Taxing Regulatory Failure

Michael Sykuta —  7 May 2012

Last month, the IRS and the US Treasury Department issued proposed rules to implement a new tax on health insurance providers and self-insured groups. The tax is part of the Patient Protection and Affordable Care Act (ACA) and will be used to help fund the new Patient-Centered Outcomes Research Institute (PCORI), which will conduct research evaluating and comparing health outcomes and the clinical effectiveness, risks and benefits of medical treatments. The proposed “comparative effectiveness research fee” will cost insurers $1 for every covered person (including dependents) in the first year and $2 in the following 6 years. The fee is scheduled to end by 2019.

Sounds reasonable on the surface. If the government is going to regulate health care, it makes sense that it would want to do research on what procedures are more or less effective so it can determine what procedures should or should not be covered under different circumstances. If that sounds a bit like rationing, it is. But it would be based on some standard of productivity. However, reasonable on the surface does not reasonable on the whole make.

One unanswered question is why the government needs to create an entire new federal agency to conduct comparative effectiveness research. One would think that private health insurance companies would already have an incentive to determine what procedures are most effective. This is also the kind of work that medical researchers engage in all the time (a quick Google Scholar search results in almost a half-million articles on “comparative effectiveness of medical treatment“). So it is quite likely that the federal government is simply recreating the wheel–a very expensive wheel–while adding costs to insurance providers. And when insurance providers’ costs go up, so do prices for healthcare coverage.

Of course, it is possible that the private insurance market is not currently doing this kind of research on comparative effectiveness of treatments and is ignoring the plethora of research in the medical journals. But if having that information could help those companies increase their profits by allowing them to direct patients to more effective treatments that reduce cost of coverage, why would they not use it?  If companies are not using this kind of information, there must be no economic incentive to do so. Which begs the question: why not?

A possible explanation is that the market for health insurance coverage has been protected from competitive pressures by the nature of the regulatory system. Although the market for insurance may seem like a national market, a maze of state-level regulations reduce the effective size of markets and increase the overall costs to insurance providers. Different regulatory processes and standards across states make it more difficult for insurance companies to operate across many states. This reduces competitive pressures between insurance providers. However, it doesn’t seem like a sufficient argument to support the idea that insurance companies regularly ignore information that would allow them to increase their profits, even if they were not competing as vigorously on prices.

Besides the motivation question, there is also a question of what the possible consequences of the new PCORI’s comparative research may be. At a minimum, one would expect that the government would begin dictating what procedures can or cannot be covered by federally-approved health care plans. While such a determination by an individual insurance company may lead to competitive behavior between providers offering different coverages, federally-established mandates will further reduce competition by limiting the margins (coverage options) on which insurers can compete.

It is also reasonable to suppose that a federally-approved list of  procedures will reduce the likelihood of innovation in treatment methods and practices by medical professionals. Reducing incentives to innovate will slow advances (and potential cost reductions) associated with possible new treatments. Having to get federal approval for new treatment options will do for treatments what the FDA has done for introduction of new pharmaceuticals (increasing costs, reducing the number of alternatives that reach clinical trials, and slowing the time to market).

The PCORI is mandated as part of the ACA. The ACA itself is a monstrosity of regulations to correct regulatory failures (part of the economic argument around the controversial mandate provisions now being reviewed by the US Supreme Court). The PCORI tax is just one more element of a regulatory response to regulation-induced market failures that is as likely to reduce health care options as to provide them.