Arnold Kling  

Taxes and Health Insurance

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The Joint Economic Committee's health economist Tom Miller published a reminder of how our health insurance was system has been (mis-)shaped by tax considerations.


Proponents of the tax exclusion for employer-provided health insurance contend that it provides the financial incentives that hold our employer-based, private health insurance system together and sustain a market-based alternative to the government-controlled health care models of many other countries. Funneling tax benefits through employers makes the after-tax cost of employer-financed health insurance more affordable. Additionally, there are relative efficiencies in the marketing and administration (and perhaps the risk pooling) of health insurance plans sold to larger employers as opposed to individual purchasers. However, economists Mark Pauly and Bradley Herring recently observed that, apart from tax considerations, the relative advantages of the employer group market, compared to the individual insurance market, are overstated. Their research discovered that much less risk segmentation occurs in the individual market, and less risk pooling occurs in the employer market, than is commonly assumed. They concluded that the real problem behind higher costs for individual health insurance is the higher administrative and marketing costs in a thin nongroup market that lacks persistent purchasers.

Employer-provided health insurance becomes increasingly anomalous as the pace of change in the economy accelerates. People are more and more likely to have to change jobs and to gravitate toward self-employment for at least part of their careers. These adjustments would be less wrenching if health insurance were attached to the individual rather than to the employer.

For Discussion. Suppose that the tax break for health insurance costs were given to individuals rather than to employers. What transition issues would this raise?


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COMMENTS (39 to date)
Jim Glass writes:

"Employer-provided health insurance becomes increasingly anomalous ..."

Remember that there never was a logical reason for it in the first place. It was anomolous from day one -- but it took a while for the consequences of the anomoly to compound.

It only occurred at all because during World War II the gov't slapped wage controls which left key major industries unable to raise wages to get the workers they needed. So the industries proposed to the gov't that they pay for employee health care costs as a compensation increase to attract workers, while treating the payments as a tax-free "benefit" to keep the payments from being counted as wages. The gov't decided that was a workaround that solved everybody's problem and said "sure".

Planning for a coherently designed medical care system played no part in it at all.

Sixty years later, here we are dealing with the law of unintended consquences and institutional path dependence. The idea that employers should provide health care is terrible for more reasons than be listed in blog comments section, and the tax treatment is almost as bad. But that's our system and it's not going to change easily or soon.

Boonton writes:

"For Discussion. Suppose that the tax break for health insurance costs were given to individuals rather than to employers. What transition issues would this raise?"

Thank you Arnold. You are 80% of the way towards embracing my voucher proposal which I've spent the last few months inflicting on anyone who will listen. The only problem is your mechanism is clumsily and inefficient. People don't get their benefit until they do their taxes, and then only if they itemize. No doubt those who are too poor to pay enough taxes to make the benefit worthwhile will create an awkward credit system that people will have to fill out all different types of forms for.

Here's a simplier system:

1. A tax dedicted to a universal benefit.
2. A voucher that can be used to buy that benefit from the free market.

There is little difference between this and taxing everyone and then refunding them whatever the amount of the tax benefit will be. It is easier, though, to say we are going to have a tax to fund this benefit and this benefit will equal whatever amount it will be for every person.

Spending via the tax code is still gov't spending. We should be honest about it.

Eric Krieg writes:

I still don't understand why health care should be subsidized. At least, I don't understand why the non-poor should be subsidized.

Model health insurance like car insurance. That is the answer. Subsidize the poor, and lets all get on with our lives!

Employer provided health insurance is a bad thing, but so is individual insurance paid for with pre-tax dollars.

David Thomson writes:

“The idea that employers should provide health care is terrible for more reasons than be listed in blog comments section, and the tax treatment is almost as bad. But that's our system and it's not going to change easily or soon. “

"I still don't understand why health care should be subsidized."

In many respects, the employers are not paying for health care! They simply redirect the pay of the worker to the chosen health care plan. The employees always pick up the final bill one way or another. If the company pays for the health insurance---then the employee’s paycheck will be smaller.

Boonton writes:

Unlike car insurance, there does seem to be a broad consensus in society that people should have access to the healthcare that they need. There is no such consensus on cars or car insurance. Most people feel if you can't afford a car you should either take the bus or get a better job.

In other countries I think this consensus is shared. I often hear such things as 'Ask Canadians what theythink of socialized medicine'...'Ask France how they are doing with medicine' etc. Yet is there any movement in these countries to abolish their system and move closer to the American model?

Eric Krieg writes:

>>Unlike car insurance, there does seem to be a broad consensus in society that people should have access to the healthcare that they need.

Which is an argument for subsidizing those who cannot afford insurance themselves (i.e Medicaid).

This is NOT an argument for subsidizing ALL health insurance!!!

Boonton writes:

"This is NOT an argument for subsidizing ALL health insurance!!!"

It's already here. Go ahead and see what happens if you try to repeal the tax benefits of employer provided health insurance? Want even more fireworks? Try repealing the deductability of medical costs for individuals!

Eric Krieg writes:

>>It's already here. Go ahead and see what happens if you try to repeal the tax benefits of employer provided health insurance? Want even more fireworks? Try repealing the deductability of medical costs for individuals!

That's a political argument, B. That's not an economic argument.

Economically, there is no justification for paying for health insurance with pre-tax dollars.

Boonton writes:

"That's a political argument, B. That's not an economic argument."

You asked why there should be a policy that subsidizes everyone's healthcare regardless of their ability to pay. I stated that there is a broad consensus that healthcare should be a universal good in society. That's a political reality. If society believed that building giant pyramids was the most important thing that could be done that too would be a political reality.

Lawrance George Lux writes:

Arnold,
There is always difficulty with Portability of Benefits, if for no other reason than the administrative costs. Boonton has an relatively effective answer, but his plan does not deal with all the Issues. Herein are the problems I understand:

1) Medical and Health Care Costs have broken free of the normal Sector Allocation process of the Economy. These Costs are rising at their own rate, independent of constraints of payment from other Private Sector areas. This is due to their freedom from taxation. Their submission to common taxation would reinstitute the Averaging of Sector Costs.

2) Health Care and Government use Government programs to hide true Costs from the Consumer, so Consumers imagine Health Care can be provided at Private Company Price schedules--which are most definitely not free market pricing.

3) Americans all assume the 'Deep Pockets' mentality of Trial Lawyers when considering Health Care, thinking some hidden Wealth is going to pay for Everyone's health care.

The fact remains Middle-Class Incomes pay for the health care of this Country. They first pay for their own care through insurance premiums, then they pay for all Others through taxes paid. Everyone better get the idea Health Care Provision Price anomalties cannot be withstood. Health Care professionals cannot earn more than equally educated professionals in other areas of the Economy. Drug Companies cannot enrich their Profitability by claims of Research Costs in excess of Economy averages, especially when they are not substantially higher. Politicians cannot continue to pass the cost of health care onto future Generations, this not because of the burden to those descendents, but the damage it is doing to current payment-structuring within Our economy. lgl

Eric Krieg writes:

>>I stated that there is a broad consensus that healthcare should be a universal good in society.

And subsidizing those who can pay achieves universality how, exactly?

If universal coverage is the aim, subsidizing the middle class is a really stupid way to do it.

No, I think that what we have now is a vote buying system. The middle class is subsidized because they voted it that way.

Boonton writes:

"If universal coverage is the aim, subsidizing the middle class is a really stupid way to do it."

Why? Assuming universal coverage is an agreed upon aim what other methods would be less stupid in your opinion?

Eric Krieg writes:

>>Why? Assuming universal coverage is an agreed upon aim what other methods would be less stupid in your opinion?

Because it is wasteful. Because it is inefficient.

Duh. Come on, Boonton, this is like Econ 101 stuff. Are you just being purposefully contrary?

And you already know my answer to your second question: mandatory catastrophic insurance.

Eric Krieg writes:

I posted this in the wrong spot.

What would be a more effective way to universal coverage?

1) Single Payer

2) Close the borders and put a moratorium on immigration?

http://www.marginalrevolution.com/marginalrevolution/2003/12/who_are_the_uni.html

Jim Glass writes:

"Unlike car insurance, there does seem to be a broad consensus in society that people should have access to the healthcare that they need."

Define "need". (Also, re car insurance there is not only consensus but law requiring that everyone have all they need, with minimum amounts specified -- they just pay for it themselves.)

"there is a broad consensus that healthcare should be a universal good in society."

What is a 'universal good'??

I'd guess that food, clothing and shelter are 'universal goods' being that lack of them generally will be fatal near universally, and a lot faster than will lack of health care coverage. But that doesn't mean the gov't nationalizes them and provides them "free" through single-payer food, clothing and housing plans.

"If universal coverage is the aim, subsidizing the middle class is a really stupid way to do it. No, I think that what we have now is a vote buying system. The middle class is subsidized because they voted it that way."

Well, yes. That's the only way the structure of Medicare makes sense. Just look at what it does and does not cover:

It *does* cover all routine predictable costs, like check-ups, people could pay out of pocket.

It does *not* cover calamaties that drop people in nursing homes and cost them their own homes and life savings.

As an insurance program that set-up is insane -- like auto insurance that pays for all your gas and oil and tires and routine maintenance, but which doesn't pay anything at all if your car gets smashed and you go flying through the windshield. It's irrational. And *bad* too -- it subsidizes waste of gas, oil, tires, etc. while leaving calamatous costs that should be socialized uncovered.

But as political vote buying it makes perfect sense. I'd love to have the gov't pick up my gas bill -- I'll vote for that! And I'm not going to crash my car.

Jim Glass writes:

One of the problems with this whole subject may be thinking of "health costs" as just one thing. But there are costs and costs and costs.

On the one hand there are routine things like doctor's visits and routine medications and simple therapies that most everyone at every age ought to expect and be able to pay out-of-pocket, just like all the other expected, normal expenses of life.

Providing these through normal market means, as food, clothing, housing and transport are, should be perfectly reasonable. If I can set aside money every month to pay for my rent and utilities and car payments, why can't I do so to take care of my body? And markets are much more efficient than government bureaucracies at providing services, let's be real about that -- so that would be better quality at lower price. And it would save working stiffs from picking up costs for Warren Buffett.

On the second hand, there are larger expenses that are less certain and more probabilistic -- like appendix removal operations, back surgery, whatever. Again, normal insurance could cover this through the market with more efficiency at better price -- unless someone wants to argue that nationalized single-payer auto insurance would operate more efficiently than Warren Buffett's Geico.

On the third hand, there are real calamitously costly high-tech "heroic" medical costs, not expected and often near the end of life (or threatening to be so). Fully one-third of all medical costs occur in the last year of life.

That's *a lot* of the whole cost for everybody, and nobody plans on them. I don't see a huge problem with socializing those costs through the government, if that's what people want and knowingly decide upon. Especially as it doesn't seem "market discipline" would have much effect on efficiency there.

But a specific gov't program designed to handle such cases would be a lot better than our current mess where Medicare misses them, then after you lose your house and lifetime savings all the costs drop into Medicaid and the gov't winds up paying them anyhow.

And on the fourth hand there are specific "market failure" cases such as when known genetic factors make a person uninsurable. Fine, so have the gov't step in to socialize costs in identified cases of market failure, with specific remedies targeted for the specific problems. Not with one general mess of a bureaucracy for everything.

So there's not just one kind of health care costs or health care economics -- there's lots of kinds. And the market can handle *most* of them, so it should.

It makes absolutely no sense to say that because there's a problem here or there that the market has difficulty with, *everything* in health care should be nationalized. That's just nuts. It's like saying that because some people need food stamps and Section 8 housing vouchers all of agriculture, food distribution and housing should be nationalized.

And there's no good reason for a tax deduction for any health care cost. It just encourages excess demand by the rich by giving a regressive tax subsidy to those in the highest tax brackets.

All this across-the-board governmentalization of health care makes no sense at all -- except vote-buying sense, of course. ;-(

Boonton writes:

"Duh. Come on, Boonton, this is like Econ 101 stuff. Are you just being purposefully contrary?"

No I am not.

"And you already know my answer to your second question: mandatory catastrophic insurance."

This is actually less efficient. The enforcement costs would be huge, both in terms of absolute dollars as well as invasion of privacy. Currently mandatory auto insurance works because you can get checked whenever you get pulled over. To really make this work you would have to do this before the fact...in other words make people prove they have insurance just because they are living in the US.

"What would be a more effective way to universal coverage?
1) Single Payer
2) Close the borders and put a moratorium on immigration?"

I'm not sure how immigration would directly effect universal coverage. Like Social Security, I suspect the fact that immigrants tend to be younger than average would make them a net benefit to a universal system...paying in to cover those who are taking out.

Single payer runs into the problem of socialized medicine. Individuals have no incentive to economize on services demanded and there is no market that can produce prices. As the Austrians will be happy to tell us, prices are valuable information that markets produce.

"Define "need". (Also, re car insurance there is not only consensus but law requiring that everyone have all they need, with minimum amounts specified -- they just pay for it themselves.)"

Need would also be defined by law here. It would be the voucher amount.


"I'd guess that food, clothing and shelter are 'universal goods' being that lack of them generally will be fatal near universally, and a lot faster than will lack of health care coverage. But that doesn't mean the gov't nationalizes them and provides them "free" through single-payer food, clothing and housing plans."

These costs are trivial and the individual who lacks them suffers the most need to rectify the situation. If I'm starving to death, I have a powerful incentive to seek out the charity and aid I need. If the structure of my finances is causing third parties to pay for my health care I have a lot less incentive to fix the situation. Society has *rejected* the option of letting me die on the street because I declined insurance and didn't save enough to pay for care.

Boonton writes:

"As an insurance program that set-up is insane -- like auto insurance that pays for all your gas and oil and tires and routine maintenance, but which doesn't pay anything at all if your car gets smashed and you go flying through the windshield. It's irrational. "

What do you think a warranty is? Ok, it doesn't pay for oil and tires but you can buy a new car with a maintenance plan that will cover everything except gas. You can't be quick to predict what the market will do. Someone may yet come out with a 'gas coverage plan' that gives you free gas up to some limit.....

With vouchers the market would be free to experiment. If an HMO was able to reduce costs by inducing people to go for cheap preventative check ups by covering them then it would win in a voucher system. If a catastrophic plan worked by getting people to economize on routine care by making them pay out of pocket, then it too would win.

Eric Krieg writes:

>>I'm not sure how immigration would directly effect universal coverage.

Did you even read the link?

When everyone has insurance, you HAVE "universal coverage"! Immigrants make up the vast majority of the uninsured. Eliminate immigrants by closing the borders, and you get univeral coverage by default.

Bernard Yomtov writes:

Jim Glass writes,

"And there's no good reason for a tax deduction for any health care cost. It just encourages excess demand by the rich by giving a regressive tax subsidy to those in the highest tax brackets."

I almost agree with this, but not quite. I find it hard to tell someone who has had large medical expenses that he owes the same income tax as someone with the same income who has been relatively healthy. It makes sense to me to treat medical costs as deductible above some threshold amount.

By strange coincidence, our tax code already does something like this. Medical expenses are deductible to the extent they exceed 7.5% of AGI.

That's not bad as a rough rule. True, it doesn't fix the incentive problem around employer-paid insurance, and it doesn't help those without other significant deductions as much as it does those who have them. These things add to the regressivity Jim complains of, and should be fixed.

Eric Krieg writes:

Bernard, what if everyone had catastrophic insurance? Then, all expenses above X amount (X being a high dollar value) would be covered. Insurance reimbursements would not be taxable, as they aren't now.

It seems to me that you shouldn't have a problem with a system where catastrophic insurance is mandatory, and routine health care must be paid for with after tax dollars.

Boonton writes:

Ahhh but catastrophic insurance isn't any type of silver bullet. HMO's were partly developed in order to cut the costs of catastrophic insurance since once you have hit the deductable you (or your doctors) have a blank check.

Lawrance George Lux writes:

The best form of catastrophic medical insurance would be an Insurance plan with premiums, but one where the Insured would pay $500 per Doctor visit. It would discourage unnecessary medical usage, and the accumulative supply of funds would pay for catastrophic care. A good 'Pay as you go System' The trouble is selling it to the American public. lgl

Eric Krieg writes:

LGL has a brilliant idea. Charge so much for ANY doctor visit, no matter for what, at a catastrophic rate!

Those wellvisits for my 6 month old would put me in the poorhouse very quickly.

Eric Krieg writes:

>>HMO's were partly developed in order to cut the costs of catastrophic insurance since once you have hit the deductable you (or your doctors) have a blank check.

Look at Jim Glass's post again. He has taken this into account by nationalizing the really bad (expensive) patients. That is his third example of "cost".

Boonton writes:

Glass's 3rd point is addressing the 'end of life' heroic health care. I have one friend who had severe back pain. He went through two years of intensive medical care, seeing all types of specialists, tests, pain medication etc. His medical bills were probably at least $500 per month or more...and he didn't even opt for the various surgery ideas that he was presented with.

After cleaning himself up from Oxycotin, he found a $750 device that sends electrical signals into his back solved 80-90% of his problem allowing him to 'manage' the remaining pain without drugs. This is an example where a person with catastrophic care could max out his deductible and have a 'blank check' afterwards.

Glass socialization of the end of year expenses wouldn't cover this example. In an ideal world, though, a good HMO would be able to counter the desire of the doctors to go the expensive route and realize the machine was a much more efficient treatment than the various drugs, surgeries, and specialists that were being pushed.

Bernard Yomtov writes:

Eric,

In general I agree with the idea you propose. I do think we need to remember that what constitutes a "catastrophic" loss depends on your financial situation. It means different things to different people.

Still, the notion of running more or less routine expenses through insurance companies has always seemed a bit silly to me, just adding administrative overhead. It's like paying someone to pay your electric bill.

Eric Krieg writes:

>>This is an example where a person with catastrophic care could max out his deductible and have a 'blank check' afterwards.

Catastrophic care effects a small proportion of people, a fraction of all health care spending and is not the driver of health care costs, except as Jim notes, at the end of life.

Controlling end of life expenses is a philosophical, moral, and religious issue, not only an economic one.

Boonton writes:

**********
Still, the notion of running more or less routine expenses through insurance companies has always seemed a bit silly to me, just adding administrative overhead. It's like paying someone to pay your electric bill.
***********

Some auto insurance companies will pay for minor dings in your windshield. Their logic is that its cheaper to pay $35 to fix a tiny chip than it is to replace the whole windshield when it expands (or to pay for an accident if it causes one).

Eric Krieg writes:

>>Some auto insurance companies will pay for minor dings in your windshield. Their logic is that its cheaper to pay $35 to fix a tiny chip than it is to replace the whole windshield when it expands (or to pay for an accident if it causes one).

And I am sure that it is fully priced into their rates. You would be foolish to pay extra for having glass fully covered (unless it exceeded your deductable, of course).

Boonton writes:

'Fully priced into their rates' has little meaning. If the insurance company is not losing money then by definition all their outgoing expenditures will be covered by their incoming premiums.

The situation the auto company is facing is if they deny coverage of the ding (which they can use their market power to repair for just $35), then many car owners may opt not to shell out the $50 or $75 to fix the ding themselves. Next thing you know they may have gotten into an accident or the ding may not cover the whold windshield which may mean the company is out hundreds of dollars.

It's cheaper to cover the ding than not. Likewise it may be cheaper for an HMO to pay for 'routine' check ups because it cuts down on larger costs in the future. You can't say it is always illogical to have insurance pay for routine expenses. Sometimes it is very logical.

In the ideal world, my HMO should be a silent partner in healthcare choices. Mining their data, they have an incentive to discover areas where some procedures save in the long run (which I like because I would rather have less need for care than more) or procedures which do not produce value. Catastrophic coverage does in fact suffer from the perverse incentive for doctors to take a 'sky's the limit' approach. As my friend found out, that isn't always a good deal for patients...nor those paying for care.

Eric Krieg writes:

Boonton, you know damn well what fully priced means. It means that the insurance company is making money on fixing windshields, irrespective of any preventative effects. And you could save money by switching to a company that does not provide such a service.

Preventative care is NOT cheaper in the long run. In fact, socialized medicine the world over shows that there aren't really any negative health effects from rationing care. Less is not more, but it isn't less either.

Boonton writes:

"Boonton, you know damn well what fully priced means. It means that the insurance company is making money on fixing windshields, irrespective of any preventative effects. And you could save money by switching to a company that does not provide such a service."

The insurance company spends money on fixing windshields. The point is that, in this case at least, they spend less by doing a $35 repair job they technically don't need to do because it is under the drivers deductible than not doing anything until X% of those dings become major expenses for them.


"Preventative care is NOT cheaper in the long run. In fact, socialized medicine the world over shows that there aren't really any negative health effects from rationing care. Less is not more, but it isn't less either."

You're being rather incoherent here. It sounds like you are equating preventative care with socialized medicine. Two totally different things. Preventative care is not always cheaper but it often is.

Eric Krieg writes:

>>Preventative care is not always cheaper but it often is.

I have seen nothing definative proving that prevenative care is cheaper. Just last month there was a front page article in the WSJ going over the mechanics of how the Canadians ration health care, and how there are not ANY measurable negative effects to denying people healthcare for long periods.

Of course, people don't like to wait in lines, especially when they are sick. That is the advantage of American health care, and why it is so costly. There are no lines. But don't try to make the case that it improves our health, because the evidence just isn't there to prove it, from what I've seen.

Bernard Yomtov writes:

I don't know how much good preventive care does, though it would take a lot to convince me that it's useless. It is worth noting that, on the assumption it does some good, insurance companies have an incentive to provide less than the optimal amount.

This is because some percentage of its policyholders are going to be someone else's policyholders next year. So to a degree the costs preventive care avoids will be borne by other companies. As the policyholder approaches age 65 the incentive grows, because Medicare is going to take over. Why spend money checking for a tumor when if the company is lucky symptoms won't show up until someone else is paying for the treatment?

Sounds pretty malicious. Do insurance companies think this way? I don't know.

Bernard Yomtov writes:

Boonton,

Glass coverage may be an option, though it's not available on my policy, and you surely pay for it if you get it. You are claiming, in effect, that the rate is less than it would be if chipped glass didn't have the potential to cause greater problems. How do you know that this is a significant factor in determining the rates?

Boonton writes:

Regarding the chipped glass, I know this from a friend I have out in Seattle where she told me auto insurance companies do this. I can't say I know this makes economic sense or not. I'm only saying if the variables are right (the % of chipped glass causing expensive claims in the future versus the low cost of fixing chipped glass (especially if you get a contractor to do it for you at reduced rates)) it would make economic sense.

Likewise, an insurance company would rather pay for a $50 doctor visit every three months for a person who just developed diabetes than to wait until that person did $750 worth of damage to their body and then pay for hospitalization.

What many people seem to be missing is that health care has not one but two agency problems. The patient's insurance company has an incentive not to pay for procedures that are needed but the patient isn't the one demanding healthcare, he is often trusting his doctor to decide what is healthcare is needed. There is a 2nd agency problem whereby the healthcare provider has an incentive to suggest procedures that are of marginal benefit.

Markets are probably the best tool for setting these conflicting interests against each other. The insurance company's desire not to pay can be set against the doctors incentive to medicate excessively (and also the influence on him by pharma company sales reps to write scripts for drugs that are unecessarily expensive) and the doctors incentives can be set against the insurance company.

Bernard Yomtov writes:

"Likewise, an insurance company would rather pay for a $50 doctor visit every three months for a person who just developed diabetes than to wait until that person did $750 worth of damage to their body and then pay for hospitalization."

What if the newly-diagnosed diabetic is 64 years old? Why spend $50 to save Medicare $750?

Your point is correct as a matter of social welfare, not to say plain decency, but what I was saying above is that the current structure may give the insurer a disincentive to do that which maximizes welfare. That's not how markets are supposed to work.

Boonton writes:

In a voucher based system, insurance companies would have an incentive to find the optimal method of paying for healthcare. This could be a combination of managed care HMO with catastrophic coverage. My point about the diabetic is to counter the claim that it doesn't make sense to use insurance to pay for routine things. Sometimes it does.

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