Why is healthcare so expensive and how can we fix it?

American healthcare is the most expensive in the world.  There are a few common theories about why, but they're all wrong.

• Healthcare is not expensive because it's the best in the world.  In fact, studies indicate it is the worst among developed countries, in spite of the fact we spend far more.
• Healthcare is not expensive because healthcare providers and insurers are "greedy".  Everyone wants more money, but few have the market power to consistently raise prices.
• Healthcare is not expensive because of "administrative costs".  Both the healthcare and insurance industries want to to minimize those costs, to maximize profits.  They can't because high administrative costs are an effect of the problem, not the problem itself.

There is one primary reason American healthcare is so horrifically expensive: the unintended consequences of massive government intervention.

It's a matter of economics.  Tax incentives tend to increase prices.  Likewise, subsidies, insurance, and uncompensated care all tend to increase prices.  The government has been practicing these interventions for decades, at a scale of tens of trillions of dollars.  Likewise, we have seen the cost of healthcare increase for decades, at a scale of tens of trillions of dollars.  We shouldn't be mystified.

The government's own data proves it is responsible for price increases.  For example, consider this chart of monthly price increases for medical care in US cities since 1950.  You can see a clear inflection point when Medicare was introduced in 1965.  Before Medicare, prices rose at about 0.3% per month.  After Medicare, prices rose at about 0.6% per month – twice as fast as before.  This matches academic research on the price effects of Medicare.

People say, "the healthcare market is broken."  Thankfully we haven't truly broken it, although we have badly gummed it up.  Basically, government interventions have bogged the market "price mechanism."  In particular, these interventions have obstructed the side of the mechanism that puts downward pressure on prices – the buyer side.  The seller side, which puts upward pressure on prices, is still mostly functioning.  That's the main reason we continue to see healthcare prices increase far above the normal rate, year after year.  That's also why increasing tax incentives, subsidies, insurance, and uncompensated work has not only failed to solve the problem, but actually made things worse.  Prices continue to rise because government interventions continue to be enforced and even escalated.  We must stop the interventions before we can unwind their unintended consequences.

Which government interventions should we stop?  Here's a list of the biggest interventions with the worst unintended consequences:

1. Tax exemption for employer-sponsored health insurance (IRS 1943).  Some tax breaks are larger than others, but this one is by far the largest.  It makes around a trillion dollars of employee income non-taxable every year – but only if that income is funneled into the health insurance industry.  This is why health insurance is generally tied to employment; the government unintentionally created a trillion-dollar incentive to tie them together.  Americans don't want health insurance being tied to employment, and they don't want the health insurance industry getting special treatment from the government.
2. Subsidizing healthcare (Medicare 1965).  The federal government has been directly subsidizing healthcare for around 60 years.  In doing so, it has been unintentionally increasing prices.  Economists have found that Medicare caused an immediate and substantial increase in prices, for example a 23% increase in hospital prices by 1970.  That is not surprising, because subsidizing something tends to increase demand, and increasing demand tends to increase price.  This upward pressure on prices has continued for over 50 years.
3. Subsidizing insurance (ACA 2010).  Subsidizing insurance is doubly dysfunctional.  The subsidy makes insurance more expensive, because there are more dollars competing for a place in the insurance pool.  Then, insurance makes healthcare more expensive, because patients become less price-sensitive (they demand more healthcare and care less about cost).
4. Forcing emergency rooms to provide uncompensated care (EMTALA 1986).  Since 1986, Congress has been forcing most hospitals to provide uncompensated emergency care.  To recoup that cost, hospitals have increased their prices for paying patients (including barely-paying patients who are financially desperate).  Basically, Congress shifted a problem from one group of people to another.

Each one of these large interventions has unintended consequences.  Economically speaking, they all tend to increase prices.  They also tend to increase the complexity of the system, and therefore increase administrative costs.  If we remove the complexity, we can allow market incentives to drive administrative costs toward normal levels.

Some people might oppose ending these government interventions, claiming they are intended to help people in poverty.  Even if we assume that was intended (and there's room for debate, especially with policies benefitting the health insurance industry), we can also agree what was unintended: these interventions have side effects that disproportionately harm people in poverty.  In many cases these interventions only help one group of poor by harming another.  For example, Medicare helps the elderly poor but harms the young poor by increasing uninsured healthcare prices.  We should follow the physician's creed: "First, do no harm."

Here are some bonus improvements that aren't about government intervention, but are about government policy:

• Medicare should pay for generic drugs when possible, not the empty premium of name-brand drugs.  A recent study found this could have saved Medicare $3.6 billion.
• Courts should not enforce healthcare prices that were not disclosed in advance.  This is for patients who pay out of pocket, who are often charged deliberately inflated prices without warning.  This is a violation of basic American contract law, which dictates that a reasonable price is expected when no price is defined in the contract.
• IRS should withdraw the nonprofit status of hospitals that are not clearly charities.  There are many nonprofit-classified hospitals operating as for-profit businesses.  These hospitals are abusing the tax code to gain an unfair advantage over non-hospital competitors like ambulatory surgery centers (ASCs) and independent providers.  Removing their nonprofit classification would definitely be more fair, and should put downward pressure on prices by increasing competition.
• Courts should be more skeptical of professional licensing regimes.  In economics, professional licensing is not only a mechanism for (hopefully) increasing quality, it is a mechanism for limiting competition and preserving higher prices like a cartel.  Given that licensing for healthcare professionals is notoriously burdensome, and apparently not producing best-in-class professionals compared to the rest of the world, courts should consider that burdensome licensing is detrimental to both patients and would-be healthcare professionals.

Not everyone realizes government intervention is the core problem with the American healthcare system – even experts.  For example, a recent thought experiment for Forbes asked how to achieve "a stunning reversal in both cost and quality" by 2040.  Out of twelve ideas proposed by different experts, none suggested reducing government intervention.  "In fact, they hardly referenced the political process at all."  In response, the doctor conducting the experiment wondered, "What should be the role of the U.S. government in effecting meaningful change and fixing American healthcare?"

You can't solve a problem until you understand what it is.  The first step to solving the problem with American healthcare prices is acknowledging a few basic facts.  First, the government has intervened in the healthcare market on a titanic scale.  Second, market interventions tend to have unintended consequences.  Our healthcare market is suffering from them every day.