The Wall Street Journal
With the Clinton plan on the ropes, the time has come to shift the health care debate to expose the underlying cause of much of what ails the health care system-the tax treatment of employer-provided health insurance.
The tax policy that ties health insurance to employment can be traced to wage-and-price controls during World War II. Employers competing for scarce labor offered health coverage as a substitute for pay to boost compensation packages without running afoul of wartime wage controls. The IRS later endorsed this practice, ruling that employer-provided health benefits-unlike virtually all other forms of compensation-could be excluded from the taxable income of employees.
The IRS decision has cascaded through the U.S. health care system for nearly half a century to dictate its structure and create many of its problems, demonstrating the awesome power of tax incentives.
The benefits that employees receive as health insurance lead many recipients to believe erroneously that the money spent on health insurance premiums is their company’s and not their own. Most also believe health insurers finance most of patients’ medical bills. These illusions obscure the truth about the real price employees pay in lost wages, inflated prices and insecurity.
Take the example of a photographer whose salary is $30,000. Her company also offers health insurance, but the $4,000 cost of the policy covering her family is excluded from her taxable income.
Because she has been encourage to believe that her premiums are paid by her employer and are therefore “free,” she and her colleagues have negotiated a rich policy with low deductibles. But the bigger the checks her employer writes for health insurance, the smaller her wage increases have been. She may not see the connection, but she sees the result: She hasn’t had a pay increase in three years, but she stays at her job because she has good health benefits. The fastest growing element of compensation is benefits, making up 39% of total employee compensation in 1992.
Health economists have been writing about the distorting and costly effects of the tax treatment of health benefits for more than 20 years, but politicians have been reluctant even to discuss it. Most, including the president, build on the current job-based system and would lock its flaws into law.
The primary problem is that users are separated from cost. Insured patients buy doctor and hospital services at a deep discount, usually paying less than 20 cents on the dollar out of pocket, giving them an incentive to overuse medical services. They have little reason to force providers to compete. Prices inevitably rise; this drives up the cost of insurance, fewer companies and individuals can afford coverage, and the number of uninsured rises, up to an estimated 38.5 million Americans at last report.
The current system also breeds insecurity. Consumers can get a tax break only if their employers buy their health insurance for them. They don’t own their policies themselves, and they are at the mercy of decisions by employers and insurance companies about premium costs and benefit structures. Worse, they may lose their health insurance or be forced to go for months without coverage if they lose or change jobs.
The rich tax subsidy for employer-provided health insurance is highly regressive. Those who purchase their own insurance receive no benefit from the exclusion, and those who have employer-provided insurance receive larger tax benefits the higher their income.
Reform could direct the tax benefits more fairly, but it means detaching health insurance from employment. In a more rational system, individuals and families would be able to directly claim the tax benefit for purchasing health insurance or health care. This prospect appears unsettling to some workers and politicians. But changing the tax code would add choices, not eliminate them.
Reforming the tax treatment of insurance would not change employers’ incentives to continue providing insurance. However, it likely will cause workers to ask for this part of their compensation to be included in their take-home pay. The photographer still could get her health coverage at work. But if she doesn’t like the HMO or the managed-care plan her employer offers, she would be able to shop for another plan that better suits her needs. She might join a group organized by her church, professional organization, union or employee association. Most important, she would own her own health insurance policy, just as she owns her auto and life insurance policies, and wouldn’t lost it because she changed jobs.
Tax relief could come as tax credits or vouchers to be used to offset the costs of catastrophic health insurance, out-of-pocket expenses, or the opening of medical savings accounts, depending on personal choice and individual family circumstances. The impact on the market would be profound. Millions of consumers shopping for individual or newly formed group policies would suddenly wake up to the real cost of health insurance. In shopping for their own coverage and making medical purchases, they would reward the efficient and cost-effective medical providers and punish the inefficient and overpriced providers.
Every American should be able to obtain needed medical care, and reforming the financing mechanism for health insurance is the most realistic and efficient way to reach that goal. Tax reform would eliminate the primarily middle-class fear that losing a job means losing health insurance. The poor could obtain private health insurance with explicit federal subsidies.
A wider range of options for health insurance would be available in a market catering to individual, rather than corporate choice. Health insurance would more likely be purchased as true insurance to protect against catastrophic loss, reducing paperwork to process hundreds of millions of small bills. Insurance would be more affordable and flexible, and many more people could afford coverage. These changes would increase the affordability of health care without triggering the job losses and wage reductions that would result from employer mandates.
Critics argue that health care decisions are too complex for the average consumer. But Americans somehow manage to buy houses, automobiles, computers, legal services, and other forms of insurance by education themselves about their options. More than 90% of medical decisions are made in a noncrisis environment, and people have time to get answers and make choices.
Each of the three main market-oriented think tanks in Washington is pursuing its own politically bold but economically sound health care ideas. When attention is paid to them, discussion has focused more on their differences than their similarities, thus fueling confusion among conservatives about how to craft a viable market-based alternative to the now-troubled Clinton plan.
But after a group of conservative senators, including Pete Domenici of New Mexico and Robert Bennett of Utah, called upon the think tanks to focus on what they held in common, health policy experts Robert Helms of the American Enterprise Institute, Robert Moffit of the Heritage Foundation, and Michael Tanner of the Cato Institute took up the challenge. This Consensus Group quickly determined that tax reform was the center of each of their market-oriented approaches. Around this core idea they have developed a broader conceptual approach to health care reform.
Most Americans agree that government control is not the answer. The more government is involved in health care, the more it will increase costs and add regulation while reducing quality and choice. The Clinton plan and most of the liberal alternatives increase the power of the state while the Consensus Group’s approach increases the power of the individual.
By forging this consensus, the three think tanks help clarify the policy choices to show that tax reform is at the heart of health care reform. Once others join this parade, there can be a real debate between those who advocate a government-run system and those who favor a system that allows the individual to unleash the full force of a competitive marketplace.
Grace-Marie Arnett is president of Galen Institute, a public policy research organization based in Alexandria, Virginia. She is the editor of Empowering Health Care Consumers through Tax Reform, published in 1999 by the University of Michigan Press.