Healthcare Spending: Why It's Out Of Control

Healthcare spending is out- of control.

Healthcare spending makes up 18% of our total government spending today, and is projected to drive virtually all of the spending growth in the next 20 years.

Over the past 50 years, health care costs have been rising at a rate of 7%-9% a year, or about 3%-5% over and above inflation. For an average family of four, healthcare costs more than $20,000 annually, and is projected to increase by over 100% to $40,000 annually by 2030, after adjusting down for inflation (assuming 4% excess inflation).

This is equivalent to a family purchasing a new car every, single year.

Much of these costs are not directly visible because most people obtain health insurance that is either subsidized by employers or by the government; however, this is the total all-in cost for healthcare today.

What does this mean?

An increasingly larger share of our resources will go to fund health care, leaving significantly less for all other spending. It also means that foreign labor is more competitive than U.S. labor to the degree that our healthcare costs exceed other nations.

Can we fix this by raising taxes on the wealthy, or by cutting spending elsewhere?

This problem cannot be solved through taxes alone, nor can it be solved through deep spending cuts elsewhere, because it doesn't fix the underlying problem of skyrocketing costs.

For example, we can compare our situation to the following: Imagine a ship that is sinking because it has a gaping hole in the middle.

Cutting spending would be similar to throwing furniture off the ship. It would help it stay afloat longer, but eventually, sailors would need to plug the hole. Raising taxes would be similar to requiring the people with more furniture to toss their furniture first. It only seems fair that those with more furniture help out more, but the hole still needs fixing.

What can we do to fix this?

First, we need to understand what is driving the excess cost-growth.

Studies have shown that 40%-60% of all excess cost growth is solely due to new technologies, with the remaining excess growth due to inefficiencies related to absorbing these new technologies into the system.

Doesn't technology normally lower costs, why is it increasing costs instead?

Technology will lower costs when it is use to replace an existing technology or service.  For example, the price of a basic calculator has fallen dramatically, from over $500,000 (or $6 million in inflation-adjusted dollars) for ENIAC down to under $10 today.

However, technology can increase costs when it enables the creation of new goods and services. By expanding the total universe of available goods, technology also increases costs. For example, technology has also enabled the creation of new consumer goods (e.g. GPS, tablets, smartphones, cameras, etc.), and owning each one of these devices require spending that was previously unnecessary.

In the same way, medical technology has enabled the expansion of the universe of available medical services, through creating new medical goods (e.g. coronary bypass, cancer drugs, diabetes drugs, HIV treatments, CAT scans, MRI scans, etc.).

But new consumer goods are still affordable; why is this not the case with medical goods?

The key difference is insurance. New medical goods are required to be covered at any cost, due to the nature of our existing insurance market. Health insurance companies must pay for any new medical good that a doctor deems necessary for improving a patient's health, no matter what the price of that new good. In fact, doctors will often over-treat patients with the newest technology to avoid malpractice lawsuits claiming that they did not do everything in their power to ensure a patient’s well-being.

What about other countries, don't they face the same challenges as the U.S.?

Nearly all countries that have well-controlled medical costs have a mechanism that determines when the cost of a new service is worthwhile to cover, either through quality-adjusted life years (QALY) or more direct price-fixing for all covered services. This allows for insurance carriers to opt-out of covering non-worthwhile costs.

The United States is one of the few developed countries without a clear method of determining when the cost of a new service is worthwhile to cover, either through QALY's or through price-fixing.

In short, our problem is that we automatically cover of every, single new medical good and service, no matter the cost of that service, without any kind of intelligent decision-making.

This lack of intelligent decision-making is driving the debt.   This is why we need to fix the debt.