each option in accordance with their financial situation and transportation needs.
Very little of this shopping around occurs in healthcare. Patients and doctors are likely to take a “kitchen sink” approach to testing,[vi] diagnosis,[vii] and treatment since there are few immediate consequences for doing so. Someone else is paying the bill, why not?
And because doctors are paid on a fee-for-service basis, they have the incentive to oblige.
This 2017 study published by the Public Library of Science found physicians self-reported that a “median of 20.6% of overall medical care was unnecessary, including 22.0% of prescription medications, 24.9% of tests, and 11.1% of procedures.”[viii]
Such unnecessary care comes with a devastating price tag. PBS reported in 2017 that unnecessary care cost America’s healthcare system at least $200 billion that year.[ix]
In economics, this is similar to the phenomenon known as “moral hazard.” This is simply when people take more risks because they are disconnected from the consequences of doing so.[x] Similarly, in healthcare people consume more and differently than they would if they had to face the financial consequences of doing so.
It is hard to advocate for a direct payer system in the current environment when prices have risen so much. Without insurance, even more people would go bankrupt due to high medical costs. Identifying the third-party payer as the source of the problem does not imply that its immediate dismantlement would be feasible. Only that we should look to ways to directly connect providers and patients so that the market can adjust with downward pressure on prices.
This legislative session, the General Assembly passed a bill that is a step in the right direction. House Bill 471 codifies the exemption of Direct Primary Care agreements from regulation by the state’s Department of Insurance (DOI).[xi] Direct Primary Care agreements establish a contractual relationship directly between patients and doctors. For a monthly fee payed directly to the doctor, patients receive certain primary care services. Removing the threat of DOI regulation will allow doctors to keep their prices low and thus encourage an increased utilization of these arrangements.[xii]
A clear next step in this area would be the support or requirement of price transparency.[xiii] While the legislature has not had a great track record in this area in recent years,[xiv] transparency of prices could be a game-changer in connecting healthcare demand with the reality of its prices.
Another way in which the federal and state government contributes to high healthcare costs is through the suppression of the supply of providers and services. In North Carolina, the most obvious culprit is the state’s Certificate of Need (CON) law. CON laws require that healthcare providers get government approval in order to operate or expand certain services. North Carolina is one of 35 states that enacts such laws; only 3 states and the District of Columbia have more restrictive CON laws than North Carolina.[xv]
A North Carolina-based lawsuit highlights the ways that these restrictive policies prevent competition in the healthcare market, allowing the existing providers to raise their prices with little fear of losing customers to more affordable options.[xvi] Winston-Salem-based Dr. Gajendra Singh, along with the Institute of Justice, are suing over the state’s CON laws. Dr. Singh wants to provide his patients with affordable, transparently-priced MRI services,[xvii] but is prevented from doing so by the state’s CON laws. While that case works its way through the court system, the legislature could act to end the practice through legislation.
Efforts to repeal the state’s CON laws have long failed to gain any traction in the state legislature. Incumbent healthcare providers have a strong incentive to protect CON laws since such requirements insulate them from competition. North Carolinians bear the ultimate weight of this protection of the status quo through reduced healthcare supply, and – consequentially – higher healthcare prices.[xviii]
Through exerting upward pressure on demand and downward pressure on supply, government interventions have contributed to the rise of healthcare prices across the US. Federal reform is needed. However, the North Carolina legislature has a part to play in removing its share of market-distorting regulations. Eliminating CON laws and encouraging price transparency is a good place to start. Read more about those topics here, and check back next week for more commentary on healthcare policy.
[i] McMaken, Ryan. Foundation for Economic Education. “The idea that the US has a ‘free market’ health care system is pure fantasy” November 20, 2018. https://www.fee.org/articles/the-idea-that-the-us-has-a-free-market-health-care-system-is-pure-fantasy/
[ii] Kaiser Family Foundation, “Health Care Expenditures per Capita by State of Residence, 2014” https://www.kff.org/other/state-indicator/health-spending-per-capita/?currentTimeframe=0&sortModel=%7B%22colId%22:%22Health%20Spending%20per%20Capita%22,%22sort%22:%22asc%22%7D
[iii] Centers for Medicare and Medicaid Services, “State Health Expenditure Accounts by State of Residence Highlights”,https://www.cms.gov/Research-Statistics-Data-and-Systems/Statistics-Trends-and-Reports/NationalHealthExpendData/Downloads/res-Highlights.pdf
[iv] John R. Graham, “The Unindicted Conspirator: High Healthcare Spending and the Rise of Third-Party Payment” (Mercatus Research, Mercatus Center at George Mason University, Arlington, VA, March 2017). https://www.mercatus.org/system/files/mercatus-graham-third-party-payment-v3.pdf
[v] Some examples: Healthcare costs are not evenly distributed across the population; patients pay premiums that are not direct payments to healthcare providers but still factor into their annual healthcare costs.
[vi] Greenberg, Jerome and Jonas B. Green. “Over-testing: Why More is Not Better” The American Journal of Medicine. 2014. https://www.amjmed.com/article/S0002-9343(13)00967-4/pdf
[vii] Bulliard, J., Chiolero, A. Screening and overdiagnosis: public health implications. Public Health Rev 36, 8 (2015). https://doi.org/10.1186/s40985-015-0012-1
[viii] Heather Lyu, Tim Xu, Daniel Brotman, Brandan Mayer-Blackwell, Michol Cooper, Michael Daniel, Elizabeth C. Wick, Vikas Saini, Shannon Brownlee, Martin A. Makary. “Overtreatment in the United States” PLoS One. 2017; 12(9): e0181970. Published online 2017 Sep 6. doi: 10.1371/journal.pone.0181970 https://www.ncbi.nlm.nih.gov/pmc/articles/PMC5587107/
[ix] Terhune, Chad. “The $200 billion perils of unnecessary medical tests” PBS News, May 24 2017. https://www.pbs.org/newshour/health/200-billion-perils-unnecessary-medical-tests
[xii] Havlak, Julie. Carolina Journal. “General Assembly closer to giving direct primary care docs legal protection” June 4 2020. https://www.carolinajournal.com/news-article/general-assembly-closer-to-giving-direct-primary-care-docs-legal-protection/
[xiii] Makary, Marty. Newsweek. “No Industry Hides Pricing from Its Customers Like Healthcare Does—This Has to Stop” October 2 2019.
[xiv] Bryson, Donald. Civitas Institute. “State Health Plan Fight: Follow the Money, Part 1” March 4 2019. https://www.nccivitas.org/civitas-review/state-health-plan-fight-follow-money-part-1/
[xv] Koopman, Christopher and Anne Philpot. Mercatus Center. “The state of Certificate of Need laws in 2016” September 27, 2016. https://www.mercatus.org/publications/corporate-welfare/state-certificate-need-laws-2016
[xvi] Balfour, Brian. “George Will on NC Doctor’s Challenge to CON Law” August 16, 2018 https://www.nccivitas.org/civitas-review/george-will-nc-doctors-challenge-con-law/
[xvii] Scott, Dylan. Vox News. “This surgeon wants to offer cheap MRIs. A state law is getting in his way.” July 31, 2018. https://www.vox.com/policy-and-politics/2018/7/31/17629526/mri-cost-certificate-of-need-north-carolina-lawsuit
[xviii] Matthew D. Mitchell. “Do Certificate-of-Need Laws Limit Spending?” Mercatus Working Paper, Mercatus Center at George Mason University, Arlington, VA, September 2016.