You Think Financing US Health Care Is Bizarre? Check Out 340B Drug Pricing

Guest post written byUwe Reinhardt

Mr. Reinhardt is the James Madison Professor of Political Economy at the Woodrow Wilson School at Princeton University.

Ms. Sally Pipes' latest post is the most recent installment in a long- running debate over the U.S. government's 340B Drug Pricing Program, which requires drug manufacturers to provide drugs to certain health-care facilities at significantly reduced prices. It throws into sharp relief the truly bizarre ways by which we finance health care in this country.Let me count these ways.

1. Over half a century's tenacious wrangling over universal health insurance makes clear our reluctance to extend comprehensive health insurance to millions of lower-income Americans who cannot afford the premiums for such coverage. On average, these uninsured receive about half the health care similarly situated insured Americans receive.

2. At the same time, however, we cling to the self-flattering notion that we are the most generous people on earth, a proposition we never hesitate to proclaim to the rest of the world.

3. To reconcile that felicitous self-image with our resistance to universal health insurance, we have constructed a health-care financing system so convoluted that it probably would not have occurred even to Rube Goldberg.

4. For starters, we allow our providers of health care - doctors, hospitals, pharmaceutical companies and other providers-to use classic price discrimination in the markets for their products and services. That tactic helps sellers to extract from buyers with different abilities or willingness to pay as much total revenue as can possibly be extracted from the buyers collectively.

7. We further have allowed hospitals and other providers of health care to enhance their revenue gathering prowess by allowing them to consolidate their market power through mergers. The Accountable Care Organizations (ACOs), encouraged by the Affordable Care Act (ACA), may well speed this process of consolidation.

8. Many states go yet further by protecting the economic turf of existing facilities through Certificate-of-Need (CON) laws designed to deter entrance into the market of would-be competitors. This idea resembles the taxi medallions issued by New York City to control the number of taxis, but also to enhance their market power.

5. The result of all these policies is that, on average, the prices of health-care services and products in this country tend to be significantly higher-often two to three times higher-than the prices of those same products and services on other industrialized countries. It can explain why per capita health spending in the U.S. in purchasing power parity dollars also is about twice as high as it is in most other industrialized nations.

5. Now, because the providers of health care in this country can extract so much revenue from the rest of society, the thought occurred to us that overall they should have enough moolah to operate for the low-income uninsured an informal, not directly compensated catastrophic health insurance system whose entry portal is the emergency department of hospitals. As President George W. Bush noted in 2007, 'People have access to health care in America. After all, you just go to an emergency room.' In 2012, presidential candidate Mitt Romney offered similar advice.

6. Indeed to make sure that hospitals do operate this catastrophic insurance system in case of life threatening illness, President Reagan in 1986 signed into law the Emergency Medical Treatment and Labor Act (commonly known as EMTALA) requiring hospitals to render patients stabilizing emergency services, including active labor, regardless of patients' ability to pay.

7. Alas, for the providers of health care, the state-based Medicaid programs have played the classic price-discrimination game that characterizes U.S. health care as any large buyer with market power in a local market would: they buy health care for Medicaid beneficiaries at prices well below fully allocated costs (including allocated fixed costs), but above the marginal cash costs of treating the low-income uninsured, so that at the margin Medicaid patients still do bring in a positive cash flow even if they don't cover fully allocated costs. From time to time, the federal Medicare program exploits its market power that way as well.

9. Because hospitals with a disproportionately large clientele of Medicaid and uninsured patients find it hard to make ends meet in this price-discriminatory game, Congress and state governments have paid them, through the back-door, so to speak, so-called disproportionate-share (DSH) monies to help them defray the marginal cost of treating these patients.

10. Teaching hospitals that tend to treat large numbers of Medicaid and uninsured patients receive additional allowance for graduate medical education (GME), although economic theory suggests that there is actually no warrant to support GME in this way.

11. Finally, to help these financially pressed hospitals and other facilities with many Medicaid- and uninsured patients cope with the high prices of pharmaceutical products, Congress saw fit in 1992 to pass the above mentioned 340B drug pricing program, signed into law by President Bush the Elder. The program is ostensibly designed to lower the marginal cost of treating low-income uninsured and Medicaid patients, but, apparently, the law was written loosely enough to permit hospitals to sell the heavily discounted drugs at large markups to commercially insured patients. Hospitals argue, however, that any profits so garnered are recycled to fund their informal catastrophic health insurance program for the poor and to treat Medicaid patients.

12. Depending on the state, there are still other back-door forms of financing distressed hospitals to make the system work. 13. Altogether, the highly complicated cash flow resulting from this strange system of financing, flowing through so a myriad of capillaries, makes it almost impossible to hold any providers formally accountable for all of the moneys they receive.

Somehow this rickety Rube Goldberg contraption of financing health care has worked in some fashion in this country, for over half a century. Many hospitals have thrived financially under it, while hospitals located in mainly low-income areas have struggled or gone under. And as a series of journalists-most recently Steve Brill in ' The Bitter Pill '-have reported, this system also has put brutal financial stress on the budgets of many American households.

If one explains this financial scheme to foreigners, their reaction invariably is two fold: first, blank stares that express incredulity, then smiles expressing vague amusement.

In her recent post, Ms. Pipes puts the blame for the alleged misuse by hospitals of the 340B drug price program on government for its lack of oversight of all hospitals receiving these funds. Oversight is needed, she seems to assume, because one just cannot trust hospitals to do the right thing.

Alas, better oversight inevitably implies more civil servants traipsing through hospitals and clinics, there to rummage around in patients' files, auditing internal cash flows and imposing penalties for perceived misbehavior. Such a policy, of course, would trigger outcries over overbearing government intrusions into the private sector. And so it goes, as Kurt Vonnegut might say.

Indeed, it can be said that in no other country is as much oversight necessary-and performed-as it already is in the U.S. Here hospitals spend hundreds of millions, possibly billions, every year to be in compliance with government regulations, and government auditors and the Inspector General's offices cost hundreds of millions more. Every U.S. hospital now has some executive vice president in charge of compliance, has a board subcommittee dealing with compliance and has a sizeable compliance department and confidential hotline for whistle blowers. There are a growing number of compliance consulting firms helping hospitals and clinics to remain in compliance with U.S. federal and state regulations, earning a fine living from the process-all at patients' expense, of course. I have never encountered anything like it in other countries whose health systems I have studied.

But, weird and cumbersome as it is, this financing scheme seems to be the system we American prefer. After all, we have kept it in place for many decades now and we only make it more complicated with every passing year, to the point that invites all manner of untoward behavior, notwithstanding the huge sums we already spend on compliance.

And we never cease to proclaim to anyone else in the world still willing to listen that ours is the best health system in the world, bar none. So, mazel tov, my friends! Enjoy.