Aug 31, 2018

Medicare for All: Taxes and Tradeoffs

Robert Graboyes Senior Research Fellow

As the debate over Medicare for All (M4A) heats up, it’s critical to keep this in mind: In all likelihood, $4.6 trillion in healthcare spending by the federal government (federal taxpayers, really) will differ profoundly from an American economy with $4.6 trillion in healthcare spending financed by the current mix of individuals, businesses, states, and the federal government. Who writes the checks and how they collect the money makes all the difference in the world.

Almost any conceivable financing mechanism for single-payer health insurance would entail heavy taxes on wages, salaries, interest, dividends, capital gains, and profits—providing powerful disincentives to work, produce, and invest. The current system of financing private health insurance, for all its flaws, contains far fewer discouragements to economic output.  Even a relatively efficient single-payer financing scheme would likely reduce the size of the economy by significantly more than the claimed health cost savings from adopting M4A.

The Blahous Brouhaha

The Centers for Medicare and Medicaid Services (CMS) forecasts that under current law, America’s total healthcare spending (by individuals, businesses, and governments) in 2022 will be around $4.6 trillion. $459 billion would come from out-of-pocket payments by patients (deductibles, co-pays, services for patients without insurance, services not covered by insurance). Private health insurance companies (financed by premiums paid by individuals and employers) would pay $1.473 trillion. $1.016 trillion would come from the current Medicare program, financed by payroll taxes and by premiums paid by patients. $782 billion would be paid by Medicaid, financed by federal and state taxpayers. The remaining $832 billion would come from a variety of public and private payers.

The M4A bill introduced by Senator Bernie Sanders (I-VT) would shift virtually all spending to the federal government. Private insurance would vanish, as would deductibles, co-pays, and the uninsured.

In his Mercatus paper, “The Costs of a National Single-payer Healthcare System,” my colleague Chuck Blahous analyzed Sanders’s M4A bill. He found that if all of Senator Sanders’s M4A expectations regarding the legislation were fulfilled, then from 2022 to 2031, total healthcare spending (again, by individuals, businesses, and governments) would decline by $2.1 trillion ($100 billion in 2022 alone). The paper noted repeatedly that Senator Sanders’s expectations—severe cuts to provider reimbursement, significant drug price reductions, administrative cost savings, and stable long-term services utilization—are highly unrealistic and unlikely to pan out.

Blahous’s primary purpose, however, was to estimate the impact on the federal government’s budget (and, hence, on federal taxpayers). He found that if Senator Sanders’s improbable assumptions did pan out (including that $2.1 hypothetical trillion in lower spending overall), then the federal government’s spending would increase over the ten-year period by $32.6 trillion—with the full burden falling on federal taxpayers. (If the senator’s expectations did not come to fruition, then the $2.1 trillion savings would evaporate and flip to increased costs. Then, the $32.6 trillion federal burden would increase commensurately.) (I broke down the underlying math earlier this month.)

Blahous’s paper prompted a furious debate over both numbers.

First, M4A supporters insisted (incorrectly) that Blahous’s paper proved M4A would save $2.1 trillion and proclaimed that reason enough to pass the bill. (Incidentally, such savings would be rather modest in the scheme of things—around $646 per American per year. That’s equivalent to healthcare spending in September 2018 dropping back to February 2018 spending levels and then resuming today’s rapid spending growth.)

Second, M4A backers argued that $32.6 trillion in extra federal spending is a non-issue, since the taxes required to finance it would merely offset the then-defunct out-of-pocket payments, individual and employer insurance premiums, state healthcare spending, et cetera. (Blahous clearly recognized this offset.) But this neutrality assumption ignores basic principles of public finance. Here’s why:   

Public Finance 101

For simplicity, let’s pretend M4A would leave overall healthcare spending unchanged, merely shifting all the spending by individuals, businesses, and states to federal taxpayers. In this scenario, there’s no $2.1 trillion in savings (as Senator Sanders anticipates), but no spending increase (as Blahous and others) anticipate.

The economic impact of M4A’s passage under this scenario depends on the distinction between lump-sum taxes and income-based taxes—principles outlined in elementary microeconomics and public finance textbooks.

With a lump-sum tax (also known as a “head tax”), everyone pays the same. In its purest form, Jeff Bezos, a middle-middle-class healthcare analyst, and a single parent earning minimum wage all pay the same. A lump-sum tax provides little or no discouragement to work harder or build a business, because the tax is static—no matter what you do. If anyone in this example gets a raise, his or her tax is unchanged. He or she enjoys the full benefit of any raise. But charging them all the same amount goes against our sense of fairness in matters of taxation.

Generally speaking, then, lump-sum taxes are efficient but inequitable. They don’t discourage work, investment, and creativity, but they’re perceived as unfair.

With an income-based tax, like personal or corporate income taxes, your tax bill rises with your income. With progressive taxation, your bill rises especially fast as you move into higher tax brackets.  Such a tax seems fair, but can discourage individuals or companies from working harder or investing. Why work harder, invest cash, and take risks if most of the rewards go to the government?

Generally speaking, then, income-based taxes are equitable but inefficient. They’re perceived as “fair,” but discourage work, investment, and creativity.

This distinction applies mostly to taxation and government expenditures, and not so much to private transactions. We object to rich and poor paying the same amount to finance schools. But for many transactions (buying clothing or a Big Mac or a plane ticket, for example), most of us don’t object to everyone paying the same price. And therein lies a serious problem with M4A.

The Agony of Tradeoffs

The core argument made by M4A supporters—that trillions in new federal healthcare spending would merely offset the trillions currently spent from other sources—sounds appealing. As Marc Goldwein of the Committee for a Responsible Federal Budget noted in a series of tweets, however, that argument ignores some real costs.

Present-day insurance premiums, Goldwein noted, somewhat resemble a lump-sum tax. If middle- and upper-income folks buy insurance policies today, they pay roughly the same price. (Medicaid and Obamacare mean that some with lower incomes probably pays less.) Hence, in the mid to upper range, health insurance premiums act as an efficient but (arguably) inequitable tax. But if you finance health insurance through federal income taxes, then the more income you earn, the more you pay for healthcare coverage. For some, that extra bite would be reason enough to work less, create less, and add less to the overall economy. This effect is particularly strong for second-earners or near-retirees, who may choose not to work at all if the return to work is low. For some investors, the difference is enough to shut down production and jobs in the US and move those investments overseas.

Goldwein’s tweets included some conjectural numbers which, he stressed, were “back of the envelope & apples-to-oranges” calculations. These rough numbers show that even “relatively efficient” sources of revenue are likely to reduce economic output by several times the purported $2.1 trillion in savings grasped by M4A backers from Blahous’s paper.

Goldwein points to a payroll tax as one plausible option for financing M4A. The Congressional Budget Office estimates a one percentage point increase in the payroll tax would raise about $100 billion in 2026, suggesting a payroll tax of 30 percent or more would be necessary to pay for M4A. As I previously calculated, this would mean tripling the payroll tax to as high as 45 percent for many workers. Such a large tax on earned income would result in significant reductions in work and the overall economy.

In other words, even if the healthcare savings touted by M4A supporters were to materialize, they would be submerged beneath a far greater loss of wages, interest, dividends, and profits.

In truth, few M4A advocates would likely support tripling of payroll taxes; some have instead proposed financing healthcare in part through taxes on the rich or even through deficits. Goldwein, in an email exchange, estimated that borrowing $33 trillion would reduce the size of the economy as measured by gross national product (GNP) by over ten percent and shrink total GNP by $15 to $20 trillion over the time period discussed in Blahous’s paper.

Goldwein has also suggested that the financing scheme put forward by Senator Sanders during the 2016 presidential campaign (60 percent financed by deficits, 25 percent by payroll tax, and 15 percent by income and capital gains taxes on high earners) “may be an even bigger hit” to the economy, producing economic losses many times the hypothetical $2.1 trillion in healthcare savings.

The claimed $2.1 trillion of savings could only appear, Goldwein notes, if the federal government structured funding as a lump-sum tax (similar to today’s private insurance premiums)—with most people (possibly including even those with low incomes) paying the same amount. But, he notes, Capitol Hill would likely view that financing structure as inequitable and politically untenable. If so, a shift from today’s mixed financing to deficit financing and income-based taxation means M4A would likely exert downward pressure on the long-term growth of the US economy (and very likely a downward jolt in the law’s first year). Again, an immediate and long-term result would almost certainly be a shift of some capital investment from the United States to foreign countries.

Still, it’s logically defensible to argue that the benefits of M4A outweigh the costs of a smaller, slower-growing US economy. But unless one is willing to argue for financing via lump-sum taxes—and practically no one is so willing—then that smaller, slower-growing economy will be part of the bargain. M4A would doubtless deliver real benefits to many Americans. But the program’s financing would almost certainly impose heavy costs on all Americans—reductions in employment, income, growth, innovation, entrepreneurship, and mobility. And once done, it essentially cannot be undone.

One can argue that the tradeoff is worthwhile—a worthy topic for debate. We can ignore the tradeoffs, but the economy will not.

Afterthought: A Better Path

Antipathy over M4A does not mean satisfaction with the status quo in US healthcare, however.

My 2014 monograph, Fortress and Frontier in American Health Care, argued that the fundamental problem with America’s healthcare debate is that all sides have excessively focused on federal insurance reform as the pathway to better care for more people at lower cost.

Like earlier proposals, including Obamacare and various Republican alternatives, insurance reform makes relatively little difference in the level of overall healthcare spending, in the quantity of healthcare resources available, or in how those resources are used. Obamacare did little to change the number of doctors, nurses, hospital beds, laboratories, drugs, or medical devices—nor in how providers use those resources. M4A advocates accept as a matter of faith that a single-payer system will yield large efficiencies. Conservative M4A opponents are similarly credulous when they assure us that shifting power over health insurance from the federal government to the states will lead to bursts of efficiency.

A more productive avenue, I argue, is to emulate what has transpired in the information technology (IT) industry over the past three decades. Worldwide, billions of people now enjoy astonishingly more and better IT at remarkably low cost compared with 30 years ago. This was not accomplished by single-payer IT financing or by granting states more authority over IT purchases. The change occurred through markets, with federal lawmakers and regulators giving wide berth to innovators.

Mining my own writings, I argue that a better, fairer, cheaper healthcare system will come less from insurance reforms and more from technologies such as lean manufacturing, synchronous telemedicine, asynchronous telemedicine, wearable telemetry, additive manufacturing, 3D bioprinting, artificial intelligence, the gig economy and smart machines, streamlined regulation, unmanned aerial vehicles (drones), next-generation electronic health records, genomics, efficient drug and device approvals, voluntary price transparency, biohacking, home diagnostics, direct primary care, disruptive diagnostic devices, harm reduction technologies, and right-to-try. Currently, federal and state laws and regulations—and restrictions imposed by provider groups—restrain the development and dissemination of such developments. In addition, states place excessive restrictions on provider licensing and healthcare business structure.

There is little reason to think that M4A will speed the development and refinement and diffusion of life-saving, cost-saving technologies such as these. The same can be said of Obamacare or of the various Republican alternatives that pop up from time to time.

Technological and managerial innovation, in short, requires a different focus from the one we’re having over M4A, which is part of a monotonous, unsatisfying debate we’ve been having for many decades.

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