What's Driving Health Care Costs?

In 1973 in France, French tax inspectors barged into the offices of the 155 year-old Cruse et Fils Freres wine shippers and discovered that the shippers were passing off inferior wines from humble growing regions as superior wines from regions like the noble Bordeaux. One vat of exceptionally bad wine was labeled, "Salable to Americans as Beaujolais."

In testimony before the Senate Committee on the Budget in January 2008, the Congressional Budget Office stated that "future health care spending is the single most important factor determining the nation’s long-term fiscal condition." Given its importance, Americans would do well to understand what's driving burgeoning health care costs and what can reasonably be done about it -- we don't want to spend a lot of money buying bad wine.

The chart above shows where the health care dollar goes, but not necessarily where we can get the most bang for buck in slowing the rise in health care spending.

Some people argue that the rise in America's health care spending is due to an aging population. But it turns out that the bulk of the projected increase in spending on Medicare is not due to demographic changes (e.g., increases in the number of beneficiaries) but rather to on-going increases in costs per beneficiary. In other words, we're spending more on our seniors that we did in the past. Why?

The reason for this is the same reason we're spending more generally on health care -- we have more high technology and better medicine and we dispense it more readily. According to the CBO, “The most important factor driving the long-term growth of health care costs has been the emergence, adoption, and widespread diffusion of new medical technologies and services by the U.S. health care system.”

The problem is exacerbated (if you want to look at it that way) by the fact that Americans are better informed about available medical technology (god bless the Internet and TV) and more aggressive in requesting it from their doctor. If they aren't already asking for the latest drug to reduce their anxieties, they're told to do so by pharmaceutical company advertising, "Ask you doctor about Zofloat, today." Prescription drugs cost, on average, 30% to 50% more in the United States than in Europe. Under most of the health care bills under consideration in the House and Senate, the secretary of health and human services would be required to negotiate drug prices on behalf of Medicare beneficiaries, a proposal that is anathema to pharmaceutical companies.

Another major factor in rising health care costs -- perhaps the most significant -- is the nexus between how doctors are paid and the cost of high tech medical procedures, such as the myocardial perfusion nuclear stress test, a procedure I had recently. I don't have my bill yet, but tests like this can easily run over $1000.

In the United States, nearly all doctors are paid piecemeal, for each test or procedure they perform, rather than a flat salary. As a result, physicians have financial incentives to perform procedures that further drive up overall health care spending. Doctors in the United States earn two to three times as much as they do in other industrialized countries. Furthermore, doctors have become much more business savvy, and like other businesses are realizing the financial benefits of vertical integration. Why “outsource” lab work when you can open your own lab and supply it a ready source of customers – your patients?

Americans generally don't begrudge doctors their high financial returns. It takes intelligence and hard work to become a doctor, to say nothing of the cost of medical school and setting up business (in fact, most new doctors start their profession in considerable debt). I don't have an opinion on whether doctors make too much money or not, but I do believe that a system that is designed to provide financial incentives to doctors to perform procedures rather than care for patients' well-being is a poorly conceived system.

It should also be noted that doctors make more from doing expensive, complex procedures. These procedures require specialists. Thus, an unintended consequence of our health care system is the over abundance of medical specialists and the growing shortage of primary care physicians.

Finally, the spectre of multimillion-dollar malpractice suits is a further incentive for doctors to practice "defensive medicine" and order expensive and often unnecessary tests.

Is it time to convert doctor's pay to a salary system? Many people think so. Most doctors don't.