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Henry Aaron

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Why Health Care Isn't Broccoli -- Some Basic Economics

Posted: 04/ 2/2012 4:08 pm

It isn't often that the course of history turns on principles taught in freshman economics. But the fate of the health reform legislation is now in jeopardy in part because some Supreme Court justices have so far failed to grasp such principles.

The government defended the mandate that nearly everyone carry insurance by arguing that almost everyone is in the market for health care at one time or another during their lives. People who are not insured may at any time become seriously ill or suffer major injury. The health care they will need is often costly and many people will not be able to pay for it. Under the Emergency Medical Treatment and Active Labor Act of 1986 hospitals must treat everyone who needs emergency care regardless of ability to pay. As a result, hospitals and other providers get stuck with bad debts. To make up their losses on the uninsured, they must charge those who have insurance more than the cost of their care. In the jargon of economics, those with insurance are forced to 'cross subsidize' those without it. And that, in turn, boosts the cost of insurance, which is already high enough, reduces its affordability, and thereby increases the ranks of the uninsured.

Because no one disputes that insurance is interstate commerce or that the Constitution authorizes Congress to regulate interstate commerce, the government argued that Congress can require people to carry insurance. To be sure, Congress could have dealt with the cost shifting problem in another way. But the insurance mandate is a reasonable way, and it is established jurisprudence that courts defer to Congress if the solution Congress chooses is reasonable, even if judges think that Congress did not choose the best course. Such reasoning led two quite conservative appellate court judges, Lawrence Silberman and Jeffrey Sutton, to rule that the insurance mandate is constitutional.

During the oral arguments on the Affordable Care Act, Justice Scalia challenged the Solicitor General, Donald Verrilli: "everybody has to buy food sooner or later, so you define the market as food, therefore, everybody is in the market; therefore, you can make people buy broccoli." Chief Justice Roberts commented that if the Court approves the insurance mandate: "All bets are off," meaning that there would be no limit to what Congress could do in regulating interstate commerce. Justice Scalia said he wanted a 'limiting principle,' so that the federal government, whose powers are constitutionally limited, would not be given unlimited sway over individual behavior. Justice Alito echoed that request.

Solicitor General, Donald Verrilli, representing the government, failed to come up with such a principle. But there is a simple answer to Justice Roberts', Scalia's, and Alito's question. When someone consumes broccoli, one is not normally imposing costs on other consumers that make broccoli more costly or unaffordable. Furthermore, broccoli is not vital to preserving life or reducing pain.

The very concept of a 'cross-subsidy' eluded the Justices. Noting that all economic decisions -- to buy something or not to buy it -- can affect prices, Justice Scalia observed, "if people don't buy cars, the price that those who do buy cars pay will have to be higher. So you could say in order to bring the price down, you are hurting these other people by not buying a car."

This is where basic economics comes in. When markets are working well, prices reflect the cost of materials used to produce goods and services and the value to users of those services. If more people buy cars, producers will use more materials causing their prices to change because those materials have to be bid away from other buyers. Increased car sales also may allow producers to use more efficient production methods or spread overhead costs. So, when auto sales change, production costs change too. Price changes associated with variations in output are how markets should work. They have nothing in common with the cross-subsidies that arise when uninsured people use services they cannot pay for and thereby impose costs on the insured, which lowers insurance coverage and contributes to a serious problem.

Later, Justice Scalia also dismissed the notion that young uninsured people are effectively in the health insurance market whether they are currently insured or not, observing: "We're not stupid. They [the young] are going to buy insurance later. They're young and need the money now. When they think they have a substantial risk of incurring high medical bills, they'll buy insurance, like the rest of us."

This statement is wrong on many levels. The most obvious is that when people have a substantial risk of incurring medical bills, insurers have to charge premiums many cannot afford. Letting people wait to buy insurance until they need it means letting them wait to buy it until many cannot afford it. Unless, that is, everyone is required to carry insurance and price differences are limited by law, which is just what the Affordable Care Act does. In that event, insurance for the old or sick will cost less than the value of services they will use, and insurance for the young and healthy will be priced above the cost of services they will use.

But there is a more fundamental error of perspective in Justice Scalia's observation. He and other opponents of the mandate seem to be thinking about relatively brief time periods -- like, one year. People may or may not be "active" in the markets for health insurance or health care over such a period. Hence, there are those who can freely choose to be outside the market while others freely choose to be in the market. These are seen as distinct groups. Forcing one of those separate groups to do something that they don't normally do or want to do may seem to infringe their freedom. If Congress is going to do that, the mandate opponents argue, there should be some limiting principle that stops Congress from doing a whole lot more that would infringe their freedom.

But, let's engage in a thought experiment... something lawyers like to do. Let's assume that the earth revolves around the sun very slowly, so that a "year" in that situation corresponds to eighty of our years. Assume further that insurance contracts run for one of those elongated "years." One of those contracts would cover healthy 20-year-olds who use little health care and feeble, disease-ridden 80-year-olds who, quite literally, could not live without it. If one thinks in these terms, the healthy 20-year-old and the sick 80-year-old are simply time-lapse images of the same human being. In discrete time, it is the pooling achieved through mandatory insurance that makes the multiple stages of the life-cycle fuse into a single sharply-imaged entity. The issue, then, is not whether there will be cross subsidies between today's young and today's old, but rather whether the lifetime costs of insurance will be averaged over time. That perspective is sufficient to sustain the mandate.

Henry Aaron is a Senior Fellow in Economic Studies at the Brookings Institution.