The Case against John Kerry's Health Plan

Studies | Health

No. 269
Friday, September 10, 2004
by John C. Goodman & Devon M. Herrick


Executive Summary

Senator John Kerry has proposed a plan to radically reform the U.S. health care system. If he is successful, millions of middle-income families will be enrolled in Medicaid, the federal-state health program for the poor. Millions more will get their insurance through a system of managed competition modeled after the federal employee’s health system and similar to what Hillary Clinton proposed more than a decade ago. Most people would be forced from the private health plans they have today.

The ostensible purpose of Kerry’s proposal is to insure the uninsured. By some estimates as many as 44 million people lack health insurance at any one time. Sen. Kerry’s goal is to insure about two-thirds of them. The effort will be expensive, even by Kerry’s own estimate. We put the price of these reforms in excess of $1 trillion over ten years — an amount equal to almost $1,000 per year for every household in America.

Unlike the Clinton plan, Kerry’s program would not mandate employer-provided health insurance coverage. Instead, it would use economic incentives to induce people to voluntarily insure. But very little of those incentives will actually go to individuals. About 90 percent of the funds will go to state governments, employers and insurance companies. In a nutshell, the Kerry plan would use taxpayer dollars to encourage public and private institutions to persuade individuals to obtain insurance. Among the inducements:

  • The federal government would pick up the additional cost of insuring Medicaid children if the states expand eligibility and increase enrollment.
  • The federal government would pay the bulk of catastrophic health expenses if employers offer insurance to all employees and pay at least one-half of the cost.
  • Additional subsidies would be offered to low-income people who insure through the managed competition system: small business employees, the unemployed, and people aged 55 to 64 years.
  • And insurance costs would be limited to a percent of family income for everyone else who individually enrolls in the managed competition system.

President Bush has proposed tax relief for people who buy insurance on their own. In stark contrast, Kerry’s tax subsidies are trickle-down — people are supposed to get derivative benefits from checks written to others. Will this approach work?

More than half of the money in Kerry’s plan will be spent expanding Medicaid (for low-income families) and the SCHIP program (for low-income children). Prof. Kenneth Thorpe, Kerry’s health adviser, estimates that as many as 26 million new people will be enrolled. However, as the public sector expands the private sector will surely contract:

  • Even Kerry assumes that for every 10 people who sign up, three people will lose employer-provided private insurance; and it could be much worse.
  • Studies in the 1990s found that every additional dollar spent on Medicaid led to a reduction in spending for private insurance of 50 to 75 cents.
  • More recent evidence suggests that private sector crowd-out is approaching one-to-one: Each new Medicaid enrollee is offset by one less person with private insurance.

Moreover, most of the private sector subsidies will go to people who are already insured; and employers will receive subsidies even if they fail to insure a single additional employee. Bottom line: It is entirely possible to spend $1 trillion and achieve no reduction in the uninsured.

Quality of care will suffer under the Kerry proposal. People who go from employer plans to Medicaid will have fewer choices of doctors, longer waits for care and some health care rationing. Those who join the system of managed competition will experience a different problem: Health plans will face perverse incentives to over-provide to the healthy and under-provide to the sick.

On the surface, managed competition sounds attractive. Each year, people could choose among competing health care plans — much like federal employees currently do. But the community-rated premiums charged bear no relation to actual health care costs. Healthy enrollees would overpay. Enrollees with high health costs would underpay. Thus health plans would have strong incentives to provide more services to profitable, healthy enrollees (in order to attract more of them) and fewer services to unprofitable, sick enrollees (in order to attract fewer of them).

Kerry explicitly rejects national health insurance, and wisely so. We have seen political pressures in other countries cause politicians to skimp on expensive, lifesaving technology even as they over-provide relatively trivial services to healthier people. And though Kerry avoids the political pressures of national health insurance, the end result may be the same because of the economic pressures of managed competition.

The plan will almost certainly lead to a new round of health care inflation. Federal spending alone will increase by more than $100 billion a year. But since there will be no increase in supply, the bulk of this new spending will buy higher prices rather than more health care. To make things worse, individuals will face perverse incentives to over-insure and over-consume.

For example, faced with virtually no out-of-pocket costs, the 26 million new enrollees in Medicaid will find no reason to show spending restraint. The bills all go to someone else. Premium caps mean that a poverty level individual will pay no more than $600 or $700 a year, with the excess premium subsidized by Uncle Sam. Given a decision to insure, the incentive will be to pick the most expensive plan available.

In an effort to hold down costs, Kerry’s advisers tout the benefits of “case management.” But in his acceptance speech at the Democratic convention, Kerry rejected all forms of managed care. He appears to have taken no position yet on Health Savings Accounts and other forms of consumer-directed health care.

Kerry’s original cost estimate was close to $900 billion over 10 years. Subsequently, he seems to have endorsed close to $300 billion dollars in savings, mainly by eliminating waste and inefficiency. Reading between the lines, it is tempting to conclude that Kerry really wants his plan to be paid for by the taxes he has promised to impose on taxpayers who earn more than $200,000 a year.

Beginning with the first full year of operation and ignoring phantom savings, we put the 10-year cost in excess of $1 trillion. But rescinding the Bush tax cuts for the “rich” will provide only one-third of that amount. For Kerry’s plan to succeed, new taxes for the middle class appear to be inevitable.

The Kerry plan would harm the economy. It would raise taxes on capital and lower workers’ take home pay. And because virtually all of Kerry’s subsidies are phased out as income rises, the plan would create new penalties for work. For example:

  • The premium cap alone would add 15 percentage points to the marginal tax rates of low-income families — for every extra dollar they earn, they would lose 15 cents of premium subsidy.
  • Assuming (as Kerry does) that employees reap the full benefits of employer subsidies and bear the full cost of their withdrawals, the small business tax subsidy would add 11 percentage points to the marginal tax rates of low-income workers, if they choose an average cost health plan.
  • If they choose a high cost plan (because so little of the premium will come out of their own pockets), their marginal tax rate could climb 19 percentage points.

When these penalties are added to other marginal tax rates created by the income tax, the payroll tax and the withdrawal of other subsidies such as the Earned Income Tax Credit (EITC), overall tax rates for low-income families would soar to levels normally thought to apply only to the very wealthy.

A major problem with the current system is that tax subsidies for health insurance are arbitrary and unfair. But rather than move to a fairer system that treats equals equally, Kerry would create a slew of new subsidies that would make the current system even more arbitrary. Under the Kerry plan, people at the same income level would receive vastly different subsidies depending on their age, where they work and how they obtain insurance.

By design, the Kerry plan does not insure everyone. So who would be left out? The people most ignored are mainly middle-income families with incomes above 300 percent of the poverty level who buy their own insurance. Over the past decade, almost all the increase in the uninsured is accounted for by this group. Further, unlike people who get tax-subsidized insurance through an employer, these families must buy insurance with after-tax dollars. President Bush has proposed a tax deduction for this group, if they purchase insurance combined with health savings accounts. Kerry offers these families virtually no relief.

The structure of the Kerry health plans raises a number of intriguing questions:

  • Why spend several hundred billion dollars on catastrophic insurance for millions of people (many with high incomes) who are already insured, while ignoring all of the non-poor uninsured who currently get no tax relief?
  • Why spend billions to subsidize small businesses if they join an insurance system that doesn’t yet exist, while denying them those same subsidies if they buy insurance that is readily available in the marketplace?
  • Similarly, why pay the cost of premium caps and other subsidies if individuals buy insurance that doesn’t yet exist, while denying them any relief if they buy insurance that is already available?
  • And why spend billions enrolling middle-income families in Medicaid instead of using those same dollars to help them enroll in employer plans and individually-owned policies which they would probably much prefer?

There is only one explanation that sensibly answers all of these questions. The real purpose of this plan is not to insure the uninsured. The real purpose is to radically change our health care system.


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