Cross-subsidies

Cross-subsidies
Cross-subsidies are an under-appreciated original sin of economic stagnation. To transfer money from A to B, it would usually be better to raise taxes on A and to provide vouchers or otherwise pay competitive suppliers on behalf of B. But our political system doesn’t like to admit the size of government-induced transfers, so instead we force businesses to undercharge B. Since they have to cover cost, they must overcharge A. It starts as the same thing as a tax on A to subsidize B. But a cross-subsidy cannot withstand competition. Someone else can give A a better price. So our government protects A from that competition. That ruins the underlying markets, and next thing you know everyone is paying more for less.

This was the story of airlines and telephones: The government wanted to subsidize airline service to small cities, and residential landlines, especially rural. It forced companies to provide those at a loss and to cross-subsidize those losses from other customers, big city connections and long distance. But then the government had to stop competitors from undercutting the overpriced services. And as those deregulations showed, the result was inefficiency and high prices for everyone.

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Health care and insurance are the screaming example today. The government wants to provide health care to poor, old, and other groups. It does not want to forthrightly raise taxes and pay for their health care in competitive markets. So it forces providers to pay less to those groups, and make it up by overcharging the rest of us. But overcharging cannot stand competition, so gradually the whole system became bloated and inefficient.

A Bloomberg article “Air Ambulances Are Flying More Patients Than Ever, and Leaving Massive Bills Behind” by  John Tozzi offers a striking illustration of the phenomenon, and much of the mindset that keeps our country from fixing it.

The story starts with the usual human-interest tale, a $45,930 bill for a 70 mile flight for a kid with a 107 degree fever.

At the heart of the dispute is a gap between what insurance will pay for the flight and what Air Methods says it must charge to keep flying. Michael Cox … had health coverage through a plan for public employees. It paid $6,704—the amount, it says, Medicare would have paid for the trip.   

The air-ambulance industry says reimbursements from U.S. government health programs, including Medicare and Medicaid, don’t cover their expenses. Operators say they thus must ask others to pay more—and when health plans best investment platform balk, patients get stuck with the tab.

Seth Myers, president of Air Evac, said that his company loses money on patients covered by Medicaid and Medicare, as well as those with no insurance. That’s about 75 percent of the people it flies. 

Source: Bloomberg.com

According to a 2017 report commissioned by the Association of Air Medical Services, an industry trade group, the typical cost per flight was $10,199 in 2015, and Medicare paid only 59 percent that. 

So, I knew about cross-subsidies, but $45,950 vs. $6,704 is a lot!

OK, put your economics hats on. How can it persist that people are double and triple charged what it costs to provide any service? Why, when an emergency room puts out a call, “air ambulance needed, paying customer alert” are there not swarms of helicopters battling it out — and in the process driving the price down to cost?

Supply is always the answer — and the one just about everyone forgets, as in this article.

I don’t know the regulation, and the article doesn’t go near it, so I will hazard guesses.

a) Not just any helicopter will do. Look at any small airport. There are a lot of helicopters hanging around whose owners would jump in a flash for an uber-helicopter call that pays $45,000. So, it must be true that in every such case you have to have an air-ambulance. Which makes a lot of sense, of course — the helicopter should have the standard kind of life-saving equipment on it. But clearly the emergency room is only going to call and allow a air ambulance.

b) Air-ambulances must be properly certified and licensed. OK, but there are still lots of people who could go in to this business, or the ones who are there could bid aggressively. That brings us to

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c) I’m willing to bet part of the conditions for copy a professional trader license is that operators must carry anyone regardless of ability to pay, and not ask any financial questions.

Competition for paying customers must be banned. Only such a ban can explain the crazy situation. If there were any way to compete for the paying customers, it would happen and the problem would evaporate.

The article comes close to confirming this suspicion.

“I fly people based on need, when a physician calls or when an ambulance calls,” he [Seth Myers] said. “We don’t know for days whether a person has the ability to pay.”

The alternative? Well, pass a tax on air ambulance rides, and use the proceeds to pay for rides for the poor or indigent. It’s the same thing — except with a tax, there needs to be no regulation or bar on competition. Or pass an income tax surcharge and do the same thing. Yes, I don’t like taxes any more than you do — but given we’re going to grossly subsidize air ambulance rides, a tax and subsidy is much more efficient than banning competition and allowing an ex-post free-for-all price gouge.

The article is most revealing, I think, that neither the author nor anyone he interviews even thinks of supply. Their explanations are as usual: demand, negotiating ability, and lack of regulation. 

It is true that when faced with an emergency, a loved one needs an air ambulance and is in danger of dying, you are in a very poor binary signals position to negotiate. But supply competition should solve that problem. If you can get $45,000 for a 70 mile helicopter ride, competing helicopter companies would have representatives sitting in the emergency rooms! When you arrive at an airport at 11 pm and want a rental car, you’re not in a great negotiating position either. Somehow they don’t charge $45,000 then! Why not? Supply competition — and the need to have good reputations in any business. 
The ex-post negotiation is surreal. 

For people with private insurance, short flights in an air ambulance are often followed by long battles over the bill.  

Consumer groups and insurers counter that air-ambulance companies strategically stay out of health-plan networks to maximize revenue. 

[This is an increasingly common scam. The hospital may be in network, but many emergency room teams are out of network contractors. You find out when you wake up.]

…the Cox family went through two appeals with their health plan. After they retained a lawyer, Air Methods offered to reduce their balance to $10,000 on reviewing their tax returns, bank statements, pay stubs, and a list of assets. The family decided to sue instead. [My emphasis]

“I felt like they were screening us to see just how much money they could get out of us,” Tabitha Cox said. 

You got it Mrs. Cox. On what planet do you get on a helicopter with no mention of cost, and then the operator afterwards looks at your tax returns, bank statements, pay stubs and lists of assets to figure out how much you can pay? Only universities get away with that outside of health care!

The reporter put the blame squarely on …  wait for it… the lack of price controls and other regulations.

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Favorable treatment under federal law means air-ambulance companies, unlike their counterparts on the ground, have few restrictions on what they can charge for their services. Through a quirk of the 1978 Airline Deregulation Act, air-ambulance operators are considered air carriers—similar to Delta Air Lines or American Airlines—and states have no power to put in place their own curbs. 

Air-ambulance operators’ special legal status has helped them thwart efforts to control their rates. West Virginia’s legislature passed a law in 2016 capping what its employee-health plan—which covered West Cox—and its worker-compensation program would pay for air ambulances

It is a sad day in America that the average reporter, faced with insane pricing behavior, can only come up with the lack of price control and regulation as an explanation. If voters don’t understand that consumer protection comes from supply competition, we cannot expect politicians to shove that enlightenment down our throats.

Does it take a genius to figure out what price controls mean? Well, medicare, medicaid and indigent people aren’t about to pay the cost. So if the companies can’t cover costs by looking at our tax returns and coming up with a tailored price gouge for each of us, that means less air ambulance flights. The kid with the 107 degree temperature will end up driving in rush hour traffic to the hospital that can help him. Some will die in the process. Actually, it means who “needs” an air ambulance will depend on connections.

That’s the problem with negoatiation as the answer to everything. Negotiation can shift costs from one person to another, but we can’t all negotiate for a better deal.

Actually, there is some supply competition — just not competition of the sort that brings down costs for non-indigent customers. The business has grown in response to its overall profitability.

The number of aircraft grew faster than the number of patients flown. In the 1990s, each helicopter flew about 600 patients a year, on average, according to Blumen’s data. That’s fallen to about 350 in the current decade, spreading the expense of keeping each helicopter at the ready among a smaller pool of patients. 

While adding helicopters has expanded the reach of emergency care, “there are fewer and fewer patients that are having to pay higher and higher charges in order to facilitate this increase in access,” Aaron D. Todd, chief executive officer of Air Methods, said on an earnings call in May of 2015, before the company was taken private. “If you ask me personally, do we need 900 air medical helicopters to serve this country, I’d say probably not,” he said. 

If there are too many helicopters for the number of patients who need them, market forces should force less-efficient operators out of business, 

Now pick up your jaw off the floor. So, the answer to inadequate supply competition is to … reduce supply!

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