A few thoughts on health care reform

The financial markets appeared to have already priced in passage of the health care bill before the weekend. There also appears to be some sense of relief the long and arduous process is coming to an end.

Our early assessment is that, while there is a great deal of cost shifting taking place, the bill that passed was less onerous than many had feared. Unfortunately, the history of massive social spending programs is that they tend to grow larger over time.

Moreover, the scoring by the Congressional Budget Office (CBO), which shows the program costing $940 billion and reducing the deficit $138 billion over the 2010 to 2019 period, was based on a strict interpretation of the bill as it was written. The costs will likely be higher than the CBO estimate and the budget deficit will also likely be larger.

Savings from Medicare cutbacks are likely to be harder to achieve than the plan suggests. Moreover, the extended phase-in of the program will likely lead to incessant political pressure to expand benefits and scale back the tax hikes.

The passage of the healthcare bill will have relatively little impact on economic conditions over the near term. Presuming the bill is signed into law following a few more procedural votes, most of the provisions of the new law will not take effect for a couple of years.

Some of the earliest changes include tax credits for small businesses to encourage them to provide healthcare coverage to their employees and new laws and rules prohibiting insurance companies from denying coverage to children with preexisting illnesses. Both take effect this year. The widely touted insurance exchanges, where people without employer-sponsored insurance coverage and small businesses can shop for health coverage, take effect in 2014.

 That same year is when most people will be required to have health insurance and is also when the Medicaid program will be expanded to include all Americans with incomes up to 133 percent of the poverty level.

Taxes will increase sooner, beginning with a new 10 percent surtax on indoor tanning salons this July. Drug companies will start paying higher taxes beginning in 2011 and higher income households will face higher taxes in 2013. The Medicare payroll tax will increase from 1.45 percent currently to 2.35 percent in 2013 and a new 3.8 percent tax on unearned income will also take affect that year on households. Both taxes will hit individuals earning $200,000 and above and couples earning $250,000 or more. In addition, a new excise tax of 2.3 percent will be imposed on sales of medical devices such as pacemakers and hip replacements.

The primary drivers for passing healthcare reform were to increase the proportion of the population covered by some sort of healthcare insurance and hold down the rate of growth in healthcare expenses. The new healthcare law appears to accomplish much of the first objective, although it is unclear how many firms will choose to pay a fine as opposed to offer coverage to their employees.

Employers with 50 or more employees will be required to provide affordable healthcare coverage to their employees or pay a $3,000 per employee fine. The rule takes effect in 2015 and also excludes the first 30 workers from the fine. Part-time workers would be covered by the law on a pro-rated, or full-time equivalent, basis.

There is little evidence the new healthcare law will hold down the price of healthcare. Healthcare costs have been rising faster than the overall inflation rate for about as long as can be
remembered. The driving force for this increase has been the aging of the population, which has resulted in increased demand of healthcare services and a lack of market discipline in the healthcare marketplace.

Relatively few people pay the full costs of medical care when they visit the doctor or purchase pharmaceuticals. Most costs are paid indirectly either by insurance companies or the government. This leads to over consumption and little to no price sensitivity. The cost of insurance and government programs are then paid for by consumers and businesses.

The cost of purchasing insurance should be reduced by the creation of exchanges, where small businesses and individuals would be able to pool their purchasing power. It is unclear how the new healthcare law will reduce actual healthcare costs, however, particularly as it will increase the number of people covered by insurance and likely result in increased demand for healthcare services.

In addition, much of the cost of healthcare services and products are real and cannot be wished away. Creating life-saving drugs and providing high-level services comes with a price.
Rather than reducing costs, the healthcare plan appears to shift costs to employers and higher-income households.

Larger employers, particularly retailers, would face higher healthcare costs or wind up paying significant fines. Smaller retailers and smaller employers in general, would fare better as they would more likely fall under the 30-worker exclusion provision. The higher taxes on investment earnings for individuals earning $200,000 or more and households earning $250,000 or more would be on top of the expected increase in tax rates following the expiration of the lower tax rates on dividends and capital gains at the end of this year.

The higher tax rates on investment earnings will draw more investment dollars into tax avoidance projects and lead to modestly lower investment throughout the economy. Likewise, the new tax on medical devices and pharmaceutical companies will modestly reduce profitability of these firms and increase their cost of capital. This could lead to less innovation and product development.

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