Sinking SCHIP

This article appeared in the November issue of USA TODAY magazine.

Despite President George W. Bush'sdecision to veto Congress' Octoberbill—and the legislative branch'sfailure to override that veto—Federallawmakers still are contemplating furtherefforts that could result in millions more middle-income families obtaining health insurancefrom government; too bad the debate over expansionof the State Children's Health InsuranceProgram is divorced from the reality ofwho truly needs assistance and the forces thatare making health insurance increasingly unaffordable.SCHIP and its larger sibling Medicaidcurrently enroll many people who do notneed government assistance, including somefamilies of four earning up to $72,000 per year.That is a direct result of Federal funding rulesthat reward states for making more Americansdependent on government for their health careservices.

Congress created the State Children'sHealth Insurance Program in 1997. That programgives Federal grants to states that providefederally defined health insurance coverageto eligible children. In 2006, SCHIP spentapproximately $8,000,000,000 to cover7,400,000 individuals. SCHIP's original goalwas to supply health insurance to childrenwhose family income is too high to qualify forMedicaid yet too low to afford private healthinsurance. Medicaid is the much larger Federal-state health insurance program targeted presumablyat the country's poorest citizens.Medicaid spends $317,000,000,000 to cover60,900,000 persons.

SCHIP currently enrolls 6,600,000 children,many from families that neither are needy norlow-income. The Congressional Budget Office(CBO) estimates that maintaining existingSCHIP benefits for the next five years wouldrequire an additional $8,000,000,000 of Federalfunding above and beyond existing levels.Pres. Bush has proposed increasing spendingby $5,000,000,000 over five years. Democratsin Congress want to raise Federal SCHIPspending by as much as $60,000,000,000 overfive years.

A better strategy for providing health careto those in need would use deregulation tomake private health insurance more affordablefor middle- and low-income families, therebyallowing government health programs to focuson those patients who most need assistance.We propose a two-part strategy for improvinghealth care access: block-granting FederalMedicaid and SCHIP funding to encouragestates to rededicate those programs to the trulyneedy and using competitive federalism tomake private health insurance affordable formore low-wage earners.

Medicaid and SCHIP provide necessarymedical services to millions of people. At thesame time, these programs have significantdownsides. For example, there are indications that Medicaid and SCHIP err on the side ofproviding too much assistance. That is, theyinduce many people to become dependent ongovernment for medical care and, in some cases,trap enrollees in dependence. Medicaid andSCHIP weaken private health care markets bycrowding out private health insurance anddriving up prices for private purchasers. ExpandingSCHIP or Medicaid would exacerbatethese problems.

Medicaid and SCHIP have grown beyondtheir original purposes and well beyond what isnecessary to provide health insurance to needyAmericans. Many Medicaid enrollees are elderlynursing home residents who could haveobtained private long-term care insurance.Economists Jeffrey Brown of the University ofIllinois and Amy Finkelstein of the MassachusettsInstitute of Technology estimate thatMedicaid's loose eligibility rules discourage66% to 90% of seniors from purchasing suchinsurance. Indeed, a cottage industry of Medicaidestate planners exists to help middle-classseniors spend Medicaid funds, rather than theirown resources, on their nursing home care.Other Medicaid enrollees come from nonelderlyfamilies that could obtain health insuranceon their own. More than one out of every fivepeople eligible for Medicaid actually has privatehealth insurance, suggesting that Medicaid'seligibility criteria is overly broad.

Rich kids on the dole

The same is true of SCHIP. When Congresscreated SCHIP, more than 60% of eligible childrenalready had private health insurance. In2005, about 55% of SCHIP-eligible childrenhad private health insurance. Depending on thestate, SCHIP now provides health insurance tochildren in families earning up to 350% of theFederal poverty level (FPL) or more. For afamily of four, that is the equivalent of nearly$72,000 per year. New York wants to increaseits SCHIP eligibility cutoff to 400% of theFPL, or roughly $82,000 per year for a familyof four. Nationwide, an estimated 89% of childrenin families earning between 300-400% ofthe FPL already have private coverage. As abasis for comparison, median family incomefor all families in 2005 was just over $56,000.This suggests that, if all states raised their eligibilitycutoff to New York's proposed level,well over half of all families could enroll theirchildren in a government health program. Finally,SCHIP also enrolls some 670,000 adults.

As a result of past Medicaid and SCHIP expansions,the share of children eligible forthose programs rose from less than one-fifth in1987 to nearly one-half in 2002. That is, despitethe fact that the share of children living inpoverty actually fell over the same period,Medicaid and SCHIP eligibility criteria arebroader than what would be necessary to coveronly those who truly need assistance.A frequently overlooked downside of Medicaidand SCHIP is that government programstargeting those below a given income thresholdcreate disincentives for beneficiaries to increasetheir earnings. As a low-income family'searnings rise, the family pays higher taxesand loses Medicaid, SCHIP, and other governmentbenefits. The combination of higher taxesand lost subsidies means that, when a familyincreases its earnings by $100, its total incomerises by only a small fraction of that amount. Inmany instances, a family that increases itsearnings can end up with less income overall.

For instance, a low-income single motherof two in New Mexico is eligible for a numberof income-related subsidies from the Federaland state governments. These include theEarned Income Tax Credit, cash assistance,Food Stamps, Special Supplemental Nutritionprogram for Women, Infants, and Children(WIC), housing and child care subsidies, andMedicaid. If she increases her earnings fromabout $15,000 to $45,000, her net income remainsthe same at around $40,000. Of the$30,000 she adds to her earnings, she loses$4,000 to taxes and $26,000 to reduced benefits.As a result of programs such as SCHIP,low-income families in New Mexico and otherstates face marginal effective tax rates thatcan exceed 100%. Such families have almostno financial incentive to achieve self-sufficiency.Expanding SCHIP would magnify thosepowerful disincentives to increase family earningsand would ensnare even more families inwhat economists call the "low-wage trap" createdby such programs.

That trap would be deepened further becauseMedicaid and SCHIP increase healthcare prices for private purchasers. For example,Medicaid price controls increase the cost ofprescription drugs for private payers by an estimated13%. Government purchasing throughMedicaid and SCHIP also can raise prices forprivate purchasers through what commonly isbelieved to be "cost shifting," but more accuratelymay be described as crowding out privatepurchasers. Thus, expanding SCHIP (andMedicaid) not only would induce greater dependenceon government, it would make financialindependence more difficult even for thosewho do not enroll.

Expanding SCHIP also would be unwisefiscally. Although policymakers expect that expandingMedicaid and SCHIP will improvechildren's health, economists have found noevidence that these programs are a cost-effectiveway of doing so. Economists Helen Levyand David Meltzer write: "It is clear that expandinghealth insurance is not the only way toimprove health. . . . Policies could also beaimed at factors that may fundamentally contributeto poor health, such as poverty and lowlevels of education. There is no evidence at thistime that money aimed at improving healthwould be better spent on expanding insurancecoverage than on any of these other possibilities."

In a survey of economic studies examiningfactors that contribute to longevity, The NewYork Times reported that education appears tohave the greatest impact, while "factors that arepopularly believed to be crucial—money andhealth insurance, for example, pale in comparison."According to RAND Corporation healtheconomist James Smith, health insurance "isvastly overrated in the policy debate" over howto increase life expectancy.

One reason that Medicaid and SCHIP maynot be cost-effective vehicles for improvinghealth is that expanding those programs reducesprivate health insurance coverage. Familiesoften substitute Medicaid and SCHIP forprivate coverage. Similarly, employers oftencut or eliminate health benefits when theirworkers become eligible for these programs. Itis well-established that Medicaid and SCHIP"crowd out" private health insurance. Crowdoutmakes expansion of public programs acostly way of increasing the number of peoplewith health insurance. A study by economistsJonathan Gruber (MIT) and Kosali Simon(Cornell University) estimates that, because ofcrowd-out, "the number of privately insuredfalls by about 60% as much as the number ofpublicly insured rises."

To illustrate, suppose that Congress and thestates were to enroll 10,000,000 additionalpeople in Medicaid or SCHIP. As a result, thenumber of individuals with private health insurancewould decline by about 6,000,000.Though taxpayers would be financing healthcare for an additional 10,000,000 persons, thenumber of uninsured would fall only by4,000,000. In other words, Medicaid andSCHIP cover four uninsured people for theprice of 10. Crowd-out is more likely to occurwhen lawmakers open these programs to higher-income families, because those families aremore likely to have private health insurancealready.

Expanding SCHIP also makes poor fiscalsense because spending on Medicaid andSCHIP already is on an unsustainable path.Cato Institute senior fellow Jagadeesh Gokhaleestimates that maintaining existing Medicaid growth rates would require implausiblyhigh tax rates in the future. According to Gokhale,"Limiting Medicaid spending growth is. . . an essential component of putting the Federalbudget on a sustainable course withoutimposing crushing tax burdens on youngerand future generations."

Nevertheless, lawmakers were ready to letthe poorest Americans carry the burden of aSCHIP expansion. Congress had considered—and still may try to institute—financing aSCHIP expansion with a 156% increase in theFederal cigarette tax, from 39 cents to one dollarper pack. According to Harvard Universityeconomist Kip Viscusi, "Cigarette taxes fallpredominantly on the very poor. The usualconcerns about regressive taxes involve thosethat are regressive in percentage terms, that is,the poor pay a higher percentage of their incomein taxes than do the wealthy. Cigarettetaxes are actually so regressive that the poorpay a much higher absolute level of taxes thando the wealthy. In 1990, people who made under$10,000 per year paid almost twice asmuch in cigarette taxes as those who made$50,000 and above."

Moreover, a higher Federal cigarette taxwould lead to more violent crime. Tax Foundationchief economist Patrick Fleenor has documentedthat high cigarette taxes fuel blackmarket activity, including truck hijackings andother armed robberies. In 2003, Fleenor wrote:"Today, 200 cases of cigarettes in a modestsizedtransport truck would have a retail valuein New York City of around $1,000,000 andwould be [a] tempting target for thieves."

Overall, 57% of Medicaid spending comesfrom the Federal treasury, with 43% derivingfrom states. Much as it did under the old Aid toFamilies with Dependent Children (AFDC)cash assistance program, the Federal government"matches" every dollar a state puts towardits Medicaid program. The Federal Medicaid"match" is completely open-ended. Statestherefore can double their money without limitby increasing Medicaid enrollment and benefits.Poorer states such as Mississippi canquadruple their money without limit. In addition,the program creates opportunities forstates to push even more of their Medicaidcosts onto taxpayers in other states than Federallaw would seem to permit. For instance, theFederal government is supposed to finance onlyhalf of California's Medicaid program. A recentproposal by Gov. Arnold Schwarzenegger,however, would bend Medicaid's rules so thattaxpayers in other states would finance threefourthsof Schwarzenegger's proposed newspending.

Since states pay a mere a fraction of thecost of expanding Medicaid to non-needyfamilies, the Medicaid "match" encouragessuch expansions. Like the former AFDC program,Medicaid's funding mechanism createsa "pay-for-dependence" incentive, rewardingstates that increase the number of Americansdependent on government. The states' openendedentitlement to Federal dollars—or, moreprecisely, to the earnings of taxpayers in otherstates—likewise increases the damage thatMedicaid does to private markets.

As with Medicaid, the Federal governmentmatches state outlays for SCHIP, though athigher rates. Overall, 69% of SCHIP spendingcomes from the Federal treasury, with 31%deriving from the states. At a minimum, theFederal SCHIP "match" allows states to tripletheir money. In some cases, states with a highproportion of low-income uninsured childrencan nearly quintuple their SCHIP outlays. UnlikeMedicaid, the Federal government caps itscontribution to each state's SCHIP program ata predetermined amount, which ostensibly deniesstates an open-ended entitlement to theearnings of taxpayers in other states. Nevertheless,the cap on Federal SCHIP allotmentsis not as binding as it might appear. Statessuch as Georgia sometimes spend all of theirallotted SCHIP funds before the end of the fiscalyear. The CBO estimates that 11 states willdo so in 2007. Typically, those states then petitionthe Federal government for additionalfunding. So far, Congress twice has bailed outsuch states, effectively rewarding those thatcommit to spending more Federal dollars thanthey have been allotted.

Congress should apply the same solution toSCHIP and Medicaid that it did to Aid to Familieswith Dependent Children in 1996. ReformingSCHIP and Medicaid—as Congress didwith welfare—would reduce dependence ongovernment and encourage states to focus governmenthealth care programs on those who trulyneed assistance. As with AFDC, Congressshould end the Federal entitlement to Medicaidbenefits and stop funding state Medicaid andSCHIP programs with matching grants; replacethose matching grants with one block grant thatneither increases nor decreases with the size ofa state's health care programs; place as few restrictionsas possible on how states spend theirblock grants; and freeze the new block grantsat 2007 levels—this could produce a savings of1.1 trillion dollars over 10 years.

Block grants would allow each state to preserveits Medicaid and SCHIP programs just asthey exist today. States that wish to expandtheir programs could continue to do so. However,states would have to pay for such expansionsthemselves, rather than have taxpayers inother states shoulder the burden. That wouldencourage each state to focus its programs onthe truly needy. Over time, states would learnfrom each other's experiments at providing efficientcare. It makes little sense for residents ofthe 50 states to send their money to Washington,D.C., only to have Washington send thatmoney back to the states. Moreover, it is arguablyunconstitutional. The Constitution doesnot grant Congress the power to provide healthcare to the needy. Under the Tenth Amendment,such "powers not delegated to the UnitedStates by the Constitution . . . are reserved tothe states." Block grants would take a step towarda more sound and constitutional means ofproviding health care for the needy, where themoney never passes through Congress' hands.

Welfare woes abated

Opponents will predict that block grantswould reduce access to care and increase thenumber of uninsured. Opponents of welfare reformmade similar predictions, which turnedout to be inaccurate. When Congress paredback cash assistance, welfare caseloads plummetedand poverty decreased—often dramatically—in every category. The poverty rate remainslower today than at any point in the 17years leading up to 1996. Many who opposedwelfare reform have since admitted that it accomplisheda large measure of good. There areindications that a block-grant approach toMedicaid and SCHIP could produce similar results.When the 1996 welfare reform law eliminatedMedicaid benefits for noncitizen immigrants,opponents predicted that coverage levelsamong that group would drop. Instead, coveragelevels increased because more noncitizenimmigrants obtained private health insurance.That experience supplies evidence that privatehealth insurance coverage expands in responseto a reduction in government coverage—sometimesenough to overwhelm the reduction ingovernment coverage.

Medicaid block grants were part of theoriginal 1996 welfare reform law until theywere dropped at the insistence of Pres. BillClinton. Congress should revive the idea torededicate government health care spending tothose who truly need assistance.

Another reason states have been eager toexpand their Medicaid programs has been therising cost of private health insurance. Statehealth insurance regulations have been a drivingforce behind that trend. The average staterequires consumers to purchase 38 separatetypes of coverage. Forty-five states require allconsumers, even teetotalers, to purchase coveragefor alcoholism treatment; 35 states, contraceptive coverage; and 13 states, in-vitro fertilization(even though a number of consumers,such as many Catholics, find those servicesmorally objectionable). Those coverage mandatesincrease the cost of private health insuranceby as much as 15%. An estimated 25% ofthe uninsured lack coverage due to the cost ofmandatory coverage laws. Underwriting restrictionssuch as "community rating" laws, atype of price control, further increase the costof private health insurance for many low-incomefamilies, and likewise increase the numberof uninsured. Such regulations price manylow-income families out of the market for privatehealth insurance. As many as 75% of theuninsured could afford to purchase health insurance,but find that the available options arenot worth the high cost of coverage.

Overregulating health care

Many individuals and employers who purchasehealth insurance cannot avoid the unwantedcosts imposed by such regulations.Under each state's licensing laws, every healthinsurance policy sold in that state must includestate-mandated coverage and comply with thestate's price controls. Given the wide variationin health insurance regulation from state tostate and the availability of lower-cost policiesin some states, many consumers and employersshould be able to obtain lower-cost healthinsurance in other states, just as they purchasemany other products from out-of-state. However,state licensing laws act as a barrier totrade. The burden of these laws falls hardeston low-income individuals; 75% of the uninsuredhave family incomes below 200% of theFederal poverty level (about $41,000 per yearfor a family of four).

Congress should sweep away those tradebarriers and let individuals and employers purchasehealth insurance licensed in states otherthan their own. Article I, Section 8 of the U.S.Constitution grants Congress the power "Toregulate Commerce . . . among the severalstates." That power exists primarily to preventeach state from erecting barriers to commercefrom other states. Congress should enact a Federallaw that prevents states from barring thesale of an insurance product licensed by anotherstate. Such a law would enable many lowincome,uninsured consumers to obtain privatehealth insurance, because it would expand theirrange of choices to include policies free of unwantedregulatory costs. The consumer protectionsrequired by the licensing state, such as financialsolvency requirements, could be incorporatedinto the insurance contract. That wouldallow the purchaser to enforce those requirementsin the purchaser's home state, with thehelp of his or her state's insurance regulators.

This "competitive federalism" approachwould improve the quality of health insuranceregulation. Giving consumers the freedom toavoid unwanted regulatory costs would forcestates to offer only the regulatory protectionsthat consumers demand. Otherwise, consumerswould take their business—and, importantly,their premium taxes—to a state that providesconsumer-friendly regulation. Competitionamong the states would drive insurance regulationtoward an equilibrium—or multiple equilibria—between too much and too little regulation.States would be unlikely to engage in a"race to the bottom" by eliminating importantconsumer protections. The first people to be injuredby such unwise regulatory policies wouldbe the voters in that very state, who then wouldpunish the responsible officials.

Competitive federalism would be a farpreferable means of making health insuranceaffordable to low-income consumers thanFederal preemption of state regulation. It preserveseach state's power to determine itshealth insurance regulations and each individual'sfreedom to choose the protections he orshe demands. Most importantly, competitivefederalism would maintain constant pressureon states not to enact costly regulations, becauseconsumers could choose policies licensedby other states. If Congress were topreempt state health insurance regulations,however, that would effectively federalize theregulation of health insurance. Over time, atthe behest of special interests, Congress wouldenact costly regulation after costly regulation,just as state legislatures have. Those regulationswould apply nationwide, meaning thatconsumers—particularly low-income consumers—would have no escape.

Competitive federalism also would be a farpreferable means of making health insuranceaffordable to low-income consumers than expandingSCHIP. Unlike SCHIP, it would requireno government spending or tax increases,nor pull more families into a low-wagetrap. Indeed, such a competitive system wouldhelp low-income families avoid dependenceon government—and it would not increase thecost of privately purchased health care. If anything,by enabling a more competitive healthinsurance market, it would force insurers toput more downward pressure on health careprices. Finally, because competitive federalismwould help more low-income families becomeindependent, it would allow state governmentsto focus their health care programs on thosewho truly need assistance.

With so many reasons not to expand SCHIP—including a lack of evidence on cost-effectivenessand the availability of better alternativesfor making coverage affordable for lowincomefamilies—why is there so much supportfor expanding means-tested governmenthealth insurance to people who do not needcharity? Support for SCHIP (and Medicaid)expansion comes from an alliance of "bootleggersand Baptists." Economists often explainsupport for government policies (e.g., restrictionson alcohol sales) in terms of those whotruly believe in the merits of the policy (i.e.,Baptists who oppose alcohol consumption)and those who benefit financially from thepolicy (i.e., the bootleggers who sell illicit alcohol).The "Baptists" behind SCHIP expansionare those who believe that the way to increasehealth care quality and access is forgovernment to finance and control the deliveryof care. An example would be left-wingadvocacy groups such as Families USA. ExpandingSCHIP and Medicaid to enroll moreand more Americans serves their goal of eventuallyhaving all citizens in government healthcare programs. This incremental strategy isneither new nor secretive. In 1993, the ClintonAdministration's Health Care Task Force explicitlyconsidered what it called a "Kids First"strategy for health care reform that first wouldhave enrolled all children and, eventually, alladults, in a government-controlled health caresystem. (Some 14 years later, then-First Ladyand now-presidential hopeful Hillary Clintonis still at it with her latest proposal for a government-run health care system.)

The "bootleggers" behind SCHIP expansioninclude those who stand to gain financiallyfrom greater government subsidies for healthinsurance and health care. They include severallobbying groups: America's Health InsurancePlans and the insurers it represents; the PharmaceuticalResearch and Manufacturers of Americaand the drug manufacturers it represents; theAmerican Medical Association and the physiciansit represents; and the Federation of AmericanHospitals and the for-profit hospitals it represents.State officials who support SCHIP expansion,such as California's Gov. Schwarzeneggerand the rest of the National GovernorsAssociation, also belong in the bootleggers categorybecause increasing Federal SCHIPspending benefits them politically, enablingthem to provide new subsidies to voters at afraction of the cost to their home states.