Because the concepts behind the Obama Administration's health care reform plans do not address the incentives in the current health care system-indeed, they often worsen these incentives-health reforms based on these concepts will have a significant negative economic impact. To quantify the impacts from reforms based on the Obama Administration's concepts, we focus on the impacts from a reform proposal that:

•          Creates another public health care option that will directly compete with private health insurers;
•          Establishes an individual mandate that requires all individuals to obtain health insurance coverage; and
•          Creates a health care exchange.

We base our analysis on the CBO's assessment of the Kennedy health care plan mentioned above.*² Because it is unlikely the Kennedy plan, as currently written, will be the final health care reform bill, we modify the CBO's analysis to reflect the impact on the health care reform market from a cumulative $1 trillion in health care subsidies spent over the next 10 years. We assume that the $1 trillion in health care subsidies will be spent in a similar manner, with similar timing, and will have impacts on the uninsured similar to those noted in the CBO analysis. 

The purpose of the subsidies is to extend health insurance coverage to the current uninsured. Some of this money is duplicative, replacing private sector dollars currently being devoted toward health insurance coverage. By 2019, approximately $4 out of every $10 in the new subsidies would be devoted toward those individuals who did not have coverage previously.

On net, assuming that the subsidies would be effective in 2012, the number of uninsured Americans would be approximately 25 percent smaller than it would have been otherwise without these subsidies. Thus, 13.3 million people who currently lack health insurance would acquire it. But as demonstrated above, expanding health insurance coverage fails to address the fundamental adverse incentives driving health care cost inflation. Consequently, reforms based on the President's priorities would not only prove costly and ineffective at achieving his goals, they would actually aggravate current problems with the  health care system. Expanding coverage in this manner would worsen the incentives by increasing the number of dollars spent that are insensitive to costs.

Finkelstein (2007) demonstrated that, historically, health care expenditures increase rapidly when medical consumers are insulated from the financial costs from using the medical system (connection rate).⁴⁸ We estimate that the increased government subsidies would reduce the expected connection rate by approximately one percentage point. See Figure 15 for a year-by-year breakdown of the changes in the connection rate due to the new government subsidies.

The reduction in the connection rate directly creates incentives for additional medical expenditures that are insensitive to price. Based on the elasticity calculations from Finkelstein (2007), due to the reduced connection rates (and the additional adverse incentives created by the lower connection rates), total medical expenditures would actually accelerate. Figure 16 illustrates the estimated additional annual increases in medical expenditures caused by the reduced connection rates, which would be 8.9 percent higher in 2019 than Obama-style reform would have enabled. Note that such increases are the exact opposite of what the proponents of President Obama's health care priorities predict.

This impact illustrates that health care reform that does not directly address the adverse incentives of the health care system will merely trade one set of bad alternatives for another.

In this case, if we assume $1 trillion in government subsidies, an additional 13.3 million individuals who would not have had health insurance would have it-at a high cost, nonetheless-accelerating health care expenditures that increase health care inflation, pressure on federal and state budgets, reduction in workers' wage growth, and lower overall economic growth.

A more fruitful approach addresses the root cause of the problem first; the adverse incentives driving the excessive growth in health care expenditures. Only when this problem is addressed can the larger insurance problem be solved without transferring the costs from one group to another.

The increase in health care expenditures represents a shift out in the demand for medical services, but does not change any incentives that would simultaneously increase the supply of medical services. Rising demand in the face of stable supply leads to increasing prices. The historic relationship between rising expenditures and rising medical inflation indicates that by 2019, increased government intervention will drive health care inflation 5.2 percentage points higher than would have been the case without such intervention (see Figure 17).

Higher health care expenditures will also have disagreeable effects on federal and state budgets. Figure 18 (next page) shows total federal government expenditures increasing by over 5.5 percent of total federal expenditures, including the direct expenditures on the new subsidies plus the higher Medicare, Medicaid, and SCHIP expenditures that would accompany higher medical costs.

The additional government expenditures must be financed through either higher taxes or higher federal government deficits. Based on the CBO's expectation that the government deficit will increase over this period, we assume that these additional expenditures will simply increase the deficit dollar for dollar. This implies that by 2019, the federal budget deficit would be $285.6 billion larger-24.6 percent more than it would have been without the health care reform (see Figure 19). The present value of the total additional federal spending that would occur based on Obama's health care reforms would be $1.2 trillion or $3,900 for every man, woman, and child in the country.

Figure 20 summarizes the overall impact on the economy due to the increased government intervention in the health care market by comparing the total increase in government health care expenditures following reforms based on President Obama's health care reform to the total reduction in economic output these reforms will cause.

Meanwhile, the proposed reform would crowd out private economic activity due to higher taxes and the larger federal deficit needed to accommodate new spending for health care (see Figure 19). The higher government burden that would have to be borne by the private sector would diminish total economic activity.*³ By 2019, Obama-style health care would shrink economic activity (GDP) by 4.9 percent compared to the baseline scenario.

*2 Elmendorf, Douglas (2009) Letter to Honorable Edward M. Kennedy Congressional Budget Office, June 15. On July 2nd, the CBO analyzed another health care reform proposal from the Senate Committee on Health, Environment, Labor and Pensions, Elmendorf, Douglas (2009) Letter to Honorable Edward M. Kennedy Congressional Budget Office, July 2. While the price tag on this analysis is smaller ($645 billion), it ...does not include a significant expansion of the Medicaid program or other options for subsidizing coverage for those with income below 150 percent of the federal poverty level...  Because leaving out lower income individuals appears to contradict the goals of health insurance reform in the first place, our analysis is based on the original Kennedy plan.

*3 For a detailed analysis of the negative impact between higher government tax burdens (specifically the government expenditure tax wedge) and economic activity please see: Arduin, Laffer & Moore Econometrics (2009) The Economic Impact of Federal Spending on State Economic Performance: A Texas Perspective The Texas Public Policy Foundation, April 2009.

⁴⁷ Author calculations based on Elmendorf, Douglas (2009) Letter to Honorable Edward M. Kennedy Congressional Budget Office, June 15, 2009.

⁴⁸ Finkelstein (2007) termed this the coinsurance rate.

⁴⁹ Author calculations.

⁵⁰ Ibid.

⁵¹ Ibid.

⁵² Author calculations based on CBO estimates of federal budget between 2012 and 2019 based on President Obama's 2010 budget submission.

⁵³ Ibid.

⁵⁴ Author calculations.