What Do Obamacare and the EITC Have in Common with Cap-and-Trade?

My preceding blog post described how market-oriented mechanisms to address environmentally damaging emissions, particularly the cap-and-trade system for SO2 in the United States, have recently been overtaken by less efficient regulatory approaches such as renewables mandates.   One reason is that Republicans — who originally were supporters of cap-and-trade — turned against it, even demonized it.

One can draw an interesting analogy between the evolution of Republican political attitudes toward market mechanisms in the area of federal environmental regulation and hostility to the Affordable Care Act, also known as Obamacare.   The linchpin of the program is the attempt to make sure that all Americans have health insurance, via the individual mandate.  But Obamacare is a market mechanism, in that health insurers and health care providers remain private and compete against each other.

As has been pointed out countless times, this was originally a conservative approach, designed to work via the marketplace:  The alternative is to have the government either (i) directly provide the health insurance (a “single payer” system, as in Canada; or under US Medicare for that matter) or (ii) directly provide the health care itself (”socialized medicine,” as in the UK; or the US Veterans Administration hospitals).  The new approach was proposed in conservative think tanks such as the Heritage Foundation. It was enacted in Massachusetts by Republican Governor Mitt Romney. By the time President Obama adopted it, however, it had become anathema to Republicans, most of whom forgot that it had ever been their policy.

One can trace through the parallels between clean air and health care.  The market failure in the case of the environment is that pollution is what economists call an externality:  In an unregulated market, those who pollute don’t bear the cost. The market failure in the case of health care is what economists call adverse selection:  Insurers may not provide insurance, especially to patients with pre-existing conditions, if they have reason to fear that the healthy customers have already taken themselves out of the risk pool.

Government attempts to address the market failure can themselves fail.  In the case of the environment, command-and-control regulation is inefficient, discourages innovation, and can have unintended consequences.   For example, CAFÉ standards (Corporate Average Fuel Economy) were partly responsible for the rise of the SUV.  Corn ethanol mandates raised food prices and accomplished nothing for the environment.  When “New Source Review” requires that American power companies adopt the most stringent available control technology if they build a new power plant, they respond by keeping dirty old plants running as long as possible (Stavins, 2006).

In the case of health care, a national health service monopoly can forestall innovation and provide inadequate care with long waits.  In general, the best government interventions are designed to target the failure precisely - using cap-and-trade to put a price on air pollution or using the individual mandate to curtail adverse selection in health insurance — and otherwise let market forces do the rest more efficiently than bureaucrats can.

American conservatives often talk as if the alternative they would prefer is no regulation at all.  But few in fact would want to go back to the unbreathable pre-1970 air of Los Angeles, London, or Tokyo.  Even those few who might want to should recognize that most of their fellow citizens feel differently.  Political reality shows that the alternative in practice is an inefficient rent-seeking system in which solar power, corn-based ethanol, and fossil fuels all get subsidies or mandates.  Analogously, few conservatives in fact will say that they want hospital emergency rooms to turn away critically ill patients who lack health insurance.  Even for those who might want this, reality shows that the alternative in practice is hospitals that give emergency care to those who lack insurance, whether because of personal irresponsibility or for reasons beyond their control, and then pass the charges on to the rest of us.

A third example is the Earned-Income Tax Credit.  It was originally considered a conservative idea: an implementation of Milton Friedman’s proposed negative income tax, it was championed by Ronald Reagan as a pro-work market-friendly way of addressing income inequality.   President Obama proposedexpanding the EITC in his State of the Union address last month.  But conservatives, again forgetting that it was their own creation, have opposed expansion of the EITC as verboten redistribution.   So proposals to increase the minimum wage get more political traction as a way to address income inequality, even though that approach is more interventionist and less efficient.

[This is the second of a two-part post, which in turn is the extended version of an op-ed published atProject Syndicate.  Comments may be posted there; or join the debate at Economist's View.].