Costs relating to healthcare have a feature that is very different from that of virtually all the other services such as education, food, and clothing. This is the extremely high variability associated with these expenses. There are long periods when most individuals have predictable expenses which can be planned for through savings. However, there are times when some individuals face very high levels of expenditures, such as when they get cancer or are severely injured in an accident. An important question that all societies need to answer is how will these expenses be paid for?
Economic theory indicates that expenses that have such an uncertain character are not best financed through savings and loans because those tools ultimately are limited by the lifetime income and other expenses of that particular individual. Instead it suggests that since all individuals, including those that are completely well, face the possibility that they may need to incur such expenses at a moment’s notice, they will be better off if they paid a fixed sum of money into a pool on a regular basis, and relied on this pool to pay for these unpredictable expenses.
Theory also argues that since almost all individuals don’t like risk, participating in such an arrangement will reduce the level of risk that they experience, and even if they never need to draw on the pool, they will feel better. However, despite the strength of the argument, the global experience is that most individuals do not spontaneously choose to participate in such an arrangement. There are a number of reasons for this, including poverty, and potentially the fact that evolution designed the human race to give little or no importance to the risk of falling seriously ill or dying sometime in the future. This is a core problem with which countries around the world have grappled.
In upper income countries, the most popular solution has been to use payment of taxes as a pooling mechanism and then to offer free healthcare services to individuals when they need them. Unlike in India where only 15-20% of the health expenditure is met out of tax resources, in the US the number is 50% and in Canada and the UK it goes up to as high as 80%. Others, like Germany and Japan, require employers to compulsorily deduct a certain portion of the employee’s salary and pay this into one or more pools of funds.
These countries then use their tax resources to pay into these pools on behalf of those that are not able to pay because of poverty or unemployment, and to shore up pools themselves if, for some reason, they run out of money. Compulsory deductions account for close to 60-65% of health expenditure in these countries. India’s Employee State Insurance Scheme has a similar character but currently accounts for less than 1% of annual health expenditures.