Holtz-Eakin & Smith on The Economics of ObamaCare

Josh Wright —  19 March 2012

Douglas Holtz-Eakin and my former George Mason colleague and Nobel Laureate Vernon Smith are in the WSJ today discussing the economic wisdom and constitutionality of ObamaCare.  From the WSJ:

The Obama administration defends the mandate on the ground that a person’s decision to not buy health insurance affects commerce by materially increasing the costs of others’ health insurance. The government adds that health care is unique and therefore can be regulated constitutionally in ways other markets cannot.

In reality, the mandate has almost nothing to do with cost-shifting. The targeted population—the young, healthy and not poor who choose to forgo coverage—has a minimal role in the $43 billion of uncompensated health-care costs. In 2008, for example (the latest figures available), the Department of Health and Human Service’s Medical Expenditure Panel Survey showed that the uncompensated care of the mandate’s targeted population was no more than $12.8 billion—a tiny one-half of 1% of the nation’s $2.4 trillion in overall health-care costs. The insurance mandate cannot reasonably be justified on the ground that it remedies costs imposed on the system by the voluntarily uninsured.

The government’s other defense is that the health-care market does not exhibit textbook competition. No market does. The economic features relied upon by the government—externalities, imperfect information, geographically distinct markets, etc.—are characteristic of many markets.  The presence of externalities and other market imperfections does not justify a departure from the normal rules of the constitutional road. Health care is typically consumed locally, and health-insurance markets themselves primarily operate within the states. The administration’s attempt to fashion a singular, universal solution is not necessary to deal with the variegated issues arising in these markets. States have taken the lead in past reform efforts. They should be an integral part of improving the functioning of health-care and health-insurance markets.

Holtz-Eakin and Smith conclude:

Without the individual mandate, ObamaCare imposes total net costs of $360 billion on health-insurance companies from 2012 through 2021. With the mandate, the law would provide a net $6 billion benefit—i.e., revenues in excess of costs—over that same time period. In other words, the benefits of the individual mandate to health-insurance companies, along with their additional revenues provided by ObamaCare’s Medicaid expansion, are projected to balance, nearly perfectly, the costs that the law’s various regulatory mandates impose on insurers.

The individual mandate and Medicaid expansions appear to many to be unconstitutional. They are certainly bad economic policy. When they go, the entire law must fall. The administration built an intricate, balanced policy on a flawed economic foundation. It is up to the Supreme Court to pull it down.

Go read the whole thing.

12 responses to Holtz-Eakin & Smith on The Economics of ObamaCare

    northfork investor 24 March 2012 at 9:00 am

    Official enuff for Andrew_M_Garland. see above.

    Michael Sykuta 21 March 2012 at 12:42 pm

    The economic rationale for the mandate is fairly simple: By eliminating restrictions on preexisting conditions, the PPACA creates a serious problem. Namely, it creates a free-rider problem in which many people would not buy insurance until they knew they were sick enough to need the coverage. The only way to avoid that problem is to force everyone to buy insurance to begin with. My friend, David Rose, had a nice piece about this in the Washington Times about 18 months ago (http://www.washingtontimes.com/news/2010/oct/27/crowding-freedom-out-of-the-market/)

    Insurance programs are inherently subject to two information asymmetry problems. The moral hazard problem (in which people overconsume the insured activity) is the one we seem to hear most about. When people don’t pay the full cost of their health care consumption, they consume more than they would otherwise.

    The second problem is the one related to the individual mandate, namely the adverse selection problem. Sickly people are more likely to buy insurance than healthy people, but insurance companies can’t tell the difference and thereby price the insurance accordingly. Sickly people have an incentive to understate their propensity to need health care coverage (i.e., to lie about needing it). When insurance companies do not have–or cannot use–information about a person’s health as the basis for pricing, they have to pool the cost of care among all customers. Thus, healthier people subsidize the care of more sickly people. At some price point, healthy people will choose not to buy insurance and assume the risk themselves. That is the large population of voluntarily uninsured individuals that the mandate targets: people who are low-cost to insure, and can thereby help subsidize the system.

    In some cases, those individuals do have catastrophic care coverage (which is what insurance is intended/designed to do as a matter of principle to begin with), but by forcing to be Obama-approved comprehensive coverage, they are still forced to buy coverage that they do not value (because their likelihood of using it is low).

    Insurance providers are typically able to deal with this adverse selection problem by screening people based on their personal attributes (e.g., driving records for auto insurance, lifestyle and family health history for life insurance, health behaviors for health insurance) and by offering different levels of coverage with different premium/copay/out-of-pocket mixes to encourage people to self-select into the appropriate type of insurance program for their personal risk profiles. The PPACA eliminates the ability of health insurance companies to use such devices, which causes the health insurance market to work less effectively…which requires government to force people to buy products they don’t want.

    The individual mandate is nothing more than the government’s attempt to fix a problem of its own creation.

      northfork investor 21 March 2012 at 1:27 pm

      that is a very nice job michael. a far better summary than the op-ed piece puts up to shoot at. However it is just not “official” enough.

        Michael Sykuta 22 March 2012 at 7:17 pm

        North…I guess I don’t know what you’re looking for as being ‘official’ enough… and official enough for what?

    Andrew_M_Garland 20 March 2012 at 11:44 am

    To Northfork Investor,

    Well, what is the economic reasoning behind the individual mandate? Can you supply a link to the official government document that explains it and the associated costs? I don’t mean the CBO scoring, I mean the government analysis which explains the PPACA (ObamaCare) to the public.

    Holtz-Eakin et al say “The Obama administration defends the mandate on the ground that a person’s decision to not buy health insurance affects commerce by materially increasing the costs of others’ health insurance.”

    If that is the government’s justification for the mandate, commerce and unique markets, then it is appropriate to argue against those reasons.

      northfork investor 20 March 2012 at 3:21 pm

      among other economic reasons for individual mandate:

      1. remove effects of asymetrical information on insurance premium pricing

      2. eliminate or reduce economic effects of providing medical services without compensation to the uninsured for some ethical reasons

      I would personally be cool with a health care law that eliminated the individual mandate if those who did not buy insurance also contracted with the rest of society to not accept medical services that they cannot pay for. At the same time let’s reduce the oversupply (and higher associated costs) of health insurance by eliminating its subsidization by the tax code. A far better policy would be to tax subsidize basic preventative health care.

      Those policies not being feasible, the individual mandate is not a terrible place to start.

      Andrew_M_Garland 20 March 2012 at 6:20 pm

      To Northfork Investor,

      Now I have your opinion, off the cuff, about PPACA. Hardly a treatise. That wasn’t my question.

      I repeat. What is the economic reasoning behind the individual mandate? Can you supply a link to the official government document that explains it and the associated costs? I don’t mean the CBO scoring, I mean the government analysis which explains the PPACA (ObamaCare) to the public.

      I don’t know of such an analysis by the President. Only that analysis could possibly present the economic reasoning behind the PPACA. Everything else is supposition, your opinion or some else’s, all after the fact.

      Why are you and I reduced to giving opinions about the basis of such an important law. Why haven’t our wise leaders presented us with an analysis and policy paper?

      Or may there is one, but I just don’t know about it.

        northfork investor 21 March 2012 at 1:26 pm

        o i got it, you are looking of the “official economic reasoning” behind the individual mandate. I do not know where to find the official government document providing the official economic reasoning behind any law. Normally they don’t publish these in “official” format. (I believe the reasoning is not “official” unless it is appropriately formated in naugahyde binders.) My original comment relates to “unofficial economic reasoning that I deem represents some of the good economic thinking behind the individual mandate” none of which is captured in Holtz-Eakin & Smith op ed piece.



    Don’t sound so surprised. These economics professors are, after all, from GMU, so what did you expect? We should have known the answer even before the question was asked — any form of government regulation creates perverse economic incentives that leads to waste and inefficiency!

    northfork investor 20 March 2012 at 6:25 am

    This is a total mischaracterization of the economic reasoning behind the individual mandate thus these lightweights find it easy to put up a couple of irrelevant stats to back up their thinking. And their mischaracterization (while not of a legal nature) certainly affects the validity of their constitutional references (they don’t dare to make their own conclusions, rather they hide behind the “appearances to (the unknown) many.”

    WSJ editorial page seems to be getting worse and worse.


    I can’t help but cringe when I read economists’ take on “constitutional” issues — and especially “libertarian” economists. Their knowledge of “the law” basically begins and ends with the Public Choice Theory of Tullock and Buchanan. The problem with this, as I see it, is that bad economic policy has nothing to do with the constitutionality of a federal statute. I don’t think lawyers should go to court and argue, for example, that the individual mandate just does not make good economic sense. That surely would be a silly legal argument. The question rather is, Has Congress properly exercised their Constitutional power. The “wisdom” of that exercise, on the other hand, is a separate issue entirely (and one that the courts should not question lightly).

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