Health-related supplements accounted for almost 12 cents of every dollar of national income in 2008 compared with less than three cents four decades earlier.
Health-related fringe benefits have grown far more rapidly than has national income over the past 60 years. Yet the share of national income accounted for by employee compensation — wages, salaries, and supplements — has declined somewhat since its 1980 peak (figure 8.1a). This again shows that in the end, fringe benefits come out of worker pay, not corporate profits.
National income can be viewed as an alternative way of measuring the net value of annual output, by adding all the costs of producing it. GDP measures gross output, but to arrive at a net national product (NNP), capital consumption (for example, depreciation of machinery) is not included. In the Bureau of Economic Analysis (BEA) National Income and Product Accounts (NIPA), national income measures the earnings of all factors of production used to produce NNP. These factors include wages, salaries, supplements, rents, interest, and profits and losses. In principle, this should equal the same sum measured in terms of final products (consumption + investment + government purchases + imports). However, because NNP and national income are measured using completely different methods, a small statistical adjustment is needed to reconcile the two totals.
Health-related supplements include not only employer-provided health coverage, but also legally required payroll deductions made by employers for Medicare and workers' compensation. Other fringe benefits, such as pensions or employer-paid retirement contributions, also grew much more rapidly than wages and salaries during this period, although not as rapidly as health-related supplements.
Examined in more detail, mandatory health-related payroll deductions for workers' compensation and Medicare peaked at 1.7 percent of national income in the early 1990s and have declined subsequently (figure 8.1b). Employee health benefits reached 4.1 percent of national income by 1993, declined during the boom years of the 1990s, peaked again at 4.4 percent in 2003 to 2005, slightly declining again thereafter. Non-health supplements peaked at 7.4 percent in the early 1980s and steadily declined thereafter until 2002, when they began increasing again. If health reform is implemented, the combination of employer penalties and mandatory increases in generosity of coverage make it possible that the employee health-benefits share will increase in future years.
Download Excel tables used to create Figures 8.1a/8.1b Tables. Figures 8.1a and 8.1b were created from the following tables (the workbook includes all supporting tables used to create this table):
Fig. 8.1a: Table 8.1.1. Total Employee Compensation -- Wages, Salaries, and Fringes -- As a Percentage of National Income, 1948-2008
Fig. 8.1b: Table 8.1.2. Health-related Fringe Benefits as a Percentage of National Income by Type, 1948-2009
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Department of Commerce. Bureau of Economic Analysis.
More than 80 percent of 2009 national income for health services was for compensation of employees compared with only 50 percent in 1963. reflecting the decline of physicians in solo practice or partnerships, the share of health-related national income accounted for by proprietors' and rental income has fallen steeply in the past 50 years.
A much higher share of national income for the health services sector flows to employee compensation than in the economy in general (figure 8.2a). The share allocated to wages and salaries, and fringe benefits, is higher than in the economy overall or in the services sector. The combined total exceeds 80 percent of health services-related national income. In the breakdown in figure 8.2a, health services include ambulatory care, hospitals, nursing homes, and residential care facilities. The category excludes the pharmaceutical industry, medical devices, and non-durable medical products sold in retail outlets such as pharmacies. More than 90 percent of national income from health facilities goes to employee compensation, compared with approximately 75 percent of national income having to do with ambulatory health services.
The share accounted for by proprietors' and rental income is more in the health services industry than in the general economy, albeit less than that in the services industry overall. Conversely, the share flowing into pre-tax corporate profits is twice as much in the general economy as in the health services industry, reflecting the dominance of non-profit and public service providers in health care described in chapter 7.
The employee compensation share of national income in the health services sector has grown dramatically in less than 50 years (figure 8.2b). Just before the introduction of Medicare and Medicaid (which began in 1966), employee compensation accounted for less than half of the national income generated by health services. But in less than 20 years after the massive infusion of public dollars into these new entitlement programs, the employee compensation share had climbed to more than 80 percent (where it has stayed ever since).
Unionization has helped spur this growth, but another factor has been the declining share of health services national income that went to proprietors' and rental income. Physicians who own their own practices get proprietors' income rather than wages. However, an increasing number of physicians are salaried, thereby elevating the relative importance of wages as a form of health sector compensation.
Download Excel tables used to create Figures 8.2a/8.2b Tables. Figures 8.2a and 8.2b were created from the following tables (the workbook includes all supporting tables used to create this table):
Fig. 8.2a: Table 8.2.1. Percentage Distribution of National Income Related to Health Services, 2007
Fig. 8.2b: Table 8.2.2. Employee Compensation as a Percentage of National Income Related to Health Services, 1963-2009
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Department of Commerce. Bureau of Economic Analysis.
The share of health-related national income accounted for by proprietors' and rental income has declined steeply in the past 50 years.
Before Medicare and Medicaid, approximately half of national income for health services went to proprietors' and rental income. Not even 20 years later, this amount was less than 15 percent. It has steadily declined further to approximately 10 per- cent today (figure 8.3a). During this period, the rest of the services sector also saw a declining share of its national income going to proprietors' and rental income, but this occurred much less rapidly than in health services.
The current level in health care (just over 10 percent) is below the share seen in the rest of the services sector and is only slightly more than the percentage in the economy overall. In contrast, the share is less than 3 percent in manufacturing.
A growing number of physicians have abandoned their own practices in favor of a buy-out by hospitals or managed care plans. There now are thousands of retail clinics run by major chains such as CVS, Walgreen's, and Wal-Mart. With health reform, pressures to adopt electronic medical records are likely to fuel a continuation of this trend away from solo practices and partnerships into corporate medicine.
In principle, owner income reflects both what unincorporated health professionals earn as labor (wages, salaries, fringe benefits) and some hard-to-measure remainder (if anything) that represents profits. If a solo practitioner with a net income of $200,000 became a hospital employee whose total compensation was $200,000, total spending would remain unchanged. However, the employee compensation share of national income would rise by the identical amount that proprietors' income fell.
Another way to look at these trends is to consider what share of total proprietors' and rental income is accounted for by the health sector. Today, health services account for approximately one in eight dollars of such income (figure 8.3b), contributing more than $100 billion to the national total. In absolute dollar terms, this is the highest it has ever been. One-eighth also is the highest share since 1994 and is almost identical to the share observed in 1929. Even so, over 80 years, the health sector share has never exceeded 20 percent except in 1932.
Download Excel tables used to create both figures: Figures 8.3a/8.3b Tables. Figures 8.3a and 8.3b both were created from the following table (the workbook includes all supporting tables used to create this table):
Table 8.3. Proprietors' and Rental Income as a Percentage of National Income for Selected Industries, 1929-2009
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Department of Commerce. Bureau of Economic Analysis.
Corporate profits before and after taxes have now reached their highest share of health services income in the past 50 years.
After-tax corporate profits for health services now exceed $58 billion. This is a large number in absolute terms but accounts for only 6.1 percent of health services-related national income. The share of such income accounted for by profits has grown considerably since 1963, when both pre-tax and after-tax profits were less than 0.5 percent of health care's national income (figure 8.4a).
These numbers reflect the growing share of health services provided by for-profit organizations and the declining share of health-related national income accounted for by proprietors' and rental income. These numbers do not include profits in pharmaceuticals or medical devices, or they assuredly would be higher.
Corporate profits in most of the rest of the economy tend to be highly sensitive to changing business conditions. Little evidence of parallel fluctuations in health services profits exists. The decline in profits starting in 1983, for example, occurred after the deep recession of 1981-1982 had ended. It can be attributed to the introduction of the Medicare PPS for hospitals, which limited payments to a fixed amount that varied by diagnosis. In contrast to the earlier cost-based reimbursement system, PPS forced hospitals to economize by limiting lengths of stay and reducing the intensity of care per admission.
Likewise, much of the downturn in profits starting in 1997 is likely caused by the Balanced Budget Act of 1997 (BBA97), which included the largest cuts in Medi- care's history. BBA97 included payment cuts for hospitals and home health agencies that sharply crimped their profitability. In late 1999, Congress passed legislation to ameliorate some of BBA97's harshest fiscal consequences. As expected, profitability again started to increase. Nevertheless, the most recent decline in profitability started in 2006, long before the most recent recession started.
Although parallel profitability numbers are lacking at a more fine-grained level, approximate measures such as gross operating surpluses suggest that profits are high- er in the ambulatory health sector than in health facilities (figure 8.4b). In ambulatory care, corporate profits appear to be increasing in importance.
Download Excel workbooks used to create Figure 8.4a Table and Figure 8.4b Table. [Note that you’d have separate links for each set of tables] Figures 8.4a and 8.4b were created from the following tables (the workbook includes all supporting tables used to create these tables):
Fig. 8.4a: Table 8.4.1. Corporate Profits Before and After Taxes as Percentages of National Income Related to Health Care, 1963-2008
Fig. 8.4b: Table 8.4.2. Gross Operating Surplus as a Percentage of National Income for Ambulatory Health Services and Hospitals and Nursing Facilities, 1998-2008
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Department of Commerce. Bureau of Economic Analysis.
Corporate profits before taxes in the health sector are less than that of other major sectors and private businesses overall.
Before-tax corporate profits for health services are generally less than half the levels seen in private businesses as a group, even during times of recession. As illustrated in figure 8.5, in goods-producing industries (agriculture, forestry, fishing and hunting, mining, manufacturing, and construction), pre-tax profits typically are in the double-digit range, reaching as much as 20 percent in recent years. In contrast, pre-tax corporate profits in health services, while increasing, have consistently been much less than 10 percent of that industry's national income.
That said, profitability in the private economy, and major sectors such as goods and other services, are much more volatile than in the health services market. Consequently, there are brief periods during recoveries from recessions in which the share of national income going to profits in these other sectors increases more quickly than in health services. However, during the past 50 years, the secular rise in health sector profits as a share of health-related national income has been more rapid than in any other sectors.
The apparent sharp rise in profitability among all other services in 1998 might be a statistical anomaly. The BEA introduced a substantial revision in how industries were categorized, and they ceased reporting an aggregate number for "Services." Thus, since 1998, the total for services had to be derived by adding component parts. However, certain services (for example, information services) now appear in other BEA-reported aggregates. Conversely, some services appearing in the component parts might previously have been included in a different industry. Thus, the trend between 1998-2008 is more likely to be accurate than is the size of the large estimated increase between 1997 and 1998.
To avoid confusion, corporate profits shown here reflect the definitions used by the BEA. The BEA makes several adjustments (for example, inflation adjustments) to what are known as "book profits" that corporations report to stockholders in various financial reports. For most purposes, the adjusted BEA numbers are technically superior to these book amounts, but the adjustments also are arbitrary to some extent.
Download Excel tables used to create figure: Figure 8.5 Table. Figure 8.5 was created from the following table (the workbook includes all supporting tables used to create this table):
Table 8.5. Corporate Profits Before Taxes as Percentages of Sector-Specific National Income, 1963-2008
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Department of Commerce. Bureau of Economic Analysis.
Among Fortune 500 companies, those in health services industry generally have lower profits than do other firms.
Even among publicly traded companies, industries having to do with health services tend to have lower rates of return than most other industries. Profitability for health services generally was less than in other major sectors of the economy (refer to figure 8.5). Some might view this as misleading because so much of the health industry is comprised of non-profit or government health providers.
An arguably fairer apples-to-apples comparison would be to restrict the comparison to for-profit firms within each sector. The most readily available numbers are rankings among Fortune 500 firms grouped by major industry (approximately 50 such industries are included in these rankings). This clearly is not complete because it ignores small- and medium-sized firms. Nevertheless, the Fortune 500 typically accounts for the lion's share of output in a given industry. Thus, these rankings provide an approximate idea of how health care firms compare to the rest of the economy. In figures 8.6a-c, the numbers in each bar show the ranking of each industry relative to all major U.S. industries. Although industry rankings were not reported with the most recently released 2009 and 2010 profit numbers, they are not likely to be sharply different from the rankings for prior years.
I start with health services industries and then turn to goods-producing components of health care (pharmaceuticals and medical equipment) in figures 8.7a-c. There are three standard measures of profits. In each case, profits are defined as the difference between revenues and costs, but the denominator used to calculate the profit rate differs. Return on revenue (ROR), what many call "profit margin," calculates profits as a percent of total revenues. Most health services industries have single-digit RORs of less than 5 percent (figure 8.6a).
When profits are divided by assets, that is, the overall capital invested in a given company, the result is return on assets (ROA). Assets equal both equity (for example, stocks) and debt. Such returns also are typically at single-digit levels for health services industries (figure 8.6b). The final measure divides only by equity, that is, to exclude debt. Using the return on equity (ROE), the health services industries attain double-digit levels of returns, but again these typically rank them in the bottom half of industries overall (figure 8.6c).
Download Figure 8.6a-c Tables used to create Figures 8.6a-c (the workbook includes all supporting tables used to create these tables).
Fig. 8.6a created from Table 8.6a. Trends in Profitability: Return on Revenue Among Fortune 500 Firms for Selected Industries, 2005-2013 (last updated 6.21.14)
Fig. 8.6b created from Table 8.6b. Trends in Profitability: Return on Assets Among Fortune 500 Firms for Selected Industries, 2005-2013 (last updated 6.21.14)
Fig. 8.6c created from Table 8.6c. Trends in Profitability: Return on Equity Among Fortune 500 Firms for Selected Industries, 2005-2013 (last updated 6.21.14)
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Fortune 500. Our Annual Ranking of America's Largest Corporations. http://fortune.com/fortune500/ (accessed June 20, 2014).
Pharmaceutical and medical devices have higher profits than do most industries, reflecting returns for discovery and innovation.
Pharmaceuticals and medical devices typically rank among the top 10 most profitable industries in America. This is true whether profits are measured as a return on revenue (figure 8.7a), return on assets (figure 8.7b), or return on equity (figure 8.7c). Occasionally, one of these two industries ranks first among all industries in some measures of profitability (figure 8.7b).
Several reasons explain why these two health industries are so much more profitable than the various health-related services industries just examined. First, as shown previously, both industries consist entirely of for-profit firms, creating an arguably more competitive environment. Although there are mixed findings regarding performance of for-profit versus non-profit or government-owned enterprises, almost all comparisons agree that rates of return (however measured) are higher in for-profit firms relative to the not-for-profit counterparts.
Second, patents play a far more important role in pharmaceuticals and medical devices than in the rest of the health care sector. By design, patents are structured to encourage innovation by permitting their owners to earn monopoly returns for a limited time. Although the nominal patent term is 20 years, more than half of this time is typically lost before Food and Drug Administration (FDA) approval due to the lengthy time required for clinical trials and regulatory review.
Third (and related), pharmaceutical R&D especially is a complex, costly, risky, and time-consuming process. Including the costs associated with hundreds of compounds that do not succeed, as well as the cost of capital (financial resources) that is unavailable for other uses during this lengthy process, more than $1 billion is spent to bring a single new drug to market. Absent the incentives provided by the patent system, there is no question that the amount of pharmaceutical R&D would be considerably less. Concomitantly, the number of new drugs discovered would be fewer. Thus, high profits represent the price paid for the benefits of new discoveries.
Whether profits are higher than needed to bring forth an optimal level of innovation is a perennial question. Several different analyses have concluded that the high level of pharmaceutical profits only slightly exceeds the industry's cost of capital. Briefly, investors demand higher profits to invest in an industry where returns on R&D are so risky.
Download Figure 8.7a-c Tables used to create Figures 8.7a-c (the workbook includes all supporting tables used to create these tables).
Fig. 8.7a created from Table 8.6a. Trends in Profitability: Return on Revenue Among Fortune 500 Firms for Selected Industries, 2005-2013 (last updated 6.21.14)
Fig. 8.7b created from Table 8.6b. Trends in Profitability: Return on Assets Among Fortune 500 Firms for Selected Industries, 2005-2013 (last updated 6.21.14)
Fig. 8.7c created from Table 8.6c. Trends in Profitability: Return on Equity Among Fortune 500 Firms for Selected Industries, 2005-2013 (last updated 6.21.14)
Download PowerPoint versions of both figures.
Fortune 500. Our Annual Ranking of America's Largest Corporations. http://fortune.com/fortune500/ (accessed June 21, 2014).