Why Health Costs Exceed Income Growth

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Why Health Costs Exceed Income Growth

This is the time of year when many employees are filling out their health insurance enrollment forms, while those without insurance are hoping to stay well.

Health care costs have been rising faster than inflation for decades. The total bill for health care for 2007 is projected to reach $7,500 per person. This is about 16 percent of the nation’s total spending, twice the share it was in 1975. The good news is that the rate of the increase in this spending is getting smaller. The bad news is that it is still much higher than the rate of inflation and puts a larger burden on individuals and employers who pay the tab. During the 12-year period of 1981-1993, the average annual increase in the cost of providing health care was 8.8 percent, for the next 12 years (1993-2005) it fell to 5.6 percent. For the Cincinnati area, during the first half of the year compared to the first half in 2006, spending on health care increased 6.2 percent, which is more than the national average.

Health economists project that these increases in health care costs will continue to exceed the rate of inflation. While there are many reasons for this, three things stand out. First is the fact that many consumers (those with health insurance) often have less motivation to curtail spending for health care than for other goods or services they purchase. The reason is that they don’t bear the immediate costs of this spending. Someone else, the insurance provider, pays the costs. In fact, most consumers don’t even know or ask their care provider for an estimate of the cost of a procedure or test. With less motivation to conserve, we can expect that spending will continue to rise. Second, medical research and technology have provided access to new treatments, tests and services which increase the quantity and quality of our health care. They also increase the costs. Finally, costs increase because of demographics. As the Greater Cincinnati Health Council has reported, the demand for health care is on the upswing as baby boomers age and lifespan as lengthen.

The UC Economics Center has calculated the how different factors contribute to these increases. General inflation accounts for about 45 percent of the growth in health care expenditures. Increases in spending for the same type of services, because of factors such as our aging population, and increases in medical cost that exceed inflation, account for 26 percent. Finally, the additional cost of new tests, treatments, and services contributes 29 percent.

While all three of the above factors affect total spending on medical care, their relative mix has changed. During 1981-1993, the effect of general inflation accounted for about the same percentage of total spending as in the next 12-year period. Extra medical care and new services produced 12 percent of the growth in the costs of providing health care during 1981-1993, but in the next 12-year period, it accounted for 29 percent of the increases. Another big change occurred in the category that includes the effects of an aging population and increased medical costs. In spite of the effects of the aging population, this category accounts for a smaller percentage of spending increases, probably because health insurance providers have negotiated lower costs with health care providers. Importantly, insurers have also designed new ways to provide consumers more motivation to conserve on spending. There is some evidence that this has had some effect. Most health economists feel that providing more of these types of incentives will further slow the rise in health care expenditures.