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The “Finance” Control Knob

Marc J. RobertsProfessor of Political Economy and Health Policy

Harvard School of Public HealthAfrica Flagship Kigali, June 23, 2010

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Why Financing MattersA country’s financing method determines:• The distribution of the cost burden: – Between sick and well– Between employed and unemployed – Between the formal sector and the informal sector

• Who has access to what services

• Who has what degree of risk protection

• Who makes coverage and provider payment decisions

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Financing Options

• If we think of the “ideal type” for each financing option we can distinguish six sources: – General revenue – Social insurance – Private insurance– Out-of-pocket payment– Community financing – International aid

• Many real arrangements depart from the “ideal type”

• Most nations use a mix of financing options

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Thinking About Distribution• Economists think about the impact of taxes in terms

of the percentage of income as a burden

• Proportional taxes take equal percentages from all

• Progressive taxes take a higher percentage from higher income individuals

• Regressive taxes take a lower percentage (but perhaps a larger amount) from those with higher incomes

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Balancing the Burden of Costs and Benefits

• The distribution of the financing burden has to be balanced against the distribution of benefits

• Even a “regressive” system can involve higher payments from upper income groups

• Then if benefits are similar for rich and poor—the poor can gain from such a system

• In reality, upper income groups often derive greater benefits from public systems since they are closer to facilities and better able to negotiate non-price barriers

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Attitudes Towards Distribution VaryPhilosophically

• Egalitarian liberals favor redistributive financing to provide for positive rights

• Libertarians say health as not “special”—just sell health care or insurance in the market place

• Many utilitarians favor some redistribution-- arguing that the rich loose less utility from paying taxes than the poor gain from getting care

• Some communitarians argue for charity based systems as an expression of good character

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The Choice Among Financing Options Always Involves Trade-offs

• Some tap a wider array of funding sources (general revenue)

• Some options are easier administratively (out of pocket payment)

• Some do a better job on risk protection (social insurance)

• Some appeal to powerful interest groups (private insurance)

• Some decentralize authority (community financing)• Some shift the burden to others (donor aid)

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The Appeal of Various Options Will Vary From Country to Country

• Some will have more reliable general revenue sources than others

• Some will have larger or smaller formal economic sectors

• Some will have stronger or weaker regional or local governments

• Some will have greater or less administrative capability

• Some will have more or less of a commitment to equity

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General Revenue Financing• Supporters argue this method subjects health sector

financing to political control and the need to compete against other spending priorities

• Critics argue such arrangements lead to unstable and unreliable funding

• Distributive effects depend on how a nation raises general revenue– Income or payroll taxes – Consumption taxes – Tariffs – Business taxes

• Typically used to finance large public systems

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The Distributional Effects of Income And Payroll Taxes

• Only comprehensive income taxes—including taxes on non-labor income– are potentially progressive

• In advanced economies, where most work in the formal sector, payroll taxes are modestly regressive. – They omit non-labor income which is more important to

upper income groups – They often have contribution caps

• In low income economies, payroll taxes can be progressive– They are often only paid by formal sector earners – Those individuals are typically relatively well off

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The Distributional Effects of Consumption Taxes

• Sales and value added taxes generally result in higher prices

• These taxes are modestly regressive – The poor spend a higher proportion of their income than

the rich– Exempting some necessities (e.g. bread) counteracts this

effect

• They can capture informal and illegal income• Collection problems depend on the structure of the

retail sector

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Tariffs Are Often Used in Low Income Countries

• Tariffs have the same distributive effect as consumption taxes--via price increases

• These prices effects are not visible to consumers

• Distributional impact can be modified by different rates on luxuries versus necessities

• With fewer ports of entry than retail outlets, easier to collect than general consumption taxes

• Can help protect local industry

• Tariff policy is constrained by international trade agreements (e.g. WTO rules)

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Business Taxes Are Attractive if You Have the Industry

• Countries with minerals, tourism or agricultural exports typically rely heavily on taxing these

• Politically attractive since most citizens don’t “see” these taxes

• Revenues depend on fluctuating world demand, prices and international competition

• Can become a source of internal political conflict as well as hindering more diversified development

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Economists Often Argue for Some Out-of-Pocket Payment

• Taps into citizens willingness to pay for health care

• Generates funds outside of over-burdened tax systems

• Modest co-pays are said to discourage over use

• Can provide needed funds at the periphery and give incentives to improve quality

• Impact on the poor in theory can be softened by exempting them from co-pay requirements

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Out-of Pocket Disadvantages• Very regressive since burden does not vary at all with

income

• Provides no risk protection

• This is especially serious for the private sector care and drug purchases

• Leads to lower or altered utilization among lower income groups (e.g. less use of preventive care, greater drug purchases from informal sellers)

• Public facilities with user fees, limited drugs, or informal payments often require significant de-facto out-of-pocket payments

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Objections to the Alternatives Have Fostered Interest in Social Insurance

• High reliance on out of pocket financing has lead to access barriers, inequitable use, and a lack of risk protection

• General revenue financed public delivery systems have been plagued by poor quality, unstable funding and public dissatisfaction

• Broad shifts in ideology have lead away from commitments to centralized state financing and provision

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The Design of an “Ideal” Social Insurance System

Social insurance systems are often designed to include at least some of the following

• A dedicated payroll tax source

• Mandatory participation from eligible enrollees

• Coverage limited to contributors and/or their families

• Operated by a single independent agency that has to meet its fiscal obligations

• That agency acts as an informed purchaser of services from various sellers

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Rationale for the “Ideal” System• Keeping revenue separate and excluding non-contributors

encourages tax compliance– Governments cannot “steal” to money for other purposes

– Contributors’ money goes to “their” care

• Mandatory participation fosters risk-spreading

• Payroll tax financing fosters some redistribution since benefits are “pro-poor”

• Purchaser-provider separation fosters efficiency – Providers have reason to produce efficiently

– Purchaser can limit buying to efficient seller

• Agency autonomy facilitates expertise– Accountable managers will not be corrupt

– Executives will be chosen for professional competence not patronage

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Actual Social Insurance Systems Vary Greatly

• Many funds operate their own delivery systems (Mexico, Turkey, Thailand)

• Many cover significant numbers of non-contributors and rely on general government tax support to finance these (Hungary, Egypt)

• Countries may have multiple funds (Germany)• Individuals may be able to “opt-out” into alternative

or private coverage (Argentina, Check Republic)• Agency may not have fiscal or managerial autonomy

(U.S. Medicare program)

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Social Insurance System Problems

• Hard to collect enough revenue where small farmers and the informal sector are economically important

• Financing can be strained if many non-contributors are covered: unemployed, children, pensioners etc.

• Governments can have a difficult time limiting benefits and controlling costs

• There are many opportunities for corruption—especially in claims processing and payment

• Upper income earners typically want to opt out and into private insurance instead

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The Long Run Sustainability of Social Insurance

• Cost pressures (from rising incomes, growing expectations, aging and new technology) are pushing up spending world-wide

• Revenue growth is often less than cost growth

• To be fiscally sustainable, social insurance systems need to be designed to constrain costs

• The key is giving incentives to providers to lower costs— avoiding fee-for-service payment

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Private Insurance• Premium-based financing is very regressive

• Companies have every incentive to deny coverage, or charge high prices, to those with chronic conditions

• Only provides limited risk pooling unless rates do not vary with individual health status—through group purchases or rate regulation

• Typically results in a lower fraction of revenue devoted to actual care compared to social insurance—the rest going to administrative costs and profits

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Community Financing• Some argue that the “ideal” system should have:

– Local control over funding and delivery– Mandatory participation– Inter-regional cross-subsidy– Limited benefits– Variation of contributions with income

• This can be a way to cover rural areas and those left out of social insurance

• Allowing voluntary participation can undermine risk sharing and foster “adverse selection”

• Poorer regions are unlikely to be able to finance equitable service levels on their own

• Effectiveness depends on political and administrative capacities at the local level

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Donor Assistance

• The only option that “relaxes” the constraints imposed by a country’s level of development

• The downside is the modern Golden Rule: “Whoever has the gold makes the rules”

• Reporting requirements and constraints on local policies and priorities can be significant

• Variations in political and economic conditions in donor countries can make funding uncertain

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Financing Summary

• No one funding option fits all situations—e.g. varying levels of development

• Most countries rely on a mix of options• The “within policy” variation is substantial—the

details of a funding scheme matter greatly to its results

• Implementation is critical—choose an approach within your nation’s administrative and legal capabilities