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Abstract

It is generally accepted that serious problems exist in the US health care system. Currently, Clinton as well as Chafee, Cooper, Gramm, McDermott, Michel, and Nickles have proposed health care reforms. In this paper the authors argue that none of these proposals would promote long term innovation. Consequently, the authors propose a decentralized medical plan which combines features from all the various plans in order to promote experimentation and innovation.

This paper was written at the time Clinton proposed sweeping changes to the medical industry. We had this to the notes to show that there are a large number of alternatives to the way that the delivery of medicine can be organized. With the failure of the Clinton plan innovations in medical systems have shifted to the private sector and to the various states.

James Feldman is now a medical student at Creighton medical school.

1. Introduction

Generous funding of medical research has led to better technology and new procedures which clearly make the United States the leader in medical care. Unfortunately, this medical system is much more expensive than any of the medical systems of other nations. The best health care is available for those who can afford it, but the distribution of quality health care is very uneven because many who can not afford it, do not have access to public medical programs, mainly Medicaid and Medicare. In response to the weaknesses of the current medical system, President Clinton, Senators Chafee, Gramm and Nickles, and Representatives Cooper, McDermott, and Michel and others have proposed major reform acts.1-7

These plans present variations on the following approaches to reduce medical costs:

1. Single payer: A single agency would pay all medical bills. [McDermott and Clinton option]

2. Managed Competition: Within a medical alliance which contains a large pool of individuals, a single quasi-governmental agency is established to operate on behalf of the consumers. This agency ranks the various medical plans and offers consumers a limited menu of the best prepaid and fee-for-service plans. The price mechanism is community-based risk pooling which requires transfer payments among the insurers based on risk-adjusted outcomes. [Chafee, Clinton, and Cooper]

3. Voluntary Associations: Small businesses can voluntarily join insurance pools to obtain quantity discounts in medical insurance. [Gramm, Michel Nickles]

4. Medical Savings Account: A fixed or variable tax incentive program designed to make consumers cost conscious. [Chafee, Gramm, Nickles]

5. Cost Controls: Government setting prices for medical services. [McDermott, Clinton]

6. Global Budgets: Setting global budgets for expenditures on all medical services. [McDermott and Clinton]

Clearly, the diversity of these approaches implies that there is no consensus on what the proper course of action should be. In addition, only single payer, cost controls, and global budgets have had large scale empirical trials. While medical science, economics, and the other social sciences can provide Congress with some insights into the consequences of managed competition, voluntary associations and medical savings accounts; Congress will have to deliberate medical reform with only a rough idea of the consequences of three of the important alternatives.

Currently, the proposed plans set forth above rely on the federal government to establish a federal framework within which states would have limited discretion to experiment with the different approaches to reform the health system . Furthermore, state experimentation requires federal approval. The process for obtaining such approval has already proven to be both restrictive and cumbersome under Medicaid.

We argue that to promote continual innovation in the US medical system, its design should promote the empirical trial of all promising alternatives. Therefore, we propose a medical system which deliberately decentralizes medical decision making to the lowest level with economies of scale to make good decisions. For this reason, the states should be granted much more power to create their own medical systems than has been proposed in any of the mentioned reforms. We argue that this approach will lead to a higher rate of innovation because the best features of each of the health system reform proposals are likely to be selected by at least one state given the wide variation in needs and political orientation among the states.

2. Theory of medical decentralization

The theory of medical decentralization presented in this section is a special case of Norman's general theory of innovation.8 Simply stated an innovation is a better way of doing things. For example, until recently Henry Ford Hospital had to admit patients for the treatment of lung cancer a day before treatment in order to ensure that the patient drank at least two quarts of water. The staff determined that if the patient kept a diary indicating that he or she drank at least two quarts of water the day before hospital admission, the patient could be admitted the day of treatment thus reducing the cost of the procedure by one day's hospital costs.9 In this paper we shall primarily focus on innovations resulting in better medical service at a lower cost to the final consumer. These innovations will be called medical service innovations when the change is attributed to an increase in medical supply efficiency and not a subsidy.

Because social science is imprecise, the impact of new alternatives can not be accurately forecasted. For example, many trials are required in the cancer treatment example to determine whether having a patient keep a diary is as reliable as having the patient in a hospital bed where the hospital staff can ensure that the patient drinks at least two quarts of water before radiation treatment. This is especially true in the macro medical policies proposed in the various medical reform bills. Based on the previous inability to accurately predict the growth in costs of Medicare or Medicaid, we assert that empirical evidence is required to determine whether any of the untested proposals are really medical service innovations.

What is lacking in any of the current federal plans is a proposal to provide an empirical test of all of the alternatives. For example, the Clinton plan offers states a choice of single payer and managed competition. In addition, the Clinton plan proposes global budgets and provides states with the option of price controls to meet their global budget. Moreover, states must seek approval for experiments from the federal government. From the existing experimental approval process in Medicaid it is likely that state experimentation will be cumbersome and time consuming. Experiments which conflict with the Clinton plan are unlikely to be approved. For example, the conservative idea of a medical savings account is incompatible with the Clinton managed competition or single payer because the healthy young would opt for the medical savings account making the cross-subsidization of either single payer or managed competition impossible to achieve. In addition, because a medical savings account would require federal legislation, medical savings accounts are not likely to be approved as an experiment if the current Clinton plan were enacted. Analogously, conservative plans do not allow states to adopt the single payer or managed competition options.

Switching to a national program which does not promote an empirical trial of all the possible choices creates another very large social cost, the cost of foregone empirical knowledge of potential alternatives. Currently, the private medical sector is undergoing a restructuring from fee-for-service to prepaid medicine with HMOs, hospital chains, and insurance companies striving to reduce medical costs. If, in the politically unlikely event, we switch entirely to a single payer system, we forego learning whether market competition might indeed be a better alternative. Similarly, if a national medical savings account plan were adopted we would forgo learning about the economic efficiencies of managed competition.

An effective plan to achieve empirical testing of a large number of macro medical policy alternatives would be to decentralize medical decision making to the lowest level with the resources to make good decisions. For this reason medical policy should be decentralized to the states. States are likely to create different medical plans because of both different needs and political philosophies. Furthermore, because medical experts disagree, even states with the same goals might select different means of achieving the same objectives. Currently there is considerable variation among the reforms undertaken in Hawaii, Minnesota, Oregon, and Washington. If the federal government opted out of health system reform, states would generate a wide variety of plans.

3. Decentralized Proposal

The role of the federal government should be to establish a legal framework that encourages the states to continue and expand the numerous reforms which they are currently making in their health care systems.10-11 Well over half the states have enacted medical insurance reforms such as guaranteeing insurability, guaranteeing renewability and placing restrictions on price increases. Over twenty have created health reform commissions. Many states are trying to make insurance affordable to small business by forming insurance pools. Washington and Florida have created managed competition similar to the Clinton proposal. Hawaii has created universal coverage. Oregon is moving towards universal care with a play-or-pay mandate and a rationing scheme for medical procedures to expand Medicaid to the near poor. Montana and Vermont are considering creating a Canadian style single payer medical system. Minnesota has created integrated medical service networks and Maryland has initiated cost containment through regulation of physicians' fees. From these previous examples it is clear that states have the economies of scale to develop excellent health care systems; however no state has been able to fully develop their plan because of current restrictions imposed by the federal government.

In order for decentralization to foster innovation, the federal government must create a framework which promotes its positive aspects and inhibits its negative aspects. For example, a state which took a pure market approach to insurance with no guarantees of insurability or renewability would create incentives for its uninsurable to move to states which pooled risk and mandated insurability and renewability.

To inhibit such perverse incentives, medical care would be partitioned into two components: (1) catastrophic coverage which provides care for expenses greater than $1800 for individuals and $3000 for families and (2) basic care for amounts less than the stated amounts. Basic health care would be completely decentralized to the states. Catastrophic coverage would also be decentralized to the states with the exception that the federal government would define the procedures covered under catastrophic coverage and the policy for setting insurance prices. The catastrophic benefits package and the price mechanism will be discussed subsequently. In addition, because the federal government is providing the states with block grants for medical care for the needy, the federal government would require states to seek federal approval for their equity medical program for the needy.

3.1 Efficiency

The fundamental federal action which would improve the efficiencies of medicine and at the same time enable the states to pursue their own basic coverage plans would be to create tax incentives to promote consumer choice. The tax incentive should cover the federal catastrophic benefits package and a fixed amount for basic coverage. It should be written so that this basic tax incentive could be used in the single payer, managed competition, voluntary associations, or medical savings account approaches to medicine.

If a state opted for a plan, such as Nickles, with a variable tax rate for medical expenses, the state would adjust the variable tax rates so that the average state per capita tax benefits would be equal to the national average. If the variable rates resulted in a difference from the national average, the state and federal government would have to settle the difference in a transfer payment.

The same tax incentive would apply whether the individual purchased his or her medical plan or whether it was provided as a fringe benefit by the employer. Neither individuals nor firms could claim a tax break for more expensive medical coverage than the federal-state specified amount. Consequently, regardless of which type of plan a state chooses, individuals and firms would be more cost conscious in their choice of plans.

Furthermore, a state would have numerous alternatives in its organization and implementation of a health care system. For instance, a state could subdivide itself into regions with different systems. However, because of incentive incompatibilities, only one choice can be selected within a specified region. For example, if a state selects a medical savings account option for basic coverage it is incompatible with any insurance plan for basic coverage because the healthiest subset with insurance would have incentives to switch to the medical savings account. A medical savings account could be combined with either a single payer, managed competition or voluntary associations for catastrophic coverage. Nevertheless, a state which opted for a medical savings account would also likely opt for voluntary associations.

Under the proposed decentralization, each state would determine the basic benefits package. States would have the option of further decentralizing medical decision making to the level of government they considered the most appropriate. For example, states which elected the medical savings plan would in effect be decentralizing the benefits package to the level of the household. Each state could determine the price policy for basic care. Such a choice must be compatible with the choice of organization. For example, while community-based risk pooling for basic coverage is compatible with either single payer or managed competition, it is incompatible with medical savings accounts which are only compatible with actuarial risk. In addition, each state would retain control over medical liability and the percentage of health costs covered by business for both basic and catastrophic coverage.

In addition, states would have the freedom to act over decentralized items without seeking approval from the federal government. Take, for example, the concept of medical regions. States, if they so desired, could form compacts to place metropolitan regions located in more than one state in a single medical region. In addition to employers, a state could empower professional societies or political units from major cities to residential housing associations to offer members or residents group rates for medical insurance. Finally, a state could experiment with agencies having more powers than insurance pools, but less than managed competition alliances.

Rather than try to achieve performance by bureaucratic regulation from Washington, state medical performance should be governed instead by the principal of "voting with your feet." For federal decentralization policy to make "voting with your feet" effective, all state residents and economic interests should have a strong political interest in their state plan. Currently, large firms which self-insure are excluded from state mandates and other insurance regulations by the Employee Retirement Income Security Act of 1974 (ERISA). Consequently, these firms and their employees have no interest in the state plan. Many governors complain that ERISA limits their ability to reform their state medical plans. By August 1993 Hawaii, Maryland, Minnesota and New York had already applied for waivers from this part of ERISA such that all businesses in their respective states would be subject to the same regulations.11 For example, the entire business community would strongly oppose excessive mandates imposed on basic health care, for example cosmetic plastic surgery or hair transplants, proposed by health care providers, if they promoted corporate relocations out of the state.

Also, the federal government should focus its attention on national problems and not problems of particular states. For example, the average medical liability insurance premium for orthopedic surgery in the most expensive state, Michigan, is more than 8 times the average premium in the 25th most expensive state, Mississippi, and is more than 25 times the average premium in the least expensive state, Indiana.12 Outrageously expensive medical liability premiums are not a national medical problem, rather they are a localized problem primarily in the cities of the Northeast.

In addition to providing the framework for medical decentralization, the federal government should continue the funding of basic medical research which has successfully led to the discovery of better medical procedures and drugs. Furthermore, as will be discussed in detail later, the federal government should accelerate its promotion of information technology applications in medicine .

3.2 Equity

We propose two policies in order to establish equity. First, the needy should be entitled to cost effective procedures, but not high risk, costly ineffective procedures. Because there is no consensus on which procedures should be allotted to the needy the final decision should be left to the states. Second, it is asinine to provide platinum health care coverage for the needy and elderly and no support for the working, near poor. Again because of a lack of consensus, the implementation of this criterion should be delegated to the states. To ensure that states are allowed freedom to come up with innovative and cost effective solutions to achieve medical equity all federal entitlement health funding should be given as a single block grant to the states.

The two major federal medical entitlement programs, Medicaid and Medicare, have generally acknowledged defects as estimates of socially desirable medical equity. Currently the federal government runs Medicaid jointly with the states to provide medical care for the poor. This program pays the medical expenses of the poor; however it provides very few subsidies for the near poor. Currently, Medicare pays 80% of the medical expenses for all the aged regardless of their income and assets. Thus, Medicare is more of a specialized retirement income program than a medical equity program. Current retirees receive Social Security and Medicare payments that combined are equal to two to five times their contributions and the contributions of their employers into Social Security. With 42 million Americans without medical insurance it is inconsistent to target all the medical subsidies to two groups.

The federal government should provide each state with a block grant equal to its Medicaid expenses. Each state would use its federal and state funds to provide the poor, and near poor financial assistance to help pay for the basic state medical plan. We also propose that the current funds spent on Medicare also be transferred as block grants to the respective states. This money should be used to supplement the medical subsidies for needy individuals in higher risk groups such as the aged. In spite of the requirements for medical equity, states would still be left with innumerable options to establish health care plans. For instance, states could follow Oregon's lead and use rationing to distribute the Medicaid funds to the near poor as well as the poor. Those states using managed competition might use cross subsidization between less risky and more risky groups. Conservative states might provide medical subsidies based on the cost based on actuarial risk versus income and assets.

Any effort to create cross-subsides in medical insurance between the healthy and not so healthy will create winners and losers. For example, while community-based risk pooling with portability and renewability will make medical insurance cheaper for older individuals and the not so healthy, it raises the cost to the healthy young forcing some of the healthy young to forego medical insurance. The market solution, actuarial risk favors the healthy young. Nevertheless, even conservatives are not likely to push actuarial risk to the limit of all available information such as requiring individuals to disclose genetic information to insurance companies. Consequently, most individuals believe in some form of risk pooling. Also, a majority of individuals believe that no one should be refused medical insurance, and that such policies should be renewable with only modest price increases.

With decentralized basic coverage, liberal states would probably use some form of community-based risk pooling for basic coverage whereas conservative states would be likely to let the market dictate the rates for basic coverage based on privacy and actuarial risk with pools for high risk. We assert that the federal government should employ a price policy to make catastrophe medical insurance affordable to the greatest number of individuals. Because community-based rating greatly raises insurance costs for the healthy young, who on average make less than the middle aged, a community-based risk pool for the catastrophic coverage would greatly reduce the affordability of this insurance. A compromise between liberals and conservatives might employ modified community-based risk pooling by age with penalties for risky behavior such as smoking. Given the fact that the working will have to support the social security retirement for the baby boom, it would be bad politics to expect the healthy young entering the work force to carry the additional burden of partially financing the medical insurance of the middle aged with higher incomes.

4. Innovation and Decentralization

Forecasters who predict that medical expenditures will continue to increase faster than the GDP lack a basic understanding of economics. First, as the percentage of personal income (wages plus fringe benefits) spent on medicine continues to grow, workers will have less interest in receiving higher costing medical benefits instead of increases in their money wage. In response to these preference changes, the health care system is and will continue to adapt. We shall discuss the cost cutting innovations currently taking place and forecast their evolution on three levels: (1) innovation in private sector medical organizations such as HMO's and PPO's; (2) the federal government's role in promoting medical innovation through research and development; (3) finally, innovations in state medical programs and how variation in state plans will promote medical service and quality innovations.

4.1 Private medical innovations

Currently private medical organizations are undergoing a rapid transformation through private competition. The two factors which have made economic competition possible in supplying medicine were the increase in the supply of medical doctors from 141 physicians per 100,000 persons to 200 per 100,000 promoted by passage of the Health Professions Educational Assistance Act (1963) and the Hill-Burton Act (1946) which subsidized the construction of an excess supply of hospital beds.13

The increase in the supply of medical doctors facilitated the shift of medicine from fee-for-service to prepaid medicine in the form of preferred provider organizations, PPOs, and hospital maintenance organizations, HMOs. From 1985 to 1993 the number of American subscribers to this type of prepaid medicine increased from 25 to 90 million. One reason for this dramatic shift is that employers were able to obtain lower and more predictable medical costs. Moreover, many doctors were willing to join PPO networks or even become salaried employees of HMOs because there was a surplus of physicians.

Under the older fee-for-service medicine financed by third party insurance, doctors had no motivation to practice cost effective medicine. Indeed, to reduce their liability to malpractice suits they subjected their patients to numerous, expensive tests of marginal benefit. PPOs and HMOs are changing the practice of medicine by providing incentives to practice cost effective medicine. Prepaid medicine creates cost-cutting incentives because profits depend on keeping the average expenses per patient below the fixed revenues. One innovation which has allowed prepaid health care plans to keep their costs low is the use of a "gatekeeper" which is a primary care physician who determines whether a patient needs to see a specialist or if the malady can be treated by the general practitioner. Thus, the less expensive primary care physician provides more medical service. In addition, HMOs establish policies about expensive tests and procedures and PPOs drop doctors from their networks if they practice expensive medicine.14

Now, let us consider medical service innovations in hospitals. With the excess of hospital beds prior to the growth of prepaid medicine, hospitals competed to have fee-for-service doctors send their patients with third party insurance to their hospitals by buying the latest technology and trying to provide all specialties under one roof.13 This led to expensive duplication of technology which was underutilized. With the increase in prepaid medicine the new incentives are for cost-effective hospitals to attract PPO organizations and those HMOs which do not have their own hospitals.

Currently to create cost-effective hospitals, hospital chains are merging into giant chains offering the entire range of medical services through specialization. For example, in 1993 Columbia Healthcare Corporation created a 190-hospital chain through mergers.15 Columbia anticipates saving $130 million through closing unneeded hospitals and combining services such as radiology and clinical laboratories. In addition, hospital chains and HMOs are forming research and development groups to improve the cost effectiveness of their operations. For example, 58 major physician-led practices recently joined forces to create Group Practice Improvement Network in order to develop and disseminate new management strategies.9 Another example is that hospital chains are offering their own medical plans which are much cheaper to administer than medical plans paid by third parties.

Prepaid medicine is currently 10 to 30% cheaper than fee-for-service medicine. Further savings may be achieved as hospital chains begin to form their own prepaid health care plans which will compete with the existing HMO's and PPO's. Consequently, we forecast the percent of medicine provided under a prepaid medical system will continue to increase. Consolidations in hospitals will continue to increase their efficiency through specialization, better use of technology, and a research and development effort to obtain more cost-effective procedures. Furthermore, physicians will increasingly need to be a member of a prepaid medical supplier network to obtain an income. We predict private market competition and the shift to prepaid medicine will cause the rate of increase in medical expenses to gradually decrease.

Obviously, to the extent that the private medical sector makes medicine more efficient, the need for a massive overhaul of the medical system is lessened. Nevertheless, there would still remain problems which need to be addressed.

4.2 Federal government

The role of the federal government in our decentralized plan is four fold. First, the federal government would establish tax incentives to make medical consumers cost conscious and then decentralize operational control of medicine to the states. Second, the federal government would have to address the problem of households moving between states by determining the benefits package and price policy for catastrophic coverage. Third, because the federal government partially funds medical equity, the federal government would need to approve the medical equity plans of the states. Finally, the federal government should actively promote research and development to promote medical discovery, invention and innovation.

For some time the federal government has funded medical research for the discovery of knowledge of diseases, the invention of new medical technology and the development of new medical procedures and delivery systems. In addition, the federal government should promote advances in information technology which would reduce the administrative costs in medicine and advance the practice of medicine. Our proposal for an increased federal role in promoting medical information technology is certainly not a new idea since almost all of the medical reform plans propose such a federal role.

One factor which greatly increases the administrative costs for most participants in the medical system is the fact that there is no commonality in insurance forms which hospitals and medical practitioners must process. Currently, with advances in communications there have been numerous advances in the electronic transmission of documents. To some extent this is taking place among medical practitioners, hospitals and insurance companies. A substantial reduction in administrative costs would occur if patients, medical practitioners, and hospitals had standard forms to submit insurance claims electronically by E-mail. All of the plans except single payer propose this action.

The federal government should do more than simply encourage a standard form for medical transactions among medical agents. The federal government should accelerate the development of computer-based patient records, an activity initiated by the Institute of Medicine in 1991.16 With digital medical records and standard medical forms, once a medical practitioner records his patients history and proscribed treatment procedure, software companies will develop programs for formatting and transmitting all the required medical documents to the correct parties. This innovation is feasible within ten to twenty years. In addition, the federal government should fund basic research through a public-private consortium for the creation of hand written notes and voice-recognition language for recording medical information. For medical practitioners to switch to electronic medical records, writing medical records on a digital assistant must be as easy as writing them on paper currently. This would make all medical practitioners much more efficient. Also, the federal government needs to encourage the move towards a uniform hospital discharge and hospital cost accounting.

The creation of standardized forms and digital medical records is not a one time event. Every five years or so these standards will have to be updated to correct defects and reflect new knowledge. These standards will enable software companies to create programs to automate medical administration and the communication of medical records. As has been the case in the gradual automation of business administration each advance will necessitate the reorganization of the administrative procedures.

Creating digital standards for medical records and administrative forms will facilitate the detailed analysis of the medical system and medical practice. One example is the study of variation in medical practice. Currently insurance companies use such data to remove medical practitioners practicing high cost medicine. With universal digital medical records, medical practitioners will have their own software to inform them of standard medical practice and whether their approach is high cost.17 Defining standard care creates incentives that patients would receive no less than standard care. Prepaid medical plans would risk expensive liability suits if they tried to pressure medical practitioners to practice less than standard medical care, and medical practitioners would have a liability suit defense if they provided standard care.

Another example of a federal government innovation is longitudinal patient record keeping to determine the long term effectiveness of alternative medical procedures. Digital medical records will make the creation of risk-adjusted measures of outcomes and outcomes management much easier.18 Finally, digital records make preventative medicine easier to perform with computer prompts. Hospitals will use digital records to more efficiently improve the cost effectiveness of their procedures. The ability of states to collect the medical data needed to operate their respective medical systems will be improved. The federal government should collect information for data bases promoting research into areas not covered either by the states or private information services.

4.3 State Innovations

Now let us consider medical service innovations promoted by decentralization of medical plans to the states. Since states will be allowed to determine their own health care policies, the operations of the medical system will result in a much quicker trial of alternative procedures and much quicker imitation of successes by the states. It is likely that at least one state would adopt each of the major proposals for medical organization currently being proposed at the national level. Many states have already established voluntary associations as a mechanism whereby small business can obtain cheaper medical insurance. Florida and Washington have a form of managed competition. Maryland is using cost controls to contain medical expenditures. Conservative states are likely to select some form of medical savings accounts. A few rural states such as Montana and Vermont might adopt the single payer system.

With the proposed decentralization states could integrate basic care with catastrophic care. For example, with managed competition or voluntary associations individuals or household could buy a single medical insurance package which covered both basic and catastrophic care. The pricing policy of the basic care portion would be determined by the state and the pricing policy of the catastrophic portion would be set by federal policy. With a single payer system the two types of care would also be integrated.

If the states adopted a wide variety of plans, such a pattern of choice would help to resolve many efficiency issues. For most of the current plans there is little empirical evidence on what efficiencies the plan would generate at a state or national level. The one exception is a single payer system modeled after the Canadian medical system because it is known that the administrative expenses of the Canadian single payer system are at least 10% less than the current US multiple insurer medical system.19 However, all plans recommend the adoption of a single insurance form for payment and transmission of paperwork electronically. Over time it is not obvious whether the transition costs to a single payer system would be worth the administrative reduction of costs. Also, Canadian hospitals currently make more effective use of medical technology,20 but US HMOs and hospital consolidations are leading to better use of technology in US hospitals. If a single payer system tends to stifle medical service innovations, such a move could be a mistake.

Numerous medical efficiency issues exist in the various plans. For example, creating voluntary associations to obtain quantity discounts and distribute risk in medical insurance necessitates much less bureaucracy than creating powerful managed competition alliances to select a menu of plans for consumers. Are the benefits of managed competition over voluntary associations worth the cost? Also, managed competition and medical savings accounts are based on very different assumptions concerning the ability of individuals and households to determine their best medical options. The purchase of medical procedures is different than the purchase of most other goods in that the consumer trusts the medical practitioner to proscribe the best procedure. The medical savings account assumes individuals and household are knowledgeable enough to act in their own best interests in the purchase of medical service. Managed competition, on the other hand, assumes that medicine has become so complex that individuals and households need an advocate to act on their behave in selecting a menu of medical plans. Large scale empirical testing is necessary to determine which assumption is superior.

The choices of the states also affect the labor costs of small businesses. One important choice is what percent of medical insurance should be paid by employers. As was previously pointed out, workers incomes equal money wages plus fringe benefits. If a state requires all businesses to provide workers with medical insurance, the cost of labor for firms previously without medical insurance will increase. They will react by reducing employment. States need some flexibility to decide how to make short term trade offs between reducing employment and increasing the number of workers with medical insurance.

Over time, from the perspective of wage compensation in a purely competitive labor market, it does not matter what percent of the health care costs are paid by businesses in each state. Suppose, for example, two firms and a worker have the same medical tax incentives. Suppose the first firm operating in a state which requires business to pay 0% of the basic health care package tries to hire a worker from a second firm in a state which requires business to pay 100% of the basic health care package. The first firm would have to compensate the worker the amount of the basic health package plus an incentive to move. Consequently, wages in states where residents pay for their medical insurance will be higher than in states where businesses pay for their employees medical insurance.

Nevertheless, the two approaches have different social implications. If business pays the entire basic medical package, the medical program will be organized through the firm and may not be convenient to the various workers' households. Where workers pay the cost of the basic plan the workers are much more likely to choose plans convenient to their households. In states where the individual pays for his or her medical program out of his or her wages, the state could empower cities, towns, and neighborhood associations to negotiate medical insurance packages for their residences.

Over time organization of primary medical services through communities is likely to be more efficient for a variety of reasons. First, local government is likely to choose plans with less transportation costs imposed on its residents. Second, primary care practitioners will be able to discuss their patients diagnoses with medical specialists through teleconferencing. With their workstations primary care practitioners will have information support systems to promote cost effective medicine.17 Moreover, many workers change jobs frequently. With community-based medicine, they would have continuity with their primary physicians. This factor is likely to become increasingly important in promoting preventative care and the use of primary care practitioners rather than high cost emergency medical wards.

5. Coverage, equity, and universal care

In the proposed decentralization plan, the federal government and states have important roles in striving to create a medical system that provides quality universal medical care to all residents. In achieving such a goal the federal government and the states must successfully solve several difficult problems. Government in defining standard benefits packages must compromise between what is affordable and what is desirable. For example, if the catastrophic coverage benefits package is too generous, it may be too expensive for near poor households without medical subsidies and create a medical entitlement program for the poor and old requiring expenditures beyond what the states and federal government are prepared to spend.

The first problem to consider is that what constitutes quality health care is constantly changing because advances in medical technology, new procedures, and new drugs are constantly being introduced into the medical system time is required to accurately determine their cost-benefits and long term effects. As the number of times a procedure is performed in an hospital increases, there is some evidence that cost decreases and the effectiveness increases through on the job learning.21 Consequently, if the rich wish to pay for procedures that are not included in the standard package because they were not considered to be cost effective, they help to make such procedures more costs effective.

Under the proposed decentralization plan the federal government determines the procedures covered under catastrophic health insurance. Each year the list of procedures should be upgraded to reflect new knowledge. The federal government also determines which expenditures on basic medical care can be counted as part of the deductible. In defining the catastrophic medical benefits package, the federal government must compromise between the need for affordability and the desire to have a fully comprehensive package.

Because there is so much dispute in what constitutes an acceptable level of medical care, the states would be granted the right to petition the federal government for experimental variances as long as the consequence of the adjustments kept the cost within 20% of the federal tax deductions. Consequently states with efficient medical plans could add procedures to take advantage of their potential tax break. However, such decisions should carefully consider the fact that any increase in state mandates makes insurance less affordable for the near poor.22 States with difficult financial problems meeting their commitment to equity could reduce coverage.

In addition to selecting an efficient medical system, a state should take steps to make its medical benefits package more affordable. States with expensive medical liability insurance could adopt the practices of states with inexpensive medical liability insurance. Also, states could reduce fraud and abuse. With the switch to prepaid medicine, there will be shortage of primary physicians. Adjusting medical schools to produce more primary physicians and fewer specialists will take some time. In inner cities and rural areas primary care medical practitioners or nurses connected through teleconferencing to medical specialists would be superior to no primary practitioners or a trip to the nearest public emergency ward. Finally, as has been recommended in many plans, the federal government could assist by relaxing the current federal antitrust statutes to allow cooperation between medical suppliers to achieve more efficient use of technology.

In our proposal for medical equity, the federal government would provide each state with a block grant equal to the federal contribution to Medicaid and Medicare. The states would have to propose an equity system and submit it to the Department of Health and Human Resources for approval. For example, a state might suggest a system of variable subsidies based on income, assets and the cost of an individual or household's medical insurance. There is unfortunately no guarantee that all the near poor above the subsidy income level would be able to afford the standard catastrophic medical coverage. Also, because many states have balanced budget amendments, circumstances such as a major recession could place some states in a financial crisis.

To meet such financial crises, the states need more tools at their disposal. States need the option of offering the needy only the most efficient medical program, cost controls, global equity budgeting and rationing. Given the current trend in Medicaid experiments, states will want to offer those receiving financial assistance only the most efficient prepaid medical care. If further action is needed, rationing may be the most effective. To some extent cost controls and fixed budgets are equivalent to rationing, in that consumers will find procedures prices below cost very difficult to acquire and global equity budgets will create long wait times as a rationing device. The advantage of rationing procedures, as has been implemented in Oregon, is that this approach focuses attention on the cost-effectiveness of alternative procedures.

A few states such as Hawaii have created medical systems which approximate the ideals of universal coverage. Given the wide range of conditions in the states there is no guarantee that all states could achieve this goal. To aid the states in their balancing acts, the federal government should make the initial coverage of the catastrophic coverage modest. First, it is easier for politicians to subsequently add coverage than to take away coverage. Second, given the previous gross errors in forecasting the growth of Medicaid and Medicare expenses, it is hard to take the forecasts of the cost of the various plans and their projected savings too seriously. Finally, it would aid the federal government's image to create a program which did not add to the budget deficit. While the budget deficit is decreasing it is still large as the economy approaches effective full employment.

Finally, a great deal of empirical knowledge gained through state experimentation is required to determine the best compromises among affordability, equity, and coverage to achieve universal care.

6. Conclusions

If any one of the medical plans proposed by President Clinton, Senators Chafee, Gramm and Nickles, and Representatives Cooper, McDermott, and Michel is enacted, the states would be forced to select from a small menu of available options, the ones which reflect the political views of the sponsor. The US would suffer an enormous social cost in that we would never know what might have been if one of the other choices had been selected. In contrast, because the various states have different needs, political orientation, and state economies, our decentralized approach would be likely to have the result that the best ideas of all the plans would be implemented in at least one state. Over time clear winners would be established.

With decentralization some states would make serious mistakes. Nevertheless, such mistakes would have much less social cost than a serious mistake by the federal government because decentralization besides promoting innovation also promotes faster imitation of success. State governments, which frequently have balanced budget amendments and must compete to attract new business, are quick to imitate successes by rival states. The federal government is much more insulated by budget deficits and cultural differences from imitating successes by other nations.

References

1. Clinton Administration American Health Security Act of 1993 , 1993 DLR 176 d37

2. Chafee, John The Health Equity and Access Reform, Senate Bill 1770, US Congress, 1993.

3. Cooper, The Managed Competition Act of 1993, H.R. 3222, US Congress, 1993

4. Gramm, The Comprehensive Family Health Access and Savings Act Summary, Senator Gramm's Office, US Congress.

5. McDermott, The American Health Security Act, H.R. 1200, US Congress, 1993

6. Michel, Affordable Health Care Now Act of 1993, H. R. 3080, US Congress, 1993

7. Nickles, Consumer Choice Health Security Act, S. 1743, US Congress, 1993

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16. Rootenberg, J., Computer-based patient records: The next generation of medicine?,

JAMA, 1992; 267: 168-169

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18. Enthoven, A., What can Europeans learn from Americans?, Health Care Financing Review, Annual Supplement 1989

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23. Pearson, L, 1992-93 Update: How each state stands on legislative issues affecting advanced nursing practice, Nurse Practitioner, 1993, January 23-38

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