What Is the Effect of a Price Increase?

What is the effect of a price increase?  The conventional answer that quantities consumed will decrease along a demand curve doesn’t always apply in health care.  The question isn’t even answerable without describing which price is being increased and specifying the mechanism for the price increase.  The price of a medical product or service usually means the price paid by insurers, along with the copayment and other out-of-pocket payments by the consumer.  But the copayment may be a small part of the total, and the copayment may not rise at all with a price increase.  An increase in the price the manufacturer charges for a drug, whether it’s branded or generic, typically will not result in an increase in the out-of-pocket cost to the consumer if the drug remains in the same tier of a tiered formulary.  It is the very lack of price sensitivity that is able to support such high prices for biological products used to treat cancer.

The price that matters for consumption, of course, is the price faced by consumers.  High-deductible health plans are designed to increase the price directly paid by individuals for the care they consume.  It is still too early to know whether high-deductible plans drive consumers to make better health care choices.  But price increases of this kind are generally unachievable in traditional Medicare.   If Medicare copayments are increased in an effort to increase the price faced by the consumer, much of the time there will be no effect on consumption, because most Medicare beneficiaries have supplemental insurance that pays for a large share of Medicare copayments and deductibles.  It’s not clear how the Centers for Medicare and Medicaid Services could raise the prices faced by beneficiaries who have a second layer of insurance coverage.

Capping or eliminating the tax exclusion for health insurance would be one way to increase the effective price of insurance, and it would undoubtedly diminish the incentives to consume too much care.  But considering the uproar over any attempt to limit the tax exclusion for health insurance — think of President Bush’s proposal to cap the exclusion at $15,000 for families and $7,500 for individuals — this does not seem to be a policy that will go anywhere.  It would have better chances if it were linked to features that ensured that patients who could derive a great deal of benefit from high-value treatments would continue to get them.  And that requires changes in benefit design, not changes in the tax treatment of health insurance.

So developing a policy to raise prices faced by consumers, and to ensure that it has the desired incentive effects, is a tall order.  It’s better to do it the right way — selectively — than crudely.  I don’t think that changes in reimbursement that would lead to selective reduction in low-value services are beyond our reach, even though we are still learning about the best approaches.  I’m not sure what “simple crude cuts” mean, but if they’re not well placed, adverse health effects are inevitable and could be large, and are likely to be experienced first by the most vulnerable populations.  The complexity of redesigning insurance is a small problem compared to the consequences of ill-directed spending cuts.

Also from This Issue

Lead Essay

  • Cut Medicine in Half by Robin Hanson

    In this month’s lead essay, the iconoclastic George Mason economist Robin Hanson argues that “our main problem in health policy is a huge overemphasis on medicine.” Hanson points to a spate of studies – especially the huge RAND health insurance experiment – to show that “in the aggregate, variations in medical spending usually show no statistically significant medical effect on health.” Hanson lays down the gauntlet and “dares” other health policy experts to publicly agree or disagree with this seemingly well-confirmed claim and its implications for policy. For Hanson, those implications are clear: “Cutting half of medical spending would seem to cost little in health, and yet would free up vast resources for other health and utility gains.”

Response Essays

  • Use a Scalpel, Not a Meat Cleaver by David M. Cutler

    Harvard’s David M. Cutler agrees with Robin Hanson’s claim that “a lot of medical spending doesn’t add much value.” However, he is “surprised by Hanson’s argument that this hasn’t been much noted,” pointing to major media coverage of this point and to his own work. According to Cutler, Hanson’s argument is “too simplistic,” suggesting that people in 1975 were better off with half today’s average medical spending. New technologies are both very successful and very expensive, and Cutler argues this extra cost is worth it. Citing research that demand-side approaches to cutting wasteful spending, such as raising consumer prices, are ineffective, Cutler plumps for a supply-side approach: “invest in information technology, monitor what physicians do, and pay providers more for better care than for less good care.”

  • Half Right by Dana Goldman

    Robin Hanson is half right, says Dana Goldman, the RAND Chair of Health Economics and Founding Director of RAND’s Bing Center for Health Economics. Medicine can only do so much, and most recent increases in longevity are the effect of healthier habits and living conditions, Goldman says. However, Goldman notes, the RAND Health Insurance Experiment, which Hanson leans on, is more than thirty years old, and many new therapies have emerged since then. In particular, new drugs have been shown to have a large impact on health. Patients required to pay for more of their care often cut out what they neeed, not what they don’t. Improved living conditions may do more for future health than more medicine, Goldman suspects. “But it may also turn out society should be spending more, not less, on medical care – just doing so in a more prudent manner.”

  • Watch Where You Cut by Alan Garber

    According to Alan Garber, the Henry J. Kaiser, Jr. Professor at Stanford, “Hanson’s diagnosis … is not particularly controversial. His solution is.” Efforts to trim excess medical spending must confront the highly variable benefits of certain medical treatments. Garber argues that Hanson’s eagerness to implement cuts, largely regardless of the details, risks cutting high-value treatments along with lower-value ones. According to Garber, what we need, first, is more and better information about the value of particular interventions. Second, we need incentives not to guide people away from overconsumption generally, but to guide them away from low-value care. Third, we need to increase the sensitivity of consumers to the costs of their health care by exposing them more to prices. Improved information and education, Garber says, will help consumers choose wisely.