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How to reform Medicare with faith in market principles – including vouchers

As Americans debate proposals to reform Medicare, they should know that all of them involve trade-offs. Where the current system and the Paul Ryan plan fall short, a true voucher system provides choice, coverage, and cost-efficiency.

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Most important, it allows free-market competition to work to fullest effect, which tends to increase choice while decreasing costs. The downside is that it’s politically radical. And critics worry that voucher amounts might be too stingy, and that a robust private insurance market wouldn’t materialize because seniors are simply too costly to insure. But if we decide that vouchers are too stingy, then we can raise the national sales tax rate to fund them more generously. If people don’t want to do that, then what they really want is magic.

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As for a robust private market not materializing for seniors, this problem in the pre-Medicare 1960s was largely an artifact of insurance being offered increasingly by employers. While it is true that insurance companies didn’t want to add new retirees to their roles, that does not mean they would not have been happy to continue insuring retirees that they had insured all along, because, in this case, the adverse selection problem (the sickest seeking out the most generous policies) would have been minimal.

Had health insurance never gotten tied to employment in the first place, some health insurance companies would have offered policies that smooth premiums over a person’s life while others would have offered policies whose premiums rise as one gets older, just as life insurance companies do now. A voucher plan would eliminate preferential tax treatment to employer provided insurance, thereby severing this unhealthy link.

The downsides of Ryan's premium support plan

Ryan’s premium support concept shares many of the appealing qualities of a voucher system. His plan covers everyone eligible for Medicare and it does so in a way that allows competition to work to fullest effect in raising the quality of care while keeping prices low. The premium support program could also significantly increase the role of competition in the provision of health care services that now fall under Medicare parts A and B. The government will know how much it can afford to contribute and will contribute only that much.

Finally, the specific premium support plan Paul Ryan proposed has the practical benefit of using a model that already works well: the Federal Employees Health Benefits Program. Those on Medicare will be able to choose from a number of plans on an exchange regulated by the federal government.

This exchange is an important element because it means Ryan’s plan, unlike a true voucher system, involves regulators who will be strongly tempted to engage in social engineering. This engineering, even when noble, interferes with the natural process by which competition leads to the most efficient outcomes.

Lobbyists, meanwhile, will attempt to manipulate these regulations to benefit their clients. And if competition between policies results in most policies being more expensive relative to the premium support level than was originally envisioned, there will be political pressure on regulators to push down premiums by mandating artificially low reimbursement rates for procedures. Distortions that are produced by this very practice are one of the greatest problems with Medicare today.

At the same time, firms in the exchange will have a strong incentive to push for regulations that help then collude with one another by eliminating margins of competition between them. This is rather like grocery stores lobbying for laws against being open on Sundays, which is good for them and bad for shoppers. Remember, regulators will inevitably get much of their technical advice from the insurance companies they regulate.


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