Such limitations also apply to social programs, the primary focus of much of federal spending. In the United States, entitlement spending accounts for over 70 percent of government expenditures and its reform is increasingly linked to discussions of deficits and growing debt-to-income ratios. Uneasiness related to this “entitlementationism,” like uneasiness related to Keynesianism, derives from its current association with national debt. Much of the health-care bill debate (as well as the debate over Medicaid, Medicare, and Social Security), for example, has to do not with the objectives of the programs themselves but with this alternative economic issue.

Continuing freely to apply Keynesian fiscal policy is today considered to be a middle-to-left-of-center political emphasis, while preventing dangerous levels of debt accumulation is generally considered a middle-to-right-of-center priority. Thus, it should be of interest to all parties to address both concerns while accomplishing positive social program outcomes—and, fortunately, there is guidance, consistent with modern economic principles, for doing so.

“Entitlementationism” is a concept that first surfaced in the mid-twentieth century—the period framed by the second term of Franklin Roosevelt and the Great Society years of Lyndon Johnson. It is the view that private goods such as health care, education, old-age consumption, and sometimes food, housing, and transportation can be effectively provided publicly. As a technical matter, economists distinguish between pure private goods, which provide benefits solely to the individual who consumes them, and pure public goods, such as national defense, which provide benefits to everyone.

The pairing of public and private provision of public and private goods results in four possibilities. Private provision of private goods through competitive markets is economically and scientifically supported as efficient. Public provision of public goods such as national defense (protection to everyone from enemies without) and law and order (protection to everyone from enemies within) is both a historically and theoretically valid government function. Private provision of public goods through market means can range from impractical to impossible and few polities have attempted it. The last pairing, public provision of private goods, particularly through entitlement programs, is primarily a twentieth-century phenomenon that seems to be running into trouble.

Modern Tools …

Is there a better way to accomplish entitlement objectives than through public provision of private goods? Low income is often correlated with low living standards and little access to good health care and education. Economists know, however, that lack of income is not intrinsically a health care problem, nor is it is a food problem, a housing problem, or an education problem; it is, of course, an income problem. Moreover, treating lack of income as if it were a health care problem (e.g., creating a program such as Medicare or a system of government health clinics) flies in the face of an economic principle of efficient policy referred to as “the intervention principle.” The intervention principle states that an economy that is run for the benefit of its members can best achieve an objective by its government intervening at the relevant price margin most closely connected to the object of interest.

Application of the intervention principle is straightforward. For example, if the social objective is to get the individuals in group A, who do not purchase health insurance, to do so, the lowest-cost way to accomplish this goal is to make purchasing health insurance more attractive to members of group A; this is achieved by precisely rewarding the purchase of health insurance precisely for the members of group A. Establishing government health insurance programs is not efficient for a number of reasons, including the fact that they tend to be too big to be precise. Government programs tend not to be targeted and usually provide goods rather than the prescribed incentives. In-kind giving (e.g. government-provided private goods or purchasing power such as vouchers or cash that can be spent only on the good) is inferior to cash, which can purchase the good in question but can be used for other necessaries by the recipient, as well, if warranted. Cash also does not encourage wasteful use as in-kind transfers do. (In-kind giving can lead to the following mindset: “I will accept the $100 of health care given to me, even if it is worth only $10 to me, because I cannot use that money for anything else.”)

Why would government engage in direct public provision of private goods rather than incentivizing their purchase (and handing out income) where needed? The primary justification for this is lack of information: If I want the individuals in group A to buy health insurance, but cannot identify who they are in order to incentivize the purchase, perhaps I should give everyone insurance; I know, however, that it will be disproportionately paid for by the rich and used equally or disproportionately by the members of group A. As just described, such entitlement programs will be more costly to society as a whole than targeted plans.

A companion to the intervention principle, the “incentive symmetry principle,” says that positively rewarding a desired action can be equivalent to negatively rewarding the opposite of the desired action. For example, rather than paying accused defendants to appear for their trials, the legal system applies the negative equivalent by making them post bond, which they lose if they do not show up. To make two reward systems equivalent in an economy sometimes requires making money payments to particular parties. For example, if food and insurance are the only two goods, you can make insurance more attractive relative to food either by raising the price of food or lowering the price of insurance. If the price of insurance is lowered, it eventually becomes affordable to everyone but creates an unnecessarily costly program, whereas if the price of food is raised, some may not then be able to afford insurance, even if they now want it.

Neither the intervention principle nor the incentive symmetry principle was known fifty years ago when most of our welfare programs were first enacted. When jointly employed, they form a powerful tool to lower costs and solve information problems as we now try to reform these same programs.

… For Modern Problems

Both the intervention and incentive symmetry principles apply in the case of health insurance (and for most other services provided by social programs), and they need to be taken into account by those struggling to lower costs while providing private goods. First, imagine the consequences of a hypothetical world where everyone is desperately interested in buying health insurance. Those who can afford to do so make the purchase. Those who cannot afford the purchase are invited to self-identify by visiting the government window and explaining their circumstances. If they qualify, they are granted cash. (We already know that the individual wants insurance because the motivation to buy insurance can be made as strong as we want as explained in the next paragraph.) So, without loss of generality, we may assume that the cash is applied toward insurance purchase. The necessary group self-identifies, so lack of information (i.e., inability to identify the group in need) is no longer an impediment. Ineffective in-kind programs are no longer needed, because outlays are granted in cash form and incentives satisfy the intervention principle. Relative to a broad-based entitlement program, expenses are low because they are targeted.

Next, consider the motivation to buy insurance. Incentive symmetry suggests that there are always alternative means to creating incentives, and one useful approach is to apply a broad-based tax that raises the price level by a given amount. (Some variant of a consumption tax, such as a value-added tax, would raise prices. If prices are raised high enough, they form the strong incentive: no one will pay five times more for their food and clothing if this can be avoided by buying health insurance.) Those who have health insurance would be rebated the tax or would not pay it at the point of purchase. Coverage can be verified in several ways, such as by swiping a card at the point of purchase. Another alternative is for rebates to be applied for periodically, as is done now for sales tax credits when federal taxes are filed. The net result is that there is a reward for buying insurance. Those with insurance face unchanged net prices, however, and thus pay no tax, and since everyone has the ability to buy insurance (though some self-identify to receive aid before buying it), no one will pay the incentive-creating tax. The incentive does its job without collecting any revenue or requiring any government outlay. Incentive symmetry informs the design of the incentive, and application of the intervention principle ensures that the intervention is targeted and rewards precisely the desired activity.

It is undeniable that improving the way we provide entitlements would lead to massive savings. The U.S.’s many entitlement programs each affect the deficit and debt differently, but let us take a look at Medicare. According to evidence cited by Thomas Saving, former trustee of the Social Security and Medicare Trust Funds, and John Goodman, President of the National Center for Policy Analysis, “seniors on Medicare use twice the health insurance as seniors who are still on private insurance, everything equal.” The suggestion—though more work would be required for a proof—is that entitlement programs that publicly provide private goods are financially inefficient and can be replaced by targeted interventions that are much less costly and no less effective.

Spending less ultimately leads to lower deficits and lower debt. This, in turn, frees Keynesianism and other social policies to be evaluated and implemented on their own merits.

Earl L. Grinols is a former Senior Economist for the President’s Council of Economic Advisors. He is currently Distinguished Professor of Economics at Baylor University. His most recent book is Health Care for Us All: Getting More for Our Investment published in August 2009 by Cambridge University Press.

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Copyright 2011 the Witherspoon Institute. All rights reserved.

Kennedy played the central role in his own care choices because he could pay for the services he received. Whether he was self-insured or carried outside insurance, the fact that those who treated him knew they would be paid through means at his disposal put him in charge of his health care.

Contrast this with an unknown taxpayer, admitted to a county public hospital or government-run clinic somewhere and added to the queue, perhaps just another Medicare or Medicaid patient with a life-threatening problem near the end of his life. Joe Taxpayer has been indirectly paying for his health care, too. Perhaps quite a bit. The difference is that he will not be the respected key component of the process and his experience will be quite different. If health care were conducted as it is in some countries, protocols for treatment of someone his age may even have denied him getting the treatment that Kennedy chose.

In America, the real health-care debate is whether Americans’ health care will look like Ted Kennedy’s or Joe Taxpayer’s. The issue, therefore, is not about reform or no reform. It is about good reform versus bad reform. How can every American’s health care look like Ted Kennedy’s? The answer is: “He who pays the piper, calls the tune.”

Imagine that every American has good health insurance, appropriate to his or her circumstances, and is the conduit through which payment is made. Imagine that doctors and hospitals post prices, can charge what they want but compete with one another for patients, and charge everyone who they do treat the same price for the same service on the same terms. Only then will every American be in charge of his or her own health care and be treated as the respected center of all decisions about their own bodies.

This system need not rest in the imagination. It’s possible in the here and now with just a few minor reforms. Here’s how:

Quality, affordable, good insurance will require that each “insurance generation” of American males and females pay for its own health care as a group year by year. For example, all males born in the year 1981 must pay for the health care that 1981-born males use in 2010—or in any other year. If we want the insurance to be good, it will cover all types of medical expenditures necessary for life and health while excluding optional procedures such as elective cosmetic surgery and hair transplants. Since it is insurance, everyone in the group will pay the same premiums for the insurance they buy. The deductibles plus co-insurance payments plus premiums of the 1981-born males pay for all of the care that the group gets. A handling charge that should be on the order of 12.5 percent of the premiums, possibly as little as 8 percent, depending on competition in the insurance market, goes to the insurance companies for doing the paperwork and claims processing. The system could be that simple.

Americans know that insurance companies can make money by collecting premiums and then not paying out on legitimate claims when they occur (which is illegal), or by utilization gate keeping (reviewing claims and denying some, which ought to be illegal), or by charging too much in premiums and investing the excess money in high-return investments.

Under a good reform, however, insurance companies would not make money in any of these ways that harm consumers. Instead, any 1981-born male could buy insurance from any company, at any time, pay the same premiums that any other 1981-born male pays for the same coverage, and have all of his medical expenditures except optional elective procedures covered. The insurance company’s role would simply be to verify that the medical event occurred, the service was provided, the service was on the list of covered services, and that the insured paid his deductible or co-insurance portion. In other words, there would be no utilization gatekeeping by law, and everyone’s insurance would be guaranteed issue, guaranteed renewable, portable, personal, and responsive.

Under this plan, insurance-company earnings would be based solely on payments to them for claims processing and paperwork. Because total medical expenditures for 1981-born males is known with certainty, or near certainty, a national re-insurance pool (insurance for insurance companies) could make transfers to insurance companies whose group of 1981-born males spent more than the group average, and receive transfers from companies whose group of 1981-born males spent less. Companies would compete with one another on the quality of their service, their friendliness, the speediness of their claims processing. They would earn no money from advantageous selection (“cream skimming,” issuing policies to an intentionally gathered healthier-than-average collection of insureds) or face threat of bankruptcy from adverse selection (issuing policies to an unintentionally gathered sicker-than-average collection of insured individuals). In other words, insurance would function as it should—just as described in textbooks.

You can’t make something cheaper to buy than it actually costs. But because the 1981-born males are today 28 years old, and the insurance companies that compete for their business will cut premiums to the least possible, the insurance just described will be priced at the least possible charge. As the 1981-born males age, they should expect that their health insurance premiums will rise, just as life insurance premiums rise. If a 1981 male wants to flatten his premium profile, he does so through savings that will go toward higher premiums later in life. Since anyone can save, the option of making insurance less costly later in life is available to all.

Finally, what about seniors who have not saved enough for their medical insurance premiums and no longer have the savings option? They can apply for charity, first from foundations and private sources that government can oversee, encourage, and help process payments from, perhaps through check-off boxes on federal tax returns. If these sources are not enough they can apply for government welfare payments financed through taxes.

The arrangements just described would take relatively few pages of federal legislation. A national re-insurance body would need to be formed. Utilization gate-keeping would need to be prohibited. A basic insurance policy would need to be defined, and motivation created to cause individuals to want to buy it. But presuming these are done, insurance would be actuarially fair, adverse selection and advantageous selection eliminated, guaranteed issue and guaranteed renewability would apply, and every American would be able to buy affordable insurance with targeted charity provided to those who needed money to buy their coverage.

Much of this has been described in my recently co-authored book Health Care for Us All: Getting More for Our Investment (Cambridge University Press, 2009). James Henderson and I estimate that the uninsured could all be covered at a national annual cost of about $1,555 each. Because each insurance generation covers its own health care costs, the arrangements would be sustainable, laterally expandable in a generation, longitudinally expandable across generations, and fiscally sound. No entitlement or threat to future generations would be created. On a national basis, having everyone covered with good insurance would cost less than one-half of one percent of national income. Savings through other easy-to-make changes would be on the order of 2.25 percent of income. In total the changes would appear to be free.

If good insurance is available and everyone has the income to buy it, there must be a strong motivation to do so. Part of the increased motivation derives from the lower insurance prices that will prevail for those under age 34, who account for nearly 60 percent of the uninsured. Additional motivation can be provided in different ways, but one that economic theory points to requires no budget outlay and takes the form of a carrot rather than a stick. If the general price level reflects a uniform tax such as a value added tax, anyone with health insurance can be rewarded with lower prices for all purchases by rebating the tax or not collecting it at the point of purchase. No budget outlay is needed to create the motivation and everyone with health insurance pays less for their food, clothing, transportation, and so on. We believe that a 20-percent reduction would motivate nearly everyone to buy health insurance.

In sum, a short bill that provided for good insurance, targeted income aid to those who needed it, and provided a positive motivation to buy insurance would need only a few pro-competitive features more to have government act as referee to keep competition in health care and health insurance markets strong. Prices would have to be posted, most favored customer pricing guaranteed by law (charging the same price to users of identical services), and certain protections for users of insurance such as providing by law that an individual has the right to take money spent by his employer on his behalf for health insurance and use it in the private insurance market if that results in a better outcome for him. All could be accomplished in a targeted intervention with little change for the 85 percent of us who have good insurance and good health care now.

But Senator Baucus has other ideas. He wants instead to spend over $829 billion over the next ten years ($3,900 per uninsured restored to coverage), more in years after that, while creating an unsustainable entitlement and leaving 25 million uninsured. He would make government the center of health care instead of empowering the patient.

Senator Baucus, like most of his committee, does not understand good health insurance or how to make it affordable. Not surprisingly, he seeks to place himself and Congress at the center of health care decisions in America. His proposal includes the words “establish” or “create” 312 times (as in “establish a new Federal commission called the Medicaid and CHIP Payment and Access Commission” or “establish the Medicaid Quality Measurement Program”). Congress will not be a referee, but the main player on the field. Because his plan’s bad features are scheduled to phase in after 2012 so as not to harm Mr. Obama’s next election, this may not be known to the American public until it is too late.

If we aspire to Ted Kennedy-quality health-care for all, then should we restructure health care to empower patients and have government act as referee or should we empower the government to create new entitlements? The real health care debate is over which of these is the best approach.


Earl L. Grinols is a former Senior Economist for the President’s Council of Economic Advisors. He is currently Distinguished Professor of Economics at Baylor University. His most recent book is Health Care for Us All: Getting More for Our Investment published in August 2009 by Cambridge University Press.

Copyright 2009 the Witherspoon Institute. All rights reserved.