Reihan Salam

One of the core ideas behind the Affordable Care Act (ACA), President Obama’s ambitious and very controversial effort to expand access to medical insurance, is that state governments will work with the federal government to make high-quality care more accessible and affordable by creating subsidized state-based insurance exchanges. For those who aren’t covered by employer-sponsored insurance or Medicare or Medicaid, the exchanges are meant to offer a range of affordable insurance plans, with subsidies varying by household income.

The architects of the ACA believed the exchanges would be one of the more politically attractive aspects of the law, as they were designed to give states considerable latitude and to harness the power of market competition. But 34 states, representing two-thirds of the U.S. population, have thus far refused to establish their own exchanges, and the federal government is scrambling to create its own exchanges in the states that have refused to play ball.

Defenders of the ACA have noted the irony that conservatives, who tend to champion state autonomy, have led the opposition to the creation of state-based insurance exchanges. Yet as Douglas Holtz-Eakin of the American Action Forum, a leading critic of the ACA, has observed, the state-based insurance exchanges are best understood as “a second Medicaid program,” which will likely suffer from the same misaligned incentives as its more familiar cousin. While the federal government will cover the entire cost of the subsidies designed to make the insurance plans offered on the exchange affordable, state governments will be free to impose regulations and mandates on insurance plans that could raise their cost. State lawmakers might want to reward medical providers by deeming that various expensive and non-essential medical treatments must be covered by insurance, but state governments will be under no obligation to bear the cost of having done so.

Even without the exchanges, state governments are notorious for imposing costly regulations that have crippled health-insurance markets, as John Cogan, Glenn Hubbard and Daniel Kessler note in Healthy, Wealthy, and Wise. Many states, for example, impose “any-willing-provider” laws that require health insurers to reimburse any medical provider willing to abide by their terms and conditions. This requirement makes it much harder for insurance plans to form efficient provider networks that can compete against others by offering less-expensive, higher-quality care.

Given the strong tendency of state lawmakers to impose onerous regulations, it is fair to ask how the United States can have a functioning private insurance market at all. The reason is that self-insured employer-sponsored health insurance plans are largely exempt from state regulations under the Employee Retirement Income Security Act of 1974 (ERISA). This is a boon to large employers that operate across state lines, and it keeps employer-sponsored insurance relatively affordable, certainly when compared to the state-regulated individual and small-group health-insurance market.

This week, House Republicans and Senate Democrats released budget resolutions that illustrate the chasm that separates the two parties.

The Republicans, led by House Budget Committee Chairman Paul Ryan, aim to shave $4.6 trillion off of the federal government’s spending trajectory. They get there primarily by reducing the growth rate of domestic social programs like Medicaid and rolling back the coverage-expanding provisions of the Affordable Care Act. Although the Ryan budget accepts the revenue increases that were part of the fiscal cliff deal and the Affordable Care Act, it does not allow for any further revenue increases.

The Democrats, led by Senate Budget Committee Chairwoman Patty Murray, aim to reduce spending by $975 billion. Yet they also call for $100 billion in new stimulus spending and shutting off the $1.2 trillion in automatic spending cuts scheduled to take place under sequestration, which suggests that spending reductions will be more than balanced by spending increases. And while the Ryan budget resists revenue increases, the Murray budget calls for $975 billion in revenue from unspecified cuts to loopholes and spending in the tax code.

Across the political spectrum, there is a growing recognition that while short-term battles over government spending are important, they would be far less ferocious and intense if our economy were growing at a faster clip. But while conservatives and liberals alike clamor for more growth, they disagree about how to produce it. The key is unleashing what the economist Joseph Berliner once called the “Invisible Foot,” the neglected counterpart to Adam Smith’s “Invisible Hand.”

Before we turn to the Invisible Foot, let’s think through the prescriptions for growth offered by Democrats and Republicans. President Barack Obama and his Democratic allies often argue that substantial increases in public investment will deliver robust growth. Republicans, in contrast, emphasize the notion that reductions in marginal tax rates will spur growth by increasing the incentives to work and invest. These approaches are obviously far apart, yet they face at least two common obstacles. First, the aging of the population and the high cost of health entitlements severely limit the government’s ability to increase spending or cut taxes. Second, advanced economies have by definition already taken advantage of the most obvious sources of productivity growth and so are forced to innovate to find new sources of productivity growth. And innovation is a trial-and-error process that is far more expensive and arduous than simply following the leader.

So the question of the day isn’t whether we want growth (yes, we want it badly) or whether we can dramatically increase public investment or dramatically cut taxes (neither strategy is in the cards). Rather, it is whether there is anything we can do to make the American economy friendlier to the kind of risk-taking and innovation that will eventually yield productivity gains without breaking the bank.