Slowly, Slowly

The Senate Finance Committee got to the heart of the issue during a hearing yesterday on "Health Benefits in the Tax Code: The Right Incentives." Three prominent economists were in solidarity in targeting the tax treatment of health insurance as key to health reform.

The value of the subsidy for job-based health insurance was a whopping $245 billion in 2007, according to Eward Kleinbard, chief of staff of the Joint Committee on Taxation. (This compares to government spending of $372 billion that year for Medicare and $340 billion for Medicaid.)

It is a much bigger middle-class subsidy than even the mortgage interest deduction, which checks in at a mere $89 billion.

Slowly, slowly it's becoming clear that addressing the tax issue is key to putting the private health sector on a sustainable track.

Committee Chairman Max Baucus, D-MT, is eyeing the generous subsidy for job-based health insurance as a revenue source for overall reform initiatives. But he would be wrong to think of this as a $245 billion honey pot for spending on other government programs.

The right solution is to make the subsidy fairer and more equitable by allowing everyone to get a tax benefit for purchasing health insurance, not just those who get generous coverage at work. Sen. John McCain has proposed just such a proposal as part of his campaign's health reform initiative.

Massachusetts Institute of Technology professor Jonathan Gruber explained the flaws in the current system this way:

When MIT pays me in cash wages, I am taxed on those wages. But the roughly $10,000 that MIT will spend this year on my health insurance is not taxed, amounting to a tax break of about $4000 to me. To be clear, this exclusion is a tax break to individuals, not to firms; firms are indifferent between paying me in wages and in health insurance. But I am not indifferent about getting paid in wages or health insurance; I pay taxes on the former but not the latter.

The tax exclusion of employer expenditures from individual taxation has three flaws.

  • First, $250 billion/year is an enormous sum of money which could be more effectively deployed elsewhere, especially through alternative approaches to increasing insurance coverage.
  • Second, this is a regressive entitlement, since higher income families with higher tax rates get a bigger tax break; about three-quarters of these dollars go to the top half of the income distribution.
  • Third, this tax subsidy makes health insurance, which is bought with tax-sheltered dollars, artificially cheap relative to other goods bought with taxed dollars, leading to over-insurance for most Americans.

As a result of these limitations, no health expert today would ever set up a health system with such an enormous tax subsidy to a particular form of insurance coverage.

Gruber continued:

So why don't we just remove it? Administratively, this would be straightforward: employers would report their spending on insurance as taxable wages on W-2 forms, and the government would raise the resulting revenues…

There are two reasons why this might be a problem — one is wrong and one is right. The one that is wrong is the concern that we will "lose employer dollars" when ESI erodes. Both economic theory and a large body of economic evidence show that there are no employer dollars: the money that employers spend on insurance would otherwise just be spent on worker wages. If MIT stopped offering insurance, over a several year period my wages would rise by $10,000 to offset the lost insurance compensation, and MIT's bottom line would remain the same. The notions of "shared responsibility" or "keeping employers in the game" are political notions, not economic ones.

The right reason to worry about the erosion of ESI is that sick and older individuals are treated much more fairly in employer groups than they will be in today's non-group insurance market. Under ESI, all individuals pay the same for insurance regardless of age or health. But in most states those who are sick or older must pay much more for their non-group insurance, and in many cases it is simply unavailable. So as employer-sponsored insurance falls we could end up with a large new set of uninsured who cannot afford, or cannot obtain at any price, non-group insurance.

The witnesses described ways that these problems can be addressed and that is a topic for another column. But until we focus on this key problem, we will continue treating symptoms and not the root cause.

Katherine Baicker, professor of the Harvard School of Public Health described the spiral of rising health costs that lead to more uninsured and lower quality of care. "[A]s health care costs rise, it becomes increasingly difficult for families to afford insurance. As more people become uninsured, public and private resources devoted to their care are stretched thin, resulting in less efficient care and worse health outcomes. The goals of controlling costs and increasing insurance coverage should thus go hand in hand."

She concluded: "Most economists would agree that our current tax treatment of health insurance is an important part of the problem, and that reforming that system would be a key component of a broader solution."

Kleinbard's testimony offers the most comprehensive description I have seen anywhere of the tax benefits for health insurance and health expenses, showing how deeply government financing is involved even in the private health sector. I recommend it.

It seems worth sharing with you here the text of a Consensus Group petition that we circulated in 1994 which we published in our book, Empowering Health Care Consumers through Tax Reform. It sounds nearly identical themes:

Health Policy Reform: Diagnosing the Problem

Reforming the tax treatment of health insurance is essential to creating a more efficient market for medical care and health insurance in the United States.

Employment-based health benefits are actually part of employee compensation. However, these health benefits are not counted as income for tax purposes. This tax policy distorts the health care marketplace. It undermines cost consciousness by disguising the true cost of insurance and medical care to employees. It artificially supports increased demand for medical services and more costly insurance. As a result, inefficient health care delivery is subsidized at the expense of efficient delivery, and cash wages are suppressed. Further, the current tax law discriminates against the self-employed, the unemployed, and those whose employers do not offer health insurance.

We support reforming the tax treatment of employment-based health insurance to promote a more efficient market in the health sector. We support restraining costs through competition and consumer incentives rather than through destructive methods such as price controls and limits on private spending set by government.

We circulated the petition by fax in the pre-Internet era, and more than 400 economists signed on.

Clearly, we have been talking about this issue for many, many years, and we cannot and will not give up. Reforming the tax treatment of health insurance is central to saving a private health sector that rewards innovation, values choices, and expands access to affordable health coverage in an increasingly mobile economy.

Grace-Marie Turner

< p>Recent News Articles and Studies

The Distribution of Public Spending for Health Care in the United States, 2002
Medicare Spending Across the Map
Controlling the Costs of Medical Care: A Dose of Deregulation
Health Coverage: A Micro-Business Perspective
Health-Care Reform, Corporate-Style
Booming Business Helps Patients Navigate Medicine
What DO We Know About the Uninsured?
A Fork in the Road: Obama, McCain, and Health Care


The Distribution of Public Spending for Health Care in the United States, 2002
Thomas M. Selden and Merrile Sing, Center for Financing, Access, and Cost Trends, Agency for Healthcare Research and Quality
Health Affairs Web Exclusive, 07/29/08

The public sector finances more than half (56.1%) of U.S. health care, according to Health Affairs, which provides the first analysis since the 1970s to comprehensively evaluate the distribution of health care outlays and health care tax subsidies. This spending totaled $752.9 billion (2002 dollars) and more than a quarter ($214.8 billion) took the form of tax preferences, primarily tax subsidies to private insurance and the exemption of most medical care spending from state and local sales taxes. The study also finds that public spending for health care goes disproportionately to seniors and those in poor health, but it is less concentrated among low-income Americans than is sometimes thought.

Medicare Spending Across the Map
Amy Hopson and Andrew J. Rettenmaier, Texas A&M University
National Center for Policy Analysis, 07/08

Medicare's costs vary dramatically among regions in the U.S., but many of the proposals being offered would only perpetuate these regional cost variations through reimbursements to fee-for-service providers or risk adjusted payments to Medicare Advantage plans. Instead, reforms are needed that would allow market forces to address some of the higher cost areas. These could include requiring competitive bidding from Medicare Advantage providers for types of beneficiaries based on their risk profiles so that providers reveal their true cost of care, and providing incentives for the beneficiaries to shop for care and seek lower cost providers by funding individual health savings accounts with catastrophic insurance coverage.

Controlling the Costs of Medical Care: A Dose of Deregulation
Richard A. Epstein, University of Chicago and David A. Hyman, University of Illinois
University of Chicago Law and Economics (Olin Working Paper No. 418), 07/11/08

Epstein and Hyman address the futility of regulatory efforts by governments to control health costs. After analyzing the deficiencies in expansion of government control over the health sector, they conclude that no administrative agency or committee of experts, no matter how well intentioned and knowledgeable, will be able to do a better job of meeting consumer demands than the private market.


Health Coverage: A Micro-Business Perspective
National Association for the Self-Employed, 06/08

A survey of nearly 4,000 micro-businesses finds that the percentage of businesses whose plans cover full-time employees dropped significantly from 46% in 2005 to 19% in 2008. The survey also shows that small businesses with the least revenue end up paying the most for health insurance. Micro-businesses grossing less than $50,000 annually spent a median of 17.6% of their gross 2007 sales on health insurance, compared to a median of only 1% spent annually by companies generating more than $500,000 annually. There are 24 million micro-businesses in the U.S. creating more than one-third of new jobs in the economy.

Health-Care Reform, Corporate-Style
David Welch
BusinessWeek, 07/29/08

BusinessWeek describes the growing popularity of company-based medical centers. In setting up a clinic, an employer can identify services it wants to provide to its workers and hire an outside firm to manage the project. Many firms offer employees a break on co-pays and other incentives if they use the center. P.H. Glatfelter, a York (Pa.)-based paper manufacturer, says the company reduced costs by $2.1 million last year using a Take Care Health clinic to serve 1,700 workers at one of its plants. A large portion of the savings comes from cutting unnecessary specialist referrals. Only 4% of the patients at the plant are sent to a specialist, while 25% of patients in the surrounding community are referred out. By avoiding 2,100 such visits, with an average fee of $250, the company shaved $525,000 from its total health-care bill.

Booming Business Helps Patients Navigate Medicine
Mike Stobbe, AP Medical Writer
The Mercury News, 07/24/08

A number of health advocacy businesses are being created to help customers find the right doctor, haggle over insurance coverage and manage other medical system headaches, The Mercury-News reports. The field is blossoming in the wake of cutbacks in corporate health benefits, an overhaul of Medicare and other changes that have forced medical consumers to shop more for medical care. Though some consumers are savvy enough to beat a billing overcharge or probe doctors' litigation histories, they don't have the time for such labors, experts said.

We predicted this new health care service in a paper we wrote in 2006 entitled, Health Advisors Will Facilitate Consumer Decision-Making.


What DO We Know About the Uninsured?
Thomas P. Miller, American Enterprise Institute
The American, July/August 2008

AEI's Tom Miller offers a detailed analysis of the trends in the number of Americans without health insurance. He says the broader issue of slowly-declining rates of insurance coverage in the United States remains more of a chronic condition (needing better diagnosis and more than one kind of treatment) than a crisis (needing emergency surgery). Universal mandates to purchase coverage won't work as long as people can't afford it, taxpayers won't subsidize it any more than they already do, and politicians won't enforce unpopular rules to buy it anyway, writes Miller. Reversing decades of overregulation, mistargeted tax subsidies, and lack of transparency in the healthcare sector would not solve all problems, but it sure would help reduce them.

Obama v. McCain

A Fork in the Road: Obama, McCain, and Health Care
Michael Tanner
Cato Institute, 07/29/08

Senator John McCain's health care proposal is far from perfect, but from a free-market perspective, it appears superior to Senator Obama's plan, writes Tanner. Obama's plan, with its heavy reliance on government, leads to the same problems that bedevil universal health care systems all over the world, especially limited patient choices and rationed care. In contrast, John McCain emphasizes consumer choice and greater competition in the health care industry. As such it stands a reasonable chance of reducing health care costs. It won't achieve universal coverage, but it will likely increase the number of people with health insurance, and most importantly, it is far less likely than Sen. Obama's proposal to do serious harm.

Sally Pipes of the Pacific Research Institute also describes the differences between the two plans and notes that Sen. McCain's reforms are the first steps in getting away from our broken system of payment by unaccountable third parties.

Upcoming Events

Grace-Marie Turner speaking on the Real Wealth Show
Real Wealth Radio Broadcast
Monday, August 4, 2008, 10:00 a.m.
Kewaskum, WI

Oklahoma Health Care Reform Task Force Meeting
Oklahoma House of Representatives Event
Tuesday, August 12, 2008
Oklahoma City, OK
Grace-Marie will speak at a meeting of the Oklahoma Health Care Reform Task Force.

Differing Approaches to a National Crisis: Presidential Candidates' Health Care Plans Debated
Oregon Health Forum Event
Tuesday, August 19, 2008, 7:00 a.m – 9:00 a.m. (Breakfast included)
Portland, OR


Health Policy Matters is a weekly newsletter containing summaries of timely and informative studies and articles on free-market health reform. It features a commentary by Grace-Marie Turner on the major developments and issues of the week as well as summaries of writings by participants in the Health Policy Consensus Group and other articles of interest from the health policy world, plus announcements of coming events. Health Policy Matters is published by the Galen Institute, a not-for-profit public policy organization specializing in information and education on health policy. For more information about the newsletter and our organization, please visit our website at

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