By Milton Friedman
Health Care News
May 1, 2003


Since the end of World War II, the provision of medical care in the United
States and other advanced countries has displayed three major features: first,
rapid advance in the science of medicine; second, large increases in spending,
both in terms of inflation-adjusted dollars per person and the fraction of
national income spent on medical care; and third, rising dissatisfaction with
the delivery of medical care, on the part of both consumers of medical care, and
physicians and other suppliers of medical care.

A key difference between medical care and other technological revolutions is the
role of government. In other technological revolutions, the initiative,
financing, production, and distribution were primarily private, though
government sometimes played a supporting or regulatory role.
In medical care, government has come to play a leading role in financing,
producing, and delivering medical service. Direct government spending on health
care now exceeds 75 percent of total health spending for 15 Organization for
Economic Cooperation and Development (OECD) countries. For the U.S., the figure is 46 percent.

Two simple observations are key to explaining both the high level of spending on
medical care and the dissatisfaction with that spending. The first is that most
payments to physicians or hospitals or other caregivers for medical care are
made not by the patient but by a third party--an insurance company or employer
or governmental body.

The second is that nobody spends somebody else’s money as wisely or as frugally
as he spends his own. These statements apply equally to other OECD countries.
Why are most medical payments made by third parties? The answer for the United
States begins with the fact that medical care expenditures are exempt from
federal income tax if, and only if, medical care is provided by the employer. If
an employee pays directly for medical care, the expenditure comes out of the
employee’s income after income tax.

That strong incentive explains why most consumers get their medical care through
their own employer, or their spouse’s or parents’ employer. The tax exemption of
employer-provided medical care in the U.S. has two different effects, both of
which raise health care costs.

First, it leads American workers to rely on their employer, rather than
themselves, to make arrangements for medical care. Second, it leads employees to
take a larger fraction of their total remuneration in the form of medical care
than they would if spending on medical care had the same tax status as other expenditures.

Employer financing of medical care in the U.S. has caused the term “insurance”
to acquire a rather different meaning in medicine than in most other contexts.
We generally rely on insurance to protect us against events that are highly
unlikely to occur but involve large losses if they do occur--major catastrophes,
not minor regularly recurring expenses. We insure our houses against loss from
fire, not against the cost of having to mow the lawn. We insure our cars against
liability to others or major damage, not against having to pay for gasoline. Yet
in medicine, it has become common to rely on insurance to pay for regular
medical examinations and often for prescriptions.

Moreover, the states and the federal government have increasingly specified the
coverage of insurance for medical care to a detail not common in other areas.
The effect has been to raise the cost of insurance and to limit the options open
to individuals. If the tax exemption for employer-provided medical care had
never been enacted, the insurance market for medical care would probably have
developed as other insurance markets have--as a way of providing for
catastrophic, out-of-the-ordinary costs, not for routine expenditures.

Throughout the OECD countries, third-party payment has required the
bureaucratization of medical care and, in the process, has changed the character
of the relation between physicians or other caregivers and patients. A medical
transaction is not simply between a caregiver and a patient; it has to be
approved as “covered” by a private- or public-sector bureaucrat and the
appropriate payment authorized.

An inescapable result is that the interest of the patient is often in direct
conflict with the interests of the caregiver’s ultimate employer--whether the
latter is a government or a corporation.

Milton Friedman, recipient of the 1976 Nobel Memorial Prize for economic
science, has been a senior research fellow at the Hoover Institution since 1977.