Medicare Reform: Economics versus Politics.

• Author: HELMS, ROBERT B.

No one familiar with the history of Medicare should be surprised that it remains at the center of an intense political debate. During the twenty years preceding the creation of the program in 1965, Democrats who sought to enact some version of national health insurance continuously battled Republicans who came up with one defensive move after another to keep the provision of medical care predominately in the private sector (Rettenmaier and Saving 1999, Helms 1999). Under the shrewd leadership of Wilbur Mills, the powerful Democratic chairman of the House Committee on Ways and Means, a series of last-minute legislative maneuvers in 1965 resulted in the addition of physician services to the package of hospital services previously proposed by the Johnson administration (for details, see Twight 1997 and Twight 1998, 375-80). The result was what many consider a confusing set of separate programs for hospital (Part A) and physician services (Part B) that remains to this day. As enacted, Medicare adopted what was regarded as "state-of-the-art" health insurance in 1965, designed for a market dominated by fee-for-service (FFS) medicine and cost-based payment schemes. Yet, as economist Ted Frech (1999) has recently written, the structure Congress adopted for Medicare in 1965 was already out of date when compared to the insurance benefits and payment methods beginning to be adopted in private insurance markets. The recent failure of the National Bipartisan Commission of the Future of Medicare to agree on a proposal for reform illustrates that the political infection injected into Medicare in 1965 is reaching a terminal stage. Faced with both an increasing number of eligible recipients and a relative decline in the number of workers paying payroll and income taxes, the program is in urgent need of reform.

My focus in this article is on a related problem, the failure of economist to provide a convincing case for the use of private-market principles as the basis for efficient reform of Medicare. My criticism is not directed to the economists who have attempted for many years to apply market principles to health-care issues, but to the larger number of economists who have not. Moreover, my criticism pertains to the failure of economists to teach the fundamental principles of economics to educated Americans, rather than to the failure of "economics." This lack of education in economics is appallingly evident in Washington, D.C., especially on Capitol Hill. Any exposure to public-choice economics should convince anyone that politicians have a strong incentive to replace market activity with government regulation as a means to gain political power. Therefore, economics educators face a great challenge. Not only must we improve the basic understanding of economic principles, but we must continually provide convincing estimates of both the direct cost of regulation and the opportunity cost of the failure to achieve a higher level of economic efficiency.

The Current Medicare Debate

Medicare has continued to play a central role in partisan politics in the last several years. Following their congressional triumph in 1994, the Republicans, as part of their "Contract with America," proposed a number of changes in Medicare that would have reduced the projected rate of growth of the program's expense and would have provided the $270 billion in seven years needed to reach a balanced budget by 2002 (Kahn and Kuttner 1999). In an ironic coincidence, the proposed Medicare saving was almost identical in amount to the Republicans' proposed tax reduction, furnishing the Democrats with the rhetorical advantage of arguing that Medicare was being "cut" in order to give the wealthy a tax break. That attack put the Republicans on the defensive and was one of the reasons they failed in their efforts to reduce taxes. Many political analysts also identify the dispute over Medicare as one of the principle reasons for Democratic gains in the 1998 elections.

Having failed in their attempts to make substantial changes in Medicare, but needing savings in the program to meet budget targets, both parties agreed in the Balanced Budget Act of 1997 (BBA) to a more traditional means of controlling the cost of the program, cutting Medicare's payment rates for hospital and physician services. (1) As a gesture toward political responsibility, the act also established the National Bipartisan Commission on the Future of Medicare, which, after a year of effort, failed to reach agreement on a plan to establish financial solvency.(2) The debate among the members of the commission is indicative of the views of those opposed to market reforms in health policy and illustrates the challenge economists face in making the case for reforms that would restore consumer and provider incentives to achieve efficiency.

Briefly, the cochairs of the commission, Senator John Breaux and Congressman Bill Thomas, proposed to reform Medicare by using a premium-support system modeled after the Federal Employee Health Benefits Program (FEHBP) and a proposal by Henry Aaron and Robert Reischauer (Aaron and Reischauer 1995, Butler and Moffit 1995, Francis 1999). Abandoning both the terminology and the methodology of a pure voucher or defined-contribution approach, the premium-support plan would have paid a defined amount toward the purchase of an insurance plan that would have been required to provide a defined set of benefits. Although such a plan would have created new choices for Medicare recipients, it would also have allowed recipients to remain in traditional fee-for-service Medicare, as 84 percent of current enrollees now do.

Two of the main arguments against this proposal were that it would have subjected future enrollees to increased financial risk if the government's payments did not keep up with future increases...