Paul J. Gertler and Jeffrey S. Hammer
Most governments spend a lot on health. How these public expenditures are financed is a crucial element of successful health policies, because it determines the budget available for public activities and has implications for how expenditures are allocated. Public expenditures are financed by both public and private sources, with public subsidies from the general government budget supplemented by private revenue from user fees. This combination affects how public subsidies are allocated and determines who gets them. Subsidy allocation decisions also determine the extent to which the poor are cross−subsidized. The structure of fees creates financial incentives that affect utilization patterns and health outcomes, and affects how well individuals are insured against the risk of large economic losses associated with unexpected illness.
This paper examines the way governments finance and allocate public expenditures on health. Much of the policy debate has focused on the extent to which governments are able to mobilize private resources to supplement public subsidies in financing these expenditures. Proponents of private resource mobilization argue that
individuals are willing to pay for medical care and that additional financing will allow governments to expand and improve crucial programs (World Bank 1987; Jimenez 1996). Opponents argue that the poor are unable to pay for medical care and will be worse off if governments expand private resource mobilization (Cornia, Jolly, and Stewart 1987; Gilson 1988).
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Most of the literature contributing to this debate has focused on the technical issues of how much money can be mobilized and what impact it has on health outcomes and access to medical care. While informative, this literature does not fully prescribe optimal policy. Optimal policy needs to be based on the benefit that the policy would have for society above and beyond what would have happened in the absence of public intervention. The benefit of a proposed policy is the extent to which it ameliorates individual and social losses from private market failures.
Priorities should be based not only on the effectiveness of the policy, but also on the importance governments place on the types of losses and the individuals who incur the losses.
We examine the implications of current policies and possibilities for policy reform in the context of competing government priorities. Governments can intervene to correct private market failures that cause health outcomes to be lower than they otherwise could be, to cross−subsidize the poor's access to medical care, and to correct
insurance and medical care market failures. Since governments have budget constraints, they cannot fully subsidize all programs and activities. This paper argues that:
Public spending on health can improve health outcomes, promote non−health aspects of well−being (for example, by insuring that individuals are not at risk for the large unexpected economic losses associated with random adverse health events), and redistribute purchasing power to the poor. Optimal subsidy and fee policy will differ depending on how much weight government places on these competing objectives. Subsidies need to be
reallocated toward the poor and toward public health programs. However, increasing public subsidies can finance only a fraction of the resources needed to expand the health sector.
Paul J. Gertler is professor of economics, finance, and public policy at the University of California at Berkeley, where he holds joint appointments in the Haas School of Business and School of Public Health. Jeffrey S.
Hammer is principal economist in the Policy Research Department at the World Bank.
Prices for curative services (user fees) have two distinct roles. They can raise revenue, freeing public resources that can be reallocated to public health activities and to limited cofinancing of quality improvements in curative care. But perhaps more important, they can increase efficiency in the use of public facilities and in the health care system as a whole. However, these gains must be weighed against evidence that higher fees can compromise the objectives mentioned above. The literature on user fees has tended to focus on raising revenue (and its
consequences for the poor), but their more important effect is likely to be in the allocation of resources. In general, user fees at the point of service can play an important role in cofinancing health care, but not as the primary means of finance.
Revenue from user fees is sometimes used to finance improvements in the quality of and access to curative medical care. Individuals are willing to pay at least some of the cost of improving quality and access, especially for drugs. However, the rich are willing (and able) to pay a lot more than the poor. Thus if governments use the average "willingness to pay" amount to finance quality improvements, the rich will use more services and the poor will use less.
Optimal policies also depend on the behavior of consumers, private providers, and civil servants. Consumers and private providers determine the market environment in which policies operate—defining limits to or in some cases additional opportunities for what can be achieved. Civil servants determine the ability of governments to implement policies. Policies that are optimal in one context should not be generalized to all. Countries differ significantly in the relative weights they place on policy goals, and in the constraints they face in their resources and in the reactions of markets. Serious policy formation requires considerably more analysis relative to ideology than has characterized debates on the topic.
Social insurance plans, which enable governments to mobilize private resources for health by collecting pre−payments and charging for the health services provided to beneficiaries, hold promise, particularly for
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middle−and high−income countries. These schemes mobilize private resources with no loss in the insurance value of the public health care system. Price discrimination is easier because it can be centralized and needs to be done only periodically, outside the pressure of having to treat an illness. Despite their promise, however, prepayment plans often introduce inefficient medical care cost inflation that developing countries may be unable to afford.
The next section discusses the role fees play in the budgetary process, considering how fees can stretch the government's budget for various programs and how they can be used to allocate public subsidies. From this discussion comes a set of conditions that determine how fees affect budgetary flexibility—most of which concern how price and quality affect utilization. The third section reviews the empirical literature on utilization. The fourth section uses the information presented in the previous sections to recommend optimal fee policy, reflecting government objectives. The final section presents conclusions.
Role of Fees in the Budgetary Process
Public expenditures on health are financed by revenues from private sources and allocations from the general government budget (general tax revenues and donor assistance). In many countries, especially developing countries, the public sector collects private revenues through fees charged at the point of service.
Much of the literature justifies increasing user fees in terms of mobilizing resources (or achieving cost recovery) and in terms of creating incentives for more efficient use of public medical services (World Bank 1987). But an equally important role for fees is in determining the allocation of subsides from the general government budget across services (hospitalization, primary care, vector control) and types of individuals (the poor, the elderly, children). The allocation of subsidies is one of the main policy instruments governments have to correct health care market failures and improve welfare.
This section describes the role of user fees in determining the government's budget constraint. The structure of fees determines not only the amount of resources available and the amount spent on each program, but also the extent to which a particular program's expenditures are publicly subsidized. It is important to remember that this discussion is limited to how fees affect the budget. It says nothing about which programs should be funded, how much
should be spent on them, and how much of the expenditure should be financed by public subsidies. That
discussion, covered later in the paper, requires information on the benefits of such allocations and the objectives of government intervention.
The Budget Constraint
Most of the resource allocation decisions that public health care systems must make are related to one another through the government's budget constraint. The two main types of decisions are: What services should be offered, and of what quality? And what should the user fee or copayment be for each service?
These decisions are relevant to all levels of government where officials have to make finance and resource allocation decisions. In many countries such decisions are made at high levels of government—either the central or provincial level. Other countries are devolving resource allocation and financing decisions to local levels. The analysis below applies to local officials and public facility−level managers as well as central and provincial officials. The extent to which it applies to the local level depends on the degree of autonomy in the system.
The level of services and the fee structure cannot be set independent of one another, but rather must be set to satisfy the budget constraint—that is, total expenditures must be less than or equal to total revenues. Revenues come from public subsidies and general tax revenue and from user charges for services provided. This budget is
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spent on administrative costs, inpatient services, outpatient services, and public health disease prevention and control activities.
Government spending on health covers a wide range of services, from public health activities (such as the prevention and treatment of communicable diseases) to curative services that benefit only the individual.
Spending on some programs (hospitalization, primary care, prenatal care) depends on the number of people who demand care. Although there may be short−term rationing of these services, in most cases the public sector is obliged to provide these services to all who request them. The costs of other programs, such as mass information campaigns and vector control programs, do not depend on the number of users. In many cases the amount of funds available for these programs is determined by the residual amount left over from spending on prevention and treatment services.
The government's budget constraint, which sets expenditures equal to revenues, can be expressed as:
where A is administrative costs, c iI is cost of inpatient service i , U iI is utilization of inpatient service i , c iO is cost of outpatient service i , U iO is utilization of outpatient service i , CDC is expenditures on programs that are not utilization driven (vector control, research, sanitation, water treatment), f iI is user fee charged for inpatient service i , f iO is user fee charged for outpatient service i , and G is subsidies from general tax revenues.
Many policymakers promote user fees as a way of mobilizing private resources for public expenditures. It is important to note, however, that charging user fees is not the same as forcing individuals to pay out of pocket.
Here we define user fees as the price received by a facility or program—not necessarily what individuals pay at the point of service. Indeed, individuals could contribute to prepayment or insurance plans to finance their payment of fees at the time of treatment. Moreover, fees are not necessarily paid to providers in the form of fee−for−service. Prepayment and insurance plans could just as easily pay providers by capitation. But since insurance affects people's utilization decisions and the form of payment affects provider behavior, the source and form of payment need to be taken into account when deciding on the structure of fees.
Although the above characterization of the public budget constraint is described in the context of centralized decisionmaking, it can easily be generalized to a less centralized structure. The simplest and most efficient budgetary model is one in which the entity that collects fees keeps them and is free to use them as it sees fit. In this case fee revenues expand available resources and local managers, if competent and publicly motivated, can use the resources to improve welfare. In this case the central government must decide how to allocate subsides from the central budget among national programs and to lower levels of government (provinces, districts, states, and so on). These lower levels of government then combine these allocations with subsidies from the local budget and decide
how to allocate the combined resources among facilities and local programs. Then each facility and program combines these allocations with fee revenue and makes expenditure allocation decisions among programs and services. Thus each decisionmaker in the process receives an allocation from a higher level of government—G in the above equation—and combines it with local resources to finance expenditures.
Resource Mobilization
The classic approach to resource mobilization is to raise prices (user fees) to generate private revenues that can be used to finance a service or finance improvements in the quality of that service. The practice of charging user fees for medical services at public facilities has been adopted throughout much of the world (Griffin 1987; Nolan and Turbat 1995; Jimenez 1996). However, fee structures and control over revenues vary greatly across settings.
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Much of the evaluation of resource mobilization focuses on cost recovery—that is, the percentage of costs covered by fees. However, it is not clear how to evaluate resource mobilization efforts when cost recovery is limited. In particular, the value of private resources needs to be measured in terms of freeing up scarce public subsidies that can be reallocated to high−priority programs (such as contagious disease prevention and vector control) and in terms of providing facility managers with enough additional resources (such as drugs) to make up the difference between effective and ineffective treatment. The value of private resources depends on the extent to which the funds provide needed budgetary flexibility at the margin, where small amounts of money go a long way.
Creese and Kutzin (1995) examined national cost recovery ratios from fifteen (mostly African) countries and found that eleven have fee revenues that finance less than 5 percent of public expenditures. While such levels are substantially less than the 10 to 20 percent potential cited in World Bank (1987), it is hard to evaluate these data outside the countries' institutional and policy environments. A number of questions come to mind. For example, how do these cost recovery ratios compare with government targets? And how much potential revenue is not being collected, and why? Many countries do not allow local units to retain and spend the fees that they collect, and dedicate few resources to administering and monitoring collection. In addition, these data usually come from national information systems that suffer from serious underreporting.
These data do not imply that well−designed and −administered programs cannot mobilize resources—just that many of the countries studied lacked the political will to do so. By contrast, China has been extremely successful in mobilizing resources through fees (World Bank 1996). Even in 1978, before recent reforms were initiated, subsidies from general tax revenues financed just 28 percent of public health expenditures. By 1993 public subsidies accounted for even less—14 percent of public health expenditures. The rest was financed through fees charged to both insured and uninsured patients. Indeed, cost recovery ratios are also high in local initiatives, where the revenue is typically retained and where it is easier to implement and evaluate resource mobilization efforts. For example, in 1993 the revenues from fees charged to insured and uninsured patients accounted for 91 percent of hospital expenditures and 84 percent of health center expenditures in China (World Bank 1996). In Senegal private revenues amounted to 127 percent of recurrent expenditures in health centers (UNICEF/BIMU 1995). Similar levels have been reported in Latin America and elsewhere (Richardson and others 1992; Olave and others 1992; Barnum and Kutzin 1993; Lewis 1993). In addition, McPake, Hanson, and Mills (1993) found that a number of African countries used drug fee revenues to obtain tangible improvements in health services.
Still, the evidence that some locales are mobilizing substantial resources does not make up for the administrative costs of collecting the fees, including the time (opportunity) costs of administering fee exemption policies. There is little if any credible data on this important issue. Most assessments take place in the context of schemes that have been funded through external assistance, which biases downward estimates of real−world administrative costs (Creese and Kutzin 1995).
The extent to which raising fees mobilizes private resources depends on the extent to which individuals are willing to pay the higher price for services. Patients are not willing to pay any amount for curative care. As fees rise, utilization will fall. The question is, by how much? The less sensitive demand is to price increases—that is, the
more price inelastic1 —the more revenue is mobilized through price increases. This is because a price increase has two effects on revenues. It increases revenues by raising the revenue per patient visit, but it lowers revenues by reducing the number of visits. If the reduction in visits is great enough, price increases actually reduce revenues. Similarly, the less sensitive is demand, the less prices will change service use.
The story is somewhat more complicated with respect to increasing user fees to finance quality improvements. In this case there are two effects on utilization—the negative effects of the price increase and the positive effect of
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the quality increase. Both need to be measured to assess the amount of resources that can be mobilized. The less price elastic and the more quality elastic is the demand, the greater are the resources that can be mobilized from a fee increase used to finance quality improvements.
Allocating Public Subsidies
In addition to mobilizing private resources, fees determine the allocation of public subsidies. This point is extremely important because it is through the allocation of public subsidies that government is able to pursue its objectives and correct market failures. Increases in fees free up subsidies that can be reallocated to other
programs. The more subsidies a given fee increase flees up, the greater is the government's budgetary flexibility in allocating subsidies. Interestingly, the condition that increases budgetary flexibility is exactly the opposite of the condition that mobilizes more private resources—namely, the more price elastic is demand, the greater is the amount of subsidies that are freed up.
To see this, we rewrite the budget constraint as follows:
where (c iI − fiI ) is the public subsidy rate per unit of a service. Then the amount of public subsidies spent on a public program is the subsidy rate times the amount of services provided. In this formulation of the budget constraint, administrative costs plus the sum of subsidies to each of the services and public health program costs cannot exceed total subsidies allocated from the general government budget.
There are a number of ways the government might want to reallocate its public subsidies. Consider an increase in public spending on public health activities such as vector control or sanitation—that is, CDC spending. To increase CDC expenditures, the government must reduce subsidies to other programs; otherwise it would spend more than its available resources and violate the budget constraint. To do so, it raises the fee for those
services—thereby lowering the subsidy for beneficiaries of the program and inducing some to stop using the service.
The amount of subsidies that can be reallocated depends on the amount freed up by the price increase, which depends on how sensitive utilization is to price. The more price elastic is demand, the greater is the drop in utilization for a given price increase. Thus the greater is the amount of subsidies that can be reallocated through reductions in both unit subsidies and volume provided. In essence, the more price elastic is demand, the more easily the government can reallocate subsidies—that is, the greater is its budgetary flexibility However, the more price elastic is demand, the fewer the amount of private resources that can be mobilized.
Another reallocation priority may be to shift subsidies from a lower−priority patient care program to a
higher−priority program. To increase public subsidies to a care program, the government lowers the fee charged, thereby increasing the subsidy rate. The amount of public subsidies going to that program increases for two reasons. First, users of the program receive a higher subsidy. Second, the lower fee attracts new users who otherwise would not have received the subsidy. This discussion implies that reallocating public subsides across care programs is a careful balance of raising and lowering user fees.
Revenue Retention
An important assumption in this discussion is that any revenues raised from private sources are kept in the health sector. If the fee revenue must be returned to the general treasury, then the fee increase effectively does not increase resources for health care; the same outcome holds when local health units are forced to return revenues to central ministries of health. It is as if the government lowered public subsidies by one dollar for every dollar raised privately. This approach implies that no resources are mobilized and
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