Meet the Author

Michael Shenk |

Research Assistant

Michael Shenk

Michael Shenk was formerly a research assistant in the Research Department of the Federal Reserve Bank of Cleveland. His work focused on international topics and housing-market indicators.


Economic Trends

An Overview of the Healthcare System

Michael Shenk

Despite much of policy makers’ time being devoted to the ongoing financial crisis and the resulting recession, there seems to be a great deal of resolve to tackle the pressing issue of healthcare reform. With this in mind, it is a good time to take a look at the healthcare industry.

As a portion of total employment, the industry is relatively large, accounting for 10 percent of total employment in February 2008, up from 7.5 percent of employment in 1990. In contrast to most other industries, employment in healthcare has been remarkably resilient over the past three recessions. In fact, since the 1990 recession healthcare employment has actually increased at a faster rate during recessions and at a slower rate during the post recession period. Thus far healthcare employment has increased 3.2 percent since the start of our current recession while total service employment has fallen by 2.3 percent. Part of the reason healthcare employment has continued to increase is due to increasing demand for healthcare services. Currently, healthcare expenditures make up 18.3 percent of the country’s personal consumption expenditures that equates to roughly 12.8 percent of total GDP. Those numbers are up from 3.5 percent of consumption and 2.3 percent of GDP in 1947.

As the demand for healthcare has increased, so has its price. While pundits frequently talk about healthcare inflation, the term is a bit of a misnomer. Inflation is the result of an excess supply of money that results in an increase in the price level (in other words, an increase in the average price of all goods and services). What has been attracting the attention of health policy analysts for years is that healthcare prices are going up more quickly than those for other goods and services in the economy. Economists refer to this as a “relative price movement,” and it is independent of inflation. The increase in the cost of health insurance is a direct result of healthcare’s relative price increase and peoples’ demand for more health services. While the increasing cost of healthcare is one of the driving forces behind calls for reform, there is no obvious or rational way to curb increases in demand for healthcare: it appears to be a natural result of rising incomes and improved medical technology. One potentially effective way to prevent prices from increasing rapidly would be to enact policies that encourage increases in the supply of healthcare.

Another driving force behind calls for healthcare reform is the issue of access to care. As of 2007, only 67.5 percent of people were covered by private health insurance. While government insurance plans such as Medicare and Medicaid covered an additional 17.2 percent of people, 15.3 percent percent of people had no health insurance in 2007. That 15 percent includes both people who are able to afford insurance but decide not to purchase it, as well as those who claim to be unable to afford insurance but do not qualify for Medicaid.

Another more recent argument for healthcare reform is that our employer-based system places an unnecessary burden on companies, making it more difficult for them to compete in the global economy. This argument doesn’t seem to hold much weight. When a company employs someone, the total cost of employing that person is what matters. Their willingness to employ someone depends on the value that person provides to the company relative to the cost of their total compensation; the form of that compensation is irrelevant. For example, if a firm values an employee at $100,000 per year, then all else constant, the firm will be indifferent between paying that employee a salary of $100,000 and paying that employee a salary of $90,000 plus $10,000 in health insurance. The fact that companies pay for employees’ health insurance indicates that they find some benefit in doing so. If it was more cost-effective to pay only cash salaries and have employees acquire their own insurance, companies would pay employees accordingly.

There are several potential reasons why employers prefer to provide their employees with health insurance instead of compensating them in cash alone. One is the tax treatment of employer-provided health insurance. Because employer-provided healthcare is purchased pre-tax, the employer can purchase more coverage than the employee would be able to if compensated with an equivalent amount of cash. As a result, employees are either better off or employers are able to compensate less than they otherwise would. On top of the income tax savings for individuals, both the employee and the employer save substantially on payroll taxes. Employees making under the maximum amount subject to social security save an amount equal to 7.65 percent of the cost of coverage, while the employer saves the same amount for each employee. In addition, employers can purchase group coverage for a lower premium than a typical employee could get on their own: in group plans insurers do not have to worry as much about adverse selection (less healthy people buying health insurance and healthier people foregoing it). Aside from being more cost-effective, employer-provided health insurance may benefit employers by reducing employee turnover and also by encouraging employees to invest in their health (reducing the aggregate cost of sick leave). Given all the complex interactions, any move away from health insurance’s current funding system needs to be carefully considered.