US Incomes Are Rising But It’s All Going on Health Care

15 january 2013

A very nice observation here from Tim Taylor. We’re all aware of the figures that show that US incomes aren’t rising, that median income has been static and so on. However, this isn’t quite the right way to measure it, just wage income. We really ought to use labour compensation and that has been rising.

However, almost all of that rise in labour compensation is going to paying for ever more expensive health care.

“To paint an accurate picture of how health care cost growth is affecting the finances of a typical American family, RAND Health researchers combined data from multiple sources to depict the effects of rising health care costs on a median income married couple with two children covered by employer-sponsored insurance. The analysis compared the family’s health care cost burden in 1999 with that incurred in 2009. The take-away message: Although family income grew throughout the decade, the financial benefits that the
family might have realized were largely consumed by health care cost growth, leaving them with only $95 more per month than in 1999. Had health care costs tracked the rise in the Consumer Price Index, rather than outpacing it, an average American family would have had an additional $450 per month—more than $5,000 per year—to spend on other priorities.”

There’s three things I’d add to this.

The first is that an increasing portion of our now higher incomes going on medical services isn’t a bad thing. This is happening all over the world and for a fairly simple reason: health care is a superior good. If you prefer, think of Maslow’s hierarchy of needs. Water first, food, then shelter and so on. As we get sufficient supplies of those earlier in the queue then we spend more of our increasing incomes on those things that come a little later in it.

This is actually the way that we prefer it: just as we’ve got richer we’ve taken more of our new riches as leisure so too are we taking more of our new wealth as health care. Note that this has nothing at all to do with how medicine is organised or paid for.

The second is that we’re caught in Baumol’s Cost Disease.  Medicine these days is largely a service industry. Services will become more expensive in relation to manufactures as incomes rise. For productivity is more difficult to increase in services than it is in manufactures. And as Baumol went on to point out productivity increases (the flip side of innovation) turn up faster in market based systems than in centrally planned ones. This does speak to how medicine is organised and delivered. No, I wouldn’t say that the current US system is perfect but I would point out that this means that moving over to a simple sole supplier system (like, for example, the UK’s NHS) is almost certainly the wrong way to go for the long term.

Finally, a small statistical point. Medicine in the US isn’t quite as expensive relative to other countries as the numbers make it appear. The reason is that most other countries have some tax system (or statutory insurance system that works through the tax system) to pay for it rather than the US private insurance system.

Which means that the US system is including the costs of collecting the money to pay for the health system in the costs of the health system. Most other countries are not for any system of taxation (and compulsory insurance through the tax system will be the same on this point) does not include the major cost of taxation: the deadweight cost on the rest of the economy. This is usually said to be,  a rule of thumb, about 20% of the sum collected or, in another formulation, perhaps 35% of the marginal revenue of the system.

So, to reach a truly comparable figure you would need to add 20-35% to the costs of a purely tax funded health care system (say, the UK’s NHS where current spending is 10-11% of GDP I think) to be able to compare it with the costs of the US system. No, this doesn’t close all of the gap and it is just a statistical quirk but it is still important. Hiding away the costs of raising the money in something we don’t count, the deadweight costs, doesn’t make those costs go away.

Finally, the political point: that something needs to be done about the US health care system I take to be true. However, that something needs to be done is not the same as saying that this particular thing needs to be done. As a purely personal opinion I think that health care reform should have moved to something more like the Singapore system. Health care savings accounts plus government run catastrophic health care insurance. Or, if you prefer a US source, something along the lines of what Brad DeLong has been proposing for a number of years.