Arnold Kling  

Capping a Bad Tax Break

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Greg Mankiw points to a story about a health policy proposal under consideration by President Bush.


Bush's health-care proposal would use tax breaks to make it easier for people who do not have employer-provided health insurance to buy coverage on their own. The tax incentives would be similar to deductions used by homeowners for the interest on their mortgages...

The current health system relies primarily on employers to provide health-care coverage as a fringe benefit. Employees are not taxed on the benefits but the Bush plan would set a cap on the amount of coverage that could be offered tax-free.

Anything above that would be taxed as income


I would grade this as "A+". The question is whether he can get any Democratic support. My guess is that some of the most extravagant health insurance plans come from unions. The fact that the President's proposal is much more "progressive" than the status quo (as it stands now, the "rich" benefit the most from not having to declare the cost of gold-plated health plans as income) will not get any support from "progressives."

What I love about it is that it takes away the childish illusion that health benefits are some sort of "gift" or "obligation" from employers. It treats them as compensation, which provides a much more grown-up basis for discussing health care.

By capping the deduction, it reverses the current situation, in which what I call "insulation" (see the current issue of Cato Unbound) is used instead of real health insurance. I believe that this has the potential to lead to meaningful reductions in health care spending for people under 65.

I would point out, however, that Medicare is still the biggest problem in health care policy today.


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TRACKBACKS (9 to date)
TrackBack URL: http://econlog.econlib.org/mt/mt-tb.cgi/633
The author at The New Editor in a related article titled Capping a Bad Tax Break writes:
    Arnold Kling on a possible new health care policy proposal from President Bush: I would grade this as "A+". The question is whether he can get any Democratic support. My guess is that some of the most extravagant health insurance plans come from unions. [Tracked on January 22, 2007 1:54 AM]
The author at Three Sources in a related article titled W Gets an A+ writes:
    It's not everyday the President gets an A+ from Arnold Kling, but he has today. In Capping a Bad Tax Break Kling applauds the prereleased details of the President's Health Care plan. I would grade this as "A ". The... [Tracked on January 22, 2007 1:53 PM]
The author at In the Agora in a related article titled SOTU Address: Triply-Worthless writes:
    As I've often stated, watching the State of the Union Show Address is a waste of time, this year for three reasons. First, Wendling's Rule of Oration: Politicians rarely, if ever, state anything important in public. We can expect Bush's... [Tracked on January 24, 2007 4:09 PM]
COMMENTS (10 to date)
Ajay writes:

You may think this is a good policy but the mayberry machiavellis in DC are adept at floating ideas and policies that they have no intention of implementing but can give them some short-term political advantage. Look at their record on school vouchers, gay marriage, social security reform, it goes on and on.

I agree with you that medicare is the biggest problem today. They set the prices for all health goods that are then slavishly followed by everyone else. This is the way the scam works, as related to me by a medical biller. Medicare pays something like 30% more than costs, on average. The insurance companies then set their prices at another 15-20% on top of medicare's price. Finally, the hospitals and clinics set their retail prices at 2-10 times costs. Medicare and the insurance companies can then go to the consumer and tell him they negotiated huge discounts, anywhere from 25-80% off the imaginary retail prices that the hospitals provide, prices that they make up for the express reason of allowing the government/insurers to fool the consumer with this made-up discount. The government and insurers can then claim they've done their job, the consumer believes they're getting a discount, and the doctors have locked in 30-50% margins minimum. That's the minimum because the 15% of the population that doesn't have insurance is then screwed because they're forced to pay the full retail prices that have been made up to justify this scam. The hospitals and clinics will claim that they cannot legally provide anything less than the retail price to the uninsured, as the government and insurers will then come investigate them because they're not getting a discount anymore. I believe this is a lie told by the clinics and hospitals so they can gouge the uninsured but I don't know enough about how exactly the law works in this situation; it's possible that it's legally murky and the hospitals take advantage of that.

These interests form an iron triangle, each one simultaneously grappling with the other two while trying to stab them in their back. Medicare and other government programs play an integral part as they fund half of health spending. The left believes that cutting out the private insurers, with their additional 15% margins and overhead, and turning the whole thing over to the government is the best way to control spending. Those of us in the free market camp believe that the only way forward is to introduce competition by removing the distorting price power of the government, along with other government distortions like regulated insulation and the employers' tax break. Just imagine all the medical progress that could have been made by now if we had competition for the last 50 years rather than the current mostly-socialized system! The fundamental problem here is the consumer, the government/insurers and hospitals/clinics are actually pretty stupid. The problem is that the consumer is even dumber. He believes not only that he has won a discount on health care but that somebody else is paying for it, not realizing that it is just deducted from his paycheck in ever fatter sums. Getting the consumer to realize that a free market system, with market solutions like catastrophic insurance and medical brokers, is the only way forward is the only way to break out of this mess.

1. I agree with the compensation point, but since compensation isn't capped, that seems to be a weak argument for capping health benefits.
2. The bigger problem would be the significant geographic variation of costs. I suppose this may be a way of driving out unwarranted variation in both utilization and unit costs, but it is a pretty blunt instrument.
3. Is this supposed to work at the individual level (in which case relatively old employees with families will have a problem) or at the employer level (in which employers like us, with relatively high cost per employee because we have more older employees. Except that we have a high deductible health plan, which would presumably be the way other employers would go.) Do employees still get to deduct their contributions to the HSA in such a case??

Thank goodness I as an employer still have freedom to bargain with my employees for benefits, and to seek out a plan that meets our needs. Turning the whole thing over to the government would remove the choice that is the basis of the current system.

Richard L.A. Schaefer writes:

Recall that World War II price controls led to the illogical link of health benefits with jobs and employers. Because wages could not be raised or raised much, a way to compete with other businesses was to offer health benefits and to raise them. In other words, they've always really been compensation. Regarding caps, it would parallel the fact that Congress finally moved to consider free tuition for kids of college profs to be compensation, rather than continue to be tax-free.

Randy writes:

"Compensation". Exactly.

Basil writes:

How does this plan address the disparity between the "cost/benefit ratio" that employees can get through "group" plans and what those who do not have access to "group" plans can get? The self-employed can already treat the cost of medical insurance as a tax deduction, but the cost and benefits of plans available to the self-employed are so skewed as to render the deductibility an irrelevant consideration: the cost is so high, and the benefits so low that even after deducting them from taxable income they don't make economic sense. If all this plan does is offer individuals currently receiving "group" benefits the option of deducting the higher -- much higher -- cost of "individual" plans from taxable revenue, it isn't going to go anywhere. It is not just the fact that people get health insurance without paying taxes on the benefit that weds them to employer supplied plans, it is also that these plans are cheaper to the individuals who can get them because they are "group" plans. Until individuals can get insured at the lower cost of risk-pooled group plans, the problem remains.

David writes:

Ajay commented that the uninsured (who are in theory the most vulnerable patients) end up paying higher rates than the insured. While still true in many cases, the tide is beginning to turn. Providence has settled a case, and other cases are in the works, regarding this very issue. See here for more:
http://www.oregonlive.com/metro/oregonian/index.ssf?/base/news/1151115930164470.xml&coll=7

Ajay writes:

David, that's hardly evidence of a tide turning, more like more grappling with another shank in the back from the government to hospitals. The hospitals will now try to stick their blade into someone else's back. As noted at the end of that article, the hospitals have a gun held to their head forcing them to give uninsured patients the same rates as insured patients for a 2- to 3-year team. They plan on going back to business as usual as soon as that term ends. Note how they make a point of stating that they give away money in "charity" write-offs to poor or uninsured patients. The truth is that they wouldn't be able to collect from those patients anyway as they have no money. However, they still plan on bleeding middle-class uninsured patients for all they have. The truth is that the uninsured are just a distraction to them, they just want to maintain the high retail prices that allow the government and insurers to perpetrate the illusion that a discount has been negotiated. If that means throwing the uninsured middle-class under the bus or giving writeoffs to the poor (to generate good PR on money they wouldn't be able to collect anyway), they're willing to do that. All that matters is continuing the gravy train from medicare and the insurance companies.

The problem is that the uninsured middle-class who they would gladly stomp are precisely the people we should be supporting. Suppose you, as a middle-class consumer, decided that you wanted to buy health care on your own, without resorting to the system of insulation that currently exists. You want to bargain with hospitals/clinics for what you think their services are worth. You cannot do this for two reasons. The first reason, which is really all the evidence you need of the scam being perpetrated, is that there is no upfront pricing. Nobody will tell you what anything actually costs most of the time (I say this as someone who has actually tried). California legislated that hospitals must maintain price lists so what the hospitals did is place them in an obscure office in the hospital without telling anybody about them. Further, each hospital cooks the books so that a pill or an MRI costs vastly different amounts depending on which hospital you go to (these last two facts were reported on in this great WSJ article. The second reason is the one I cited earlier, they won't negotiate with you and will tell you they can't because of legal reasons, meaning medicare and the insurers will come after them. This is most likely a lie, they're most likely abusing a murky legal situation. This is how medicare and other government programs' funding of half of health spending corrupts the whole system. By funding such a large chunk of spending, the hospitals/clinics will always do whatever they can to keep that pork trough full, especially since there are no quality of care requirements attached. Therefore, any individuals who would like to actually bargain in a free market have no choice, that free market is crushed by the huge pricing power of government, with the insurers piggybacking along.

jt007 writes:

The self-employed can already treat the cost of medical insurance as a tax deduction, but the cost and benefits of plans available to the self-employed are so skewed as to render the deductibility an irrelevant consideration: the cost is so high, and the benefits so low that even after deducting them from taxable income they don't make economic sense.

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That isn't correct. You can only deduct medical costs (insurance premiums, cost for services, hospital bill, etc.) that exceed 7.5% of your gross income. I am self employed in California and before I got married had Blue Cross. At age 39 I was paying about $150 for a $2,500 annual deductible policy and that was in California which is one of the most expensive states in the nation. Affordable insurance is readily available to the self employed

David writes:

I agree with the fact that it is a more grown up way to handle health care issues pertaining to large corperations and businesses. It almost seems today that they feel as if they are giving a good employee the "gift" of health care that is a must for any citizen no matter what. What I dont understand is why the rich dont get a hit on some of this instead of the average middle class working adult. I understand that everyone needs health care, but why should it be easy for wealthy people to get away with tax breaks when the average joe gets hit up for taxes. And as for the little blip about Medicare, that is absolutely true, and it will ALWAYS be the biggest problem unless someone has a bright idea to fix it, and we havnt seen one yet.

Brian writes:

I don't regularly read your blog, so I apologize if this is something you've covered in the past, but why is Medicare the "biggest problem" in health care today?

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