Tag Archives: Duke University

Birth control, keg stands, and moral hazard

A Colorado organization managed to produce ads promoting health insurance under the Affordable Care Act that are so goofy that some supporters thought they were a parody produced by over-caffeinated tea partiers. But the ads are more than just an unwitting parody. Some of them also unwittingly illustrate an economic principle that is crucial for understanding the cost of health insurance: moral hazard.

Two of the best examples are reproduced below.

lets get physical

keg stand

Source: www.doyougotinsurance.com

Contrary to what you might think after reading the ads, “moral hazard” does not mean health insurance is hazardous to your morals. (For some commentary on what these ads say about morality, look here.)

Moral hazard refers to an insured party’s incentive to take greater risk because the insurer will pay the costs if there is a loss. The two ads above pretty clearly say, “Go ahead and engage in risky behavior, because if there’s a cost, your health insurance will take care of it.”

In the health care context, moral hazard can also involve excessive use of health care services because the insurer is paying the bill. “Excessive,” in this context, means that the patient uses a service even though its cost exceeds the value to the patient.  For example, my Mercatus colleague Maurice McTigue tells me that before New Zealand reformed its health service, a lot of elderly people used to schedule monthly visits to the doctor’s office because it was free and provided a good opportunity to socialize with friends and neighbors. Visits dropped significantly after New Zealand’s health service instituted a $5 copay for doctor visits — which suggests that some of these visits were pretty unnecessary even from the patient’s perspective!

Moral hazard can have a big influence on the affordability of health insurance. Moral hazard losses in private insurance plans can equal about 10 percent of spending. Moral hazard losses in Medicare and Medicaid are much higher, equal to 28-41 percent of spending. (References for these figures are on page 8 of this paper.)

Duke University health care economist Christopher Conover and I examined the eight major regulations rushed into place in 2010 to implement the first wave of Affordable Care Act mandates. The government’s analysis accompanying these regulations failed to take moral hazard into account. In other words, federal regulators extended insurance coverage to new classes of people (such as “children” aged 21-26) and required insurance plans to offer new benefits (such as a long list of preventive services), without bothering to figure out how much of the resulting new health care expenditures would be wasted due to moral hazard.

Is it any wonder that health insurance under the Affordable Care Act has turned out to be less affordable for many people? Makes me want to do a keg stand to forget about it. After all, if I fall down and get hurt, I’m covered!

How many people still have their old health plans?

A few days ago, I pointed out that many people with employer-provided health insurance plans may not be able to keep the same plan, because even some small changes to employer-sponsored plans could make them forfeit their “grandfathered” status. Duke University health care economist Christopher Conover and I noted in 2012 that the “grandfathering” regulation could have been written much more flexibly to prevent some of this.

On October 30, Chris published an article in Forbes that put some numbers on this abstraction. Based on survey data showing what percentage of plans complied with various provisions of the Affordable Care Act (ACA), he estimated that 129 million (68%) will not be able to keep their old health insurance plans, even if they liked them.  That does not mean these people will go uninsured. Rather, they will have to buy more expensive plans that include coverages mandated in the ACA.

This result is consistent with figures the Department of Health and Human Services supplied in its 2010 analysis of the grandfathering regulation that established the very restrictive terms an insurance plan had to meet if employers or policyholders wanted to keep it.

The true promise of the ACA is now clear: “If you like your current health plan, tough luck; you will buy a plan with coverage the federal government has decided you must have.”


Why We Need a Tax AND Spending Cut

Republicans are talking a lot about certainty. But even if they had won some sort of a victory where they got the current tax rates written in stone, spending is on such an unsustainable path in terms of entitlements, it really isn’t certain at all.

That is me in the NYT. If I had had more space and more eloquence, I might have said something similar to this:

If you hate taxes, cut spending! …Short-term, uncertain duration “tax cuts” are not tax cuts at all, but deficit-financed spending.

That’s Mike Munger, economist and political scientist from Duke University. There is more here and here

What is the economic logic behind this result? Why is it that a tax cut without a concomitant spending cut might not improve the economy? There are two economic models that predict just such an outcome:

Extreme Case:

In what might be called an “extreme case”, a tax cut without a spending cut has zero effect on the economy. This is an extreme case because it requires a rather generous view of humans: it assumes we are all super-logical forward-looking processing machines (all of us, of course, except for politicians; the model assumes they don’t have a clue). The model works something like this:

Step 1. Government cuts (lump-sum) taxes without cutting spending.

Step 2.  This requires an increase in government borrowing.

Step 3.  Forward-looking taxpayers recognize that deficits are future taxes (Munger uses the helpful acronym DAFT). Because of this, they reduce current consumption in order to save for the taxes.

Step 4.  The reduction in taxpayers’ consumption completely offsets the deficit-financed government consumption. And the increase in taxpayers’ savings completely offsets government’s increase in borrowing.

In the end, switching from taxes today to taxes in the future has no effect on interest rates, national savings, current consumption, exchange rates, future domestic production, or future national income.

Economists will recognize this as the Ricardian Equivalence theorem. Non-economists will likely find this a tad implausible.

But we don’t have to rely on such an extreme model to find that a tax cut without a spending cut might not be much help. Consider another, less-extreme, model:

The Less-Extreme Case:  

Step 1.  Government cuts (lump-sum) taxes without cutting spending.

Step 2.  This requires an increase in government borrowing.

Step 3.  Only some taxpayers recognize the deficits as future taxes. As a result, these taxpayers reduce their consumption and increase their savings. But these actions only partly offset government’s deficit-financed consumption.

Step 4.  Since the public’s increased appetite for savings isn’t enough to fully finance all of the extra government borrowing, government has to get its money from somewhere. It therefore draws on two sources:

  1. Government can borrow more domestically, but has to pay a higher price in the form of a higher interest rate (under the Ricardian model, the public wants to save more, so government doesn’t have to pay a higher price). Higher interest rates make it more difficult for private investors to fund their own projects (private investment is crowded-out), lowering the nation’s capital stock.
  2. Government borrows the money from foreigners. Under this scenario, interest rates may not rise, but future national income falls because of the burden of repaying the increased borrowing from abroad.

Step 5.  Because the nation’s capital stock shrinks, future growth suffers.

Under either scenario, a reduction in lump-sum taxes—unaccompanied by a reduction in spending—fails to jump-start the economy the way politicians hope that it might.

A Big Assumption:

There is one other assumption that I have smuggled into the analysis above. Note that “Step 1” under both scenarios is a reduction in “lump sum” taxes. A lump sum tax is a tax that everyone has to pay, regardless of how much they work or consume. Economists often use it as a benchmark for efficient taxation because if the tax isn’t associated with working or consuming, then it won’t affect peoples’ decisions to work or to consume, and therefore won’t do economic harm.

It is standard for economists to assume lump sum taxation when they are talking about deficits because it makes the analysis cleaner. But, of course, taxes are not lump sum. In the real world, most of government’s revenue is derived from income taxation.

And we know from theory and data that high marginal tax rates reduce the incentive to work, save, and invest, harming economic growth. Moreover, we have reason to believe the effect can be quite large.   

So in evaluating the recently-struck tax deal, we have to weigh the “tax increases harm economic growth” evidence against the “deficits harm economic growth” evidence. In the end, I suspect we are better-off in the short-run without a major tax increase in two weeks. But in the long-run we need to cut BOTH taxes and spending. As Professor Munger puts it, the alternative is “DAFT.”