Code Red: Two Economists Examine the U.S. Healthcare System

March 31, 2012

The Supreme Court on Moral Hazard

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 10:11 am

I have had to take some time off for a funeral of a someone very near to me, so I have not had a chance to comment on the Supreme Court hearings. Nor do I have much time to do so now. But I would like to comment on Justice Alito’s line of questioning about burial insurance. His questioning was in response to one argument used to justify the purchase mandate, namely that sick individuals will receive medical care at someone else’s expense and therefore there is an economic justification for mandating the purchase of health insurance in order to prevent free riding. Alito noted that individuals who did not provide for their own burials will still be buried at taxpayer expense. This is another form of free riding. If the Supreme Court were to uphold mandatory purchase of health insurance, could Congress not also mandate purchase of burial insurance?

Solicitor General Donald Verrilli seemed surprised by Alito’s questions and did not provide a good answer. Yet these questions strike at the heart of the case and at deeper economic issues. There is a direct analogy between the market for burials and the market for healthcare. Just as some patients free ride off of the generosity of others, some deceased do the same thing. By extension, any time that a good is provided at a price below cost, whether by the government, a charity, or any other organization for that matter, we can expect a certain degree of moral hazard behavior. Some individuals who ought to purchase the good themselves will instead free ride on the generosity of others.

So if we have soup kitchens, some folks may not set aside enough money for their own meals. Shelters for the homeless may encourage some people to be homeless. And so forth. Maybe these moral hazard problems are miniscule; maybe they are large. But there is surely at least some small degree of free riding in all of these examples and many more. So can Congress mandate that individuals prepay for their food and shelter? More generally, how far can Congress go to offset free ridin?

It seems to me that deciding on the insurance mandate is all about drawing lines. Does the Constitution ban any efforts to rein in free riding through mandated purchases? Does it permit all efforts? And if healthcare free-riding is on one side of the line and burial expense free riding (or food or shelter) is on the other side, how do we draw that line in a way that legislators and the courts can understand? Unfortunately, Verrilli punted on this question. I wonder whether the Supreme Court will provide an answer.

I would consider the following: How severe is the free riding? Is it more than a miniscule portion of the overall market? Is the cost of the free riding borne voluntarily by the seller or passed along to everyone regardless of their desire to bear it? Does the free riding threaten the proper functioning of markets (e.g., health insurance markets)? How burdensome is the remedy? On balance, I would think that health insurance is different from burial insurance and a lot different from prepayment for food and housing. Thus, there is a logical defense of the purchase mandate. But I am not a Constitutional lawyer (not that that will lead to some consensus opinion.)

As a final note, I read that it would be constitutional to tax everyone and then hand out healthcare credits for those who buy insurance. So why is it unconstitutional to penalize those who don’t buy insurance when the two policies have the same net financial effect?

It seems that the Supreme Court will be ruling on much more than the future of Obamacare. It will be ruling on the use of economics as a policy tool. We are all holding our breaths.

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