A MIDDLE-AGED man felt chest pains. As an executive at IBM, an information-technology firm, he had excellent health insurance, so he went straight to a specialist. His cardiologist put him through a bunch of tests, including a computerised tomography scan. A radiologist noticed something odd in his neck, so he went to a neck surgeon, who checked him out and found nothing. He went back to the cardiologist, who gave him an angiogram, which caused dangerous complications and landed him in hospital for a while. In all, he ran up more than $150,000 in medical expenses before the chest pains disappeared on their own.

When they reappeared several months later, he spoke to Paul Grundy, the head of health-care technology at IBM. Dr Grundy, a doctor of preventive medicine by training, asked him if his lifestyle had changed recently. The executive mentioned that he had taken up gardening again. Dr Grundy quickly established that his chest pains sprang from a muscle he had strained through overzealous weed-whacking.

Such stories are all too common. Americans will spend a staggering $2.5 trillion on health care in 2009, says the Congressional Budget Office. As a share of national income that is far more than other rich countries spend (see chart 4), despite America's slightly younger population. To say that Americans do not get value for money is putting it mildly. They live no longer than Europeans and die younger than the Japanese. Meanwhile, 46m of them lack health insurance.

There are many reasons why American health care costs so much. Americans love fancy new medical technology. New drugs, for example, are prescribed a year or two earlier in America than in Europe, and do not come cheap. American doctors pay a fortune to insure themselves against frivolous lawsuits. A study in the New England Journal of Medicine found that even in cases where no medical error was found, plaintiffs received payments a quarter of the time. And half of medical malpractice payments were gobbled up by lawyers and overheads.

But the central problem is that most Americans get their health insurance through their employers. This dates back to the era of post-war wage controls, when firms offered benefits instead of pay rises. Today's tax code sets it in stone. Employers can buy health insurance with pre-tax dollars. Individuals cannot.

This creates an agency problem. When a typical patient goes to the doctor, he has no idea what anything costs. He pays only about 15% of the bill, so if the doctor recommends something he will probably say yes. The doctor gets paid for everything he does, so he has a powerful incentive to perform costly, unnecessary procedures. Besides, he may be socked for damages if he omits a test that a lawyer subsequently convinces a jury might have been useful. The costs are passed on to insurers, who pass them on to employers in the form of higher premiums, who then pass them on to workers in the form of lower pay.

This last point is not widely understood. Many Americans think of soaring health-care costs as a burden on companies. And it is true that some high-profile ones, such as carmakers, have come unstuck by promising health benefits that subsequently became too expensive. GM spends more on health insurance than on steel. It is also true that small firms find the bureaucracy of health insurance hasslesome. However, in general the real victims of health-care inflation are not businesses but ordinary Americans. As the cost of coverage rises, their wages are squeezed, or coverage is dropped altogether.

The proportion of the cost of employer-provided health insurance shouldered by employees is “at or close to 100%,” says Jonathan Gruber, an economist at the Massachusetts Institute of Technology. Last year, employer-provided health insurance reduced wages by 7.9%, according to the Bureau of Labour Statistics. The stagnation of middle-class incomes in recent years is in large measure caused by health-care inflation. Tying people's health insurance to their jobs also makes it harder for them to switch jobs or set up their own firms.

Reforming health care is Barack Obama's domestic priority. He is determined to increase coverage and curb costs. To increase coverage, he would subsidise individuals and small firms to buy insurance and bar insurers from excluding sick people. To promote competition, he would create a national insurance exchange where people could shop for different plans. As well as private insurance, he would offer people the option of buying into a public plan like the one that covers federal workers. To curb costs, he would promote the use of information technology and “evidence-based medicine”, the notion that you measure what works and only do it if it does. He would also allow imports of drugs from countries where they are cheaper (for example, because prices are set by a state monopsony).

Getting all this through Congress will be an ordeal, as Hillary Clinton discovered in the 1990s. But some kind of reform is likely, perhaps this year. The consequences could be far-reaching. Mr Obama seems determined to offer every American the option of buying government health insurance and if Congress agrees, private insurers will be walloped—some say wiped out.

A government scheme could offer much lower prices. Unlike a private insurer, it would not have to make provision for future liabilities; it could simply stick the bill to future taxpayers. Medicare, the government scheme for old people, has unfunded liabilities of $36 trillion—two-and-a-half times America's GDP. If opened to all, it could undercut private insurers by “screwing our children and grandchildren”, says Regina Herzlinger, a health-care expert at Harvard Business School.

The insurers that survive will be those that keep costs under control. Fee-for-service insurance must adapt or wither. Managed care will return. This is the model whereby doctors work for the insurer, which pays them to keep people well. Instead of letting patients go straight to a specialist, managed-care firms like Kaiser Permanente make them see a primary-care doctor first, who will figure out whether the problem is serious. This is crucial. Specialists tend to recommend their own specialism—surgeons advocate surgery, and so on. The lack of a gatekeeper in traditional fee-for-service insurance leads to over-doctoring that is often harmful as well as costly, as that IBM executive discovered.

Managed care, provided by firms also called health-maintenance organisations, (HMOs), grew rapidly in the 1990s but then retreated. One reason, according to Alain Enthoven, a health-care specialist at Stanford University, is that firms pushed their staff into HMOs without a choice, which angered many. Another is that they failed explicitly to pass on the savings to employees. This might change. For example, Stanford gives employees a choice of five health plans. If they pick the cheapest, (Kaiser, which is also arguably the best, says Mr Enthoven), the university pays the full cost. If they pick a more expensive one, they must pay the difference. Four-fifths choose an HMO.

The high price of pills

Health-care reform worries drug firms. Under the current system, Americans not only adopt new drugs more quickly than people in other rich countries; they pay 50% more for the same drugs, according to McKinsey. In a more government-dominated system, drug firms' profits would suffer. So would their incentive to innovate. It typically costs them a billion dollars to develop a new drug. They can only recoup their vast R&D outlays thanks to high margins in America. The rest of the world enjoys a free ride. But that could change.

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I'm afraid we'll have to remove your wallet

Billy Tauzin, the drug industry's chief lobbyist, protests that European-style rationing would cost American lives. But drug firms are already bracing themselves for leaner times. Several are merging to cut overheads and pool their research skills: Merck with Schering-Plough, Pfizer with Wyeth, Roche with Genentech. And many are finding that they can cut costs by outsourcing drug-testing. Quintiles, the largest firm that undertakes such work, saw its revenues grow by 19% last year. Pharmaceutical research is getting more expensive because it is getting more complex, says Dennis Gillings, Quintiles's chief executive. Many new drugs are aimed at old people who may already be taking several other pills. Testers have to be sure that they will not interact harmfully.

Mr Obama plans to spend $19 billion to promote health IT. The system is sorely in need of the efficiencies that digitisation might make possible. Only 4% of American doctors have a fully functional electronic medical-records system and another 13% have only a basic one, according to the New England Journal of Medicine.

Simply putting computers on doctors' desks is not enough, however. They must have incentives to use them. For managed-care firms, the incentives are already there. If their doctors can call up a patient's medical records on a screen, along with information about suitable treatments, they can get better results for less money. Fee-for-service doctors, who gain nothing by providing more cost-effective care, have been slower to digitise. Mr Obama says he will offer them incentives to do so. Meanwhile, private firms are trying to show them that IT can make their lives easier.

By chance, one of these firms, Athena Health of Massachusetts, is run by a cousin of George Bush. Rather than trying to sell doctors software which they might never use, Jonathan Bush says he uses software to provide a service, just as Amazon uses software to deliver books. His firm helps 13,000 doctors to digitise their patients' records and handle the maddening process of billing insurers. Mr Bush says his clients get paid 11% more than before (because insurance firms' bureaucracy sometimes used to defeat them) and 34% faster. He saves the patients money, too. Doctors without electronic records often find it easier to do another $500 chest X-ray today than to dig up the results of the one they did yesterday, marvels Mr Bush.