Obama Plan Neglects Importance of Incentives

Published November 3, 2009

While undoubtedly well-intentioned, President Barack Obama’s health care reform plan ignores a central concern of economics.

Economics is the science of incentives. As most economists learn early in their careers, an efficient, productive society is one in which individual incentives are aligned as closely as possible with desirable social goals. Consider, for example, Adam Smith’s observation that in most markets producers find it in their self-interest to meet other peoples’ needs.

That is why most economists reject socialism, in which everyone at the bottom has a self-interest in undermining a plan imposed by a few people at the top.

It turns out there’s something worse than socialism. It involves giving everyone an incentive to undermine the top-down plan, then imposing a collective punishment on them when they respond to the perverse incentives.

That is the way Obama proposes to control health care costs.

European Example

Obama is not alone. This is the way many European countries attempt to constrain health care spending. It also is the way our federal government tries to control Medicare costs. At the risk of oversimplification, it works something like this.

The federal government sets the fees for all doctor services, but leaves doctors free to decide how many of those services to perform. The fee for a patient visit is strictly regulated, for example, but the number of visits is not. Then the government announces if total collective Medicare spending fails to moderate, it will impose an across-the-board percentage reduction in all doctor fees.

This sets up a vicious cycle in which everyone’s incentives are perverse. The more the doctors act in their self-interest, the more social waste there is, and the more we are all punished.

Vicious Circle

From the individual physician’s point of view, after all, there is nothing he or she can do to affect the total amount of spending. The doctor’s own behavior is such a small part of the whole system, it is imperceptible.

But the doctor knows the only way he can increase his own income—or just maintain his standard of living—is to increase the number of services. Care that might have been more efficiently delivered in a single patient visit, for example, gets spread out over two or three visits.

When the collective spending again fails to meet the target, the government imposes another across-the-board fee reduction and the cycle starts all over again.

Suppose, however, we could put the doctor in a room with a Medicare official and free them to agree on a different compensation system. Given that opportunity, every primary care physician in the country could think of ways to save taxpayers money and increase his own income at the same time! Services provided over three visits, for example, could be provided with one visit plus a phone call or two, or one visit plus an e-mail exchange—if only the government would pay more for the one visit.

Market-Altering Policies

Thus if doctors could freely re-contract with Medicare, they would repackage and re-price their services in ways mutually beneficial to them and to Medicare—and the taxpayers. They would substitute higher-quality visits for lower-quality ones and economize on resources and the use of patients’ time.

What makes all dysfunctional systems dysfunctional is that people do not have the opportunity to make such mutually beneficial adjustments. Unfortunately, most private payers today are every bit as bureaucratic as Medicare and tend to pay the same way Medicare pays.

What Obama should be doing: thinking of ways to free doctors in the manner just described.

What Obama is going to do instead: impose more perverse incentives on all providers.

He said so himself. In his remarks to the joint session of Congress in September, Obama endorsed the idea of an “automatic trigger” to cut payments to hospitals and physicians if Medicare spending fails to meet a target.

John C. Goodman ([email protected]) is president of the National Center for Policy Analysis. An earlier version of this column appeared at his Web site, http://john-goodman-blog.com. Reprinted with permission.

For more information …

Remarks on health care by President Barack Obama to Joint Session of Congress: http://www.whitehouse.gov/the_press_office/Remarks-by-the-President-to-a-Joint-Session-of-Congress-on-Health-Care/