Much is made of the way in which the government taking over responsibility for healthcare is going to reduce the total cost of it. Of course this would be possible if, having taken over the financing, the government simply denied everyone any expensive treatments. But this is not quite what is being proposed. At least, not yet.

Instead, the argument is made that the current privately based system has some fat that can be liposuctioned out, leaving a healthier, thinner, but otherwise unchanged system where all can get healthcare with a lower total cost. One does not have to be as cynical as David Friedman (“Anything done by government costs at least twice as much as a privately provided equivalent”), assuming that David is indeed being cynical rather than merely factual, to wonder whether this is going to work out quite as planned.

The government raising the money to pay for a health insurance system costs more than the current system the private sector uses to fund itself.

The lard to be removed is usually identified as the administrative costs of the insurance companies themselves: The profits they make (sometimes, for many are in fact nonprofits), the paper shuffling that follows a procedure through hospitals, surgeries, physicians' offices, and so on. A reasonable estimate for the costs of this part of the system is 25 percent of the total cost of claims. The exact number matters little for this is usually compared with Medicare's 2 percent or so administrative costs . . . and voilà! Somehow get the private sector as efficient as the public sector and we will have 20 percent of the system's costs to play with. We can thus expand healthcare coverage to those currently uninsured at no overall cost, and we are all extraordinarily clever little boys and girls for we have found an example of the fabled, almost mythical, free lunch. We have shown not just Robert Heinlein to be wrong, but Friedman pere as well.

There is only one small problem with the basic logic of this argument: it is not true. For what has been missed is the concept of deadweight costs.

Think through what the administrative costs of the two competing systems are. In the private sector the insurance company is covering not only the paper-shuffling costs, they are also covering the costs of having to raise the money in the first place. The costs of persuading people to part with their money for the service they get. Medicare, of course, is only counting the costs of disbursing the money, not getting it. Some acknowledge this and point out that the IRS has low administrative costs as well, again at the trivial 1 percent or 2 percent levels, but this is again ignoring deadweight costs.

Deadweight costs are the loss to the economy (or if you prefer, to the utility of individuals) when they are forced to pay for something they would not do voluntarily. Clearly, when people are voluntarily purchasing healthcare there are no such costs. However, when we tax everyone to provide healthcare for everyone then we do indeed have such costs: the fact that some are voluntarily uninsured tells us that. What we now need to know is, what is the deadweight cost of taxation?

Because of the deadweight costs of taxation itself, costs that are not included in the propaganda we are increasingly being fed, we might well find that there is in fact, overall, no saving of money.

A useful rule of thumb, found in many a textbook, is that the cost is going to be around 20 percent of the sum raised. Another more accurate estimate is that, at current federal tax rates, the deadweight costs of raising marginal money are 33 percent. Suddenly it looks like that free lunch is just as mythical as we originally assumed. For while it might even be true that government will be more efficient at running a health insurance system, government raising the money to pay for it costs more than the current system the private sector uses to fund itself.

Now, I do not insist that the above numbers are accurate in every detail. Only that if we are to compare the costs of the two alternatives, we have to look at all of the costs of the two alternatives. And in doing so, because of the deadweight costs of taxation itself, costs that are not included in the propaganda we are increasingly being fed, we might well find that there is in fact, overall, no saving of money. And thus no fat to cut to pay for those currently uninsured.

Which rather means that we had better go back to the drawing board before spending a few hundreds of billions (or has it become trillions now?) on building a system that we have not properly analyzed as yet.

Tim Worstall is a Fellow at the Adam Smith Institute in London.

Image by Darren Wamboldt/Bergman Group.