U.S. spends $700 billion on unnecessary medical tests

“Peter Orszag, director of the Congressional Budget Office, estimates that 5 percent of the nation’s gross domestic product-—$700 billion per year –goes to tests and procedures that do not actually improve health outcomes…The unreasonably high cost of health care in the United States is a deeply entrenched problem that must be attacked at its root.”

This quotation comes from a Progressive Policy Institute (PPI) report.  There is little doubt that much of health care is unnecessary or at least is not worthwhile in the cost-benefit sense.  However, how do we fix this problem?  PPI has some suggestions which the Healthcare Economist will scrutinize.

1. Prospective Payment.  Currently, a majority of physicians are paid on a fee-for-service basis.  This encourages physicians to work harder (they get paid more for doing more services), but also encourages them to recommend unnecessary treatments to patients.  My own research finds that when specialists are paid on a fee-for-service basis, surgery rates increase 78% compared to when they are paid on a capitation or salaried basis.  Using a prospective payment system would give physicians an incentive to under-provide services.  Further, insurance companies could collect rents by enrolling only healthier patients so that the cost of care would be less for these individuals.  Prospective payment could work for specific diagnoses (as in the DRG system), but one must worry about DRG creep.  Also, if there is a high variance in the cost of treating a specific disease, than a fee-for-service compensation may be superior.   While the prospective payment system does have appeal in cutting costs, it could reduce patient access to medical care as well.
2. Let individuals choose their own plan. This proposition has great appeal for those who favor consumer choice.  Everyone likes choice.  However, issues of adverse selection can negate any welfare gains from additional choice.  High risk individuals have a hard time getting insurance and if they do the price is often unaffordable.  PPI suggests setting a up a local area purchasing pool to counteract the issues of adverse selection. I am not exactly sure how the PPI proposal would be implemented (do insurance companies charge a fixed rate for all individuals enrolled? do they adjust premium by age or sex?)  Would enrollment in this pooling mechanism be mandatory?  If so, this could drive down costs and significantly reduces issues of adverse selection.  However, mandatory enrollment in the pool could also reduce consumer choice.
3. Create a “Health Fed”.  “A Health Fed, as former Sen. Tom Daschle has proposed, would set national goals for health-care spending and patient outcomes based on the potential gains for integrated care.”  This I think is a horrible idea.  Having the federal government try to reduce costs and improve quality at such a high level is likely to be expensive and counter-productive.  Spending money on medical is not a bad thing; good health is one of the items individuals value most in life.   Thus, if the federal government set medical spending limits, this could lead to rationing.  What we want to happen is to reduce medical spending for unnecessary or wasteful medical procedures.  I don’t think a “Health Fed” would be very helpful in accomplishing this goal.