An important question about any public provider of health insurance is whether it would have access to taxpayer funds. If not, the public plan would have to stand on its own financially, as private plans do, covering all expenses with premiums from those who signed up for it.See also the WSJ and Roger Kimball.
But if such a plan were desirable and feasible, nothing would stop someone from setting it up right now. In essence, a public plan without taxpayer support would be yet another nonprofit company offering health insurance. The fundamental viability of the enterprise does not depend on whether the employees are called "nonprofit administrators" or "civil servants."
In practice, however, if a public option is available, it will probably enjoy taxpayer subsidies. Indeed, even if the initial legislation rejected them, such subsidies would be hard to avoid in the long run. Fannie Mae and Freddie Mac, the mortgage giants created by federal law, were once private companies. Yet many investors believed -- correctly, as it turned out -- that the federal government would stand behind Fannie’s and Freddie’s debts, and this perception gave these companies access to cheap credit. Similarly, a public health insurance plan would enjoy the presumption of a government backstop.
Such explicit or implicit subsidies would prevent a public plan from providing honest competition for private suppliers of health insurance. Instead, the public plan would likely undercut private firms and get an undue share of the market.
Economist/columnist Paul Krugman disputes the point, saying "the standard competitive market model just doesn’t work for health care: adverse selection and moral hazard are so central to the enterprise that nobody, nobody expects free-market principles to be enough." See also here.
Mankiw responds on his blog:
In my view, these comments are just off point. The Obama administration says it wants a public insurance plan that will compete on a level playing field with private plans (that is, without taxpayer subsidies). Is there any cogent economic analysis that suggests that such a policy addresses problems of adverse selection and moral hazard? None that I know. If it has to stand on its own financially, the public plan has no special advantage in addressing these issues.(via Maggie's Farm, Doug Ross)
In any event, it is not like the only alternatives available to us are a government-run health insurance plan or unregulated laissez faire. The most intriguing proposal in the current policy debate is the Wyden-Bennett bill (see this David Brooks column or this letter from CBO on the proposed legislation). That seems to be the best hope for truly bipartisan healthcare reform. At this point, given the legislative strategy of Congressional leadership, the hope is slim at best.