Health-care inflation in the US

In some of my previous posts I mentioned this article by David Goldhill ("How American Health Care Killed My Father," Atlantic Magazine, September 2009). Although I have serious problems with his proposed solution, Goldhill provides an excellent description of what is wrong with health care in this country. On the second page of the article he makes the following point:

In designing Medicare and Medicaid in 1965, the government essentially adopted this comprehensive-insurance model for its own spending, and by the next year had enrolled nearly 12 percent of the population. And it is no coinci­dence that the great inflation in health-care costs began soon after.

In light of this statement, I thought it would be interesting to find out how much health-care cost inflation has actually occurred both before and after 1965. The Bureau of Labor Statistics maintains a website with a lot of data of this kind. By clicking on the Databases and Tables section of the site, you can find inflation data in various categories. Clicking on "Top Picks" under the section "All Urban Consumers (Current Series)" you'll find a series of boxes to check. Checking the box to the left of "U.S. Medical Care, 1982-84=100 - CUUR0000SAM" and then clicking "Retrieve Data" provides a table of medical-care price index data for different years. I set the date range to 1935 through 2009 to obtain the medical-care price index for those years. Similarly, checking the box to the left of "U.S. All items, 1982-84=100 - CUUR0000SA0" and then clicking "Retrieve Data," provides a table of the consumer-price index data for all items for different years. By plotting both of these time series, I obtained the following graph:

This graph shows how health-care costs in the US have increased from 1935 through 2009, in addition to showing overall inflation (i.e., the consumer price index, or CPI) for the same time period. Note that, just as Goldhill claims, health-care costs have increased continuously at a rate substantially greater than the CPI over a period beginning around 1965. For the thirty years prior to 1965, health-care inflation was comparable to overall inflation. Specifically, the annual health-care inflation rate averaged 3.06% between 1935 and 1965, while the average annual increase in the CPI was 2.81% for this same period. Thus, between 1935 and 1965, annual increases in prices for medical care were only 8.8% higher on average than the average annual increase in the CPI. Between 1965 and 2009, however, the average annual health-care inflation rate was 6.33%, compared with an average annual increase in the CPI of 4.46% for the same period. So, from 1965 through 2009, prices for medical care increased at an average annual rate that was 42.1% higher than the average annual rate of increase in the CPI.

The question is: What has caused health-care prices to increase at such an alarming rate for nearly half a century? Is Goldhill correct in his claim that Medicare and Medicaid had a lot to do with it? If so, how is it that these government programs produced such out-of-control price increases?