Can Taxes Help Address High Health Care Prices?

Health care markets across the country are not functioning properly. Prices for health care are high, have increased rapidly, and vary in seemingly incomprehensible ways. The harms from high health care costs include patients that skip or delay necessary care, decreases in wage growth, increases in federal spending that may lead to higher taxes, and increases in disparities in health care access. In their March 2020 report to Congress, the Medicare Payment Advisory Commission concluded that “the preponderance of the research suggests that hospital consolidation leads to higher prices for commercially insured patients.”

Many researchers and policy makers have called for increased antitrust enforcement to help restore competition to health care markets. Despite this increased attention and increased success in challenging anticompetitive mergers in the past decade, more than 95 percent of hospital mergers go unchallenged by either the Federal Trade Commission or state attorneys general. Market entry for new hospitals is difficult, and antitrust enforcers have been loathe to “unscramble the egg” and unwind hospital mergers. Consequently, while increased oversight can slow the pace of future consolidation, antitrust enforcers will struggle to address the harms of higher prices that can result from existing provider market power.

So far, state policy makers concerned about high medical prices that may result from market power (or other causes) have focused on the use of regulations to force prices down. In this article, we argue that taxation provides another policy tool, and in some instances one more targeted at the harm of excessive prices for health care.

Regulation Versus Taxation

Some researchers advocating regulatory approaches to excessive prices have called for price caps for the highest-price providers and price growth caps that constrain price inflation. Others have suggested flexible global budgets, a modernized version of the all-payer rate setting system in Maryland.

We propose taxation as a policy tool that may be more effective than such regulation in addressing the harm of excessive prices for health care. Consider two textbook examples of when to use regulation or taxation to address harms: the meltdown of a nuclear power plant and global warming. As to nuclear plant safety, we know whom to regulate (the plant operators) and the level of safety that the regulations should require (a lot). And thus, regulations are the preferred tool.

With reducing greenhouse gas emissions, the situation is reversed. We know we want major reductions, but we are not sure which sectors can most easily and efficiently produce those reductions. If we just order a certain reduction from one industry (say power plants), then we might miss out on lower-cost reductions that could have been achieved by other sectors (say emissions from cars or airplanes or cows). Furthermore, big disparities exist in the cost of carbon reduction. Suppose we want to reduce emissions by 100 tons, and there are two industries each contributing 100 tons of pollution. Suppose as well that industry A can reduce emissions at a cost of $25/ton and industry B can reduce emissions at a cost of $50/ton, but we the regulators don’t know these costs upfront. Indeed, the industry might not know because it has never had to respond to a carbon tax before. If the regulator requires each industry to cut emissions by half for a global reduction of 100 tons, then it will cost $3,750 (or, [50*25] + [50*50]). But if we imposed a carbon tax of $30 per ton, then it is worth it for industry A to reduce emissions to 0 because it is cheaper to reduce its emissions ($25/ton) as compared to paying the tax ($30/ton). Thus, the tax results in the same reduction of 100 tons of carbon at a cost of $2,500 (or, 100*25). Of course, it might turn out that this level of tax produces much more (or less) than the targeted reduction. As a general matter, it is a lot easier to adjust a tax rate than a regulatory mandate. As a result, in such a situation of uncertainty, taxation is the preferred tool.

A Proposal To Tax Excessive Provider Prices

On balance, medical prices more closely resemble climate change than nuclear accidents in that we recognize the harm in high prices, but how best to bring down those prices remains unknown. Who is best positioned to reduce prices and by how much is difficult to determine and will likely vary across different contexts and market conditions. While traditional price caps provide an incentive for providers to cut costs, there is the danger, at least theoretically, that if prices are set too low, the quality of health care services could decline or cause safety-net providers to close.

Instead of setting price ceilings, we propose policy makers consider a tax on that part of the price that exceeds a certain threshold. This tax could be incremental and progressive. For example, lawmakers could apply a tax of 2 percent on prices between 155 percent and 170 percent of the rate that Medicare charges for the same service and a tax of 5 percent on prices between 170 percent and 185 percent of the Medicare rate, and so on. Revenue generated by these taxes could be used to support other health-related policies such as increasing subsidies for those purchasing insurance on the exchanges, expanding those subsidies to new populations, or increasing prices paid by state Medicaid programs.

These taxes resemble those proposed to curb carbon emissions, Discourage inadequate health insurance, and reduce executive compensation. As in these other markets, a tax on high health care prices will encourage innovation among providers that want to avoid the tax or pay less tax and can do so cost-effectively. For providers that do pay the tax, then that provides useful information to policy makers. In some instances, this might indicate that the causes of the high prices cannot be as easily ameliorated by all parties. For example, rural hospitals may have higher fixed costs relative to marginal costs than their urban counterparts and may find it difficult to reduce prices (to avoid or minimize the tax) because they cannot as easily make up revenue shortfalls by increasing volume.

Policy makers must thus consider the dynamics of the existing market to determine whether a progressive tax on provider rates is the most appropriate solution. For instance, progressive taxation alone will not reduce market power, so a provider with market power may be able to further increase its prices to account for the taxes. Policy makers can perhaps control for this by adjusting the rate of tax increase between the different payment bands to make the taxes in the highest band quite onerous. In markets where a particular health system or provider has extensive market power that it is using to drive up prices egregiously, then perhaps policy makers could impose a tax that is so large that it is effectively a cap on prices at a certain percentage of Medicare payment rates (for example, 500 percent). On the other side, independent rural hospitals or community hospitals with a more complex case mix and high relative fixed costs may require downward adjustments to their tax rates to account for their higher underlying costs, although some of this may be adequately addressed already through Medicare payment adjustments.

Because high prices may result from different market conditions, policy makers might choose to apply this tax in specific (highly concentrated) markets. However, a recent study by Maximilian Pany, Michael Chernew, and Leemore Dafny found that high-price hospitals are not confined to markets that meet antitrust standards for “highly concentrated markets” and suggested that policies that target the high prices directly are likely to be more effective than those that limit action based on market concentration. As a result, we recommend policy makers consider applying the tax statewide to give all high-price hospitals a financial incentive to reduce prices.

In at least some contexts, a tax on excessive prices is a win-win; it allows higher-quality or higher-status providers to elect to pay the tax and charge more for their services, while providing governments with a new stream of revenue to help subsidize care for those who cannot afford the more expensive products or services. Of course, it matters who in the end is paying the burden of the tax—high-cost providers through reduced compensation, high-capacity consumers through higher charges for features they value (quality, reputation, and so forth), or perhaps the broader system through higher insurance costs. Who ends up paying the tax depends on the context of the markets, so it is important that any policy imposing a surcharge also include some commitment to study the actual incidence of the tax.

Also, important to note is that the initial tax rate can turn out to be too low or too high to accomplish its goals. For example, if the rate is too low, then it might trigger little cost reduction and not raise much money for those least able to afford expensive care. In such a case, the rate can be raised. If it is too high, then the state may struggle to attract and retain sufficient numbers of high-quality providers, in which case, policy makers could reduce the rate. Again, getting this tax right will be an iterative process, and ideally legislation imposing the tax would require a regular assessment of its success.

Finally, policy makers should apply these taxes on provider rates equally to both for-profit and nonprofit health care providers, as both have the capacity to charge excessive prices in the commercial market. A tax applied to all health care providers improves the competitive position of any entity able to offer lower-cost care of high quality.

In the end, our contention is not that a high-cost progressive surtax is a one-size-fits-all cure for high prices driven by market power; just the opposite. We contend that a tailored progressive surtax can be a part of bespoke policy solutions that use many policy tools.

Legal Discussion Of Taxation Versus Rate Setting

As a legal matter, state exercise of the taxing power is not always governed by the same rules as the power to regulate. In some ways, the laws governing taxation will make things easier for the states. For example, a Maryland law concerning price gouging was struck down as violating the federal constitution (dubiously in our opinion) because the court believed that many of the pricing transactions Maryland aimed to regulate would occur out of state, beyond the state’s jurisdiction. By contrast, an excise tax on higher-price prescriptions or medical services would resemble (sometimes progressive) state excise taxes on many narrow categories of goods and services, from alcohol to watercraft.

Thus, arguably, a tax on excessive prices has a better chance of surviving the inevitable legal onslaught than a regulation aimed at excessive prices. On the other hand, many state constitutions have special rules that make it harder to raise taxes than impose regulations, and so it might be harder politically to raise taxes than impose a regulation.

Conclusion

It appears increasingly likely that the states will remain at the front line in trying to provide affordable care to their citizens. As conversations in state legislatures swirl about ways to control health care costs, we want to remind policy makers not to ignore one of the most potent tools in their toolbox—their taxing power.

Author’s note

Katherine L. Gudiksen and Jaime S. King have funding from UC Hastings College of the Law, Arnold Ventures, the Robert Wood Johnson Foundation, and the Commonwealth Fund. Katherine L. Gudiksen also has funding from the National Academy of State Health Policy, and Jaime S. King has funding from the University of Auckland. Darien Shanske receives funding from the University of California, Davis School of Law.

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