LTC Bullet:  Goodman on Better Risk Management

Friday, September 23, 2016

Seattle—

LTC Comment:  We invite your consideration of an exceptional paper by health policy guru John C. Goodman after the ***news.***

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LTC BULLET:  GOODMAN ON BETTER RISK MANAGEMENT

LTC Comment:  Having come to understand what’s wrong with long-term care public policy in the late 1980s, I decided I needed to have a better grasp of acute health care policy.  I read John C. Goodman and Gerald L. Musgrave’s seminal Patient Power(Cato Institute, 1992) and was totally blown away.  The book is clear, comprehensive, and convincing.  What surprised and pleased me about its analysis was that health policy generally as explained in the book and LTC policy specifically as I’d come to understand it fit together perfectly.   Government is the source of dysfunctions in both and solutions in both depend on bringing consumers back into the market while phasing government interference out.

So I’ve followed Goodman’s work at the National Center for Policy Analysis and more recently at The Goodman Institute for Public Policy Research with great interest.  He’s best known as the “Father of Health Savings Accounts,” but I’m pleased to see he’s branching out into much broader public policy analysis.  I want to focus your attention today on a new paper he presented recently to the Mont Pelerin Society (MPS).  The MPS was founded by Milton Friedman, Friedrich Hayek and other classical liberals and counts among its members more than a half dozen Nobel Prize recipients.  Goodman says

My paper . . . presents a new way of approaching public policy reform - especially reform of entitlement programs. It draws on work by Kotlikoff, Saving and other scholars we are working with. My book on this subject will be published by the Independent Institute later this year.

Find his paper, titled “Better Than Government:  New Ways of Managing Life’s Risks,”here.  What follows are excerpts I’ve selected to convey the gist.  We’ll let you know when the book becomes available.

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Excerpts from John C. Goodman’s “Better Than Government:  New Ways of Managing Life’s Risks

This paper is based on three ideas.

The first idea is the win/win policy change.

A typical government program is funded by taxpayers and provides goods, services or money to a group of beneficiaries. Imagine that you could make a change in that program that reduces the cost to the taxpayers and enhances the value of the program for the beneficiaries – at the same time. Who could possibly object to that?

I think there are thousands of opportunities to make win/win policy changes in the US political system. Win/win policy changes ought to be irresistible to politicians – whether Republican or Democrat, conservative or progressive, independent or socialist. After all, win/win means that everyone comes out ahead. There are no losers. What could be more popular?

And yet win/win is just about the last thing our representatives seem disposed to talk about. It’s almost as if members of Congress think they were sent there to do battle. If they don’t draw blood, if someone doesn’t suffer as a result of their efforts, they apparently think they aren’t doing their job. Perhaps for that reason, Washington is dominated by a zero-sum mentality: everyone’s gain must be offset by someone else’s loss.. . .

The second idea is what I call the trial and error principle.  . . .  Whenever two policy extremes exist such that one kind of cost falls and another rises as we move back and forth between them, there is almost always some intermediate point where everyone gains. We can’t find that point by armchair theorizing, however. We must be willing to experiment and adapt. That is, we must be willing to do the kind of experimentation that private markets do every day.

Why do I think there are thousands of opportunities for win/win public policy changes? Because so many government programs are so visibly inefficient. They labor under archaic rules and regulations . . . -- obstacles that any private entrepreneur would jettison in a second. Further, they inevitably leave all of us with perverse incentives. When we act on those incentives we do things that make social costs higher and social benefits lower than otherwise.

Economists define inefficiency as a state of affairs in which everyone could potentially be better off by doing things differently. If government programs are inefficient, we know that in principle everyone could be better off through some sort of policy change.

Here is the third idea: win/win strategies can be used to solve our most difficult public policy problems – problems created by social insurance.

Many people incorrectly assume that the reason for the growth of government in the twentieth century, both here and abroad, was the need to take care of the poor and the unfortunate. Even the term “welfare state” suggests that way of thinking. But modern governments in developed countries are not principally focused on welfare for the poor. They are focused on benefits for the middle class.

More than one commentator has loosely characterized our federal government as an insurance company connected to an army. That insurance is “social insurance.”

All developed countries in the world today face a common problem: they have promised more than they can deliver. People are expecting benefits for which taxpayers are unlikely to be willing or able to pay, once the needed tax increases become evident. In addition, the benefits that government provides are all too often delivered inefficiently, impersonally, inflexibly, and in a way that encourages perverse behavior on the part of the beneficiaries.  . . . 

There are certain risks that human beings always have faced. These include:

• The risk of growing too old and outliving one’s assets.
The risk of dying too young and leaving dependent family members without resources.
The risk of becoming disabled and facing financial ruin.
The risk of facing a major health event and being unable to afford needed medical care.
The risk of becoming unemployed and finding no market for one’s skills.  . . .

In the United States, the federal government provides an income, pays medical bills, and covers a large part of the cost of long-term care for people during their retirement years. For people of working age, the federal government is subsidizing health insurance and insuring against disability and unemployment. State governments are also involved — insuring workers for injury, death, and disability on the job. Although many of these programs include the word “insurance” in their names, they are very different from traditional indemnity insurance. In many respects, they are not insurance at all, but merely thinly disguised vehicles for redistributing income. 

These programs have been insulated from private-sector competition. People who find a better way of insuring on-the-job injuries or health or disability expenses or providing for retirement income are normally not able to take advantage of that knowledge. For the most part, we are all forced to participate in monopoly insurance schemes, regardless of potentially better alternatives. Even where competition is allowed (as in health insurance) it is regulated so tightly that no one ever sees a real premium for any health plan. Government insurance and government-regulated insurance are also subject to special interest political pressures that undermine its rational provision.  . . .

[I]n the United States and in most other countries around the world social insurance schemes almost always leave individuals with perverse incentives. For example:

• Social Security’s early retirement program and its survivorship benefits discourage work by imposing an implicit marginal tax rate of 50 percent — on top of all the other taxes workers face.
Our unemployment insurance and disability insurance programs literally are paying people not to work.
• Both Social Security and Medicare have substantially altered the lifetime consumption and saving behavior of most people.
• Both Medicare and Medicaid encourage the over-use of healthcare and long-term care services.
Obamacare’s employer regulations are encouraging part-time rather than full time work, encouraging contract labor, outsourcing jobs rather than making new hires and discouraging small firms from becoming larger. . . .

Because of the temptation to spend payroll tax revenues that are not needed to pay social insurance benefits on other politically popular programs, social insurance is almost always operated on a pay-as-you-go basis. This has resulted in huge unfunded liabilities both in this country and abroad. These unfunded promises have created enormous implicit liabilities for governments around the world. According to a Social Security trustees report, the unfunded liability in Social Security and Medicare is $107 trillion, or more than six-and-a-half times the size of the entire U.S. economy. If the implicit, unfunded promises in Medicaid, Obamacare and other programs are included, the government’s total implicit debt is almost twice that figure.  . . .

Here is the principle behind social insurance, then: government intervenes in those insurance markets where people’s choices to insure or not insure impose potential costs on others. Because of basic human generosity, society is not going to allow people to starve or live in destitution. So when people don’t insure for retirement, disability, and so forth, society is going to step in and help where help is needed. Implicitly, we have a social contract that socializes the downside of certain risks. If we allow the upside to be left to individual choice, we will have privatized the gains and socialized the losses. When people don’t bear the social cost of their risk-taking, they will take more risks than they would otherwise, a behavioral response known as “moral hazard.”  . . .

Here is the upshot: In fashioning better choices for people, we must at the same time prevent them from becoming free riders on the rest of society if their choices do not turn out as well as planned.  . . .

If individuals can find better ways of protecting themselves against life’s risks, they should be allowed to take advantage of those discoveries. If they are willing to take responsibility for their own needs and relieve others of that burden, they should be encouraged to do so. Wherever possible, the goal should be to maximize choices and opportunities for individuals, leaving to government the minimum role of ensuring that the needs of the most vulnerable continue to be met.  . . .

If we do nothing to reform our nation’s entitlement programs, we will eventually be forced to adopt harsh policies. High-income individuals will be cut off, of course. They will not receive any Social Security checks. Or if they do get them, the government will take the money back through higher taxes. Instead of getting subsidized Medicare, they will be forced to pay the full (unsubsidized) premium — and then some. Yet these changes will amount to no more than a drop in the bucket for Uncle Sam. Before it’s over, most people will find that they are getting less than what was originally promised. In fact, it’s likely that everyone will face higher taxes, smaller benefits, or both. Such a zero-sum outcome is one in which everybody loses. And because everyone will lose, these reforms will be difficult and painful to enact. They will be resisted by everyone. Is there an alternative? . . .

In what follows, I propose a simple idea. People of any age should have the opportunity to opt out of social insurance in favor of alternatives that better meet their individual and family needs. In particular, they should be able to substitute assets and arrangements they have voluntarily chosen, and that they own and control, for the government systems in which they are now forced to be participate.  . . .

There is only one general condition that must govern these choices: They must not increase the expected burden for other taxpayers. This means that there must be (1) a reasonable expectation that the direct tax burden for others will not rise as a result of an individual’s opting out and (2) a reasonable expectation that the individual will not try to return to the government program (thus creating an additional burden for everyone else) if the private option turns out to be disappointing. This condition implies that opting out must be a win/win proposition.  . . .

Despite this almost self-evident fact, most proposals to change our social insurance programs – proposals coming from both political parties – are zero sum. For every gain they promise, someone else must bear a loss. For example, some Democrats are proposing more generous Social Security benefits. But those benefits would be paid for by imposing new burdens on the young, either in the form of higher payroll taxes or a larger public debt. Some Republicans are proposing to solve future deficit problems by reducing future benefits – a burden for the young without any corresponding gain.  . . .

There is a more general principle here: Any time anyone — rich or poor — can find a way to solve the social problems Social Security and Medicare were designed to address and leave the taxpayers with a smaller burden in the process, we should welcome the change.  . . .

We don’t want the elderly to live out their remaining years of life in extreme poverty. Most of us don’t care very much, however, if seniors fail to live out their remaining years in luxury. That is important to remember because Social Security benefit payments are actually highly regressive.  . . .

What about private savings? If private savings are to serve as acceptable substitutes for benefits there would probably have to be some assurance that the funds would not be squandered or gambled away. Part of the requirement might be that the funds be held by reputable financial institutions and that they be managed according to prudent investment rules. There would also have to be rules governing the rate of withdrawal during the retirement years and a general prohibition against putting the asset up as collateral for loans or other indebtedness.

Texas A&M University economists Thomas Saving, Andrew Rettenmaier and Liqun Liu have produced a first-of-its kind calculation of the value of Social Security to young people in light of the political uncertainty about its future. They conclude that a 21-year-old earning an average wage with a moderate degree of risk averseness would be better off if he could completely opt out of the system by paying a 4.5 percent payroll tax for the remainder of his work life. That means he would forgo all future Social Security benefits and avoid all future Social Security taxes, including the current 12.4 percent tax he and his employer are now paying.  . . .

Think back to the mid-twentieth century when many social security systems were devised in countries around the world. What rational person would choose a system that makes promises to pay young people benefits five or six decades into the future without making any provision to save and invest the funds needed to pay those benefits? What rational person would devise a system that encourages young people to believe they will get benefits five or six decades into the future, knowing all along that the payment of benefits depends on future taxpayers -- but without knowing what the fertility rate will look like a half century later and therefore without knowing how many future taxpayers there will be? In short, what rational person would devise an entire retirement system, using the same techniques that Bernie Madoff used to scam his investors?

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LTC Comment:  That’s enough to give you the flavor of this paper.  I hope this inspires you to read it in fullhere and to await eagerly, as I will, the book-length treatment of these ideas.