In Which I Pick a Fight with the Cato Institute

It’s not my purpose here to talk at length about The Cato Institute.


Some people say that it does important work to push towards a free-market ideology in this country to the benefit of all. Others will say that it is a non-scientific political organization controlled by a small group of GOP donors. You can read about it yourself and decide how credible you think they are. I’m just looking at one piece of research they put out; don’t going extrapolating it too far.

Michael F. Cannon is the Director of Health Policy Studies at Cato. As I mentioned, we’ve had a number of interactions on Twitter. I’ve honestly been pleased at his willingness to engage a semi-amateur. He brings up good points of which I hadn’t previously thought. I’ve learned from him and from sources he has referred me to. However, in this exchange we had a fundamental disagreement. I claimed that Medicare/Medicaid (which I’ll jointly refer to as the “Meds” provide health coverage for less than private insurers. He responded that this was “go-home-you’re-drunk false.” I shared this report from Kaiser Family Foundation which summarized the literature comparing spending per enrollee for government and private health insurance programs. He responded, cautioning that spending and costs are not the same thing. To illustrate this, he sent me a report he had written in 2009 on the very topic. Does it show what he claims – that government health insurance is not actually less expensive than private? Let’s find out.

The crux of the paper is that, especially for health insurance programs, “spending” is not the same as “total cost.” I agree. By spending, I mean (and I think he agrees) the amounts that are actually disbursed. It includes the amount paid to providers and overhead; for private programs, it should include profits as well. Beneficiaries’ out-of-pocket costs should also be added. If two systems have the same “internal” spending, but one system has an additional $1,000 per person in co-pays and deductibles, then we can agree that health spending in said system is $1,000 higher.

Health insurance systems all have costs beyond spending. For example, if the government subsidizes a specific insurance system, this must be included when comparing different systems. If these subsidies are direct, they are generally easy to quantify; as they become less direct, the result becomes more uncertain. Insurance programs may also increase costs to society as a whole; these are called externalities. Quantifying externalities can be challenging, but they should be considered and included where reasonably identifiable.

Before I look at his arguments, I think it’s important to define the context and a notion of “efficiency.” This discussion occurred in the context of my claim that we could, generally, save on health costs (without sacrificing quality) by moving people from private to public insurance. In this context, I’ll define efficiency of a health insurance system as the incremental total cost to ensure an average enrollee. The context of Cato’s paper is the proposed “public option,” which would allow people a choice to buy government versus private health insurance. I think my definition of efficiency is relevant here also. As described above, we should consider the “costs,” which will be broader than direct spending.

(Note: the article in question predated our discussion by eight years, his paper is obviously not a direct response to my views. I will note places where its content does not address my questions; this is in no way a value judgment. I have offered Mr. Cannon the chance to respond before this paper is published, but have not yet received a response.)

Let’s begin with the direct spending. Which spends less? Government or private health insurance? You can go look at the Kaiser report yourself, but here is a quick summary:

  • A study covering the period 1996-1999 found that total spending for the average Medicaid enrollee would be 18% higher if they were moved to private insurance. The study noted that this difference is not due to lower service use by Medicaid enrollees.

  • Another study, conducted from 2005 data, found private insurance spending to be 26% higher for adults and 37% higher for children. It also noted that out-of-pocket spending specifically is 500-600% higher for private coverage.

  • A third study used the same 2005 data, but split spending by type. Medicaid compared favorably for every type of health spending. (No web link; see Kaiser for citation).

  • A fourth study, looking at the period 2003-2009, found private insurance spending to be “over 25 percent higher,” after adjusting for the population in Medicaid. This 25% higher does not even include out-of-pocket spending, which would be at least three times higher for those using private insurance.

There are some more studies, but you get the point. I’m confident to state that direct spending per Medicaid enrollee is around 25% lower than for a comparable private insurance enrollee. Referring to the Cato paper, I do not see any figures or studies to dispute this conclusion. Given the topic of the paper, silence looks a lot like assent in this case. If private companies are going to end up more efficient, they make up significant ground outside of direct spending.

Those who claim government health programs are more efficient often note their lower overhead. Cannon’s piece disagrees with this approach, saying that private insurance’s higher administrative costs may actually make it more efficient. Specifically, he notes that profits (which represent 3% of premiums, according to the CBO) “could lead a government program to be less efficient.” He also notes that the Meds save administrative costs by not reviewing claims as aggressively. This is a plausible claim – if every $1 spent on administrative costs eliminated $2 of wasteful spending, then increased administrative costs could reduce total costs. As evidence, Cannon notes that Medicare reported making $10.4 billion in improper payments in 2008.

That $10 billion sounds big, but remember that it is only around 2% of the $469 billion in Medicare spending that year. In any case, it’s already included in direct spending. Adding it again would be double-counting. When all payments – proper and improper – are included, the government program is 25% cheaper. And, we are making a comparison here: Medicare does make some improper payments, but certainly private insurance companies do too. What is the comparable number for them? Cannon doesn’t say, and I’m not aware of a comparable study.

Now, it is possible that if Medicare increased its administrative costs, this would be offset by larger reductions in spending. And Medicare should of course look for ways to become even more efficient than private insurance. It is, however, a bit disconcerting to see the “small government” Cato Institute suggesting that the problem with the Meds is that they don’t have enough bureaucrats, paperwork and red tape. But this is all moot: any case for private efficiency will have to be made outside of direct spending.

The first area of indirect costs mentioned in the paper is the Meds’ use of other government resources. Cannon is correct, some of these costs should be allocated. He quotes several areas, specifically “parts of salaries for legislators, staff and others working on Medicare, building costs, marketing costs, collection of premiums and taxes, accounting including auditing and fraud issues, etc.” Being able to use the IRS to collect its “premiums” is a big benefit for the government insurers, no question. Legislative and staff salaries are a bit more remote – the number of Congresspersons would be the same if Medicare had more enrollees. But sure, apply some of this too. My understanding is that building and marketing costs are paid by Center for Medicare and Medicaid Services (CMS). Auditing and fraud studies are also often done by CMS, such as the one mentioned above studying improper payments. The costs of running CMS are already included in the overhead of these programs, i.e. we’ve already counted it. That being said, I’m sure there are various other ways CMS uses various resources here and there.

But let’s put this in perspective – total annual spending on the IRS is around $11 billion and Congress is an additional $5 billion. If you assign the entire cost of both to the government health programs, it would add around 1.5% to their total cost. And both Congress and the IRS do things other than work on government health programs. When you allocate only a portion of the costs, shared government resources would increase costs by less than 1%. Real, but barely moves the needle.