Just How Wrong Is Conventional Wisdom About Government Fraud?

I’ll never forget the day after Christmas 2005, standing alongside my car, which was tilted at a 45-degree angle in the ditch that passed for a curb alongside a pitted, crumbling road. As the sky darkened, not a light glowed anywhere within sight; neither a single police car nor any other sign of public authority appeared for hour after gloomy hour. I was in post-Katrina New Orleans.

I’d been asked by the State of Louisiana to advise on the design of programs to aid homeowners dispossessed by the hurricane -- what ultimately became known as the “Road Home” program. I don’t claim to know much about housing policy, but I do know about the ways governments screw things up. I quickly recognized a classic case in the making.

The receding waters in the Gulf had left behind the conditions for a perfect storm of fraud: hundreds of thousands of poor people clamoring for billions of dollars of federal aid that needed to get out the door as quickly as possible. As a result, post-Katrina discussions were shaped by the perceived need to ensure multiple safeguards and to move slowly in releasing the intended aid.

I thought that was backward. If the money were made more easily available, there would have been more fraud. But if the program had stated upfront that ill-gotten gains would be met with fierce investigation and prosecution on the back end, it could have distributed the cash faster, enabling more people to rebuild their homes, and their lives, much quicker. Instead, it was two to three years before most victims started receiving any money. Two and a half years after the storm, nearly 40 percent still had not received a cent.

Meanwhile, there was fraud anyway. The federal government reported about $500 million of it -- or a little less than 10 percent of the total aid payout. Most of this wasn’t undeserving poor people ripping off the system just so they could get a new house in one of the grimmest neighborhoods in the country. More frequently, it was undeserving middle-class people ripping off the system to pocket the money for themselves. It turns out fraud was rampant among officials at government agencies and even charities. The resulting federal report was so scathing that some of these folks actually gave back $18.2 million in fraudulent gains; no one knows how much more disappeared. Those who did properly receive payments were often ripped off by shifty contractors and, as a result, never able to rebuild their homes.

None of this was unique or unpredictable, however -- because the problem with fraud isn’t government programs or beneficiaries. It’s that fraud losses are a cost of doing business in just about everything.

According to the Association of Certified Fraud Examiners (ACFE), the typical business loses 5 percent of its revenue to fraud each year. Even when detected, 40 to 50 percent of victimized companies don’t recover their losses. The industries most likely to be victims of fraud are the banking and financial sector; government and public administration; and manufacturing. I can’t quite figure why manufacturing is on the list, but it’s easy to conjecture that banks and governments are frequent targets of fraud because they’re in the business of handing out money. But as ACFE reports -- and as we just saw in the Katrina example -- it’s usually managers and executives who commit the worst fraud. 

It’s not easy to get agreement on actual fraud levels in government programs. Unsurprisingly, liberals say they’re low, while conservatives insist they’re astronomically high. In truth, it varies from program to program. One government report says fraud accounts for less than 2 percent of unemployment insurance payments. It’s seemingly impossible to find statistics on “welfare” (i.e., TANF) fraud, but the best guess is that it’s about the same. A bevy of inspector general reports found “improper payment” levels of 20 to 40 percent in state TANF programs -- but when you look at the reports, the payments appear all to be due to bureaucratic incompetence (categorized by the inspector general as either “eligibility and payment calculation errors” or “documentation errors”), rather than intentional fraud by beneficiaries.  

A similar story emerges with everyone’s favorite punching bag, food stamps (or, as they’re known today, SNAP). Earlier this year, Senator John Thune of South Dakota and Rep. Marlin Stutzman of Indiana, both Republicans, introduced legislation to save $30 billion over 10 years from SNAP, purportedly by “eliminating loopholes, waste, fraud, and abuse.” Once you dig into their fact sheet, however, none of the savings actually come from fraud, but rather from cutting funding and tightening benefits. That’s probably because fraud levels in SNAP appear to be as low as with the other “pure welfare” programs we just touched on: “Payment error” rates -- money sent in incorrect amounts and/or to the wrong people -- have declined from near 10 percent a decade ago to 3 to 4 percent today, most of it due, again, to government error, not active fraud. The majority of food-stamp fraud appears to be generated by supermarkets “trafficking” in the food stamps. Beneficiaries intentionally ripping off the taxpayers account for perhaps 1 percent of payments.

No one knows for sure how much Medicaid and Medicare fraud there is. According to the FBI, the cost for Medicare fraud is anywhere from 3 to 10 percent, while Attorney General Eric Holder estimates $60 to $90 billion in fraud in Medicare and almost the same amount in Medicaid fraud -- approaching 20 percent. While nowhere near as large as Medicare and Medicaid, the Supplemental Security Income (SSI) and Social Security Disability Insurance (SSDI) programs are each estimated to be paying about 10 percent of their expenditures in fraudulent claims.

To round out the picture, you can toss in defense contractor fraud -- perhaps as much as another $100 billion per year, roughly in the same range as Medicare and Medicaid combined. All told, fraud in federal programs may come to $300 billion a year or about 10 percent of the budget (as with financial services). Simply cutting that in half, to the average fraud levels in the private sector -- which, as we’ve seen, the federal government has done in recent years with error rates in SNAP – would achieve as much in savings as the entire sequester. Fraud doesn’t consume government, and eliminating it -- as I previously discussed with waste -- won’t solve the deficit problem.

But it would help. A number of techniques have been developed for identifying fraud and its perpetrators:

• Tap the profit motive. Florida uses private-sector audits conducted in return for a portion of the money recovered from fraudsters.
• Cross-reference benefit-recipient lists. Cross-referencing databases of social benefit recipients can cut down on fraud, such as recipients who did not disclose income from one programs that would make them ineligible for another; prisoners collecting benefits to which they are no longer entitled, like unemployment; or those who are simply dead.
• Use new technologies. Artificial-intelligence detection systems are programmed to learn normal billing patterns and identify aberrant billing activities. The systems can also identify collusion between provider networks.
• Do it the old-fashioned way -- just more. Research has shown that the typical anti-Medicaid-fraud worker recovers, on average, $200,000 per year. As unpopular as it is to say, sometimes hiring more government workers saves taxpayer money.
• Enlist beneficiaries in fighting fraud. This may sound heretical to government-haters, but the fact is that any program’s intended beneficiaries aren’t the problem -- they’re the stakeholders. Road Home beneficiaries reported fraudulent claimants. Medicare and Medicaid patients have been enlisted to spot billing fraud.

And that takes us back to the main point:  For the most part, fraud isn’t the product of scheming low-income beneficiaries -- Mitt Romney’s 47 percent -- living high on the hog on your dime, but rather someone other than the beneficiary standing to make a buck off it. Medicare and Medicaid fraud is largely committed not by patients -- very few people are trying to rip off taxpayers to obtain unneeded spinal taps or root canals -- but by providers: unscrupulous (or sometimes just incompetent) doctors and hospitals billing for procedures the patient didn’t need or didn’t receive. 

A landmark 2012 study in the Journal of the American Medical Association not only found that fraud rates are consistent across both government programs and wholly private health care; it also concluded that a “less harmful strategy” than the “common” approach “to contain costs us[ing] cuts, such as reductions in payment levels, benefit structures, and eligibility” would be to “reduce waste” -- mostly on the provider side. “The savings potentially achievable from systematic, comprehensive, and cooperative pursuit of even a fractional reduction in waste are far higher than from more direct and blunter cuts in care and coverage.”

Combatting fraud requires efforts and investments that target the real perpetrators, not cheap shots at beneficiaries and reflexive cuts in their programs. There are, after all, equal levels of fraud and theft in other fields, most notably finance -- but we don’t try to reduce it by shutting down the entire industry and blaming the customers.