Link between taxes and health-care costs.

• Author: Barkey, Patrick M.
• Position: INDIANA INDICATORS

"THINGS THAT CAN'T GO on forever, don't." If those famous words of the otherwise obscure Nixon-era economic advisor Herbert Stem apply to anything, it is health-care spending. Most of us recognize that health care is expensive, breaking the budgets of many households, pressuring businesses and even challenging the spending capacity of giant federal programs such as Medicare and Medicaid. What is less clear is why this is so, and what can, or should, be done about it.

We spent more than $33 billion on health care in Indiana in 2004, the most recent year for which data are available. For the past four years spending on health care statewide has grown at an annual rate of 8.2 percent, nearly twice as fast as the 4.2 percent average growth in the entire state economy.

It's not all bad news--we are getting something for all that money, after all. Roughly half of the increase in costs is due to increased utilization of health care goods and services. In fact, with our older, more affluent population, it would be a shock if we didn't spend a bigger portion of our budgets--individually and collectively--taking care of ourselves.

[GRAPHICS OMITTED]

But half of the higher spending tab is due to higher prices--for everything from drugs to hospital care. In an otherwise tame inflation environment, health-care prices stand out as an area of the economy where sticker shock still prevails.

This is distressing, but to economists, at least, it is unsurprising. There are a number of aspects of healthcare policy in this country that feed the fires of healthcare spending growth, and indirectly support the ability of health-care providers to push through high price hikes, beyond what might be possible in the rest of the economy. Some of these might surprise you.

The tax system might seem like a strange place to start when analyzing health-care spending growth. But taxes do more than simply present us with bills to pay. They also can change our behavior. And in the case of health-care spending, the system encourages us to spend more on health care, even in the face of higher prices. Here is how it works.

When we...