1. The “Finance” Control Knob
Marc J. Roberts
Professor of Political Economy and Health Policy
Harvard School of Public Health
Africa Flagship Kigali, June 23, 2010

2. Why Financing Matters A 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

3. 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
Flagship Course: Washington DC, October 18, 2006, Session 4

4. 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

5. 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

6. Attitudes Towards Distribution Vary Philosophically
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

7. 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)

8. 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

9. 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

10. 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

11. 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

12. 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)

13. 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

14. 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

15. 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

16. 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

17. 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

18. 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

19. 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)

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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