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Rethinking Social Insurance

Professor Martin Feldstein (American Economic Review - March 2005)

An Executive Summary by Stephen Milgate - Executive Director, Australian Doctors' Fund

Professor Martin Feldstein, President of the American Economics Association 2004 and George F Baker, Professor of Economics Harvard and President of the National Bureau of Economic Research is a strong public supporter of social security reform including the introduction of savings accounts.

In his article Prof Feldstein explains that:

• Western Governments have relied on "social insurance" to protect citizens in the area of disability, unemployment, retirement and health. The escalating costs of these programs are now causing a re-think across the Western world. He has been involved in social insurance for 30 years.
• Otto von Bismark introduced social insurance in Prussia in 1881 in an attempt to win support for his conservative government and to fend off the appeal of the social democrats.
• In the US, social security and unemployment insurance were enacted nearly 70 years ago with little change today despite substantial changes in economic and technological fundamentals.
• Across the western world these costs are rocketing (7% of US GDP 2003) and 37% of US Government outlays. These costs will rise dramatically with population ageing.
• Social insurance has undesirable effects. e.g. unemployment benefits increase unemployment, retirement benefits induce early retirement and depress saving, health insurance programs increase medical costs, hence Governments always wanting to redesign social insurance programs.
• Social insurance is mandatory, private insurance is not. Some social insurance is induced by substantial subsidies.
• Social insurance is different from welfare payments. Welfare payments are means tested. Social insurance is "event conditioned" and is paid whenever the event occurs regardless of individual's income or assets.
• Social insurance is not designed to redistribute income, welfare is.
• Most of the benefits of social insurance go to middle and high income households.
• Europeans hold the view that social insurance is about social solidarity i.e. everyone is in the family and should be treated equally. i.e. uniform health care for all. "Although this is a more often asserted political goal rather than practical reality". [Comment: it is an official lie]
• Opposing view to Europeans is that uniform health care or retirement income forces people to participate in a common program rather than take personal responsibility and make decisions based on their own preferences. The European view emphasizes that individuals are incapable of making complex decisions on health and retirement. The opposing view emphasizes the right and ability of individuals to act in their own best interests.
• He (Feldstein) argues for a blending of both views. Choice plus a role for government. His views are based on utilitarian grounds.
• Whilst a perfect and benevolent government may be better that a private market burdened by market imperfections, in reality governments are neither perfect nor necessarily benevolent. "Political actors do not maximise a social welfare function but reflect political pressures and bureaucratic preferences". Also social insurance programs impose costs that must be offset against benefits.
• Governments are unable to distinguish those who are poor through bad luck or inadvertence from those who deliberately choose to act in a way that leads to eligibility for free benefits.
• Means testing doesn't work because it induces behaviour which allows some to qualify for benefits and hence taxes others who do not behave in the same way. Means testing taxes savings.
• The way to go is investment based social insurance programs for retirement, unemployment and healthcare of the retired population rather than pay as you go means tested programs or do nothing.
• His three value judgments or principals on which his recommendations sit are: PERMIT INDIVIDUAL CHOICE, CREATE PROGRAM TRANSPARENCY, RECOGNISE POLITICAL DYNAMICS. e.g. An example of political dynamics - if all drugs consumed by seniors are covered by government insurance there will be pressure to regulate the price of those drugs. This regulation will discourage the development of drugs for diseases that affect the elderly; hence an insurance plan to improve drug access for the elderly leads to reduced availability of new drugs for the elderly. [Comment: because the latter is often hidden or delayed it is not often argued]
• The harmful effects of social insurance on the economy and states that these harmful effects are not often recognised by the public or government or the bureaucracy e.g. the reduction in national savings, inducing early retirement, raising unemployment and pushing up health costs as well as crowding out private health insurance programs.
• He (Feldstein) wants to strengthen the taxpayer's perception of the link between taxes paid and future benefits. He wants to move from the existing complicated defined benefit rules to a defined contribution system and even a notional defined contribution system i.e. to link each workers social insurance tax payment to his or her resulting future benefits. [Comment: i.e. a strong relationship between tax paid and benefit obtained]
• Programs have to be designed to balance protection and distortion while seeking reforms that improve the available trade off e.g. low co-payments in health insurance reduce the risk of forgoing needed care or suffering a major drop in consumption but they also lead to an increase demand for care that is worth less than its cost of production. "As protection becomes more complete the marginal value of protection declines and the incremental distortion rises. The primary goal of social insurance should, therefore, generally be to prevent catastrophic losses; poverty in old age, long term loss of income when unemployed, very expensive out of pocket medical costs and the consequences of permanent disability". i.e. marginal value of additional protection should just equal the marginal cost of distortion. [Comment: WHAT FELDSTEIN IS SAYING IS THAT MEDICARE SHOULD LOOK AFTER THE BIG THINGS, THE CHRONIC PROBLEMS THAT COST LOTS OF MONEY AND NOT INDUCE A PATIENT TO GO TO THE DOCTOR AND OBTAIN A FREE BANDAID BECAUSE IT IS CHEAPER THAN BUYING A PACKET AT THE CHEMIST. AT PRESENT MEDICARE SPENDS A LOT OF MONEY ON THE LITTLE THINGS. MEANWHILE OUR MENTAL HEALTH SYSTEM OFFERS LESS PROTECTION TO CHRONIC SUFFERERS FROM THE ADVERSE ECONOMIC EFFECTS OF CATASTROPHIC ILLNESS, PARTICULARLY LOW INCOME EARNERS OR PERSONS OF LIMITED MEANS.]
• Medicare in the US is more difficult to reform than unemployment insurance or social security but unless it is reformed its costs will outstrip rises in social security retirement benefits. He points out that the demand for health insurance is greatly increased by the tax treatment in the US which excludes employer payments for health insurance from the taxable income of employees allowing health plans to be purchased with pre tax dollars. This induces demand for low deductible, low co-insurance plans, hence increasing dead weight loss caused by distortion in demand. Previous reforms have failed. In 2003 Congress introduced new health saving account rules allowing individuals or their employers to deposit up to $5000 of pre tax income into a HSA. "The individual forgoes the advantage of the tax free income in the form of the employer paid premium but gets an even larger tax free income in the form of health savings accounts contribution". These HSA's create a strong incentive to produce policies with high deductibles, hence removing distortions whilst catastrophic insurance retains protection as distortions are reduced.
• He (Feldstein) calls for increased incentives in the form of replacing the deductible with a 50% co-insurance rate on spending up to twice the level of the HSA saving deposit, e.g. a $5000 deposit would incur a co-payment of 50% on the first $10,000 spent on care increasing cost consciousness.
• Feldstein believes such a system will help people value their health "although we all understand the adverse health effects of obesity, smoking, and lack of exercise not everyone acts on this information" and "some will be more willing than others to sacrifice more of other consumption to increase spending on health care. Health savings accounts will allow this expression of taste in health care spending instead of effectively inducing almost everyone to purchase high cost health care".
• Feldstein believes to remedy the rising costs of Medicare and health expenditure requires two components, first, changing spending incentives to slow the growth of Medicare outlays and second, using a mixed financing system to raise the needed funds without the sharp tax increase that would otherwise be needed.

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Some conclusions for Australia, by Stephen Milgate

• As social insurance Medicare is not without the blights of US social insurance schemes, namely driving health costs higher and failing to look after chronic problems adequately.
• Medicare in Australia pays a lot of the little bills but leaves people with illness such as chronic mental illness outside the system of quality care.
• Medical savings accounts could be introduced into our system to give it more balance. They may be incorporated into superannuation accounts. They could be part of the private health insurance range of products.
• Medical savings accounts are the central feature for the world's most efficient high quality health care system, namely the Singapore system
• The barriers to introducing medical savings accounts are not cultural differences between Singapore and Australia or Australia and the US. The problem is that our income taxation rates are almost double Singapore's. We are a high taxing, low savings economy conforming to the European philosophy that none of use can be trusted with our own money. We must hand it over to the bureaucracy who will hand it back to us in government programmes less their percentage. Hence we allow government to spend for us [and praise themselves in the process.] Future prosperity and affordable health care demand that we change this mindset and become a high saving, low taxing economy which choice and safety for all. Taxation reform must go hand in hand with health reform. Medical savings accounts are accumulated from tax free dollars, hence increasing savings and building personal responsibility with safety into the healthcare financing model.
• Federal and state health ministers are incapable or unwilling to look at positive change. They have a vested interest in the status quo and rely on external pressure to shift momentum.

6 September 2005