An unhealthy externality

Brian Ritz
is a member of the Undergraduate Economics Club.

Harvard economist N. Gregory Mankiw states 10 fundamental economic principles in his introductory textbook aptly named “Principles of Economics.” Here are two of them.

Principle No. 6: Markets are usually a good way to organize economic activity.

Principle No. 7: Governments can sometimes improve market outcomes.

Translation: Free markets are great, but they aren’t perfect.

Markets only allocate efficiently if all of the costs and benefits go directly to the parties involved. If an uninvolved third party is affected by the trade, markets fail because the third party can receive a benefit for which they have not paid or incur a cost for which they are not compensated. Trade partners disregard external costs and benefits, resulting in a less-than-optimal allocation of goods. Mankiw correctly points out that governments can remedy the situation through several actions, from defining property rights to levying Pigovian taxes which tax externalities.

In the case of health care, government subsidies actually create externalities. The government disconnects a person’s decisions from the potential costs of health care by subsidizing it. Subsidies insulate unhealthy individuals from costs associated with smoking, excessive drinking, eating fatty foods, playing football, and everything else that is potentially detrimental to your health.

Anyone in control of money has an incentive to save money. The federal government is no different. If substantial health care subsidies are enacted, bureaucrats in power will actively look for ways of saving the taxpayers’ money. They will be incentivized to approve less gastric by-pass surgery, less treatment for STDs, less cancer treatment and so on. It’s unpopular to deny care to a sick, law-abiding, tax-paying citizen, but it is popular to tout preventative care as a way to stop people from becoming fat or getting cancer in the first place. It will pay for the government to advise its citizens of what they should and should not do. “Eat This, Not That” could morph from a section in Men’s Health Magazine to official government policy.

Indeed, it already has. In 2006, New York City banned artificial trans fats from city restaurants. If individuals were solely responsible for their own health care costs, the ban would be an unwarranted limit on the freedom of New Yorkers. Introducing a subsidy to defray the costs of, say, heart surgery puts taxpayers on the hook for the cost of an individual’s decision to eat trans fats. The subsidy essentially increases the number of people affected by an individual’s decision to consume unhealthy trans fats from one to millions.

It is easy to see the rationale for banning unhealthy foods once it affects an entire nation. People will say, “Why should I have to pay for the health costs of Joe the Plumber’s fatty diet?” And they will be right. But to save the taxpayer this expense, is Congress more likely to dismantle a health care entitlement or ban — or excessively — tax demonized vices that threaten America’s health? Both solutions are economically justified, but the popular one would limit the freedom of choice upon which America is founded.