Understanding the issue of costs from a politician's perspective

As I was traveling back from the east today I thought for a while about the parallels between the discussions in the current House debates about college costs and the broader discussions in California and the nation about health care costs. In both instances the politicians are confusing cost and price - but in reality they are a bit different in each instance.

There are four key terms in relation to the college cost issue, as pointed out by the National Commission on College Costs in 1997 (on which I served). They are Cost (the actual expenditures made to keep the college open), Price (what parents and students see as the sticker price), Subsidy (money that goes to every student, some of it based on financial need and some not based on financial need) and Net Price (the difference between Price and Subsidy - different for almost every student). Over almost any period of time the cost of college has gone up at a rate that is higher than the underlying rate of inflation. There are lots of reasons for that (and some of them are good). But if you look at the net price for needy students that has remained relatively constant. There is one other issue going on that is related to state governments. In recent years, almost across the board, legislatures have decided that the level of subsidy going to all students should be diminished. That changes the price that students pay but it has nothing to do with college costs. As noted above in California the net price for students with financial need has been held constant.

In health care issues there is a constant chatter about the rising cost of health care. And if you look at the data - at least as a percentage of GDP - we are paying a greater percentage of our GDP to health care than we did a few decades ago. That has lead many politicians to decry the increasing costs of health care. But we are not buying the same market basket of goods and services that we once did.

In both higher education and health care consumers are insulated from the true costs. When you buy a car, or a loaf of bread you can get a pretty good idea of the costs (Costs + Profit = Price) but in the case of health care and higher education that is much harder to do. In health care a high percentage of workers have some kind of insurance coverage which blunts the price effect in two ways - first, their premiums are deducted from their paychecks so they may miss how much their coverage costs. And second, there is little relationship between the co-pays they are asked to bear and the actual cost of delivery. The stories of $100 aspirin on a bill in a hospital are legendary.

In higher education it is even more complex. As the National Cost Commission found, no student pays the full price of higher education. All students receive a generalized subsidy either paid for by the taxpayer or by endowments or both. Some students also receive a grant based on need or talent. Clearly, higher education could do better on its cost structures. The decision process in universities is complex and not prone to much care about costs. Parents and students demand amenities (gyms and internet to name two) which add to the problem.

But even with the complexity the politician's role here is not to think about costs. There is a uniformly negative response in the economics literature to price controls (which despite that politicians seem to often embrace). Ultimately what politicians seem to want to do is one of two responses. (Both of them negative to the long term sanity on either issue.) The first is to try to allow one group to bear a smaller percentage of the prices in the market. Some of that may be based on a theory of equity. The second response is to simply make a political calculation about shifting the costs borne by consumers to another group. In the California debates about health care the prices borne by some consumers would have been shifted to the doctors and hospitals through a tax (called a fee but it was a tax).

A recent ad in California on the health care issue is a good example of the level of discussion - the seemingly middle class speaker says "I cannot afford to get full health care coverage" - one wonders why the car makers have not done a similar ad with him asking to drive a Lexus rather than a Ford.

So how do you solve the problems here? I think there are three basic responses that need to be tried a lot more. The first is transparency. We should figure ways to allow consumers to understand the true cost of health and higher education in an easier way. That might require some basic changes. For example, one could see some significant changes in whether the cost of health insurance is included in the base of income (now it is not). Second, we should have an explicit discussion about equity in the system. One function of government is to improve the setting for the least well off in society. The third is to quit yammering about costs. Ultimately with better transparency and a clearer definition of who should receive an equity compensation paid for by taxpayers, costs will begin to sort out relatively quickly.