Arnold Kling  

The High-Cost Producer

Cost of Sarbanes-Oxley... Where are the Jobs?...

Alex Tabarrok points out how government ends up paying too much for pharmaceuticals.

in some areas, Medicaid accounts for a large fraction of the market...In this situation it makes sense for pharmaceutical companies to raise prices - they lose customers in the private market but this is more than made up for by the increase in prices that they can charge to Medicaid. As a result, average prices for HIV and antipsychotic drugs are higher than for any other drug categories.

Tabarrok cites a paper by Mark Duggan which claims that Medicaid chooses the most expensive antipsychotic drugs without any apparent improvement in outcomes over less expensive medications.

On a separate issue, George Will writes,

Recently, Indiana Gov. Joseph Kernan canceled a $15 million contract with a firm in India for processing state unemployment claims. The next highest bidder was a U.S. firm that would have charged $23 million. Because of this potential 50 percent price increase, there would have been $8 million fewer state dollars for schools, hospitals, law enforcement, etc.

These examples are consistent with the argument that Government is the high-cost producer. According to that view, transfering responsibility for a service from the private sector to the government raises the cost of that service. In health care, of course, the costs may be hidden in the form of longer wait times or less treatment.

Arguing against this view is Paul Krugman.

A recent study found that private insurance companies spend 11.7 cents of every health care dollar on administrative costs, mainly advertising and underwriting, compared with 3.6 cents for Medicare and 1.3 cents for Canada's government-run system. Also, our system is very generous to drug companies and other medical suppliers, because — unlike other countries' systems — it doesn't bargain for lower prices.

...What would an answer to the growing health care crisis look like? It would surely involve extending coverage to those now uninsured. To keep costs down, it would crack down both on drug prices and on administrative costs. And it might well cut private insurance companies out of the loop for some, if not all, coverage.

For Discussion. Would getting rid of private health insurance and subsituting government as the orovider lead to lower costs, as Krugman implies?

Comments and Sharing

COMMENTS (19 to date)
Donald Lacombe writes:

I'm wondering how much of the administrative costs paid by private insurance companies are costs associated with regulatory mandates that Medicare and the Canadian system do not have to pay.

Mcwop writes:

Ahh, what about costs outside of government to administer the system. How much do hospitals and private individuals spend to work with the system, file claims etc…? Factor that in, and I bet the picture changes dramatically. The IRS budget is about $9 billion dollars. Pretty small in comparison to what the government takes in tax revenues. Not included in that amount are costs incurred by non-IRS agencies to help enforce, and make the tax code work (including those the cost jumps to $15+ billion). You must also add to that the approximately $157 billion is spent by the public and business to comply with the tax code. So I am not buying the argument pushed by folks like Krugman without seeing a detailed analysis that factors in costs such as these.


Stephen writes:

Not in America.
In theory government can operate exactly the sdame way private companies can, except that goverment is not for profit, has huge bargaining power for buying, and can regulate to reduce costs, so it should have a big cost advantage.
If it wants to...
I think American goverment is (both Democrats and Republicans) about serving companies and not the public good. This major sea change is the difference between Canada and the US - government wants to give tax money away to private companies, else it won't get the donations to get in next time.

Boonton writes:

Gov't programs can benefit from economies of scale when the job is straightforward. Take Social Security, their job is simple: Issue numbers, collect payments, cut checks. Administrative expenses are small per dollar going in and out of the system.

If gov't's job is complicated then the cost goes up. Income taxes are complicated because income is a complicated concept to begin with. Same thing with choosing the optimial health care.

Solution: IMO: Let the gov'ts role be simple. Collecting taxes and funding a universal healthcare voucher. Individuals would have the incentive to police private insurance companies since the ones that have the lower administrative expenses would be able to offer more coverage at the same price.

Eric Krieg writes:

Krugman himself has said previously that it is technology that is driving health care costs. So what has changed now?

Medicare is no better at containing cost pressure due to technology than HMOs. In fact, it is probably worse, because there is no one scrutinizing doctors for how they are prescribing technology.

Because I'm so stressed out at work and home (2 kids under 3 will do that to you) I have acid reflux. As everyone knows, there are some really good, new drugs to treat the condition. My doctor prescribed Prevacid for 4 months. The HMO was monitoring prescriptions, and intervened, saying that only 2 months of use was warranted (it's a $100 per month prescription).

Now, it costs the HMO to monitor prescriptions. But managing the technology (in this case, a name brand prescription) is the way to keep costs to more reasonable levels.

Prevacid kicks ass, by the way. Prilosec OTC works good too. I haven't had heartburn since starting on them. I used to wake up with heartburn every night.

Bernard Yomtov writes:

"You must also add to that the approximately $157 billion is spent by the public and business to comply with the tax code. So I am not buying the argument pushed by folks like Krugman without seeing a detailed analysis that factors in costs such as these."

How about providing a little detailed analysis yourself, before you demand it of others? Where does that $157 billion figure come from?

And on the subject of health insurance and administrative cost, are you seriously maintaining that individuals, hospitals, and companies don't incur any costs in dealing with private insurance companies? That's laughable. How about a detailed analysis comparing the hassle of dealing with them to that of dealing with government?

Eric Krieg writes:

Medicare recipients really like the program. It is probably less of a hassle to deal with Medicare than with your average HMO.

The real question is, what is driving health care costs. If it is technology, as Krugman used to say when Clinton was President, then the question is what is the best way to make sure that the system is operating as efficiently as possible.

david foster writes:

If government was the sole provider of health insurance, exactly *how* would prices be set? Consider a drug which is made only by one company. We now have a "market" with one seller and one effectively one buyer: basically, not a market at all.

Lawrance George Lux writes:

Where are all the Libertarians and Free Market advocates? The Government as 'Sole-Provider' of Health Care would be the worst disaster possible, with complete elimination of Free Market forces. What is wrong with the health care system today lies in the lack of a free market.

Medical royalties should be defined by a Averaging process to provide consistency per Unit, and charges some Twenty percent above the Unit Mean should be taxed with a Surcharge. Government medical provision Contracts should be handled like other Government contracts, with Item specification and Quality Control, said Contracts issued to the lowest Bidder. lgl

Mcwop writes:

One, I provided a source link from the Heritage foundation. Two, that link will lead to further sources. Three, there is Google. Four, you don't buy that number, then look at the revenues of one tax company H&R Block; about $4 billion. Big money is spent complying with taxes. So I have done a little analysis there.

Your point is well taken on costs to comply with private insurance, but does Krugman's number already include that? That is what I mean by further analysis. I will contend that complying with Medicare is very costly, especially when considering the amount of reimbursement. My wife is a nurse manager in an outpatient urology office. Complying with Medicare is more time consuming than private insurers and reimbursement is less. In some cases procedures are done at a loss. The office has been considering dumping medicare patients, which is a common practice among doctors. Heck medicare does not even cover everything. People have to spend time figuring out the Medigap maze.

Also, my line of work is administering retirement plans and total benefits outsourcing (pension, medical etc...). Look at MEDCO; a very effieicent processor of drug benefits.

Bernard Yomtov writes:


Your link to the Heritage Foundation works, but their links don't seem to. Given their ideology, I'm going to reserve judgment on their figures until I see some justification. The H&R Block number is interesting, but only $1.4 billion of their $3.8 billion in FY 2003 came from US tax work.

Krugman's wording seems clear to me. He's talking about what the insurance companies spend, not what patients, hospitals, doctors, and businesses spend dealing with them. Even if these costs are somewhat higher for Medicare than for private insurance they have a long way to go to make up the gap.

And I'm not convinced that private insurance is more efficient administratively. There's a whole level of complexity introduced. Companies spend time explaining benefits, deciding on plans, etc. Providers have to keep track of who has what insurance, changes, referral procedures, etc. I don't think it's impossible that private plans are less of a burden, but again I'd like to see a careful comparison.

Binyamin Wallace writes:

BusinessWeek recently wrote about the sickly state of the U.S. health-care system.

The U.S. health-care system is in need of some strong medicine. The Health & Human Services Dept. said in January that the U.S. devoted 14.9% of real gross domestic product to health care in 2002. That is up from 14.1% of GDP in 2001 and 13.3% in 2000. Surprisingly, all that money doesn't make Americans healthier than citizens in Europe or Japan who spend far less on medical care.

Mcwop writes:

Bernard I do agree, and that is exactly the comparison I have been looking for.

The exact H&R Block revenues from tax operations is $1.9 billion for the year, the 1.4 number was for the fourth quarter 2003. [Source] -

Once one starts looking at all the other tax perperation companies such as: intuit, big accounting firms, etc... It is a huge industry.

Here is a study by IBM and the IRS on tax compliance costs (pdf - its a good read):

In 1993 the Office of Tax Policy research at Univ of Michigan Business school has reearch as well.

I wonder what tune Krugman would sing if someone proposed a flat tax to reduce tax compliance costs. The money saved could buy a lot of health insurance for the uninsured.

Bernard Yomtov writes:


You're right, the H&R Block figure is $1.9 billion. I misread. Intuit's Turbotax revenue is about $420 million, by the way. That seems like an awful lot of copies.

The IRS link didn't work. Is there a typo?

The UM paper isn't really about calculating compliance costs. It gives a few figures, in your general ballpark, but also suggests that there is no good data on this.

I've never really understood the "flat-tax for simplification" argument. Calculating your tax once you know taxable income is about as easy as it can possibly be. Even dealing with the usual deductions is not particularly hard. The tricky, time-consuming part is figuring out your income if your financial situation is complex. How would a flat tax eliminate this problem?

Scott M. Harris writes:

The first thing I ask myself when pondering one of these issues is whether the issue being discussed is the most effective one to address. Is improving the efficiency of the health care delivery system the right problem to solve? I don't think so.

C. Everett Koop, the Surgeon General who was conservative in everything but dress, once estimate that over 70% of medical expenditures in the United States were lifestyle related. We ought to be discussing how best to improve the general welfare, which includes general wellness. How can we design a truly just system, one that is fair not only to current members of our society but also to members of other societies, future generations, and even other species?

A truly just welfare system ensures both minimum standards of welfare and ever wiser means of promoting the general welfare. Governments best ensure the former and markets the latter. For example, a just system might combine a government run safety net program paid for by progressive income taxes with a tax exempt universal welfare savings account program. The latter would allow tax free expenditures for qualified retirement, medical, unemployment, and educational expenses. It would also allow unlimited giving to qualified charitable organizations. Upon the death of the last exempt beneficiary, all funds not willed to qualified charitable organizations would be taxed at rate at least as progressive as that of the income tax system. Ideally, the government program would shrink to insignificance over time. However, it would never be eliminated. Like a militia, it would remain available for emergencies.

Mcwop writes:

Honestly I am not sure on the flat tax part in how the simplicity would work out. There does not need to be a flat tax to have a simpler tax code either, and I can visualize simplyfying how income is calculated. Many tax returns are simple, until you get into complex transactions, depriciation etc... A lot of the complexity falls to corporations and small businesses (partnerships, sole proporietors, etc...).

Also, I don't want to come across as too obtuse with some sort of nationalized health program. I am not dead against it, but there are good ways to execute it and bad ways. Always wondered why the government does not create a quasi-government corporation like FNMA to sell policies to the uninsured, and corporations. Seems that there are some economies of scale to be had there. THis organization could even make profits free from taxes, or be run as a mutual company.

For the IRS link copy it and paste it in your browser Address area, that should initiate the PDF download. Does not seem to work directly from this page.


Bernard Yomtov writes:


That worked. I looked a the study.

Just to summarize: based on a survey the study estimates that individuals spent $18.8 billion out-of-pocket and 3.2 billion hours on taxes for tax year 2000. Arbitrarily assigning a value of $25/hour leads to a total compliance cost for individuals of $99 billion. (Yes, I noticed that the $157 billion you gave included businesses as well as individuals).

The study has some pretty significant weaknesses - enough that I would take its conclusions with very many grains of salt.

I suspect that the response rate has some selection bias - that people who are relatively annoyed by taxes, possibly because they end up spending relatively more time on them, are more likely to respond.

The time estimate is based on self-reporting. That is notoriously inaccurate. If someone called me up and asked me how much time I spent on taxes last year I don't think my answer would be very accurate. How accurate would yours be? Does this mean it would be too high? We can't say for sure, but I suspect it would be. Doing taxes is unpleasant. An hour spent idslikely to seem longer, and be remembered that way. Look at their table 4. They show an average of 8 hours spent on 1040EZ, and eleven on 1040A. Those times just don't seem reasonable to me.

Most of the cost is incurred by what they call SE taxpayers - self-employed. Not surprising, since they will obviously have more complex returns. But there are issues, mentioned in the paper, separating the work done on taxes from ordinary business record-keeping. Of course this problem will be worse with estimates of business compliance costs.

I guess my conclusion is that the method is pretty weak, and the time estimates are likely biased high. So I'm still going to reserve judgment as to the real compliance cost.

DAvid Thomson writes:

“Krugman himself has said previously that it is technology that is driving health care costs. So what has changed now?”

Paul Krugman’s whole existence seems devoted to one goal: destroying President George W. Bush! Nothing else seems to matter. The economic scholar who used to write some splendid books and pieces for is now mad as a hatter. That is what has changed now!

David Thomson writes:

“Krugman's wording seems clear to me. He's talking about what the insurance companies spend, not what patients, hospitals, doctors, and businesses spend dealing with them. Even if these costs are somewhat higher for Medicare than for private insurance they have a long way to go to make up the gap. “

Insurance companies who must earn a profit are the only ones who will ultimately keep costs down. The government responds mostly to political pressures---and politicians are infamous for bribing the voters. Lastly, have we already forgotten that Von Mises and Hayek warned that a socialist society must rely on the private sector for rational pricing? The disappearance of private insurers would almost immediately play havoc with the pricing issues

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