Accounting Rules Force States to Confront Hard Choices

Massachusetts Deputy Comptroller Eric Berman visited Professor Joyce's Public Budgeting and Finance class earlier this week. Mr. Berman focused his remarks on an a previously obscure (to me at least) accounting standard that is forcing states and local government to confront the cost of retiree health care and other post-employment benefits in a big way.

The accounting standard calls for states to start paying for retiree benefits as they are accrued (similar to how you accrue vacation time) instead of as benefits are paid (i.e., when you are 65 and sign up for retiree health insurance). The crux of the problem for states and local governments is that they have been paying for their public employees' retiree benefits out of general revenues on a yearly basis. But now, under these new rules, they have to pay not only for the current cohort of retirees, but also set aside money for current employees who are accruing retiree benefits while they are working.

Faced with a bigger budget item in what's become tough financial times, states and local governments are feeling the pressure. Mr. Berman discussed a a number of the policy alternatives some governments are considering in dealing with the crisis, including:

1. Issue bonds;
2. Establish an irrevocable trust;
3. Sell of state owned assets;
4. Use tobacco money; and,
   
5. Reduce retiree benefits and/or shift costs onto the retirees.

In discussing the merits of alternative 5, Mr. Berman argued that increasing copayments for doctor visits could have beneficial effects beyond shifting costs from the state to the retiree--it would force consumers to confront the cost of health care such that it would lead to a more equitable market place.

Reflecting the pressures of uncontrollable increases in health care costs, Mr. Berman's policy alternatives make some sense--if you are thinking in the short-term about the state's coffers--not if you are trying to help people stay healthy or protect their limited income from costly medical procedures.

Increasing the price tag for state retirees (or any population with a fixed and limited amount of resources) to take advantage in a service will decrease demand for that service. There are a number of studies on this point, one most recently about how copayments for mammograms are a deterrent which may then lead to more incidents of breast cancer and harder to treat breast cancer. (Read: Higher hospitalization costs for the state later and unnecessary deaths)

From an economic point of view, Amitabh Chandra, Jonathan Gruber and Robin McKnight have a paper on "Patient Cost-Sharing, Hospitalization Offsets, and the Design of Optimal Health Insurance for the Elderly," which states in the abstract:

Patient cost-sharing for primary care and prescription drugs is designed to reduce the prevalence of moral hazard in utilization. Yet the success of this strategy depends on two factors: the elasticity of demand for those medical goods, and the risk of downstream hospitalizations by reducing access to beneficial health care. Amazingly, we know little about either of these factors for the elderly, the most intensive consumers of health care in our country. We remedy both of these deficiencies by studying a policy change that raised patient cost-sharing for retired public employees in California. We find that physician office visits and prescription drug utilization are very price sensitive; while direct comparison is difficult, the price sensitivity appears to greatly exceed that of the famous RAND Health Insurance Experiment (HIE). Moreover, unlike the HIE, we find large "offset" effects in terms of increased hospital utilization in response to the combination of higher copayments for physicians and prescription drugs. These offset effects are concentrated in patients for whom medical care is presumably efficacious: those with a chronic disease. Finally, we find that the savings from increased cost-sharing accrue mostly to the supplemental insurer, while the costs of increased hospitalization accrue mostly to Medicare; thus, there is a fiscal externality associated with cost-sharing increases by supplemental insurers. Our findings suggest that optimal insurance should be tied to underlying health status, with chronically ill patients facing lower cost-sharing.

Chandra et al. are essentially saying that when California increased copayments for state retirees, they saved a bunch of money for the state, but they lowered health outcomes for their population (more hospitalizations) and shifted costs from the state to Medicare, a federal program paid for with tax dollars. Which is similar to shifting your costs from your left pocket to your right pocket, to borrow Mr. Berman's turn of phrase.

Raising copayments and reducing benefits alone will not solve the problem of uncontrollable costs in a particular state or for the country. In order to control medical inflation we will need to cut waste in the system (i.e., move from paperless records to electronic records), reduce unnecessary medical errors and services, and encourage patients to take responsibility for their health.

I don't mean to say that these three policy alternatives will solve the evolving fiscal crisis at the state level. I don't think they will, but I do think they will go much further to control costs than reducing benefits and increasing copayments. Ultimately, health care is a national economic issue that will need to be dealt with by the federal government through national reform. Which is what, as the most recent GAO paper on state and local retiree health care costs notes, many states have been waiting for.