January 2017 is Obamacare hunting season and Sen. Rand Paul decided to throw his replacement plan proposal into the mix of Republican ideas on the discussion table. Finally we have something concrete and serious from the Republicans to work with. The summary can be found here and law nerds can find the entire 149 page bill on Capitol Hill here. So how does it look? Well, it’s not great. It’s actually pretty bad for a variety of reasons rooted in poor understanding of economics and human behavior, but let’s go over the summary section by section.

Repealing Obamacare

Effective as of the date of enactment of this bill, the following provisions of Obamacare are repealed: Individual and employer mandates, community rating restrictions, rate review, essential health benefits requirement, medical loss ratio, and other insurance mandates.

Alright, repealing the individual mandate is an immediate reprieve for the 6.5 million poor taxpayers whom the government was forcing to pay $3.0 billion in penalties because they valued having money for things like food and rent more highly than subsidized health insurance. Repealing the employer mandate is a benefit more broadly to the working class by making it easier for employers to hire above the 50 person boundary imposed by Obamacare. Repealing the insurance regulations and requirements allows them to revisit their plans and deliver a greater diversity of products that better match consumers needs. We’re doing well so far, let’s see what’s next.

Protecting Individuals with Pre-Existing Conditions

Provides a two-year open-enrollment period under which individuals with pre-existing conditions can obtain coverage.

Restores HIPAA pre-existing conditions protections. Prior to Obamacare, HIPAA guaranteed those within the group market could obtain continuous health coverage regardless of preexisting conditions.

Another good change. The patient protection portions of the Patient Protection and Affordable Care Act were popular for obvious reasons, but they’re also the reason why it should be called the Patient Protection and Unaffordable Insurance Act. The Obamacare regulations give far too much protection to individuals and open up the insurance market to abuse by patients who take advantage of their information asymmetry by signing up for insurance only when they anticipate heavy usage of the healthcare system. Rolling back the regulations to the 1996 HIPAA pre-existing condition rules restores to insurance companies ways to protect themselves from such manipulation. These are good changes so far, but unfortunately this is the repeal portion of the bill. The rest is the replace portion, and it’s all downhill from here.

Equalize the Tax Treatment of Health Insurance

Individuals who receive health insurance through an employer are able to exclude the premium amount from their taxable income. However, this subsidy is unavailable for those that do not receive their insurance through an employer but instead shop for insurance on the individual market.

Equalizes the tax treatment of the purchase of health insurance for individuals and employers. By providing a universal deduction on both income and payroll taxes regardless of how an individual obtains their health insurance, Americans will be empowered to purchase insurance independent of employment. Furthermore, this provision does not interfere with employer provided coverage for Americans who prefer those plans.

This is very bad economics. For those not familiar with this issue, there is a massive loophole in the tax code where health insurance benefits provided by the employer are not subject to taxation. The rule is rooted in World War II wage controls where employers were not allowed by the government to give employees salary increases because of the war effort, but the worker unions negotiated to be allowed to receive health insurance benefits instead of additional wages. Except the tax code did not have any provisions for these health insurance benefits. By the time that Congress realized this loophole, the unions had also realized that they were effectively receiving a subsidy from the government on every dollar that they got paid in health insurance as opposed to wages, and the practice became so widespread that politicians were not able to muster the courage to go through with the fix. The result is that 60% of Americans receive insurance through their employer. This is an enormous economic problem, because it completely distorts the insurance market. The employer does not know your preferences, willingness to pay, and healthcare needs. Therefore making the employer the primary purchaser of health insurance guarantees sub-optimal insurance selection and decreases market competition. If your employer provides only one or two insurance plan choices, did you as a consumer really participate in the insurance marketplace? By tying the insurance to the employer rather than the individual, it makes insurance less portable and forces the individual to renegotiate their insurance every time that they get a new job or move between state which makes people less likely to do so if they do develop a condition. In addition, the tax loophole results in an effective market distortion of the pricing signals (if they existed, more on that later) that the economy creates. By giving health insurance an effective 20-30% subsidy, this guarantees that people will purchase more insurance than they need and that providers, knowing that there is an excess of insurance protection in the marketplace, increase their prices in order to take advantage of this fact. This doesn’t make healthcare easier to pay for the insured, and makes it MORE difficult to afford for the uninsured. Expanding this loophole to insurance premiums for the sake of “equality” only makes the problem worse!

Expansion of Health Savings Accounts

Provides individuals the option of a tax credit of up to $5,000 per taxpayer for contributions to an HSA. If an individual chooses not to accept the tax credit or contributes in excess of $5,000, those contributions are still tax-preferred.

Removes the maximum allowable annual contribution, so that individuals may make unlimited contributions to an HSA.

Eliminates the requirement that a participant in an HSA be enrolled in a high deductible health care plan. Currently, in order to be eligible to establish and use an HSA, an individual must be enrolled in a high-deductible health plan. This section removes the HSA plan type requirement to allow individuals with all types of insurance to establish and use an HSA.

In addition to the above changes, there is a very long list of HSA deregulation giving people more freedom in how they can spend their HSA accounts and how they can transfer that money between people and funds if necessary. This is the core of the new Republican healthcare agenda, trying to move people off unlimited premium driven insurance plans and to a more cash based healthcare market. It’s a great idea, but it’s necessary to be critical and skeptical about this bill’s implementation. Critical because these changes further expand the tax loophole described above to cash based purchases of healthcare, which further inflates healthcare prices. This hurts the uninsured more than everybody else, because the insured are loss protected after their deductible limit is reached. It’s also necessary to be skeptical, because promoting health savings accounts implies that people are able to take their cash and use it to make purchases in a transparent competitive free market. No such thing exists.You can’t go to your local hospital’s website, navigate to the orthopedics section, and find out the cost of a hip replacement. Healthcare is the only industry where there are no publicly available prices and it’s acceptable to quote a price after the service has been delivered. Imagine airlines billed you for a transcontinental flight AFTER you arrived at your destination. Would you be surprised if they tried to overcharge you? Without transparent prices it’s completely irrational for consumers to try purchasing their healthcare on a cash basis. It’s safer to stick with your insurance than risk it with the HSA. Providers, for their part, will never be the first to provide prices because doing so would mean that they would have to actually compete for business and innovate, instead of generating profits by overcharging your insurance behind the scenes. Despite all the changes proposed by Sen. Rand, HSA’s in this bill are a non-starter without provider side reforms.

Charity Care and Bad Debt Deduction for Physicians

Amends the Internal Revenue Code to allow a physician a tax deduction equal to the amount such physician would otherwise charge for charity medical care or uncompensated care due to bad debt. This deduction is limited to 10% of a physician’s gross income for the taxable year.

Is this real? Somebody pinch me. Besides the obvious critique that this is a physician senator peddling to the physician special interest, here’s why this is a terrible idea. In Brazil health expenditure is a limitless tax deduction. So what do people do? They go to their friendly neighborhood physician and have him write out receipts for a large amount of fake healthcare which they use to reduce their taxable income while giving the physician a kickback for his cooperation in the scheme. Every single physician will max out this Sen. Paul tax deduction. Physicians who did not have enough uncompensated care during the year will go to their friendly neighborhood uninsured patients to “provide” charity care until they reach 10% of gross income. In addition, this rule encourages physicians to increases the cost of their services, because Increasing their billing to insured patients increases their gross income, which in turn increases the allowed net amount of the 10% tax deduction.

Pool Reform for the Individual Market

Establishes Independent Health Pools (IHPs) in order to allow individuals to pool together for the purposes of purchasing insurance.

Amends the Public Health Service Act (PHSA) to allow individuals to pool together to provide for health benefits coverage through Individual Health Pools (IHPs). These can include nonprofit organizations (including churches, alumni associations, trade associations, other civic groups, or entities formed strictly for establishing an IHP) so long as the organization does not condition membership on any health status-related factor.

Sure, deregulation is good, but this won’t go anywhere as long as employers provide insurance. Businesses will always have more negotiating power against insurers than self-organized groups of individuals, so people will always get a better deal from their job than their individual group.

Interstate Market for Health Insurance

Increases access to individual health coverage by allowing insurers licensed to sell policies in one state to offer them to residents of any other state.

Exempts issuers from secondary state laws that would prohibit or regulate their operation in the secondary state. However, states may impose requirements such as consumer protections and applicable taxes, among others.

Gives sole jurisdiction to the primary state to enforce the primary state’s covered laws in the primary state and any secondary state.

Allows the secondary state to notify the primary state if the coverage offered in the secondary state fails to comply with the covered laws in the primary state.

In addition to HSA’s, this is the other major tent pole of the new Republican health insurance agenda. Trump especially emphasized deregulation of state barriers on insurance as a major fix to the health insurance market. That’s probably not the case. The problem is that insurers trying to move into new states do not have a provider network in the target state, and therefore have no negotiating power which results in plans that are more expensive and networks that are smaller than the incumbent insurers. Even Kaiser ended up fumbling when they tried expanding to the east coast. The idea is good, and the changes are a move in the right direction, but it likely won’t be meaningful except for cases where insurers are especially abusive in their relationship with the local providers.

Association Health Plans

Association Health Plans (AHPs) allow small businesses to pool together across state lines through their membership in a trade or professional association to purchase health coverage for their employees and their families. AHPs increase the bargaining power, leverage discounts, and provide administrative efficiencies to small businesses while freeing them from state benefit mandates

More bad policy. We discussed already how employer sponsored health insurance is bad because it limits individual participation in the insurance marketplace and results in suboptimal health insurance utilization. While this change has the understandable goal of increasing small business bargaining power against insurers, it only expands the employer’s presence in the insurance marketplace when we need less of it. In the words of American philosopher Donald Trump, “Bad!”

Anti-Trust Reform for Healthcare

Provides an exemption from Federal antitrust laws for health care professionals engaged in negotiations with a health plan regarding the terms of a contract under which the professionals provide health care items or services.

This section applies only to health care professionals excluded from the National Labor Relations Act. It would also not apply to contracts or care provided under Medicare, Medicaid, SCHIP, the FEHBP, or the IHS as well as medical and dental care provided to members of the uniformed services and veterans.

Hold on. Full stop. What? So if a health insurance company tries to negotiate a rate with an independent specialist, the Sherman anti-trust act is waived and he is allowed to collude with all the other independent specialists in an area in order to push up his negotiated rates? In an economy where physicians are generally overpaid compared to their counterfactuals? From an economic perspective that’s fine, cartels fall apart because there’s always an incentive for members to cheat and eventually one of the colluders will independently agree to lower rates in exchange for more referrals. But Anti-Trust Reform? Let’s at least be honest Sen. Rand “Physician Special Interest” Paul that this will only increase cost of care and call it Trust Empowerment.

Increasing State Flexibility to Conduct Medicaid Waivers

Provides new flexibilities to states in their Medicaid plan design, through existing waiver authority in current law.

The final tent pole in Republican healthcare policy, giving power back to the states, a tale as old as time. This is guaranteed to be part of the final policy, regardless of whose plan is passed. Innovation and decentralization is good and I look forward to what the states will create.

Self-Insurance Protections

Amends the definition of “health insurance coverage” under the Public Health Service Act (PHSA), and parallel sections of ERISA and the Tax Code, to clarify that stop-loss insurance is not health insurance.

This provision is designed to prevent the federal government from using rule-making to restrict the availability of stop-loss insurance used by self-insured plans.

This is interesting. Some of these regulations are decent, like requiring stop-loss insurance to cover unpaid claims if the small business plan terminates. Others, like requiring a certain amount of healthcare spending before stop-loss is allowed to kick in, are very invasive. That being said, it is completely correct to say that stop-loss insurance is not health insurance. If it were, every single financial product that insurance companies use to manage their risk profile could be construed as health insurance.

Conclusion

What’s the verdict? It’s pretty disappointing. The only good thing it achieves is the repeal itself, because the replacement is mediocre. A mixture of decent changes that aren’t going to reduce costs significantly (interstate sale, individual pool reform) and well-intentioned bad policy (tax treatment equalization, association health plans).

In fact, it’s embarrassing that people claim Sen. Rand Paul is libertarian leaning when this bill engages in such heavy manipulation of the tax code and obvious pandering to the physician special interest. The biggest problem with the bill is that it focuses entirely on health insurance reform and does nothing with respect to regulation on the provider side of the equation. Obamacare proved that you can’t reduce health care costs through financial engineering, but even Obamacare tried to address provider behavior with bundled payments and the accountable care organizations. Healthcare COSTS will not be reduced until providers have to quote prices, until incumbents are no longer protected by certificates of need, and until the physician trade union is no longer protected by scope of practice and licensing restrictions.

Failing to push any provider side change(except for empowering their cartel powers!), or provide any evidence based insurance reforms, the bill gets a C+. Why not an F? There’s a fringe case where it could work out. The tax treatment equalization section means that there will be no tax treatment difference between employer sponsored health insurance premiums being paid directly by the employer or by the employee. Therefore some employers may opt to increase employee wages and not pay directly for health insurance in order to appear more competitive in the job market. Healthy employees then could choose to opt out of health insurance and keep the money instead of buying through their employer. This would result in an employer sponsored insurance death spiral due to increasing average costs, which would ultimately increase the uninsured population and could force providers to compete on price. That’s a lot of ifs, however. A simple “providers must quote a real price on their website for every episode of care that they provide” bill is much more reliable.