04/03/2012 08:42 am ET | Updated Jun 03, 2012

A True Limiting Principle for the Supreme Court Justices

In the Supreme Court hearings last week on Obamacare(s), aka, the Affordable Care Act (ACA), several Justices repeatedly raised the question of what was the "limiting principle" being advanced by the Justice Department in its support of the law mandating that uninsured individuals participate in the insurance health exchanges to be established under the Act.

In plain English, the Justices were asking whether their sustaining the mandate would open the door to Congress mandating purchases of broccoli (Justice Scalia's example), burial plots (Justice Alito's example), cell phones (Justice Roberts' example), or any other product whose purchase was deemed to have social value.

Solicitor General Donald Verrilli replied that sustaining the mandate would not give the Congress unlimited power to mandate other product purchases for two reasons. First, the ACA mandate involved regulating the existing purchase of an existing product, namely health insurance, not enforcing purchase of a new product or enforcing new purchase of an existing product. Here, Mr. Verrilli claimed that the uninsured are already effectively buying insurance, but at a zero price, by relying on the state to cover their cost.

Second, Mr. Verrilli said this mandate was a means of effecting the ACA and that courts have upheld regulating specific types of commerce (like farmers growing wheat for their own consumption) that undermines broader commerce regulations (like overall restrictions on wheat production).

Mr. Verrilli's first limiting principle is a pretty thin rope on which to hang the ACA's mandate. His second limiting principle is of questionable merit since the mandate can be said to be the broad commerce regulation itself.

To economists, the principle for federal intervention in interstate commerce is the standard argument for government intervention in commerce of any kind, namely market failure. Private markets fail for a number of reasons. The list includes externalities, monopoly, non-excludability (in the case of public goods), economies of scale, asymmetric information, and adverse selection.

Asymmetric information and adverse selection are the problems that plague the health insurance market, which have left some 50 million Americans uninsured. Here's what's involved:

Joe knows he has cancer. The insurance company doesn't know this information. But it knows there are Joes out there with cancer. So it prices its policy at a high price so that it will be able to cover its costs if the Joes with cancer buy the policy. The price is so high that the Sallys without cancer don't buy the policy and are left uninsured. This selection of the policy by Joe and not by Sally is adverse to the insurance company's interests, so this is where the term "adverse selection" comes from. In some circumstances, even the Joes won't buy the policy and the entire market will fail.

So Mr. Verrilli had a very clear answer to give when asked about the limiting principal with respect to mandates. He should have said the principle is to mandate actions in markets that are facing severe malfunctions due to market failure. The market for broccoli doesn't fit this bill. Nor does the market for cell phones or the market for burial plots. Each of these markets functions very well on its own. There is an externality argument for compelling cell phone purchase (to call the police in emergencies) or burial (to keep the public from smelling and viewing the decaying corpse), but these aren't compelling externalities because so many adults have cell phones and also have enough funds to pay for their funerals.

If one looks at where the federal government has intervened in commerce under the Commerce Clause of the Constitution, it's primarily in situations involving very significant market failure.

This blog as well as my prior blog suggests that Mr. Verrilli may have kept his cards far too close to his chest. He should have told the Court that the mandate was a tax in sheep's clothing and that the limiting principal was correction of extreme market failure.