HEALTHCARE EXPENDITURE AND THE INCOME EFFECT: A CAUSAL ANALYSIS

Abstract

The rate of healthcare expenditures as a share of GDP in the United States is growing at an alarmingly fast rate. A leading economic theory that explains this phenomenon is the income effect, which claims that the rise in per capita income is the main reason for increases in healthcare expenditure. This paper seeks to estimate the causal effect of per capita income on per capita health expenditures at the state level by instrumenting for income using time-series variation in global oil prices interacted with cross-sectional variation in state level oil reserves in the United States. The benefit of using an instrumental variable approach is that it can effectively separate the potentially exogenous sources of variation in income, allowing for a cleaner analysis. I run an ordinary least squares regression as well as an instrumental variable regression in order to compare the results between the two. I refine and improve past economic models in order to achieve an accurate study of the causal relationship between increases in income and healthcare expenditure in the United States in the years 2000-2009.