America’s Economy: A Backlash Avoidance Policy

For the past several years, American economists and government officials have been justifying the great financial bailout of 2008/09 in terms of its backlash avoidance effect.

Why backlash avoidance? Well, they explain that excessive consumer and corporate debt represented a primary cause of the 2008/09 crash. And they acknowledge that such overleveraging of debt should usually be rectified by shifting funds from consuming goods and services (i.e. current spending) to repaying debt.

But here’s the rub: if we all decide to stop spending at the same time in order to repay debt, the decline in economic activity could actually worsen the slump that was triggered by the excessive debt. Thus, the economy would experience a backlash effect.

The solution? At the very moment when consumers and corporations feel compelled to “do the right thing” and focus on repaying debt, the government should encourage them to do what is customarily the “wrong thing” and consume more products and services instead. Supplemental government spending (i.e. economic stimulus) may be necessary as well.

Several backlash avoidance policies appear to apply to the American economy of 2014 as well. But today, ironically, government officials may find it advisable to sit back and passively allow the free market to heal the economy.

For instance, the sharp contraction of Gross Domestic Product during the recent winter has been attributed in part to an unexpected decline in health care spending. So should the government rush to stimulate more spending on health care services? Well, no, the Affordable Care Act (i.e. Obama Care) is explicitly designed to reduce the bloated cost structure of the American medical system.

In addition, the home construction market continues to lag below normal historical levels, thus weighing down economic growth. So should the government encourage banks to relax their mortgage lending standards to encourage new residential construction? Of course not; sub prime mortgage loans, also known as “toxic debt,” represented a primary cause of the 2008/09 collapse of the global economy.

Furthermore, the economy continues to be plagued by the unusually harmful effects of long term unemployment among mature workers. So should the government develop new programs to explicitly encourage the hiring of mature workers? Regrettably, such programs may discourage the hiring of recent college graduates, who are struggling with unprecedented levels of student loans.

To be sure, government officials are finding it difficult to passively permit health care spending to slump, home construction to lag, and mature workers to remain unemployed when assistance can be justified on economic (and perhaps even moral) grounds. And yet it was also difficult for officials to authorize the bailout of 2008/09, a decision that may have prevented a second Great Depression.

There is a difference, though, between the situation in 2008/09 and the one that exists today. In 2008/09, an activist government was needed to authorize a bailout. Today, though, by simply allowing economic trends to run their course, the government may be able to ensure a beneficial outcome.

Oddly enough, the much derided paralysis of America’s federal government may help it remain passive in the face of public pressure to take action. In other words, the government’s very dysfunctionality may allow the health care, home construction, and mature worker employment sectors to generate the short term pain that is required to ensure long term prosperity.

Obama Care: Did The President Lie?

Do you remember the first time that a representative of America’s Republican Party accused President Obama of a lie about the Affordable Care Act?

It was a fairly spectacular setting. The President was delivering his first ceremonial State of the Union speech to a joint session of Congress. When Obama declared that his health care reform proposal would not extend medical services to illegal residents, Republican Congressman Joe Wilson interrupted the speech by screaming “You Lie!”

He later apologized for his severe breach of decorum, but today, Republicans are no longer apologizing for accusing the President of telling lies about the Affordable Care Act. So did Obama lie to the American people when he claimed that “if you like your (health) plan, you can keep your (health) plan”?

The answer depends on what the President meant by the word “plan.” If he meant “health insurance policy,” then he didn’t lie. Health organizations are now cancelling “plans” that don’t meet the minimum definitions of “insurance policies.” Indeed, these companies are not cancelling insurance policies at all, but instead are cancelling more limited types of health plans.

What is the difference? Well, insurance policies are designed to cover consumers against catastrophic losses. The plans that are now being cancelled, though, often feature benefits that are limited at extremely low levels, or that permit companies to cancel coverage or drastically increase premiums once consumers become ill and need to claim benefits. Such plans are actually designed to avoid coverage for catastrophic illnesses, not to insure for them.

This is why Aetna’s home page, for instance, carefully differentiates between “health plans” and “insurance solutions” to consumers. The firm refers to “plans” and “insurance” as distinct and separate services because they design and sell them as uniquely different types of contracts.

If President Obama was thinking of “comprehensive health insurance” when he said that “if you like your plan, you can keep your plan,” then he was indeed telling the truth. If that was what he had in mind, then he wasn’t referring to the types of contracts that are now being cancelled by companies.

But if he was thinking of the types of low benefit, easily cancellable contracts that the Affordable Care Act explicitly deemed insufficient for insurance purposes, then he was not speaking truthfully. After all, the Affordable Care Act was designed to require Americans to purchase full insurance policies that provide coverage far superior to the terms of these meager plans.

So did the President lie? Reasonable people may differ; you are certainly free to decide what you will. Perhaps we can all agree, though, that it would be helpful for our political leaders to use more precise language in the future … beginning, for example, with a clear definition of a “health plan.”

The Massachusetts Strategy: Medical Cost Budgets

As the American presidential contest barrels towards the Labor Day holiday weekend and the proverbial “home stretch” of the campaign, the candidates continue to fling charges at each other regarding the health care system.

Mitt Romney, of course, continues to refer to the President’s universal health care plan as a burden on American society and as an unnecessary tax on the middle class. And Barack Obama continues to riposte that his Affordable Care Act is actually modeled on the 2006 landmark Massachusetts law that Romney championed as Governor.

Lost in the squabbling, though, is the fact that the Massachusetts model of universal health care has now been in operation for six long years. So how is it doing? Is it achieving its goals?

Primary Goal: Mission Accomplished!

The primary goal of the Massachusetts law, of course, was to extend health insurance coverage to virtually all state residents. That mission has indeed been accomplished; over 98% of all residents are now enrolled in state-mandated and government approved health insurance plans.

The enrollment process for individual policy holders is managed through an online portal known as the Health Connector. Many industry specialists have praised the effectiveness of the portal; in fact, it has become a model for the state-based “exchanges” that are now being developed across the nation to comply with the provisions of the Affordable Care Act.

Regrettably, investigative reporters at the Boston Globe have noted thousands of cases of individuals who appear to be “gaming” the system by enrolling in health plans for brief periods of time in order to gain temporary coverage to receive medical services. Nevertheless, the vast majority of the 6.5 million residents of the Commonwealth of Massachusetts appear to be complying with the letter and the spirit of the 2006 insurance coverage law.

Secondary Goal: Yet To Be Achieved?

The secondary goal of the Massachusetts law was to reduce the cost of providing health care services to residents throughout the Commonwealth. And the actual results? Pragmatically speaking, the evidence is mixed at best that the costs of medical care are actually trending downwards.

In theory, as a result of the enrollment of all residents into insurance plans, the utilization rates (and thus the costs) of primary medical care and preventive care services should increase over time. Policy makers are hoping, though, that these increases will be offset by concomitant declines in the utilization rates (and thus the costs) of hospital emergency room services and preventable disease treatment regimens.

Many studies have confirmed that these utilization and cost trends are indeed occurring for certain clusters of individuals. But other studies have noted that the overall costs of providing medical services to the population may be increasing significantly.

Next Step: Government Cost Targets

So how do the current Governor Deval Patrick and the Massachusetts Legislature intend to address the challenge of controlling medical costs? Earlier this month, they signed a bill into law that establishes explicit cost reduction targets for levels of health spending throughout the state.

For the next five years, through 2017, the law is designed to limit inflationary increases in health spending to levels that are consistent with the growth of the Massachusetts economy. And thereafter, it is designed to reduce health inflation rates to annual levels that are one-half of one percent below the growth rates of the state’s gross domestic product.

According to government estimates, the aggregate costs of medical care will decline by up to $200 billion over the next fifteen years if the health system meets these targets. Whether or not the system will actually do so, though, is any one’s guess.

It May Take Years

Does the Massachusetts model of universal health care represent an approach that should be replicated across the nation? A successful Massachusetts initiative, of course, can serve as an effective model for the other 49 states.

On the one hand, government mandated universal cost budgets may distort the market for health care services. Let’s assume, for instance, that the Commonwealth experiences an outbreak of influenza in a year when its costs are budgeted to decline by one half of one percent. If it diverts funds from other initiatives to fight influenza, it may force itself to abandon health programs with significant long term benefits.

On the other hand, it is possible that the government of Massachusetts is the only entity that possesses the authority and the power to mandate cost reduction activities on a statewide basis. In other words, no other organization may be able to accomplish such broadly defined goals.

It is, regrettably, too early to assess whether the cost budgeting law will prove to be effective. That is not surprising; after all, it took years to conclude that the original 2006 law could succeed at enrolling most residents in insurance plans. It may likewise take years to assess whether medical cost inflation can be controlled through the use of budgetary targets.

John Roberts and the Affordable Care Act

When Supreme Court Chief Justice John Roberts cast the deciding vote to uphold the constitutionality of the Affordable Care Act, he justified his decision by applying the legal principle of substance over form.

Substance over form? It is a principle that is commonly accepted as a theoretical concept, but one that is not always followed in practice. Many of the loopholes that are enshrined in American tax legislation, in fact, actually embrace form over substance.

Nevertheless, Justice Roberts relied on the principle in order to affirm the Court’s acceptance of the Act. Thus, before deciding whether to agree with his decision, it may be helpful to assess whether it was appropriate for him to apply the principle.

Gifts vs. Wages

The definition of the theory of substance over form is a simple one; namely, government officials should focus on a transaction’s underlying economic reality, as opposed to its superficial legal structure, when establishing its regulatory practices.

For instance, let’s consider an employee who earns $1,000 per week by providing services to an employer. Can the parties avoid paying payroll taxes by structuring each weekly payment as a “thank you” gift instead of a wage?

Of course not; the federal government would never allow them to do so. Even if a legal contract is structured in a manner that superficially refers to such payments as “gifts,” the economic substance of each payment would nevertheless represent a wage for tax purposes.

In other words, the tax burden would be determined by the transaction’s substance and not its form.

Double Irish and Dutch Sandwiches

On the other hand, in practice, many American corporations exploit loopholes that emphasize legal form over economic substance.

Consider, for instance, the issue of royalty payments. If a company must pay royalties to another firm, those payments would represent tax deductions to the company and taxable revenue to the other firm. If the company owned its own patents, though, it would not be required to pay royalty payments to itself.

But let’s assume that a company that owns its patents creates a wholly owned subsidiary in a tax jurisdiction with no (i.e. a zero percent) corporate income tax. Let’s also assume that it transfers ownership of the patents to the subsidiary, which then charges royalty payments to the parent company. The corporate parent would enjoy the benefit of treating the payments as tax deductions. Of course, the subsidiary would need to declare the royalty income in its own tax jurisdiction, but it would not pay any taxes on that income if its tax rate is zero!

Most companies have no economic need to make payments to wholly owned subsidiaries. And yet many have created complex royalty strategies, such as Apple’s infamous Double Irish with a Dutch Sandwich, that emphasize form over substance.

Penalties vs. Taxes

How can we apply the concept of substance over form to the Affordable Care Act? Well, by 2016, all Americans will be required to purchase health insurance policies, and will be required to pay fiscal penalties of 2.5% of taxable income if they fail to do so.

President Obama, having promised during the election campaign to avoid raising taxes on middle class Americans, has insisted that the penalties should not be considered taxes. Thus, the Act itself refers to these payments as “penalties” or “fines” and not as higher taxes. In other words, the U.S. Congress has structured the “penalties” in a manner that avoids the legal structure of “taxes.”

And yet Justice Roberts clearly considers the economic substance of the payments to be more relevant than the legal form. After all, he reasoned, any citizen who purchases insurance will enjoy a lower tax burden than one who opts to pay the penalty.

So he concluded that the Act’s penalty provision simply represents a tax break to subsidize the cost of procuring health insurance policies. Like the home mortgage interest deduction and the higher education tuition deduction, Roberts decided that the economic substance of the law deserved to be treated as a matter of taxation policy.

The Cain Train!

Now that Justice Roberts has struck a blow in support of economic substance over form, will the Court reconsider the legality of tax loopholes? Will the justices prohibit such byzantine corporate structures?

The American public, after all, continues to support proposals for eliminating tax deductions and instituting “flat taxes” in place of the current system of taxation. Radio talk show host Herman Cain, for instance, briefly became the Republican Party front-runner for President of the United States on the strength of his 9-9-9 flat tax proposal.

As long as corporate lobbying activities promote the development of new loopholes, it is difficult to foresee their eventual elimination. Nevertheless, if you believe that economic substance should outweigh legal form in matters involving taxation, you may agree with the decision made by Justice Roberts regarding the Affordable Care Act.

Banning Soft Drinks: The Big Apple’s Health Gambit

Democrats and Republicans have long agreed that the obesity epidemic deserves the attention of government officials. Republican Governors from Mike Huckabee to Arnold Schwarzenegger, for instance, have exhorted Americans to pay more attention to diet and exercise. And more recently, Democratic First Lady Michelle Obama has written a best selling book about the vegetable garden that she has planted on the grounds of the White House.

Last week, though, New York City’s Independent Mayor Michael Bloomberg raised the stakes by proposing a ban on mega-size cups of soda. He and his Health Commissioner, Thomas Farley, then made the rounds of the television talk shows, defending their actions in the interest of public health.

But their explanations quickly generated an intense backlash from critics. Some argued that business revenue would suffer if the demand for such monster-sized beverages is denied. And others, choosing to occupy the moral high ground, insisted that a ban would represent an infringement by “big government” on the personal liberties of American citizens to choose their own diets.

In many ways, the argument represents a reflection of the far broader debate over the federal government’s role in the nation’s health care system. And regrettably, at the heart of the argument lies a misunderstanding about the scope of Mayor Bloomberg’s proposed regulation itself.

I Blew Out My Flip Flop, Stepped On A Pop Top …

Most major news organizations that are covering the controversy have reported that the Bloomberg Administration is proposing to ban the sale of large quantities of soda. That is not true; in fact, the Administration is banning cups (i.e. containers) that hold soda, and not the soda itself. Furthermore, the Mayor is only proposing to ban certain cups, i.e. those that it claims are damaging to the public interest.

His proposal is certainly not without precedent. Beverage containers have been heavily regulated since Oregon became the first state to pass a beverage container deposit law to support a recycling initiative in 1971. Since then, various beverage containers and their accoutrements have been outlawed across the nation for environmental reasons.

The once-ubiquitous removable pull tabs (or “pop tops”) on soda and beer cans, for example, such as the ones that were memorialized in Jimmy Buffet’s classic song Margaritaville, were banned in many jurisdictions and then replaced by tabs that remain attached to their cans. In other jurisdictions, government officials have adopted numerous measures to wean the public away from traditional non-biodegradable plastic milk bottles that can remain in landfills for decades.

Indeed, American government officials have long restricted the use of various beverage containers in order to protect the health of our ecological environment. But does this imply that our government leaders possess the authority to do likewise in the name of protecting our personal health as well?

The Nanny State

Interestingly, the local New York City antagonists who oppose Mayor Bloomberg’s beverage regulation echo the national critics of President Obama’s national health care legislation by using the same phrase to describe the reason of their disapproval.

And what is that phrase? It’s “the nanny state.”

Oxford Dictionaries defines the phrase as one that describes a government that is “overprotective or … interfering unduly with personal choice.” But neither Oxford, nor other linguistic authorities, offer any interpretive guidance about how to distinguish “appropriately protective” government regulation from “overprotective” regulation, or “appropriate” interference from “undue” interference.

For instance, ever since the Massachusetts Bay Colony mandated the public education of all citizens in 1642, American municipalities have required parents to educate their children in accordance with government approved curricula. Even home schooled children are often required to engage in government sanctioned registration processes.

No one is arguing that mandatory public education is an undesirable component of a “nanny state.” And yet health care services, as opposed to education services, appear to attract that criticism.

The Public’s Dime

It is important to keep in mind that proponents of personal health care legislation tend to offer two very different rationales for their positions. One is that the promotion of personal health represents a moral imperative, one that outweighs any political concerns regarding the value of personal liberty. And another is that the prevention of disease reduces the social and fiscal cost of delivering health care services, and is thus an economic imperative as well.

Although disputes involving perceptions of morality cannot be assessed in a scientific manner, the impact of disease prevention activities on the cost of health care services is indeed a measurable consideration. Obesity, in particular, has been estimated to inflict an annual cost of $190 billion on the United States economy each year.

If a government regulation addressing the size of a soda cup can significantly reduce this immense financial burden, it is difficult to argue against it on economic grounds. Nevertheless, as long as certain critics continue to frame the debate as a matter of personal liberty, they will undoubtedly continue to argue against Mayor Bloomberg’s proposal on political grounds.

Health Insurance: Counting The Under-Insured

Are you concerned that your favorite baseball player isn’t pulling his weight for the home team? Our parents would have been content to track his batting average, but today you would undoubtedly follow his on base percentage as well. It’s an arithmetic enhancement of the original ratio; instead of simply dividing his hits by the number of times at bat, you’d include his walks in the numerator too.

What if it’s too cold to sit outside and watch the game? You’d better check the wind chill temperature before you leave home! Although our parents would have been content to simply note the actual temperature, you’d prefer to subtract a few degrees to account for the impact of air currents.

Economists make the same mathematical adjustments when assessing our economic health. They no longer simply note the inflation rate; they now modify it to calculate the core rate, which excludes highly volatile items such as food and gasoline. Likewise, they modify unemployment rates by counting individuals who are working, but who are nevertheless under-employed.

And what about the health care industry, the economic sector that is threatening to devour our government budgets? Years ago, policy analysts simply tracked (and hoped to minimize) the rate of the uninsured. Today, though, they’re modifying that statistic to include another group.

Counting The Under-Insured

Once upon a time, health insurance was health insurance; citizens either possessed it or lacked it. Generally speaking, if Americans were covered by health insurance policies, they knew that they would be reimbursed for the costs of all medically necessary services.

To be sure, there were (and still are) annual cost caps on coverage levels. But years ago, the costs of care were much lower, and thus the caps were very rarely reached. And even when that occurred, insurers could often be persuaded to waive the caps for charitable purposes, or providers could be persuaded to provide the services without billing the insurers.

Today, though, uninsured Americans are not the only citizens who are concerned about obtaining access to medically necessary services. The medically under-insured must be concerned as well, given that truly comprehensive health insurance policies are becoming much rarer.

Et Tu, Empire Blue?

By the next quarter, for instance, many small business owners in New York State who are insured by Empire Blue Cross Blue Shield will be trading down to much skimpier health insurance policies. They’re not doing so on a voluntary basis; instead, Empire is phasing out many of its traditional full-fledged plans and transitioning firms to a handful of less desirable ones.

Can’t those business owners switch to plans offered by other insurance companies? Well, yes … but only four other insurers are still serving New York’s small business community. And according to Crain’s New York Business, only three (Oxford, Emblem, and Aetna) are maintaining a sizable commitment to the market.

A total of three firms cannot possibly maintain a truly competitive economic market. And considering that Blue Cross Blue Shield traditionally played the role of the nation’s “safety net” insurance provider, its retrenchment from New York’s small business market is undoubtedly complicating health policy.

Aflac, Aflac!

Although the rate of the uninsured is closely tracked — it’s now 16.3% of the American population, or 49.9 million citizens, and climbing — the rate of the “not fully insured” is not as well known. And yet that’s the true number of Americans who are at risk of coverage denials for medically necessary services.

Many of the small businesses that are reluctantly trading down to less desirable Empire policies would probably be included in this statistic. The tens of millions of consumers who are covered by Aflac would likely be included as well. Interestingly, the firm explicitly acknowledges that its product “helps pay (for) what Major Medical Insurance doesn’t.”

How important is the plight of the under-insured? From a health care policy perspective, they might be even more costly to the nation’s health care system than the uninsured. That’s because the uninsured will often “make do” without any care at all, or will learn to utilize charitable programs such as Federally Qualified Health Centers. The under-insured, though, will tend to rely on their limited coverage options until their coverage “caps” are triggered, and then throw themselves into our overburdened system of hospital emergency rooms.

A Quarter Of The Population

Last September, the Commonwealth Fund defined the “under-insured”  as citizens who possess health insurance policies, but who must spend a very large amount of their income on medical expenses. They estimated that 29 million Americans were underinsured in 2010, 80% more than the 16 million who were underinsured in 2003.

With America’s population now standing at 312 million, they represent 9.3% of all Americans; thus, a staggering 25.6% (i.e. 16.3% + 9.3%) of all citizens are not fully insured. With firms like Empire continuing to withdraw from major market segments, this rate will likely continue to increase for the foreseeable future.

The Evolving Economics of Health Care

When President Obama and the Democratic Congress passed the Patient Protection and Affordable Care Act last year to reform the nation’s health system, they didn’t schedule all of the transformational regulations to take effect immediately. For instance, the central innovations of the plan — a legal mandate to purchase health insurance, paired with the development of state-based insurance exchanges — were assigned full implementation dates in the year 2014.

In the meantime, though, the economics of the American health care industry aren’t just sitting idly by, waiting for the legislation to take full effect. Instead, as economic conditions evolve, organizations are making plans and taking steps to position themselves to exploit the terms of the new law.

Regrettably, from the perspective of American consumers of medical services, these steps are driving the costs of health care into the stratosphere. And if the process continues to play out in accordance with current trends, there may not be much of a competitive, free market health care system left to regulate by the year 2014.

Fewer Insurers

Let’s begin by considering the number of insurance companies that are now competing with each other to offer health care policies to consumers. Because we allow these firms to eliminate their competitors by simply acquiring them, the competitive market continues to shrink into smaller and smaller clusters of firms.

Furthermore, these insurance companies are focusing more intensively on providing services to enrollees in federal government programs. That’s why Cigna paid $3.8 billion to buy Healthspring, for instance, and why Humana acquired MD Care. In each case, a huge insurer became even larger by purchasing a potential (or actual) competitor in the field of government services.

A health care industry with very few insurers simply doesn’t function in the same manner as a competitive market place. Firms in such industries are relatively less likely to compete based on factors like quality, innovation, and superior service; instead, they are relatively more likely to focus on strategies like maximizing prices and passing along the costs of medical care to customers. With fewer competitors to challenge them on the first set of factors, firms enjoy the freedom to focus instead on the second set of factors.

Fewer Payors

Of course, if the market were to be dominated by large numbers of strong payors — such as employers or trade associations, entities that purchase health care benefits on behalf of their employees or members — one could rely on the payors themselves to compel insurers into competing on the basis of quality. Unfortunately, though, the American health insurance industry is losing payors, not adding them.

Consider Walmart, for instance. The largest employer in the United States has shaken up many industries with its mammoth purchasing power, and could conceivably play the same role in the health insurance industry. But the firm appears to be more interested in driving employees out of its health plans than aggressively purchasing health insurance policies on their behalf, as evidenced by their recent increases in employee health premiums, as well as their refusal to cover certain part time employees.

Some commentators have voiced concern that the implementation of a national network of state-based health insurance exchanges, given its ability to serve as an alternative to employer based health insurance coverage, would result in employers dumping their health benefits benefits entirely and driving their employees onto the exchanges. In fact, some believe that Walmart is planning to execute that very strategy, and is now driving up the employee costs of health care to unaffordable levels in pursuit of this goal.

On Their Own

Even the most avid supporter of a single payor program, financed and managed by the federal government, would likely concede that a truly competitive free market health care system would be highly beneficial to consumers. Imagine a city filled with thousands of insurers and payors, of every conceivable shape and size, eagerly searching for any strategic advantage that could differentiate them from their competitors and help attract new consumers.

Now that’s a fairly compelling scenario, isn’t it? With thousands of competitors occupying each segment of the market, no single party could possibly exert control over the entire system. And consumers could continuously “go shopping” for coverage, forcing each organization to compete with multitudes of others for their loyalty and premium dollars.

The contrary scenario, though, is the one that currently exists, and that is becoming more and more entrenched with every large insurance acquisition and every dramatic employer decision to shift the costs of providing access to health care onto employees. Indeed, such actions provide consumers with fewer and fewer choices of payers, who in turn must choose from fewer and fewer choices of insurers.

The results? Ultimately, the economics of the industry will inevitably dictate the outcomes. Costs will continue rising, service levels will continue shrinking, and consumers will continue to be left on their own to fend for themselves.

Health Care Consolidation: Efficiency or Monopoly?

Who (or what) should be blamed for the dramatic increase in the cost of private health insurance in the United States?

To a certain extent, of course, the aging of the population and the development of technologically complex treatment options have contributed to the burgeoning costs of insurance. Consolidation activities within certain sectors of the health care industry have impacted costs as well, with hospital mergers eliminating competition among providers and insurer mergers doing likewise among payers.

Last week, however, the city of Pittsburgh, Pennysylvania witnessed a health care consolidation transaction of a different kind. Instead of a large hospital or insurer swallowing up a rival, the insurance company Highmark decided to cross industry sectors and directly acquire West Penn Allegheny Health System and its Allegheny General Hospital subsidiary.

Why would Highmark want to do such a thing? And is the emergence of insurer / provider conglomerates a beneficial public policy development … or yet another nail in the coffin of a competitive health care system?

A Case of Vertical Integration

A producer purchase of a provider system isn’t a terribly unusual event from a macro-economic perspective. Energy production companies have owned or franchised retail consumer outlets for decades; Exxon Mobil and Chevron, for instance, simultaneously drill for oil, refine it into gasoline, and then develop franchise contracts with gasoline stations to provide it to consumers. Energy firms have even coined specialized terms to describe the dual sides of their business operations: the phrase upstream activities refers to the production process, whereas downstream activities refers to the refining, sales, and marketing processes.

Economists refer to this type of merger as vertical integration, a process by which a single firm acquires (or otherwise controls) an entire value chain of the production, sales, and distribution of a category of products or services. It is distinctly different than horizontal integration, a process by which firms merge with their competitors (or potential competitors) in order to develop larger market shares in their narrowly defined segments of their value chains.

In the private sector health insurance industry, employers generally purchase access to health care from insurance companies, which then contract with hospitals and other providers to deliver services to employees. Although patient advocates and provider lobbyists may argue that hospitals and patients occupy the very center of the health care system, from a value chain perspective, insurers can be characterized as upstream organizations and hospital networks as downstream organizations.

A Mixed Record

Clearly, vertical integration strategies have succeeded in the energy industry. But can they do so in the health care industry?

Based on recent history, the track record for such business strategies among insurers and providers is most decidedly mixed. On the one hand, Kaiser Permanente of California has remained one of the most highly respected and successful health care conglomerates in the nation by managing provider and insurer functions simultaneously. On the other hand, though, Humana — one of the largest health insurers in the United States — pulled out of the provider market in 1993 after concluding that there are too many natural conflicts of interest between the two industry segments to justify a conglomerate approach.

New York State, a geographic pillar of the national health care industry, has also experienced mixed results. On the one hand, the rise of the Catholic Church’s statewide health plan Fidelis Care did nothing to save St. Vincent’s Hospital of Manhattan, or its seven fellow Catholic hospitals in New York City, from closure. On the other hand, the New York City Health and Hospitals Corporation continues to find success with its wholly owned MetroPlus health plan subsidiary.

Efficiency vs. Competition

Interestingly, California and New York represent relatively competitive health care markets, with several hospital networks and insurance companies competing for business in each state’s major population centers. It is possible that the natural forces of free market capitalism have helped blunt the deadening anti-competitive effects of vertical integration in these regions, thereby preventing conglomerates from evolving into monopolies.

Pittsburgh, though, represents a very different type of health care market. Its hospital sector is currently dominated by the University of Pittsburgh Medical Center; thus, Highmark’s acquisition of the badly trailing second tier hospital may actually result in an increase of provider competition. Usually, merger partners argue that the beneficial cost efficiencies to be derived through consolidation justify the possible harmful effects of a loss of competitive players; in Highmark’s case, though, public policy advocates in the Steel City may enjoy the twin benefits of cost efficiencies and greater (as opposed to lesser) competition.

It is understandable why Highmark was attracted to the acquisition opportunity; after all, by strengthening the closest rival to a dominant hospital system, it may be able to improve its own contracting position with both medical providers. Although conventional wisdom stipulates that competitive markets often suffer whenever major organizations merge or acquire each other, from a public policy perspective, this particular merger might well produce a different outcome.

Filing Your Tax Return: Competition or Monopoly?

In America, an extremely heated public debate rages on about the role of the federal government in managing and paying for health care services. On one side of the argument, Republicans have rushed to the defense of House Representative Paul Ryan and his proposal to convert the Medicare system into a private sector voucher plan. And on the other side, the Democratic Governor of Vermont has taken the first concrete steps  towards implementing a Canadian-style single payor government system for an entire American state.

Interestingly, though, similar debates are also taking place about other sectors of the economy. For instance, let’s consider the Do-It-Yourself (DIY) income tax electronic form preparation and filing industry. Although many states have developed their own internet-based government systems for citizens to file their income tax returns, the Internal Revenue Service of the federal government has instead opted to encourage private corporations to compete with each other to provide this service to taxpayers.

Last week, however, the United States Department of Justice (DoJ) filed a lawsuit to block a corporate acquisition that would utterly transform the competitive market for such tax return preparation services. Was it an example of an unwarranted government intrusion into a private sector market place? Or, alternatively, did it represent an appropriate case of government oversight and regulation?

Seventeen Competitors … Or Only Three?

At first glance, the market for DIY income tax preparation services appears to be a highly competitive one. After all, the Internal Revenue Service promotes seventeen organizations that offer tax filing services to the public … and those are only the firms that are willing to provide free assistance to citizens with relatively low Adjusted Gross Incomes! Many other firms across the nation sell competitive services as well, although they decline to provide any free filings.

It is indeed a broadly diverse list, ranging from the national for-profit industry giant HR Block to the tiny start-up I-CAN! program of the nonprofit Legal Aid Society of Orange County, California. Nevertheless, it is important to note that 90% of all electronic tax filers across the nation have opted to utilize the services of only three organizations: Intuit, HR Block, and 2nd Story Software.

Intuit, of course, is a $3.5 billion global technology company. And HR Block prepares one out of every seven tax returns that are filed in the United States. 2nd Story, though, is a relatively small, privately owned firm that has made its mark by being a “maverick” on service pricing.

In October 2010, HR Block announced a plan to acquire 2nd Story and its TaxACT filing service, a move that would effectively consolidate 90% of the federal income tax filing market into the hands of a pair of industry giants. After studying the merger for more than seven months, the DoJ filed a lawsuit last week to block the transaction in order to preserve private market competition.

Broader Ramifications

The questions raised by the DoJ’s action, of course, extend far beyond the DIY income tax filing industry. Does the federal government possess the right to prevent private corporate mergers in the name of preserving competition, even for industries that actually support a large and diverse collection of competitive service organizations? Can it justify taking such actions by noting that the largest competitors in the industry have amassed significant shares of the total market?

These broad questions are relevant to regulatory policy in many economic sectors, including — perhaps most importantly, considering the current debate over federal policy regarding Medicare — the health insurance industry. After all, in many population centers across the United States, the market share of the two or three largest private health insurers now exceeds 90%. The entire state of Rhode Island, for instance, is only served by three commercial insurance companies, with Blue Cross Blue Shield serving 70% to 80% of the self-insured large group and fully insured markets, and with the national industry giant United Health serving another 10% to 20% of these clients.

While the debate over national health care policy raged through Congress last year, many Democratic proponents of a “government option” supported a proposal to trigger such an option where ever private insurance markets are non-competitive as a result of insurer consolidation. If the DoJ succeeds in establishing that a large market share in the hands of a duopoly of tax return preparation providers is in fact non-competitive, could it then reassert the need for a “government option” health insurance plan in states like Rhode Island by utilizing the same rationale?

Similar questions can be asked about the federal government’s sponsorship of Amtrak in the public transportation industry, of the U.S. Postal Service in the package delivery industry, and of many other government programs and services as well. To prevent free-for-all disputes from flaring up in each of these ostensibly unique industries, it may be helpful to begin such debates by achieving some level of consensus about the appropriate role of government in maintaining market competition.

Rethinking Medicare: The Paul Ryan Approach

Imagine, for a moment, that you are 85 years old and blessed with a reasonably healthy physical constitution. Like many Americans of that age, you may take blood pressure medication on a daily basis to control a mild heart condition, and you may feel the plague of arthritis starting to creep into your fingers and knees. Nevertheless, all in all, you would probably believe that you have no reason to complain about the health care service system.

But what would you do when you actually need to obtain medical care? Since the advent of the Medicare program in 1965, all Americans over the age of 65 in need of care have simply traveled to the offices of their doctors and flashed their enrollee identification cards. Although these seniors do pay modest monthly premiums, the vast majority of all of their medical costs — from medication expenses to physical therapy fees — is financed by the federal government.

Last week, though, Republican House Budget Committee Chairman Paul Ryan unveiled a vastly different vision for Medicare, one that would utterly transform the program. And then, for good measure, he proposed an equally dramatic transformation of the Medicaid program.

Buy It Yourself!

For Americans who reach age 65 after January 1, 2022, Ryan proposed that the Medicare program simply hand them a list of private insurance companies, and invite them to buy policies for themselves. The federal government would subsidize costs by sending each insurer a “premium support payment” for each enrollee; nevertheless, insurers would be free to establish prices as they see fit, and enrollees would be expected to either pay the difference or survive without insurance.

Medicaid, the health insurance plan for the poor, would be converted into a “block grant” system under the Ryan plan. The federal government would simply hand each state a lump sum of money each year; governors and legislators would then be free to cover as many — or as few — citizens and services as they see fit. Each state would decide for itself whether to charge citizens for insurance coverage; if it decides to do so, Medicaid enrollees would be required to either pay the amounts or live without access to health care.

Ryan argued that these innovations are required to slash the federal government’s budget deficit to manageable levels, and to finance a reduction of the federal income tax rate for the wealthiest taxpayers from its recent levels (between 35% and 40%) to a significantly lower 25%. According to Ryan, the lower tax rates are needed to stimulate future economic growth.

The federal government’s budget would undoubtedly be placed on much sounder footing under Ryan’s plan. However, there would be no guarantee that elderly or poor citizens could obtain health coverage from any insurer.

Obama and Romney

Ironically, Ryan’s proposal regarding the government’s compilation of a health insurer list is actually similar to the concept of Health Insurance Exchanges that are embedded in President Obama’s national health plan. And Obama’s plan is itself similar to Republican Governor Mitt Romney’s universal Health Connector web site for Massachusetts.

Indeed, despite occupying opposite ends of the political spectrum, Obama and Romney each signed legislation that guarantees access to affordable health insurance to all citizens. Ryan’s proposed legislation, though, would seek to ensure a stable government budget and lower income tax rates by withdrawing this guarantee from the seniors and the poor who already possess it.

The Ryan plan implicitly relies on competitive market forces to maintain health coverage, presuming that a significant number of insurance plans would rush into the vacuum that would be created by an expiring Medicare system. But is it reasonable to assume that private firms would rush into this industry sector, simply because a dominant government program is withdrawing from it?

Too Big To Fail

Furthermore, let’s assume for a moment that the private sector does manage to take the place of the current Medicare program by enrolling tens of millions of senior citizens into government subsidized plans. Might those private plans then be deemed “too big to fail” by the federal government?  After all, if such plans ever begin to default on tens of millions of consumer health insurance policies, wouldn’t the government be forced to consider a bail-out?

75 million people, for instance, are now enrolled in the health plans of UnitedHealth Group; this insurer may indeed already be too big to fail. What if the firm signs up tens of millions of additional elderly consumers? How could the federal government then permit it to fail?

An ensuing bailout of the health insurance industry could make the recent banking industry rescue seem like small potatoes. If the Ryan plan results in the replacement of an explicit government program with an implicit government guarantee of private insurers — similar to the government’s implicit guarantee of Fannie Mae debt, for instance — the initiative may indeed fail to achieve its author’s laudable goals.