How Government Made US Healthcare Expensive
It has to do with decades of bad public policy
Healthcare policy and reform is one of the most important issues in the United States today. President-elect Joe Biden has proposed a healthcare plan that would give Americans the ability “to purchase a public health insurance option like Medicare.” Biden and his team believe that this would reduce health related expenditures due to the cheaper prices offered by the public option.
The main problem with Biden’s plan is that it mostly doesn’t address what made the American healthcare system expensive in the first place. I will be going over the several factors that made the United States healthcare system the most expensive in the world.
1. Lack of competition in the Pharmaceutical Industry
The government heavily protects drug manufacturers from competition. The problem is so widespread and costly that Biden even addresses it in his plan:
To create more competition for U.S. drug corporations, Biden will allow consumers to import prescription drugs from other countries, as long as the U.S. Department of Health and Human Services has certified that those drugs are safe.
The benefits of such a policy if implemented would be immense. A major reason why prescription drugs are priced so high in the US is due to the lack of market competition in the pharmaceutical industry. The reason for the lack of competition is due to patent applications that the government provides to pharmaceutical companies which delay competition and increase prices. The empirical evidence on this matter does validate this claim.
A 2018 report from the Initiative for Medicines Access and Knowledge looked at several of the highest selling drugs in the US and the amount of patent applications that were filed by the drug manufacturers:
Such filings allow drugmakers to a) increase the price of the branded drugs by an average of 68% in six years, and b) seek to stall generic competition by an average of 38 years. While these average figures are disconcerting, examples among specific drugs run even more extreme in each category. Among the top grossing and best known drugs on the market today, some of the ‘worst offenders’ include AbbVie having filed 247 patent applications for Humira, Pfizer’s 163% price hike over six years for Lyrica, and Roche’s and Genentech’s efforts to seek 48 years of patent exclusivity for Herceptin. These examples are not outliers; our analysis indicates that patent holders for the other top twelve drugs also abuse the patent system, hike the price of drugs, and delay generic competition.
Drug manufacturers use patent applications that the government provides to delay generic competition and increase prices, leading to commercial monopolies and increased prices for the consumer. In fact, high prescription drug prices are one of the leading causes of the expensive healthcare system America has today.
What would be the potential savings from patent reform? A study from the National Bureau of Economic Research looked at the Waxman-Hatch Act of 1984 and the effects it had on drug prices and R&D investments. One potential downside to patent reform is that it could reduce investments in medicinal research because of decrease in future profits from the drug research. The Waxman-Hatch Act tried to solve this problem by balancing out market exclusivity and expanding generic competition.
The study concludes that following generic entry into the market, prices fall dramatically.
Our analysis finds that in each of nine major therapy areas average pharmaceutical treatment costs have declined, in some cases very dramatically (in one therapeutic class, 84.1%) following generic entry. These cost declines encompass the entire set of molecules within each therapeutic class, not simply the molecule whose patent has expired. Across all nine therapeutic areas, at 24 months post‐generic entry, the weighted mean reduction in pharmaceutical treatment cost is 35.1%.
But the problem with the Waxman-Hatch Act is that it granted drug manufacturers a five-year period in which they had market exclusivity over the new drug, which meant that the FDA could not approve a generic version of that drug.
The intent of such a provision in the Waxman-Hatch Act was to allow private investments in medical research to remain steady. One common defense of broad patent rights in drug manufacturing is that it allows for large scale private investment in medicinal innovation.
However, the new incentives for companies to manufacture generic drugs created in the Waxman-Hatch Act did prove to be mostly successful. The study showed above proved that following generic entry into the market, prices fell substantially.
Further reform needs to be done that allows for further generic entry into the market while maintaining incentives so that companies can continue to invest and innovate. With such reform, prices will drop due to increased price competition while continuing large-scale investment in medical research.
2. Certificate of Need Laws (CON)
CONs are a license granted by a state regulatory agency that allow for an expansion hospitals and other healthcare facilities.
CONs were created when President Richard Nixon signed the National Health Planning and Resources Development Act in 1974. As of 2020, 35 states require CONs for the development of new healthcare facilities.
The main problem with CONs is that they lead to a decrease in the supply of medical care. With rising demand for high quality healthcare, decease in supply naturally leads to higher prices. CONs also restrict market competition with healthcare, by providing already existing hospitals the ability to increase prices due to the lack of competition.
Let’s go over the empirical research behind this:
A recent study released this year CON laws and their impact the quality of healthcare during the COVID-19 pandemic.
States with high healthcare utilization, proxied by above average hospital bed or ICU bed utilization respectively, that reformed their CON laws during the COVID pandemic saw a significant reduction in weekly deaths for both COVID and non-COVID patients. This reduction was prominent for natural death, Septicemia, Diabetes, Chronic Lower Respiratory Disease, Influenza or Pneumonia, and Alzheimer’s with a net effect of 28 lives saved per 100,000 people.
This is one of the few major negative effects of CON laws. Not only do they potentially reduce the quality of healthcare, they also restrict the supply of hospital beds and other medical equipment necessary for quality healthcare.
This study published in the Journal of Healthcare Finance found that there are severe negative effects with CON Laws on the healthcare system as a whole:
CON laws are shown to reduce the number of beds at the typical hospital by 12 percent, on average, and the number of hospitals per 100,000 persons by 48 percent. These reductions ultimately lead urban hospital CEOs in states with CON laws to extract economic rents of $91,000 annually.
The effects of CON laws can actually hit rural areas the hardest. This is because CON laws lead to fewer hospitals per capita in rural communities.
A study from economists Thomas Stratmann and Christopher Koopman looked into the effects that CON laws had on rural communities:
. . .the presence of a CON program is associated with 30 percent fewer total hospitals per 100,000 state population and 30 percent fewer rural hospitals per 100,000 rural population. Moreover, we find 14 percent fewer total ASCs per 100,000 state population and 13 percent fewer rural ASCs per 100,000 rural population.
All of these restrictions on hospitals, medical facilities, and medical equipment lead to higher prices for consumers of medical care.
A literature review conducted by economist Matthew D. Mitchell finds significant evidence that CON laws increase health related expenditures. The study reviews 20 peer-reviewed studies from reputable academic journals.
The overwhelming weight of evidence suggests that CON laws are associated with both higher per-unit costs and higher total expenditures. The evidence is mixed on whether CON laws have increased the efficiency of particular hospitals by channeling more patients through fewer facilities, and there is no evidence that CON decreased overall investment as its proponents had hoped. The weight of evidence suggests that CON regulations persist because they protect politically potent special interests from competition.
The findings from that paper are consistent with other papers. This 2007 study found similar results, with CON laws having a ‘statistically significant’ positive relationship with hospital costs.
Another paper found that due to the inelastic demand for healthcare, CON laws are ineffective at increasing efficiency.
CON will increase spending by raising prices. The data partially bear out these predictions, showing that CON does not reduce any type of spending and may actually increase spending on hospitals and physicians, especially by Medicare.
Overall, CON laws seem to have several negative effects. They increase health-related expenditures by reducing the supply of hospitals and other medical facilities. They decrease the quality of care received by reducing hospital beds, MRIs, CT scans, and other medical equipment. CON Laws also reduce efficiency by increasing costs for hospitals.
Repealing CON laws would have significant positive effects on efficiency, cost reduction, and healthcare quality.
3. Medicare and Medicaid Reimbursement Rates
Medicare and Medicaid are two of the largest government health programs in the world. Currently, Medicare costs $722 billion annually, with Medicaid costing around $448 billion.
The problem with both of these programs are the reimbursement rates that hospitals earn for providing healthcare the recipients is often financial unstable for these hospitals. As the graph shows above, hospitals operate at a loss when covering Medicare and Medicaid patients, with losses growing every year.
The losses from Medicare and Medicaid cause hospitals to charge private insurers significantly more to compensate for the fact that Medicare and Medicaid’s reimbursement rates are not sufficient.
A study from the RAND Corporation found that private insurers are often charged much more than Medicare is.
In 2018, across all hospital inpatient and outpatient services, employers and private insurers included in this study paid 247 percent of what Medicare would have paid for the same services at the same facilities, including both professional and facility fees. This difference increased from 224 percent of Medicare in 2016 and 230 percent in 2017. In 2018, relative prices for hospital inpatient services averaged 231 percent of Medicare and 267 percent of Medicare for hospital outpatient services.
A CBO study found similar results. Looking at 2013 claims data from large insurers, they found that, on average, hospital payment rates for insurers were larger than Medicare.
We found that the hospital payment rates of three large insurers in their commercial plans in 2013 were an average of 89 percent higher than Medicare’s FFS rates — or put another way, Medicare’s FFS rates were 47 percent lower than commercial rates
When you expand the sample size, the results are still the same. A literature review from the Kaiser Family Foundation found that Medicare causes hospitals to charge private insurers significantly more for the same healthcare services.
Based on the reviewed studies comparing Medicare and private insurance rates for hospital and physician services, this brief finds that private insurance payments are consistently greater, averaging 199% of Medicare rates for hospital services overall, 189% of Medicare rates for inpatient hospital services, 264% of Medicare rates for outpatient hospital services, and 143% of Medicare rates for physician services.
Since Insurance companies are charged significantly more for the same medical services, they naturally end up passing the cost burden to consumers, increasing the price of health insurance.
4. Medical Licensing and Scope of Practice Laws (SoP)
Medical licensing is a form of occupational licensing, where the government creates a regulation that requires people to obtain a license to practice an occupation.
Currently, state licensing boards grant licenses to students who apply for one. In theory, medical licensing is supposed increase the quality of healthcare by supplying the healthcare system with well qualified professionals.
Instead, medical licensing (and occupational licensing in general) acts as a barrier to entry, by limiting the supply of healthcare workers into market, which artificially boosts wages for existing healthcare workers, and increasing prices for consumers.
Currently, physician wages in the United States is the highest in the world.
But the number of physicians per 10,000 people in the US is relatively low. With the number being only around 24.5 per 10,000. This is due to strict occupational licensing laws, which restrict the supply of physicians into the system. This increases the wages of already existing physicians and other healthcare workers.
The empirical research shows that reforming medical licensing can lead to increased access and reduced prices.
One study, from the National Bureau of Economic Research, looked into the effects of relaxed occupational licensing laws on prices, wages, and employment patterns. They found that relaxed licensing laws and giving nurses more flexibility reduced prices.
Our estimates from FAIR Health, Inc. show that changing occupational licensing laws to allow more autonomy by nurses lowers permitted prices by 3 to 16 %.
One common counterpoint is that licensing leads to better outcomes, but there is little to no evidence that suggests licensing leads to better outcomes. The study cited previously shows that strict licensing requirements don’t lead to better outcomes.
. . . we were not able to find any influence of these changes in the regulatory climate on infant mortality rates or malpractice insurance rates as indirect measures of the quality of the service provided.
Similar to medical licensing, scope of practice laws restrict the ability of certain healthcare workers to care for patients is a variety of ways. These laws supposedly increase the quality of healthcare for patients.
But the vast evidence suggests that Scope of Practice do not lead to better outcomes, rather, they lead to lower consumer satisfaction as well as increased costs to the healthcare system as a whole.
This study, published in 2017, looked into the effects of SoP laws on the quality of primary care provided. It found that SoP laws did not improve the quality of healthcare, rather it worsened the quality.
(1) chronic disease management, cancer screening, preventable hospitalizations, and adverse outcomes of care provided by primary care nurse practitioners are better in reduced and restricted practice states compared to states without restrictions and (2) by decreasing access to care, SoP restrictions negatively affect the quality of primary care.
The effects on prices and spending is substantial. Reform in SoP laws can lead to massive reductions in costs.
One study looked at relaxed SoP laws on the cost of Medicaid patient care.
The results suggest that allowing physician assistants to prescribe controlled substances is associated with a substantial (more than 11%) reduction in the dollar amount of outpatient claims per Medicaid recipient.
Other research shows similar conclusions. This study looked at the effects that expanded SoP for nurse practitioners (NPs) had on costs.
We found that visits to retail clinics were associated with lower costs per episode, compared to episodes of care that did not begin with a retail clinic visit, and the costs were even lower when NPs practiced independently. Eliminating restrictions on NPs’ scope of practice could have a large impact on the cost savings that can be achieved by retail clinics.
A RAND Corporation literature review looked at the overall empirical research on SoP laws on healthcare outcomes, wages, and prices.
Our own review of the literature demonstrates that granting APRNs full practice authority would likely increase access to health-care services for Ohioans with possible increases in quality
Overall, medical licensing and SoP laws seem to be an immense barrier of entry into the healthcare system. Those laws seem to increase prices and decrease the quality of care received by patients.
Reforming medical licensing and repealing SoP laws would lead to major cost savings and improved healthcare outcomes.
5. Compliance with State Regulations
Compliance with state regulations are often a massive burden to hospital and insurance budgets, which eventually lead to higher prices for families and patients.
This study, from researchers at Pacific University looked into the cost burden and other effects of regulatory compliance on hospitals in Oregon.
On average each Oregon DRG hospital spent approximately $3.9M annually, and each Type A and B hospital spent close to $0.5M annually on labor alone to comply with state regulations
One major effect of regulatory compliance is that it increases administrative spending, which one of the the main reasons why healthcare is expensive in America.
Similar effects can be seen on a national level as well.
This report looks at 190 hospitals countrywide and looks into the effects of regulatory compliance.
An average-sized community hospital (161 beds) spends nearly $7.6 million annually on administrative activities to support compliance with the reviewed federal regulations — that figure rises to $9 million for those hospitals with PAC beds. Nationally, this equates to $38.6 billion each year to comply with the administrative aspects of regulatory compliance in just these nine domains. Looked at in another way, regulatory burden costs $1,200 every time a patient is admitted to a hospital.
$38.6 billion annually is a significant burden, one which leads to higher administrative costs and higher prices for patients and insurance companies. Experts recommend that significant regulatory reform is necessary to reduce administrative costs and health related expenditures.
Conclusion
Decades of public policy on the state and federal level has resulted in a costly healthcare system. Patent laws and lack of drug imports have lead to soaring drug prices. CON laws, which started in the early 70s, has increased healthcare spending and as reduced the quality of healthcare. Medicare and Medicaid’s reimbursement rates have lead to hospitals charging insurance companies significantly more to stay afloat, leading to increased prices for people nationwide.
Medical licenses and SoP laws have decreased the quality of healthcare while increasing prices for patients. And compliance with regulations has put a extreme burden on hospitals and has lead to increased administrative spending and costs for the healthcare system as whole.
Thank You For Reading
