Home > Health Care Policy, Obamacare > An Analysis of Obamacare Part III: Obamacare and Incentives

An Analysis of Obamacare Part III: Obamacare and Incentives

In previous essays, I argued that Obamacare will drive up the cost of health insurance policies and it will increase health insurance expenditures.  However, there is an additional route through which Obamacare could slow the growth of health care expenditures.  That would be if Obamacare somehow changes the incentives facing the buyers of health care, causing health care expenditures to rise more slowly than they otherwise would grow.  I will argue here that because Obamacare does not reform the incentive problems in the existing Medicare system and reported changes in incentives related to the Medicare Prescription Drug program, Obamacare is likely to make health care expenditures grow more rapidly than they have in the past.  And taxpayer subsidies may be unexpectedly large if workers lose their health care insurance coverage provided by their employers.


One of the reasons why health care expenditures have risen as rapidly as they have is that buyers perceive no connection between out-of-pocket expenses and the health care that they buy. An example, familiar to many parents, serves to illustrate the problem.

Imagine taking a child to a toy store and saying to him or her “You may have whatever toys you want and I will pay for them.” Obviously the child will want almost everything in the store but now compare that outcome with the outcome from the following statement. “You can have whatever toys you want as long as you pay for half the cost of the toys.” Clearly the child will buy less in the second case compared to the first case. The first of these examples applies to Medicare. Since Medicare recipients experience no change in their Medicare payments in connection with the health care services that they buy, it is hardly surprising that, with incentives like these, health care expenditures have been growing very rapidly. I am not aware of any provision in Obamacare that would change the Medicare incentives faced by the buyers of health care services, causing them to buy less health care than they otherwise would. But there are reported changes in incentives that might cause health care expenditures to rise more rapidly than they have in the past.

One change concerns the so-called “donut hole” associated with the prescription drug coverage initiated during the Bush Administration. The plan currently stops paying for drugs once payments to the individual reach a given threshold, then kick in again when medication purchases rise to a sufficiently high level. The existence of the gap in coverage provides an incentive for people to rein in their drug usage so as to avoid the gap in coverage. It has been reported that Obamacare eliminates the gap in prescription drug coverage. With the gap eliminated, there is no longer any incentive to keep drug usage down. Thus if Obamacare does indeed eliminate the “donut hole,” the new law actually will cause health care expenditures, specifically drug expenditures, to rise even more rapidly than they have in the past.

Further, corporations have taken accounting charges that reduce their earnings in connection with Obamacare. The reason is that Obamacare removes the tax deductibility of the subsidy received by corporations if they provide prescription drug coverage to retirees. The subsidy was given to corporations to prevent them from dropping prescription drug coverage in response to the enactment of the Medicare Prescription Drug program. It will be interesting to see if corporations respond to this change in incentives by dropping the coverage provided to retirees because of the removal of this tax subsidy. If they do, the costs of the Prescription Drug Medicare program will correspondingly increase.

Finally, Obamacare may induce firms to drop the health care coverage that they provide to their employees. I have argued previously the Obamacare will drive up the cost of health insurance policies and health care. If this is true, it may be profitable for firms to simply drop the coverage that they provide and pay the fines that they will incur when they don’t provide coverage. The lower the fines, the more likely it is that firms will drop coverage. As people lose their coverage, they will need to buy insurance in the exchanges set up by Obamacare and the cost of these policies will be subsidized by taxpayers. Thus Obamacare may provide incentives causing people to lose their job-provided insurance, forcing taxpayers to provide additional insurance subsidies.

The Bottom Line

There appears to be little chance that Obamacare will actually reduce or slow down the growth of health care expenditures because of changes in buyer incentives in the Medicare Prescription Drug program. This analysis, coupled with our previous ones, all point to health care expenditures rising faster than they have in the past, contrary to the claims made by President Obama. And it may also happen that people will lose their insurance, forcing a bigger-than-anticipated subsidy from taxpayers.

Next Up: Obamacare and the Government Deficit


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Economics One

A blog by John B. Taylor

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