In March of 2010, President Obama signed into law the Patient Protection and Affordable Care Act (PPACA), the nation’s latest attempt to “reform” health care. Yet, despite all the new spending and taxes, and all the new rules and expanded government oversight, PPACA doesn’t address most of the problems that afflict American health care.

Many of these problems are well known: Health care and health insurance costs are high and rising rapidly. Care providers and insurers seem inhospitable, inflexible and inscrutable. Some health care practices seem wasteful. And many Americans are uninsured or fear they will lose coverage when they most need it.

Other problems are not well known. Chief among them is iatrogenesis—injury or illness caused by care providers. Iatrogenesis is one of the largest contributors to premature death in the United States. As many as 180,000 people die each year[1] following medical errors including unnecessary surgeries[2], adverse drug events[3], and poor hygienic practices.[4] At the same time, providers routinely face malpractice suits that ultimately are judged to have no merit[5], but are costly to defend.

Still other health care problems are known but ignored. Medicare and Medicaid’s fiscal woes are well established: current tax and spending rates will underfund the programs by tens of trillions of dollars over the long term. Yet few politicians or voters support policies that would make the programs solvent.

As diverse as those problems are, they have one root cause: the economic connection between health care consumers and providers is weak, which reduces incentives that should help consumers to receive quality, efficient care. Consumers pay out of pocket for less than 12 percent of U.S. health care costs[6], while most of the rest is paid by government (45 percent), private employers and their insurers (21 percent), and other private insurers (11 percent).[7] Consumers do ultimately fund those third parties through taxes, forgone wages, and insurance premiums, but the heavy third-party involvement distorts the relationship between providers and consumers.

Health care providers have strong economic incentive to please the third parties, sometimes to the detriment of consumers. Consider two examples: Government is trying to control Medicare and Medicaid costs by limiting payments to providers; as a result, many providers limit the number of Medicare and Medicaid beneficiaries they see. Third parties require extensive paperwork documenting that care is appropriate; as a result, providers devote considerable resources to processing paperwork. The third parties’ preferences are neither irrational nor nefarious, but they place additional demands on the health care system beyond the demands of consumers.

Many conservative policy analysts argue that if the third-party distortions were reduced, health care costs would fall considerably. As evidence, they point to developments in health care services that usually aren’t covered by third parties. The inflation-adjusted cost of LASIK eye surgery fell 27 percent between 1999 and 2010, yet LASIK has one of the highest customer satisfaction rates of any surgery. Similarly, the inflation-adjusted cost of laser skin resurfacing, a type of cosmetic surgery, fell 18.5 percent between 2003 and 2010 despite a large increase in demand for the procedure.[8]

I’m not as optimistic that reducing third-party distortions would result in a dramatic fall in health care costs. But a stronger economic connection between consumers and producers would increase the incentive for providers to offer the types and manner of care that consumers value more, and reduce practices that consumers value less. That would go a long way toward easing many of the problems with American health care.

Unfortunately, instead of strengthening the economic relationship between providers and consumers, PPACA does the opposite, increasing the role of third parties. So how did American health care become so distorted by third parties? That’s the topic for next time.