JONATHAN CHAIT MAY 26, 2011
The one health care proposal Republicans can agree on is to allow insurers to sell health insurance across state lines. Liberals object that this would create a regulatory race to the bottom. States would strip away requirements that insurers cover this or that condition, and the state with the most lax controls would end up as headquarters to most insurers, who would cherry-pick the market by peeling off healthy customers buying plans that don't cover chronic conditions.
Michael Cannon of the Cato Institute says no, that could never happen.
Opponents will claim that regulatory federalism will lead to a ‘‘race to the bottom,’’ with some states so eager to attract premium tax revenue that they will eliminate all regulatory protections or skimp on enforcement. In reality, both market and political forces would prevent a race to the bottom. As producers of regulatory protections, states are unlikely to attract or retain customers—insurers, employers, or individual purchasers—by offering an inferior product. Purchasers will avoid states whose regulations prove inadequate, and ultimately, so will insurers. Moreover, the first people to be harmed by inadequate regulatory protections will likely be residents of that state, who will demand that their legislators remedy the problem. The resulting level of regulation would not be zero regulation. Rather than a race to the bottom, regulatory federalism would spur a race to equilibrium—or multiple equilibria—between too much and too little regulation. That balance would be struck by consumers’ revealing their preferences.
Fellow libertarian Peter Suderman finds this persuasive. It's the kind of frictionless model that one might construct if you were starting from the unshakable premise that markets always self-correct. But of course, Cannon's argument would apply equally well to credit cards, right? Suppose you let credit cards set up in any state they want, operating under that state's laws, and sell across the country. Cannon's argument would suggest with equal force that the state's residents would object to any regulations that favored that industry's profit over the interests of consumers. In fact, we tried that experiment, and Cannon's model isn't how it worked out:
[I]n 1978, the Supreme Court said banks should follow the rate cap in their home states. This meant that as long as a credit-card company relocated to a state with a higher interest-rate limit, the company could lend to borrowers anywhere under that higher limit. Following the court's ruling, Citibank chairman Walter Wriston offered Gov. Bill Janklow a deal: If South Dakota lifted its rate cap altogether and formally invited Citibank to the state (as federal law required), the banking giant would move its credit-card operations to South Dakota—along with 400 good jobs.
The bill was introduced and passed in the space of a day. Soon after, Delaware lifted its cap, too. Voilà, South Dakota and Delaware became the hosts of most credit-card companies...
The problem is that without consumer protections, companies use pricing practices, like teaser rates, to attract cash-strapped families and then slap those families with interest rates of 35 percent or higher plus penalties of $35 a month. Rates can double or triple without notice, even if you never miss a payment. Credit-card use and bankruptcy rose together for years (until the 2005 federal bankruptcy legislation), and last year, banks made $40 billion in plastic profits.
Have the citizens of South Dakota and Delaware risen up in righteous anger at their state legislatures, demanding that they clamp down on misleading lending practices? No, they haven't. And the reason is very simple. Those states gain far more from being the headquarters of a large industry, which provides them jobs and a tax base, than they lose from their citizens being occasionally ripped off by credit cards. For a small population state, the attractions of a major industry setting up shop within state laws almost invariably outweigh the costs it would incur in poor regulation.
Indeed, those costs are virtually nil, since the poor regulation is likely to occur anyway. If you're South Dakota, your state legislature might decide it's tired of its citizens getting slammed with rates that skyrocket without warning or ridiculous fees. You might decide you want to tighten your regulations, and maybe you could buck the overwhelmingly powerful credit card industry, which owns all the state's politicians, to do so. But if you did, the industry would just shift on over to Delaware, and the jobs would be gone and your constituents would still be getting ripped off anyway.
Obviously this dynamic doesn't apply to large states -- California isn't going to let health insurers deny treatment for diabetes so it can boost its employment by trivial sum. But for small states, the calculation changes -- the lure of 400 jobs was enough for South Dakota to let the credit card industry write whatever regulations it wanted.