In spite of the late hour in the health care debate, Congress has not yet decided how to restrain runaway health care costs. The essential choices are a top- down strategy of government limits on health care spending enforced by price controls or a bottom-up strategy of consumer choice and market competition. History clarifies that choice: Previous government efforts to regulate prices in peacetime have invariably failed. Moreover, government attempts to control prices in the health care sector would undermine concurrent efforts to restructure the marketplace.

In Mandate for Change, the Progressive Policy Institute (PPI) described the pitfalls of price controls and legislated limits on health care spending:

In a sense, health budgets make government over-accountable. They make every problem into a political problem, even on matters best resolved by the private sector. Every provider who feels his rate inadequately reflects some local variation; every patient who suffers waiting for use of a scarce technology; every hospital forced to effect lay-offs -- each of these individually wrenching problems is laid at the feet of the local member of Congress, and, ultimately, the party and the president responsible for creating and enforcing the public budget.¹

Nonetheless, three major bills in Congress prescribe bureaucratic price regulation as the cure to escalating health care costs: the Clinton Administration's bill, the McDermott-Wellstone single- payer bill, and the health reform bill recently reported by the House Ways and Means Subcommittee on Health.,² Each proposal would clamp a national limit on health care spending and enforce it through combinations of price controls on the premiums charged by health plans and on the prices charged by providers. ³

The idea of controlling costs by government fiat is seductively simple. But it rests on a conceit as persistent as it is damaging: that government bureaucracies can allocate resources more wisely and efficiently than millions of consumers and providers pursuing their interests in the marketplace. The alternative -- one rooted in America's progressive tradition of individual responsibility and free enterprise -- is to improve the market's ground rules in order to decentralize decision-making, spur innovation, reward efficiency, and respect personal choice.⁴

As centrally planned economies crumble around the world, many in the United States seem bent on erecting a command and control economy in health care. This policy briefing examines the reasons why government price regulation would fail to constrain health care costs and create many adverse side effects.

Price Controls Freeze Current Inefficiencies in Place and Block the Improvements Underway in the Health Marketplace

From Minnesota to Florida, American firms are inventing new, more efficient forms of health care delivery. Organized systems of care, often called managed care, are displacing the old model of independent doctors paid on a fee-for-service basis. In Minneapolis, for example, health insurance costs one- third less than in New Orleans or Houston.⁵ The introduction of price controls would retard this restructuring of health care markets, overriding market pressures to contain prices and locking in inefficiencies that have made the system so costly. In areas like Baltimore and New York where regulators set hospital prices, costs have risen 20 percent faster each year than in areas where managed care dominates the market.⁶

Price regulation also would impede efforts to redress the national oversupply of specialists and undersupply of primary care providers. Primary care doctors are essential for preventing disease or detecting it at early stages when treatment is often the least expensive. For example, giving people with pneumonia antibiotics is far less expensive than hospitalizing them. Yet price controls discourage the upfront investments necessary to organize providers into networks, in which primary care doctors act as gatekeepers. HealthSystem Minnesota, a partnership of the Mayo Clinic, Park-Nicollet Medical Center, and other highly efficient group practices, uses half of its physicians for primary care and has stopped hiring specialists.⁷ Nationwide, however, less than 35 percent of the nation's doctors practice primary care.⁸

Not surprisingly, some specialists welcome price controls -- which would lock in their high income -- and fear competition, which might depress it. For example, the American College of Surgeons has endorsed the single-payer approach, which would control prices at the current level and preserve surgeons' relative value among physicians.⁹

Political Forces Will Undermine Price Controls

Regulators rarely permit the businesses they regulate to fail. Imagine a large, inefficient health plan teetering on the verge of bankruptcy but unable to raise its prices above the premium caps. What government would let the plan go under, disrupting health care for scads of voters, when it could avert such a political calamity simply by relaxing price controls? This is precisely what happened in New York in 1993, where state regulators approved 27 percent premium increases for Empire Blue Cross/Blue Shield of New York to keep that troubled company solvent.¹⁰ As Jeremy Rosner wrote in Mandate for Change: ". . . those who cannot survive in the market find a way to survive in the legislature."¹¹

Economist Charles Schultze calls this the rule of "do no direct harm."¹² Government policy must not appear to be the cause of a business failure which results in a loss of jobs. By contrast, competition closes inefficient businesses every day. The Congressional Budget Office (CBO) raises the specter of backlash to the Administration's premium caps when it warns that they "are likely to create immense pressure and considerable tension."¹³ In practical terms, this means that politicians will likely raise the caps, vitiating their cost-disciplining impact.

Politicizing the price of goods and services inevitably leads powerful interests to jockey for special advantages. Medicare offers an illustration: According to the commission that advises Congress on Medicare hospital payments, hospitals associated with medical schools receive unjustifiably high payment adjustments for the cost of training physicians.¹⁴ Yet lobbyists for teaching hospitals and their Congressional allies have repeatedly blocked moves to curb those payments.

The reductio ad absurdum of price regulation occurs when members of Congress set payments to medical providers, as they routinely do in Medicare. Senator John Chafee (R-R.I.) tells the story of how he and Representative Pete Stark (D-Calif.), working through the night on a budget bill, had to decide on payments for nurse practitioner services and for the diagnosis of heart disease: "Now, I'm not going to speak for Congressman Stark. . . . But I can say as far as Senator Chafee goes, he's totally incompetent in those areas."¹⁵ Unfortunately, not all members of Congress share Senator Chafee's qualms about micromanagement.

Price Controls Spawn Growing Regulation

Many people remember the controversy over wage and price controls in the early 1970s. Less memorable were the massive regulations needed to implement the controls. C. Jackson Grayson Jr., who chaired the commission that regulated prices, describes how one regulation begets others: "No matter how simply you begin, your controls will get more complex and voluminous. We started in Phase II [of price controls] with 3 pages of regulations and ended with 1,534. In an effort to correct one inequity, you create another."¹⁶ The Administration's premium caps likewise will demand extensive legislation and regulation to address the inevitable conflicts among providers and patients. One study estimates that the plan would start with 2,891 pages of regulations, 2 times more than the regulations for Medicare.¹⁷

Price Controls are Easy to Circumvent

People find ingenious ways to beat price regulation. In the early 1970s, grocers invented new cuts of beef, like the "watermelon roast," to avoid price controls on the usual cuts.¹⁸ Medicare regulations have inspired computer programs that increase providers' income by taking advantage of ambiguities in the classification of medical services, such as charging separately for services that in combination bring in less income. Regulation can also lead to favoritism and corruption.¹⁹ In Canada and Britain, political contacts help patients avoid waiting lines, while in Japan, the wealthy use lavish gifts to jump ahead in line or gain access to more experienced doctors.

Price Controls Make Quality Take a Back Seat to Quantity

Slapping price controls on fee-for-service medicine, as the Administration proposes, will lead many providers to protect their income by increasing their volume of services. After Congress cut doctors' Medicare fees in 1990, specialists (except for surgeons) were able to recoup 60 cents for every dollar in cuts by performing more services.²⁰ This shift from quality to quantity may lead doctors to prescribe more tests than are necessary or to spend less time with patients, enhancing the possibility of making mistakes in diagnosis and treatment.

The problem is vividly illustrated in Japan, where doctors are paid regulated fees and see an average of 49 patients per day, which is roughly double the U.S. average.²¹ Concerns about quality cause Japanese patients to wait in long lines for services at public and teaching hospitals, where doctors are reputed to be more careful.

In fee-for-service medicine (Medicare and the Japanese system are examples), the cost of unnecessary or bungled treatment is easily passed back to consumers through premium increases because insurance companies (or the government) pay the bills without solving the problem. The threat of a malpractice suit may mitigate the economic incentive to rush treatment, but such suits usually reflect only the most egregious errors. In contrast, managed care plans make less money if they have to fix a mistake because they are paid for each person they enroll, not for how many procedures they do.

Price Controls Undervalue Preventative Care

PPI Vice President Robert J. Shapiro notes that price regulation may undervalue medical services that have a long-term payback: "Controls and global spending ceilings will drive providers to cut costs by eliminating those activities generating the lowest rate of return for providers, such as preventive medicine."²² The early detection of breast cancer saves lives and reduces treatment costs, but failing to detect it early imposes few immediate costs on a health plan because the disease takes years to develop. Indeed, a health plan trying to cut costs to meet a premium cap might decide to limit mammography.

Of course, Congress can simply mandate more preventive care: Senator Edward Kennedy (D-Mass.) has proposed to increase the Administration's mammogram coverage.²³ The difficulty arises, however, when Congress chooses to emphasize the wrong services, thereby draining finite resources from medical procedures of greater long-term value. It is better to let consumers and providers weigh the relative value of health care services through their transactions in the marketplace. Moreover, without price regulation, health plans would have greater incentive and flexibility to invest in the general health of all members so they would be healthier, need fewer services, and, as a result, be more satisfied customers.

Price Controls Will Dampen Innovation and Investment

Price controls stymie the development of new technology because the government must approve payments for its use. For example, under Medicare, payments for the use of new technology must be approved by a federal agency. Approval sometimes takes more than three years.²⁴

Because their rate of return would be limited by government, health plans would be less likely to invest in quality improvement systems, new primary care facilities, and cost-saving technology. More than any other sectors of the health care market, the pharmaceutical and biotechnology industries rely on long-term investment. Yet the Administration's bill would establish a drug pricing review committee, which would become a de facto regulator of drug prices. Why would companies spend heavily to research and develop breakthrough drugs if price controls prevent them from recouping their investment?

Price Controls Limit Consumer Choice

The White House bill quite arbitrarily bars any health plan from charging more than 20 percent of the average price of premiums in a given area. This narrows the range of choices that otherwise would be available to consumers willing to spend more for the services they want.²⁵ And this provision affects only the middle class, because the rich can afford to purchase more services beyond those covered by their insurance.

Price Controls Miss Their Target

The point of health reform is not to limit overall health care spending, but to constrain cost increases by squeezing out waste and inefficiency, disciplining demand, and delivering better value for money. No one knows what is the "right" level of national spending for health care. Yet a global budget presumes to set that level and transfer from consumers to government decisions between spending on health care rather than other goods and services.²⁶

Conclusion

Ultimately, government price regulation will always fail because it does not change the underlying economic forces driving up prices. If we are serious about slowing the growth of health care costs, we have to change the ways we consume and provide medical care. Price controls evade the hard but essential work of structural reform in health care markets: They are a quintessentially political response to an economic problem. The alternative is to allow well-functioning markets to set prices and allocate resources, while ensuring that all Americans have access to affordable health care coverage. The market-oriented approach leaves decisions to cost-conscious consumers and health care providers rather than bureaucrats.

Endnotes

(1) Jeremy D. Rosner, "A Progressive Plan for Affordable, Universal Health Care," Mandate for Change, Will Marshall and Martin Schram, eds., p. 123.

(2) Senator George Mitchell (D-Maine) and Representative Richard Gephardt (D-Mo.) are sponsors of the Administration's bill, the Health Security Act, H.R. 3600/S. 1757. Representative Jim McDermott (D-Wash.) and Senator Paul Wellstone (D-Minn.) are sponsors of the American Health Security Act, H.R. 1200/S. 491. The House Ways and Means Subcommittee on Health's bill is a draft bill.

(3) The difference between the bills is the degree to which the government would micromanage the prices of provider services as opposed to capping the overall premiums of health plans. For example, the Administration's bill would cap the premiums of all types of health plans: health maintenance organizations (HMOs), preferred provider organizations (PPOs), and fee-for-service insurance plans; the prices of providers' services would be subject to government regulation only in the fee-for-service plans. In contrast, the Ways and Means bill would cap the premiums of only HMOs; for all other plans, the government would limit the providers' prices. The single-payer bill, which would eliminate all health plans except for HMOs, would regulate providers through direct government payments for their services; payments to HMOs would be capped.

(4) The logic of this market-oriented approach is elaborated in Mandate for Change, Will Marshall and Martin Schram, eds., 1992, and in subsequent PPI reports, "Health Care Reform and the Laws of Economics," Robert J. Shapiro, 1993, and "Breaking the Health Reform Deadlock: The Competitive Path to Universal Coverage," David B. Kendall, 1994.

(5) Mark Alan Chesner, Millman & Robertson, Inc., survey of 1,050 U.S. cities' small group health insurance premiums, November 16, 1992.

(6) Pulse Analysis, January, 1993, Sherlock Company, Gwynedd, PA.

(7) James L. Reinertsen, M.D., President, HealthSystem Minnesota, "Health System Reform, Marketplaces, and Physician Manpower," Remarks to the Physician Payment Review Commission, October 29, 1993.

(8) Sharon McIlrath, "Too Many Specialists?" American Medical News, August 17, 1992.

(9) The American College of Surgeons supports a single- payer system on the basis of maintaining access to specialty care and choice of physician. A far less regulatory approach would be to require all health plans with limited networks of providers to offer customers an option to go outside the network if no plan in a given area had such an option. This requirement has been proposed by the Jackson Hole Group, which developed the concept of managed competition.

(10) Alain C. Enthoven and Sara J. Singer, "The Clinton Health Plan: A Single-Payer System in Jackson Hole Clothing," Health Affairs, Spring (I), 1994, pp. 86-87.

(11) Jeremy D. Rosner, "A Progressive Plan for Affordable, Universal Health Care," Mandate for Change, Will Marshall and Martin Schram, eds., pp. 123-124.

(12) Charles Schultze, "The Public Use of Private Interest", Brookings Institution, Washington, D.C., 1977.

(13) Congressional Budget Office, "An Analysis of the Administration's Health Proposal," U.S. Congress, February 1994, p. 76.

(14) Prospective Payment Assessment Commission, Report and Recommendations to the Congress, March 1, 1993, pp. 50- 51.

(15) Senator John Chafee speaking at a health care symposium sponsored by the Progressive Policy Institute, April 13, 1994.

(16) C. Jackson Grayson Jr., "Experience Talks: Shun Price Controls. . . ," The Wall Street Journal, March 29, 1993.

(17) Jim Tozzi et al, "The Regulatory Requirements of the Health Security Act," Multinational Business Services, Inc., Washington, D.C.

(18) Steven Mufson, "Price Controls: Past as Health Care Prologue," The Washington Post, March 14, 1993.

(19) Stuart M. Butler, "Fatal Attraction of Price Controls," Health Policy Reform: Competition and Controls, Robert B. Helms, ed., AEI Press, 1993, pp. 15-18.

(20) Physician Payment Review Commission, "Annual Report to Congress," 1993, p. 232.

(21) Naoki Ikegami, "Japanese Health Care: Low Cost through Regulated Fees," Health Affairs, Fall 1991, p. 103, and American Medical Association, Socioeconomic Characteristics of Medical Practice, 1990/1991, p. 74.

(22) Robert J. Shapiro, "Principles and Strategies for Health Care Cost Containment," testimony before the Senate Committee on Finance, March 10, 1994.

(23) "Summary of Chairman's Mark, Health Security Act," Committee on Labor and Human Resources, U.S. Senate, May 9, 1994.

(24) Senator David Durenberger and Susan Bartlett Foote, "Medical Technology Meets Managed Competition," The Journal of American Health Policy, May/June 1993, p. 25.

(25) Alain C. Enthoven and Sara J. Singer, "The Clinton Health Plan: A Single-Payer System in Jackson Hole Clothing," pp. 87-88.

(26) Price controls also may face a legal challenge. Courts have interpreted the Fifth Amendment's prohibition on confiscation of private property for public use without just compensation as allowing regulated companies the right to a fair rate of return. The price controls on premiums probably would be challenged as confiscatory because they are set through formulas that limit income without considering the costs incurred by a specific plan. The Administration's bill tries to avoid this problem by prohibiting any judicial or administrative review of the price controls on premiums. This provision is arguably unconstitutional. See Alain C. Enthoven and Sara J. Singer, "The Clinton Health Plan: A Single-Payer System in Jackson Hole Clothing," p. 87.

David B. Kendall is Senior Analyst of Health Policy for the Progressive Policy Institute.