The GOP Tax Bill has been passed by Congress and signed by President Trump, proving that Republicans are indeed capable of passing more than month-long spending extensions (if only just).
The Tax Cuts and Jobs Act makes several big changes to the US tax code–some good, others less so. The bill also has major implications for the US healthcare system because it repeals the individual mandate of Obamacare.
In the short-run, this repeal will provide limited tax relief for healthy individuals that would prefer to go without health insurance. Unfortunately, it will make things much worse for sicker Americans and give a political bailout to Democrats who want to blame Republicans for Obamacare’s failures.
Up until now, the claim that the GOP is destroying Obamacare has been largely fictional. Obamacare has been collapsing based on its own flaws. But by repealing the individual mandate, the GOP has volunteered itself as a scapegoat, and the repercussions do not bode well for liberty or for healthcare.
The Individual Mandate and the Four-Legged Stool of Obamacare
The individual mandate refers to a penalty imposed on individuals who did not have health insurance during the year. The penalty was designed to coerce young and healthy individuals to purchase health insurance and effectively subsidize premiums for older and sicker people.
This provision was correctly seen as an essential feature of the Obamacare ecosystem because it tried to counteract problems created by other provisions of the law. It’s a classic illustration of how one economic intervention necessitates another.
It works like this:
The core goals of Obamacare were to get more people health insurance and to prevent insurers from denying coverage to people with pre-existing conditions. Achieving this was straightforward. The Affordable Care Act just made it illegal. All else equal, this would cause dramatic increase in the annual claims insurers need to pay out for the average policyholder.
Since the insurance companies don’t want to lose money, they would try to mitigate the effect of this provision in one of two ways. They could just stop covering the required treatments for especially expensive health issues. For example, an insurance company might decide that chemotherapy is no longer covered on their plans to deter existing cancer patients from signing up with them. Or the second option is that they could raise premiums astronomically only on sick patients without technically “denying coverage” to them.
To prevent the insurance companies from reacting in these ways, Obamacare included two more provisions. It created the concept of essential health benefits to prevent insurers from offering stripped-down policies. Obamacare also implemented a “community rating” system for pricing, which severely limits insurers’ ability to set prices based on the expected costs of an individual policyholder. The pricing can only vary by a limited amount (3 to 1) for a given policy and the variation can only be based on a few generic factors such as location, age, and tobacco use.
So if the monthly premium for a 25-year-old, non-smoker was set at $1,000 in a particular location, the monthly premium for an elderly, non-smoker with pre-existing conditions in the same area could not exceed $3,000 for the same plan. The monthly premium for a 25-year-old, non-smoker with an expensive pre-existing condition in the same location would have to be just $1,000.
Taken together, these provisions meant that insurers would have to cover the sickest patients, provide coverage for their expensive illnesses, and charge those people a similar price as everyone else. For insurance companies to make ends meet, their only option would be to raise premiums significantly–on everyone.
In turn, this would make healthcare insurance unreasonably expensive for poor people. So subsidies were created in the form of tax credits and direct payments to insurers.
Higher premiums would also make health insurance altogether undesirable for healthier individuals that don’t expect to spend much on medical bills. Additionally, since pre-existing conditions will be covered regardless, healthy individuals have little incentive to get insurance before they have a big problem. Combined, these factors would lead many currently healthy and young people to avoid getting health insurance entirely.
This is finally where the individual mandate comes in. Since it’s no longer in most individuals’ interest to get health insurance, the individual mandate is designed to coerce them into doing so. If they don’t have insurance, and don’t have a qualifying excuse, they have to pay a fine.
The whole system works together, just not very well. Obamacare ends up like a four-legged stool. The goals were to provide coverage for more people and guarantee coverage to people with pre-existing conditions. But to support these objectives, it had to create essential health benefits, standardized pricing, subsidies, and the individual mandate. These are the four legs. If one leg gets removed, the rest of the system would inevitably fall–and cause considerable mayhem on its way down.
The Obamacare “Death Spiral”
The way Obamacare will collapse now that the individual mandate is repealed is often described as a death spiral. In economics, the problem is known as adverse selection.
With no threat of a penalty, more young and healthy people will decide to forego health insurance. The remaining population that has health insurance for the year will now be older, less healthy, and more expensive for insurers to cover, on average, than they were when the penalty existed. This will cause insurers to take a loss or earn less money than their stakeholders require.
The next year, the insurers will have to raise premiums across the board to compensate for their more expensive policyholders. But these higher premiums will, in turn, cause slightly more young and healthy people to avoid insurance. Again, the remaining pool of insured people gets older, sicker, and more expensive than the previous year, and insurers will then have to try to raise premiums the next year to keep up. Then more healthy-ish individuals will opt out.
This is the death spiral. The cycle is self-reinforcing, and the end result is that no one will be able to afford insurance. Additionally, the insurance companies themselves will be either bankrupt or exit the industry.
The process above is an entirely foreseeable chain of events. Indeed, to some extent, the death spiral has already started even with the individual mandate in place. Since the penalty is still cheaper than insurance premiums, millions of people have opted to pay the penalty and go without insurance to save money. Moreover, from 2015 to 2016, the number of people who had purchased individual private insurance plans already declined in absolute terms (see Table 1).*
Needless to say, the death spiral is bad for just about everyone involved in the long run. Healthy people lose access to a functional insurance system, sick people have to pay parabolic premiums, and insurers will lose money. The only winners are proponents of single-payer healthcare–who will gleefully point to the smoldering ashes of Obamacare as proof that the “market” has failed.
By repealing the individual mandate, the Republicans just voted to accelerate this process.
The good news is that Obamacare’s days are definitely numbered. But when it fails, the wrong lessons will be learned, and we’re likely to end up with even more government intervention in healthcare, not less.
*To evaluate the adverse selection problem, it’s important to look only at the number of people who purchase private insurance as individuals (instead of receiving it through their employer). Premiums in the individual market have been much more volatile because this is where many of the previously uninsured and sickest Americans have gone to purchase their coverage.