Adam Stebbing writes:

In an election campaign in which both sides are competing to spend as little and save as much as possible, one obvious source of savings – the Private Health Insurance Rebate – has been ignored. Means testing, or abolishing, this rebate would increase both the fairness and efficiency of public spending. It would cut at least $2 billion each year from the budget – which could otherwise be allocated to fund things like mental health programs or a national dental scheme.

The Private Health Insurance Rebate sounds good in theory. It’s a policy that provides individuals with at least a 30 per cent discount on health cover with a private health fund for themselves and their families. But in practice, the rebate offers poor value for public money because it provides most of its benefits to high-income earners, while doing relatively little to alleviate pressures on the public purse.

Most of the benefits from the rebate flow to the better off for three reasons.

First, the rebate is only available to those that can afford private health insurance. To save 30c, you need to spend a dollar on private health insurance premiums. For many Australians, especially those on low incomes, the household budget does not stretch to pay for private health cover.

Second, the rebate gives discounts to those who can afford private cover for health services not available to those who rely on Medicare. For instance, in 2008-09, the rebate effectively subsidised the dental services used by people with private cover by more than $437 million. Benefits for these kinds of services are generally not provided through Medicare and working families often struggle to afford them.

And thirdly, the rebate has the potential to reduce the tax paid by some high-income earners. Along with the premium discount provided by the rebate, high-income earners get a benefit if they get private cover from avoiding the Medicare Levy Surcharge (MLS). In some cases, high-income earners pay less tax by purchasing private health insurance since the benefit received through the rebate and the tax discount provided by the MLS amount to more than the cost of cheap private cover.

If the rebate’s inequitable benefits weren’t enough cause for alarm, the inefficient use of public money is of equal concern. The rebate is currently the government’s largest contribution to the private health sector, costing $4.2 billion in 2008-09.

Although it featured among the key justifications for its introduction, the rebate provides an inefficient device to subsidise private hospitals. Because it subsidises the operations of private health insurers, less than half of the money spent on the rebate is allocated to private hospital services. In fact, if the rebate were replaced with direct funding of private hospitals (set at the current level of support), we could save the budget’s bottom line $2 billion each year.

Closely related to this, the efficiency of the rebate is undermined by the high administrative costs of private health funds – particularly when they are compared with Medicare. On average, private health insurers allocate 15.5 per cent of their funds to administration and to profits, whereas Medicare only spends 3.9 per cent of its budget on administration. This implies that the money spent on the rebate could be more efficiently allocated if it were redirected to pay for services provided through the public system.

Further, by increasing demand for private health services, the rebate may amplify rather than alleviate the pressures on the public health system. On the one hand, by increasing the amount of work available in the private sector, the rebate has the potential to shift doctors from the public to the private sector because of the higher salaries offered. On the other hand, by expanding the operations of private health funds that purchase many of the same services, the rebate may undermine the purchasing power of Medicare – as the sole insurer in a national market – and limit its capacity to exercise price constraint.

And, perhaps the most straightforward criticism of the rebate is that it largely benefits those who would purchase private health insurance anyway. Since the rebate was introduced in 1999, the proportion of the population with private health insurance has only increased from 31 to 45 percent. At $4.2 billion and growing, the rebate is clearly an inefficient and costly means to support private health services and relieve pressure on the public health system.

Public health advocates, public servants, economic liberals, and academics have all long touted the rebate’s waste of public funds. Even the Treasury recently advised Treasurer Wayne Swan (in a confidential briefing that became public) that the rebate amounted to ‘very poor policy’ and should be scrapped.

Yet, wide recognition of the rebate’s flaws has not translated into reform. In its first term, the Labor government attempted to take the important first step of means testing the rebate. But, the government was blocked in the Senate by the Coalition, who was joined by Senators Fielding and Xenophon. In an indication of how wasteful and expensive the rebate is, the government estimated that the Senate’s rejection of the means test would cost the Budget $100 billion over the coming 40 years.

Unfortunately, the Private Health Insurance Rebate’s flaws are far from unique and are exhibited by other similar programs that subsidise consumers when they purchase private services. As I point out with Ben Spies-Butcher in Getting Value for Public Money, our chapter in More Than Luck, alternative policies that are more equitable and efficient would be to directly subsidise the private producer or to provide the service directly.

The majority report from the Labor Senators is careful to quote several comments from Peter Costello in his second reading speech back in 1996 and the explanatory memorandum in order to demonstrate that its stated purpose was to provide an incentive only to higher income earners. However, the grounds for defending the levy have shifted, reflecting over a decade of Howard era support for the private health industry. We’re now told that it would have a catastrophic impact on health funds. These concerns are largely dispelled by evidence from health policy experts and health economists cited in the report. There’s scepticism that the much heralded exodus from private health will actually take place, for two reasons – that the life time cover provisions are likely to provide the stronger disincentive, and that those who actually value private health won’t leave. In addition, the best estimate is that the costs to the public sector would be around 1.6% of inpatient expenditure, an increase relatively easy to absorb.

In effect, no one is disagreeing that the policy measures in place represent a subsidy to private insurers – of massive proportions. Using figures from the Productivity Commission and other sources, the report discloses that the 30% rebate alone cost $980 million in 2006-7, dwarfing the value of tax concessions available to primary producers – $192 million – and mining – $130 million and even surpassing the dizzy heights of assistance to the manufacturing industry – valued at $963 million. Yet the financial press, all the commentators and economists routinely decry such “industry assistance” as “business welfare” (with reason). Somehow the specious argument that the private health industry provides a public good isn’t held to anything like the same standard of rigorous assessment, though that case is made in this report by Greens Senator Rachel Siewert in her dissent.

Given that the evidence from independent experts suggests that the arguments of the industry and the opposition are gross exaggerations, it seems undeniable that the bill should be passed as a matter of equity. It will be interesting to see what Senators Xenophon and Fielding think.