Incentivizing poor and low-income persons to work and save more

Vijay K. Mathur

Published in Standard-Examiner, October 28, 2012, Ogden, Utah

Means-tested anti-poverty programs determine eligibility based on income and assets. If benefits to able-bodied low income and poor persons are cut in larger proportions of their increasing earnings and assets, it provides a disincentive to earn and save more. Benefit cuts are like a tax on work earnings.

The study by John Karl Scholz, Robert Moffitt and Benjamin Cowan (SMC), Discussion Paper no. 1350-08, September 2008 (www.irp.wisc.edu), cites a study of low-wage single-parent families in New York where benefit cuts were such that their extra dollar earnings, from working between 8 to 35 hours per week, would increase their take home by only 15 cents per dollar earned (a 85 percent cut in income). However, there is also an upside of anti-poverty programs. SMC study investigates the role of social insurance programs and means-tested transfers, including entitlements, in reducing poverty. Assuming no behavioral response, they show these programs do reduce percentage of poor across different family types between 35 percent to 86 percent. The investigators did not want to confound the effect of anti-poverty programs on poverty rates by including behavioral responses. Even though anti-poverty programs have substantially reduced poverty rates, there is still a significant fraction of poor people in the country.

It appears that a large proportion of post transfers residual poverty rates must be due to behavioral responses to programs’ benefit policies. Program benefit cuts are an increasingly larger proportion of increasing earnings and assets, as the above study for New York shows. In addition, more benefits are guided to single parent as opposed to two parent families, thus encouraging formation of single parent families and/or encouraging divorces. The data show that single parent families headed by females have a much higher poverty rate than two parent families.

Since benefits and Earned Income Tax Credit (EITC) increase with family size, they tend to encourage more children in a single-parent family. Large family size is another source of hardship for poor families. However EITC, one of the fastest growing means tested program after Medicaid, is a pro-work program. Mr. Romney once remarked that the 47 percent of Americans who do not pay federal income taxes claim victimhood and expect the government to provide these transfers. It includes all those low-income people and poor who receive EITC. The credit provides incentive to work. Therefore, if the credit is taken away, poverty roles will further increase. In fact all means tested poverty programs for able-bodied persons, including food stamps, TANF (Temporary Assistance to Needy Families), housing subsidies and supplemental nutrition program (WIC), should be tailored around the theme of work incentives.

If we are serious about reducing poverty, benefits should increase when able-bodied poor and low-income families earn and save more, until income reaches a threshold level equal to "Basic Needs Budget" (BNB) proposed by National Center for Children in Poverty (NCCP) at Columbia University (www. Nccp.org). NCCP’s budget based income thresholds are higher than the poverty income thresholds defined by the Census Bureau, and vary from high-cost to low-cost cities and types of families. For example, Kinsey Dinan of NCCP (March, 2009) proposed annual income need of $41,000 for a single-parent family with two children in moderate-cost city, Des Moines, Iowa. It is 233 percent of the federal poverty level.

There is another beneficial side effect of pro-work EITC. The study by Gordon Dahl and Lance Lochner (DL), American Economic Review, August 2012, investigates scholastic achievement of children five years old and over due to EITC. They use a data set of 4,500 children from the National Longitudinal Survey of Youth and sample period (1987-2000) and measure family income as total net income, including EITC net of federal and state taxes and transfers. Test scores on PIAT (Peabody Individual Achievement Tests) measure scholastic performance of children. These standardized scores measure ability in mathematics, oral reading, reading comprehension and ability to derive meaning from printed words.

They find that increase in current income due to EITC significantly increases a child’s math and reading scores. Increase in scores is larger for younger children growing up in poor disadvantaged families, such as unmarried households, minority families, families with low-educated mothers. The effects are also more pronounced for boys. These findings are predictive of a better future for poor children and economic well-being of poor families.

Evidence indicates that means tested anti-poverty programs would provide incentives for work if a smaller proportion of benefits were reduced with increase in earned income. Census Bureau’s measures of poverty income are inadequate and hence should be modified along the lines of BNB. Also, benefits should promote education and skills and asset accumulation to put poor families on a sustainable path to economic self-sufficiency and replace programs that subsidize employers such as Work Opportunity Tax Credit. These subsidies do not help fill the skill gap emerging in the labor market due to the changing structure of the economy.

This is the second part of a two-column series by Mathur, who wrote on Oct. 21 about a renewed focus on poverty and entitlements. Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He also writes blogs for the Standard-Examiner at http://blogs.standard.net/economics,etc.

Renewed focus on poverty and entitlements

Vijay K. Mathur

Published in Standard-Examiner October 19, Ogden, Utah

Election times in slow-growth economy bring attention to poverty and safety net programs to alleviate poverty. In the first presidential debate, Mitt Romney blamed President Barack Obama for the increase in the poverty rate. He promised to create 12 million jobs. Such a statement on jobs recognizes that increase in poverty is due to lack of job opportunities. However, this statement contradicts his remarks at the private fundraiser that 47 percent of Americans, who do not pay federal income taxes, consider themselves as victims and are dependent on government for entitlements.

Perhaps Mr. Romney’s views on 47 percent of Americans also fit his tax and spending agenda. Cutting income tax rates by 20 percent across all income brackets and other tax cuts, on top of Bush tax cuts, primarily benefit the rich. He also intends to increase defense spending and reduce the budget deficit. His claim, that he can accomplish his goal by reducing tax loopholes and deductions and increase the level of economic growth, is far fetched at best. Therefore, in all likelihood, Mr. Romney has to dip into Social Security, Medicare, Medicaid and other entitlements, which would be extremely burdensome to low-income and poor households and even to many middle-income households.

Let us look at some facts about poverty and then examine how much difference safety-net programs make in the lives of the poor. Census Bureau defines a family as poor if its annual pretax money income falls below the poverty threshold. Thresholds vary with the size of family.

For example, in 2011 poverty thresholds were $11,484 for one person with no children, $15,504 for two-person household under 65 years of age with one child, $18,106 and $18,123 for three person households with one child and with two children respectively, and $10,788 for those 65 years old and over with no children.

Census Bureau data shows that in 1959 poverty rate for all people in the U.S. was 23 percent of the population. It declined throughout 1960s, reaching a low point of 11.1 percent in 1973. This decline was partly due to the passage of The Economic Opportunity Act in 1964 during President Johnson’s administration. The poverty rate has increased to 15.9 percent in 2011. Among children 18 and under it has always been higher than for all people since 1973, and in 2011 it was a scandalous rate of 27 percent. The elderly poverty rate in 1959 was 35 percent, but in 2011 it was close to 12 percent, due mainly to social insurance programs. I am sure deep recession of 2007 worsened these rates.

The question is, how much difference is made in reducing poverty by social insurance programs (SIP), and Means-tested Transfers (MTT), including entitlements. SIP has dedicated funding and provide benefits to those who have made contributions to the programs. MTT are financed by general tax revenues, and provide benefits to eligible persons and families based on income and assets.

A major study by Professors John Karl Scholz, Robert Moffitt and Benjamin Cowan (SMC), Discussion Paper no. 1350-08, September 2008 at http://www.irp.wisc.edu, is instructive in gauging the effectiveness of these programs. They investigate SIP (Social Security, Medicare, unemployment insurance, workers’ compensation and disability insurance) and MTT. MTT includes three types of programs: 1) Medicaid and Supplemental Security Income for the aged, blind and disabled, 2) cash transfers, for example, Temporary Assistance for Needy Families that replaced AFDC (Aid to Families with Dependent Children) in 1996, Earned Income Tax Credit, and 3) in-kind transfers, for example, food stamps, housing assistance, head start, school lunches, and nutrition programs for women, infants, and children,

SMC analysis includes 1984, 1993 and 2004, but I report here their findings for only 2004. They assume away behavioral responses to the anti-poverty programs that may provide work disincentives and hence may increase the poverty rate. They find that in 2004 all transfers (including SIP, all cash transfers, all in-kind transfers, all MTT except child care credit and foster child payments) reduced percentage of poor families and individuals from 30.3 percent with no transfers to 12 percent after transfers.

In 2004 for different family types, the transfer system was very effective as well. For example, from pre-transfers to post-transfers, percentage of single-parent and two-parent poor families decreased 71 percent and 66 percent respectively, the percentage of employed poor decreased 51 percent and the percentage of elderly families and individuals decreased 86 percent.

Using SMC data I find that in 2005 spending on MTT (including Medicaid) was 53 percent of spending on SIP. The evidence suggests that safety-net programs with minimum disincentives for work would be very effective in reducing poverty. SMC cite past evidence that reducing entitlement benefits had imposed a heavy indirect tax on the poor for working.

Therefore, any trimming of these programs to offset tax cuts for the rich must be done with careful thought and not be guided by ideology. The character of a nation and its people is determined by how its most vulnerable people are treated.

This is the first part of a two-column series by Mathur. Next week he will write about incentivizing poor and low-income persons to work and save more. Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland Sate University, Cleveland, Ohio. He also writes blogs for the Standard-Examiner at http://blogs.standard.net/economics,etc.

Ryan’s muddled thoughts are of Rand, Hayek

Vijay K. Mathur

Published in Standard-Examiner September 9, 2012  

Let me first briefly give you some background on both of these thinkers, who, according to media reports, have shaped Rep. Paul Ryan’s thinking on government and free markets. For more details on their views, you could read their books, "The Fountainhead" and "Atlas Shrugged," by Ayn Rand and "The Road to Serfdom," (1994), first published in 1944 by late Austrian economist and Nobel laureate Friedrich A. Hayek.

 Ayn Rand was born in Russia in 1905 and developed intense dislike of the Bolsheviks and communism. In 1926 she migrated to the U.S. Her two fictional novels contain some of her views about government’s role in society and on economic policies. NPR site (www.npr.org) presents an interview of Rand by late "60 Minutes" journalist Mike Wallace, in which she expressed her concept of "objectivism." She says this concept is a system of morality that is "not based on faith ... but on reason." She was totally against all forms of controls, including taxes, and a firm believer in laissez-faire with no government regulation. The economic concept of laissez-faire was first proposed by a group of French writers called physiocrats during 17th and 18th centuries.

Ayn Rand was completely opposed to any general welfare programs such as Social Security, Welfare, Medicare, Medicaid, and unemployment compensation. This ideology contradicts the U.S. Constitution, since Article I, Section 8 specifies that the Congress provide for national defence and general welfare. The idea of laissez-faire advocated by Rand, was a critical response to mercantilism during 17th and 18th centuries’ Europe, whereby the merchant class persuaded states to regulate the economy to serve their own self interests. It seems that they believed in individual rights and property rights but only so long as their interests were served.

Hayek admits that his controversial book is a political book. He severely criticized socialism, where means of production are controlled by government. According to him, socialism works against individual freedom and it "…means abolition of private enterprise, of private ownership of the means of production, and the creation of a system of planned economy in which entrepreneurs working for profit are replaced by a central planning body." He supported competitive markets and criticized planning. Hayek was as critical of conservatives as he was of liberals who advocated or sympathized with socialism. He states, "A conservative movement by its very nature, is bound to be a defender of established privilege and to lean on the power of government for the protection of privilege." This comment exactly fits what current GOP and Romney/Ryan have on their agenda.

The U.S. and democracies of Western Europe have neither laissez-faire nor socialism, as defined by Hayek. These are mixed economies where governments’ role in markets is complementary in nature rather than a substitute for private enterprise. Even China, India and many Eastern European countries are gradually moving away from socialism as Hayek envisioned. Rand’s and Hayek’s fears of socialism and ultimately totalitarianism are not based on reality of markets in the U.S. and other countries of Western Europe. Rep. Ryan’s notion of free markets and regulation is outmoded and indicative of muddled thinking on the role of markets and government. Research, since the days of Rand and Hayek, has shown that markets in some areas of the economy, without government assistance and/or intervention, do not work efficiently due to market failure problems.

Environmental quality, national defense, human capital accumulation (education), research and development and space exploration are some of the examples of sectors where markets break down. For example, if an oil refinery pollutes, it violates homeowners’ property rights when they suffer health problems or property damages. Therefore, unless government intervenes to force the refinery to internalize its cost of pollution in the price of oil, the refinery has no incentive to do so. One may argue that individuals could sue the refinery. That is a very inefficient way to solve the problem. A cost effective strategy requires the government to own property rights for air-sheds on behalf Americans and hence enforce those rights by pollution taxation or by creating a market for pollution rights.

Another example of market failure arises when there is a very high risk in providing a product or service, such as infrastructure development, space exploration, basic R&D and other public goods. The U.S. government role is also called for in providing services for the general welfare of its citizens, as the Constitution specifies.

Mr. Ryan must understand that Hayek’s ideas and especially Rand’s ideas on free markets must be tampered with economic reality of markets. It is the government that had to come to the rescue of markets in the Great Depression of 1930s and again in the great recession of 2007-08; regulations had to be implemented to restore the integrity of the financial system plagued by scandals.

Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio.  He also writes blogs for the Standard-Examiner at http://blog.standard.net/economics,etc.

Here we go again on the Affordable Care Act

Vijay K. Mathur

Published in Standard-Examiner, July 21, 2012, Ogden, Utah

The decision by the Supreme Court on the Affordable Care Act has not satisfied the right wing of the Republican Party in the Congress and their sympathizers. The congressional attempt to repeal ACA is a fruitless and unproductive exercise. If there is any iota of common sense left in this Congress, it is advisable to make constructive changes in the law that will benefit all Americans.

Professors John F. Cogan, Glen Hubbard (Mitt Romney’s adviser) and Daniel Kessler (CHK) in their op-ed in The Wall Street Journal, June 6, present the usual conservative point of view about ACA while lacking some facts, and espousing blind faith in market forces to fix the health care problem. Let me briefly summarize some of their arguments against the ACA below.

CHK claim that ACA will stifle innovations and increase health care cost without creating more value, and the mandate to buy insurance will not result in better health outcomes. CHK cite the 2008 study by Prof. Jack Hadley, et al in Health Affairs, to support their contention of weak evidence of cost-shifting by uninsured onto insured. They blame government policies for preventing market forces from reducing cost and improving access to health care. However, arguments for fixing the tax code, redesigning Medicare and Medicaid and changing states’ insurance regulations to improve the health care system have some merit.

CHK are unaware that ACA creates the Patient-Centered Outcomes Research Institute to promote innovations. Bloomberg Business Week, Spring 2012, reports that this institute, funded by $3 billion over 10 years, will provide grants to medical researchers to test drugs and a host of other treatments. In addition, $1 billion has been distributed as grants to approximately 3,000 small biotechnology companies, and funds are allocated for research in public health. The ACA also creates the Center for Medicare and Medicaid Innovation, which works with the private sector to promote innovations to lower cost and improve quality of care. This public-private partnership is the hallmark of R&D in many other industries, and hence health care is no exception.

On the cost side, Ezra Klein (www.washingtonpost.com/blogs) reports that CBO estimates show that the insurance coverage provisions of the ACA will have a net cost of just under $1.1 trillion during 2012-2021 period — about $50 billion less than its March 2011 estimate. Furthermore, this is only the outlay side and not the revenue side of the ACA.

CHK ignore the adverse selection problem, when insurance companies are saddled mainly with high cost users of medical care. This is part of the reason for the mandate. The 2012 Rand Corporation study (www.rand.org) estimates that by 2016 ACA with mandates will result "in coverage for 91 percent of the nonelderly population" as opposed to only 81 percent without mandates. Rand study also shows that under individual exchange plans, average premium per enrollee will increase 9.3 percent without the mandate in the ACA by 2016. However, the estimated premium increases, generated by the CBO, range from 15 percent to 27 percent without the mandate.

Cost-shifting by the uninsured could take many different forms. For example, it may cause premiums of insured to rise, may lead to absorption of losses by hospitals and/or doctors, may affect the quality of care, and may increase the cost of Medicaid and Medicare. There are numerous studies on cost-shifting with varied conclusions and estimates. Most studies, however, conclude that there is cost-shifting and hence an increase in premiums of insured persons.

The 2005 study by Families USA found that nationally uncompensated health care costs exceeded $43 billion. Two thirds of that was shifted to the privately insured (close to $922 for family and $314 for individuals). The study in Health Affairs, January/February 2006, by Allen Dobson, Joan DaVanzo and Namrata Sen, comes to the conclusion that, "states with low public payments relative to costs and high degree of charity care are associated with higher private payment-to-cost ratio." Their data show that aggregate hospital payment-to-cost ratio for Medicare and Medicaid are declining and for private payers increasing since early 2000.

CHK’s reliance on market forces to solve health care problems ignores market failure problems associated with asymmetric information, adverse selection, moral hazard, and spillovers across medical care services and across insurers over time. In addition, studies by R. Cebul. J. Rebitzer. L. Taylor and M. Votruba, in The American Economic Review, August 2011, and by L. Dafny in The American Economic Review, September 2010, found that medical insurance markets are monopolistic. In fact, CRTV present a very cogent argument for including public option in the ACA.

It seems CHK are espousing the usual conservative viewpoint, with some meritorious arguments for simplifying rules, regulations and tax laws, without recognizing fundamental features of ACA and issues in the provision of medical care and health insurance to all Americans. As surgeon and researcher Atul Gawande comments in his New Yorker article on ACA, "The rhetoric of intransigence favors extreme predictions, which are seldom borne out."

Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He also blogs for the Standard-Examiner at http://blogs.standard.net/economics, etc.

Debunking the idea of lower tax rates for rich

Vijay K. Mathur

Published in Standard-Examiner, Ogden, Utah, June 15, 2012

Right-wing conservative media pundits, journalists, and their sympathizers in the Congress and think tanks, bombard us with constant one-liners that federal income tax rates are too high, and the cure for our unemployment problem is lowering federal income tax rates. Obama administration has proposed increasing tax rates on the rich and lowering the rates on middle- and low-income Americans to raise revenue. But the followers of Grover Norquist's "no tax increase pledge" in the Congress have constantly opposed raising tax rates on the rich.

This opposition to raising tax rates on the rich follows the same old reasoning that increasing taxes on the rich will reduce growth, increase unemployment and hence decrease tax revenues. Therefore, one questions if this stand on taxes is based upon sound economic analysis or is it just old political and bipartisan rhetoric meant to misinform Americans about the effect of increasing taxes on the rich? A recent major study published in the Journal of Economic Literature, March 2012, by Emmanuel Saez, Joel Slemrod and Seth H. Giertz (SSG), provides very convincing evidence that increasing marginal income tax rate (rate when income exceeds an individual's tax bracket by an extra dollar) more than the current 35 percent rate for the top 1 percent of income earners will increase federal government revenues.

SSG find that under very reasonable assumptions, supported by vast literature on tax issues, when one combines maximum federal and average state income tax rates, Medicare and average sales tax rates in the U.S., the top marginal tax rate on ordinary income as of 2009 is 42.5 percent, the estimated revenue maximizing tax rate is 72.2 percent and the estimated corresponding top federal income tax rate is 68.4 percent. These estimates are substantially higher than the current top marginal tax rate of 35 percent. It should be emphasized that no one in the Obama administration is proposing such high rates.

But the data shows that very high federal marginal income tax rates from 91 percent to 68.8 percent did exist from 1952 to 1981.

President Obama has proposed for 2013, a 39.6 percent marginal tax rate for those households with incomes of $388,350 and over, according to the Wall Street Journal.

In 2009, 22,000 millionaires paid only 15 percent of their income in income taxes. SSG does recognize that high tax rates on the rich produce behavioral responses that include actions like reducing hours of work, career choices, timing of compensation or accepting non-taxable compensation, tax avoidance or tax evasion. However, SSG contends that for most rich people, where behavioral responses are concentrated, responses to higher individual income tax rates include a shift away from taxable individual income to other forms of income such as corporate income, deferred compensation that is taxable at a later date, stock options and dividends.

SSG also claims that estimates are affected by the tax system that allows different rates for capital gains and dividends, and a host of deductions and tax credits.

Even with the current complicated tax system, the primary message from the study is that increasing the top tax rate, as President Obama is proposing, will not be detrimental to the economy and will increase tax revenues.

There is no doubt that the current tax system would be much better for the economy if many tax deductions, credits and other loopholes are substantially reduced. In addition, increasing tax rates on capital gains and dividends (constituting a large fraction of income of the rich), combined with substantially reduced corporate income tax rates, will provide a significant boost to businesses and the economy. Our tax/expenditure system has become skewed in favor of the rich and wealthy and does not much encourage human and physical capital accumulation and R&D; its effect also shows up in the skewed distribution of income.

SSG data show that since 1981 marginal tax rate on the top 1 percent has declined substantially, and precisely at that time their income share has started increasing dramatically. Tax Policy Center data show that in 2008 only 59 percent of the top 400 adjusted gross income (AGI) taxpayers paid the marginal tax rate of 35 percent and over and none paid effective average tax rate of 35 percent and over. SSG admits that inequality of income between the rich and non-rich may not be due only to the tax system.

However, starting in 1986 the sharp drop in marginal income tax rate on the top 1 percent accompanies the dramatic jump in their income share. At the same time, the next 9 percent in the income distribution, who also got a tax break starting in 1981, only gained a modest increase in income share. It is hoped that Americans pay attention to objective facts on taxes and about our current tax system and not be persuaded by empty rhetoric on the right based on ideology, emotions and twisted facts.

Mathur is former chairman and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/

Health insurance and broccoli: A mismatched comparison

Vijay K. Mathur

Published in Standard-Examiner, April 4, 2012, Ogden, Utah

Recently, the U.S. Supreme Court heard arguments for and against the 2010 Affordable Health Care Act. Justice Antonin Scalia, a skeptic of the health insurance mandate in the law, raised the question to the government attorney, Donald Verrilli, that if the government can mandate to buy health insurance, why can't it mandate to buy broccoli?

The question implied that broccoli is good for a healthy diet and hence good for healthy outcomes; hence if the federal government is allowed to mandate buying of health insurance, it can overreach by mandating consumption of food products like broccoli.

Let me examine Justice Scalia's broccoli example and compare the mandate for broccoli consumption with the mandate to buy health insurance.

First, health insurance is not the same type of product as broccoli or cabbage or cauliflower. If a person does not consume broccoli, he has many close substitutes to improve his health.

In addition, if an individual does not consume broccoli he will not get sick and die. However, if a person does not have health insurance and faces serious illness or injury, he may face the choice between not seeking medical care and suffer debilitating health consequences or even death, or showing up in an emergency clinic for medical care. The 1986 law (Emergency Medical Treatment and Active Labor Act) mandates that emergency clinics provide medical care to all who show up. I wonder why Justice Scalia and some other justices are skeptical about a health insurance mandate on buyers but have not raised any questions about the mandate on the suppliers of emergency medical care.

Second, health insurance insures against risk due to the randomness of illness or injury. Most risk-averse people buy health insurance. However, many others who are young, healthy and are willing to take more risk may prefer to free-ride on insured persons. The uninsured are passing part of the cost of risk on to insured people, knowing that they can depend upon emergency clinics. In fact, those who are uninsured may engage in more risky behavior and hence consume more emergency medical care because they have reduced the cost of risk by passing it to others. On the other hand, higher premiums will lead to under-consumption (less than optimum) of medical care by the insured.

Mandating broccoli consumption, or even a healthy diet and lifestyle, will not insure against random illness and injury. Hence, given the mandate in 1986 law, mandating broccoli consumption is inconsequential in its effect on cost of medical-care providers and hence others' insurance premiums.

Third, the insurance system works when the pool of insured consists of people with varied health status. The diversified pool of healthy and relatively sick people keeps the premiums low, since premiums are affected by average risk. However, if the insurance pool consists only of sick people, the price of insurance will skyrocket and hence will drive most people out of the insurance market. This adverse selection problem causes market failure, where insurance providers may not survive due to losses or if they do survive, the premiums may be so high that many people may not be able to afford insurance or many with pre-existing health conditions may not be able to get insurance.

Broccoli market does not face adverse selection problem. There is no need of a pool of consumers -- healthy and sick -- to lower the price of broccoli. Mandating health insurance with penalties (or user charge for risk) forces all, especially healthy and young people, to join the insurance pool to lower the premiums based on average risk of the pool.

Fourth, health insurance, as opposed to broccoli consumption, enables a person or household to use a variety of medical services, including drugs, in case of illness or injury. An uninsured broccoli consumer who shows up in the emergency clinic will not be able to get the most efficient combination of medical services and drugs to treat illness or injury. Therefore, quality of health outcome will suffer and cost will rise over a period of time due the increased frequency of use of emergency clinics by uninsured broccoli consumers.

Fifth, given the mandate to emergency clinics in the 1986 law and the fact that insurance companies cannot refuse to provide insurance based on preexisting health status, according to the Affordable Care Act of 2010, mandating health insurance for all Americans is a least-cost strategy to deal with 30 million uninsured. This policy, with guidelines provided by the FDA for healthy diet and lifestyle, will go a long way in solving the escalating cost of medical care, which is expected to rise from a little more than 17 percent in 2010 to 26 percent of the Gross Domestic Product in 2035.

I hope the Justices of the U.S. Supreme Court are familiar with distinctive features of the health insurance market and broccoli market and are not persuaded by arguments advanced by ideologues and constitutionally challenged people.

Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio.  He blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/.

Public option in private insurance

Vijay K. Mathur

Published in Standard-Examiner, Ogden, Utah, March 6, 2012

During the debate on the health care bill in Congress in 2010, Republicans and some Democrats vehemently opposed the inclusion of public option in the provision of health care insurance for non-seniors.

The opposition from the health insurance industry was expected, but the opposition to the public option from the Republicans in Congress expanded to include the entire health care bill. Finally, the Affordable Care Act (ACA) of 2010 passed, but without the public option and support of all the Republicans in Congress.

The main argument against the public option was that it would be unfair to the private insurers, because they would be at a disadvantage to compete with the government-subsidized health insurance. Furthermore, opposition in Congress, especially Republicans, argued that government intervention in the private market amounts to creeping socialism, creating inefficiencies and resulting in increasing cost of health care. The opposition groups, so fearful of socialism, did not realize that Medicare for seniors, Medicaid for low-income Americans and health care for veterans are actually part of the public health insurance system. There was at least an option of public health insurance in the original health care bill for other Americans who do not meet the requirements of existing public insurance programs.

In the August 2011 issue of The American Economic Review, authors Randall Cebul, James Rebitzer, Lowell Taylor and Mark Votruba (CRTV) present very convincing arguments, supported by their meticulous empirical analysis, in support of the public option in health insurance plans in the insurance market. This study undermines some of the myths propagated by Republicans, Tea Party loyalists and current Republican presidential candidates.

CRTV investigate the private insurance market in the presence of "search frictions." For a significant majority of people under the age of 65, health insurance is provided through group plans purchased by employers. Health insurance is a complex service involving a multiplicity of factors. Employers, especially small size employers, face a complicated task of shopping for insurance. They have to make comparative decisions among insurance policies and companies regarding drug coverage (brand name, generics and formularies), network of pharmacies, doctors and hospitals, copays, deductibles and other fees.

In fact, a service industry, with health insurance brokers, has developed to facilitate choice among policies. Search frictions, according to CRTV, increase the administrative-health insurance cost to employers. Let me summarize their findings:

            First, search frictions result in disparity in insurance premiums for identical policies, and employer groups' premiums are higher (due to monopolistic power) than what a purely competitive market will produce. Due to lack of competition in premiums, insurers engage in a "marketing arms race," resulting in excessive spending on marketing strategies to attract clients. The excess of premiums above the competitive market premiums entails transfer of monetary benefits of consumers (termed as consumer surplus by economists) to insurers, amounting to $34.4 billion in 1997. A study by Leemore Dafny in The American Economic Review, September 2010, also shows that insurance companies engage in price discrimination.

Second, there is a significant turnover in policies (an average of 20 percent per year), since employers, in their quest for seeking less expensive policies, drop insurance for the entire group of employees. High turnover increases administrative cost of insurers and lessens incentive to invest in preventive health care, thus undermining quality of care and disease management (including chronic diseases). In The Journal Economic Perspectives, Fall 2008, CRTV cite a 2007 Commonwealth Fund Report that finds that if the U.S. spends the same amount on administrative cost as Germany and Switzerland, it would save $32 billion to $46 billion a year. Both Germany and Switzerland have a mixed private and public health insurance systems.

Finally, CRTV finds that a socially optimum government policy would be to subsidize a public health insurance option. It would displace the highest-priced policies and would reduce incentive to private insurers to engage in excessive marketing campaigns, thus improving market efficiency. It would also make private insurance more attractive to consumers by narrowing the dispersion of premiums and bringing premiums much closer to the competitive market price.

Our current private health insurance system also hinders mobility of labor and causes dispersion in unemployment rates across cities and states. A public option, besides improving efficiency in health insurance market, would also improve efficiency in labor markets by promoting labor mobility. We should also not forget that healthy people are productive people.

It is ironic that Rep. Paul Ryan has now proposed with Sen. Ron Wyden a new Medicare plan for seniors in which private health insurers will compete with the current Medicare plan. Rep. Ryan, however, joined other Republicans in denying a public option for non-elderly Americans in the ACA. This double standard is not only inequitable but also inefficient. All politicians and policy makers must base their decisions on unbiased facts, not on ideologies and fear-mongering about socialism. Congress should reconsider including the public option in 2012.

Mathur is former chair and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/.

Ryan-Wyden proposal on Medicare needs close scrutiny

Vijay K. Mathur

Published in Standard-Examiner, January 13, 2012, Ogden Utah

Rep. Paul Ryan, R-Wis., and Sen. Ron Wyden, D-Ore., have made a new proposal to reform Medicare. This proposal is in sharp contrast to the earlier proposal by Rep. Ryan.

In that proposal, elderly people who turn 65 in 2022 would have received premium support for private health insurance, and those who turn 65 before 2022 would have had the choice to remain in the traditional Medicare plan or opt out to choose private health insurance with subsidized premiums. This plan was dropped when Democrats and elderly groups objected to this attempt to privatize Medicare. Now Rep. Ryan is at it again with the help of Democratic Sen. Wyden to gain traction to his plan in the Congress, and especially among senior Americans.

On Dec. 31, 2011, the Standard-Examiner, in its editorial page, published an editorial by the Chicago Tribune, in which the Tribune has praised the new proposal by Rep. Ryan and Sen. Wyden. Following is a critical look at some of features of the new proposal:

1. Starting in 2022, Americans over the age of 55 would have the choice to remain in the current Medicare plan or choose a private health insurance plan from the Medicare-approved exchange. However, contrary to many media reports, including the Chicago Tribune, the Center on Budget and Policy Priorities reports that premium support for traditional Medicare or private plans would substantially shift costs to beneficiaries, thus "leading to the demise of traditional Medicare over time..."

2. The plan would tie the growth in spending per beneficiary to Gross Domestic Product, plus 1 percent on per capita basis. For over two decades potential (full employment) GDP growth had been close to 3.5 percent per year, however actual growth may differ from potential. For example, in 2011 the growth rate was close to 2 percent and is expected to be 2.4 percent in 2012. If health care cost rises faster than actual GDP growth as it has over time, beneficiaries will bear substantial out-of-pocket costs for health care. The proposal recommends congressional intervention to restrain cost. However, given the recent congressional paralysis on many significant economic issues, I do not expect much from Congress to restrain the cost of health care in the market place. The Affordable Care Act of 2010 (passed without any Republican vote) restrains cost by reforming delivery systems, payment systems, research, and, as a last resort, it creates an Independent Payment Advisory Board to make proposals to restrain Medicare cost if cost rises more than actual GDP growth plus 1 percent.

3. The CBPP appropriately states that the current Medicare plan -- a defined-benefit plan -- will be replaced by a defined-contribution plan in the new proposal. As opposed to the Affordable Care Act, the proposal does not specify health care cost cutting measures.

4. The proposal claims to protect low-income beneficiaries but, as CBPP reports, the proposal lacks specifics about premiums and cost sharing. Jennifer Rubin writes, for The Washington Post, that under the new plan, Medicaid beneficiaries would continue to receive support for out-of-pocket expenses, while other low-income seniors would receive "fully funded" savings accounts. However, according to the CBPP, the proposal is not clear about who would be eligible, how much would be deposited in savings accounts, and how the funding would be indexed yearly. It is also not clear what will be the states' share in this funding. High-income seniors will face reduced subsidies -- a good idea that can be implemented even now.

The new plan may not result in significant budgetary savings, according to the CBPP. The proposal lacks specific actions to restrain costs of medical care, including hospital cost, insurance premiums and drugs' cost. However, it is clear that it is intended to pass the major burden of health care costs onto seniors. Then there are questions, such as, could one switch between the public option and the private option, how the shortfall will be financed in the traditional Medicare funds in the interim period when the new plan goes into effect, and how the private option will be funded.

The idea that private insurance companies will have to compete with traditional Medicare under the proposal makes economic sense. Rep. Ryan should have voted for the public option in Affordable Care Act. Now he is touting the virtues of public option side by side with private insurance in the Medicare proposal. Given the fact of increasing merger activity among hospitals and among insurance companies and medical care institutions, and the fact that the proposal lacks the specifics to control cost of health care, it is not apparent that this public-private competition would succeed in restraining cost.

Once the details come out, one can then evaluate if this change of mind by Rep. Ryan on public-private competition is meant to create a windfall to private insurance companies or meant to reform and save the Medicare system.

Vijay K. Mathur is the former chair and professor of economics and is now professor emeritus, Economics Department, Cleveland State University, Cleveland, Ohio.  He writes original blogs for the Standard-Examiner at http://blogs.standard.net/economics-etc/