Concrete Measures to Address Real Income Stagnation of the Poor and Middle Classes

Piketty - Saez 1945 to 2013, June 2015, log scale

I.  Introduction

The distribution of the gains from economic growth has gotten horribly skewed since around 1980, as the graph above shows (using a log scale so that distances on the vertical scale are equal relative changes).  Average real incomes of the bottom 90% of households have fallen by 5% in real terms since 1980, while the real incomes of the top 0.01% have grown by 325%.  This is astounding.  Something has changed for the far worse in recent decades.  The real incomes of these groups grew at roughly similar rates in the post-World War II decades leading up to 1980, but then diverged sharply.

An earlier post on this blog looked at the proximate factors which took substantial growth in GDP per capita (which grew at about the same pace after 1980 as it had before) down to median wages that simply stagnated.  As discussed in that post, this was principally due to a shift in distribution from labor to capital, and a shift within labor from the lower paid to the higher paid.  (Demographic effects, principally the increased participation of women in the labor force, as well as increases in the prices of items such as medical care relative to the prices of other goods, were also both important during this period. However, both have now become neutral, and are not factors leading to the continuing stagnation in recent years of median wages.)

The purpose of this blog post is to look at concrete policy measures that can be taken to address the problem.  The issue is not slow growth:  As noted above, per capita growth in GDP since 1980 has been similar to what it was before.  The problem, rather, is the distribution of the gains from that growth, which has become terribly skewed.

Discussion of this is also timely, as a consensus appears to be forming among political leaders in both major parties that something needs to be done about the stagnant incomes of the poor and middle classes.  Several of the candidates seeking the Republican presidential nomination have said they wish to make this a primary issue of the 2016 campaign.  This is good.  If they are serious, then they would support measures such as those laid out below.  I doubt they will, as they were strenuously opposed in the past to many of them, and indeed championed the changes in policy from the Reagan period onwards which are, at a minimum, associated in time with the deterioration in distribution seen in the chart above.  But one can hope.

This is a long blog post, as it discusses a long list of measures that could be taken to address the predicament of the poor and middle classes.  Many (although not all) of these policies have been reviewed in previous posts on this blog.  Thus the discussion here will in such cases be kept individually brief, with the reader encouraged to follow the links to the earlier blog posts for more substantive discussion of the points being made.  And the reader with limited time may wish to scan through the section headings, and focus on those topics of most interest.

II.  A Policy Program

A.  Labor Market

We start with the labor market, as it is fundamental.

1)  Raise the minimum wage:  The minimum wage is now less in real terms than what it was in 1950, during the presidency of Harry Truman.  This is amazing.  Or perhaps what is amazing is the argument made by some that raising it would price workers out of their jobs.  Real GDP per capita is now 3.75 times what it was then, and labor productivity has grown to 3.5 times what it was then.  But the minimum wage is now less in real terms than what it was then.  The minimum wage in 1950 was not too high to price low paid workers out of the market, and labor productivity is three and a half times higher now.

Obama has called for the minimum wage to rise to $10.10 per hour from its current $7.25 per hour (with this then indexed to the rate of inflation).  This would bring the minimum wage back only to where it was in the 1960s, a half century ago.  There is no evidence that such a rise will hurt low wage workers, and it would still leave a full time worker (at 40 hours a week, and with no vacation time, so 52 weeks per year times 40 hours per week = 2,080 hours per year) at such a minimum wage (2,080 x $10.10 = $21,008 per year) earning well less than what is needed to bring a family of four up to the poverty line ($24,250 per year for a family of four in 2015).  This is the minimum that should be done. Indeed, it should be more.

2)  Ensure predictable work hours:  Many workers, particularly in sectors such as retail and food service (whether fast food or traditional restaurants), are increasingly being required to accept “flexible” work hours, where their employer tells them only a short time ahead what days to come in, at what time to report, and for how many hours.  They might be told a few days before, or only the day before, or sometimes only on the day of possible work, whether they will be needed and should report to work.  This is sometimes called “just-in-time” scheduling (a term taken from just-in-time inventory management) or “on-call” scheduling, and managers are rewarded for what is seen as “optimizing” their use of labor.

But it plays havoc with the life of many workers.  They cannot take a second job in the evening to help make ends meet, if they do not know whether their primary job may sometimes require that they come in on short notice to work an evening shift.  Students cannot enroll in college classes in order to finish a degree if they do not know whether they might be called in during class time.  Parents and especially single mothers can have great difficulty in arranging for child care when their work schedules are unpredictable.  And an unpredictable number of weekly work hours, of perhaps 30 hours one week and 20 hours the next, makes budgeting impossible.

Recent developments in computer and communications technology have made on-call scheduling possible and increasingly common.  Establishments such as Starbucks can receive at some central office real-time information on coffee sales (from the cash registers, via an Internet connection), and together with other factors (weather forecasts; whether a convention is in town) can run sophisticated software algorithms predicting how many workers will be needed, exactly when, and which ones should be called in.

The problems this creates for low income workers has only recently come to be recognized.  An important spark was a story in the New York Times on August 13, 2014, on the impact on a worker at Starbucks.  This led Starbucks the very next day to announce it would change its practices, but a review a month later by another news organization raised questions as to whether anything of significance had really changed.

Starbucks can possibly be shamed into improving it working conditions, as it sells high-end coffee to those with significant disposable income.  And if the problem were solely with Starbucks and a few similar firms, a shaming approach might possibly be effective. However, while Starbucks may have become the symbol, the practice has unfortunately become increasingly widespread.  Furthermore, there is competitive pressure across firms to adopt such practices.  If Starbucks stops the practice, it may face coffee retailers who continue to “optimize” their use of labor through such practices, who can then take away business by charging less.  There is thus pressure on firms to impose the lowest standards they can get away with.

There is no federal law against such labor practices.  There may be state laws which might constrain the practices in some way in certain jurisdictions, but they are not widespread. What is needed is a legislated solution which will apply generally, and should be undertaken at the federal level.  This has been done before.

Abuses of labor had become common during the “gilded age” of the late 1800s / early 1900s (when income distribution was, not coincidentally, as bad as it is now).  Progressive Era and later New Deal reforms addressed some of the more egregious issues.  Work place safety and child labor laws were enacted, a minimum wage was established, and a 40 hour work week was set as the standard, where a worker is required to be paid overtime at the rate of “time and a half” (150% of their regular wage) for any hours worked beyond 40 in a week.

The issue of unpredictable work hours could be addressed similarly.  All workers would have a normal set of hours, defined individually and a function of their particular job.  They would always be paid for this set of normal hours.  But it is recognized that firms may have an unexpected need for additional workers at certain times (for example to substitute for a worker who is sick).  Workers could take on such additional shifts beyond their regular hours if they so chose, but as a financial inducement for the firm not to rely on such job calls, the firm would be required to pay 150% of normal wages for such time (as for overtime work).

This would lead firms to assess better when they need workers and when not, and build this into the standard work schedules.  Firms have little incentive to do this now, since the cost of unpredictable schedules is shifted onto the workers.  Note also that with this system there will not be an incentive to further split up jobs, as all workers will be assigned an individualized normal schedule.  The firms will gain no flexibility by splitting a 30 hour a week job into one of 20 hours and one of 10 hours.  They will still need to determine when workers are expected to be needed, in order to assign hours accordingly.  And to the extent they do not do this carefully, they will be penalized as they will then need to pay 150% of the wage when a worker needs to be brought in to cover those extra hours.

Predictability in hours is extremely important to low wage workers.  Indeed, it is quite possibly more important than raising the minimum wage.  It will shift some of the costs of unpredictability back onto the firm, where it had been until modern computer and communications technology (and lax labor laws that did not foresee this) allowed the firms to shift onto workers the cost of unpredictability.  Firms did this to raise profits, and business profits did indeed then rise while wage earnings stagnated.  This is precisely the issue that needs to be corrected.

3)  Manage policies to return the economy rapidly back to full employment when there are economic downturns:  While it would be ideal always to keep the economy at or close to full employment, economic downturns happen, most recently in 2008 in the last year of the Bush administration.  But when they do, the priority should be to return the economy to full employment as rapidly as possible.  Everyone can of course agree on this. Differences arise, however, on how to do it.

Monetary policy should be used to the extent possible, but there is a limit to how much it can do since interest rates cannot go below zero.  And they have been at essentially zero since late 2008, following the Lehman Brothers collapse.  The Fed can also try to reduce long term rates (such as through quantitative easing), and while its policy here has had some beneficial effect, it is also limited.

Monetary policy in a downturn such as that just experienced must therefore be supported also by expansionary fiscal policy.  Additional government spending is the most effective way to expand demand, as it does this directly.  Tax cuts can also help, but are less effective since a significant share of the reduction in taxes may be partly saved by households (and likely will be largely saved by higher income households).  There will thus be less stimulative effect per dollar from tax cuts than from direct spending.

Unfortunately, government spending was cut each year from 2010 up to 2014. This was the first time in at least 40 years that government has cut spending in a downturn.  Hence the economic recovery has been the slowest of any over that period, and only picked up in 2014, when government spending was finally allowed to increase.

Republicans have argued that to return the economy to full employment, one should instead reduce regulations.  But this makes no sense.  Regulations in the middle of a downturn are not far different from what they were before the downturn began, so how can they be blamed for the unemployment, and how would reducing them lead to less unemployment?  And if some regulations are wrong, one should change them, whether the economy has high unemployment or low unemployment.  Regulations do not serve as a macro policy to reduce unemployment, but rather serve a micro purpose to ensure the economy functions efficiently.

A slack labor market will have a direct effect on income inequality.  When there is available labor that is unemployed, a laborer will have little leverage to negotiate for higher wages. And unemployment has been higher, on average, in the three decades following 1980 than in the three decades before 1980.  A simple regression analysis suggests that if the average rate of unemployment after 1980 had simply matched what it had been before 1980, then the real incomes of the bottom 20% of households would not only have grown at a rate similar to how fast they had grown before, but also at a rate similar to that of the top 20% in the period after 1980.  That is, there would have been continued growth in the real incomes of the bottom 20% after 1980, instead of stagnation, and no increase in inequality relative to the top 20%.  Keeping the economy at close to full employment is critical to the poor and middle classes.

B.  Fiscal Policy

Fiscal policy is therefore an important instrument to keep the economy at full employment, or to return it to full employment from a downturn.  What specifically should be done?

1)  End the Congressional budgetary “pay-as-you-go” rules when in or recovering from a recession:  The Budget Enforcement Act of 1990 required that, as a budgetary rule, any increase in mandatory government spending or reductions in taxes must be “paid for” over the next five years as well as the next ten years by offsetting spending cuts or tax increases, so as to be budget neutral over these periods.  While the rules have been modified over the years, were not in place for a period during the Bush II administration, and were not always abided by (such as for the large tax cuts at the start of the Bush administration), they have acted in recent years to limit the government spending that was needed to recover from the downturn.

Over the course of a full business cycle, covering the full period over when the economy is at or close to full employment and when it is not, a limit on the size of the government deficit is warranted.  But by setting such a limit to apply identically and continuously both in a downturn and when the economy is booming, one limits the government expenditures that may be needed for a rapid recovery.  The rule should be suspended during any period when the economy is in a recession or recovering from one, to be replaced by a rule that applies over the course of the business cycle as a whole and which focusses on the government debt to GDP ratio rather than simply the government deficit.

2)  Stop cuts to important safety net programs such as food stamps and unemployment insurance, especially in a downturn:   Safety net programs such as food stamps (now called SNAP) and unemployment insurance are critically important to the poor and middle classes, and especially so in a downturn. They provide limited support to households who lost their jobs or other sources of income in the recession, due to no fault of their own.  (The 2008 downturn was a consequence of the reckless management of banks and other financial institutions in the US, and the policy decision of the Bush administration officials not to make use of their regulatory powers to limit it.  This led to very high bank leverage, a build-up of the housing bubble, and then collapse when the housing bubble burst.)

As unemployment rose and incomes fell, especially of the poor and near poor, many more households became eligible for food stamps and, having lost jobs, for unemployment insurance.  Expenditures on these and other safety net programs expanded, as they are designed to do in a downturn.  But Congressional Republicans then forced through cuts in the key safety net programs (e.g. unemployment insurance, and food stamps) by limiting eligibility, and have sought much more extensive cuts.

If one wishes to help the poor and near poor, one does not cut programs which help them directly, and especially not when they most need them.  These programs are also extremely efficient.  The food stamp program (SNAP) spends only 5% of its budget on administrative costs.  Few charities are anywhere close to as efficient, but at least some prominent Republicans think otherwise.  Former Congresswoman Michele Bachmann, at one point the leading contender for the Republican presidential nomination in 2012, asserted that 70% of food stamp funding went to “bureaucrats”.  This was absurdly wrong.

Safety net programs in the US, while efficient for the money spent, are however highly limited in how much they do spend.  US income inequality or poverty rates are actually not worse than those seen in other high income OECD economies in terms of wages and other income paid to workers. That is, the US capitalist market economy does not itself produce more unequal outcomes than those of other high income OECD economies.  The US is near the average in this across all the OECD countries.  But once one takes into account government taxes and transfers, the US turns out to be the very worst, both in terms of inequality (as measured by the Gini coefficient) and in terms of poverty (by the share of the population considered poor).  The problem is not that the US tax and transfer programs are not especially progressive:  They are in fact more progressive than in most countries.  The problem is that they are simply too small to matter.

3)  Implement a public infrastructure investment program:  American public infrastructure is an embarrassment.  Compared to other high income countries, US roads, bridges, mass transit, and other public structures, are clearly inadequate in scale, are in terrible condition due to inadequate maintenance, and constitute what is in effect a growing debt that will need to be repaid in the future when they finally have to be rebuilt (normally at much greater cost than if they had been maintained properly).

Public investment has been cut back especially sharply in recent years, whether measured as a share of GDP or simply in real per capita terms, as a consequence of Congressional cuts in the budget.  But while the cuts have been especially sharp since 2010, the problem is long-standing.  Amazingly, US non-defense public investment in structures in 2013 was less, in real per capita terms, than what it was in 1960, even though real per capita GDP almost tripled over this period.

It should therefore be no surprise that roads and bridges are in poor condition (with some bridges that have even collapsed), mass transit systems are in poor repair, and all are grossly inadequate to what we need.  This impacts especially the middle classes, who have to sit in traffic jams daily just to get to work.  Toll roads or tolled lanes built by private concessionaires have become fashionable in recent years to build roads that government is no longer willing to pay for, but they can be expensive.  The tolled lanes opened recently in Northern Virginia in the I95/I495 corridor have tolls that, for the entire length, could conceivably reach $40 or more per trip (and double that per day).  Rich people can afford this, but most of those with middle class incomes cannot.

Adequate public infrastructure is needed to raise productivity and for the economy to grow.  And the recent severe downturn should have been a time for a special effort to expand such investment, putting to work unemployed construction and other workers, in firms that had capacity to produce more than they could sell due to low demand in the downturn.  Furthermore, the government could have borrowed long term funds during this period at historically low rates, and even at times at negative real rates.  It was insanity not to utilize the unemployed labor and underutilized firms, financed by funds at low or even negative real cost, to build and repair infrastructure that the economy and especially the poor and middle classes desperately need.

But this was not done.  It instead will need to be done over the coming years (and at much higher cost, due to the lack of maintenance), when the economy is hopefully at full employment, interest rates have returned to normal levels, and anything extra spent on public infrastructure will need to come out of less being available for other goods and services, including for private investment.

4)  Increase public support to higher education:  At one time, students could pay for the total costs of attending a state university, including room and board, through work at just the minimum wage during summers and part time during the academic terms.  This is no longer the case.  In part this is due to the fall in the minimum wage in real terms from where it had been in the 1960s.  But it was also a consequence of the rising cost of university education (a result of Baumol’s cost disease) coupled with sharp cutbacks in the share of these costs covered by state support to their colleges and universities, shifting more of the cost onto students and their families.

This reduction in state support to their colleges and universities needs to be reversed, or soon state schools will in effect no longer exist.  They will have become essentially private schools catering to those who can afford them.  And while federal programs exist to help students (most importantly the Pell Grant program, which provides grants of up to $5,775 per year, in academic year 2015/16), they are limited and family income based.  The maximum Pell Grant goes only to the poorest households.

There are different ways to assist students from poor and middle class households to continue their schooling beyond high school.  President Obama, in this year’s State of the Union address, proposed for example that federal support be provided so that community colleges would stop charging tuition for students in good standing.  One would in essence be extending the availability of public schooling from 12 years now to 14 years.  The budget cost would be relatively modest at just $6 billion per year.  Others have suggested, constructively, that using such funds to expand the Pell Grant program would achieve the same aim, while assisting also those low income and middle class students who would do better by enrolling in a four-year college.

The response of the Republicans in Congress has, however, been in the opposite direction.  While rejecting Obama’s proposal for community colleges, the recent proposal from the House Budget Committee would instead freeze the maximum Pell Grant at $5,775 for at least the next ten years, thus leading to its erosion in real terms as prices rise (much as the minimum wage has eroded over time due to inflation).

C.  Tax Policy

Tax policy has a direct impact on income distribution.  But while most still accept the principle that taxes should be progressive (the principle that the rich should pay taxes at a higher rate than the poor), the tax system the US in fact has is regressive in many of its aspects.

1)  Stop the preferential tax treatment of income from wealth:  The wealthy pay a lower rate of taxes on their income from wealth than most of the population pays on their income from labor.  In terms of policy options to address inequality, little would be more straightforward than to end the practice of taxing income from wealth at lower rates than income from work.  Tax rates on all income groups could then be reduced, with the same total tax revenues collected.

The long-term capital gains tax rate on most assets is only 15% for most earners (there is an additional 3.8% for those households earning more than $250,000 bringing the rate to 18.8%, with this rising by a further 5% points to 23.8% for those earning $464,850 or more in 2015).  These rates on income from wealth are well below what is paid by most on income from labor (wages).  While the regular income tax rates (on wages) vary formally from 10% in the lowest bracket to 39.6% in the highest, one should add to these the social insurance taxes due.  These are often referred to loosely as Social Security taxes, but they include both Social Security at a 12.4% rate (up to a ceiling in 2015 of $118,500), and Medicare taxes at a 2.9% rate (with no ceiling).  Note also that while formally the employee pays half of this and the employer pays half, analysts agree that all of the tax really comes out of wages.

Once one includes social insurance taxes on wages, the effective tax rates on income from labor goes from 25.3% for the lowest bracket to 40.3% on those earning between $74,900 and $118,500, after which it drops down to 27.9% as the Social Security ceiling has been hit, and then starts to rise again.  The long-term capital gains rate is always below this even for the very richest, and normally far below.

To add further complication, preferential rates of 25% apply to long-term capital gains on certain commercial building assets (“Unrecaptured Section 1250” gains), and 28% apply to collectibles (such as fine art or gold coins) and certain small business stock. These are still well below what most pay in taxes on income from work.

This system not only worsens income inequality, but also creates complications and introduces distortions.  Many of those with high income are able to shift the categorization of their incomes from what for others would be wage income, to income which is treated as long-term capital gains.  Properly structured stock options, for example, allow CEOs and other senior managers to shift income from what would otherwise be taxed at ordinary income tax rates to the low rates for capital gains.  “Carried interest” does the same for fund managers.  With many fund managers earning over $100 million in a year, and indeed some earning over $1 billion, this preferential tax treatment of such extremely high earnings is perverse.

The reform would be simple.  All forms of income, whether from labor or from wealth, would be taxed at the same progressive rates that rise with total household income.  The one issue, which can be easily addressed, is that income from long-term capital gains should be adjusted for inflation, to put the gains all in terms of current year prices.  But this can easily be done by scaling up the cost basis based on the change in the general price level between when the asset was bought and when it was sold.  The IRS could supply a simple table for this.

2)  Reduce marginal effective tax rates on the poor:  Conservatives have long argued for cuts in marginal tax rates for the rich, arguing this would lead to faster growth (“supply-side economics”).  While there is no evidence that lower tax rates in recent decades have in fact led to faster growth, this was the stated rationale for the big tax cuts under Reagan and then Bush II.

Liberals have noted that if one were really concerned about high marginal tax rates, you would look at the high marginal effective tax rates being paid at the other end of the income scale – by the poor and those of moderate income.  Studies have found that these can range as high as 80 or even 100%.  The marginal effective tax rates take into account the impact of means-tested programs being phased out as one’s income rises.  When extra income is earned, you will pay not only a portion of this in taxes, but you will also lose a portion of benefits that are being provided (such as food stamps) in programs that phase out as income grows.  If the extra paid in taxes plus the amount lost in benefits matches additional earnings, the marginal effective tax rate will be 100%.

Conservatives have started to pay attention to this.  An opinion column in the Wall Street Journal last September by Senators Marco Rubio and Mike Lee (both Tea Party favorites) decried the 80 to 100% marginal effective tax rates that low income workers might face, arguing this can act as a strong disincentive to work.

In reality, the rates being faced by the poor are normally less, although still substantial. The issue is complex since the effective tax paid will depend not only on income, but on such factors as:  1)  Family composition (whether married and number and age of children); 2) Where one lives (what state and often what city or county); 3)  Particular benefit program qualification criteria (which will vary by program, and will often depend on many factors other than income); and 4) Whether the individual always enrolls in programs they are qualified for, as one may not be aware of certain benefit programs, or find the benefits to be too small to be worthwhile (because of difficulties and complications in enrolling, with these quite possibly deliberate difficulties in some jurisdictions).

The Congressional Budget Office, in a careful study issued in November 2012, concluded that the marginal effective tax rate for citizens with incomes of up to 450% of the federal poverty line averaged about 30% in 2012.  And under law as then in effect, this would rise to 32% in 2013 and 35% in 2014.  There was a good deal of variation within the average, with a marginal effective tax rate of as much as 95% (for example, for single mothers with one child with an income in the range of about $18,000 to $20,000, which was just above the poverty line for such a household).  But rates of 40% or more were not uncommon.

Such rates, even when not at the 80 to 100% extremes cited by Senators Rubio and Lee, are high.  Even at just 30% (the average) they are double what those who are far better off pay in long-term capital taxes.  While the conservative senators argue that such high marginal rates discourage work effort (there is in fact little evidence that this is the case – when you are poor, you are desperate for whatever you can get), such high marginal rates are in any case unfair.  If one wants to help those of low and moderate income, these effective tax rates should be reduced.

There are three ways, and only three ways, to reduce the marginal effective tax rates on the poor.  One is to get rid of the benefit programs for the poor altogether.  If they receive no food stamps to begin with, one has nothing to lose when incomes rise.  But this then penalizes the poor directly.

One could also phase out the programs more slowly, and pay for this by reducing the benefits to the poorest.  This is then a transfer from the poorest to the somewhat better off than the poorest.  Senators Rubio and Lee proposed this route (without explicitly calling it that) by reducing benefits such as food stamps and providing instead larger child tax credits for all households (including the rich).  This would be a transfer from the poorest to those of higher income (including the rich), and especially to those with large families.  The poorest would be penalized.

Finally, the third and only remaining option is to phase out the benefit programs more slowly.  This reduces the marginal effective tax rate that poor households will face if they are able to obtain jobs paying more than what they earned before.  It will not penalize the poorest, but it does of course require that budgets for the programs then rise.  But this will be support made available directly to the poor, and in particular to the working poor (as they are the ones facing the high marginal effective tax rates from additional earnings). If one is concerned about poverty and inequality, this is precisely the support that should be provided.

3)  Tax inherited wealth the same as any other wealth:  Wealth that is inherited enjoys significant tax benefits.  The only exception is wealth that is so large that it becomes subject to the estate tax (greater than $10.86 million for a married couple in 2015).  But few pay this due to that high ceiling, as well as since one can establish trusts and use other legal mechanisms to avoid the tax.  Indeed, in 2013 (the most recent year with available data), estate taxes were due on less than 0.2% of estates; the other 99.8% had no such taxes due.  This is down from over 6% of estates in the mid-1970s, due to repeated changes in tax law which narrowed and reduced further and further what would be due.

Any wealth that is passed along within the effective $10.86 million ceiling will never be subject to tax on capital gains made up to the point it was passed along.  That is, the cost basis is “stepped-up” to the value upon the date of death.  If one had purchased $100,000 of General Electric stock 40 years ago, the stepped-up value now would be roughly $3 million, and no taxes would ever be due on that $2.9 million of gain.

This is not fair.  Taxes on such wealth should be treated like taxes on any other wealth, and as argued in item #1 of this section above, all sources of income should be taxed the same (recognizing, importantly, that capital gains should be adjusted for inflation).

Some have argued that this cannot be done for inherited wealth since those inheriting the wealth may not know what the original cost basis was.  But this is not a valid excuse.  First of all, the two most important categories of wealth that are passed along through estates are homes and other real estate, and stocks and bonds and other such traded financial assets.  There are government land records on all real estate transactions, so it is easy (and indeed a matter of public record that anyone can look up) to find the purchase price of a home or other real estate.  And purchases of stocks, bonds, and other trade financial assets are done via a brokerage, which will have such records.

Second, if there are any other assets with special value (such as valuable coins or works of art) that will be passed along through an estate, the owner of those assets can include a record of their cost basis as part of the will or trust document that grants the asset to those inheriting the estate.

4)  Equal tax benefits for deductions should be provided for all income levels:  Under the current tax system, if a rich person in a 40% marginal income tax bracket makes a $100 contribution to some charity, then the government provides a gift to that rich person of $40 through the tax system, so that the net cost will only be $60.  If a middle class person in a 20% marginal tax bracket makes a $100 gift to the exact same charity, then the government will pay them back $20, for a net cost of $80.  And if a poor person in the 10% bracket makes a $100 gift to that same charity, the net cost to him will be $90.

This is enormously unfair.  There is no reason why deductions should be made more valuable to a rich person than to a poor person.  And there is an easy way to remedy it. Instead to treating deductions as subtractions from taxable income, one could take some percentage of deductions (say 20%) as a subtraction from taxes that would otherwise be due.  The $100 gift to the charity would then cost the rich person, the middle class person, and the poor person, the same $80 for each.

5)  Set tax rates progressively, and at the rates needed to ensure a prudent fiscal balance over the course of the business cycle:  I have argued above that all forms of income should be taxed similarly.  Whether you earn income from working or from wealth, two households with the same total income should pay taxes at the same rates.  This is not only for fairness.  It would also simplify the system dramatically.  And this is not only for the obvious reason that calculations are easier with one set of rates, but also because the current diverse rates interact between themselves in complex ways, which make computing taxes due a headache when there are different rates for different types of income.  Perhaps most importantly, it would eliminate the incentive to shift income from one category to another (e.g. from wage income to stock options) where lower taxes are due.  That creates distortions and wastes resources that should be used for productive activities.

There remains the question of what the new rates should be.  I do not have the data or the detailed tax models which would allow one to work that out, but a few points can be made.  One is that the new tax rates would be lower (at any given level of income) than what regular income tax rates (on wage income) are now.  This is because the tax rates on income from wealth (such as for capital gains, or inherited wealth) would be unified with the now higher tax rates on income from labor, so the new overall tax rates on regular income can be lower than before to yield the same level of tax revenues.  General income tax rates would come down.

Second, one should of course preserve the principle of progressivity in the tax code.  Rich people should pay taxes at a higher rate than poor people.  As Warren Buffitt argued eloquently in a New York Times column in 2011 (“Stop Coddling the Super-Rich”), there is no economic justification for the rich to pay taxes at lower rates than those with less income.  And it is grossly unfair as well.  Their secretaries should not pay at higher rates than the rich (fully legally) pay.

Third, one needs to recognize that the purpose of taxes is to raise revenues, and rates should thus be set at the levels required to cover government expenditures over time.  As argued above, the budgetary accounts should not be forced to balance each and every year, since fiscal policy is extremely important to move the economy back to full employment in an economic downturn (and fiscal policy is basically all that is available when interest rates are at the zero lower bound, as they have been since late 2008 in the US).

But over the full course of the business cycle, tax rates should be set so that the tax revenues collected suffice to keep the government debt to GDP ratio at a stable and reasonable level. This implies deficits when unemployment is high, and surpluses when the economy is close to full employment.  The economy was at full employment in 2006-07 (unsustainably so due to the housing bubble building up in those years) with the unemployment rate below 5% and as low as 4.4%.  Unfortunately, due to the Bush II tax cuts, the government’s fiscal deficit in those years was still significant.

Applying these principles, the tax rates needed for this would need to be worked out.  This can be done, but I do not myself have access to the data that would be required.  In the end, I suspect that regular income tax rates could be reduced substantially from what they are now, with this still sufficient to provide for adequate government expenditures over the course of the business cycle.  But the rich would pay more while those of low to moderate income would pay less, and whether this would then be possible politically is of course a different issue.

D.  Health Insurance

Access to health insurance is important.  A careful statistical analysis published in 2009 found that the likelihood of dying is higher for the uninsured than for the insured, and the lack of universal health insurance (as was then the case in the US) was leading to an estimated 45,000 more Americans dying each year than would be the case if they had health insurance.  This is greater than the number of Americans killed in action over the entire period of the Vietnam War.

The ObamaCare reforms have been a big step forward to making it possible for all Americans to obtain access to health care, but it remains under threat.  If Republicans are serious about helping the poor and middle classes, they should support the following.

1)  First, stop trying to block health care access for all:  ObamaCare, while not perfect (it reflects political compromises, and is based on the system of individual mandates first proposed by the conservative Heritage Foundation in 1989), is nonetheless working.  An estimated 16.4 million Americans now have health insurance coverage, which they did not have before ObamaCare became available.  And a Gallup poll found that there was a higher satisfaction rate among those obtaining health insurance policies through the ObamaCare exchanges, than among those with traditional health insurance policies (mostly via employers).

Despite this, Republicans continue to campaign aggressively to terminate ObamaCare, and have supported lawsuits in the courts to try to end this health care access.  A case now before the Supreme Court, with findings to be announced this month (June 2015), may declare that the federal government payments made through certain of the ObamaCare exchanges (those not run by the states) to those of low to moderate income, cannot be continued.  If the Supreme Court finds in favor of those opposed to such payments, these low and moderate income households will no longer be able to obtain affordable health insurance.

If the Republican presidential candidates are in fact in favor of helping the poor and middle classes, they should call for an end to the continued efforts by their Republican colleagues to terminate ObamaCare.  There are ways it could be improved (e.g. by taking more aggressive actions to bring down the cost of medical care to all in the US), but it is working as intended, and indeed better than even its advocates expected.

2)  Extend Medicaid in all states in the US:  The ObamaCare reforms built on the system of existing health insurance coverage.  Medicare would remain the same for those over age 65; employees in firms would normally pay for health insurance coverage through employer based plans; Medicaid would expand from covering (generally) those up to the poverty line to include also those with income up to 133% of the poverty line; and all those remaining without health insurance would be allowed to purchase coverage from private health insurers competing on internet-based health insurance exchanges, where those with incomes of up to 400% of the poverty line would receive federal subsidies to make such health insurance affordable.

The Medicaid expansion to cover all those with incomes of up to 133% of the poverty line was thus one of the building blocks in the ObamaCare reforms to enable all Americans to obtain access to affordable health care.  Because of its historical origins in health care programs for the poor that had traditionally been implemented in the states, Medicaid is implemented at the state level even though it is funded jointly with the federal government. For the Medicaid expansion to 133% of the poverty line, the federal government through the legislation setting up ObamaCare committed to funding 100% of the incremental costs in the first three years (2014 to 2016) with this then phased down to 90% in 2020 and thereafter.

Despite this generous federal funding, the Supreme Court decided in 2012, in its decision that also found ObamaCare in general to be constitutional, that Congress could not force the states to expand Medicaid to the higher income limits.  Thus the expansion became optional for the states, and as of April 2015, 21 states have decided not to.  The 21 states are mostly in the south or the mountain west, with Republican legislatures and/or Republican governors or mostly both.

Blocking this Medicaid expansion in these states is being done even though an expansion would cost little or nothing.  There is literally no state cost in the first three years as the federal government would cover 100% of the extra costs.  And while the federal share would fall then to a still high 90% for 2020 and thereafter, allowing more of the poor to be covered by Medicaid will reduce state costs.  The poor in this gap in coverage are forced to resort to expensive emergency room care, for which they cannot pay, when their health gets so bad that it cannot be ignored.  These costs are then partially compensated by the state.

A careful analysis for Virginia, undertaken for the state by Price Waterhouse Coopers, concluded that if Virginia opted in to the Medicaid expansion, the state would save $601 million in state budget costs over the period 2014 to 2022.  And this did not even include the indirect benefits to the budget from higher tax revenues, as a consequence of the additional jobs that would be created (nurses and other care providers, etc.) and the higher incomes of hospitals from less uncompensated care.

Denying affordable health care to the poor with incomes of between 100% and 133% of the poverty line is callous.  These are the working poor, and there really is no excuse.

3)  Ensure employers pay a proportionate share for health insurance for their part-time workers:  Employers have traditionally not allowed part time employees to obtain (through their wage compensation package) health insurance cover in employer-based plans.  There was a practical reason for this, as health insurance plans only provided cover in full.  It has been difficult to provide partial plans, so part time workers have traditionally gotten nothing.

This has now changed with the introduction of the ObamaCare health insurance market exchanges.  Those without health insurance coverage through their employers can now purchase a health insurance plan directly.  One could therefore now require that all employers make a proportionate contribution to the cost of the health insurance plans for their part time workers.  That is, for someone working half time (20 hours a week normally) the employer would contribute half of what that employer pays for the health insurance plans for their full time workers.

There would then be no incentive (and competitive advantage) for an employer to split a full time job with health insurance benefits into two half time jobs with no health insurance benefits for either worker.  Under the current system of normally no health insurance benefits for part time workers, employer are in essence shifting the cost of health insurance fully onto the worker and onto the federal government (and hence general taxpayer) if the worker earns so little that they are eligible for federal government subsidies to purchase health insurance on the exchanges.

The proportional employer contribution would be paid to the “account” of the worker in the same way (and at the same time) as Social Security and Medicare taxes are paid for the worker.  The funds from this account would then be used to cover part of the costs of the worker purchasing health insurance on the ObamaCare exchanges.  And if the worker was working in two (and sometimes three or more) part time jobs in order to make ends meet, the total paid in from all of the worker’s employers might well suffice to cover the cost of the health insurance plan in full.

4)  Allow competition from low cost public health insurance:  As part of the political compromises necessary to get ObamaCare passed in the face of steadfast Republican opposition, only private health insurers are allowed to participate in the ObamaCare health insurance exchanges.  Yet Medicare, which provides health insurance to all Americans age 65 and older, is far more efficient than private health insurance providers.  Giving Americans the option (not a requirement) to purchase Medicare administered health insurance on the ObamaCare exchanges would introduce much needed competition. There are often only a few insurers competing in the exchanges, which are all state-based (3 or fewer insurers in 15 of the 51 states plus Washington, DC, with only one insurer offering policies in West Virginia).

But even with multiple insurers competing on the state exchanges, the private insurers in general have high costs.  Private health insurers nationwide (and for all the policies they offer) have administrative costs plus profits equal to 14.0% of the health insurance benefits they pay out.  This is huge.  The same figure for Medicare is only 2.1%.  Medicare costs only one-seventh as much to administer as private health insurance.  And note these lower costs are not coming out of low payments to doctors and hospitals since the 14.0% and 2.1% are being measured relative to claims paid.

It would be straightforward to allow Medicare to compete on the health insurance exchanges.  One would require that Medicare charge rates sufficient (for the resulting client base, which will of course be younger than and generally healthier than Medicare’s senior citizens) to recover its full costs for such coverage.  But Medicare could use its existing administrative structure, including computer systems and contracts with doctors, hospitals, and other medical care providers at the rates that have already been negotiated.

Purchasing a Medicare administered health insurance policy on the exchanges would be fully optional.  No one participating in the exchanges would be required to buy it.  But with its lower costs, the competition Medicare would introduce into the exchanges could be highly effective in bringing down costs.

E.  Pensions

Probably the greatest failure of any social experiment of recent decades has been the switch of employer pension plans from the traditional defined benefit plans that were common up to the early 1980s, to defined contribution schemes (such as 401(k) plans) that have grown to dominance since the 1980s.  In doing this, employers not only shifted the investment, actuarial, and other risks on to the individual workers, but also typically reduced their matching funding shares significantly.

The end result is that workers are now typically woefully unprepared for retirement.  The funds accumulated in their 401(k) and IRA accounts for households (with head of household aged 55 to 64) with a 401(k) account, only amounted to $111,000 in 2013 (for the median household).  Such an accumulation, for households who will soon be in retirement, would suffice to provide only less than $400 a month by the traditional formulas, or $4,800 per year.

This is woefully inadequate, and these households will need to rely on what they can get from Social Security.  But Social Security payments are also not much.  For 2012 (the most recent year with such data), the median Social Security pension payment per beneficiary (age 65 or more) was just $16,799 per year, or per family unit (with head aged 65 or more) just $19,222 per year.  Furthermore, if nothing is done, the Social Security Trust Fund will run down to a zero balance in 2033 based on the most recent projections.

Fully funding Social Security is eminently solvable, as will be discussed below.  The annual cost (including for disability insurance) will rise from roughly 5% of GDP currently to 6% of GDP in 2030, as the baby boomers retire, or an increase of just 1% of GDP.  But what many do not realize is that on current projections, Social Security expenditures are then expected to remain stable (under current benefit rules) at that 6% of GDP for the foreseeable future, in projections that go out 75 years.  One can find 1% of GDP to save Social Security.  But the politicians in Washington will need to agree to do so.

There are several measures that need to be taken to ensure income security for the poor and middle classes in their old age:

1)  Raise, and certainly do not reduce, Social Security payments to those of low and modest income:  Social Security payments, while a crucial safety net, are low.  As noted above, the median payments in 2012 for those aged 65 and older were just $16,799 per beneficiary and $19,222 per recipient family (for the old age component). Such payments are minimal.  Yet these are just medians, meaning half of all recipients received less than even those figures.

Despite being so low, these Social Security payments are critical to many Americans. For the entire population of those aged 65 and older, Social Security accounted for half or more of their total regular income for two-thirds of the population (65% to be precise); Social Security accounted for 90% or more of their income for over a third of the population (36%); and Social Security accounted for 100% of their income for a quarter of the population (24%).  This is incredible, and shows the failure of the current pension systems in the US to provide a reasonable income in retirement for American workers.

The situation is, not surprisingly, worse for those of low to moderate income.  For the bottom 40% of the population by income, where 40% is by far not a small or insignificant share, Social Security accounted for half or more of their regular total income for 95% of them.  Social Security accounted for 90% or more of their income for three-quarters (74%) of them, and for 100% of their income for over half of them (53%).

Social Security benefits are by no means large.  Yet a large share of Americans depend on them.  They should not be cut, but rather should be raised, at least for those of low to moderate income who are critically dependent on them in their old age.

2)  Broaden the base for Social Security taxes to ensure the system remains fully funded:  As noted above, the Social Security Trust Fund will be depleted in 2033 (based on current projections, and including the disability component – while technically separate, the trust funds for old age and for disability insurance are normally treated together).  While some argue, with some justification, that the Trust Fund is fundamentally just an accounting tool, which can be “topped-up” with regular federal government transfers if necessary, there are also good reasons to stay with the Trust Fund rules.  They help keep the Social Security system out of routine Washington politics, and the temptation by conservatives to cut Social Security benefits in order to reduce the size of government.

Under the current Trust Fund rules, participation in the Social Security system is mandatory; taxes are paid on wage earnings (up to a ceiling of $118,500 in 2015); at a rate of 12.4% for Social Security pension and disability coverage for the employer and employee combined (excluding the 2.9% with no wage ceiling for Medicare); and upon retirement, these contributors will receive regular monthly payments from Social Security until they die, based on a formula which is linked to how much was paid into the Social Security Trust Fund during their working career (for the 35 years of highest inflation adjusted earnings).  The formula is complex, and “tilted” in the sense that those earning less will receive back somewhat more than they paid in, while those earning in the upper end of the taxable range will receive back somewhat less.  There is therefore some progressivity, but the degree of progressivity is limited.  Finally, the taxes paid into the fund will earn interest at the rate of the long-term Treasury bond yield of the time, so the taxes paid in to the fund grow over time with interest.

Based on these Trust Fund rules and on current projections of growth in worker earnings (and its distribution) and of what pay-outs will be as workers retire, the Trust Fund is expected to be depleted in 2033.  The basic cause is not that Social Security administration is inefficient and wasting funds.  It is, in fact, incredibly efficient, with a cost of administration of just 0.5% of benefits paid out (on the old age component).  Note this is not on assets, but on benefits paid.  As will be discussed further below, the typical expenses on savings in 401(k) and similar accounts will be 2 to 3% of assets each and every year.

The principal cause of the Trust Fund being depleted, rather, is that life expectancies have lengthened, and hence the period over which Social Security old-age payments are made have grown.  Crudely (and ignoring interest for this simple example), if life expectancy at age of retirement has grown by 50%, so that the number of years during which one will draw Social Security payments has grown by 50%, then the amount needed to be paid in to the Trust Fund to cover this lengthened life will need to grow by 50%.

Longer life expectancies are good.  The Social Security Trust Fund will run out of assets in 2033 not because the funds are being wasted (as noted above, administrative costs are incredibly low), but because people are living longer.  But this will need to be paid for.

But it is also critically important to recognize who is living longer.  As incomes have stagnated for those other than the rich since Reagan took office (see the chart at the top of this post), life expectancies for the poor and middle classes have in fact not increased substantially.  Rather, the overall life expectancy is rising principally because those at higher income levels are enjoying much longer life expectancies (in part precisely because their incomes have been growing so fast).

Specifically, life expectancy for a man at age 65 in the bottom half of earnings rose from 79.8 years in 1977 to 81.1 years in 2006, an increase of just 1.3 years.  But life expectancy at age 65 for a man in the top half of earnings rose from 80.5 years in 1977 (only 0.7 years longer than men in the lower half of the earnings distribution in that year) to 86.5 years in 2006, an increase of 6.0 years.  People are living longer, but it is mostly only those of higher income who are enjoying this.  Life expectancies have not changed much for those of low to moderate income.

It would therefore be perverse to penalize those of lower income to make up for the Trust Fund shortfall, when it is the lengthening of the life spans of those of higher income which is leading to the depletion of the Trust Fund.  Yet proposals to raise the retirement age, or to increase Social Security taxes on all, would charge the poor as much as the rich to make up for the Trust Fund deficit.

Rather than penalize the poor, Social Security taxes should be raised on those who are better off to pay for their increasing lifetime benefits.  And this is of course also precisely what one should want to do if one is concerned about inequality.

The obvious solution is to broaden the tax base for the Social Security tax to include incomes now excluded – which are also incomes that accrue to the rich.  First, note that the shortfall to be made up when the Social Security Trust Fund is expected to be depleted (if nothing is done) in the 2030s would require a 20% increase in revenues.  That is, following a transition between now and about 2030 as the baby boomer generation retires, the long term projection is that Social Security tax and other revenues will level off at about 5% of GDP, while Social Security obligations will level off at about 6% of GDP. That is, we will need revenues to increase by about 20% to make up the shortfall, to get to 6% of GDP from 5%.  (A more precise estimate, but from my blog post of a few years ago, is an increase of 19.4%).

Broadening the Social Security tax base would easily provide such an amount of funding. For wages alone, there is the current ceiling of $118,500 (in 2015) on wages subject to Social Security tax.  At this ceiling, only 83% of all wages paid are subject to this tax.  This is down from 89% in 1980 as an increasing share of wages are being paid to the very well off (those with wages above the ceiling).  If one were to tax 100% of wages rather than only the current 83%, one would in fact obtain the funds needed, as that alone would provide an increase of over 20% (100/83 = 1.205).

But broadening the base should not stop at simply ensuring the taxes paying for Social Security are paid by all wage earners equally, rich and poor.  There is no economic rationale why only wage income should be taxed for this purpose, and not also income from wealth.  And income from wealth is primarily earned by the wealthy.

Using figures from the National Income and Product (GDP) accounts, total private income (including not just wages, but also income from interest, dividends, rents, and so on, but excluding government transfers) in 2014 was 65% more than just wages alone.  (Note that while these income concepts from the GDP accounts are not the same as the income concepts defined in the income tax code, they suffice for the illustrative purposes here.)  A uniform tax rate of 7.5% rather than 12.4% (12.4/7.5 = 1.65), but on all forms of income and not just wage income, would thus suffice to generate the Social Security tax revenues to fund fully the Trust Fund for the foreseeable future.

But one important proviso should be noted.  Such tax rates (of either 12.4% on all wage income, or 7.5% on all forms of private income) would generate the revenues required to fully fund the system based on current benefit payment projections.  However, with benefit payments tied to one’s history of tax payments, one would also need to change the benefit payment formulae to reflect the broader tax base.  Otherwise the benefits due would also change to reflect the higher amounts paid in.

Finally, as noted above, current Social Security benefit payments are low and really need to be increased.  While I do not have the data and models that would be required to work out fully some specific proposal, the figures here can give us a sense of what is possible. For example, a possible balance might be to broaden the tax base to include all forms of income, but then to reduce the tax rate on this not all the way from 12.4% to 7.5%, but rather to the halfway point of 10%.  But this 10% rate would then suffice to permit a one-third increase in overall benefits (10/7.5 = 1.333), which one should want also to concentrate on those of low to moderate income.  The overall tax rate would be cut, but in broadening the tax base to all forms of income one could support a significant increase in benefits.  Overall taxes paid would be higher (everything has to add up, of course), and while low and moderate income earners would mostly see a reduction in the taxes they owe, richer individuals would pay more.

3)  Require that 401(k) plan administration fees are paid for by the entity choosing the provider:  Turning from Social Security to private pension plans, where defined contribution plans (401(k) plans and similar) are now the norm, the key issue is to keep fees low.  Unfortunately they are extremely high, and take away a large share of the investment returns on the funds saved.

One cause of this is that the fees being received by the financial advisors are often hidden in various ways, and charged in different ways by different entities.  There is no standard, and average levels are not made publicly available to provide a basis for comparison. The fees charged will also vary sharply depending on the type of investment product being used (i.e. direct equities, mutual funds of different types, insurance products including annuities, various complex products, and more).  Finally, while individual fees might sometimes appear to be low, they are imposed at several layers in the investment process, and in total come to very high levels.  Not surprisingly, according to one survey 93% of the respondents dramatically underestimated what their cumulative 401(k) fees will come to.

Estimates for what the average fees in fact now are vary.  At the base will be the fees charged by a plan administrator, chosen by the firm of the employee and responsible for the record keeping, for allocating the investments as chosen by the plan participant, and so on. These fees will vary depending on the size of the firm and the deal negotiated on behalf of the employee, but one set of estimates are that these fees average 0.5% of plan assets annually in large firms (plan sizes of $100 million or more), 0.9% in medium size firms (plan assets of $10 million to $100 million) and 1.4% in small firms (plan assets of less than $10 million).

On top of these base administrative fees one will then have to pay the fees charged by the investment vehicles themselves.  Mutual funds are perhaps most common, and the expense fees on these (normally subtracted from the investment returns, so the amount being paid will not be obvious) average about 1.1%.  But they can range widely, from less than 0.1% for standard index funds, to over 2%.  On top of this, one has the cost of buying and selling the investments (whether mutual funds or equities or the other products), which some estimate may average 1.0%.  But these too can vary widely.

Finally, one may have individual fees on top of these all, which depend on the services being requested (whether investment advice, or entry and exit fees, or loan advances against balances in the worker’s pension accounts, and more).  These will vary widely, but one estimate is that the median might be an annual cost of about 0.7% of assets.

The total amount lost in fees each year can therefore easily be in the range of 2 to 3% of assets, and 2.5% is a commonly taken average.  Note also that these fees (or at least most of them) will be taken by the financial managers regardless of whether the investments perform well in any given year.

Over time, these fees will take for the financial administrators a large share of the investment returns that were intended for worker retirement.  A simple spreadsheet calculation, for example, will show that over a 40 year time horizon, where (for simplicity) equal amounts are set aside each year for retirement, with an assumed 5% real rate of return but financial fees of 2.5% a year, the financial cost will have taken away by the 40th year 45% of what would otherwise be the balance saved.  (It will not equal 50% because of the way compounding works.)  This is 90 times the total fees that would be charged by Social Security for the old-age support it provides, which as noted above is only 0.5% of benefits paid out.  Note that I am not arguing that the private fees should be the same as what the cost is for Social Security to administer the accounts.  Social Security is an extremely efficient system.  The specific share taken by financial fees will also depend, of course, on what is assumed for the rate of return and other parameters. But anything like 90 times as much is a lot.

Furthermore, many of the fees being charged on the private pension accounts will continue into the retirement years, so the final amount paid out in benefits will be even less.  Assuming there will be 20 years of retirement following the 40 years of work, with returns and fees continuing as before, the annual amount that could be paid out to the worker in retirement will be only 44% of what would be paid out if the fees were at the 0.5% (of benefits only) of Social Security, a reduction of 56%!

Fees are therefore hugely important, but the worker can manage (through the decisions they make) only some of them.  In particular, the basic plan administration fees for managing the accounts are made at the firm level.  When firms had defined benefit pension plans, these costs were included in what the firm covered.  They kept track of, or contracted out to some specialist, the individual payment obligations and other bookkeeping.  But when firms switched to defined contribution schemes, most commonly 401(k)s, the firms chose to incorporate the costs of the plan administration into charges against the individual account balances, thus shifting these on to the workers.  But the workers had no choice between plan administrators:  They were chosen by the firm.  And with the firm not bearing the cost, the firm might not worry so much about what the cost was.  Rather, they might choose a plan administrator based on how good they were at making sales pitches, or whether they did other work for the firm where they might extend a discount, or based on who provided the fanciest annual conferences for their clients (the decision maker in the firm) at some resort in Hawaii.

Some firms of course make a sincere effort to choose the best balance between plan administrator cost and performance, but others do not.  But to resolve this, a simple reform would be to require that firms pay the cost of plan administration directly from the firm’s accounts, and not out of the pension savings of the workers.  This would return to what had normally been done with the traditional defined contribution pension plans, where firms had an incentive to ensure plan administration costs were kept low.

4)  Require low cost investment options be included in 401(k) and similar schemes:  One can also keep financial fees down by investing in low cost investment options, such as simple and standard index funds.  The Vanguard S&P 500 Index Fund, and now even the Vanguard Total Stock Market Index Fund, each charge an annual expense fee of just 0.05%.  This is far below the 1 to 2% charged by most managed mutual funds.

Such low cost options are included in many 401(k) plans, but unfortunately not all.  Such options should be required in all.

5)  Provide an option of investing in “Social Security Supplemental Accounts”:  One very low cost investment option would be to invest a portion of one’s 401(k), IRA, and similar balances, into a supplemental account managed by Social Security, which would then be paid out along with one’s regular Social Security checks.  Accounts would earn a return equal to the long-term US Treasury bond rate, the same as existing Social Security balances do now.  The option would take advantage of the extremely high efficiency of the Social Security Administration.

With the far lower cost of Social Security relative to what private financial institutions in the US charge, the net return on such investments would be attractive.  Given historical long term bond interest rates and the differences in fees, the returns would be comparable to what might be earned in pure equity investments, but far less volatile.  And the returns would be far better than what on average has been earned in actual 401(k) and IRA accounts, given how they have historically been managed.

The Social Security Supplemental Account would be purely voluntary.  No one would be forced to put a share of their 401(k) or IRA assets into them.  But this would be an attractive option for at least a share of the plan assets, earning a comparable return (after fees) but with far less risk.  It would be especially attractive to middle class families who may have significant but not huge assets in their retirement accounts, who are seeking to ensure a safe retirement.

F.  Conclusion

The returns to economic growth have become horribly skewed since Reagan took office, but there is much that could be done to address it.  This blog post has discussed a number of actions that could be taken, and if the Republican (and Democratic) candidates are truly concerned about the direction of income inequality, there is no shortage of measures to consider.  And this is not an all or nothing set of actions:  While complementary and mutually reinforcing, taking some actions is better than none, and more is better than some.  Nor are they in general administratively difficult to do.  Most are straightforward.

But action is clearly needed.

 

Part Time Workers and the Affordable Care Act: A Proposal to Address the Real Issue

Part Time Workers as Share of Total Employed, Dec 2007 to Dec 2014

A.  Introduction

The Affordable Care Act (ACA, and also often referred to as ObamaCare) has been working well by any objective measure.  There are now more than 10 million additional Americans who have health insurance who could not get affordable health care before; the share of the uninsured in the US population is now a quarter less than what it was before the individual mandate of the Affordable Care Act went into effect; and this has been achieved at premium rates for the new plans that are reasonable and well less than opponents charged they would be.  Health care costs have also stabilized under Obama, both as a share of GDP and in terms of health prices relative to overall prices, in contrast to the relentless increases in both before.  And while some have criticized this, it is good that there are now minimum quality and coverage standards in health insurance plans.  Such standards are good in themselves.  And without such standards, purported health care “plans” which offer next to nothing (due, for example, to extremely high deductibles) and which can then cost next to nothing, would lead to a death spiral for genuine health care plans that cover costs when you are sick and need treatment.

Gains from the ACA are also reflected in the findings of a recently published report from The Commonwealth Fund.  The Commonwealth Fund has been organizing a periodic survey on health care coverage since 2001.  The most recent survey (for 2014) found that for the first time since the question was first asked in 2003, there was a reduction in the number of Americans avoiding (because of cost) health care services that they needed.  And for the first time since the question was first asked in 2005, the number reporting medical bill or debt problems also fell.  Personal financial distress due to medical problems has been reduced, due to greater access to health insurance and due to health insurance plans that now meet minimum standards.

Despite this (but not surprisingly given the position they staked out against the reform), the Republican Congress continues to vote to repeal, or at least weaken, the law.  The most recent vote was aimed at the provision in the Act which complements the individual mandate to purchase health insurance, with an employer mandate requiring firms with 100 full time equivalent employees or more from January 1 of this year (and with 50 or more from January 1, 2016) to offer health insurance to their full time employees or pay a fee.  The proposed Republican bill would change the definition of a full time worker from one who normally works 30 hours or more a week, to one who works 40 hours or more a week.

The supporters of the change charge that the prospect that employers (with 50 or 100 employees or more) will soon be required to offer health insurance to their full time employees has led firms to cut working hours of their employees, to shift them from full time to part time status, and hence avoid the employer mandate of the ACA.  As a Republican congressman from Texas said:  “We have heard story after story from every state in the union that employers are dropping workers’ hours from less than 39 hours a week to perhaps less than 29.”

This accusation is confused on several levels.  This post will first look at whether there is in fact any evidence that workers are being shifted from full time to part time status as a result of the ACA (or indeed for any other reason).  The answer is no, at least at the level of the overall economy.  Second, there has been a good deal of confusion in the discussion on what the issue really is with regard to part time workers, including by prominent congressmen such as Paul Ryan.  Either Ryan does not understand what the employer mandate is, or if he does, then he has deliberately mischaracterized it.

The public discussion has also avoided altogether the real issue.  It is not that firms with 50 workers or more would be required to offer health insurance to their employees (most do already), but that this insurance is only made available to their full time workers.  Part time workers get nothing, no matter what size firm they work at.  The final section of this blog post will discuss a way to resolve this equitably.

B.  What is the Evidence on Whether the ACA Has Increased the Ranks of Part Time Workers?

The opponents of ObamaCare assert that as a result of the employer mandate, firms have been shifting workers from full time to part time status.  E.g., instead of employing one worker for 40 hours, they are choosing to employ two workers for 20 hours each.  If true, the ratio of part time workers to the total employed will rise.

The chart at the top of this post shows this has not been the case.  It is based on data from the Bureau of Labor Statistics, from its Current Population Survey.  This monthly survey of households is used to determine the unemployment rate among other statistics.  The households surveyed are asked whether household members are employed full time or part time (if employed), and if part time, whether this is by choice (because they only want to work part time) or because they want a full time job but cannot find one.  The chart above shows the ratio of workers who are working part time not by choice but for economic reasons, to all workers employed.  Note that the BLS data defines a part time worker as one with fewer than 35 hours of work per week.  While this differs from the 30 hour standard in the ACA, as well as the 40 hour standard in the recently passed Republican legislation, the results in terms of the trends should be similar.  The BLS does not publish data with a different cutoff in terms of hours per week for what is considered part time work.

As in any economic downturn, the ratio rose rapidly in the economic collapse of the last year of the Bush administration.  Regular jobs were disappearing, with some of them shifting to part time status.  Indeed, the absolute number of part time jobs was increasing at the time, even as the total number of jobs was falling, thus leading to two reasons for the ratio to rise, and rise rapidly.

The ratio reached a peak soon after Obama took office, and began to fall about a year later.  Since then it has fallen at a fairly steady pace in terms of the trend.  There were sometimes relatively sharp month to month fluctuations in the data, but this can be on account of statistical noise.  The data comes from a limited sample of households, with only 5 to 6% or so of those employed on part time status (for economic reasons) for most of this period, so the statistical noise in a relative sense (month to month) will be large.  But the downward trend over time is clear, and at a similar downward pace for close to five years now.

What one does not see is any shift in this downward trend linked either to the signing of the Affordable Care Act in March 2010, or to the start of the individual health insurance mandate in January 2014, or to the anticipation of the start of the employer health insurance mandate in January 2015.  Note that since the classification of a worker as a full time or part time worker (and hence the classification of the firm as crossing the 100 or 50 full time worker standard) will be in a period of up to 12 months before the employer mandate goes into effect, one would have seen an impact in 2014 if the 2015 mandate mattered.  There is no indication of this.

The data cover the overall economy.  The figures refer to millions of workers as well as millions of employers.  The US is a large place.  Within such a large place, it will undoubtedly be possible to find particular cases where employers will say that they reduced worker hours to part time status so that they could avoid the health insurance employer mandate.  And one could indeed probably find a long list of firms making such statements.  It would be even easier to find a long list of firms and other entities where working hours were cut, whether or not there was any employer mandate pending.  In a dynamic economy, there will always be a large number of such cases (along with a large number of cases of firms going in the opposite direction, converting part time jobs to full time jobs).

Such anecdotal information, and even a long list of such anecdotes, is not evidence of an issue of substantial scale.  As seen above, there is no evidence of it in the overall numbers.  But one should still recognize that the issue could exist in particular cases.  The question, however, is what is the real issue here, and if there is one, how can it be addressed.

C.  What the Employer Health Insurance Mandate Says

For better or worse, the US health care insurance system is built around health plans normally provided to workers through their place of employment, as part of their overall wage compensation package.  The system began during World War II and has expanded since, supported through substantial tax advantages.  By now, health insurance provision is close to universal among large employers, but substantially less so among small private firms:

Share of Private Firms Offering Health Insurance – 2013
< 10 employees 28.0%
10 to 24 employees 55.3%
25 to 99 employees 77.2%
100 to 999 employees 93.4%
≥ 1000 employees 99.3%
< 50 employees 34.8%
≥ 50 employees 95.7%
All private employees 84.9%
Source:  MEPS, Tables I.A.2 and I.B.2 (2013)

Overall, 84.9% of private sector employees are in firms that offer health insurance as part of their wage packages.  And 96% of firms with more than just 50 employees offer health insurance.

The Affordable Care Act built on this and did not replace it.  Liberals (including myself) would have preferred moving to a system where Medicare would be extended to cover the entire population rather than just those over age 65.  Medicare is an efficient and well managed program, and as an earlier post in this blog discussed, its administrative expenses come to only 2.1% of the benefits paid.  In contrast, administrative costs (including profits) of private health insurance are seven times higher at 14.0% of benefits paid, and an even higher 18.6% of benefits paid in the privately administered Medicare Advantage plans.

But Obama agreed instead to support an approach first proposed by the conservative Heritage Foundation, which was then put forward by Republicans in Congress as their alternative to the health reforms proposed by the Clinton administration (coming out of the task force Hillary Clinton chaired), and which was later adopted in Massachusetts when Mitt Romney was governor.  These plans were built around keeping the existing employer-based provision of health insurance for most of those employed, but to complement this with markets where individuals could purchase health insurance directly if they did not have employer-based coverage, coupled with an individual mandate to buy such health insurance.  The individual mandate is necessary to counter what would otherwise be a resulting death spiral of health insurance plans if everyone is granted access (including those with pre-existing conditions) but only the sick then purchased health insurance (for a description and discussion, see this earlier Econ 101 blog post).

It was not unreasonable to believe that the Republicans would not oppose a plan whose origins lies in their own earlier proposals, but that was not to be.

As noted, the individual mandate is necessary to avoid death spirals in health insurance plans for individuals.  Complementing this, an employer mandate to offer health insurance to their employees is necessary to counter what could otherwise be a “race to the bottom”.  If certain firms did not support such health insurance for their employees, thus reducing the cost to them of their workers, they could undercut competitors who did provide good health insurance support.  It could lead to a race to the bottom.  While not yet widespread in the US, especially for larger firms (see the table above), there has been increasing competitive pressure in the US over the last couple of decades to cut such health insurance support.  An increasing number of employers have done so.

Thus the ACA includes an employer mandate to complement the individual mandate.  However, while the individual mandate went into effect on January 1, 2014, the employer mandate has been twice delayed, and has now (as of January 1, 2015) gone into effect for firms employing 100 of more full time equivalent employees, and will go into effect on January 1, 2016, for firms employing 50 or more full time equivalent employees.  It is this provision that the Republicans in Congress are now trying to subvert.

The charge by Paul Ryan and others has been that medium to small size firms have been cutting the hours of their employees to shift the workers from a full-time classification to a part-time one.  The aim, they say, has been to reduce the number of their full time workers to below 50 so as to avoid the employer mandate.  For example, in a recent opinion piece published in USA Today, Congressman Ryan wrote:  “The law requires employers with more than 50 full-time employees to give them health insurance.  But because the law defines “full time” as 30 hours or more, employers are keeping employees below that threshold to avoid the mandate entirely.”

However, that is not what the law says.  Precisely to avoid such an incentive, the boundaries on the size of a firm subject to the employer mandate is defined in terms of full time equivalent workers (whether 50 or 100).  That is, if a job is split from one full time worker to two half time workers, the number of full time equivalent workers is unchanged.  The two half time workers count as one full time worker for the purposes of the statute.  Cutting back on the number of hours of individual workers to make them part time will not change the status of the firm when the total hours of labor to produce whatever the firm is producing remains unchanged.  And it would be foolish for a firm to produce and sell less when the demand exists for such sales, simply to avoid this mandate.

There is, however, a critically important issue here which Ryan and his colleagues have not discussed.  While splitting jobs of full time workers into multiple part time jobs will not change the status of the firm on whether it is subject to the employer mandate, shifting workers from full time to part time status does affect whether the firm would be required to include health insurance as part of their wage compensation package.  Firms subject to the mandate must offer an affordable health insurance plan available to at least 95% of full time (not full time equivalent) workers, or pay a fee.  The fee (of up to $2,000 per year per worker, less 30 workers per firm) is designed to partially offset (and only very partially offset) the cost of health insurance that they are shifting to others.

But such health insurance typically only is provided to full time workers.  This is true even for giant corporations.  Hence a firm can avoid making health insurance available to its workers by shifting them from full time to part time status.  This has always been the case, and is indeed a problem.

The Affordable Care Act addresses the issue only partially and tangentially.  By including a definition of what constitutes full time work at 30 hours a week or more, the ACA reduces the incentive to shift workers from the traditional 40 hours per week for full time work, to just under 40 hours in order to avoid providing health insurance cover.  A firm would need to cut a normal worker’s hours to below 30 hours per week to avoid providing health insurance, and is unlikely to do that for its regular work force.  But by moving the dividing line up to 40 hours per week, as the Republican legislation passed on January 8 would do, one opens up a loophole for firms to reduce worker hours from 40 to say 39 per week (or 39 1/2 or even 39.99 I would suppose).  Firms would be able easily to avoid offering health insurance to what are in reality their regular, full time, workers; use this to undercut competitors who do offer such insurance; and thus spark a race to the bottom on health insurance coverage in those industries.

D.  Addressing the Problem of Health Insurance for Part Time Workers

As noted above, the ACA does not do much to address the problem of part time workers receiving nothing from their employers for the health insurance everyone needs.  Setting the floor at 30 hours per week helps by ensuring workers close to the traditional 40 hour workweek will receive an employer contribution to their health insurance, and avoids the incentive to shift workers from 40 hours per week to just a bit below.  But part time workers of less than 30 hours per week will still normally receive nothing from their employer to help cover their health insurance.  And it creates an incentive for employers to structure positions as two workers at 20 hours per week, say, than one at 40.  While whether or not the firm was subject to the employer mandate would not be affected (since it is expressed in terms of full time equivalent workers), whether or not the firms would need to provide anything in terms of health insurance would be affected.

But there is a way to address this, now that the individual health insurance marketplaces are operational under the ACA.  All firms could be required to contribute an amount for their part time workers proportional to the hours of such part time work to what full time work would be.  That is, if two workers are each working half time, the firm would contribute an amount of 50% (for each) of the cost of the employer contribution to the health insurance for one full time worker.  The total cost would be the same whether the firm employed one full time or two half time workers.  There would also then not be an incentive to split jobs from full time workers to multiple part time workers.

The employer contribution to the part time worker’s health insurance costs would then be paid, along with taxes such as for Social Security or Medicare, to the government in the name of the specific part time worker.  These funds would then be used as a partial pay down of the costs of that worker purchasing health insurance on the individual health insurance market exchanges set up under the ACA.  And while other splits could be considered, I would recommend that those funds would be split half and half between what the worker would need to pay on the exchange for his or her health plan, and what the government subsidy would provide.

A simple numerical example may help clarify this.  Using made up numbers, suppose the full monthly cost of a standard (Silver level) health insurance plan on the individual exchange where the worker resides is $400.  Assume also that at the current income level of this (part time) worker, the government subsidy for such insurance would be $200 per month, while the worker would pay $200 per month.  Now assume that firms would be required to pay proportional shares of what they provide to full time workers for their health insurance, and that this would come to $100 per month for this part time worker.  This would be split half and half between what the government subsidy would be and what the worker would pay, so under the new approach the government would provide $150, the worker would pay $150, and the funds coming from the firm would cover $100, summing to the $400 total cost.

A few specifics to note:  Many part time workers hold down multiple jobs.  They would receive for their “account” the total proportional amounts from all of their employers.  Many part time workers are also part of married couples.  There could be a household account into which all the sums were paid (for each family member), which could be used to purchase a family health plan on the exchanges.  In the event that the family was not purchasing insurance through the exchange (perhaps, for example, because the spouse worked at a firm providing family coverage), the amount paid by the firm for the part time worker would be returned to the firm (or canceled from the start).

And if the total amounts paid in from the full set of employers for that individual (or family) led to the government subsidy falling all the way to zero, any excess would be allocated to what the individual would pay for the insurance.  This could be common in cases where the family income of the part time worker was close to, or above, the income limit on which government subsidies are provided.

It is only with the advent of the individual health insurance exchanges that this method for covering part time workers became possible.  Previously, firms were not in a position to purchase half of an insurance policy for a half time worker.  But now they can contribute an amount equal to half the cost, with this then used to help purchase coverage on the individual marketplace exchanges.

Note also that with this reform, it would matter less whether full time work was defined as 30 hours per week or 40 hours per week or whatever.  I would recommend keeping the 30 hour per week boundary as it would be a factor in determining what the employer contribution would be.  But it would not be as critical as now, where the boundary determines whether 100% of the employer share of the health insurance cost is paid or 0% is paid.  There would be a smooth transition (a worker of 39 hours when 40 hours is defined as the standard would still receive 39/40 of the payment, and not zero), without a drop straight to zero.

There would also be no reason to limit this extension of the employer mandate only to firms with 50 (or 100) or more full time equivalent workers.  All firms should make such a contribution to covering the cost of their workers’ health insurance needs, just as they all make a contribution to Social Security and Medicare taxes.  Indeed firms of whatever size (although this will soon apply only to firms with less than 50 full time equivalent workers) that do not have any health insurance plan for their staff should participate.  The amounts paid could be set as a proportion to the cost of the medium Silver level plan available on the individual health insurance exchanges in their area.

Undoubtedly, there will be assertions by the Republicans that requiring such a contribution to health insurance costs for their part time workers will lead to an end to such jobs.  This would be similar to the arguments they have made that raising the minimum wage will lead to higher unemployment of lower paid workers, and arguments that were made earlier that paying Social Security taxes would lead to higher unemployment.  But as was discussed in an earlier blog post, there is no evidence that increases in the minimum wage in the magnitudes that have been discussed have led to such higher unemployment.  Ensuring firms contribute proportionally to the health insurance costs of their part time workers would not either.

The Cost of Health Care Has Stabilized Under Obama

Total National Health Expenditures as Share of GDP, 1980-2013

A.  Introduction

The Centers for Medicare and Medicaid Services (CMS) released in early December its regular annual estimate of overall health care expenditures in the US.  Their highly detailed tables start in 1960 and now go through 2013, and they provide the most reliable and complete regular figures on health care spending in the US.  While a number of news outlets noted that national health care expenditures had once again remained stable at 17.4% of GDP under Obama (for the fifth straight year now), there is much more that one can derive from these numbers that is of interest to anyone concerned with US health care expenditures.

B.  National Health Care Expenditures as a Share of GDP

The stability of total national health care expenditures at 17.4% of GDP under Obama is indeed significant.  But it is not unprecedented:  Health care expenditures were also stable as a share of GDP for an extended period during the Clinton administration.  But the general path has been strongly upward over recent decades, with the share now close to double what it was in 1980.  Large increases during the Reagan/Bush I and Bush II presidential terms were not offset by the stability during the Clinton and Obama years.  While I have not examined in detail the primary reasons for this difference, I would suspect that a factor has been the greater willingness during Democratic administrations to use government initiatives to hold down health costs.

But while the share of health expenditures in GDP in current prices has almost doubled over this period, the share expressed in terms of constant prices has been flat.  That line is also shown in the chart above, in red.  While there is no published estimate of a price deflator specifically for overall national health expenditures, it is reasonable to use the price deflator in the GDP accounts for personal consumption of health care.  The personal consumption figure accounts for about two-thirds of national health care expenditures, where the remainder will be for such items as investment in hospitals and equipment, for direct government expenditures on health care such as for doctors in the military and in the Veterans Administration, and for research.

Using this price deflator, the share of health expenditures in GDP in real terms in fact declined some over 1980 to 2000, rose by an equal amount between 2000 and 2009, and since then has been flat, to end in 2013 at the same share as it was in 1980 (8.9% of GDP in terms of the prices of 1980).  This is pretty remarkable.  Despite an aging population over this period, where older people require much more health care services than younger ones do, US spending on health care as a share of GDP would have been no higher in 2013 than it was in 1980 if the price of health care relative to overall prices (the GDP deflator) had not changed.

Note that this is not a result of the prices of 1980 as being something special.  The same result would have been found using the prices of any year.  And while not shown in the diagram above, the constancy of the share of health expenditures in GDP in real terms held back to the mid-1970s.  The share rose from the mid-1960s to the mid-1970s, in part due to the introduction of Medicare (the Medicare Act was passed during the Johnson administration in 1965, and the program started in 1966).  The increase in share over that period was by about a quarter (from a bit over 7% to a bit less than 9% of GDP, all in terms of 1980 prices).  It has since been relatively constant.

C.  Relative Prices Matter

The GDP share could only rise in current prices when it was flat in constant prices because the price of health care rose relative to the general price deflator for GDP.  This is just arithmetic.  It is therefore of interest to look more closely at what has happened to the relative price of health care.

For the period since 1980, health care prices have consistently out-paced the rise of overall prices until the last few years:

Change in Relative Price of Health Care vs. GDP, 1980-2013

 

The price index for GDP is a weighted average of the prices of all goods and services produced by the economy.  That is, and speaking loosely, a GDP price index rising by say 2% implies that about half (in weighted terms) of all prices rose by more than 2% while about half rose by less than 2% (including some that could have fallen).

What is unusual for the health care price index is that it has risen consistently faster than the overall GDP price index, until recent years.  The increase was particularly rapid during the Reagan / Bush I years, with the health care price index outpacing the GDP price index by 4.1% per year on average over this period.  For the more technically minded, the GDP deflator rose at an annual average rate of 3.9% over this period, while the health care price index rose at an annual average rate of 8.2%, so the relative price rose at the rate of 1.082/1.039, which equals 1.041, or 4.1% a year.

A 4.1% relative price growth compounded over 12 years (1980 to 1992) is huge:  At that rate, health care prices rose by 62% more than overall prices over that 12 year period.  And that is the immediate cause of health care rising as a share of GDP from 8.9% to over 13% in current prices over the period, despite a slowly falling share in real terms.  Real health care consumption relative to GDP fell, but total health care expenditures still rose relative to GDP in current dollar terms due to the higher relative prices for health care.

The relative price of health care relative to GDP then continued to rise, but at a much slower pace, during the Clinton years.  It then bounced back up some during the Bush II years (other than in 2005 and 2006, when the GDP deflator rose in the peak years of the housing bubble and then matched the increases in the price deflator for health care in those two years).

Under Obama, the relative price of health care came back down, and indeed was significantly negative in 2011 for the first time since before 1980.  This was then followed by two further years of zero or negative growth.  There have not been three consecutive years zero or negative growth in the relative price of health care in the US since 1946 to 1948, two-thirds of a century ago.

The Obamacare reforms account for at least some of this.  The Affordable Care Act (Obamacare) was passed in early 2010, and while the insurance coverage reforms (making health care insurance coverage available for all Americans) only went into effect in 2014, other health care reforms went into effect immediately.  These included a wide range of individually modest, but cumulatively significant, measures to bring down costs.  For example, the Medicare system for compensating hospitals now is set up to provide a financial incentive for good rather than poor quality care.  Under earlier systems, hospitals were paid more when the patient received poor quality care and got an avoidable infection, for example.  Such measures improved efficiency and brought down costs.

D.  Even At a Constant Share of GDP in Real Terms, Per Capita Consumption of Health Care Can Still Rise 

The relative price of health care has stabilized for three years now under Obama, while the share of health care expenditures in GDP, whether in real or nominal terms, has stabilized for five years.  But has this been achieved at the cost of reducing the availability and use of health care?  No:

Growth of Real Per Capita Personal Consumption of Health Care, and of Real GDP, 2001-2013

This diagram plots what has happened since 2001 to real per capita national health expenditures (from the same figures as used above from the CMS, but now converted into real per capita terms), real per capita personal consumption of health care services (from the GDP accounts), and real per capita GDP.  The figures are all scaled to equal 100 in 2008.  The national health expenditure and personal consumption of health care lines track each other fairly closely.  One could have used either.

As the graph shows, real per capita expenditures on (or use of) health care services have increased each year over this period.  There was still an increase, although at a slower pace, in the peak years of the economic downturn in 2009 and 2010.  And the increases continued, at a strong pace, in 2011 to 2013, when GDP was recovering as well.

When health expenditures stabilized as a share of GDP under Obama, some analysts at first speculated that this was due to lower consumption of health care services during the economic downturn.  Unemployment was high and many had less access to health insurance.  But use of health care services did not fall during the downturn.  And it then came back strongly in 2011 to 2013.  The stable share of GDP has been due to stable prices for health care since 2011, with real per capita health care expenditures then rising at a similar rate as rising real per capita GDP.

E.  Why Isn’t the Figure for National Health Expenditures Equal to 18% of GDP? 

An earlier post in this blog in the series on health reform stated that the US has been spending close to 18% of GDP on health care.  This was 50% more than the second highest spending OECD country (the Netherlands) and close to double the average spent of all OECD countries.  The figures were for 2011 and came from the then current OECD data for the US and other OECD countries (close to, but not quite the same as, the national health expenditure totals from the CMS for the US).  Why are the figures for the US now at 17.4% of GDP in 2011, as well as since?

The US health expenditure numbers have in fact not changed.  They are still expected to total $3 trillion in 2014.  The reason for the difference (aside from round-off:  they were a bit below 18% in the earlier numbers) is that the estimate of the denominator in the health expenditures to GDP ratio has changed.  In the summer of 2013, the BEA revised its methodology for estimating GDP, as it periodically does.  While there were several changes, the one with the largest impact was to revise the treatment of research and development expenditures.  The BEA had before treated such expenditures as what economists call an intermediate product (a good which is immediately used up as goods are produced, much like coking coal is used up in the production of steel).  They decided it was more appropriate to treat them as an investment product, which will last for several years (depreciating over time).  This was purely a methodology change.  But the effect was to revise estimated GDP up by about 3 to 3 1/2% in recent years.  This was not just applied to the GDP figures of recent years, but rather to the full GDP series going all the way back to 1929.  Hence the year to year growth rates were largely unaffected.

But a denominator which is now larger will lead to a health expenditure share in GDP which is lower.  By simple arithmetic, a share of 17.9% of GDP will fall to 17.4% of GDP if GDP is estimated to be 3% higher than before.

F.  Conclusion

Health care costs stabilized during Obama’s tenure, with health care costs as a share of GDP now flat (in both constant and in current prices) in contrast to the big increases (in current prices) before.  This has not come at the expense of falling availability or use of health care services.  They have continued to grow throughout his presidency, and especially since 2010.

Looking forward, 2014 may be different.  The Obamacare insurance reforms came into effect in 2014, and have reduced the ranks of the uninsured by more than 10 million Americans.  The share of the population without any health insurance fell by over 30%.  The newly insured are likely to make greater use of regular health care services in 2014, especially by those who previously had conditions which had been left untreated due to an inability to pay before.  However, this may be offset by fewer emergency room admissions by those who previously had no other option, where emergency room care is an especially expensive way to deliver health care services.

It is not clear what the net effect will be.  Preliminary quarterly GDP data (for the first three-quarters of 2014) do not show a rise in the share for personal consumption of health care (there was a growth in real terms similar to the growth in real GDP).  But these numbers are still early and preliminary.  And the full national health expenditure numbers for 2014 will not be out until next December.

But so far, health expenditures as a share of GDP have stabilized under Obama, and the preliminary indication is that this is continuing in 2014.  This is a major achievement.  But they have stabilized at what is still a very high share of GDP, far higher than what is spent on health in other OECD countries.  Much more aggressive and fundamental reform will be necessary to bring the share down to the far lower levels of what other countries spend, and yet obtain  health outcome results that are similar to or better than the outcomes in the US.

Transparency of Quality is Essential for a Well-Functioning Health Care System

New York State CABG Mortality, with distribution, 1989-2011

A.  Introduction

Prospective patients will try to assess the quality of the medical care provided by the doctors or hospitals where they might go, when deciding where to seek treatment.  They seek out recommendations from friends and family, they look at publicly available rankings such as those of US News and World Report, and they have their own past experience with some doctor or hospital.  More recently, more information has become available on the internet, allowing prospective patients to look up personal histories on medical providers (where they went to medical school, their age, what languages they speak), as well as to view consumer comments and ratings on dedicated medical websites as well as websites such as Yelp.  There may also be reputational ratings (where doctors are asked what other doctors they would recommend), such as those conducted by the Washingtonian magazine in the Washington, DC, area.

But such information is limited, possibly biased, and superficial.  Recommendations of friends and family, your own experience, and comments and ratings on sites such as Yelp, are really just anecdotal, based on a very limited number of cases.  Individuals will also not always know whether the care they received was in fact high quality or not (there may have been complications, but they will normally not know if they were avoidable).  Rankings in reports such as that of US News and World Report have been criticized for being based on a small set of statistics (limited to those that the publication can obtain) which might have limited relevance.  And reputational ratings can be self-reinforcing, as those being surveyed rate some doctor or hospital highly simply because they have been highly rated in the past.  They may well have no real basis for making an assessment.

Most fundamentally, this information does not focus on what one really wants to know:  Does the doctor or hospital provide good quality care that will cure the patient?  Information such as that above has little on whether the doctors or hospitals are in fact any good at what they do.  Rather, the information is mostly on inputs (where did the doctor go to medical school, for example), or on superficial factors (was the receptionist pleasant when one checked in).

As a result, one can find out more on the quality of a $500 television that one is looking to buy, than on the quality of a doctor who will perform a coronary artery bypass surgery on you.

But information on actual results of doctors and hospitals, in terms of success rates (was the condition cured) and mortality rates, the frequency of medical complications, and other such measures, in fact exist.  The problem is that most of this information, with some exceptions noted below, is kept secret from the public.  Especially limited is information on the performance of specific doctors.  But the information is collected.  There are mandatory reports filed with government and regulatory authorities (both at the federal and state levels in the US).  Insurance companies (including Medicare) will know for the population they cover whether the treatment actually worked or required additional attempts or changes in approach.  Insurance will also know whether there were complications that then had to be treated (with the resulting expenses then filed).  And they will know all this at the level of the individual doctor and medical facility, and for the well defined specific medical procedures which were performed.

The information therefore exists.  The problem is that it is not made publicly available.  The normal rationale provided for this secrecy is that the information is complex and can be difficult to interpret by someone other than a medical professional.  But that is a lame excuse.  The information could be released in a form which adjusts for such factors as the underlying riskiness of the particular cases a doctor has dealt with (there are standard statistical ways to do this), and with accompanying information on the degree of uncertainty (derived statistically) in the information being provided.  One would also expect that if such information were made publicly available, then specialized firms would develop who would take such information and assess it.  Based on their technical analysis, they would sell their findings to insurance companies and firms, as well as interested individuals, on which doctors and facilities performed the best for specific medical procedures.  Government entities interested in good quality care (such as Medicare, in the public interest and also because good quality care costs less in the end) could also assess and make such information available, for free.

The real reason such information on outcomes is in general not made publicly available is rather that the results can be embarrassing for the doctors and hospitals.  And more than simply embarrassing, there could be huge financial implications as well.  Patients would avoid the doctors and hospitals who had poor medical outcomes.  With close to $3 trillion now being spent each year on medical care in the US, this means there are huge vested interests in keeping this information secret from the public.

This is starting to change, however.  As noted above, there are exceptions as well as experiments underway to provide such information to the public.  But it has been fragmented, partial, and highly limited.  The limited information that has been provided so far has been primarily at the level of hospitals, although there have been some experiments with data also being provided on the performance of individual doctors in certain specialties.

From these trials and experiments, we know that widespread availability of such information in an easily accessible form could have profound impacts on the practice of American medicine.

B.  The Impact of Transparency – A New York Experiment

The oldest and longest lasting experiment has been in New York.  Starting with data from 1989 (made publicly available in 1990), the New York State Public Health Commissioner has released the risk-adjusted 30-day in-hospital mortality rates of those undergoing coronary artery bypass graft (CABG, or simply heart bypass) surgery, by specific hospital.  They started to release physician specific mortality rates (on a three-year rolling basis) from December 1992.  There have been a number of good descriptions of, and analyses of the impacts of, the New York program.  Sources I have used include the articles here, here, here, and here.  In addition, a good description is provided as the third chapter in the excellent book by Dr. Marty Makary, Unaccountable, a source I will make further use of below.  Dr. Marty Makary is a physician at The Johns Hopkins Hospital, specializing in pancreatic surgery.  In addition to his many medical research publications, Dr. Makary has undertaken research on how to improve the quality of medical care delivery.

The chart at the top of this post shows what happened to 30-day in-hospital mortality rates following heart bypass surgery since 1989, across hospitals in New York State performing this procedure.  Only hospitals doing 70 or more such surgeries in any given year are included in the chart.  This was to reduce the statistical noise arising from small samples (and there were only a few exclusions:  two hospitals were excluded in two of the 23 years of data, and only one or zero in all of the other years).  A total of 28 hospitals were covered in the 1989 set, with the number rising over time to 38 in 2011.

The data were drawn from the annual reports issued by the New York State Department of Health.  Reports for 1994 to 2011 (the most recent report issued) are available on their web site.  Reports for earlier years were provided to me by a helpful staff member (whom I would like to thank), and the figures for the first half of 1989 were published in a December 1990 article in the Journal of the American Medical Association.  All the mortality rates shown are risk-adjusted rates, as estimated by the New York Department of Health, which controls for the relative riskiness of the patients (compared to the others in New York State that year) that were treated in the facility.

The chart depicts a remarkable improvement in mortality rates once it became known that the figures would be gathered and made publicly available, with individual hospitals named.  The chart shows the fall over time of the average rate across the state (note this is not the median rate, but rather the mean), as well as the minimum and maximum rates across all hospitals with 70 or more CABG procedures in the year.  The ranges at the 90th and 10th percentiles are also shown.  Among the points to note:

1)  The average risk-adjusted mortality rate fell sharply in the early years, and since then has continued to improve.  Furthermore, the underlying improvement was in fact greater than what it appears to be in these figures.  The average mortality rates shown in the chart are for the mix of patients (by riskiness of their health status) in each given year.  But especially in the early years, when angioplasty and coronary stent procedures were developing and found to be suitable for lower risk patients, the pool of patients for whom coronary bypass surgery was needed became a riskier mix.  Taking this into account, while the overall average mortality rate fell by a very significant 21% between 1989 and 1992, once one accounts for the higher risk of the patients operated on in 1992, the fall in the cross year risk-adjusted mortality rate was an even larger 41% over just this three year period.  Technology for CABG procedures did not change over this period.  Transparency did.

2)  The improvement in the coronary artery bypass surgery mortality rate in New York is especially impressive as New York was starting from a rate which was already in 1989 better than the average across all US states.  And by 1992, the rate in New York was the best across all US states.

3)  What is perhaps even more interesting and important, not only did the average rate in New York improve, but also the dispersion in mortality rates across hospitals was dramatically reduced.  The maximum (worst) mortality rate dropped from almost 18% in the first half of 1989 to under 6% by 1992.  The minimum rate was 2.1% in 1989H1, and fell to zero in 9 of the 12 most recent years.  One sees this narrowing in dispersion also in the range between the 90th and 10th percentile bands.

Publication of the mortality results got a good deal of media attention in the early years, and led to pressure, especially on the poor performers, to improve.  Note that the information being gathered was not anything new.  State health authorities long had reports on death rates by hospitals.  What was new was to make this information publicly available, with hospitals named.

Hospitals with poor records then scrambled to improve.  A range of actions were taken.  Some might have seemed obvious, but even so, were not undertaken until the mortality rates by hospital were made publicly available.  For example, hospitals with poor records began to create cardiac specific teams of nurses and other staff, rather than draw on staff from a pool who could be assigned to a wide range of different medical conditions.  Such specialization allowed them to learn better what was needed in cardiac surgery, and to work better as teams.  Such a reorganization at Winthrop Hospital, which included bringing in a new Chief of Cardiac Surgery who led the effort, led to a drop in its mortality rate from 9.2% in 1989 (close to the worst in the state in that year) to 4.6% in 1990 and to 2.3% in 1991 (better than the state wide average that year of 3.1%).

Other issues were highly hospital specific.  For example, one hospital (St. Peter’s in Albany) saw that its mortality rates for pre-scheduled elective and even urgent CABG surgery cases were similar to those elsewhere in New York.  But it had especially poor rates for emergency cases, which raised its overall average.  After reviewing the data, its doctors concluded that they were not stabilizing sufficiently the emergency patients before the surgery.   After it corrected this, its mortality rates fell sharply.  They were among the highest in New York in 1991 and 1992 (at 6.6% and 5.8%), but the rates then fell to 2.5% in 1993 and 1.4% in 1994 (when the New York average rate was 2.5%).  Mortality in emergency cases fell from 26% in 1992 (11 of 42 cases) to 0% in 1993 (zero in 54 emergency cases).

Another hospital (Strong Memorial) also found that its mortality rates for routine elective cases were similar to the New York average, but very high for the emergency cases, bringing up its overall average.  The problem was that while they had a good adult cardiac surgeon, he was always fully booked with routine cases, and hence was not available when an emergency case came in.  They then used one of two doctors who were not trained in adult cardiac surgery to handle the emergencies (one was a vascular surgeon, and the other a specialist in pediatric cardiac surgery).  By hiring a new adult cardiac surgeon and then better balancing the schedule, the rates soon dropped to normal.

American health care has traditionally relied on state regulators, armed with reports on hospital and indeed surgeon specific practices and outcomes, to impose safety and good practice measures.  But there is no way a central regulator can know all that might be underlying the causes of poor outcomes, or what actions should be taken to remedy the problem.  They also will not focus on hospitals with relatively good, or even average, mortality rates, even though such institutions could often still improve.  By releasing the data to the public, hospitals with poor records will be under great pressure to improve, while even those with relatively good records will see the need to get better if they are to stay competitive.  And the actions taken will often be actions that no central regulator would have been able to see, much less require.

C.  Staff Surveys as Another Indicator of Quality

Outcome indicators, up to and including mortality rates, are one set of measures which could have a profound impact on the quality of health care delivery if made publicly available.  An additional type of measure has been developed by Dr. Marty Makary, tested with a number of hospitals, and is now routinely used in hospitals across the US.  But the results are then typically kept secret from the public.

Specifically, Dr. Makary developed a simple staff survey (see here and here, in addition to his book Unaccountable referenced above) with some key questions.  The survey goes to all staff in a hospital, and asks questions such as whether the respondent would feel comfortable having their own care performed in the hospital unit in which they work.

In the original test, the surveys were sent to all staff at 60 hospitals across the US.  They got a 77% response rate, which is quite good.  What is most interesting was the wide range they found in the results across the hospitals.  For example, on the question of whether the staff member would want their own care performed at the hospital unit in which they work, there were two hospitals where close to 100% of the staff said they would, but also one hospital in which only 16% said they would.  There was a fairly even spread between these two extremes, and in about half of the hospitals surveyed, less than half of the staff said they would want their own care performed there:

Makary Hospital Staff Survey - Care in Own Unit.003

This would be powerful information to have as a patient.  The insiders are really the ones who know best what quality of care is being provided.  If even they would not want their health care needs met at their hospital, one knows where one would want to avoid.

It is recognized that the original Makary survey was done with the promise that the identities of the individual hospitals would not be revealed.  Should such surveys be made publicly available, the staff responding might well be less negative.  But the identities of the individual staff members would still be kept confidential (with the data gathered by an independent third party, and anonymously over the web).  There would certainly still be some dispersion in results across hospitals, and one could take into account the possible biases when judging the results.  And if a hospital is rated poorly by its staff even when they know the results will be made public, one knows which hospitals to avoid.  One would expect such hospitals then to scramble to improve the quality of the care they provide.

D.  While a Number of Transparency Initiatives Are Underway, They Remain Fragmented and Partial

Patients have always sought information on the quality of the care they will need, and have made decisions on where to go based on what they can find out.  But the information that they have been able to obtain has been only partial, highly fragmented, and far from what they really need to know to make a wise decision.

People will also find measures that are easily observed, but not necessarily terribly important to the quality of the care they will receive.  For example, they may find out whether parking is free and convenient, but this should not normally be a driving factor for their decision.  More relevant, and obviously something they will know, will be geographic location:  Is the facility close to them, or further away?  But they will normally have little basis for determining whether it is worthwhile to go a facility that is further away.

There has been a substantial expansion in recent years in the amount of information one can find on providers.  While still limited, one can find out more now than before.  There is the New York experiment described above, which New York soon extended from hospitals to individual surgeons, and also to angioplasty and cardiac stent procedures.  New York has also brought together on one web site easy access to a wide range of health topic data sets.  These include data sets on outcomes and quality of care indicators (such as the most recent CABG mortality rates by hospital and by surgeon, for example) but also many others (such as the most common baby names chosen).

The Obama administration has also expanded substantially the public availability of information on hospital quality measures.  The Centers for Medicare and Medicaid Services (CMS) now makes available at its Medicare Hospital Compare site results at the hospital level, drawn primarily from the data they have for Medicare patients, on such outcome measures as mortality rates, complications, hospital readmission rates, and other indicators.  However, they are still partial, and instead of showing, for example, actual and historical figures by hospital for indicators such as the rate of complications or mortality, they simply show whether the rates are similar to the national norm, or better or worse by a statistically significant margin (at the 95% significance level).

With the clear positive impact of the New York experiment, other states have also begun to implement similar programs.  But they remain partial and fragmented, and do not provide the comprehensive picture a patient really needs if they are to make a wise choice.

In addition, many professional medical societies have begun to collect similar data from their members, and then calculate risk-adjusted measures.  However, they have then kept the individual results secret, with identifying information by hospital or physician not made available.  Individual hospitals and physicians could release them if they so chose, and some have.  But one can safely assume that only those with good results will release the information, while those with poor results will not.

The same is true for hospital staff surveys, such as the one described above pioneered by Dr. Makary.  Such surveys are now widely used.  Dr. Makary reports in Unaccountable (published in 2012) that approximately 1,500 hospitals were then undertaking such surveys.  The number is certainly higher now.  But the results are in general kept secret.  Some hospitals make them publicly available, but one can again safely assume that these will be the ones with the better results.  Without the others for comparison, it is difficult to judge how meaningful the individual figures are.

So the relevant data are often collected already.  It is only a matter of making them public.  There is not a question of feasibility in collecting such data, but rather a question of willingness to make them public.

E.  What a Transparent System of Information on Quality Should Include

As noted above, people will gather what information they can.  But what they can gather now is limited.  What is needed is hard data on actual outcomes, identified by hospital and by individual doctor.  As the New York experiment discussed above indicates, the result could have a profound impact on quality of care.

Specifically, there should be easy access to the following specific measures:

a)  Volume:  While not directly an outcome measure, it is now well established in the literature that a higher frequency of a doctor undertaking some specific medical procedure, or that is done by all the doctors at some hospital or medical facility, is positively associated with better outcomes.  A doctor that undertakes a procedure a hundred times a year, or more, will on average have better outcomes than one who does the procedure only a dozen times a year (i.e. once a month).  And volume can be easily measured.  The problem is in obtaining easy access to the information, and at the relevant level of detail (i.e. by individual doctor, and for the procedure actually being considered for the patient, not just of some standard benchmark procedure).

b)  Success rates:  While many of the outcome measures being used in various trials and experiments are negative measures (mortality rates; complication rates), a more useful starting point would be risk-adjusted success rates.  What percentage of the procedures undertaken by the individual doctor or at the medical facility for some condition actually leads to a cure of the condition?  How success is defined will vary by the medical issue, but standard ones are available.  If the risk-adjusted success rate is 80% for one doctor and 99% for another, the choice should be clear.  Yet I have never seen a trial or experiment where such success rates by medical facility, much less at the level of individual doctors, were made publicly available.

c)  Success rates without complications:  A more stringent measure would be not only that the procedure was a success, but that it was achieved without a noteworthy complication such as an infection.

d)  Complication rates:  Moving to negative measures, one wants to see minimized the complications associated with some procedure.  The medical profession has identified the complications often found as a result of some medical procedure, and significant complications will be reported.  They can also normally be identified from medical insurance records, as they require treatment.  As with mortality rates, these should be published on a risk-adjusted basis.

e)  Mortality rates:  The ultimate “complication” is mortality.  As discussed extensively above, these should be made available by medical procedure and by individual doctor on a risk-adjusted basis.  The 30 day mortality might be appropriate for most medical procedures, but for others the 60 day or 90 day rates might be more appropriate.  Medical societies can work out what makes most sense for a given procedure.  But everyone should then be required to use the same measure, to allow comparability.

f)  Bounceback rates:  Bounceback rates are the percentage of patients undergoing some procedure, who then need to be readmitted back to a hospital (the original one or some other) within some period following release, usually 90 days.  Readmission rates are regularly collected by hospitals, and they can also be risk adjusted when made publicly available.  They are a good indication that some problem developed.  Some rate of readmission might well be expected for certain procedures.  They are not risk free.  But one wants to see if the bounceback rates are especially high, or low, for the physician or medical facility being considered.

g)  Never events:  Never events are events that should never occur.  While a certain rate of complications will normally be expected, one should never see an operation done on the wrong side of the body, or sponges or medical instruments left in the body after the surgeon has sewn up.  Hospitals know these and keep track of them (as such never events often lead to expensive lawsuits), but not surprisingly want to keep them secret.

h)  Hospital Staff Surveys:  As discussed above, Dr. Marty Makary developed a survey that would go to all hospital staff, which asks a series of questions on the quality of care being provided at the facility.  While approximately 1,500 hospitals were already administering the survey in 2012 (when his book Unaccountable was published), they are voluntary and in general not made publicly available.  They should be.

While the surveys can cover a long list of questions, Dr. Makary recommends (Unaccountable, page 216) that the percentage of hospital staff responding “yes” to the following three questions, at least, should be made public:

–  “Would you have your operation at the hospital in which you work?”

–  “Do you feel comfortable speaking up when you have a safety concern?”

–  “Does the teamwork here promote doing what’s right for the patient?”

F.  Conclusion

There are of course many other measures of quality one could examine, and there has been some movement in recent years to making more available.  These include results from patient surveys (“were you content with your experience at the hospital?”, “were the rooms kept clean?”), as well as the percentage of cases where certain established medical best practices were followed (“was aspirin given within 24 hours of a suspected heart attack?”).

Such additional measures might well be useful in particular cases.  It will depend on the individual, their particular condition, and what specifically is important to them.  People should have a choice, and do the research they personally wish to do.

But until hard measures on actual outcomes, such as those described above, are made widely available, and on a comprehensive rather than partial and fragmented basis, it will not be possible to make a well informed and wise choice on which doctor and medical facility to go to.  Without this, there can be no effective competition across providers.  There will be little pressure on the poor quality providers either to improve their performance, or drop out and let providers who can deliver better quality care treat the patients.

The impact on the quality of health care services provided would be profound.

More on the Widely Varying Charges for Common Health Procedures: Price Variation for Standard Blood Tests

Blood Test Prices in California - Lipid Panel

A.  Widely Varying Prices Charged Even for Standard Blood Tests

This post is an addition to an earlier post on this blog that looked at the widely varying prices being charged in the US for common health procedures.  As that post noted, such differences in prices for what are fundamentally the same services are a clear indication that the market is not working.  The prices would be similar if the market was working, with differences that are relatively small and explainable by factors such as geography.  But that is not the case.

That post looked at data from a number of studies (including my own simple research on the prices that I would be charged in the Washington, DC, area, for a common surgical procedure).  Prices could vary by a factor of 10, and indeed often even more.  And as that post showed in a series of charts, the prices actually paid in the US (at the rates negotiated by insurers) are not only widely varying, but also consistently far higher than the prices paid for the same procedures in other countries.

A criticism of studies that examine the prices being charged for health care procedures is that individual cases can differ, with some more complex than others.  Thus prices might vary for that reason.  Even though it is difficult to see how costs can vary by a factor of ten or more even with differing levels of complexity for some standard procedure (such as a hip or knee replacement, for example), one can recognize that differing degrees of complexity might explain at least some of the price differences.

Thus a study published last week in the BMJOpen, an open-access on-line journal affiliated with the British Medical Journal, is of interest as it addresses the question of whether such price variation is found also for procedures where case complexity does not enter.  The lead author is Dr. Renee Hsia, of the Department of Emergency Medicine at the University of California – San Francisco.  In an earlier study, summarized in the blog post cited above on health care price variation, Dr. Hsia had looked at the prices charged by hospitals in California for an uncomplicated but urgent appendectomy.  She found that the prices varied by a factor of 120, between the lowest rate charged and the highest.

In the current study, Dr. Hsia with her colleagues looked at the prices charged by California hospitals for ten common blood tests.  The prices reviewed are the so-called “chargemaster” rates, or the list prices at the hospitals for the tests.  The actual price paid will then normally be a lower rate negotiated with the hospital by your insurer (if you have insurance), but the chargemaster rate is the starting point.  Why this matters will be discussed below.

Dr. Hsia was able to obtain the data for California because hospitals there are required to report to state authorities the average prices they charged for a number of common procedures.  Since routine blood tests are standard, and are not more or less complicated for one patient vs. another (the blood is drawn, brought to a standard machine, and the results then read), one cannot argue that the price variation observed might be a consequence of different degrees of case complexity.

The results from one of the blood tests examined, that of a standard lipid test (which measures blood cholesterol levels), is shown graphically at the top of this post.  Data was available from 178 hospitals, and each hospital reported the average price it charged for this test over the course of 2011.  The price charged at one hospital was only $10 per test.  The average price charged at a different hospital, for the exact same blood test, was $10,169 per test, or over 1,000 times as much.  Such variation is absurd.

These are, of course, the extremes.  But even if one focusses on observations in the middle of the distribution, it is impossible to see how such variation in prices charged can be justified.  The price at the 5th percentile (meaning 5% of the hospitals charged this price or less) was $76.  The price charged at the 95th percentile (meaning 5% charged this price or more) was $602.  This is almost 8 times higher than the price at the 5th percentile.  The results for the other nine blood tests examined were broadly similar (with ratios between the prices at the 95th and 5th percentiles varying from a high of 12 times and a low of 6.8 times).

B.  Chargemaster Rates Matter

What can justify such a spread?  Nothing that I can see.  The tests are standard, use standard machines, and all use similarly drawn blood.  The response of a spokeswoman for the California Hospital Association was that the prices reviewed in the study are “meaningless”, since virtually no one (she states) pay these rates.  As noted above, the rates reviewed in the study, as in the earlier study of the prices charged for appendectomies, are the chargemaster rates of the hospitals.  These are the regular list prices for the procedures, which are then typically discounted in negotiations with individual insurers.

But there are still several problems with this, including:

1)  How much the prices are negotiated down will vary according to the bargaining strength of the patient’s individual insurer in the region.  In the bargaining process discussed in an earlier post in this series on health reform, insurers will bargain with hospitals on what the rates will be.  Their relative bargaining strength will depend on how concentrated the local market is in terms of hospitals (if there is only one hospital, or one chain of hospitals all owned by the same entity, but a number of insurers, the bargaining power of the hospital will be great) versus insurers (in one insurer dominates in the market, while there are many hospitals, that insurer will have great bargaining power).  If you have insurance with an insurer who does not command great market share in the region, the price you will have to pay may be close to the chargemaster rate.

2)  If you do not have insurance (and many could not get health insurance, prior to the reforms of Obamacare), you will be charged the chargemaster rate.  You might then try to bargain individually with the hospital, but the starting point will be the chargemaster rate.  And many hospitals will insist, unless you are poor, that you have to pay that chargemaster rate.

3)  You may well have insurance, but if the particular hospital you are in is not in your insurance network (perhaps because you were brought by an ambulance to the nearest hospital in an emergency), you will be charged the chargemaster rate.  Your insurance company might pay a portion of this at what they consider to be a “reasonable rate”, but this is likely to be close to what your insurer has negotiated with others, and as we have discussed in the earlier blog posts cited above, this might be only one-tenth of the chargemaster rate.  You will then still be responsible for the other 90%.  This can be a lot, if you are at the hospital where a simple lipid panel blood test is charged at over $10,000.

4)  You may well again have insurance, and be in a facility that is in-network for your insurer, but your insurer might disagree on whether some standard blood or other test ordered by your doctor was really needed.  Your insurer will then refuse to cover the cost of that test, and you will be charged the chargemaster rate.

I am personally facing a case of that right now.  While the amounts are small in absolute terms, the issue is the same.  My doctor ordered a set of routine blood tests for me earlier this year, and my insurer covered all except one.  For that one, the insurer asserted that there had not been a need (even though both my doctor, and research I found on the web, made clear that the test was in fact needed).  The lab therefore charged me the full chargemaster rate (which in this case was $213.98), even though the negotiated rate Aetna would have paid, had they agreed it should be covered, was only $16.23.  That is, the full billed rate was 13.2 times the negotiated rate.  I would have been glad to pay the negotiated rate in full, and the $16.23 the lab has negotiated with Aetna is evidently a rate sufficient to provide an adequate profit to the lab.  But find it absurd that I should have to pay over 13 times more.  I am appealing, but do not know yet the outcome.

5)  Finally, it is worth noting that the chargemaster rates can matter for other issues as well. For example, hospitals are typically required to provide a certain amount of “charity care” (care provided to the poor without health insurance for free or at discounted rates) in order to benefit from certain tax breaks.  This is especially important and valuable for private, profit-making, hospitals.  Valuing such services at the chargemaster rates, when these rates are 1000 times higher than what someone else might charge, will make it look as if the hospital is providing a good deal of charity care.

C.  Conclusion

This new study should put to rest the argument that price variation in health care services is principally due to variation in the degree of complexity of individual cases.  Common blood tests are standard, and they show price variation which is huge as well as similar in degree to that seen for standard health care procedures (see the review in the earlier post).  The prices vary not principally due to case complexity, but rather due to a grossly misfunctioning market for health care services, where there are strong forces keeping out effective competition and any pressure to converge on low prices from efficient providers.