Medicare's Mythical Administrative Cost Savings

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The title of this post is going to make some of my readers very angry.  Medicare has lots of administrative cost savings, they will say.  This may be so.  But I mean mythical in another sense:  there's ultimately no way to prove or disprove these amazing savings.  The problem is indeterminate.

Jon Cohn, who I respect greatly, spends a lot of time on the money and time that insurance companies put into denying claims.  This is undoubtedly true.  But I have two caveats.  First, some of that effort is a good thing:  without it, there would be fraud.   No, not the automatic denials so many insurers are fond of, and I'm not defending.  But Medicare should probably spend a lot more effort rooting out excessive billing. And I don't know what percentage of claims denial consists of refusing to line the pockets of doctors and labs.

But the more important point is that I doubt this is the majority of their administrative costs, or even the difference between their administrative costs and Medicare's.  I'm not trying to justify the bullshit automatic claims denial, but that's not actually a very costly process:  a hospital submits a bill, they deny it, you yell at them.  Nor is refusing to cover people with pre-existing conditions, or any of the other multifarious complaints of single-payer advocates.

Rather, private insurers have costs that Medicare doesn't have within the agency.  Private insurers bill.  Medicare does too, but the IRS has its own budget--hell, its own courts--which don't show up on Medicare's balance sheet.  Private insurers negotiate with suppliers.  Medicare does too, but most of the negotiation takes place between lobbyists and Congressmen who again, do not show up on Medicare's balance sheet.  The Federal government has all sorts of these little items which relieve government agencies of reporting certain costs.  But the costs remain.

My guess would be that these explicit costs are still lower than Medicare's.  But then there are implicit costs to government fiat that markets don't have.  As Tyler Cowen points out, taxation has deadweight losses, and Medicare is a tax on employment, which is something we are particularly anxious not to suppress right now.

The final point is that while people commonly think of administrative costs as "wasted", in fact, they are an important part of the market system.  As Alex Tabarrok points out, and I have myself from time to time, many of the arguments in favor of national health care are literally socialist.  And no, I am not using that term to apply to "anyone who is in favor of redistribution" or "government programs".  But consider the following common arguments:

  • National health care will be cheaper because we will reduce administrative overhead
  • National health care will reduce wasteful competition in the form of me-too drugs
  • National health care will reduce wasteful competition in the form of advertising and other marketing expenses
  • National health care will allow us to rationally distribute care to where it does the most good rather than the current messy, wasteful hodge-podge
  • National health care will use resources for production instead of profits
  • National health care will achieve economies of scale in purchasing and record-keeping
  • People will not overuse free goods because there are hard limits to desired consumption

These were all arguments advanced in favor of socialism.  Contrary to popular conservative belief, socialists were not unfamilier with either the incentive problems of communism (people will not work hard if there's no benefit to doing so) or the Hayekian argument about the value of prices, aka the Socialist Calculation Problem.  Rather, smart socialists thought that they could overcome these problems with a combination of status competitions (Hero of the Soviet Union, Second Class) and massive efficiencies gained by wringing all that fragmented, wasteful competition out of the system.  Economists who would be ashamed to make these sorts of arguments about Proctor and Gamble or the used car market suddenly start parroting these things as if they hadn't been thoroughly discredited by the last seventy years.

But why were they discredited? That list looks really, really good on paper, even to my jaded libertarian eyes.  A lot of the answer lies in the reason that we don't like monopolies--even though that list is just as true of monopolies as it is of the government.  Monopolies, government or private, are risk averse, slow to innovate, and generally run things for the benefit of themselves rather than their customers.  Hamstringing them with regulations can limit measurable outcomes, like excess profit-taking, but not unmeasurable ones, like the people who might have been cured by a drug the system didn't invent.  And the political system introduces its own problems.  As Robert Heinlein pointed out years ago, systems that have only positive feedback loops tend to fail catastrophically.

My critics will want me to explain why, then, Europe can do it cheaper.  The answer is threefold.  First, most European nations have better governance than we do--the American political system is a Public Choice disaster.  Second, they pay people less money in a way that's hard to replicate here (and even if it wasn't, would be a one time savings that wouldn't check the rate of growth).  Third, we're still driving quite a bit of product innovation.  Our messy, organic, wasteful, unfair, irrational system allows experimentation, and they cherry pick the best results.  If we stopped doing this, their system would stop looking so good.

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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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