July 3, 2012


How to Replace Obamacare (JAMES C. CAPRETTA and ROBERT E. MOFFIT, Spring 2012, National Affairs)

To be credible, the replacement for Obamacare must address in a plausible way the genuine problems with our system of financing health care. Pre-eminent among these are the explosion in costs, the rising numbers of uninsured, and the challenge of covering Americans with pre-existing conditions.

The good news for Obamacare opponents is that much of the work of building such a plan has already been done. A small but persistent band of reformers and economists has spent many years promoting and refining the elements of a market-based approach to remedying what ails American health care. These ideas have animated scores of plans released by various organizations, including some proposed after Obamacare's enactment. And while these plans differ in their details, they share a core set of seven principles that should form the basis of any proposal for replacing Obamacare.

The first crucial component of any serious reform must be a "defined contribution" approach to the public financing of health care -- the essential prerequisite for a functioning marketplace that imposes cost and quality discipline. In most sectors of our economy, the normal dynamics of supply and demand keep costs in check and reward suppliers that find innovative ways to deliver more for less. As described above, however, this is not the case in the health-care sector, principally because the federal government has completely distorted consumer incentives.

For market forces to work, consumers must be cost-conscious. Those who decide to consume goods or services must face tradeoffs that require them to prioritize the various uses of their money. In the health sector, there is virtually no cost consciousness on the part of consumers: The vast majority of Americans get their insurance through their employers or through Medicare or Medicaid. In each case, as noted above, the federal subsidy grows as the cost of insurance grows, thereby undermining the incentive to keep costs low. When an employer decides to provide a more generous health-benefit plan to his employees, the U.S. Treasury pays for a good portion of the added costs, because health insurance is a tax-free fringe benefit for workers. When a doctor orders more tests or procedures of dubious clinical value for a patient enrolled in Medicare, it is mainly taxpayers who pick up the tab. And when states pile more people into Medicaid, it is again taxpayers -- federal and state -- who shoulder the cost. With this kind of subsidy structure, it is not at all surprising that cost escalation throughout the health system has been rapid.

A replacement program for Obamacare must therefore move American health care away from open-ended government subsidies and tax breaks, and toward a defined-contribution system. Under this approach, health coverage would be provided through competing insurance plans; government's involvement would come through the provision of a fixed financial contribution toward the purchase of insurance by each beneficiary. That subsidy would not vary based on a person's insurance plan, giving Americans every incentive to shop for good value in their health coverage and to get the most for their defined-contribution dollars.

In the context of employer plans, this approach would mean moving away from the unlimited tax break that is conferred on employer-paid premiums, and instead providing directly to workers a fixed tax credit that would offset the cost of enrollment in the private insurance plans of their choice. Workers selecting more expensive insurance plans would pay for the added premiums out of their own pockets. Those choosing low-premium, high-value plans would pocket the savings, enabling them to offset additional health expenses if they wished to do so. This system would not only be more efficient: It would also be a far more equitable way to provide health benefits through the tax code. American taxpayers would get a break for health coverage as individuals, irrespective of their employment status or the generosity of the health plan provided by their employers.

In the context of Medicare and Medicaid, meanwhile, the government would similarly provide a fixed (though of course far more generous) level of support, sometimes called "premium support," that would guarantee insurance coverage to beneficiaries but would allow them to choose among competing options and encourage them to seek out the best value for their money (as discussed at greater length below).

The second pillar of reform should be personal responsibility and continuous-coverage protection. Obamacare attempts to address the challenge of covering people with pre-existing conditions with heavy-handed mandates, especially the requirement that all Americans enroll in government-approved insurance plans (the so-called "individual mandate"). A replacement program for Obamacare should come at the problem from the opposite direction, with government forsaking coercion and instead extending a new commitment to the American people: If you stay continuously enrolled in health insurance, with at least catastrophic coverage, you will never again face the prospect of high premiums associated with developing a costly health condition.

For this commitment to become a reality, some changes would have to be made to both federal law and state insurance regulation. (These proposed changes are discussed in more detail in "How to Cover Pre-existing Conditions," by James Capretta and Tom Miller, published in the Summer 2010 issue of National Affairs.) To begin, the federal government would need to close the gaps in protection that emerge when people move from employer-sponsored plans to the individual market regulated by the states. This problem could be remedied by amending the 1996 HIPAA law to allow workers to move directly from group to individual insurance without first having to pay out of pocket for the (lengthy) extension of their employer-based plans through so-called "COBRA" coverage. In 1985, the Consolidated Omnibus Budget Reconciliation Act (or COBRA) allowed workers who lose their jobs to remain on their employers' health-insurance plans for months, provided they pay the full premium cost themselves (usually a significant expense). HIPAA then required workers eligible for this COBRA option to exercise it before they could be given any protection in the individual insurance markets regulated by the states. Since hardly any workers follow this prescribed course, they enter the individual market with no protections from pre-existing condition exclusions. That would change if workers were protected when they moved directly from group to individual insurance plans.

Next, states would need to amend their regulations of the individual and small-business insurance markets to require insurers to sell coverage to customers who have remained continuously covered. These new regulations would also have to require that such coverage be made available at standard rates -- that is, at rates that apply without regard to differences in health status (age and geographic adjustments would be permitted).

Because some workers who leave job-based plans for the individual market could be quite sick, a credible Obamacare replacement plan would also need to include a new approach to covering the high insurance costs for these Americans. Different proposals have offered different mechanisms, but all would move the burden away from the sick patients themselves to a larger and broader pool of people, either through regulation or through a direct government program such as a high-risk pool. For people who have not been continuously insured, these protections generally would not apply. States could continue to allow insurers to charge higher premiums to these individuals based on their respective health risks. There would thus be a very strong incentive for all Americans to remain continuously covered. (At the time of enactment, it would make sense to give those Americans who were not in continuous coverage the opportunity to come into the new system without penalty and to secure this new protection.)

This approach would achieve the goal of providing realistic and affordable options for people with pre-existing conditions, but without imposing the misguided, overbearing, and counter-productive architecture of Obamacare -- and in a way that encourages a competitive insurance market and an innovative health sector rather than undermining them.

The third pillar of reform must be a genuine partnership with the states. Under Obamacare, states are treated as mere functionaries in a new centrally planned and federally managed system. The law gives state officials a take-it-or-leave-it choice: They can implement and administer the new policies under Obamacare -- such as state-level insurance exchanges -- to the letter, without any deviation or adjustment, incurring the extra costs of these new programs along the way. Or state governments can refuse this managerial responsibility and instead have the federal government come in and operate the exchanges and other new components of the law on the states' behalf. But in neither case are the states afforded any independence or flexibility, any room to adapt the requirements imposed by Obamacare to the particular circumstances of their populations, or to innovate to achieve greater quality or efficiency.

A replacement plan must be true to the Constitution and reflect a genuine federalist philosophy. Any program to address the problems in American health care will entail some degree of national policy, but it can still leave ample room for state initiative and encourage state-level solutions. There is good reason to allow such discretion: States vary significantly in their demographics, their economic profiles, their infrastructure, their levels of employment and poverty, their Medicaid enrollments, and their numbers of uninsured. There is wide disparity among states in the costs of uncompensated care, the scope of employment-based health insurance, and the condition of individual health-insurance markets. States differ markedly in the range of their health-care problems and in their capacities to cope with them.

Moreover, states can be powerful engines of policy innovation and experimentation in health-care reform, insurance-market reform, and tort and medical-malpractice reform, as well as in the financing and delivery of care in safety-net programs. In recent decades, a number of states have attempted their own solutions to our health-care financing crisis. But because that financing crisis is driven by deformed federal policies, all that these states have been able to do is try to mitigate the effects of Washington's mistakes. A reform that addressed those mistakes directly at the national level could then free the states to address the problems of health-care financing in the ways that best suit their needs.

To respect federalism and reap its benefits, nothing in an Obamacare replacement agenda should compel state adoption, instead leaving the participation of state governments completely voluntary. Those states that do participate in any federal initiative should be given meaningful control over the most important components of regulation, especially the power to design and operate their own health-insurance markets (within minimal federal standards). Such deference to state authority would mean allowing states to retain full control over matters like what coverage to require in health insurance and how to facilitate consumer enrollment in qualified plans. Crucially, no Obamacare replacement program should include a federal requirement that states set up health-insurance exchanges that could later become instruments of excessive regulatory control. Rather, states should be given two tasks: informing consumers of their insurance options, and easing their enrollment into the plans they choose by cooperating with the federal government to facilitate the payment of credits and vouchers directly to private insurers. How states perform these critical tasks should be left entirely up to them.

Defined-contribution financial support, protection for Americans who remain continuously enrolled in insurance plans, and genuine federalism are the essential overall concepts that must define any serious health-care reform. But policymakers will also need to apply these principles to the transformation of today's funding and financing mechanisms: the tax exclusion for employer-provided health coverage, and the Medicaid and Medicare systems.


The fourth pillar of a real reform agenda would therefore address the tax treatment of employer-sponsored plans. Today's arrangement is somewhat counterintuitive: Because the tax exclusion for health-care premiums is open-ended, workers and employers have an incentive to make health benefits a disproportionately large share of total compensation. And because employers obtain and manage health plans for their workers, there is far too much distance between those who purchase care and those who consume it. The key decisions in American health care thus rest not with patients and doctors, but rather with employers, managed-care executives, and government officials -- a structure that has prevented the emergence of a properly functioning marketplace. Individuals and families rarely have a property right in their health-insurance policies and rarely control the terms and conditions of coverage (as they do with auto, life, or home owner's insurance). Health insurance is rarely portable in any real sense of the term, as workers cannot remain enrolled in the same insurance plans when they switch jobs.

Federal tax policy is at the root of these market malfunctions, and has caused a host of related problems. These include higher health-care costs, the absence of continuous and secure coverage, a lack of transparency in health-care financing, discrimination against lower-income workers and favoritism toward higher-income workers, and a playing field tilted decidedly in favor of group health insurance and against individually purchased coverage. Among economists, including some of President Obama's advisors, there is an overwhelming consensus that reform of health-insurance markets must begin with a major change in the federal tax treatment of health insurance.

The most plausible way to implement such a change would be to transform today's tax exclusion for employer-provided insurance into a standard tax credit that would extend to all Americans, regardless of employment status, which they could then use to purchase the private coverage of their choice. As to how such a consumer-controlled federal tax credit would be designed, policymakers have a variety of options from which to choose. For instance, in its 2011 "Saving the American Dream" plan, the Heritage Foundation proposed replacing today's unlimited tax break with a new, non-refundable tax credit that would be phased out for the wealthiest citizens. Another approach would be to limit the credit to some pre-determined level of insurance coverage. Because the credit amount would not be increased for workers selecting more expensive insurance plans, those choosing such plans would pay the difference while those opting for plans with lower premiums would not be penalized (with a diminished tax benefit) for economizing.

One such proposal was offered during the 2008 presidential campaign by Senator John McCain, who suggested a universal program of refundable tax credits that would be payable to all households. In 2007, President George W. Bush proposed replacing today's tax treatment of insurance with a universal deduction for health-insurance premiums that would be available to people in employer-sponsored plans, as well as to those in the individual market. In both cases, the value of these credits and deductions would increase over time by some measure of inflation -- ensuring that they would keep pace with fluctuations in the cost of living, while also ensuring that government's costs would remain predictable and manageable.

In all of these formulations, the essential common element is a move toward consumer control. Individuals would become active, cost-conscious consumers looking for value in the health-care marketplace. This shift would, in turn, create tremendous incentives for those delivering medical services to find better and less expensive ways of caring for patients and keeping them well.

Posted by at July 3, 2012 5:43 AM

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