HealthCare Spending Goes Up More SLowly When Users Pay Their Own Bills

A simple chart will help you understand why healthcare spending has gone out of control.

Economists have shown that if a good’s price is zero or decreasing, then the demand for this good will likely increase. In 2008, consumers were only directly responsible for 11.9 percent of total national healthcare expenditures, down from 43 percent in 1965, according to new data from the U.S. Department of Health and Human Services. This means that someone other than consumers pays roughly 88 percent of all healthcare costs, giving consumers little incentive to mind costs and much incentive to over-consume.

The graph below shows out-of-pocket payments by consumers and spending by Medicaid, Medicare, and private insurers on healthcare from 1965 to 2008. Since the passage of Medicare in 1965, consumers’ out-of pocket spending on healthcare has decreased steadily as a percentage of overall U.S. healthcare spending. While real and nominal out-of-pocket healthcare payments increased over the period, growth in these costs was dwarfed by a much more rapid growth in overall spending. On average, consumers’ out-of pocket healthcare costs increased 6.7 percent each year, while national healthcare expenditures increased by an average 9.8 percent each year.

By contrast, increases in expenditures by private insurers, Medicaid, and Medicare accounted for the majority of this excess cost growth—since 1965, private insurers’ spending has increased by an average 10.8 percent annually, Medicaid spending has increased by an average 15.4 percent, and Medicare spending has increased by an average of 15.6 percent each year. Also, as you can see, the rate of growth in both Medicare and Medicaid spending far outpaces the rate of growth in out-of-pocket and private insurance costs.

And it’s about to get much worse. On Christmas Eve, the Senate passed the Patient Protection and Affordable Care Act, which further expands Medicaid and Medicare’s roles in the U.S. healthcare system.

Much of the rationale behind the current reform of the healthcare system is about controlling inflation in healthcare costs. However, based on the trend presented above, a better alternative to the semi-nationalization that the president has in mind would be to increase individual responsibility for medical decisions and costs. When people aren’t exposed to the true cost of their care—even if they pay for it in foregone wages and higher taxes—they consume more.

Veronique de Rugy is a senior research fellow at The Mercatus Center at George Mason University.