Back to top

How Government Policy Inflates Health Care Costs: The Curse of Cross-Subsidies


Published September 29, 2020

Cross-subsidies exist when the government allows companies to overcharge one set of consumers in order to subsidize others. Cross-subsidies require the government to enforce monopolies to stifle new competition that would otherwise offer lower prices. Innovation suffers and prices rise as a result. A more effective way to lower health care prices is to tax and spend on budget using market prices.

Discussion Questions:

  1. How would you explain cross-subsidies to your friends?
  2. What are examples of cross-subsidies in other industries?

Additional Resources:

  • Read “The Curse of the Cross-Subsidies,” by John H. Cochrane. Available here.
  • Read “The Tax-and-Spend Health-Care Solution,” by John Cochrane. Available here.
  • Read “Cross-Subsidies,” by John H. Cochrane. Available here.
View Transcript

Why is paying for health care such a mess in America? And why is it so hard to fix? Cross-subsides are a root cause of the problem: The government wants to help a group of people, so it forces businesses – doctors, hospitals, health insurers – to undercharge those people. To make up the lost money, the government allows those businesses to overcharge someone else.


But, in order for this scheme to work, the government can’t let other or new health providers and insurers offer better or cheaper care to the people who are overcharged. So the government has to enforce monopolies and stifle competition.


Stifling competition in any market removes the pressure to innovate, to lower costs, or to improve service for consumers. And soon everybody, even the people getting the subsidy, pays more than they would in a competitive market.


The government wants to help the elderly and the poor pay for health care. But lawmakers do not want to be seen taxing and spending, so they force doctors, hospitals, and insurers to do it.


Medicare and Medicaid programs pay hospitals and doctors less than the cost of treatment. The government mandates that hospitals provide emergency care to everyone, regardless of whether they pay. Health care providers make up the difference by overcharging people with private insurance, or cash-paying customers. In return, the government makes it hard or impossible to start new hospitals or insurance companies that cater to young, healthy, and cash-paying customers.


This is an old game. The federal government used to require that telephone companies provide landlines at low cost, especially to rural areas. So it forced a cross-subsidy from overpriced long-distance calls. The government enforced telephone monopolies to keep new phone companies out and long-distance prices up. When telephone service was deregulated, costs for everyone plummeted, and the quality and quality of service grew enormously. Now we take cell phones for granted.


Just like phone company of the 1960s, continued reliance on cross-subsidies within the U.S. health care system will just lead to larger and larger costs and less and less efficiency. We talk about competition and transparency, forcing hospitals to disclose prices for example, but the government cannot allow competition and transparency as long as it insists on funding care for some people by overcharging others.


If the government wants to subsidize health care and insurance for the poor, elderly, and other groups, it should do so directly and on-budget. And raise the money for it honestly and forthrightly through taxes. It should then leave markets free to compete ruthlessly for the rest of our business. There is no fundamental reason that in order to help people in need, your and my health care and health insurance must be so thoroughly screwed up.


Taxing and spending is not good for the economy, but it’s better than cross-subsidization. It allows most people’s heath care and insurance to be provided by an unfettered competitive innovative market. It ensures voters can see where their money is going, and decide if they want to be more or less generous and to who. The taxes would be unpopular, but our health bills would go down far more than our taxes would go up, and the quality and efficiency of our health care would skyrocket.