FUNDAMENTAL TRUTH #67: “Free health care is very expensive.” -Old Pithy

Posted by PITHOCRATES - May 24th, 2011

No Such thing as a Free Lunch

Things cost.  In more ways than one.  A free lunch, for example, isn’t free.  If a client takes out a customer for lunch they’re hoping to get something in return.  A new contract.  A new sale.  Continued good will for a future contract or sale.  Even with the quintessential honest business person.  Who can’t be bought.  But can always be persuaded in the event of a tie.  Where all things being equal, the tie will likely go to the relationship that fosters the greater good will.  And there’s nothing wrong with that.  It’s one of the intangibles to consider.  And sometimes the intangibles can outweigh the tangibles.  Especially if there are tricky milestones to meet.  And a fastidious customer to please.

Then there’s the lunch itself.  It isn’t free.  Someone has to pay for it.  Because a restaurant is not just going to give their lunches away for free.  Because it costs them to make a lunch.  They have food to buy.  And people to pay.  From food prep to cooks to wait staff.  And food suppliers don’t give their food supplies away for free.  Because they have their own bills to pay.  And people don’t work for free.  Because they, too, have their own bills to pay.

Even though you’re not picking up your own tab, you are still paying for it.  Buying lunches is an entertainment expense.  Part of the larger marketing and sales budget.  Which is part of the larger overhead account.  Here’s how it works.  You have sales revenue.  And cost of sales (i.e., direct costs to make those sales).  You subtract cost of sales from Revenue and you have gross profit.  You subtract overhead from gross profit to get net profit.  Which is greater than zero in a healthy business.  To do this you need to make sure your sales prices include the costs of all of these free lunches.  In other words, sales prices include a markup to cover the costs of the free lunches.  So you end up paying for your free lunch.  Even though someone else is picking up the tab at the restaurant.

The Remarkable Mechanism of the Free Market

For those of you who enjoy the occasional free lunch, do you notice how often you get one?  It’s usually occasionally, right?  Maybe a free lunch once a month or so.  Maybe a nice spread at the holidays.  You may even get a nice Christmas gift.  Say a nice bottle of scotch.  Or a gift certificate where you can buy something nice.  The free lunches and gifts are nice.  And you probably wish you could get these freebies on a more regular basis.  Because free is nice.  But, of course, they’re not free.  You in fact pay for every last one.  Or your boss.  Because it adds to the cost of whatever your company buys.  And the more free stuff you get, the higher the prices your company pays.  To cover the costs of the free stuff.  But if the markups get too high, your company will have to stop buying that stuff.  And find someone else to buy from at more reasonable prices.

Some of you may not care what your boss pays for this stuff.  You figure he or she is rich.  He or she can afford it.  But he or she is not as rich as you think.  Because running a business is not as easy as it seems.  You see, wherever you work, they sell stuff, too.  And they compete with other people selling similar stuff.  This competition keeps sales prices down.  So to be profitable, you have to keep your own costs down.  And if you buy things at highly inflated prices that include a lot of free lunches and gifts, your costs will be greater than your revenue.  Your company will lose money.  And look for ways to cut costs.  Like laying a person or two off.  And if you’re one of those people, then you’ll start caring about what your boss pays for this stuff.

This is the remarkable mechanism of the free market.  Competition keeps sales prices down.  And costs down.  Because someone’s sales are someone else’s costs.  That’s why people simply can’t charge what they want.  There’s a limit to the amount of markup you can place on any sale.  And a limit to the amount of free lunches and gifts that can be buried in sales prices.

Health Care Insurance became Expensive after it became a Benefit

Now let’s look at health care.  The ultimate free lunch.  Before World War II we used to pay for our own health care.  But when the government implemented price controls on wages, employers couldn’t entice the best and brightest anymore with higher wages.  So they came up with a new idea.  Benefits.  Can’t pay you more money?  Not a problem.  We’ll pay for your health care instead.  Let’s you keep more of your money.  So it’s just like getting a raise.  It started with GM.  And spread to the other automotive companies.  Soon, everyone was providing health care insurance as a benefit. 

Eventually, health care insurance began to pay for everything.  You went to the doctor’s office and paid only a small co-pay out of pocket.  Everything else was free.  Someone else paid.  Just like getting a free lunch.  Only problem was that these free lunches added up.  And there was no free market mechanism to keep prices down.  Someone else paid.  Who wasn’t even at the lunch.  They weren’t there to say, “Hey, I can’t turn in an expense report with a $200 bar tab on it.  It’ll come out of my pocket.  Then my boss will fire me.  Have a Coke instead.  They give free refills.”  Nothing like this happens in health care.  So the costs of health care went up.  And the sales price for health insurance sky rocketed.  It was breaking the back of businesses.  It was becoming the largest single expenditure they had.  And it kept going up.  And never came down.  Soon, employees started paying a portion of these costs through a payroll deduction.  And that deduction kept going up.  As did co-pays.  But these were just a drop in the bucket compared to what the employer was paying.  It got so bad that they had to choose between staying in business.  Going to a cheaper and less comprehensive health care plan.  Or dropping insurance altogether.

Worse, as these employee deductions went up, young, healthy people cancelled their health insurance.  This left only heavy uses of health care with health care insurance.  Older and less healthy people.  And families.  The young and healthy didn’t go to the doctor.  So most of their premiums helped to pay for those who did.  When they started to leave the system the insurance rates on those remaining went up to pick up their lost contribution.  Soon, health insurance wasn’t health insurance anymore.  A fortune was paid in premiums.  And a fortune was spent on health care costs.  It just took money from those not sick today to pay those who were sick today.  It’s now little more than a transfer payment.  And has more in common with Medicare than insurance.

Some of the most Expensive Free Health Care in the World

Medicare has the same problem.  Only worse.  Because it’s a program for the elderly.  Who are big consumers of health care services.  Who are also retired.  And living longer thanks to the good health care they’re getting.  Of course, Medicare isn’t insurance.  The government reimburses health care provides with money collected through payroll taxes.  When they set up Medicare, there was still an expanding birth rate.  So taxpayers then outnumbered retirees on Medicare.  But that changed soon.  The birth rate declined radically.  We went from having big families to having small families.  So retirees on Medicare now outnumber current taxpayers.  So fewer taxpayers must pay more in taxes.  Which is an even bigger problem than the private health insurers are facing.

This means that the free health care we get is some of the most expensive free health care in the world.  And it’s like this because the consumer of the health care isn’t paying the bill.  When a private insurer or the government pays, there is no free market mechanism keeping costs down.  Like in private business.  Who know the full cost of a free lunch.  And they don’t give so many away that they have to raise their prices so much that it makes their goods and/or services unaffordable.

There is no lunch crisis (free or otherwise).  But there is a health care cost crisis.  And the big difference between the two is the free market mechanism.  Health care needs more of it.  For it is the most effective thing in keeping costs down.  It would be so effective that it may even make health care insurance what it once was.  Insurance.  Where a lot of people pay a little bit in to protect their financial assets.  To pay for the few with an unexpected catastrophic expense.

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