Monday, November 14, 2011

Kenny Rogers vs ObamaCare

As widely expected, the Supreme Court has agreed to address several constitutional issues arising from the Patient Protection and Affordable Care Act (a/k/a ObamaCare).

Individual Mandate

Most of the public scrutiny of ObamaCare focuses on the constitutionality of the "individual mandate." The individual mandate requires individuals and families to purchase "minimal essential" health insurance. Individuals and families that fail to comply are subject to penalties. No penalties apply to very low-income taxpayers. Certain individuals are exempt from the mandate and penalty regime (e.g., illegal immigrants).

The penalty is the greater of a flat dollar amount per individual taxpayer that rises to $695 in 2016 and is indexed by inflation thereafter (with caps for children and families) or a percentage of the taxpayer's household income that rises to 2.5 percent for 2016 and subsequent years (also capped). See examples here.

Ghost Penalties

True to form, Congress designed a complicated penalty regime that isn't projected to raise much revenue. The Congressional Budget Office and Joint Committee on Taxation estimated that approximately 21 million non-elderly residents will be uninsured in 2016, but that a substantial majority of them will not be subject to the penalty. CBO/JCT projected $4 billion in annual revenue from the penalty from 2017 to 2019.

As the CBO/JCT numbers illustrate, Congress designed the penalties to lack teeth. Approximately 50 million individuals were uninsured in 2010. Roughly 40% of that pool (21 million) will remain uninsured after implementation of ObamaCare. Not so hot. Of the remaining uninsured (21 million), only 3.9 million (20%) have sufficient taxable income to be dinged for penalties.

These numbers are astonishing. Congress assumed that, by 2016, nearly 99% of the population would not be subject to penalties. (We're projected to have approximately 320 million Americans in 2016.) We don't have the assumptions underlying those assumptions. Congress must have concluded that the uninsured would either purchase insurance to avoid penalties, or use new tax subsidies to fund premiums (irrespective of the penalties). More on this "carrot" and "stick" approach below.

You've Got to Know When to Hold 'Em...

Why did Congress impose a "mandate" that individuals and families purchase minimal essential coverage?

Let's step back. Approximately 50 million individuals were uninsured in 2010. Many of those individuals made a conscious or unconscious economic decision not to purchase health coverage. In other words, they had sufficient discretionary income to purchase health coverage, but they chose to spend money on goods or services other than health insurance. These individuals were effectively "gambling" that they would not become sick or injured. Many of the Gamblers were young and healthy individuals who are unlikely to become sick on an actuarial basis.

Congress wanted to coerce these Gamblers to participate in the private health insurance market for reasons discussed here by Princeton economic professor Uwe Reinhardt.

In layman's terms, private insurance depends on a large "pool" of younger, healthier individuals whose premiums are used to pay the health care expenses of older, sicker individuals. If younger, healthier individuals become Gamblers (stop paying premiums), the costs of older, sicker individuals are spread among a smaller "pool." This increases the average premiums charged to the remaining members of the pool, encouraging even more younger, healthier individuals to become Gamblers. If enough young, healthy individuals become Gamblers, a private insurance scheme can face a "death spiral" effect.

ObamaCare created new incentives for young, healthy individuals to become Gamblers. Remember all the buzz over "pre-existing conditions"? ObamaCare requires health insurers to accept all applicants willing to pay (guaranteed issue). And it requires that health insurers charge the same premiums, regardless of the health status of the applicant (community rating). See Reinhardt for more. The key point is that guaranteed issue and community rating tend to increase the cost of insurance for younger, healthier individuals, because insurers cannot exclude older, sicker individuals, and they cannot modulate premiums to reflect health status.

Let's imagine a young, healthy individual in his or her early 20s (a Gambler). Our Gambler graduated from high school or college and landed a job in a service industry that pays decent wages but offers no health benefits. Our Gambler has no dependents, and prefers to allocate his or her disposable income to rent, car loan payments, school loan payments, vacations, beer and "medicinal" marijuana rather than purchasing health insurance. Under ObamaCare, our Gambler can coast along as an uninsured, spending the "premium savings," until stricken by accident or injury. If hit by accident or injury, our Gambler calls up a health insurer and starts paying premiums. The health insurer cannot reject our Gambler based on a "pre-existing condition." And it cannot charge higher premiums based on the health status of our Gambler.

Our Gambler presents a big problem for the drafters of ObamaCare. The mandate and penalty regime are supposedly the "stick" that discourage rampant gambling. They are supposed to backstop the "carrot" of tax subsidies.

...And When to Fold 'Em

ObamaCare arguably involves more "carrot" than "stick." Gamblers not impressed by the penalty regime will receive tax subsidies if they participate in the private insurance market. Specifically, ObamaCare provides for refundable tax credits that individuals and families can use to help cover the cost of health insurance premiums paid to a state exchange.

State exchanges are intended to improve the transparency and competitiveness of health insurance markets, thus lowering costs. The mechanics are fairly open-ended and complicated. In theory, an uninsured individual should be able to browse a "menu" of standardized insurance plans from different carriers through an exchange. The exchange concept raises various issues beyond the scope of this post. The tip of the iceberg: why create 50 government-regulated state exchanges rather than trying to create a competitive national health insurance market?

Congress assumed that virtually nobody would pay penalties. The penalty regime is expected to generate annual revenue of $4 billion for several years after implementation. In contrast, the CBO has estimated that the "exchange subsidies and related spending" would cost more than $100 billion annually during that period (see PDF p. 16).

Big picture, it appears that Congress believed that the tax subsidies and a more accessible "menu" of insurance options (the state exchanges) would encourage Gamblers to fold 'em. I'm surprised by the CBO numbers. Remember, Congress expected that ObamaCare would move approximately 30 million uninsured out of Gambler status into the system. In the 2016-2020 period, the average tax subsidy per uninsured is projected at roughly $3,800. $3,800 sounds very low relative to the cost of individual health insurance.

Break Out the Dentures

The Supreme Court is poised to examine the constitutionality of the individual mandate and penalty regime. The penalty regime was designed to have no teeth, legally or economically. We live in strange times. The constitutionality of ObamaCare hinges on a mechanism that Congress did not intend to have any teeth. Anybody have a good dentist? More to come in my next post.

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