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Obamacare: The Good, the Bad and the Ugly

A doctor's office visit for routine health checkup.
A doctor's office visit for routine health checkup.
Photo by Joe Raedle/Getty Images

In 2010 a fractured U.S. Supreme Court upheld the controversial individual mandate of the Patient Protection and Affordable Care Act, or ACA, and thereby saved President Obama’s signature healthcare law from ignominious defeat. That ruling, made possible by Chief Justice John Roberts’s fifth and deciding vote, brought cheers from liberals and jeers from conservatives. Setting aside, for a moment, questions about the law’s constitutionality, can Obamacare be justified on economic ground?

Opponents of Obamacare say that the free market should decide the question of who gets healthcare and who doesn’t. The problem with this argument is that at some point the exclusion costs – the costs of keeping people from accessing market-provided healthcare – would become socially and economically inefficient.

They are socially inefficient because by excluding people from healthcare with cost-prohibitive premiums, the market passes on all the costs to society. They are economically inefficient because excludable healthcare confers benefits to some while denying benefits to others, thereby simultaneously making one group better off and another worse off. The latter violates what economists call Pareto efficiency.

Theoretically, the ACA’s employer and individual mandates can correct these inefficiencies. The play-or-pay aspect of the employer mandate is necessary to subsidize health care for people whom the market would otherwise exclude due to the inability to pay. Fining companies $2000 per employee for failing to offer affordable health insurance to their employees is a logical way to prevent free-riding employers from dumping the costs of employees’ healthcare onto the taxpayers.

But to make health care nonexcludable, the employer mandate alone is not enough. No one can be denied healthcare if it is universal. Toward this end, the individual mandate requires all Americans to obtain health coverage, either through their employers, the government, or on their own, so that everyone would share in the costs and benefits.

However, there are at least two potential problems that can make these mandates less attractive. The first problem concerns the difficulty of determining the optimal amount of health care each recipient really needs.

In the market place, consumers reveal their need for healthcare by their willingness to pay. Since consumers are heterogeneous, they have different valuations for the same quality and quantity of healthcare offered. The ACA makes two questionable assumptions. First, all consumers have identical valuation for some fixed level of healthcare, and second the government can determine what this fixed level is.

Regulations that flow from the above assumptions can be problematic. Requiring employers and employees to offer and accept, respectively, a healthcare package that meets the government’s standard of “minimum essential coverage” can potentially inhibit welfare-improving trades.

For instance, it might be more efficient for employers to offer employees above-competitive wage in return for substandard health coverage, and for employees to choose to forego quality health coverage for more income. But under the mandates, this more gainful alternative is unattainable, leaving both employers and employees worse off as a result.

The second problem is that the mandates still do not completely overcome information asymmetry. Bringing everyone into the insurance pool to reduce risk and lower premium costs does, in theory, address the adverse selection difficulty, but it leaves the moral hazard conundrum unresolved.

Because health care can never be a pure public good due to its rivalrous characteristics—one person’s use of a hospital bed today means one fewer hospital beds to go around for everyone else tomorrow—what is to keep people from consuming more health care than is optimal by taking more health risks or making more frivolous visits to the doctor’s office? The theory of moral hazard predicts that this is how a rational person would act if part of his or her premium cost is being subsidized by someone else.

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