Erosion of confidence in the confident market solution

In a prior post I described James Capretta’s plan that could replace Obamacare’s exchanges with lighter-touch regulations. I also wrote that his plan seemed to be identical to that offered by Yuval Levin and Ramesh Ponnuru. An essential, common feature of the approach offered by these gentlemen is that they do not include competitive bidding. That is, the premium subsidy for consumers in the individual and small-group markets would not be a function of market premiums; it’d be a flat tax credit.

To these authors, I presume this is a feature. By stepping away from the competitive bidding design of the Affordable Care Act’s (ACA’s) exchanges — in which subsidies are tied to to the premium of the second cheapest silver rated plan — their proposal does not require an administrator to take and manage bids from qualified plans. With this obviation, many regulations fall away. The market is unleashed! (To be fair, a few, other regulations would or could be put in their place.)

And yet, I think a flat tax credit is far from the most efficient design. One should not abandon competitive bidding and exchanges eagerly. The fundamental reason is that we do not know the right level of tax credit. It cannot be determined administratively. Capretta suggests starting levels “of about $5,000 [for families], and for individuals, about $2,500,” and then indexing them “to grow with some measure of inflation.” Is this exactly how much support should be offered individuals and families for purchase of health insurance? Why should it be identical across markets, which exhibit considerable variation in health care costs and premiums? To what measure of inflation should it be indexed?

Similar puzzles have arisen with respect to Medicare Advantage plans, for which subsidies are set administratively. We know what happened. They shot up well above what plans reported was necessary to provide the Medicare benefit. The ACA was supposed to change that, and to a large extent it did. But the administration also layered on a quality bonus program — the value of which has been questioned by MedPAC and the GAO — that helped keep payments above cost, providing yet another example of the difficulty of administratively setting and maintaining payments at an efficient level. Capretta’s argument against exchanges, which necessarily drove him away from competitive bidding, is that they invite price controls. The lesson from Medicare Advantage is that administratively set subsidies invite bureaucratic meddling too, which is no less damaging to the efficiency of markets.

Competitive bidding, which I’ve covered extensively, is an alternative to guessing the right subsidy level, as it ties that level to the actual cost of plans (or a plan) in a market. Moreover, if plan bidding is conducted on a market-by-market basis, it permits subsidies to vary with the geographic cost of care. This provides protections for consumers, as it keeps subsidies in line with their actual premium costs; and it provides protections for taxpayers, as it prevents subsidies from running amok, as they have for Medicare Advantage plans.

One might be concerned that competitive bidding implies a defined benefit, as opposed to a defined contribution (e.g., in the form of a pre-determined tax credit), but it need not. One can retain competitive bidding in a defined contribution regime, though possibly at the expense of the consumer protection I just described. My point is that if one’s interest in a pre-set tax credit, such as that Capretta proposed, is because it’s a defined contribution, one need not abandon competitive bidding to achieve that.

To be sure competitive bidding requires some additional regulations. Plans must bid their costs for some set of benefits. Thus, one needs to specify a minimum benefit standard and establish standardized plans for the purposes of bidding. But this also aids competition. Choice among many different options that vary in many different dimensions is difficult for consumers. Such an environment weakens competition, as consumers are forced to rely more heavily on inaccurate heuristics. This is the basic premise of a managed competition design, of which competitive bidding a one variant. Exchanges so designed are good for competition and consumers. One can always argue what the minimum benefit and standardized designs should be, of course.

Perhaps one might be reasonably pessimistic about exchanges, given the poor roll-out of and some of those in specific states. There’s no denying this has been a disaster. And yet, we also have examples of well-functioning exchanges. Kentucky’s works well, for example. Enrollment in the California exchange has been brisk. Medicare has a perfectly fine, exchange-like environment on for Medicare Advantage and Part D drug plan selection. There are also private exchanges that serve businesses and individual markets. I’m no fan of a big bureaucracy screwing up a large IT project such as, but I don’t think that condemns the exchange concept; it condemns the administration overseeing that bureaucracy.

My final concern about abandoning exchanges that harness a competitive bidding design is that I do not find doing so to be a conservative notion at all. For one, we know competitive bidding works. It’s a sound theory that has been tested. Capretta, Ponnuru, and Levin know this. Medicare’s drug benefit program — Part D — has a competitive bidding design that has performed well, and Capretta himself has praised it. The Federal Employees Health Benefits Program also has competitive bidding design elements and has been cited by conservatives, Capretta included, as a model.

Competitive bidding is also central to any Medicare premium support proposal worth considering. In this context, Levin once called it “the confident market solution.” I agree! With so much evidence of its soundness, and having expressed confidence in it, I’m surprised to see thought leaders for right-of-center policy abandon it. Have they lost the courage of their convictions? If there is a clear line of conservative logic from the confident market solution to an administratively set subsidy, I am not aware of it.


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