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Steven Pearlstein

A Culture Of Subsidies Inflates Costs

By Steven Pearlstein
Wednesday, December 1, 2004; Page E01

What two things do a college education, health care and housing have in common?

One is that the price of these things has been rising at least twice as fast as other prices. The other thing is that they are all subsidized by government.

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That is no coincidence. As most economists will admit, the subsidies are deeply implicated in the rapidly rising prices -- so deeply, in fact, that it calls into question whether they do very much for the people they are supposed to help.

Let's take college tuition, which this year rose at a rate of 11 percent at public and 6 percent at private four-year colleges. In their defense, college presidents (whose pay has been rising faster than everyone else's on campus) will blame students and their parents for demanding more services, programs and amenities. They'll pull out flip charts to show that while the posted tuition appears to have leapt ahead, that's really a statistical mirage because of all the extra scholarship aid (read: discounts) they are giving out. And if that's not enough, they'll send you studies showing that the value of a college degree, measured in terms of future earnings, makes a degree a Wal-Mart-like bargain.

All of this may explain why colleges want or need or deserve to raise tuition. But the reason, in the end, that they do raise prices is, like any business, because they can. And one of the big reasons they can is the ever-increasing amount of public money pumped into the system in a losing effort to keep college "affordable." In effect, these well-intentioned subsidies have the perverse effect of shielding colleges from the kind of market discipline that would have forced them to hold down prices by constantly improving their productivity and efficiency, as happens in just about every other industry.

In health care, the big culprit is the tax deduction for employer-paid health insurance, which has hard-wired into the American psyche the expectation that companies should pay for their employees' health insurance. After all, if an employer is willing to spend $9,000 to give your family comprehensive health care, few people would choose to take the $9,000 in cash, pay $2,000 in taxes on it, and use the remaining $7,000 to buy their own insurance.

Unfortunately, the unintended effect of this $112 billion-a-year tax deduction is to make insured consumers largely indifferent to how much health care they consume or what it costs. And in the face of such indifference, doctors and hospitals and drug companies have done what any profit-maximizing industry would do: push prices and utilization up 7 to 10 percent each year until so many people are priced out of the market that government is forced to pump in even more money, spurring a whole new round of spending increases.

And then there is homeownership, which has somehow become synonymous with "the American dream." The mortgage interest deduction already costs the Treasury $62.6 billion a year, supplemented by billions more in implicit subsidy provided via Fannie Mae, Freddie Mac and the regional Home Loan Banks. To a large degree, however, this money has rewarded those already with homes while making it harder for everyone else to afford one.

How is that? Imagine there are two identical houses offered for sale on the same street, the only difference being that one comes with a monthly rebate of $250. Which house would you be willing to pay more for? Obviously the one with the rebate. How much more? Up to $249 a month, which at today's interest rates works out to roughly $50,000.

The home mortgage deduction is no different than a monthly rebate. Over time, its effect is to boost the price of the house until it incorporates most of the subsidy. And the more the house appreciates, the bigger the tax deduction, creating a dynamic of ever-increasing house prices.

What all of this suggests is that in a competitive marketplace, government efforts to help people pay for vital services can be self-defeating if they are not properly designed. That's something to consider during what are likely to be heated debates on health care, tax reform and aid to higher education.

Steven Pearlstein can be reached at pearlsteins@washpost.com.

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