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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment The Market for Drug Treatment Richard Steinberg Medical care is not an ordinary purchase. The purchaser hires someone else (typically, a doctor) to tell him or her what to buy. Most of the risk is borne by the patient—payment is not contingent on the success of the treatment. Payment for services may be prospective or retrospective and is often the responsibility of third parties (insurers or government), although responsibilities are often shared by the purchaser (through copayments, deductibles, caps, restrictions on eligible providers, and restrictions on covered services) and the general public (financing the implicit tax expenditures on employer-financed health insurance and on the medical deduction from personal income taxes). Within this unusual market, the market for treatment of drug problems is unique. In many cases (and in all of the cases considered here), the purchase of drug treatment is a direct response to criminal activity by the customer, although not all customers are charged with this crime. Sometimes the purchase of treatment is voluntary, although it is commonly coerced, either implicitly (through threats of prosecution for possession or loss of employment) or explicitly (as a court sentence). When the service is purchased voluntarily, we have what Winston has called an "anti-market" in which people pay to not consume something.1 Ideally, the service would change the addict's preferences for drugs, but this is not easy to accomplish. (The best minds on Madison Avenue were unable to change our preferences regarding the "New Coke," a much easier task than changing preferences for an addictive substance like cocaine.) Realistically, we must measure success more by our ability to minimize the social side effects of drug addiction than by our ability to conquer the addiction itself. For most illnesses, society has considerable sympathy for the victim. Sometimes the reason for this feeling is obvious, as when the onset of illness is completely Richard Steinberg is in the Department of Economics, Virginia Polytechnic Institute and State University.
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment outside the victim's control. We have sympathy for older victims of lung cancer, even though their smoking may be the cause of illness, because they became addicted to cigarettes before they knew of the risks. Society's sympathies for the younger victims of lung cancer (who know about the risks they run) and for alcoholics are mixed, but there appears to be a near consensus against sympathy for drug addicts. The limits of public compassion are tested by calls for public subsidies for drug treatment. If such programs are to pass political muster, the case for them must be made in terms of benefits to nonaddicts. This paper concerns the market (supply and demand) for drug treatment. Alcohol, tobacco, nasal spray, and other legal "drugs" are beyond the scope of this study. Only the market for treatment of drug problems is covered; the market for drugs themselves is not considered except insofar as treatment interacts with this market. After briefly surveying some relevant facts, the paper presents rationales for public intervention and a framework for policy analysis. A later section discusses the effects of various policies on market equilibrium, considering the interrelated markets for treatment and insurance coverage and some difficulties in empirical application. The paper concludes with a discussion of policy options to enhance supply, policy options to enhance efficiency, and policy options in the insurance market. THE FACTS More than 1.8 million Americans have received treatment for drug or alcohol abuse or dependence (both referred to here as addiction) out of a population of addicts that is undoubtedly larger.2 There are three major types of treatment: inpatient, residential, and outpatient. Treatment modalities include detoxification, maintenance, and drug-free outpatient.3 Facilities are provided by the government and the for-profit and nonprofit sectors. Addicts utilize many sources to pay for treatment. The federal government assists through Medicare and Medicaid. Eligibility for the medically indigent under Medicaid differs by state, and not all states cover such treatment. A sliding-scale fee structure is typical. State and local governments provide most of our nation's treatment, available to the poor at no charge or at steeply subsidized rates. Nonprofit hospitals (and, to a lesser extent, for-profit hospitals) accept a limited number of patients on a charity basis. Medical insurance plans historically have played only a minor role in financing drug treatment, but this pattern is changing. Spurred on in part by state mandates,4 66 percent of health care insurance participants (a
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment group that comprised 95 percent of the nation's employees) in the private sector were covered for drug treatment in 1986. Coverage was even higher for state and local government employees. In 1987, 86 percent of participants (93 percent of employees were participants) were covered for drug treatment.5 Finally, the proliferation of drug testing has been accompanied by a concomitant increase in the demand for treatment as a first step remedy for positive test results. This trend is of growing importance, for, in 1987, 30 percent of the Fortune 500 companies screened employees for drug.6 Many of those who seek treatment do not do so voluntarily. Various sources indicate that perhaps 25 to 35 percent of patients are under court orders to seek treatment, and another 25 to 35 percent are implicitly coerced, seeking treatment after arrest but before sentencing. The remainder are self-referred, although many of these individuals have been heavily pressured by employers, friends, and family.7 RATIONALE FOR PUBLIC INTERVENTION Welfare Economics and the Pareto Standard No doubt it would be pleasanter to live in a world with less drug addiction, but from this fact we cannot automatically conclude that public intervention is warranted. Resources are scarce and social needs boundless. The subdiscipline of welfare economics is dedicated to determining when unregulated markets are optimal in the face of scarcity and when public diversion of limited resources to a particular need is worth the opportunity cost. A state of the world (denoted an economy) can be described by the quantities of each "good" affecting each person. A "good" is defined as anything the consumer cares about, including nontraded values such as good health or freedom from crime. One economy is said to "pareto-dominate" another if no individual prefers the second economy and at least one individual prefers the first. (This definition derives from Italian economist Vilfredo Pareto.) Thus, pareto-dominance is established by unanimous preference. An economy is said to be pareto-optimal if it is feasible and not pareto-dominated by any other feasible economy. There are, in general, an infinite number of pareto-optima to choose from, and they differ in the distribution of real income. Most economists would agree that the best economy is one of the pareto-optima (although there is no consensus on which one). The reason is simple: if an economy is not pareto-optimal, there is a feasible alternative that would make at least one person (more likely every person)
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment better off without hurting anyone. Since the days of Adam Smith, it has been well known that when all goods are traded in competitive markets, the outcome is pareto-optimal (nowadays, this is known as the first fundamental theorem of welfare economics). Thus, when markets are complete and competitive, the only case for government intervention is a distributional one; society might prefer an alternative pareto-optimum containing a different distribution of income. When markets are incomplete or noncompetitive, there is a (rebuttable) presumption that the market is not pareto-optimal, establishing a prima facie case for governmental intervention. There are many reasons to doubt the applicability of the first theorem to economies containing drug addicts. First, the notion of consumer sovereignty underlying the pareto standard is debatable here. Second, markets are not complete. Relevant markets for trading certain side effects of addiction and for trading information do not exist. Addiction and Consumer Sovereignty Economists are, with just cause, reluctant to prescribe what is good for a person. Generally, a person's own ''revealed preferences" are taken as data so that any change in consumption resulting from an enlargement in an individual's choice set (the set of feasible combinations of goods) is regarded as proof of betterment. This reverence for consumer sovereignty is natural when consumers are well informed and preferences are stable. Furthermore, economists are typically wary of social decisions to overrule individual preferences, for they fear that such decisions open the door to the worst kind of paternalistic excess. Psychologists, on the other hand, study the reasons why people do not do "what is best for them." The "medical need" paradigm overrules individual preferences entirely, replacing them with a determination by physicians of the amount of care a person should have to obtain the highest state of health possible within the constraints of current medical knowledge.8 Despite these objections, most economists remain unpersuaded that the state can do better than individuals in determining what is good. In cases of drug addiction, the economists' presumption is confronted with its severest test. First, consider the diversity of preferences evidenced by an addict who asks you to lock him up until he "kicks" the habit. This addict is, in effect, asking you to reduce the size of his choice set, indicating that he does not now want to enjoy the consumption that would be revealed if he were later unconstrained. Economic theories of addictive behavior fall into two general cate-
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment gories. Theories of "rational addiction" assert that decisions to consume drugs or kick the habit are made by individuals with stable preferences and full knowledge of the future consequences of their consumption decisions.9 In such a setting, drug addicts may regret the circumstances of life that have caused addiction to be their "best" option, but they would never regret the choices they have made (given the circumstances). Theories of "multiple personality" assert that consumption of addictive substances alters the addict's preferences among goods, in effect making them into another person.10 Prospective addicts may consider the impact of their choice on "the person they will become,'' but the theories differ as to how they make decisions and whether they will ever regret the decisions they have made. None of the theories developed so far is fully comprehensive, but each can explain some observed aspect of addictive behavior. For example, Becker and Murphy's (1988) "rational" theory is the only one to explain why some addicts voluntarily undertake a "cold turkey" approach in their attempt to kick their habit. In contrast, Becker and Murphy's model cannot explain the pain of addicts who wish they could quit but cannot, or the behavior of the addict who wants you to lock him in a room until he has fully withdrawn. Some sort of "multiple personality" theory appears to be necessary to rationalize these aspects of behavior. The application of these theories to policy questions remains underdeveloped, but some conclusions emerge. The "rational addict" would always prefer a gift of public money to an equal-sized public subsidy for drug treatment. Because addicts always do what is best (in terms of their own values), they will put money to its best use. If they are ready to kick the habit and want to purchase help in doing so, they can use their cash grant for treatment. But many addicts will prefer to use the money in other ways, ways that bring them greater satisfaction. Thus, the case for public subsidy of treatment cannot rely on the addict's self-interest (as self-defined) if addicts are "rational." A different conclusion emerges from some (but not all) of the "multiple personality" theories. A single physical person must, at various times, consider the interests of four "psychological people"—the potential addict, the potential person the consumer would be if she avoids addiction, the actual addict, and the reformed addict—each of which has different preferences that must somehow be reconciled. It is quite possible that the reformed addict will prefer a subsidized (or even coerced) treatment program over an equivalent sum of money, although during addiction the same person would feel differently. A self-interest case for subsidized treatment can emerge from such a model.11 One could argue that addicts are not perfectly informed; thus, their choices do not maximize their well-being. If they were fully informed of the consequences of drug addiction, one could conjecture that many would
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment be willing to quit or, at least, not start. There is probably some (but not much) truth to this assertion: some addicts are suicidal, others value the experience of drug consumption very highly, and both groups would not change their behavior even if they were better informed. If it were only an informational problem, public education programs would be the obvious solution. If we knew for certain that each addict would want to quit if fully informed of the consequences, and that educational programs were expensive or ineffective at informing addicts, then a coerced treatment program would more efficiently serve the addict's self-interest. As a practical matter, however, this rationale is unpersuasive and overly paternalistic. One could justify intervention by rejecting the principle of consumer sovereignty as it applies to drug addiction. Society can continue to care about the well-being of each of its citizens but still reject the notion that drug addicts are the best judges of their own well-being. Drug treatment may be a "merit good"—a good that addicts systematically undervalue. The problem with such an approach is the same: where does such paternalism stop? Should society reject the self-valuations of skiers, Democrats, or listeners to disco music? A valid distinction could, perhaps, be drawn in the case of addictive drugs. We might reject self-defined interest whenever behavior leads to objective decreases in physical well-being.12 If we accept the "multiple personality" theories of addiction, we could draw a finer distinction. Consumer sovereignty is not as well defined—which personality is the one whose interests society should protect? Society need not accept the individual's resolution of this conflict. We could reject the self-defined interest of the addict in favor of the self-defined interest of the rehabilitated addict on grounds of objective physical well-being. Is it really paternalistic if the former addict will thank us someday for interfering with his previous preferences? Another way society could decide which of the many consumer preferences possessed by an individual it wished to respect is to use the legal concept of duress. Decisions made under duress are legally suspect. Thus, if we lock an addict up (at his own request) until withdrawal is complete, we are not violating consumer sovereignty even if he begins to protest his incarceration. Withdrawal causes duress; his protests are suspect and should not be respected. One could extend this argument further, although it becomes less persuasive in extension. Once addicted, the addict's decision to continue using drugs can be regarded as one made under duress, considering that contemplation of withdrawal is quite stressful in itself. Under this theory, we would be justified in locking up an addict until withdrawal were complete even if the addict did not request such an action.
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment In summary, it is difficult to construct a case for public subsidies or coerced drug treatment based on the addict's own interest, for paternalism sets a dangerous precedent. However, addictive behavior raises unique doubts about the consumer sovereignty standard, and it may be possible to draw fine distinctions allowing limited rejection of this standard. Ethical doubts about the wisdom of such a policy will remain; the case for public intervention can more soundly rest on the interests of nonaddicts in controlling addictive behavior, to which the discussion now turns. External Effects of Drug Addiction An "externality" is an effect of market transactions (production, consumption, or trading activities) on third parties who do not control the transaction. For example, when one consumer purchases electricity from a power company, other consumers are forced to consume the resulting air pollution. When externalities affect only prices (denoted a pecuniary externality), they are not pareto-relevant, but when a market transaction directly affects the well-being or productivity of others (a technological externality), there is a presumption in favor of governmental intervention. Technological externalities generally cause a departure from pareto-optimality 13 so that governmental intervention has the potential to help some individuals and hurt no one. Drug addiction causes a variety of external costs. Thus, when drugs are not illegal or otherwise regulated by government, we can expect addiction rates to be excessive. The exact sense in which it would be excessive is that the benefits to third-party victims from a cutback in drug consumption would exceed the (self-perceived) loss to addicts, so that, with suitable compensation, everyone's lot could be improved. 14 Some drug addiction remains in a pareto-optimum, but there would be less addiction than in an unregulated market. If drug addiction causes external costs, then drug treatment causes external benefits. Thus, in a free and unregulated market, we would expect to see too little drug treatment, and some sort of subsidy may be warranted. Some of the external effects of drug addiction are well known, although the extent to which they occur remains understudied. Addicts commit property crimes to finance their habit. Their demand for illegal drugs creates a market in which drug traffickers use force and fraud to maintain monopoly power and reduce the threat of prosecution. Some drugs cause violent and antisocial behavior. Moreover, drugs can affect reaction time and judgment, leading to auto accidents, airplane or railroad crashes, and on-the-job injuries and fatalities. Drug consumption can also
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment lead to unemployment and consequent receipt of public support, financed through distortionary taxation. The control of contagious diseases has external benefits, and perhaps drug treatment is a similar case. When one individual is vaccinated, that individual helps others (by reducing the chance that the disease will be transmitted) as well as herself. Drug addiction appears to be similar, for addicts often support their habit by "pushing," initiating new users and later profiting by supplying them with drugs. In addition, drugs can spread in a clique through social pressures on nonusers. Although the contagion model has considerable descriptive appeal, there is a relevant distinction from the perspective of externality theory. It is one thing to catch a disease from an unvaccinated carrier (who evidences no signs of the disease); it is quite another to decide voluntarily to start using drugs after interacting with another drug user. Unless new users are coerced or fooled into using the drug until they are addicted (as in allegations of spiked candy or ice cream), they are party to a market transaction and not victims of an externality. However, nonusers who are concerned about such external effects as crime are clearly made worse off every time there is a new user. From this perspective, contagion is not itself an externality, but it interacts with and worsens other externalities that result from drug addiction. The "multiple personality" theories of addiction suggest an alternative rationale in which contagion is directly the source of an externality. One facet of the personality is unable to resist temptation and consequently consumes drugs whenever surrounded by other users. Another facet wants to avoid becoming an addict at all costs but is unable to control the behavior resulting from the first facet. This second facet, if it is regarded as a separate person, is externally affected by contagious drug consumption. Unable to refrain from drugs when temptation presents itself, this physical person may vote for laws restricting drug availability and encouraging treatment of others in order to avoid temptation. Intravenous (IV) drug users are thought to be the major vector for the spread of the acquired immune deficiency syndrome (AIDS) into the heterosexual population. Although the rationality or education of those sharing needles can certainly be called into question, there is no externality issue among IV drug users: each needle sharer is directly transacting with another needle sharer, and the transaction is purely voluntary. However, if one needle sharer knew he were likely to have AIDS and concealed this information from someone sharing the needle, there would be an informational externality. Here, there is no direct transaction between the parties on the important, good "information." The same analysis applies to interactions between needle sharers and nondrug-using sex partners. There is no externality without informational asymmetry, for the informed sex
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment partner is the final link in a chain of voluntary transactions. Informational asymmetry is, however, quite likely here. Finally, intervention in the drug market may be warranted to reduce statistical discrimination. Statistical discrimination occurs whenever employers are unable to ascertain the qualities of potential employees and so judge them by the average characteristics of the potential employee's ethnic or social class. Employers, unable to ascertain the drug status of potential employees, may discriminate against urban youths and ethnic groups that are thought to contain a greater proportion of addicts. When these groups are employed, it is at a lower wage to "compensate" the employer for the risk he is taking. Drug use by some members of an ethnic class has external costs for other members of that class who will be victimized by statistical discrimination. Such use may have beneficial externalities for other ethnic groups, who will be in high demand if their perceived drug use is low. However, one set of externalities cannot simply be cancelled against another—inequity is due to variation and not averages. Furthermore, the average quality of job matches (that is, whether the right worker will be employed in the right job) is degraded because of discrimination resulting from drugs. As a result, overall productivity will suffer. In summary, it is very difficult to construct a rationale for intervening in the drug treatment market based on the interests of the addict. If we really want to make the addicts better off (in their own judgment), a gift of money is far superior to a subsidized or coerced treatment program. One can argue that addicts do not know what is in their own best interest, but there are dangers in the paternalistic overruling of anyone's preferences. Moreover, it is difficult for an outsider to determine whether a particular addict is unable to act in his own interest, for observations of addiction are always consistent with a "rational" model. Yet even if there is no interest in regulating addiction for the addict's sake, there is a clear rationale for intervening in the drug treatment market. Rational addicts ignore the harmful side effects of their addiction on others. Public intervention is justified to reduce these externalities. Some Welfare Economics of Insurance Some goods are regarded as valuable simply because consumers desire them, and economists have little to say about such preferences. Other goods are desired as means to an end. It is most common to regard insurance as one such good. Insurance reduces the expected utility loss resulting from environmental uncertainty. The value of insurance thus depends on the individual's tastes (risk aversion) and the level of
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment uncertainty.15 At the individual level, it is unclear why drug treatment insurance should have value. Whether or not we regard addiction as a disease, the initial choice to consume drugs is clearly under the control of the consumer so that environmental uncertainty is minimal. Indeed, there appear to be only three sources of uncertainty. First, there is uncertainty about whether (and how quickly) consumption will result in addiction. A consumer planning to try cocaine just once might wish to purchase insurance to cover the possibility that he might become instantly addicted and need expensive treatment to stick to his plan. Second, there is uncertainty about future needs for treatment. A consumer may rationally decide to indulge and have no plans for treatment to kick the habit but may be wary about the possibility of being caught and ordered into treatment. Insurance thus reduces the financial consequences of the random event "getting caught." Finally, there is uncertainty about future choices. A young nonuser contemplating an insurance purchase may be uncertain about whether his tastes will change in the future and lead to drug use. Alternatively, he may believe he has stable tastes but is currently avoiding drug use because of the high current price. He is uncertain whether the future price will fall sufficiently to induce him to consume at some time in the future. It is questionable whether most of the people who consume drugs worry very much about any of these possibilities. Many consumers would entirely discount the possibilities of becoming addicted or getting caught using drugs. Some are present oriented and neglect the future almost entirely. Some are oblivious to financial consequences, which would largely fall on others (their parents, their creditors, etc.). Many have low self-esteem and feel little desire to protect themselves against future consequences. Thus, the private value of insurance appears to be minimal. The fact that drug consumers have little demand for insurance does not imply that they have little demand for insurance policies. An addict who knows she wants to purchase treatment would wish to purchase an insurance policy to reduce her treatment price. There is no reduction in the consequences of uncertainty here, merely an income transfer. Insurance companies seek to avoid writing such policies, but as a practical matter, they cannot entirely avoid this occurrence. The key distinction in terms of welfare economics is that pure insurance is automatically pareto-improving (if the seller of insurance is less risk averse than the buyer or is able to pool risks), whereas insurance policies need not be. In this case, insurance policies are probably pareto-improving even though they do not provide pure insurance because the income transfer encourages the consumption of treatment and this reduces external costs suffered by those making the transfer. Many health insurance policies are purchased for a
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment group—either a family or a set of employees. A family head might wish to purchase insurance to protect the family from the consequences of a choice by one of the other members to consume drugs. The key distinction here is that the family head regards drug use by others as a stochastic event with external consequences for the rest of the family. Employers might wish to provide drug insurance for employees because of pecuniary externalities. When an addict receives treatment, future health care costs may be reduced. Indeed, it has been argued that the reduction in this patient's future health care costs would more than cover the cost of addiction treatment.16 If this is so, then the firm's overall costs of insurance are reduced, allowing it to purchase more insurance or offer higher salaries for other employees or to increase the wealth of the owners of the firm. Thus, treatment of one addict has external benefits (mediated through the price system) on other employees and stockholders. The externality in this case is pecuniary, not technological. Thus, this externality provides no basis for state intervention (such as mandated or subsidized coverage). In competitive equilibrium, insurance firms would offer drug treatment coverage to firms at a rate lower than the direct costs of treatment, and the optimal quantity of coverage would be purchased.17 The incremental cost of drug treatment coverage would be set equal to the incremental aggregate health care costs (which may be negative). If drug insurance more than pays for itself (as alleged), insurance rates would be lower for those employers who provide such coverage. There is another reason why drug treatment insurance may be of value to employers. Few employers wish to hire addicts, but one cannot be sure at the time of hiring whether a particular employee is or will be an addict. Once addiction is discovered, it may be cheaper for the employer to pay for treatment than to fire the worker, for recruitment and training costs are substantial and on-the-job experience enhances productivity. Insurance thus brings the usual gain in expected utility by reducing financial risk, but this gain accrues to the owners of the firm rather than the insured party. Yet the story is even more complicated because both parties have some bargaining power when employee drug addiction is discovered. The employee has bargaining power because it would be expensive to replace him. The employer has bargaining power because an untreated but experienced employee may be worth less than a raw recruit; consequently, the firm can credibly threaten to fire the addict if he does not seek (and personally pay for) treatment. Although the author knows of no formal models of this bargaining situation, it would seem that drug insurance with some sort of cost sharing, either explicit (such as copayment) or implicit (salary reductions or deferred raises), would emerge. There is a subtler reason for employee provision of drug treatment coverage. It is difficult for employers to observe the individual productivity
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment part-time employed addict This is the segment of the addict population most likely to turn to crime; consequently, the external benefits of extending a subsidy to this group may be greatest of those for any group. Subsidizing individual purchases of drug treatment insurance is no better because it is likely that many addicts would fail to purchase insurance at any price. There may also be political problems with subsidizing a specific type of health insurance. Some will oppose such policies as apparently subsidizing criminals. Others will decry the inequity of subsidizing just one kind of insurance and attempt legislatively to link such subsidies with subsidies to other sectors of the health insurance industry, sectors that are already oversubsidized. Finally, there is the difficulty of structuring incentives so that they encourage increased provision of services rather than mere expansion in insurance company profits. The insurance industry has large barriers to entry and exit and is heavily regulated by the state. As a result, one cannot rely on competition to eliminate opportunistic behavior of this sort. If subsidies are politically unattractive, inefficient, or too expensive, mandated coverage appears to be an attractive alternative, and, indeed, many states have taken this option. As was pointed out earlier, the optimal mandate would incorporate a reduction in the copayment rate, but the author is not aware of any states that are currently taking this approach. In general, it would be difficult to write a proper practical mandate. Insurance companies may respond to state requirements by providing coverage only for cheap and ineffective treatment modalities. Any attempt to write into law financing for specific modalities would face charges of favoritism and unfair competition. Given our current ignorance of the comparative social cost-effectiveness of the different modalities, such charges would be hard to rebut. Finally, mandates add to the cost of insurance coverage. It is clear that the total cost of the wide variety of state mandates is an important deterrent to employer-provided insurance coverage, although the impact of drug addiction mandates is undoubtedly smaller. Under federal law, any firm can elect to self-insure its workers and escape the strictures of state mandates. According to the Health Insurance Association, 70 percent of employees who work for companies with more than 500 people are covered by self-insurance programs.57 Although the typical self-insurance plan now provides some coverage for drug treatment, the copayment rate remains socially excessive. The reason, as was discussed earlier, is that some of the benefits to drug addiction control are external to the addict, any supplemental insurer personally contracted with by the addict, and the addict's employer. Small employers are less able to self-insure, and, indeed, only 14
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment percent of employees at companies with fewer than 50 people are covered by such plans.58 The only way they can escape mandates is to withdraw entirely from the provision of health insurance. Although current drug addiction mandates are clearly not a major factor, mandates in general have led to this problem. A study by Gail Jensen estimated provisionally that about ''one in five small U.S. companies that didn't offer health insurance in 1985 would have implemented plans if their states' mandates were eliminated'' (Jensen, 1988:307). A similar study released by the National Center for Policy Analysis estimated that "some 25% of the nation's 37 million people without health insurance lack coverage because of the mandates."59 Again, companies have far less reason to oppose drug addiction coverage then other mandates, but the potential impact of a massive increase in the required coverage level should not be ignored. A policy of coerced employer-provided insurance (whether self-insurance or commercially obtained) with reduced copayment would provide the optimal insurance package for employees, but this policy would have an important detrimental side effect. If insurance rates were adjusted in accordance with the firm's individual record (as is common for larger firms that are commercially insured and is implicit whenever firms self-insure), this practice would increase the cost of hiring potential drug addicts. As a result, employers would practice "statistical discrimination" to a greater extent then they do now, avoiding the hiring of members of groups that have a high probability of drug addiction. Companies increasingly are turning to "cafeteria plans," which enable employees to pick and choose desired benefits. This otherwise desirable trend hurts drug addiction coverage for two reasons. First, as noted earlier, addicts would neglect the external benefits of treatment when deciding which insurance benefits to pick and would therefore select a suboptimal level of coverage. Second, as Diane Canova put it, "[a]lcohol and drug treatment (benefits) may not be picked up because of the stigma and personal denial associated with the problems." 60 State mandates should, perhaps, be reformed to ensure that drug treatment coverage is required, not elected, for all employees. In any case, it is difficult to structure an effective policy that would improve on the free-market provision of health insurance, and many addicts are unemployed and uninsured. Unless this country turns to a national health insurance plan, policies that directly alter the drug treatment market seem superior to policies that alter the insurance market.
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment Notes 1 Gordon Winston, "Addiction and Backsliding: A Theory of Compulsive Consumption," Journal of Economic Behavior and Organization 1(4), 1980, pp. 295-324. 2 Dan Richman, Maria Rundinsky, and Jennifer Fine, "Drug Abuse May Present Growth Opportunity for Nation's Hospitals," Modern Healthcare 16, October 10, 1986, p. 46. In 1985, it was estimated that there were 70 million citizens that had used drugs illicitly at least once, 23 million within the past month. Of these, 1.8 million were clinically dependent, and another 1.8 million exhibited drug-related pathology but were not judged to be dependent on drugs. 3 A 1984 survey of programs that received money administered by the state alcohol and drug administration (this categorization omits most for-profit programs and some nonprofit and public programs) revealed that, of 272,042 admissions for drug treatment, 7,706 were to hospitals, 53,643 were to residential facilities, and 210,693 were to outpatient environments. By modality, 38,625 entered detoxification, 38,713 entered maintenance, and 185,006 entered drug-free programs (William Butynski, Nancy Record, JoLynn Yates, and the National Association of State Alcohol and Drug Abuse Directors, Inc., State Resources and Services for Alcohol and Drug Abuse Problems, Fiscal Year 1984, U.S. Department of Health and Human Services, Public Health Service, Alcohol, Drug Abuse, and Mental Health Administration, Rockville, Md., 1985). Similar statistics for 1986 reported in the Journal of the American Medical Association, 258, October 16, 1987, p. 2023, indicate that there were 385,593 drug admissions, 72.2 percent of which were on an outpatient basis. Heroin was the leading drug, but cocaine admissions more than doubled over the previous three years. 4 By 1987, 36 states had mandated that substance abuse coverage be incorporated into insurance policies, but the type and number of treatments for which coverage was required varied considerably (Myk Cherskov, "Substance Abuse in the Workplace," Hospitals 61, June 20, 1987, p. 68). However, the Employee Retirement and Income Security Act of 1974 preempts state law and allows self-insured employers (who covered 42 percent of surveyed employees in 1985) to ignore this state mandate (Michael A. Morrisey and Gail A. Jensen, "Employer-sponsored Insurance Coverage for Alcoholism and Drug Abuse Treatments," Journal of Studies on Alcohol 49, September 1988, pp. 456-461.
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment 5 The author wishes to thank John Thompson of the Bureau of Labor Statistics for providing him with these data. 6 Cherskov, "Substance Abuse in the Workplace." 7 See Chapter 4 of Treating Drug Problems, Volume 1. 8 For a discussion of the distinction between the economist's notion and the medical need concept, see James R. Jeffers, Mario F. Bognanno, and John C. Bartlett, "On the Demand Versus Need for Medical Services and the Concept of 'Shortage,'" American Journal of Public Health 61, January 1971, pp. 46-63. 9 Examples of this type of theorizing include Gary S. Becker and Kevin M. Murphy, "A Theory of Rational Addiction," Journal of Political Economy 96, 1988, pp. 675-699; George J. Stigler and Gary S. Becker, "De Gustibus Non Est Disputandum," American Economic Review 67, 1977, pp. 76-90; Laurence R. Iannaccone, ''Consumption Capital and Habit Formation with an Application to Religious Participation," Ph.D. dissertation, University of Chicago, 1984; Robert J. Michaels, "Addiction, Compulsion, and the Technology of Consumption," Economic Inquiry 26, 1988, pp. 75-80; and Thomas A. Barthold and Harold M. Hochman, "Addiction as Extreme-Seeking,'' Economic Inquiry 26, 1988, pp. 89-106. 10 Theories of this sort include Menahem E. Yaari, "Consistent Utilization of an Exhaustible Resource, or, How to Eat an Appetite-arousing Cake," Working Paper, Hebrew University, Center for Research in Mathematical Economics and Game Theory, 1977; John Elster, Ulysses and the Sirens: Studies in Rationality and Irrationality, Cambridge University Press, Cambridge, 1979; Winston, "Addiction and Backsliding"; Richard H. Thaler and H.M. Schefrin, "An Economic Theory of Self-Control," Journal of Political Economy, April 1981, pp. 392-406; and Thomas C. Schelling, Choice and Consequence, Harvard University Press, Cambridge, Mass., 1984, and "Egonomics, or the Art of Self-Management," American Economic Review 68, May 1978, pp. 290-294. The paper by George A. Akerlof and William T. Dickens entitled "The Economic Consequences of Cognitive Dissonance" (American Economic Review 72, June 1981, pp. 307-319) differs in spirit but is clearly relevant as well. Finally, psychologists have developed and tested models similar to those of economists. See, i.e., Karl E. Bauman, Predicting Adolescent Drug Use: Utility Structure and Marijuana, Praeger Publishers, New York, 1980, and the references contained therein.
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment 11 Even so, the problem of securing individualistic welfare comparisons remains. For discussions of the limitations of many ingenious attempts to construct welfare orderings from endogenous preferences, see Robert A. Pollak, "Endogenous Tastes in Demand and Welfare Analysis," American Economic Review 68, May 1978, pp. 374-379, and T.A. Marschak, "On the Study of Taste Changing Policies," American Economic Review 68, May 1978, pp. 386-391. 12 For an interesting essay on "the material welfare approach" to welfare economics, see Robert Cooter and Peter Rappoport, "Were the Ordinalists Wrong about Welfare Economics," Journal of Economic Literature 22, June 1984, pp. 507-530. 13 No departure from pareto-optimality occurs when a competitive secondary market arises in which third parties conduct transactions (explicitly through bribes and other payments or implicitly through court suits) with the generators of the externality. Such markets often do not exist. Thus, in terms of the first fundamental theorem, equilibrium is suboptimal owing to the incompleteness of markets. Technological externalities can only establish a prima facie case for intervention. There is no guarantee that government is willing or able to make the changes necessary to obtain pareto-optimality. 14 A market with unregulated drug is not pareto-optimal, whereas a market with an optimal reduction in drug use would be. Nonetheless, the latter need not pareto-dominate the former. Although the total gains are such that no one need suffer, as a practical matter, the winners often fail to compensate the losers in policies adopted by majority-rule political systems, preferring to keep the total gains for themselves. It remains controversial whether policies that only potentially pareto-dominate the status quo should be adopted. 15 See Mark V. Pauly, "Taxation, Health Insurance, and Market Failure in the Medical Economy," Journal of Economic Literature 24, June 1986, pp. 639-641, for a brief survey of the theory of insurance. 16 An additional complication has been neglected for the sake of clarity. Some individuals will receive treatment for addiction even if their insurance policy does not cover the costs of this treatment. For these individuals, future health care costs are lower whether drug insurance coverage is extended to them or not, and there are no pecuniary externalities. The impact of this complication on employer choice of plans is unclear, depending on whether those employees who would seek treatment
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment even in the absence of coverage would accept lower compensation from other sources in return for employer coverage of these bills. 17 We are looking, in a sense, at the optimum ceteris paribus, for there are other reasons why optimality would not be obtained. On the one hand, the personal income tax treatment of employer-provided insurance leads to overinsurance; on the other, employee turnover leads to underinsurance. See Pauly, "Taxation," pp. 629-675, and Rashi Fein, Alcoholism in America: The Price We Pay, Comp Care Pubs., Minneapolis, Minn., 1984. 18 Pauly, "Taxation," pp. 641-643, and the references cited therein. 19 John Wakeman-Linn, "Coverage Ceilings on Outpatient Mental Health Care: The Patient's Perspective," Department of Economics, Williams College, March 1988. 20 Most cost-benefit analyses done in the real world are not done properly. Much of the shortfall in quality is unavoidable and appropriate, for it is costly to gather the "ideal" data set. Far more disturbing is the fundamental confusion often evidenced between accounting and social welfare data. Analysts incorrectly restrict attention to those things that can be easily measured (all too often including no more than the prices and quantities bought and sold), substituting a value of zero for their best guess on difficult-to-measure items. The result is a biased and incomplete policy prescription, and the technique as a whole is unfairly castigated by a form of statistical discrimination. 21 A. Myrick Freeman III provides an excellent introduction to the use of the hedonic technique in his book The Benefits of Environmental Improvement: Theory and Practice, Johns Hopkins University Press, Baltimore, Md., 1979. Since then, a voluminous literature refining and critiquing the technique has appeared, but a review of this literature is beyond the scope of the present paper. 22 The appropriate solution is a matter for further study, as not all variation in crime rates is due to variation in addiction levels. Ideally, one would want to control for that portion of variation in crime rates that is independent of addiction and not control for addiction-caused variations. This could be accomplished with a simultaneous equations structural estimation technique. Alternatively, one could control for crime, estimate an auxiliary equation between drug use and crime rates, and combine estimates to impute the total value of drug control. Although these solutions
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment are reasonably straightforward in simpler statistical models, it might prove difficult to integrate them with the more elaborate techniques sometimes employed in hedonic analysis. 23 This argument relies on the fact that commuters, shoppers, or tourists are merely passing through the high-addiction community. If the high-addiction community were their final destination, the cost of drug addiction to outsiders would be reflected in local property values. If the workplace were in a high-crime district, the employer would have to offer higher salaries to attract workers, and this would reduce the value of the land site to employers. Similarly, high crime would reduce the value of a store attracting shoppers or a tourist attraction. 24 See Ronald G. Cummings, David S. Brookshire, and William D. Schulze, eds., Valuing Environmental Goods: An Assessment of the Contingent Value Method, Rowman and Littlefield, Totowa, N.J., 1986. 25 Heterogeneous prices, such as those generated by a sliding-scale fee system, are considered below. 26 Some economists would prefer to model the addict's choice of insurance plans (which differ in copayment rates) and of treatment amounts as a simultaneous decision, so that one cannot take C as given when determining Q. The problem is a standard one of representing general equilibrium with partial-equilibrium diagrams. Nonetheless, the equilibrium itself can be characterized by this diagram, although interactions between markets affect the locations of the curves. Alternatively, one can assume that insurance does not cover preexisting conditions (and that this restriction can be enforced); consequently, the purchases must be done sequentially. Then, it does make sense to regard C as given when selecting Q. 27 The effect is exactly analogous to a sales tax, but it operates in the opposite direction. 28 It is implicitly assumed that the copayment rate or the public subsidy rate is the same for every addict. This would not be the case if the public subsidy rate were a sliding scale depending on the income and insurance coverage of the recipient addict. These figures seem ill-suited to analyzing heterogeneous subsidies of this sort, but they can be easily handled in equation form. 29 It has been assumed that the income elasticity of demand for treatment
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment is small enough to ignore. If not, the inframarginal price subsidy would lead to an increase in demand if treatment were a normal good. It remains true that past the binding cap, the stimulus to demand is smaller than would occur without a cap. Furthermore, unless the income effect were large enough to push the intersection past the discontinuity, the equilibrium quantity would not change. 30 There is a technical exception to this conclusion of little practical importance. If safety were a sufficiently inferior good, it is possible that a public safety program would be counterproductive. 31 Pauly, "Taxation," does this. 32 Henrick Harwood personal communication, September 1988. 33 See Pauly, "Taxation," pp. 662-664, for further discussion of endogenous quality. 34 Comprehensive Care Corporation of Irvine, California, offered free treatments for relapses up to five years after completion of the program (Cynthia Wallace, "Treatment Guarantees to Proliferate Despite Claims that Ads are Misleading," Modern Healthcare 17, July 17, 1987, p. 40). The program was discontinued, however, after it would found that cocaine addicts had more relapses than expected. 35 For example, Randall P. Ellis and Thomas G. McGuire, "Cost Sharing and Patterns of Mental Health Care Utilization," The Journal of Human Resources 21, Summer 1986, pp. 359-379. 36 See Pauly, "Taxation," pp. 660-662, and the references cited therein. 37 The technique was originally developed in Gary Burtless and Jerry Hausman, "The Effect of Taxation on Labor Supply: Evaluating the Gary Negative Income Tax Experiment," Journal of Political Economy 86, 1978, pp. 1103-1130. It was later applied to labor supply in Jerry Hausman, "Labor Supply," in Henry Aaron and Joseph Pechman, eds., How Taxes Affect Economic Behavior, The Brookings Institution, Washington, D.C., 1981; to housing in Jerry Hausman and David Wise, "Discontinuous Budget Constraints and Estimation: The Demand for Housing," Review of Economic Studies 47, 1989, pp. 75-96; and to charitable donations in William Reece and Kimberly Zieschang, ''Consistent Estimation of the Impact of Tax Deductibility on the Level of Charitable Contributions,'' Econometrica 53, March 1985, pp. 271-293.
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment 38 Martin Feldstein and Lawrence Lindsey, "Simulating Nonlinear Tax Rules and Nonstandard Behavior: An Application to the Tax Treatment of Charitable Contributions," in Martin Feldstein, ed., Behavioral Simulation Methods in Tax Policy Analysis, National Bureau of Economic Research, Cambridge, Mass., 1983. 39 "Should Cocaine Cost More? Less?" (editorial), New York Times, July 28, 1988, p. 22. 40 Mark D. Uehling, "Drug Rehabilitation: The Addict Glut: Public Treatment Centers Lack Beds and Funds," Newsweek 108, August 25, 1986, p. 34. 41 "And Localities Must Fight for Drug Treatment" (editorial), New York Times, June 5, 1988. 42 Uehling, "Drug Rehabilitation." 43 Henrick Harwood, personal communication, September 1988. 44 Unpublished data from the National Drug and Alcoholism Treatment Utilization Survey (NDATUS) indicate that insurance payments rose from $40 million in 1982 to $350 million in 1987, whereas client fees rose from $35 million to $160 million and public third-pay expenditures from $60 million to $140 million over the same period (all figures are in nominal dollars). 45 Ibid. 46 See the author's unpublished paper, "Econometric Analysis of the Relations Between Government Social Service Expenditures and Private Donations," April 1989, and the references therein. 47 Henry Hansmann, "The Effect of Tax Exemption and Other Factors on the Market Share of Nonprofit Versus For-Profit Firms," National Tax Journal 40, 1987, pp. 71-82. 48 Henry Hansmann, "The Rationale for Exempting Nonprofit Corporations from the Corporate Income Tax," Yale Law Journal 91, 1981, pp. 45-100. 49 Uehling, "Drug Rehabilitation," referred to the "'not in my backyard' syndrome."
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment 50 See Julian Wolpert and Michael Dear, "Satellite Mental Health Facilities," Annals of the Association of American Geographers 65, 1975, pp. 24-35, and Michael Dear, Not on Our Street: Community Attitudes to Mental Health Care, Dion: London, 1982, for a discussion of some of the policy issues involved in siting an "obnoxious" facility. 51 New York Times (editorial), June 5, 1988. 52 Robert W. Paulson, "People and Garbage are not the Same: Issues in Contracting for Public Mental Health Services," Community Mental Health Journal 24, Summer 1988, pp. 91-107. 53 He noted (p. 96) that "[t]he political economy of human service delivery systems tends to limit competition. Two studies of purchase of service contracting for human services . . . suggest that agencies tend to create a negotiated environment in which each agency in the system stakes out its own territory (domain) and has a monopoly within that market segment. Instead of competition developing, there is a system of market shares resembling a collective oligopoly." 54 If there are only two or three facilities, it is possible they would collude rather than compete, a problem that is well-known and not completely resolved. It is clear that the number of existing firms is less important than the ease with which new firms could enter and exit in the event of collusion between existing firms. 55 Pauly, "Taxation," p. 670. 56 Alain C. Enthoven, "A New Proposal to Reform the Tax Treatment of Health Insurance," Health Affairs 3, 1984, pp. 21-39. 57 Cited in Wall Street Journal, December 28, 1988, p. B1. 58 Ibid. 59 Ibid. 60 Ibid.
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Treating Drug Problems: Volume 2, Commissioned Papers on Historical, Institutional, and Economic Contexts of Drug Treatment ACKNOWLEDGMENT The author wishes to thank Henrick Harwood, Mark Pauly, Sharon Brown, Jacques Cremer, Stephen Sheppard, William T. Smith, II, Philip J. Cook, and Nels Pearsall for helpful discussions.
Representative terms from entire chapter: