The Danger of Price Controls

Health care markets are less efficient than most other economic sectors for several reasons, but one is crucial: the federal government heavily influences health care prices. Counterproductive new economic proposals from Democratic presidential candidate Kamala Harris would effectively impose new federal price controls, introducing many of the health sector’s inefficiencies throughout the broader economy. In today’s newsletter, I discuss the economics of price controls and their resulting damage. I then discuss the inefficiencies resulting from Medicare’s payment policies and conclude with an analysis of Vice President Harris’s drug pricing and Obamacare policies that extend price controls and wasteful industry subsidies. On that subject, as Vice President Harris lays out her policy platform, my colleague Theo Merkel recently coauthored an analysis of her Medicare for All proposal and an accompanying National Review op-ed.

The Economics of Price Controls

In introductory economics classes, students learn how prices generally coordinate economic activity in an efficient manner. Prices provide information about how much value consumers place on products relative to alternatives, production costs, future expectations, and more. And they provide beneficial incentives. For example, when prices rise, consumers have incentives to economize and search for alternatives and suppliers have incentives to bring more of the product to market.

Politicians, whether in response to adverse outcomes from their inflationary policies or to try to win votes, have in the past enacted price ceilings—maximum prices permitted by law. Price ceilings produce economic chaos. Prices no longer provide information about the relative value of certain products, and incentives disappear for consumers to economize and suppliers to bring more product to market.

Economists are in near universal agreement that price controls produce profound ill effects. See what happened in the Soviet Union or more recently Venezuela. For an intuitive explanation of the damage of price controls, Marginal Revolution University has several videos.

Last week, in an alarming development, Vice President Harris proposed widespread price controls as a centerpiece of her economic agenda. This proposal is a reaction to Americans’ frustration with the inflation of the past four years—inflation caused by policies Harris supported. If, for example, her price controls on groceries are enacted, there would be shortages and rationing of food and increased social division.

Government Price-Setting Abounds in Health Care

Largely through Medicare, Washington sets prices throughout the health sector—a structure that distorts decisions, reduces efficiency, and leads to resources being allocated based on the political power of providers rather than the value to consumers and patients. In 2019, following Senator Elizabeth Warren’s Medicare for All proposal, I wrote about how the federal government distorts health care markets through administrative price-setting:

The federal government currently causes huge market distortions in health care because of the political process underlying how Medicare sets rates. The process brings intense pressure from interest groups, with the process dominated by medical specialists who unsurprisingly secure better rates for themselves at the expense of general practitioners. The political process underpays for certain services, leading to shortages, and overpays for others, leading to excess utilization. Former senior Obama administration official and medical doctor Atul Gawande argues that it is striking that Medicare, a public program largely for seniors, underpays for general geriatric care, evidenced by the fact that the country has far too few geriatricians.

As a result of bias toward maintaining the status quo and risk aversion of regulators, the political process behind Medicare rate setting can result in rates being very difficult to change even as technology improves and better alternatives emerge. This stifles innovation, since the success of any medical innovation depends on Medicare payment policy. That policy, in turn, benefits entrenched interests that thrive under the status quo and resist reforms that threaten existing arrangements they find beneficial.

Medicare’s distortions include paying much higher amounts for equivalent services in hospital outpatient departments or physician practices that hospitals own, rather than independently owned physician practices. This leads to higher bills for patients and taxpayers than necessary and produces large incentives for hospitals to buy physician practices and convert them to hospital outpatient departments, consolidation that both increases prices and decreases quality. Although there is widespread policy agreement for Medicare site neutral payments (see Paragon’s recent event with former Health and Human Services Secretaries Kathleen Sebelius and Alex Azar), the political power of hospitals and general policy inertia has perpetuated a bad outcome. Medicare’s power throughout the health sector is amplified as many private insurers base their payments on Medicare rates, and Medicare Advantage payment rates are typically highly correlated with traditional Medicare rates

Harris’s Counterproductive Health Care Agenda

Vice President Harris’s price control agenda extends to health care. She proposes to expand the power of the HHS secretary to set prices for prescription drugs in Medicare. Earlier this week, my colleague Jackson Hammond analyzed round one of price-setting, concluding that the initial savings have been washed away by a Biden administration bailout of insurers, done to avoid the Part D premium increases that the Inflation Reduction Act’s counterproductive Part D redesign would have caused for seniors right before the election. But the long-run effects of less pharmaceutical research and development and the diminished American health outcomes will remain.

Vice President Harris also proposes to substantially boost direct taxpayer subsidies to health insurers for Obamacare. The original subsidies were necessary because Obamacare’s regulatory structure made individual health insurance unattractive to middle-income people through high premium, high deductible, and narrow network plans.

Democrats in Congress enlarged the subsidies, initially as a temporary COVID-19 measure, making plans free for people who claimed low-income and making subsidies available to people in the top two income quintiles. Harris’s proposal to make these expanded subsidies permanent fits a broader, harmful pattern: government regulation and price controls produce lower quality products, so government then needs to step in with subsidies to get people to buy the product.

Based on what we have learned, Congress should not extend the boosted subsidies and should revert to the original Obamacare levels. The expansion of the subsidies has produced massive fraudulent enrollment and spending (which Paragon has estimated and documented in two papers), severely diminishes smaller employers’ willingness to offer coverage, and gives insurers incentives to increase prices and premiums. Pouring subsidies on favored industries (health insurers have made massive profits from Obamacare) may be a political priority for Vice President Harris, but the American people should reject such cronyism. Policymakers should instead improve incentives for Americans to get value from their health spending, including by permitting lower-income Americans an option to directly receive a health care subsidy to buy the services that best meet their needs, rather than funneling the money directly to insurers.

All the best,

Brian Blase
President
Paragon Health Institute