How to measure health care cost control

How to measure health care cost control

I want to propose a four-part test for measuring any particular bill on health care cost control.

short run

long run

Federal deficit

1

2

Government health care spending

X

3

Private health care spending

X

4

In each case, I will define the test so that “yes” is a good outcome:

Test 1: The bill does not increase the federal deficit in the short run.

Test 2: The bill significantly reduces the federal deficit in the long run.

Test 3: The bill significantly slows the growth of government health care spending in the long run.

Test 4: The bill significantly slows the growth of private health care spending in the long run.

I believe our Nation’s long-term fiscal problems, and the problems resulting from the growth of per capita health care spending, are higher priorities to solve than reducing the number of uninsured Americans now. I would rather solve America’s health care cost problems of the future than expand government now. This is my value choice. I expect and accept that others will disagree.

As a result of this value choice, I believe any bill that fails any one of these four tests is fiscally and economically irresponsible, and therefore worth defeating.

There does not have to be a tradeoff. A bill could go after the core policy drivers of health care cost growth, especially the tax exclusion for employer-provided health insurance, and replace it with incentives for individuals to shop for high-value health insurance and high-value health care. Such a bill could meet all of the above tests and significantly reduce the number of uninsured. I will describe such a bill in a future post. Such a bill is not going to be passed by this Congress.

I think the administration would agree with my test. They might define Test 3 to be a subset of Test 2. I think it’s important analytically to separate the two.

In practice the test gets slightly more complex. Test 1, “The bill does not increase the federal deficit in the short run,” breaks down into (1A) “over the next five years” and (1B) “over the next ten years.” The Congressional budget rules require that a bill not increase the federal deficit over the next five years. To his credit, the President and his advisors have also been emphasizing that it is important to meet the same test over the next ten years. From a formal legislative process standpoint, only the five-year window is formally binding, because Congress passed a 5-year budget plan (called a budget resolution). In particular, proponents of a bill will need 60 votes in the Senate for any bill that fails (1A). All other tests can be violated and passed with a simple majority.

I will apply this four-part test framework to each major legislative proposal considered by Congress. I want to begin today by walking briefly through each test.

Test 1: The bill does not increase the federal deficit in the short run.

I would like to make this test more stringent – my personal policy preference would be “The bill reduces the federal deficit in the short run,” especially given the path of expected budget deficits under the President’s budget. The actual test, “does not increase,” is the test in the Congressional budget resolution. It says that at a minimum, any new spending should be offset.

I would also like to make the test apply to federal spending, rather than just the federal budget deficit. I would almost certainly oppose a bill that increases government spending over the next ten years by a few hundred billion dollars, and offsets it with the same amount of tax increases. Again, I’m matching my test to the minimally binding one that Congress will apply to itself. This means that this test for me is one-way: any bill that fails it should be opposed, and some bills that pass it should still be opposed, because they dramatically increase the size of government. Still, for the purpose of this exercise I am applying the looser deficit-based short-term test.

By choosing a looser short-term test than I would prefer, I believe I accomplish two goals:

  1. This test conforms with the formal budget rules that will govern this bill (measured over a five year period).
  2. This test fits the “Blue Dog” / conservative Democrat / moderate Republican view of the world. I think I’m taking away an excuse for them to object to my four-part test.

Test 2: The bill reduces the federal deficit in the long run.

For each of these tests, I’m defining “long run” as more than ten years. That’s an arbitrary breakpoint.

While I’m willing to say I could swallow some bills that do not increase the short-term budget deficit, a bill must significantly reduce the long-run federal deficit to be fiscally responsible. Given that our long-term federal deficit path is unsustainable to the point of national economic collapse, and given that health care cost growth is one of the primary drivers of that deficit path, not making the problem worse is insufficient. A bill must result in dramatic reductions in future budget deficits to be fiscally responsible.

This test interacts with Test 3 in a somewhat subtle way. While Test 1 is a deficit test, the facts of our long-term budget problem mean that Test 2 is driven by Test 3, which is about government spending on health care.

Test 3: The bill significantly slows the growth of government health care spending in the long run.

Test 2 is about the long-term budget deficit. Test 3 is about long-term government spending on health care. The President and his budget director are correct when they identify unsustainable per capita health care spending as a primary driver of long-term deficits. (They are incorrect when they identify it as the primary driver of long-term deficits, and dismiss the importance of Social Security spending and aging of the population, as the President did yesterday. I will return to this point in a future post.)

In mid-April I explained that America’s long-term budget problems are driven by unsustainable spending growth, and not by the level of taxation. I think it’s one of my most important posts. I hope you will find time to read it if you have not done so already. Here is the key graph:

taxes and spending long term trends

On the above graph, the white line is federal spending, and the dotted lines are various tax policies. The expanding gap between the white line and the dotted lines is the federal budget deficit. You can see the gap (deficit) explodes as the spending line pulls away from the tax lines.

America’s long-term budget problems are driven entirely by the difference between the slope of the white spending line and the dotted tax lines. Over the long run, a constant tax policy always grows as fast as the economy, and so it remains flat on a graph that measures quantities as a share of the economy. So while we can and do debate about the level of the dotted tax lines, they’re always going to be flat.

You can see that any flat tax line cannot keep up with a rapidly growing upwardly sloped white spending line. Even if you were to rais the flat dotted line to 25% of GDP, you would still have a long-term deficit problem because of the slope of the spending line. The key to success is not just lowering federal spending, it’s tilting that white line dramatically downward. This is what the President and his budget director correctly mean when they say we need to bend the (government) cost curve downward. And they deserve praise for identifying federal health care spending as a major driver of that white line’s slope.

It is therefore odd and self-contradictory that they have proposed raising taxes to offset the higher spending of a new health care entitlement for the uninsured. While you can technically meet my short-term Test 1 by doing so (in a Blue Dog / centrist way that I would oppose, but you’d meet it), it is mathematically impossible in the long run to offset a new health care entitlement with higher taxes, unless your bill also slows the growth of health care spending in other ways.

To put it graphically:

  • The new health care entitlement for those who are now uninsured would raise the level of the long-term white federal spending line.
  • Even if you increase taxes, raising the dotted federal tax lines so that the deficit gap between spending and taxes over the next five or ten years does not increase (thus meeting my Test 1), in the long run the new health care spending will grow faster than the economy, while the new tax revenue stream will grow at the same rate as the economy. You will therefore be exacerbating the long-term deficit problem caused by the white spending line above.
  • The only way to solve this is if you make other changes in the bill that bend downward the slope of the white line.

This last bullet is the President’s stated solution. In effect, he is saying, I’m OK raising long-term federal spending on a new health care entitlement, and thus raising the level of the white line in the long run, as long as we raise the dotted tax lines to offset it in the short-run, and as long as we make other changes to tilt that white line downward (or at least not upward so much.)

The President and his allies have a problem, in that their specific policy of expanding pre-paid health insurance to tens of millions of uninsured Americans will instead increase the slope of the white spending line. The academic evidence is clear that as third-party payment for health care increases, sensitivity to cost decreases and health care spending (total and governmental) increases. Creating a new entitlement for the uninsured helps the uninsured. But it worsens our long-term budget problem in two ways: it raises the level of the long-term spending line, and it increases its slope. Both exacerbate an already-devastating long-term federal budget picture.

So for the President to meet his stated goal, and to make any significant progress on our long-term budgetary problems, the rest of the bill must not only bend the spending line downward, it must do so by more than these two factors that raise the white line by creating a new health care entitlement. I think it’s a mistake to make your most serious problem worse before trying to solve it.

Test 4: The bill significantly slows the growth of private health care spending in the long run.

This is closely related to but separate from Test 3. I praise the President for correctly identifying society-wide health care cost growth as the problem to be solved, rather than just government health care cost growth or the number of uninsured. Private sector health care cost growth is what keeps the number of uninsured high, and it is what squeezes the wages and budgets of more than 200 million Americans with private health insurance. We must make policy changes that stop distorting behavior to encourage unsustainable cost growth in private sector health care.

As I said above, the expansion of third-party payment for the uninsured exacerbates this problem, as would any policy changes that might discourage people from moving to high-deductible plans, or discourage people from shopping for health insurance or medical care based on quality and price.

The President correctly identifies this problem. He admirably says it is a condition that must be met by health care legislation. Unfortunately, he has made no specific policy proposals that would achieve this goal. The President and his budget director emphasize policies that would provide private sector consumers with better information about the health care they use. They have proposed policies that would change government spending policies. They have proposed no policies that would change incentives for private consumers of health care. (I wrote about this in April.) Without such policies, you cannot meet Test 3 or Test 4. And without such policies, expanding government entitlement spending is horribly irresponsible in the long run.

The belt-and-suspenders of the Kennedy-Dodd health care bill

There is much debate about whether a health care reform bill should include a government-run health insurance plan, a so-called “public option.” Advocates argue that such a plan can compete fairly with private health insurance, and that this competition would “keep insurers honest.” They also argue that more choices are a good thing.

I fall in the other camp. I think that government cannot compete on a level playing field with the private sector. Government always has advantages because of its sovereign power. I also think that in most markets there is a range of private health insurance plans competing for business, and so the addition of one more plan is not worth the downsides of government involvement. (I believe that competition is flawed because for most people their employer shops for health plans. I prefer a system in which individuals are shopping for health plans.)

The government cannot compete on a level playing field with private firms:

  • Fannie Mae and Freddie Mac had competitive advantages relative to their purely private counterparts. They leveraged those advantages to the gain of their management and shareholders until they collapsed and jeopardized the entire financial system.
  • Ford Motor Company was not bailed out. It is now disadvantaged relative to GM and Chrysler, which benefited from government oversight, funding, and effective rewriting of bankruptcy rules.
  • Government-provided terrorism reinsurance is preventing private reinsurance from returning to the marketplace.
  • Most physician- and hospital-reimbursement structures are based on the methodologies of the largest payor in the market, Medicare.
  • Government-run direct student loans are now crowding out the guaranteed student loan program, in which private banks and financing firms offer loans. The government advantage comes from control over small details of the program that give direct loans a competitive advantage.

(I would appreciate further examples if commenters have any. Updates are in green.)

The ultimate fear of having a government-run “public” option is that it will crowd out private health insurance, and that ultimately most Americans will be getting their insurance from the government.

At the same time, I hope that opponents of Kennedy-Dodd and the developing House Democrats’ health care bills don’t miss a critical point. Even if the public option is successfully stricken from this legislation, the Kennedy-Dodd goals will be largely achieved by other parts of the bill.

Separate from the Kennedy-Dodd language that creates a new public option, other language in the bill:

  • Gives a government-appointed Medical Advisory Council the ability to determine a standardized package of minimum benefits;
  • Establishes three tiers of standardized copayments and deductibles, as well as the total dollar value of benefits included relative to an industry average;
  • Mandate relative premiums for people with different risk profiles;
  • Gives the Secretary of Health and Human Services authority to set a maximum percentage of administrative expenditures and profits for health plans;
  • Requires plans to provide incentives for certain models of delivery of medical care; and
  • Gives State “Gateways” authority to redistribute resources among health plans to account for the risk distribution of their beneficiaries.

If the government determines benefits, cost-sharing, relative premiums, expenses, and profits, and can take funds from one health plan and give them to another, then the insurance function is governmental.

The ultimate fear of a public option would be immediately implemented by other parts of the Kennedy-Dodd bill. Health plans would turn into a version of Fannie Mae and Freddie Mac: they would have (regulated) private profits but public purposes. (A friend points out that the Fannie/Freddie comparison doesn’t work well here. F/F are more about “private profit but public risk.”)

This is a smart tactical move by the authors of the bill. They have a belt (the public option) and suspenders (government control of private insurance). They achieve their policy goal even if they lose the public option.

Killing the public option is essential, but it isn’t enough to prevent government-run health care.

Ten more things about the official Kennedy-Dodd health care bill

Ten more things about the official Kennedy-Dodd health care bill

The Senate HELP Committee staff has filed an official copy of their draft legislation with the Senate clerk. A friend and I were discussing today two possible tactical scenarios:

  1. The weekend leak forced the majority staff to release their official text as damage control. Under this scenario, filing the official copy is a damage mitigation strategy: “If there’s going to be a version out there, let’s at least have it be a version we want.”
  2. The weekend leak was by the majority staff, and filing the official text is part of a gradual rollout strategy.

I’m guessing scenario 1 is right. Either way, we now have official text to chew on. This text is more expansive than the leaked version I posted Monday. It contains some new items, but is largely identical to the leaked draft.

More importantly, I have now had more time to read the 615 page bill. (I skimmed some parts.) Doing so turned up some things I missed the first time. So here are ten more things you should know about the official draft of the Kennedy-Dodd health care bill.

(Editorial note: I have made a page that will always have the latest version of this complete list, along with the comparison to the House Democrats’ bill. I will also post when I update that page.)

  1. The employer mandate section from the leaked draft has been replaced with [Policy under discussion].

    A few inside friends confirmed my guess – they think this is a tactical move by the majority staff to try to relieve blowback from the employer groups: Chamber of Commerce, Business Roundtable, NFIB (the small business lobby), etc. Until it is otherwise demonstrated, I will continue to assume that the Chairman’s mark will include language that will roughly parallel that in the leaked draft.
  2. The bill gives the Secretary of Health and Human Services authority to limit premiums and profits of health plans by forcing plans to rebate to enrollees premiums above a certain margin.
    Specifically,  section 2704(a) is the “Requirement to provide value for premium payments.” A health plan must report how much of their premium revenues are used for clinical services, how much for “activities that improve health care quality,” and how much for “all other non-claims costs.”Section 2704(b)(1) then tells the Secretary to look at how much other health plans spent on “all other non-claims costs,” and based on that survey, set an allowable percentage for this category. Plans are then required to rebate premiums if they go above this amount. This is direct (but confusing) regulation of premiums and profit margins.I found the labeling of this section interesting. It appears that this section will be the justification for the claim that this bill reduces health care costs. Loosely phrased, it appears their argument will be “We’re reducing health care costs by forcing plans to lower their administrative costs and profits.”
  3. The bill mandates that health plans include and provide financial incentives for the “medical home model” for services, then gives a highly prescriptive description of this model, detailing the interactions among the health plan and different types of providers.

    Section 3101(m) requires qualified health plans to develop and adopt a strategy “that provides increased reimbursement or other incentives for … improving health outcomes … including through the use of the medical home model defined in section 212 [of the] Affordable Health Choices Act, for treatment or services under the plan or coverage;”Section 212 then sets up the “medical home model” over seven pages of legislative text. I am far from an expert in plan-provider relationships, and am not familiar with the medical home model. But the language looks highly prescriptive, as if it is defining an extensive set of rules about the interactions among plans and different types of providers. I would love help from some commenters on what’s going on here, or some more education about the “medical home model.” My instinct is that, even if it is a good delivery model, the federal government should not be tilting the playing field for or against it.
  4. The bill requires health plans adopt Medicare and SCHIP�s �generally implemented incentive policy to promote high quality health care.
  5. Employers must offer the same health insurance to all employees, independent of salary.
  6. Gateways can charge a tax of up to 3% of premiums to cover implementation and administrative costs.This is a huge deal. Take a typical $13,000 (employer-based) family health insurance policy. That means the State can add up to $390/year to the cost.
  7. The Secretary of Health and Human Services shall required that Gateways shall “ensure that [uninsured] individuals are directed to enroll in the program [that she deems] most appropriate.” This is in the context of whether they should enroll in a private health plan, or a government plan: Medicaid, SCHIP, or the new “public option.” The bill gives SecHHS authority to push/force State Gateways to push/encourage/force? the uninsured toward (or away from) particular types of plans. The danger is that a SecHHS could say, “It’s best to have all the uninsured in a government plan.”
  8. States (through Gateways) shall redistribute premiums from plans with low-risk individuals to those with high-risk individuals.

    This gives the people running Gateways a tremendous amount of power over health plans.
  9. States can opt out their state and local employee plans for the first four years. I’m trying to think of a reason why they should be treated differently. Otherwise, it looks like caving to pressure either from State governments, or from public employee unions.
  10. The bill creates a new $10 B “Reinsurance for Retirees” fund to subsidize costs for those between ages 55 and 64. The bill defines eligible “employers” to include “a voluntary employee benefit association.” This may include the UAW VEBA.

    This looks like a fallback. Traditionally, health advocates on the Left have wanted to allow near-retirees (55-64) to “buy in early” to Medicare. And I need to be clear – I cannot conclude that this provision was written specifically to benefit the UAW VEBA. I just know that it allows a VEBA to apply as an employer for a share of this fund, and that the UAW VEBA is the most prominent one that might ask for such funds.

Remember, you can now always find an updated version of the complete list here.

While the list of two dozen items surely creates an impression of why I oppose this bill, I would like to put some structure on it. I hope to post in the next few days a higher-level view that crystallizes my biggest concerns with this bill in a structure that is easier to understand.

(photo credit: Wikipedia)

Understanding the House Democrats' health care bill

Understanding the House Democrats' health care bill

Yesterday I posted and described the draft Kennedy-Dodd health care bill. Today I would like to do the same for an outline produced by House Democrats.

Here is a three-page outline of “Key Features of the Tri-Committee Health Reform Draft Proposal in the House of Representatives,” dated yesterday (June 8, 2009).

The three committees are:

  • The House Ways & Means Committee, chaired by Rep. Charlie Rangel (D-NY). The Health Subcommittee is chaired by Rep. Pete Stark (D-CA).
  • The House Energy & Commerce Committee, chaired by Rep. Henry Waxman (D-CA). The Health Subcommittee is chaired by Rep. Frank Pallone, Jr. (D-NJ).
  • The House Committee on Education & Labor, chaired by Rep. George Miller (D-CA). The Health, Employment, Labor and Pensions Subcommittee is chaired by Rep. Robert Andrews (D-NJ).

The document suggests this is a joint product of the three committees and/or their subcommittees. My sense, however, is that it is Speaker Pelosi who is driving the bus. This is in contrast to the Senate, where the committee chairmen (Kennedy/Dodd and Baucus) appear to have the pen, in less well-coordinated efforts.

Kennedy-Dodd and the House bill outline are remarkably similar. Whether this represents House-Senate coordination or parallel thought processes is unclear.

I think the easiest way for me to present the House bill outline is in comparison with the Kennedy-Dodd bill. So here my description from yesterday of the Kennedy-Dodd bill, with today’s comparison to the House bill outline in red. I hope it’s comprehensible and useful this way. If you read yesterday’s post, you can skim the text in black and focus on the new text in blue.

Here are 15 things to know about the draft Kennedy-Dodd health bill and the House bill outline.

  1. The Kennedy-Dodd bill would create an individual mandate requiring you to buy a :qualified” health insurance plan, as defined by the government. If you don’t have “qualified” health insurance for a given month, you will pay a new Federal tax. Incredibly, the amount and structure of this new tax is left to the discretion of the Secretaries of Treasury and Health and Human Services (HHS), whose only guidance is “to establish the minimum practicable amount that can accomplish the goal of enhancing participation in qualifying coverage (as so defined).” The new Medical Advisory Council (see #3D) could exempt classes of people from this new tax. To avoid this tax, you would have to report your health insurance information for each month of the prior year to the Secretary of HHS, along with “any such other information as the Secretary may prescribe.” The House bill also contains an individual mandate. The outline is less specific but parallel: Once market reforms and affordability credits are in effect to ensure access and affordability, individuals are responsible for having health insurance with an exception in cases of hardship.
  2. The Kennedy-Dodd bill would also create an employer mandate. Employers would have to offer insurance to their employees. Employers would have to pay at least a certain percentage (TBD) of the premium, and at least a certain dollar amount (TBD). Any employer that did not would pay a new tax. Again, the amount and structure of the tax is left to the discretion of the Secretaries of Treasury and HHS. Small employers (TBD) would be exempt.The House bill outline also contains an employer mandate that appears to parallel that in Kennedy-Dodd: “Employers choose between providing coverage for their workers or contributing funds on behalf of their uncovered workers.”
  3. In the Kennedy-Dodd bill, the government would define a qualified plan:
    1. All health insurance would be required to have guaranteed issue and renewal, modified community rating, no exclusions for pre-existing conditions, no lifetime or annual limits on benefits, and family policies would have to cover “children” up to age 26.The House bill outline is consistent with but less specific than the Kennedy-Dodd legislative language. The House bill outline would “prohibit insurers from excluding pre-existing conditions or engaging in other discriminatory practices.” I will keep my eye on what “other discriminatory practices” means in the legislative language. Does that mean that a health plan cannot charge higher premiums to smokers? Like the Kennedy/Dodd bill, the House bill outline would preclude health plans from imposing lifetime or annual limits on benefits: “Caps total out-of-pocket spending in all new policies to prevent bankruptcies from medical expenses.” This would raise premiums for new policies. The House bill outline “introduces administrative simplification and standardization to reduce administrative costs across all plans and providers.” I don’t know what this means, but suggest keeping an eye on it.
    2. A qualified plan would have to meet one of three levels of standardized cost-sharing defined by the government, “gold, silver, and bronze.” Details TBD. Same: “… by creating various levels of standardized benefits and cost-sharing arrangements…” It also contains this addition relative to Kennedy-Dodd: “… with additional benefits available in higher-cost plans.” But note the “various levels of standardized benefits.” This appears to be more expansive government control of health plan design than in the Kennedy-Dodd draft.
    3. Plans would be required to cover a list of preventive services approved by the Federal government.This is unspecified in the House bill outline. We’ll have to wait to see legislative language.” The House bill would require plans to “waive cost-sharing for preventive services in benefit packages.”
    4. A qualified plan would have to cover “essential health benefits,” as defined by a new Medical Advisory Council (MAC), appointed by the Secretary of Health and Human Services. The MAC would determine what items and services are “essential benefits.” The MAC would have to include items and services in at least the following categories: ambulatory patient services, emergency services, hospitalization, maternity and new born care, medical and surgical, mental health, prescription drugs, rehab and lab services, preventive/wellness services, pediatric services, and anything else the MAC thought appropriate.This appears parallel but is less specific for now: “Independent public/private advisory committee recommends benefit packages based on standards set in statute.” I find the “standards set in statute” interesting. It suggests that provider and disease interest groups will have two fora in which to lobby for their benefits to be mandated: Congress, and the advisory committee.
    5. The MAC would also define what “affordable and available coverage” is for different income levels, affecting who has to pay the tax if they don’t buy health insurance. The MAC’s rules would go into effect unless Congress passed a joint resolution (under a fast-track process) to turn them off.The House bill outline is silent on this.
  4. Health insurance plans could not charge higher premiums for risky behaviors: “Such rate shall not vary by health status-related factors, … or any other factor not described in paragraph (1).” Smokers, drinkers, drug users, and those in terrible physical shape would all have their premiums subsidized by the healthy. The House bill outline says it would “prohibit plans [from] rating (charging higher premiums) based on gender, health status, or occupation and strictly limits premium variation based on age.” If the bill were to provide nothing more, this would appear to parallel the Senate bill and preclude plans from charging higher premiums for risky behaviors.
  5. Guaranteed issue and renewal combined with modified community rating would dramatically increase premiums for the overwhelming majority of those Americans who now have private health insurance. New Jersey is the best example of health insurance mandates gone wild. In the name of protecting their citizens, premiums are extremely high to cover the cross-subsidization of those who are uninsurable.The House bill outline is silent on guaranteed issue and renewal. I’m going to make an educated guess that the bill includes these provisions as part of “other discriminatory practices,” and they have just left them out of the outline. Given the philosophy behind this outline (with which I disagree), it would be a striking omission. But for now, the outline says nothing specific on these topics.
  6. The bill would expand Medicaid to cover everyone up to 150% of poverty, with the Federal government paying all incremental costs (no State share). This means adding childless adults with income below 150% of the poverty line.The House bill outline “expands Medicaid for the most vulnerable, low-income populations,” so we have no specifics other than that there’s an expansion.” I cannot tell if this is expanding eligibility or benefits. The outline also “improves payment rates to enhance access to primary care under Medicaid.” I assume this means the bill would expand the Federal share paid of each dollar spent by a State Medicaid program on primary care, rather than the Federal government actually mandating specific payment rates to be implemented by States. Federal micromanagement of specific Medicaid provider payment rates was eliminated in the mid 1990s.
  7. People from 150% of poverty up to 500% (!!) would get their health insurance subsidized (on a sliding scale). If this were in effect in 2009, a family of four with income of $110,000 would get a small subsidy. The bill does not indicate the source of funds to finance these subsidies.The House bill outline has a sliding scale up to 400% of poverty. If this were in effect in 2009, a family of four with income of $88,000 would get small subsidy.
  8. People in high cost areas (e.g., New York City, Boston, South Florida, Chicago, Los Angeles) would get much bigger subsidies than those in low cost areas (e.g., much of the rest of the country, especially in rural areas). The subsidies are calculated as a percentage of the “reference premium,” which is determined based on the cost of plans sold in that particular geographic area.The House bill outline is not specific on this point. I would not expect it to be – this is something you can tell only from legislative language.
  9. There would be a “public plan option” of health insurance offered by the federal government. In this new government health plan, the federal government would pay health care providers Medicare rates + 10%. The +10% is clearly intended to attract short-term legislative support from medical providers. I hope they are not so naive that they think that differential would last.The House bill outline “creates a new public health insurance within the Exchange … the public health insurance option competes on ‘level field’ with private insurers in the Exchange.” There are no specifics on how the public plan would work, or on provider payment rates.
  10. Group health plans with 250 or fewer members would be prohibited from self-insuring.” ERISA would only be for big businesses.The House bill outline is silent on this point.
  11. States would have to set up “gateways” (health insurance exchanges) to market only qualified health insurance plans. If they don’t, the Feds will set up a gateway for them.The House calls it an Exchange rather than a Gateway. While the Senate bill would tell each State, “Create a Gateway or we’ll create one for you,” the House bill outline says to each State, “We’re creating a single new national Exchange. You’re in it unless you develop your own State or Regional Exchange.”
  12. Health insurance plans in existence before the law would not have to meet the new insurance standards. This creates a weird bifurcated system and means you would (probably) be subject to a different set of rules when you change jobs.The House bill outline appears to parallel the Kennedy-Dodd draft: “Phases-in requirements to benefit and quality standards for employer plans.” This means that new plans will be more expensive than old plans. It also means they’re creating a bifurcated system with all sorts of perverse unintended consequences for employment flexibility.
  13. The bill does not specify what spending will be cut or what taxes will be raised to pay for the increased spending. That is presumably for the Finance Committee to determine, since it’s their jurisdiction. The House bill outline lists specific topics for changes to Medicare reimbursement:
    • Changing (how?) the Medicare reimbursement for doctors, called the “Sustainable Growth Rate” (SGR).
    • “Increasing reimbursement for primary care providers”
    • “Improving” the Medicare drug program. I won’t be surprised if, when I see the specifics, I disagree that their changes are “improvements.” In the past this has meant having the federal government mandate specific prices for drugs.
    • Cutting payments to Medicare Advantage plans.
    • Expanding low-income subsidies for seniors and eliminating cost-sharing for all preventive services in Medicare.

    The House bill outline also uses positive language to describe things that might generate budgetary savings from Medicare and/or Medicaid. The hospital readmissions point is specific. The first two points could increase or decrease federal spending, depending on the specifics.

    • “Use federal health programs … to reward high quality, efficient care, and reduce disparities.”
    • “Adopt innovative payment approaches and promote[s] better coordinated care in Medicare and the new public option through programs such as accountable care organizations.”
    • “Attack the high rate of cost growth to generate savings for reform and fiscal sustainability, including a program in Medicare to reduce preventable hospital readmissions.”
  14. The bill defines an “eligible individual” as “a citizen or national of the United States or an alien lawfully admitted to the United States for permanent residence or an alien lawfully present in the United States.” The House bill outline is silent on this point.
  15. The bill would create a new pot of money for state gateways to pay “navigators” to educate people about the new bill, distribute information about health plans, and help people enroll. Navigators receiving federal funds “may include … unions, …” The House bill outline is silent on this point.

This would have severe effects on the more than 100 million Americans who have private health insurance today:

  • The government would mandate not only that you must buy health insurance, but what health insurance counts as “qualifying.”
  • Health insurance premiums would rise as a result of the law, meaning lower wages.
  • A government-appointed board would determine what items and services are “essential benefits” that your qualifying plan must cover.
  • You would find a tremendous new disincentive to switch jobs, because your new health insurance may be subject to the new rules and would therefore be significantly more expensive.
  • Those who keep themselves healthy would be subsidizing premiums for those with risky or unhealthy behaviors.
  • Far more than half of all Americans would be eligible for subsidies, but we have not yet been told who would pay the bill.
  • The Secretaries of Treasury and HHS would have unlimited discretion to impose new taxes on individuals and employers who do not comply with the new mandates. (The House bill outline is not specific on this point.)
  • The Secretary of HHS could mandate that you provide him or her with “any such other information as [he/she] may prescribe.” (The House bill outline is not specific on this point.)

I strongly oppose the Kennedy-Dodd bill and the House Tri-Committee bill.

If this topic interests you, I highly recommend Jim Capretta’s blog Diagnosis.

(photo credit: speaker.house.gov)

Understanding the Kennedy health care bill

Understanding the Kennedy health care bill

Over the weekend a draft of Senator Kennedy’s (D-MA) health care bill leaked. After playing with Adobe Acrobat, here is the text of the draft Kennedy bill as a text file (173 K), and as a single Acrobat file (3.4 MB). Update: I fixed the broken link to the PDF. Unlike the leaked version, both of these are searchable.

Calling it the “Kennedy” bill is something of an overstatement. Senator Kennedy chairs the Senate Health, Education, Labor, and Pensions committee, and his staff wrote the draft. By all reports, however, Chairman Kennedy’s health is preventing him from being heavily involved in the drafting. Senator Reid has designated Senator Chris Dodd (D-CT) to supervise the process, but as best I can tell, it’s really the Kennedy committee staff who are making most of the key decisions. For now I will call it the Kennedy-Dodd bill.

As the committee staff emphasized to the press after the leak, this is an interim draft. I assume things will move around over the next several weeks as discussions among Senators and their staffs continue. This is therefore far from a final product, but it provides a useful insight into current thinking among some key Senate Democrats.

Update: I now have a three-page outline of the House Democrats’ health care bill. I have a new post which contains all of the content below, and compares it to the House bill. If you read the new post, you’ll get two for the price of one: Understanding the House Democrats’ [and Kennedy-Dodd] health care bill[s].

Here are 15 things to know about the draft Kennedy-Dodd health bill.

    1. The Kennedy-Dodd bill would create an individual mandate requiring you to buy a “qualified” health insurance plan, as defined by the government. If you don’t have “qualified” health insurance for a given month, you will pay a new Federal tax. Incredibly, the amount and structure of this new tax is left to the discretion of the Secretaries of Treasury and Health and Human Services (HHS), whose only guidance is “to establish the minimum practicable amount that can accomplish the goal of enhancing participation in qualifying coverage (as so defined).” The new Medical Advisory Council (see #3D) could exempt classes of people from this new tax. To avoid this tax, you would have to report your health insurance information for each month of the prior year to the Secretary of HHS, along with any such other information as the Secretary may prescribe.”
    1. The bill would also create an employer mandate. Employers would have to offer insurance to their employees. Employers would have to pay at least a certain percentage (TBD) of the premium, and at least a certain dollar amount (TBD). Any employer that did not would pay a new tax. Again, the amount and structure of the tax is left to the discretion of the Secretaries of Treasury and HHS. Small employers (TBD) would be exempt.
    1. In the Kennedy-Dodd bill, the government would define a qualified plan:
        1. All health insurance would be required to have guaranteed issue and renewal, modified community rating, no exclusions for pre-existing conditions, no lifetime or annual limits on benefits, and family policies would have to cover children up to age 26.
        1. A qualified plan would have to meet one of three levels of standardized cost-sharing defined by the government, gold, silver, and bronze. Details TBD.
        1. Plans would be required to cover a list of preventive services approved by the Federal government.
        1. A qualified plan would have to cover “essential health benefits,” as defined by a new Medical Advisory Council (MAC), appointed by the Secretary of Health and Human Services. The MAC would determine what items and services are “essential benefits.” The MAC would have to include items and services in at least the following categories: ambulatory patient services, emergency services, hospitalization, maternity and new born care, medical and surgical, mental health, prescription drugs, rehab and lab services, preventive/wellness services, pediatric services, and anything else the MAC thought appropriate.
        1. The MAC would also define what “affordable and available coverage” is for different income levels, affecting who has to pay the tax if they don’t buy health insurance. The MAC’s rules would go into effect unless Congress passed a joint resolution (under a fast-track process) to turn them off.
    2. Health insurance plans could not charge higher premiums for risky behaviors: “Such rate shall not vary by health status-related factors, … or any other factor not described in paragraph (1).” Smokers, drinkers, drug users, and those in terrible physical shape would all have their premiums subsidized by the healthy.
    1. Guaranteed issue and renewal combined with modified community rating would dramatically increase premiums for the overwhelming majority of those Americans who now have private health insurance. New Jersey is the best example of health insurance mandates gone wild. In the name of protecting their citizens, premiums are extremely high to cover the cross-subsidization of those who are uninsurable.
    1. The bill would expand Medicaid to cover everyone up to 150% of poverty, with the Federal government paying all incremental costs (no State share). This means adding childless adults with income below 150% of the poverty line.
    1. People from 150% of poverty up to 500% (!!) would get their health insurance subsidized (on a sliding scale). If this were in effect in 2009, a family of four with income of $110,000 would get a small subsidy. The bill does not indicate the source of funds to finance these subsidies.
    1. People in high cost areas (e.g., New York City, Boston, South Florida, Chicago, Los Angeles) would get much bigger subsidies than those in low cost areas (e.g., much of the rest of the country, especially in rural areas). The subsidies are calculated as a percentage of the “reference premium,” which is determined based on the cost of plans sold in that particular geographic area
    1. There would be a “public plan option” of health insurance offered by the federal government. In this new government health plan, the federal government would pay health care providers Medicare rates + 10%. The +10% is clearly intended to attract short-term legislative support from medical providers. I hope they are not so naive that they think that differential would last.
    1. Group health plans with 250 or fewer members would be prohibited from self-insuring. ERISA would only be for big businesses.
    1. States would have to set up “gateways” (health insurance exchanges) to market only qualified health insurance plans. If they don’t, the Feds will set up a gateway for them.
    1. Health insurance plans in existence before the law would not have to meet the new insurance standards. This creates a weird bifurcated system and means you would (probably) be subject to a different set of rules when you change jobs.
    1. The bill does not specify what spending will be cut or what taxes will be raised to pay for the increased spending. That is presumably for the Finance Committee to determine, since it’s their jurisdiction.
    1. The bill defines an “eligible individual” as “a citizen or national of the United States or an alien lawfully admitted to the United States for permanent residence or an alien lawfully present in the United States.”
  1. The bill would create a new pot of money for state gateways to pay “navigators” to educate people about the new bill, distribute information about health plans, and help people enroll. Navigators receiving federal funds “may include … unions, …”

This would have severe effects on the more than 100 million Americans who have private health insurance today:

    • The government would mandate not only that you must buy health insurance, but what health insurance counts as “qualifying.”
    • Health insurance premiums would rise as a result of the law, meaning lower wages.
    • A government-appointed board would determine what items and services are “essential benefits” that your qualifying plan must cover.
    • You would find a tremendous new disincentive to switch jobs, because your new health insurance may be subject to the new rules and would therefore be significantly more expensive.
    • Those who keep themselves healthy would be subsidizing premiums for those with risky or unhealthy behaviors.
    • Far more than half of all Americans would be eligible for subsidies, but we have not yet been told who would pay the bill.
    • The Secretaries of Treasury and HHS would have unlimited discretion to impose new taxes on individuals and employers who do not comply with the new mandates.
  • The Secretary of HHS could mandate that you provide him or her with “any such other information as [he/she] may prescribe.”

I strongly oppose this bill.

Update: If this topic interests you, I highly recommend Jim Capretta’s blog Diagnosis.

(photo credit: kennedy.senate.gov)

Parsing the President’s health care reform letter

Parsing the President’s health care reform letter

The White House has released a letter from the President to the two Senate Chairmen who are working on (different) versions of health care reform: Senator Kennedy (D-MA), Chairman of the Health, Education, Labor, and Pensions (HELP) Committee, and Senator Max Baucus (D-MT), Chairman of the Senate Finance Committee. The letter is dated yesterday and was delivered as part of a White House meeting between the President and Senate Democratic leaders, including the two Chairmen.

This important letter attempts to shape the pending legislation. It makes new proposals, and it tries to set boundaries to constrain the work of the Chairmen. I am going to walk through the letter and explain what I think it means. I will walk through it in sequence, but will cut out the fluff, and occasionally add emphasis in bold. Each of these quotes could merit a post by itself. I will instead provide a survey of the whole letter. The first notable text is the second paragraph:

Soaring health care costs make our current course unsustainable. It is unsustainable for our families, whose spiraling premiums and out-of-pocket expenses are pushing them into bankruptcy and forcing them to go without the checkups and prescriptions they need. It is unsustainable for businesses, forcing more and more of them to choose between keeping their doors open or covering their workers. And the ever-increasing cost of Medicare and Medicaid are among the main drivers of enormous budget deficits that are threatening our economic future.

This is fantastic, especially as 2. He is focusing on health cost growth as the underlying problem, rather than just focusing on the uninsured, which is only one symptom of the problem. I wrote about this in mid-April: By focusing only on covering the uninsured, are we solving the wrong problem? Here’s the key picture from that post. We need to focus on the red box, and not just the blue box.

hc cost flowchart

The President’s letter continues:

We simply cannot afford to postpone health care reform any longer. This recognition has led an unprecedented coalition to emerge on behalf of reform — hospitals, physicians, and health insurers, labor and business, Democrats and Republicans. These groups, adversaries in past efforts, are now standing as partners on the same side of this debate.

There is a less noble explanation for the existence of this coalition. I wrote in mid-May, “[The provider groups] want to share in the spoils of increased government spending on health care, they want to avoid being the political and policy targets of legislation, and they see no political downside to supporting a popular and powerful President with Democratic supermajorities in both the House and Senate.”

At this historic juncture, we share the goal of quality, affordable health care for all Americans. But I want to stress that reform cannot mean focusing on expanded coverage alone. Indeed, without a serious, sustained effort to reduce the growth rate of health care costs, affordable health care coverage will remain out of reach. So we must attack the root causes of the inflation in health care.

This is an astonishing paragraph from a Democratic President. As he has done in the past, he says his goal is health care for all Americans, rather than health insurance for all Americans. This language will allow him to declare victory with a bill that does not provide universal pre-paid health insurance.

He then reiterates that expanded coverage is insufficient. A bill “must attack the root causes of the inflation in health care.” This is fantastic and unexpected from a Democrat.

The President’s letter then veers wildly off course. That paragraph continues:

… So we must attack the root causes of the inflation in health care. That means promoting the best practices, not simply the most expensive. We should ask why places like the Mayo Clinic in Minnesota, the Cleveland Clinic in Ohio, and other institutions can offer the highest quality care at costs well below the national norm. We need to learn from their successes and replicate those best practices across our country. That’s how we can achieve reform that preserves and strengthens what’s best about our health care system, while fixing what is broken.

Geographic disparities in health spending are enormous, and if we could somehow magically reduce spending in high-cost areas to match that in low cost areas, without sacrificing too much quality, then we would make major progress in reducing the level of national health spending. Budget Director Peter Orszag is the primary proponent of this argument, since before he entered the Administration.

But the Administration has no plan and no proposals that would actually reduce geographic disparities in health care. They have proposals which would provide people with more information about the health care they use, but they have not proposed to change the incentives people have to use that care. If you don’t change the incentives, you will make no significant progress in reducing geographic spending disparities or slowing health cost growth. I wrote about this in late April: Slowing health cost growth requires information AND incentives, and then found that CBO had already made this point.

More importantly, it is absurd to say that geographic disparities are “the root causes of the inflation in health care.” We know what drives health cost growth: (1) technology, (2) income growth, (3) increases in third party payment, and (4) aging of the population. Some argue that administrative costs also contribute to growth, but I’m skeptical. We also know that the first three reasons account for two-thirds to nearly all of cost growth, depending on which study you prefer.

The President’s letter correctly identifies the problem to be solved as health cost growth, and then completely misdiagnoses the sources of that growth. The Administration continues to grossly foul up the problem definition, not propose a solution, and get a free ride from a lazy and compliant press corps. You cannot slow health spending growth merely by stating a vague intent to do so.

The letter continues:

The plans you are discussing embody my core belief that Americans should have better choices for health insurance, building on the principle that if they like the coverage they have now, they can keep it, while seeing their costs lowered as our reforms take hold.

Two things jump out from this sentence. The first is a clear and oft-repeated signal that “if [you] like the coverage [you] have now, [you] can keep it.” The President says this is a core belief. It also protects the Administration from one of the most effective attacks on expansions of government health care: that it will squeeze our your private care. This is tactically smart.

The second is the return to “seeing their costs lowered as our reforms take hold.” This addresses the first box on the right side in my diagram above, and I compliment the President and his team for identifying that growing health spending hurts the more than 100 million Americans who now have health insurance, and not just those who lack it.

But for those who don’t have such options, I agree that we should create a health insurance exchange … a market where Americans can one-stop shop for a health care plan, compare benefits and prices, and choose the plan that’s best for them, in the same way that Members of Congress and their families can.

  • A (singular) exchange, or 50 State exchanges? There’s a big difference.
  • I have never been enamored of the “one-stop shopping” argument. I’m not opposed to it, it just doesn’t excite me. Mostly I fear that exchanges become vehicles for Washington-directed redistribution.
  • It is fascinating that he takes the traditional liberal argument that “you deserve health care that is good as Members of Congress get,” and turns it into “Americans can … choose the plan that’s best for them, in the same way that Members of Congress and their families can.” This is creative.

None of these plans should deny coverage on the basis of a preexisting condition, …

The hardest problem in health care reform is how to deal with the small percentage of Americans with predictably high health costs. To quote Harvard’s Dr. Kate Baicker:

Uninsured Americans who are sick pose a very different set of problems. They need health care more than health insurance. Insurance is about reducing uncertainty in spending. It is impossible to “insure” against an adverse event that has already happened, for there is no longer any uncertainty. If you were to try to purchase auto insurance that covered replacement of a car that had already been totaled in an accident, the premium would equal the cost of a new car. You would not be buying car insurance – you would be buying a car. Similarly, uninsured people with known high health costs do not need health insurance – they need health care. Private health insurers can no more charge uninsured sick people a premium lower than their expected costs. The policy problem posed by this group is how to ensure that low income uninsured sick people have the resources they need to obtain what society deems an acceptable level of care and ideally, as discussed below, to minimize the number of people in this situation.

We need to distinguish between the uninsured and the uninsurable. The uninsured lack health insurance for a wide variety of reasons. Some uninsured are healthy, some are sick.

The uninsurable are those who are already sick or injured, and who have predictably high future health costs. If you have an incurable disease, you are uninsurable, because there is little uncertainty about your future spending. (I’m oversimplifying -there is little uncertainty that you will have high health costs.) As Kate points out, “Uninsured people with known high health costs do not need health insurance – they need health care.”  The policy problem posed by this group is how to ensure that low income uninsured sick people have the resources they need to obtain what society deems an acceptable level of care.

So when the President says that “None of these plans should deny coverage on the basis of a preexisting condition,” the practical effect is that health insurance plans will be required to provide health care to the uninsurable, label it as “insurance,” and then charge healthy people higher premiums than are merited by their own health status. It’s a way of hiding the cross-subsidization.

… and all of these plans should include an affordable basic benefit package that includes prevention, and protection against catastrophic costs.

The word “basic” is unusual from a Democrat. The traditional Washington health debate has Republicans (generally) arguing that we should want more people to be able to afford access to “basic” health insurance, while Democrats (especially those farther Left) saying everyone has a right to “good” health insurance. Setting aside the access vs. right debate for the moment, the word “basic” is a more centrist choice than I would have expected from this President.

He then runs into one of the classic problems of government-designed health care reform: who defines the benefit package? By saying that all of these plans should include X, he is punting the question of who gets to define X, and how specific will they be?Governments have a terrible track record of political micromanagement of medical benefits.

I strongly believe that Americans should have the choice of a public health insurance option operating alongside private plans.

Note that he chose “I strongly believe that Americans should have” rather than the stronger “Americans must have.” Despite the urgings of the Left, the President is leaving himself room to jettison the “public option” if that is the price of getting the Republican votes he may need. Also, he says “alongside private plans,” again emphasizing that the public option will not, in his view, squeeze out private coverage. I think he’s wrong and it will squeeze out private coverage, and would point to what his Administration is trying to do to Medicare private plans as proof.

I understand the Committees are moving towards a principle of shared responsibility — making every American responsible for having health insurance coverage, and asking that employers share in the cost. I share the goal of ending lapses and gaps in coverage that make us less healthy and drive up everyone’s costs, and I am open to your ideas on shared responsibility. But I believe if we are going to make people responsible for owning health insurance, we must make health care affordable. If we do end up with a system where people are responsible for their own insurance, we need to provide a hardship waiver to exempt Americans who cannot afford it. In addition, while I believe that employers have a responsibility to support health insurance for their employees, small businesses face a number of special challenges in affording health benefits and should be exempted.

This is a fairly hard slap at a mandate (individual or employer). “I understand [you] are moving toward … I share the goal … and I am open to your ideas on shared responsibility” is not a ringing endorsement of a mandate. He then guts the universal nature by saying that it should exempt “Americans who cannot afford it” as well as small businesses. These exemptions would create tremendous distortions and inequities. The resulting patchwork mandate would be a mess. With this paragraph, I think the President weakens the prospect of a mandate becoming law.

Health care reform must not add to our deficits over the next 10 years — it must be at least deficit neutral and put America on a path to reducing its deficit over time. To fulfill this promise, I have set aside $635 billion in a health reserve fund as a down payment on reform. This reserve fund includes a numb

er of proposals to cut spending by $309 billion over 10 years –reducing overpayments to Medicare Advantage private insurers; strengthening Medicare and Medicaid payment accuracy by cutting waste, fraud and abuse; improving care for Medicare patients after hospitalizations; and encouraging physicians to form “accountable care organizations” to improve the quality of care for Medicare patients. The reserve fund also includes a proposal to limit the tax rate at which high-income taxpayers can take itemized deductions to 28 percent, which, together with other steps to close loopholes, would raise $326 billion over 10 years.

I am committed to working with the Congress to fully offset the cost of health care reform by reducing Medicare and Medicaid spending by another $200 to $300 billion over the next 10 years, and by enacting appropriate proposals to generate additional revenues. These savings will come not only by adopting new technologies and addressing the vastly different costs of care, but from going after the key drivers of skyrocketing health care costs, including unmanaged chronic diseases, duplicated tests, and unnecessary hospital readmissions.

  • “It must be at least deficit neutral” – Good.
  • “and [must] put America on a path to reducing its deficit over time” – Even better, if he were to actually propose a policy that might do this. Without such a proposal, this is empty and weak.
  • “I have set aside $635 billion in a health reserve fund as a down payment on reform” – Horrible. He wants to create the entire new obligation, but fund only about half of it.
  • “… cut spending by $309 billion over 10 years” – True, but his budget hides $330 B in additional spending on doctors and $17 B to expand Medicaid, so the net is a Medicare/Medicaid spending increase of $38 billion over 10 years. (See table S-5 on page 121 of the President’s budget.) The President’s budget increases spending on these entitlements, and uses a baseline game to claim budgetary savings to offset a new health entitlement.
  • “… cutting waste, fraud and abuse” – This is the old chestnut to suggest that the cuts are good policy and won’t hurt. There is waste, fraud, and abuse, but the cuts will also involve real reductions in payments to health providers, and they will hurt (which doesn’t make them wrong to do).
  • “… a proposal to limit the tax rate at which high-income taxpayers can take itemized deductions to 28 percent” – Democrats in Congress rejected this months ago.
  • “… by reducing Medicare and Medicaid spending by another $200 to $300 billion over the next 10 years” – Excellent. Will he provide specifics? I would be happy to suggest some.
  • “… and by enacting appropriate proposals to generate additional revenues.”- aka “raise more taxes” – Horrible from my perspective.
  • “… going after the key drivers of skyrocketing health care costs, including unmanaged chronic diseases, duplicated tests, and unnecessary hospital readmissions.” – As I said earlier, these are not the key drivers of skyrocketing health care costs, and it is misleading and irresponsible to claim they are.

To identify and achieve additional savings, I am also open to your ideas about giving special consideration to the recommendations of the Medicare Payment Advisory Commission (MedPAC), a commission created by a Republican Congress. Under this approach, MedPAC’s recommendations on cost reductions would be adopted unless opposed by a joint resolution of the Congress. This is similar to a process that has been used effectively by a commission charged with closing military bases, and could be a valuable tool to help achieve health care reform in a fiscally responsible way.

This is new and interesting to me. “A commission created by a Republican Congress” is odd, since MedPac is not known as a nonpartisan advisory group. It is also odd to imagine giving MedPac real decision-making authority, given that it is comprised of representatives of provider groups (doctors, hospitals, nurses, etc.)

I know that you have reached out to Republican colleagues, as I have, and that you have worked hard to reach a bipartisan consensus about many of these issues. I remain hopeful that many Republicans will join us in enacting this historic legislation that will lower health care costs for families, businesses, and governments, and improve the lives of millions of Americans. So, I appreciate your efforts, and look forward to working with you so that the Congress can complete health care reform by October.

I can read this either way. My gut says this means, “Get me a bill by October.” I would prefer it be broadly bipartisan, but don’t let the lack of Republican support prevent you from getting me a bill.

Summary & Conclusions

The news in this letter is:

  • The President continues his rhetorical focus on reducing long run health costs in addition to expanding coverage.
  • While appearing to push for a public option and universality, he is leaving himself room to compromise on both if needed to get a bill to his desk.
  • He has made a mandate harder to legislate by insisting on large exemptions, and he has not signaled any support for a mandate. Goodbye mandate, I think.
  • He is insisting on deficit neutrality over 10 years and reducing the deficit in the long run, while not proposing policies that achieve either goal. He is opening the door to more Medicare and Medicaid savings to reach these goals and has floated a $200-$300 B number without specifics.
  • He has opened the door to a binding commission to cut Medicare and Medicaid spending, modeled after the Base Realignment and Closure (BRAC) process.

I have mixed conclusions:

  • At the 30,000-foot level, he has broken new ground for Democrats in defining the problem correctly as unsustainable health cost growth, rather than the subsidiary problem of the uninsured. I compliment him for this.
  • At the 5,000-foot level, he botches the problem definition by focusing on geographic disparities while ignoring the commonly acknowledged major drivers of health spending increases: technology, income growth, and third party payment. This is a fatal flaw.
  • He continues to assert that we must slow cost growth, without proposing any policy changes that would do so in a measurable way. This is an abdication of leadership and irresponsible.
  • To genuinely slow health cost growth, you need to change incentives. Doing so involves political pain. Congress will not want to do that pain, and will not do so if the President doesn’t propose specifics.
  • In addition, the short-term budget numbers still don’t add up. He has problems with the “down payment” meaning they’re not paying for the full new obligation, ignoring the doctors and Medicaid spending hidden in the baseline, and Congress rejecting his biggest tax increase proposal.
  • I am glad that he is leaning against, or at least undermining, the case for a mandate.
  • The MedPAC idea is interesting. It probably won’t work, but I don’t want to dismiss it out of hand.

The President’s letter makes it harder, not easier, to get a bill. While I like some elements of the letter, it is inconsistent with the President’s actual proposals. You cannot magically slow health spending growth without proposing policy changes that affect incentives and behavior. If the President is not willing to bite the bullet and lead on slowing long-term health cost growth, he will instead get a bill which is just a straight entitlement expansion, partly offset by Medicare Advantage cuts and tax increases, and obscured by budget gimmicks. His advisors will then have to construct a bogus argument that they have addressed long-term spending growth.

That would be a terrible outcome.

Understanding the GM bankruptcy

Many of you are new to this blog since I wrote extensively about autos six weeks ago. As background, I coordinated the auto loan process for President Bush last fall as the Director of the White House National Economic Council (the position now held by Dr. Lawrence Summers). I wrote a series of posts on the auto loans beginning when the President made his late-March announcements, and continuing into the spring. For reference, here are those posts:

  1. Auto loans: a deadline looms
  2. Auto loans: options for the President
  3. Auto loans: the Bush approach
  4. Auto loans: Chrysler gets an ultimatum, GM gets a do-over
  5. Auto loans: the press forgot to ask about the cost to the taxpayer
  6. Should taxpayers subsidize Chrysler retiree pensions or health care?
  7. The Chrysler bankruptcy sale
  8. Mixed results on the Chrysler announcement

This morning I posted some basic facts on the General Motors announcement. Now it’s time for some analysis. Like my post Understanding the President’s CAFE announcement, this is a monster post. I hope you find it valuable despite its length.

I want to try to tease apart the various questions that get conflated in the public forum. My primary goal is to give you a structure for thinking about the issue. My secondary goal is to persuade you to agree with my views on each question. I will be satisfied if you give me credit for achieving only the primary goal.

Here is how I tease apart the questions:

  1. What are the arguments for further government intervention?
  2. Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?
  3. Is the pre-packaged bankruptcy likely to succeed?
  4. Is it fair?
  5. Did the government structure the taxpayer financing correctly?
  6. Will the Administration run GM?

Let’s take them one-by-one.


1. What are the arguments for further government intervention?

Today the President explained why he chose to put another $30.1 B of taxpayer funds at risk to prevent GM from liquidating now. Speaking about his decision on March 30th, he said today:

But I also recognized the importance of a viable auto industry to the well-being of families and communities across our industrial Midwest and across the United States. In the midst of a deep recession and financial crisis, the collapse of these companies would have been devastating for countless Americans, and done enormous damage to our economy — beyond the auto industry. It was also clear that if GM and Chrysler remade and retooled themselves for the 21st century, it would be good for American workers, good for American manufacturing, and good for America’s economy.

This is more expansive than what President Bush argued last December:

In the midst of a financial crisis and a recession, allowing the U.S. auto industry to collapse is not a responsible course of action. The question is how we can best give it a chance to succeed. Some argue the wisest path is to allow the auto companies to reorganize through Chapter 11 provisions of our bankruptcy laws – and provide federal loans to keep them operating while they try to restructure under the supervision of a bankruptcy court. But given the current state of the auto industry and the economy, Chapter 11 is unlikely to work for American automakers at this time.

The distinction is important. President Bush’s arguments were time-dependent: (a) we should try to prevent our weak economy from taking another big hit right now, and (b) let’s buy GM and Chrysler time to get ready to restructure. He also argued (c) that it was unfair to dump a liquidating auto industry on his successor (even if his successor might do something different than he would). It was a “too big to fail now” argument.

Today President Obama made it clear that he made the decision to commit additional funds, if his conditions were met, at the end of March. He then added new reasons to those expressed by President Bush: that America needs “a viable auto industry,” and that it would be good for America if GM and Chrysler survived. While he emphasizes what he would not do, “I refused to let these companies become permanent wards of the state,” President Obama defines a national interest in having auto manufacturers headquartered in the U.S. He reinforced that with his closing line, which was surreal:

And when that happens, we can truly say that what is good for General Motors and all who work there is good for the United States of America.

This is a big expansion of the justification for government intervention in the market. Ford is not failing, and Chrysler is emerging from bankruptcy. President Obama is arguing that American taxpayers need to fund the survival of a third (the biggest) U.S.-based auto manufacturer, because it is important “to the well-being of families and communities across our industrial Midwest and across the United States” and because “it would be good for American workers, good for American manufacturing, and good for America’s economy.” This argument could be extended to almost any large U.S. firm, at almost any time.

My view: I am extremely uncomfortable with the President’s expanded argument for further government intervention. Had the President instead argued, “The economy is beginning to recover, and we cannot jeopardize that with another major shock,” I would have been less uncomfortable with today’s commitment of additional taxpayer funds.


2. Given these arguments, should the U.S. government intervene further by putting more taxpayer funding at risk to prevent GM from liquidating?

The public debate has evolved in the past two months. Earlier this year the question posed was, “Should the Administration bail out GM?” The basic options were “yes,” “no,” and “only if they enter bankruptcy, and if they do they should try to pre-package it.” The President chose the last of these options. The President decided to put $30.1 B of additional taxpayer funding at risk to help prevent GM from liquidating in the near future, and to help them through a restructuring process.

The benefits and costs are similar to what I described in late March. Here’s the updated version:

Benefits

  • If the firm survives the bankruptcy process intact, it has a higher probability of being viable in the long run (than in a restructuring outside of bankruptcy).
  • If the firm survives restructuring, the taxpayer has a higher probability of being repaid.
  • Old equity holders faced the full costs of the firm’s failure (by being wiped out). No additional moral hazard is created.

Costs

  • There are still significant risks to GM’s survival:
    • Will GM and the Administration defeat the objecting unsecured creditors in court? (however unfair that might be)
    • Will the bankruptcy process conclude quickly (within 90 days)?
    • Will GM continue to lose market share? Can GM make cars and trucks that people want to buy?
    • Will the new fuel economy and emissions rules restrict GM’s ability to make attractive vehicles?
  • This is a big new cash outlay from the taxpayer. This costs the taxpayer, and further constrains available TARP funds.

The President made clear his answer to this question on March 30th. At that time he laid out the conditions under which he would provide additional funding, and those conditions were met. No one should be surprised that he is now putting more taxpayer funding at risk. I am surprised that they only need $30 B.

My view: We crossed this bridge back in late March. It is not a new decision today to put more taxpayer funding at risk. I don’t like it, but I am at least glad that some incentives have been restored: the firm has to go through a bankruptcy process, shareholders are wiped out, and management was fired. I remember arguments from last fall and earlier this year that GM should get more taxpayer dollars outside of a bankruptcy process. That would have been far worse, and today’s actions mitigate some moral hazard.

Given the relative strength of the U.S. economy now compared to last December, I would have preferred an outcome of a pre-packaged bankruptcy + private DIP financing, and not exposing taxpayers to any additional risk. If GM is really as viable as GM and the President claim it now is, then they should have no problem convincing capital markets to provide them with short-term financing. (Judge Richard Posner argues this.) I will guess that this was not actually a viable option, because the pre-packaging could only come together with the direct involvement of the government. I think the real options would have been expose taxpayers to $30B more risk, or allow GM to liquidate. I would go with the latter: if GM can’t find private financing, they’re on their own. I assume this means they would liquidate. This would have been harsh and painful for those affected. I believe the consequences of further intervention now are worse for a larger number of people in the long run.


3. Is the pre-packaged bankruptcy likely to succeed?

There are two components to this question:

  • Is the bankruptcy process likely to be quick and successful?
  • Will the resulting company succeed without additional taxpayer aid?

I do not feel well-qualified to comment on the first question. The talking heads all repeat that “GM’s bankruptcy is more complicated than Chrysler’s,” with little detail about why. I would point out that the Administration is one for one in this process. Their use of this part of the bankruptcy code (section 363), and the process where the old GM sells the good stuff to a new GM, and then the remaining parts are liquidated, appears to have worked for Chrysler. From my perspective, the burden of proof now shifts to those who argue this bankruptcy will take more than 90 days. I didn’t like it because of the precedent it set, but I wouldn’t bet against the Administration succeeding again.

Other than the “good for GM is good for America” quote, the biggest surprise in the President’s remarks was how heavily he was betting that a restructured GM will succeed. He could easily have taken the posture, “GM has made some hard decisions, and they have a tough road ahead if they want to survive and succeed.” Instead, he attached his own credibility to GM’s future success and said:

So I’m confident that the steps I’m announcing today will mark the end of an old GM, and the beginning of a new GM; a new GM that can produce the high-quality, safe, and fuel-efficient cars of tomorrow; that can lead America towards an energy independent future; and that is once more a symbol of America’s success.

Even with a cleaned up balance sheet and more taxpayer funding, it is by no means certain that GM will survive for the long run. If GM fails in the next few years, the taxpayers will have lost an additional $30.1 B that the President committed today. In addition, the above quote will come back to haunt the President. I understand wanting to set a positive and optimistic tone. I am confused why he did so at such great political risk to himself.

I found it useful to return to my first post on the autos and review what this new pre-packaged bankruptcy + DIP financing does to the wide range of challenges faced by GM:

Revenues

  • The economic slowdown means fewer vehicles are being purchased from all auto manufacturers, foreign and domestic.
  • Even apart from the economic slowdown, U.S. auto manufacturers have been losing market share over time.
  • This is in part because they made a bet on light trucks versus smaller cars. This product mix doesn’t work when gas prices are high. Think of the proliferation of SUVs in the past 10 years. (Note that this was in part the fault of U.S. government policies. SUVs are technically light trucks, and so they qualify for lower fuel economy requirements.)

Costs & productivity

  • The Detroit 3′s ongoing labor costs are higher than those of foreign-based firms. This is still true when you compare an American worker in a GM plant in Michigan, for instance, with an American worker in a Nissan plant in Mississippi.
  • Productivity is lower in U.S. plants of U.S. firms than it is in U.S. plants of foreign-based firms. Some of this is because of the UAW contract that mandates certain inefficiencies. Some of it is poor management.
  • The Detroit 3 have huge dealer networks that are costly to the manufacturers. These dealer franchises are often protected by state laws that make it hard for the manufacturers to make these networks smaller and more efficient.
  • Auto manufacturers face a burdensome and unpredictable legislative and regulatory environment.

Balance sheets

  • The Detroit 3 have enormous legacy costs from their retirees. Past UAW contracts provided generous benefits that continue to burden these firms. This drains profits (when they earn them) away from productivity-enhancing investments.

So can GM survive, and for how long? Can they profit and flourish, as the President suggests they will?

  • The Administration and GM argue that a restructured GM can break even in a national market of only 10m vehicles sold in America each year. (We’re now around 9.5m/year. “Normal” is around 16m/year.) If accurate, this is astonishing.This would appear to address all three of the bullets under revenues. Addressed? I’m skeptical. I need to review the assumptions in GM’s new plan, especially about market share.
  • I have seen no evidence that GM and UAW have reduced significantly GM’s ongoing labor costs to be competitive with the transplants. Maybe I have missed it. Unaddressed.
  • Productivity is still lower in U.S. plants of U.S. firms that it is in U.S. plants of foreign-based firms. As a result of high compensation costs per worker and low productivity, it appears that labor cost per vehicle produced will still be uncompetitive with the transplants. Unaddressed.
  • GM’s dealer network is being dramatically reduced. Addressed.
  • The CAFE and emissions requirements are even more burdensome than predicted, but now have at least some degree of stability, given the national standards. On net, worse than before.
  • The balance sheets will be relieved of enormous debt and legacy health and pension obligations. Addressed.

My view: I need to look more at what GM is assuming for market share. The removal of the legacy obligations, combined with a big chunk of taxpayer change, will buy then many months of survival.

The Administration is stressing the balance sheet improvements, and they deserve credit for that. Conservative critics focus on the additional burdens of the fuel economy and emissions rules, and they’re right, too.

I would focus even more on the questions asked by several commenters: “Will people want to buy GM cars and trucks?” Additionally, can GM make a profit with still high labor costs, still low productivity, still burdensome work rules, and still slow product development cycles?

I want to GM to survive and be profitable in the long run. Their chances are now drastically improved, assuming they survive bankruptcy. But I don’t know if that’s an improvement from a 1% chance to a 20% chance, or from a 1% chance to an 80% chance. A lot more needs to change beyond just cleaning up the balance sheet, and many of those needed changes are deep-seated in the culture, structures, and processes of America’s third-largest company.


4. Is the pre-packaged bankruptcy fair?

Absolutely not. But I want to be precise in my criticism.

The easiest thing to do in Washington is to criticize the negotiator. “I could have gotten a better deal,” we say. I should begin my expressing my sympathy and offering my congratulations to Steven Rattner and the Obama team for closing what was undoubtedly a complex and difficult set of negotiations. I’m sure this one was not easy, and theirs was a thankless task.

At the same time, I share the concerns of many that the deal was not even-handed, and that the precedent will damage future business lending. I have grave concerns about how far they were willing to stretch bankruptcy processes and the traditional capital structure to get a deal.

First I need to correct the Administration, as well as some bad reporting today by the Washington Post. In last night’s background briefing for the press, an unnamed Senior Administration Official claimed (emphasis added):

Secondly, as you know, the UAW has reached a new agreement with GM and that agreement has been ratified that involves significant concessions by the UAW … concessions that are in virtually every respect more aggressive than what the previous administration demanded in its loan agreement.

In the term sheet for the December loan we (the Bush Administration) made to General Motors, we set out “targets,” which we took directly from the Corker amendment offered the week prior on the Senate floor:

  1. Reduce outstanding unsecured debt by not less than 2/3 through conversion into equity or other debt;
  2. Reduce the total amount of compensation, including wages and benefits, paid to their U.S. employees so that, by no later than December 31, 2009, the average of such total amount, per hour and per person, is an amount that is competitive with the average total amount of such compensation, as certified by the Secretary of Labor, paid per hour and per person to employees of Nissan Motor Company, Toyota Motor Corporation, or American Honda Motor Company whose site of employment is in the United States.
  3. Eliminate the jobs bank.
  4. Apply work rules no later than 12/31/09 “in a manner that is competitive with Nissan … Toyota or Honda in the U.S.”
  5. Not less than half of their VEBA payment should be in the form of stock.

As best I can tell:

  • They more than accomplished target #1.
  • They did little to nothing on #2. I have seen no evidence that compensation of current workers has been changed. UAW Chief Ron Gettelfinger claimed in a message to his members, “For our active members these tentative changes mean no loss in your base hourly pay, no reduction in your health care, and no reduction in pensions.” Maybe there’s a distinction between this statement and “total compensation.” If so, it would be great if someone could help me understand this. But it appears GM and UAW did nothing to address target #2.
  • UAW agreed to #3 in late March.
  • They made no apparent progress on target #4. I have neither seen nor heard evidence that the work rules have been relaxed. I am happy to be corrected.
  • They accomplished #5.

It was incorrect for the Senior Administration Official to call these “demands” of the Bush Administration. They were targets, not hard conditions. It is an overstatement to say that they “are in virtually every respect more aggressive than what the previous Administration demanded,” unless “virtually every respect” means “except for compensation and work rules.” (I am happy to be corrected if I have just missed the changes.)

The Washington Post then further flubbed it by writing:

Critics say it is unfair that the restructuring plan gives the union health trust a larger share of the new GM than the bondholders. But administration officials defend the plan, offering several justifications.

First, they note that the terms of the proposed GM restructuring echo the terms laid out by the Bush administration in December, when it extended $13.4 billion in loans to GM.

The Bush administration’s loan agreement required a 50 percent reduction or “haircut” for the union trust, but a 66 percent cut for the bondholders. The Obama deal requires larger cuts for both sides, though more for the bondholders.

The agreement does more than meet three of the five targets laid out by the Administration. It appears to make no progress on the other two targets. Thus the terms do not “echo the terms laid out by the Bush administration in December.”

More importantly, the targets we (Bush team) laid out said nothing about the distribution of equity shares. The criticism is not that the deal doesn’t cut the VEBA enough, or reduce unsecured debt enough. The criticism is that someone lower in the capital structure (UAW’s VEBA) got a much greater equity share than someone higher in the structure (unsecured creditors). It is disingenuous to point to the targets in the Bush Administration’s December loans to justify this inequity.

The deal is unfair to unsecured creditors, because they get a worse deal than someone standing behind them in line (the UAW’s VEBA). It has nothing to do with who those parties are (labor vs. creditors). It is about the importance of maintaining a stable and predictable set of rules to govern the capital structure of a firm, and the value that stability creates for firms’ ability to raise capital. All these arguments boil down to the cardinal rule of waiting in line for the kindergarten bus: it’s not fair to cut in line. If that rule is broken too often, chaos ensues.

The Administration could be arguing, “Sure it’s unfair, but UAW had more leverage on us than the creditors, so we struck the best deal that we could. We needed UAW to sign onto the deal, while we thought we could roll the creditors in court.” This would better justify the disproportionate equity shares than claiming, “This is a fair deal.”

The objecting creditors will now defend their rights in court. If the Chrysler precedent is an example, you should bet against them. It is interesting that the President did not attack them as “speculators” this time, so at least the rhetorical leverage against them is weakened.

My view: I am more concerned with the signals this unfair treatment sends to future investors. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain firms. I wish I knew whether a different prepackaging was possible, one which would have maintained the precedence of the capital structure and did not stretch the bankruptcy process again. Unfortunately, it is impossible to know.


5. Did the government structure the taxpayer financing correctly?

Judge Richard Posner argues the government should have provided a loan rather than taken an equity stake in GM. The President suggested one reason why they preferred an equity stake: a loan would further burden GM with a stream of near-term interest payments to the government.

I think Judge Posner strikes a nerve with his suggestion. It seems that much of the public discomfort comes from the government now being the owner of GM. It’s the 60% number that made me gasp. It highlights a tradeoff between two goals on which conservatives focus: value for the taxpayer, and avoiding government interference and control. There is a tradeoff between the two.

I believe the U.S. government could auction its equity shares late this year and divest itself completely from General Motors.This would solve the government ownership problem. In doing so, I presume that taxpayers would recoup far less than the $30 B of cash provided.

Question for conservatives: How much of a loss are you willing to take on the $30 B to get the U.S. government out of GM quickly?

My view: I assume there is a non-trivial chance that GM may still fail in the next several years. I like the President’s and his team’s strong language today that this $30 B is the last taxpayer aid, but I would like to reinforce that by ending the government’s ongoing involvement in GM as quickly as possible. I am willing to sacrifice a significant portion of the $30 B to achieve that goal. I therefore recommend that, if GM emerges from bankruptcy, the Administration then establish a much more rapid timetable for selling its equity stake, even if that means the taxpayer loses much of the $30 B. Get us out of GM before the end of 2010. This will strengthen the bulwark against providing additional taxpayer funds if GM fails again.

Note:

  • Under current law, the authority to provide any firm with additional TARP funding expires December 31, 2009. Correction: Secretary Geithner can, after notifying Congress, extend the TARP authorities to October 3, 2010.
  • The “set a timeline” argument has direct parallels to a certain national security debate.

6. Will the Administration run GM?

Here I give the Administration credit for good intent and good initial execution. I take at face value the President’s statement that he does not want to run or control GM, and I give him points for saying so explicitly. I am sure there are others, including some in his Administration and some on Capitol Hill, that would love to run GM as Government Motors. I will trust the President when he says he is not one of those people.

I further give the Administration credit for the “Principles for Managing Ownership Stake” they released in today’s fact sheet. While they are being released in the specific context of the U.S. government’s new equity stake in GM, the White House writes more generally “(T)he Obama Administration has established four core principles that will guide the government’s management of ownership interests in private firms.”

  • The government has no desire to own equity stakes in companies any longer than necessary, and will seek to dispose of its ownership interests as soon as practicable. Our goal is to promote strong and viable companies that can quickly be profitable and contribute to economic growth and jobs without government involvement.
  • In exceptional cases where the U.S. government feels it is necessary to respond to a company’s request for substantial assistance, the government will reserve the right to set upfront conditions to protect taxpayers, promote financial stability and encourage growth. When necessary, these conditions may include restructurings similar to that now underway at GM as well as changes to ensure a strong board of directors that selects management with a sound long-term vision to restore their companies to profitability and to end the need for government support as quickly as is practically feasible.
  • After any up-front conditions are in place, the government will protect the taxpayers’ investment by managing its ownership stake in a hands-off, commercial manner. The government will not interfere with or exert control over day-to-day company operations. No government employees will serve on the boards or be employed by these companies.
  • As a common shareholder, the government will only vote on core governance issues, including the selection of a company’s board of directors and major corporate events or transactions. While protecting taxpayer resources, the government intends to be extremely disciplined as to how it intends to use even these limited rights.

Given that I trust the President’s statements on this point, the risks here are unintended consequences, from within his own Administration and from the Congress. They are big risks, and these are dangerous waters. I hope the Administration treads carefully.

My view: Given the undesirable situation of government equity stakes in, and even controlling ownership of, firms like GM and AIG, as well as potentially Citigroup and other banks, these are good principles. They are also easy to monitor. It is interesting and good that the White House fact sheet says, “The [UAW's] VEBA will have the right to select one independent director and will have no right to vote its shares or other governance rights.” (emphasis added)

I urge the President to:

  • Enshrine the principles from today’s fact sheet in the term sheets for the taxpayer investments in GM (and other firms). We did this last December in the GM and Chrysler term sheets. Tie yourself to the mast. This will give you an easy excuse later when someone pressures you to vote those shares in a way that conflicts with the taxpayer’s interest.
  • Set clear rules for Administration contacts with GM – it’s probably best to funnel all contacts through specific Treasury or NEC officials on the autos task force. No freelancing phone calls to the Administration-appointed directors or “informal chats” with them from White House staff, or from DOT, EPA, USTR, DOE, even State. Put a firewall around interactions with GM.
  • Come out hard and quickly against the first proposal from a Member of Congress to leverage the ownership stake for a non-taxpayer goal. Nip it in the bud, especially if the idea comes from a friend.

It’s easy to criticize a huge decision like the one made by the President today. I strongly disagree with where we are headed, and I am concerned with the precedent that this deal sets for capital investment in American firms. The alternative, however, is that you have to be willing to allow GM to fail. I would be willing to do so, and it is therefore easy for me to express my views. In summary, they are:

  1. I am extremely uncomfortable with the President’s expanded argument for today’s government intervention.
  2. My first choice would have been to push GM to get private DIP financing. Assuming that was infeasible, I would have recommended denying GM the DIP financing, even if that meant they would liquidate. The economy is sufficiently healthier now than it was last December that I would be willing to risk the additional shock. But I agree the President crossed this bridge at the end of March.
  3. I would bet in favor of GM emerging from bankruptcy, and against them surviving as an intact firm for 5 years without additional taxpayer funding.
  4. The pre-packaging deal was unfair to unsecured creditors, to the benefit of UAW retirees. The Administration loses credibility with me by trying to argue this was a fair deal. They would have been more credible if they had argued it was the only deal they could get. I worry that the President’s actions create political risk and will permanently raise the cost of capital for certain U.S. firms.
  5. If a loan rather than an equity purchase had been possible, I would have preferred that – I find Judge Posner’s arguments persuasive. Given the equity investment, I urge the Administration to divest as quickly as possible, even if it means a loss to the taxpayer.
  6. Given the undesirable situation of the U.S. government owning GM and other large firms, the Administration’s new “Principles for Managing Ownership Stake” are solid. They need to lock them in, and corral or beat back all those people who work in the Executive Branch and Congress who have other goals in mind for GM and will be tempted to exert some leverage.

I thank you for making it through this extremely long post, and again want to thank all of the fantastic commenters. If you dislike the President’s announcement, I urge you to consider this question: Suppose the deal announced today were the only possible pre-packaged bankruptcy, and your choice was to take it or allow GM to liquidate now. What would you do?

Basic facts on the General Motors bankruptcy

In a few hours I will offer my thoughts and reactions to the General Motors bankruptcy filing and the President’s noon announcement. For now, here is what I have been able to figure out from the White House fact sheet and secondary source reporting through CNBC and the Wall Street Journal. I assume that both sources are being fed directly from the White House, Treasury, and GM, so I think there is a high probability these sources are accurate.

Note that I do not generally intend to become a news source. I will instead focus on analysis. What you see below is a variant of something I whipped up this morning for my old Administration colleagues that I thought I would share with you as well.

In my experience both on the White House and on Capitol Hill, I found that it was sometimes helpful to my principal to collect and group information as you see it below. There are a lot of good reporters, but they sometimes structure their stories in ways that make it hard to understand. TV business news tends to release the information as it comes out. So while you could learn everything below from the WSJ, CNBC, and the fact sheet, I hope that the structure makes it easier to process.

This is the kind of presentation I might have dashed off for President Bush or Senator Lott for a big news item so they would not have to spend time digging through press coverage. This is one of those “fold it up and put it in your inside jacket pocket” memos. Also, as a principal it’s nice to know what you need to know. You can have the confidence that, if you know this information, you have a basic but thorough understanding of what’s going on. (Hint to my Hill friends: feel free to use this for your boss. You just saved an hour.)

Process
  • GM’s bankruptcy filing was expected to be at 8 AM EDT in NY Southern District in Manhattan. (CNBC)
  • Obama and GM CEO Fritz Henderson are scheduled to hold back-to-back press conferences beginning at noon today. (CNBC)
  • They are using the same Section 363 process that Chrysler used. The new GM buys the good parts of the old GM. The old parts are liquidated. (White House fact sheet)
  • “would allow a much smaller GM to emerge from court protection in as little as 60 to 90 days.” (CNBC) (This is a guess/spin. How optimistic is it? GM is much harder than Chrysler. -kbh)
  • “Al Koch, a managing director at advisory firm AlixPartners, will be appointed chief restructuring officer in charge of liquidating those GM assets” (CNBC)
  • “Autos task force will stay in business … shifting to an investment manager role” (CNBC)
In “the new GM,” ownership is:
  • 60% of equity goes to the U.S. Government. USG also gets $8.8B in debt and preferred stock.
  • UAW’s retiree pension/health plan (the “Voluntary Employee Beneficiary Association”) gets 17.5% of equity, plus:
    • warrants to buy another 2.5% of equity;
    • a $2.5 B note (three installments, ending in 2017); and
    • $6.5 B in perpetual preferred stock (9% coupon).
  • Approximately 12% of equity goes to the Canadian (and Ontario?) governments. They also get about $1.7 B in debt and preferred stock.
  • Bondholders of old GM get about 10% of the equity, for giving up $27.1 B in unsecured debt. This was approved by bondholders representing 54% of unsecured debt. The other 46% are the biggest risk for the bankruptcy filing. (CNBC, WSJ)
  • “Bondholders could take up to 25 percent of GM if it recovers to be worth what it was in 2004, before it began round after round of cost-cutting in what proved to be a failed bid to make up for lost sales.” (I need to understand this better.)
  • Secured bondholders expect to be paid face value. (WSJ)
Governance of the new GM
  • UAW’s VEBA can select one independent director, but cannot vote its shares or other governance rights(!) (White House fact sheet)
  • “Canadian government will have the right to select one initial director.” (White House fact sheet)
  • “The U.S. Treasury will also have the right to appoint the initial directors other than those that will be selected by the VEBA and the Canadian government.” (White House fact sheet)
GM gets about $40 B of new cash to help pay its bills during bankruptcy. This is called debtor-in-possession (DIP) financing.
  • U.S. Government: $30.1 B in new debtor-in-possession (DIP) financing. (WH fact sheet, CNBC)
  • Governments of Canada & Ontario: $9.5 B
NewCo / OldCo
  • “Today GM is announcing its intention to close 11 facilities and idle another 3 facilities.” (White House fact sheet)
  • “[GM] has not provided an update target for job cuts but had been looking to cut 21,000 factory jobs from the 54,000 UAW workers it now employs in the United States.” (CNBC)
  • “While the ‘new GM’ is expected to emerge quickly from court protection, the automaker’s shuttered plants, stranded equipment and other spurned assets would be left to liquidation in bankruptcy.” (CNBC)
  • Previously announced: “closing more than a dozen factories and shedding the Pontiac, Saturn, Saab and Hummer brands.” (WSJ)
  • GM will “shutter 2,600 dealers.” (WSJ)
  • “The new GM will also pursue a commitment to build a new small car in an idled UAW factory.” (WH fact sheet)
  • GM will shed more than $79B in debt. (WSJ)
  • “GM at the last minute also found buyers for some unwanted subsidiaries, including German-based Opel, which is being acquired by a consortium led by Canadian auto-parts supplier Magna International Inc., and the Hummer brand, whose buyer remained undisclosed.”
Future
  • “The U.S. Treasury does not anticipate providing any additional assistance to GM beyond this [new $30.1 B] commitment.” (White House fact sheet)
  • “As a result of this restructuring, GM will lower its breakeven point to a 10 million annual car sales environment. Before the restructuring, GM’s breakeven point was in excess of 16 million annual car sales.” (White House fact sheet)
  • “The administration said the goal of the restructuring was to help GM be profitable in a year when the industry sells 10 million vehicles, versus the 16 million it sold in 2007.” (CNBC)
  • “GM will continue to honor consumer warranties.” (WH fact sheet)
  • GM is being removed from the Dow Jones Industrial Average 30 (“the Dow”), along with Citigroup. They will be replaced by Cisco and Travelers. (CNBC)

Update: If you’re really into this topic, you can read the Administration’s background briefing (for the press) that they held last night.

Understanding the President’s CAFE announcement

Understanding the President’s CAFE announcement

(Editorial note: I was doing so well moving to shorter posts. I fail miserably in achieving that goal here. I went the comprehensive route instead. I promise to return to shorter posts in the future. Buckle up – this is a long ride. I hope you find it’s worth it.)

(Update: There’s an important correction in #3 below. The estimated job loss for the option I think most closely approximates the Administration’s proposal should be about 50,000 over five years, rather than about 150,000 over five years. I apologize for the error.)

There is not yet much data available on the President’s CAFE announcement. Luckily, we have a huge base of analysis that the National Highway Traffic Safety Administration (NHTSA) did in 2008 that allows us to infer a lot from what was announced. Here are the specific data points we have from the President’s announcement:

  • The average fuel economy standard will be 35.5 mpg in 2016. That’s a weighted average of all cars and light trucks sold in the U.S.
  • Assuming that the Wall Street Journal’s reporting is accurate, they would require cars to hit 39 mpg by 2016, and light trucks to hit 30 mpg by 2016.

These fuel standards are the implementation of a law proposed by President Bush in January 2007, and passed by (a Democratic majority) Congress and signed by President Bush in December, 2007. The Bush Administration developed rules to implement the law and brought them right up to the goal line, but did not finalize them before the end of the Administration.The Obama Administration has now significantly modified the Bush rules.

Technically the Administration is today announcing that they will release a new proposed rule. While the news coverage makes it sound like this is a done deal, this is the beginning of a regulatory process, not the end. Still, the starting point is extremely important.

In developing the Bush proposal, NHTSA developed six options. I will show you four of those. Conveniently, what we know about President Obama’s proposal lines up almost perfectly with one of those options. This allows us to use NHTSA analysis of this option to make some initial estimates of the effects of the President’s new proposal. As always, you can click on the graph to see a larger version.

CAFE comparison

This graph shows the fuel economy requirements, in miles per gallon (mpg), for a nationwide fleet average. In actuality there will be two standards, one for cars and one for light trucks (SUVs are light trucks). It gets even more complex than that, because the standard adjusts for vehicle footprint (the shadow made by the vehicle when the sun is directly overhead). This incorporates an element of vehicle size in the requirement as a proxy for safety. If everyone just moved to tiny little vehicles, we would get much better fuel economy, but we would also have more highway fatalities. So the NHTSA methodology balances fuel efficiency and safety. The “S” in NHTSA stands for Safety. For reasons that I fail to understand, safety sometimes gets taken for granted in the Beltway policy debate relative to fuel efficiency, environmental benefits, and economic costs.

The four lines are from NHTSA’s analysis for the rule that we (the Bush Administration) did not quite finalize:

  • Green is the baseline – what the standard would be if the Administration did nothing.
  • Yellow shows the Bush proposal. This line is the result of a methodology that tries to maximize net societal benefits (= total societal benefits minus total societal costs).
  • Blue shows a different methodology, in which the standard is raised until total societal costs equal total societal benefits, so net societal benefits equals zero. This is the highest you can go before the model says that the rule is making society (in the aggregate) worse off, taking into account all costs and benefits. This line and option are labeled TC=TB.
  • The red line is the extreme upper end of what NHTSA thinks can be done if all manufacturers use every fuel economy technology available, without regard for cost. No one suggests it is a viable policy option, but it is a useful reference.

The purple dot is what we know about the Obama proposal. We only have a 2016 figure, which is conveniently right in line with the TC=TB option analyzed by NHTSA last year. So I’m going to make an assumption that the Obama proposal roughly matches this blue line in the intervening years. When I compare the separate numbers we have from the Administration for cars and light trucks with the six NHTSA options, they line up in a similar fashion with the TC=TB option, reinforcing my view that this is a solid assumption. This means I will use the NHTSA estimates of the TC=TB blue line option as a proxy for the effects of the Obama proposal. Technically, someone can quibble that it’s not precisely identical, but until I see data to the contrary, that’s just quibbling.

This means the Administration can dismiss the entire analysis that follows by saying their proposal differs from the TC=TB option. I cannot disprove such a claim if they make it, but my response would be, “How different? Show me.” I feel quite comfortable using this option for my own analysis, and will do so until presented with an alternate set of numbers by the Administration. (I helped coordinate much of this policy process for President Bush in 2007 and 2008.)

Here are ten things you might want to know about President Obama’s new fuel economy proposal. I will reference some tables and analysis from the NHTSA analysis done for the near-final Bush rule. This is a long list, so this summary will let you skip around as you like:

  1. It’s aggressive.
  2. Rather than maximizing net societal benefits, this proposal raises the standard until (total societal benefits = total societal costs), meaning the net benefits to society are roughly zero. This is not an invalid framework for making a policy decision, but it is unusual. It represents a different value choice.
  3. NHTSA estimated that a similar option would cost almost 150,000 50,000 U.S. auto manufacturing jobs over five years.
  4. NHTSA guesses that under a similar option, manufacturers will make huge increases in dual clutches or automated manual transmissions, a big increase in hybrids, and medium-sized increases in diesel engines, downsizing engines, and turbocharging.
  5. It will have a trivial effect on global climate change.
  6. The national standard = the California standard (roughly).
  7. The auto manufacturers got rolled by the Governator.
  8. Granting the California waiver means California has leverage for next time.
  9. In Washington, EPA is now in the driver’s seat, not NHTSA.
  10. Today’s action will accelerate EPA’s regulation of greenhouse gas emissions from stationary sources. While Congress is futzing around on a climate change bill, EPA is getting ready to bring their “PSD” monster to your community soon.

1. It’s aggressive.

You can see this from the graph above. Within the Bush Administration we considered a range of options that would raise average fuel economy by between 1% per year and 4% per year. Our near-final rule would have raised this combined car/truck average about 4.7% per year from 2010 through 2015. My math shows that the Obama proposal would raise this same measure about 5.8% per year through 2016. That’s really aggressive. (In this post all years are Model Years for vehicles.)

Note: The press is reporting that Team Obama says they’re doing about +5% per year. They’re measuring starting in 2011.I use 2010 so I can compare Bush and Obama.

2. Rather than maximizing net societal benefits, this proposal raises the standard until (total societal benefits = total societal costs), meaning the net benefits to society are roughly zero. This is not an invalid framework for making a policy decision, but it is unusual. It represents a different value choice.

The NHTSA analyses look at a range of benefits to society, including economic and national security benefits from using less oil, health and environmental benefits from less pollution, and environmental benefits from fewer greeenhouse gas emissions (this is new). They also consider the costs, primarily from requiring more fuel-saving technologies to be included by manufacturers. NHTSA assumes these increased costs are passed on to consumers. More expensive cars mean that fewer cars are sold, which means that fewer auto workers are needed. NHTSA calculates economic costs to car buyers and to society as a whole, and job losses among U.S. auto workers.

A standard rule-making methodology is to look at all the costs to society, and all the benefits, and make them comparable (by converting them into dollar equivalents). You then ask, What policy will maximize the net benefit to society as a whole, taking into account all costs and benefits? This is the approach NHTSA used in building the yellow line.

The blue line represents a different approach. (See the TC=TB line on Table VII-6 on page 613 of the NHTSA analysis.) You take the same analysis of costs and benefits, but instead ask, How much can we increase fuel economy before the costs to society as a whole outweigh the benefits to society as a whole? This results (in theory) in no net benefit (and no net cost) to society, but allows you to maximize the fuel economy subject to this constraint.

The Obama Administration’s numbers are in line with this latter approach. It’s not wrong. The Obama approach is quite different. It represents a different value choice, in which a higher priority is placed on the benefits of increased fuel economy, and lower priorities are placed on increased costs to car buyers and job loss in the auto industry.

3. NHTSA estimated that a similar option would cost almost 150,000 50,000 U.S. auto manufacturing jobs over five years.

Update: I was sloppy and missed the note on page 585 which said that table VII-1 shows cumulative job losses. Thus, the total over five years is 48,847 (which I’ll write as “almost 50,000″), and not the 148,340 I earlier calculated. I apologize for the error, and thank James Kwak for catching my mistake.

See Table VII-1 on page 586 of the NHTSA analysis. NHTSA estimated that the TC=TB option, which I’m using as a proxy for the Obama plan, would result in the following job losses among U.S. auto workers:

MY 2011

MY 2012

MY 2013

MY 2014

MY 2015

5-yr total

8,232

24,610

30,545

36,106

48,847

148,340

Compared to the Bush draft final rule, this is 118,000 37,000 more jobs lost.

Since I know this table is inflammatory, I will anticipate some of the responses:

  • This is an estimate for the job loss from the TC=TB option analyzed by NHTSA in 2007. This is the closest proxy for the Obama rule, and I’m convinced it’s a good proxy until someone demonstrates otherwise. But technically, it’s not a job loss estimate for the Obama proposal.
  • This estimate was done in a different economic environment (late 2008), and before the U.S. government owned 1.5 major U.S. auto manufacturers. My guess, however, is that these changed conditions should push the estimated job loss up from the above estimate, rather than down.
  • There’s a false precision in the above table. It’s just what NHTSA’s model spits out. I draw this conclusion: The Obama plan will increase costs enough to further suppress demand for new cars and trucks. This will cause significant job loss, and probably in the 150K 40K range over 5-ish years, with a fairly wide error band. I don’t put any weight on the precise annual estimates.

4. NHTSA guesses that under a similar option, manufacturers will make huge increases in dual clutches or automated manual transmissions, a big increase in hybrids, and medium-sized increases in diesel engines, downsizing engines, and dialing back turbocharging.

NHTSA does a detailed analysis of the costs of new technologies to improve fuel efficiencies, and they talk to the manufacturers and examine their product plans. They then guess what technology changes the manufacturers might make to comply with a higher fuel efficiency standard. Here are their estimates for increased penetration in MY 2015 for various technologies under the TC=TB / Obama proxy option. This is from Table VII-7:

Baseline

TC = TB

(Obama proxy)

Increased penetration

Dual clutch or Automated manual transmission

8%

60%

+52%

Hybrid electric vehicles

0%

24%

+24%

Turbocharging & engine downsizing

11%

24%

+13%

Diesel engines

0%

12%

+12%

Stoichometric gasoline direct injection

30%

39%

+9%

It would be great it if a commenter could educate us a little on these technologies.

5. The proposal will have a trivial effect on global climate change.

I always chuckle when elected officials boast about the number of tons of carbon that a policy proposal will not inject into the atmosphere. The White House is doing so today, emphasizing “a reduction of approximately 900 million metric tons in greenhouse gas emissions.” That sounds like a a lot, but who the heck knows?

We are fortunate that NHTSA analyzed the climate effects of all six options in terms more amenable to our comprehension.Here are their estimates for baseline, the Bush option, and the TC=TB (Obama proxy) option. This data is from Table VII-12 in the NHTSA analysis:

CO2 concentration (ppm)

Global mean surface temperature increase (deg C)

Sea-level rise (cm)

2030

2060

2100

2030

2060

2100

2030

2060

2100

Baseline

455.5

573.7

717.2

0.874

1.944

2.959

7.99

19.30

37.10

Bush

455.4

573.2

716.2

0.873

1.942

2.955

7.99

19.28

37.06

TC=TB(Obama proxy)

455.4

573.0

715.6

0.873

1.941

2.952

7.99

19.27

37.04

OK, this still doesn’t mean a lot to me. Let’s take some more data from the same NHTSA table, and see the change from the baseline of not raising fuel economy standards at all. Now we can see the direct climate benefits of these proposals:

CO2 concentration (ppm)

Global mean surface temperature increase (deg C)

Sea-level rise (cm)

2030

2060

2100

2030

2060

2100

2030

2060

2100

Bush

.1

-.5

-1.0

-.001

-.002

-.004

0

-.02

-.04

TC=TB (Obama proxy)

.1

-.7

-1.6

-.001

-.003

-.007

0

-.03

-.06

Ah ha! This is useful information. As you can see, the effects are trivially small:

  • Both options would reduce the global mean surface temperature by one-thousandth of one degree Celsius by 2030. The Obama option would reduce the global temperature by seven thousandths of a degree Celsius by the end of this century.
  • The effects on sea level are too small to measure by 2030. By 2100, the Obama proposal (technically, the TC=TB proxy) would reduce the sea-level rise by six hundredths of a centimeter. That’s 0.6 millimeters.

Hmm. That’s not too much, especially when you consider this is the policy that will affect the #2 source of greenhouse gas emissions in our economy. (#1 is power production.)

In anticipation of some pounding by the climate change crowd:

  • These are NHTSA’s calculations using the MAGICC model, not mine. I’m just reporting their results.
  • If you have different estimates, I’m happy to consider posting them for comparison. I am less open to arguments about why the MAGICC model is wrong, or why NHTSA’s inputs into that model are wrong. I don’t know the model well enough to debate the points.

Again, the point is not the precise estimates. It’s the order of magnitude. Please don’t tell me this model is flawed. If you disagree with these calculations or this model, give me some numbers you think are better, and that lead to a different conclusion.

Imagine if the President had instead said today, “This new fuel economy and greenhouse gas emissions rule will slow the increase in future global temperature seven thousandths of a degree Celsius by the end of this century, and it means the sea will rise six tenths of a millimeter less than it otherwise would over the same timeframe.” It loses some of its punch, no?

Similarly, when the Supreme Court pushed in Massachusetts v. EPA toward regulating greenhouse gases from new cars and trucks to protect the public health and welfare from “endangerment,” I wonder if they understood that an aggressive proposal would reduce the future sea level increase by 0.6 mm?

6. The national standard = the California standard (roughly).

Technically, the Administration will be setting two standards: one for fuel economy, and another for CO2 emissions from tailpipes. In theory, the two will (basically) match up, hand-waving past a lot of second-order things like flexible fuel vehicle credits and new vehicle air conditioning standards.

During the Bush Administration there was a tussle between California and the federal government. California wanted a waiver to be able to set their own standards for CO2 emissions from cars and light trucks. Another 13 or so States wanted to follow a new California standard. The proposed California standard was significantly more aggressive than anything discussed in Washington.

We argued that having multiple emissions standards would be inefficient. Auto manufacturers would then have either to make cars to meet two different standards, or just dial up the fuel efficiency on all vehicles, so that the California standard would become the de facto national standard.

The President resolved this today by (basically) setting one national standard for fuel economy, and a roughly parallel standard for CO2 tailpipe emissions, that approximate the higher California standard. California is happy that they got their higher numbers. The auto manufacturers avoid the inefficiencies of multiple standards, while having to eat (actually, pass on to customers) the higher costs of making even more fuel efficient vehicles.

7. The auto manufacturers got rolled by the Governator.

The heads of several auto manufacturing firms stood with the President today and smiled. They lost this fight. They pushed incredibly hard during the 2007 legislative battle, and during the subsequent regulatory process, for a fuel economy standard that rose about 2% per year. They dug in hard against a growth rate greater than 3% per year, and told us that 4% per year would destroy them. Our near-final rule averaged about 4.7% per year. The Obama rule averages about 5.8% per year. Either way, this is way, way more than the auto manufacturers wanted.

They had no leverage, of course, and an outcome similar to this was predictable after the November election. So they’re putting the best face they can on it. Interestingly, the press statement from Ford CEO Alan Mulally does not say that he endorses the specific numbers proposed by the President, but instead (emphasis is mine):

Today’s announcement signals the achievement of a crucial milestone - an agreement in principle on a national program for increased fuel economy and reduced greenhouse gases.

This national program will allow us to move forward toward final regulations that all stakeholders can support. We salute the cooperative efforts of the Obama Administration, the state of California, environmental groups and others that played a constructive role in this process.

The framework of the national program will give us greater clarity, certainty and flexibility to achieve the nation’s goals. We will continue to work with the federal agencies to finalize the standards that we are committed to meeting.

Tip for reporters: Ask Ford (and the other manufacturers) if they support the specific numbers proposed by the President today. The statement above is trying to leave Ford wiggle room to argue for smaller numbers in the rulemaking process. If the auto manufacturers wiggle, then you have a repeat of the situation from last week’s health care announcement.

And of course, 1-2 of the U.S. auto manufacturers are now controlled by the U.S. government.

8. Granting the California waiver means California has leverage for next time.

As I understand it, the Administration is technically granting California its EPA waiver, and California has agreed not to invoke it for this process (MY 2011 – MY 2016). Assuming the waiver doesn’t get un-revoked (can it be?) by a future Administration, this means that next time around California will begin the process with the authority to set its own tailpipe emissions standard.

This means that, when we do this again in about five years, California holds all the cards. To quote the Governor in another context (wait for it), “Ill be back.” California will have leverage to set its own standard, which means they can again dictate the national standard. The Obama Administration has moved the primary decision-making locus for future vehicle fuel efficiency rules from Washington DC to Sacramento.

9. In Washington, EPA is now in the driver’s seat, not NHTSA.

The Administration has said there will be two rules. NHTSA will set a fuel economy rule, and EPA will set a tailpipe emissions rule. We know that EPA will always be more aggressive than NHTSA. This means that, to the extent Washington remains involved in future standards (see #8 above), the primary decision-maker becomes EPA rather than NHTSA, since auto manufacturers will have to comply with the more aggressive of the two. NHTSA does not become irrelevant, but the bureaucratic strength is definitely shifting.

This bureaucratic power shift suggests a higher priority will be placed in the future on environmental benefits, and a lower priority on economic costs and safety effects, as we see with today’s proposal.

10. Todays action will accelerate EPA’s regulation of greenhouse gas emissions from stationary sources.While Congress is futzing around on a climate change bill, EPA is getting ready to bring their “PSD” monster to your community soon.

EPA is in the midst of taking comments on an “endangerment finding” that is a huge deal in the climate change policy world. If the EPA Administrator finds that greenhouse gas emissions from new cars and trucks “endanger public health and welfare,” then it starts a regulatory process. It appears the President is prejudging the result of this regulatory comment process:  “the Department of Transportation and EPA will adopt the same rule.”

As a former colleague has taught me, a proposal to regulate greenhouse gases (under section 202 of the Clean Air Act) would greatly accelerate when greenhouse gases become “subject to regulation” under the Clean Air Act. This would trigger ramifications that reach far beyond cars and trucks. As early as this fall, greenhouse gases could become “regulated pollutants” under the Clean Air Act. Once something becomes a “regulated pollutant,” a whole bunch of other parts of the Clean Air Act kick in, and EPA is off to the races in regulating greenhouse gases from a much (much) wider range of sources, including power plants, hospitals, schools, manufacturers, and big stores.

One of the scariest elements of this is called the “Prevention of Significant Deterioration” permitting system. In effect, EPA could insert itself (or your State environmental agency) into most local planning and zoning processes. I will write more about this in the future. It terrifies me.

Thanks for making it to the finish line!

Third party payment in health care (part 3): Technology drives cost growth

Third party payment in health care (part 3): Technology drives cost growth

Imagine that Sony plans to bring to market a new TV that is twice as good as the old $500 TV but costs $200 more to produce. If instead it is twice as good but costs $2,000 more, they will probably hold off and look for a less expensive way to improve quality.

Now imagine that TV insurance covers 90% of the incremental cost, so the consumer only sees a price increment of $200 for a TV that costs $2,000 more to make. You, and many others, would demand this new TV, which is high quality but probably low value for you, since the true incremental cost is probably more than you’re willing to pay for that quality increase.

Knowing this, Sony will likely make lots of new high-tech TVs, and will expand their R&D programs to push the limits of TV quality improvement. They won’t care much about the higher costs, because demand for any new quality-improving technology is increased by the presence of TV insurance.

This is likely to be true even if you were also told that your TV insurance premium comes out of your wages, because the cost of that insurance depends mostly on how many of your work colleagues buy new and better TVs. In addition, that insurance premium is both hidden to you and distant when you’re at the store buying the TV.

Americans would have the best TVs in the world, and companies would compete based on who can produce the highest quality TVs, almost regardless of cost.

We don’t have TV insurance today, and yet TV quality improves fairly rapidly. The market, as an aggregated collection of individual purchasing preferences, determines a balance of improved quality and high cost that results in “high value technology improvements.” Sony and its competitors try to meet the demand for high value technology improvements, rather than for any technology improvements without regard to cost.

The hidden nature of employer-provided health insurance and the tax subsidy for that insurance distort people’s decisions so that they purchase health insurance with low deductibles and high premiums. This encourages us to use lots of health care without too much regard for the cost of that care.

In her testimony before the Senate Finance Committee, Kate Baicker explained why insurance causes greater consumption of health care:

Insurance, particularly insurance with low cost-sharing, means that patients do not bear the full cost of the health resources they use. … The RAND Health Insurance Experiment (HIE), one of the largest and most famous experiments in social science, measured people’s responsiveness to the price of health care. Contrary to the view of many non-economists that consuming health care is unpleasant and thus not likely to be responsive to prices, the HIE found otherwise: people who paid nothing for health care consumed 30 percent more care than those with high deductibles. This is not done in bad faith: patients and their physicians evaluate whether the care is of sufficient value to the patient to be worth the out-of-pocket costs.

This is why Kate (and I, having learned from Kate) talks about “high value health care.” As a policy matter, we should not want to encourage people to use either more or less health care. We should instead want people to be free to choose high value health care without distortion, in which each person decides how to get the greatest value per dollar spent and what is the right balance of improved quality and higher cost.

Everything that I have explained so far about third party payment in health care contributes primarily to a high level of health spending. None of these factors alone, however, explain the extraordinary growth of health spending. This is where we grasp the rose by the thorn: the primary driver of long-term health care cost is technology. America spends more on health care each year primarily because we demand more and better health care each year. We just don’t know that we’re demanding it, because government policies push us toward high-premium low-deductible health insurance that increases our demand for high-quality but low-value technology improvements.

In January of 2008, the Congressional Budget Office reviewed three studies of the sources of cost growth in real per capita health care spending in the U.S. Here is their summary of two of the studies in chart form. (The third study had ranges and was too difficult to graph. It assigned a range for technology of between 38% and 62%.)

health cost growth graph

You can see that technology explains half to two-thirds of the long-term growth in real per capita health spending. Another 10-13% is the direct result of changes in third-party payment that further insulate us from the cost of the medical care we use (mostly the creation of Medicare and Medicaid).

There are two points here:

  1. Our employer-based health insurance system hides the cost of premiums and subsidizes those premiums. This encourages those with employer-provided health insurance to ignore some of the higher premium costs, and pushes us toward policies with low deductibles and copayments (at the expense of higher hidden subsidized premiums). These low deductible policies encourage us to use low value health care and result in unsustainably high and rapidly growing insurance premiums that crowd out wage growth.
  2. These low deductible policies also reduce our sensitivity to the costs of new medical technologies. We choose improved technology without proper regard for whether that technology is worth the higher cost, because government policies are distorting our decisions.

According to the two studies shown above, the interaction of these two factors is responsible for 2/3 to 3/4 of health care cost growth. This is where we get to the politically uncomfortable part.

  • Health care costs are on an unsustainable path. We must slow the growth of those costs.
  • 2/3 to 3/4 of health care cost growth comes from policies that push us toward low deductible policies and cause us to demand technology improvements without much consideration of the cost of those improvements.
  • Any solution that addresses the “change in third-party payment” source of cost growth will mean that people pay more out-of-pocket when they go to the doctor or hospital. In exchange they will get lower premiums. Still, this higher out-of-pocket spending is higher for some politicians to swallow (especially Democrats).
  • Any solution that addresses the technology source of health care cost growth will mean that new medical technologies will be developed less rapidly.

Nobody in Washington wants to tell you that last point. We argue about administrative costs, about medical liability costs, about insurance company profits, and about waste, fraud, and abuse. All of those are important contributing factors to high levels of health spending, and we should definitely make reforms that try to lower those levels. But our long-term problem is principally about the growth rate, and addressing the growth rate involves a real tradeoff. New medical technologies and drugs will still be developed, but not quite at the breakneck rate that we’re used to. This is grasping the rose by the thorn.

The only question left then becomes who will make those determinations. Should determinations of “high value health care”and “high value technology improvements” be made by the government, or as the result of the decisions of millions of Americans acting independently based on their own preferences?

You can probably guess my answer.

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