Healthcare Economics: Healthcare Spending in the US

Healthcare Economics: Healthcare Spending in the US

In the U.S, healthcare spending has risen from 5 percent of the nation’s GDP in 1960 to 18 percent in 2018 (1). In other words, Americans spent $3.65 trillion on healthcare in 2018, an amount that is larger than the GDPs of Brazil, the U.K., Mexico, Spain, and Canada (2). The $3.65 trillion in spending represents $11,212 per person, with 59% of the spending going to hospitals, doctors, and clinical services. According to estimated growth rates, by 2027, health care will represent 19.4 percent of the country’s entire GDP (2). There are quite a few forces at work contributing to healthcare spending and its growing share of the U.S economy.

Healthcare spending in the U.S has increased due to various economic, technological, and demographic changes. First, many medical services, such as doctor’s visits, are personal services. Economically speaking, productivity does not change much over time for many providers of personal services. However, when overall productivity of the economy is rising, costs and prices rise in sectors of low productivity – a phenomenon known as Baumol’s cost disease (1). This phenomenon is especially relevant for healthcare, as the demand for the services of this sector are price inelastic, leading to increased spending. Second, while there have been significant advances in medical technology, many of these advances, rather than being cost-saving, have increased spending. In the past, physicians had little treatment for many diseases, but today, there are more options for treatment. These new treatments extend and enhance the quality of life, but they are often expensive. For example, robotic surgery is now performed in over 36% of hospitals across the U.S, but the total cost of the procedure across the nation was estimated to be $2.5 billion and growing (3). Third, changes in the population may have increased the demand for healthcare. The share of the U.S. population 65 years or older, for instance, increased from 9 percent in 1960 to 15 percent in 2015. Because the elderly consume more healthcare than the young, an older population leads to greater healthcare spending (4).

One striking fact is that the United States spends an especially high fraction of its GDP on healthcare. Most developed nations spend 9 to 12 percent of GDP on healthcare, while the U.S spends more than 17 percent (1). Critics of the American healthcare system use this comparison to argue that the United States is uniquely inefficient (4). They point out that life expectancy is higher in some nations that pay less for healthcare, such as Canada, France, and Japan. They sometimes suggest that greater reliance on government rather than private health insurance, as is the case in most other nations, could lower costs without adversely affecting health outcomes (1). Defenders of the American healthcare system accept that some reforms might reduce costs, but they believe that reliable conclusions are hard to draw from the international comparisons. For example, the rate of obesity is higher in the U.S than it is in most developed nations. Higher rates of obesity reduce life expectancy and increase health care costs. Thus, some of the international differences observed in health data do not shed light on healthcare systems but, instead, reflect differing lifestyle choices regarding diet and exercise (3). One notable and widely debated difference between the United States and other nations concerns pharmaceutical pricing (5). Canadians on average spend about 30 percent less on drugs than Americans do (and residents of most European nations spend even less). Critics of the U.S. healthcare system believe that pharmaceutical companies are taking advantage of America’s less centralized system by charging exorbitant prices for patented drugs. They argue that the U.S. government should follow Canada’s lead and undertake more aggressive regulatory policies to reduce drug prices. Defenders of the U.S. system believe that expanding price controls into the United States would substantially reduce the incentives for pharmaceutical companies to engage in research into new drugs. Consumers would benefit from lower prices today, but they would bear the cost of a smaller range of treatments in the future (1).

Another unique aspect of healthcare spending in the U.S is the fact that out-of-pocket spending is a declining share of health expenditure (1). The percentage of out-of-pocket spending has declined from 56 percent in 1960 to 12 percent in 2015. Conversely, third-party payment has risen from 44 to 88 percent of health spending (1). Of the large amount that is not paid out of

pocket, just over half is paid by government insurance programs, such as Medicare and Medicaid, and just under half is paid by private insurance companies (1). Many economists believe that the United States health system has become too reliant on health insurance, especially for small or routine expenditures. They believe that excessive insurance exacerbates the issue of moral hazard and thereby drives up healthcare costs. To explain excessive insurance, they note that the U.S. income tax gives preferential treatment to employer provided health insurance. Compensation in the form of health insurance is tax-exempt, unlike cash compensation. As a result, employees have an incentive to bargain for more generous (and thus more expensive) health insurance than they otherwise would, reducing the amount of healthcare they pay out of pocket (1). The Affordable Care Act tried to remedy this problem by levying a so-called “Cadillac tax” on especially expensive employer-provided health plans. This policy would level the playing field between paying workers in the form of cash compensation and paying them in the form of generous health insurance. That is, the tax code would no longer give an incentive for excessive insurance. The Cadillac tax was originally scheduled to go into effect in 2018 but has been delayed until 2020 (1).


  1. Mankiw, N. (2017). The Economics of Healthcare.
  2. Sherman, E. (2019, February 21). U.S. Health Care Costs Skyrocketed to $3.65 Trillion in 2018. Retrieved from
  3. Norbeck T. B. (2013). Drivers of health care costs. A Physicians Foundation white paper – second of a three-part series. Missouri Medicine, 110(2), 113–118.
  4. Probasco, J. (2019, October 8). Why Do Healthcare Costs Keep Rising? Retrieved from
  5. Epstein, L. (2019, July 30). 6 Reasons Healthcare Is So Expensive in the U.S. Retrieved from