Managing Editor’s Note: Milton Friedman, recipient of the 1976 Nobel Memorial Prize for economic science, wrote this almost two years ago. His sage observations then are even more meaningful today.
Since the end of World War II, the provision of medical care in the United States and other advanced countries has displayed three major features: first, rapid advance in the science of medicine; second, large increases in spending, both in terms of inflation-adjusted dollars per person and the fraction of national income spent on medical care; and third, rising dissatisfaction with the delivery of medical care, on the part of both consumers of medical care, and physicians and other suppliers of medical care.
A key difference between medical care and other technological revolutions is the role of government. In other technological revolutions, the initiative, financing, production, and distribution were primarily private, though government sometimes played a supporting or regulatory role.
In medical care, government has come to play a leading role in financing, producing, and delivering medical service. Direct government spending on health care now exceeds 75 percent of total health spending for 15 Organization for Economic Cooperation and Development (OECD) countries. For the U.S., the figure is 46 percent.
Two simple observations are key to explaining both the high level of spending on medical care and the dissatisfaction with that spending. The first is that most payments to physicians or hospitals or other caregivers for medical care are made not by the patient but by a third party–an insurance company or employer or governmental body.
The second is that nobody spends somebody else’s money as wisely or as frugally as he spends his own. These statements apply equally to other OECD countries.
Why are most medical payments made by third parties? The answer for the United States begins with the fact that medical care expenditures are exempt from federal income tax if, and only if, medical care is provided by the employer. If an employee pays directly for medical care, the expenditure comes out of the employee’s income after income tax.
That strong incentive explains why most consumers get their medical care through their own employer, or their spouse’s or parents’ employer. The tax exemption of employer-provided medical care in the U.S. has two different effects, both of which raise health care costs.
First, it leads American workers to rely on their employer, rather than themselves, to make arrangements for medical care. Second, it leads employees to take a larger fraction of their total remuneration in the form of medical care than they would if spending on medical care had the same tax status as other expenditures.
Employer financing of medical care in the U.S. has caused the term “insurance” to acquire a rather different meaning in medicine than in most other contexts. We generally rely on insurance to protect us against events that are highly unlikely to occur but involve large losses if they do occur–major catastrophes, not minor regularly recurring expenses. We insure our houses against loss from fire, not against the cost of having to mow the lawn. We insure our cars against liability to others or major damage, not against having to pay for gasoline. Yet in medicine, it has become common to rely on insurance to pay for regular medical examinations and often for prescriptions.
Moreover, the states and the federal government have increasingly specified the coverage of insurance for medical care to a detail not common in other areas. The effect has been to raise the cost of insurance and to limit the options open to individuals. If the tax exemption for employer-provided medical care had never been enacted, the insurance market for medical care would probably have developed as other insurance markets have–as a way of providing for catastrophic, out-of-the-ordinary costs, not for routine expenditures.
Throughout the OECD countries, third-party payment has required the bureaucratization of medical care and, in the process, has changed the character of the relation between physicians or other caregivers and patients. A medical transaction is not simply between a caregiver and a patient; it has to be approved as “covered” by a private- or public-sector bureaucrat and the appropriate payment authorized.
An inescapable result is that the interest of the patient is often in direct conflict with the interests of the caregiver’s ultimate employer–whether the latter is a government or a corporation.
Milton Friedman, recipient of the 1976 Nobel Memorial Prize for economic science, has been a senior research fellow at the Hoover Institution since 1977. This article was excerpted from the Winter 2001 issue of The Public Interest (http://www.thepublicinterest.com).