Is health care a necessity or a luxury? Pooled estimates of income elasticity from US state-level data

Abstract

This paper provides new evidence on the income elasticity of health care by combining stationarity and cointegration tests of health care expenditure and incomes with estimates of the cointegrating relationship between them. A recently updated dataset of health care expenditures and disposable personal income for the US states for the years 1966-1998 is used. The principal findings are that health care expenditures and incomes at the state level are non-stationary and cointegrated. Dynamic OLS cointegrating regressions of the pooled state time series estimate the income elasticity of health care at 0.817 to 0.844, well below unity, confirming that health care expenditure, even at the aggregate level, is a necessity good.

Health expenditure and income in the United States

“…As for income, the unit root hypothesis is rejected when an intercept only is included, while it cannot be rejected in the intercept and trend case, for any choice of p. Given the trended nature of our variables, these results lead us to conclude that health expenditure and disposable income are non-stationary. This empirical evidence is consistent with research on US data at a State level by Freeman (2003) and other works on national-level OECD data by Blomqvist and Carter (1997) and Gerdtham and Lothgren (2000).…”

“…However, such estimator, ignoring the sizeable amount of cross section dependence in spending, is likely to be seriously biased. Our FE coe¢ cient, though close to 1, is smaller than that obtained by Freeman (2003), which is roughly 1.30. We note that Freeman's study di¤ers from ours in a number of characteristics that might explain (in part) the di¤erences in the FE estimation.…”

“…Since the seminal papers by Kleiman (1974) and Newhouse (1977), much emphasis has been given to the role of income in determining health care expenditure. The debate is still open on whether health care is a luxury or a necessity good, namely, if income elasticity of expenditure is above or below unity (Parkin et al, 1987;Gerdtham et al, 1992; Hitris and Posnett, 1992; Hansen and King, 1996; Blomqvist and Carter, 1997; Di Matteo and Di Matteo, 1998, Freeman, 2003. The controversy over the nature of health care has been exacerbated by the policy implications of the empirical results.…”

“…In fact, it is reasonable to expect the e¤ect of global shocks to vary considerably across individuals, also depending on the characteristics of the population units. To allow for more general error cross section dependence, other studies build the empirical distribution of unit root test statistics by bootstrap techniques (Freeman, 2003; Carrion-i-Silvestre, 2005; Wang and Rettenmaier, 2006;Chou, 2007). However, the bootstrap procedure is subject to size distortions in …nite samples, particularly in cases where N is small relative to T , as in the study of health expenditure in the OECD countries (Maddala and Wu, 1999).…”

“…Freeman (2003) …nds that health care expenditure and income at State level in the US in the period 1966-1998 are non-stationary and cointegrated, ultimately observing that health care is a necessity good. More recently, Wang and Rettenmaier (2006), allowing for structural breaks in unit root tests, support the evidence that spending and income in US States are non-stationary, though not cointegrated.…”