September 19, 2011 8:40AM

Let the Market Cut Medicare?

The center‐​right consensus is that in order to balance the budget and improve health care, Congress needs to overhaul Medicare using some form of voucher or premium support. Whereas the current program offers an essentially unlimited subsidy for medical care, under these options Congress would give each enrollee a fixed subsidy with which they could purchase private health insurance. But how should Congress determine the size of these fixed subsidies?

The House GOP approved a budget under which Congress would pick the amount. Beginning in 2022, all new enrollees would receive a voucher. The average voucher amount would be equal to the average amount Medicare currently spends per enrollee in 2011, adjusted for overall inflation. Congress would adjust the actual voucher amount for each enrollee based on health status and income, so some enrollees would receive larger and some would receive smaller vouchers. But since the average voucher would grow at the rate of inflation (i.e., about 2.5 percentage points slower than per‐​enrollee Medicare spending currently grows), this approach would reduce Medicare spending over time.

A drawback of this approach is that opponents can (and do) demagogue it, claiming that the vouchers would be insufficient and seniors would die for lack of medical care. This demagoguery ignores two important factors.

First, as Peter Orszag and President Obama themselves loved reminding us during the ObamaCare debate, there is lots of wasteful spending in the Medicare program. Orszag frequently cites the Dartmouth Atlas, which estimates that one third of Medicare spending is pure waste. Since the amount of the House GOP’s vouchers would be based on per‐​enrollee Medicare spending, they would essentially give Medicare enrollees 50 percent more money than they would need to purchase all the beneficial medical care that Medicare currently provides. The vast amount of wasteful Medicare spending is a disgrace. But when converting to a voucher system it’s an absolute boon, because it provides a huge margin of safety. It means that enrollees could reduce their medical consumption by one third without harming their health.

Second, the anti‐​reform demagogues presume that vouchers would do absolutely nothing to make health care more efficient. Vouchers would make the nation’s 50 million heaviest consumers of medical care cost‐​conscious in a way they have never been before. Like an old man trying to send back soup at a deli, they will force providers to cut costs and thereby make their vouchers go farther.

It is because of this second factor that Yuval Levin proposes a different way of setting the voucher amount(s). Levin proposes to use a competitive‐​bidding process. Under this approach, everyone in Medicare would receive a voucher equal to the second‐​lowest bid that health plans submit to provide a standard package of benefits. Enrollees could then apply their voucher to any private plan or even a government‐​run plan. Under this approach, enrollees would still be cost‐​conscious: if the health insurance policies they choose cost more than the voucher amount, they would have to make up the difference; if the policies cost less, they would keep the savings. Levin argues that this cost‐​consciousness would also lead enrollees to put pressure on providers to cut costs, and therefore the amount of the second‐​lowest bid would automatically grow at a slower rate than per‐​enrollee spending under the current Medicare program. “In such a system,” Levin writes, “the premium‐​support benefit would grow exactly as quickly as required to provide a comprehensive insurance benefit, since the growth rate would be determined by a market process rather than a preset formula. ” Voila! The competitive forces of the market would cut Medicare spending.

The best evidence that competitive bidding will reduce Medicare spending is that the durable medical equipment manufacturers have fought efforts to impose it on them. So while I’m not hostile to the idea, I don’t think it’s an improvement over the House GOP plan.

First, Levin calls competitive‐​bidding “the Confident Market Solution” because he is confident that markets will reduce the cost of health care. I’m confident of that too. But I’m also confident that rent‐​seeking will be present in Medicare, no matter what reforms Congress enacts. I am far less confident that markets will reduce costs faster than rent‐​seeking will increase them. My sense is that politicians will be much more likely to hold the line on rent‐​seeking if they actually draw one.

Second, House Budget Committee chairman Paul Ryan (R‑WI) crafted a House budget that proposed to reduce the growth of Medicare spending using hard, score‐​able numbers. Hundreds of House members likewise stuck their necks out by voting for it. The Confident Market Solution essentially undercuts those folks by telling them they should not have done something so bold and courageous. Levin is no doubt correct that a competitive‐​bidding process that doesn’t specifically commit Congress to reducing Medicare spending growth is more politically feasible than a voucher plan that does. When politicians choose the more politically perilous option, however, reformers should tell the world why that was the right thing to do.

Third, Levin would include a public option in the competitive‐​bidding system. I am also confident that the government would heavily subsidize that health plan until it drove private insurers (and any hope of cost‐​cutting innovations) out of the market.

I’ve discussed what I think is a better approach to Medicare reform here and here.