Amy Finkelstein writes,

Research I conducted shows that Medicare had a substantial effect on the health-care sector. By 1970, the program caused a 37% increase in hospital spending. This is an enormous number. If I extrapolate from the Medicare experience to compute the effect of the overall spread of insurance — both public and private — between 1950 and 1990, it suggests that it is responsible for about half of the sixfold growth in real per capita health-care spending during this period.

Why does increased health insurance lead to increased health spending? One factor is that when individuals have insurance, they tend to consume more health care. This makes sense: If you only have to pay some fraction of the cost, you are more likely to go for an extra doctor’s visit or get an additional diagnostic test than when you have to pay the full cost out of pocket.

Another reason is that hospitals and doctors respond to the increased demand for health care by changing some of the ways in which they practice medicine. For example, hospitals were more likely to adopt new medical technologies after Medicare was introduced because now, with greater insurance coverage, there were more people who could afford these new technologies.

I disagree with Finkelstein on one important point, to be explained below.Finkelstein’s research came up when I was at CBO the other day, feeling like an amateur in a room full of pros. One of the pros said that Finkelstein may have under-stated the extent to which Medicare increased insurance coverage. If so, he pointed out, she may have overstated the response rate of medical spending to insurance coverage. However, his criticism would only cut her estimated elasticity in half.

Another pro asked why insurance has not emerged that has the characteristic that it does not pay for newly-invented medical services. Such insurance would be less expensive than standard health insurance.

My only response is was that there are lots of forms of insurance that economists have dreamed up that would be more affordable and provide good protection to consumers. However, we do not observe these in the market place. Instead, the main cultural imperative that seems to be driving health insurance and many other of our health care institutions is the imperative that doctors must earn high incomes.

Finkelstein says,

Recent state efforts to create universal health-insurance coverage would reduce the fraction of the population in a state without insurance…We are likely to witness an improvement in the financial security of the currently uninsured. There are also likely to be increases in health-care spending — quite possibly substantial ones.

She fails to distinguish between insulation and insurance. Insulation–health insurance with broad coverage and low deductibles–helps ensure that doctors have high incomes.

Real health insurance would protects consumers who have illnesses requiring really expensive treatment. It would provide financial security with less incentive for increased spending.

My point is that expanding the number of consumers with real health insurance does not have to increase health spending by the levels that Finkelstein’s research would project. The key is to switch from insulation to real insurance, which in turn means changing the cultural imperative from one of supporting the income of doctors to one of giving consumers the ability to mitigate their financial risks.