Scott Sumner  

Do we really want to control health care costs?

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In America, the government heavily subsidizes the provision of "health care." (The scare quotes will be explained later.) For example, roughly 40% of the cost of health insurance for middle class families is paid for by the government, via tax deductions for health care costs. This partly explains why Americans spend far more on health care than residents of other countries. One of the few good provisions in Obamacare is a tax on "Cadillac" health plans, which is scheduled to begin in 2018. This will basically offset the subsidy, so that consumers would face the true cost of the health insurance they purchase (at the margin.)

Here's an example of waste. One of my few luxuries is daily wear soft contact lens, which cost about $600/year. That's actually more than I'm willing to pay for a slight improvement in quality of life, but this cosmetic purchase is considered "health care" and thus taxpayers pick up 40% of the bill via a "flexible benefits program." At a price of $360/year, it's worthwhile for me to buy this product. Indeed most of the health care expenditures that I've made over my life would not have been incurred if I had to pay out of pocket, even though I could have easily afforded all of them. The subsidy was the deciding factor. Economic inefficiency.

When Obamacare was being debated I got into some arguments with commenters, who told me that I should support the plan because it had the sort of cost controls I favored. I replied that the controls were delayed until 2018, which meant they probably were not going to be implemented. This tax is an arrow aimed right at the heard of the medical industrial complex, which absorbs 18% of GDP. I found it hard to believe that this sort of cost control could survive special interest politics. Here's a story that suggests there is increasing opposition to the tax on expensive health care plans, just as I expected:

The so-called Cadillac tax was meant to discourage extravagant coverage. Critics say it's a tax on essentials, not luxuries. It's getting attention now because employers plan ahead for major costs like health care.

With time, an increasing number of companies will be exposed to the tax, according to a recent study. The risk is that middle-class workers could see their job-based benefits diminished.

First to go might be the "flexible spending accounts" offered by many companies. The accounts allow employees to set aside money tax-free for annual insurance deductibles and out-of-pocket health costs. That money comes out of employees' paychecks, and they're not able to use it for other expenses. Savvy consumers see it as a way to stretch their health care dollars.

The catch is that under the law those employee contributions count toward the thresholds for triggering the tax.

There are other wrinkles: Companies in areas with high medical costs, such as San Francisco, are more likely to be exposed to the Cadillac tax than those in lower-cost areas like Los Angeles. Ditto for employers with unionized workers who won better benefits through bargaining.

Republicans in Congress and a sizable contingent of Democrats are calling for repealing the tax. Hillary Rodham Clinton, the front-runner Democratic presidential candidate, says she's concerned and would re-examine the tax. Since it doesn't take effect right away, it's an issue for the next president.

"As currently structured, I worry that it may create an incentive to substantially lower the value of the benefits package and shift more and more costs to consumers," Clinton said in response to a candidate questionnaire from the American Federation of Teachers.

Oddly, this story makes me slightly more optimistic that I was wrong, and that real cost controls will occur. Note that Hillary Clinton says she would "re-examine" the tax. That suggests to me that she supports it, as otherwise she would have taken the politically popular stance. But I remain concerned that it will be watered down under pressure from the health care industry. Even worse, I expect them to make it more complex, carving out exemptions for favored types of health care.

The GOP opposition is disappointing, but the Democrats also share some of the blame. In 2008 John McCain proposed switching the tax deduction for health insurance into a lump sum credit, which would have controlled costs even more effectively than the Obamacare plan. Obama opposed the idea. In addition, McCain's proposal was intended to be more revenue neutral, whereas the Obama approach incurred the wrath of Republicans by raising taxes. Nonetheless, the GOP would make a big mistake if they repeal the tax, as the rising cost of healthcare is one reason why living standards for the middle class have risen more slowly in recent decades. Some of the increase in "real total compensation" is being gobbled up by rapidly rising health care costs.

PS. Just to be clear I have nothing against rising health care costs, if they reflect the decision of consumers who bear the cost of their purchases. My concern is that the massive government subsidies (as well as other policies like barriers to entry into health care provision, and mandates that health insurance cover all sorts of ordinary expenditures that shouldn't require insurance) have led to an enormous amount of wasteful excess spending.

PPS. I despise flexible saving accounts. For me, the benefits in tax savings are almost entirely offset by a lot of annoying and confusing paperwork. It's what economists call a "deadweight loss", just pure economic waste produced by foolish government policies. The private sector has these too, with things like $25 rebates on the contact lens, but only after lots of silly paperwork. I do see the price discrimination argument in favor of rebates, but if my time filling out the forms is worth $24 it's worth doing, and yet almost a complete waste of resources from a social perspective.


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COMMENTS (18 to date)
J Hanley writes:

I think if you reimbursed me for my share of your contact lens costs, you'd still be satisfied with the price.

I despise the flexible savings accounts, too. You're right about the tax advantages being outweighed by the costs of doing paperwork.

Ken P writes:

I guess I'm fortunate with my FSA. For me the paperweight amounts to swiping my FSA card instead of my credit card. Automatically deducted. No issues with it.

The Cadillac provision may be slated for 2018, but the effects have already taken place. My employer informed us last year that they were gradually changing our health plan so that when it takes effect our plan would not be classified that way.

John Thacker writes:

I don't like FSAs at all, because of the "use it or lose it" provision. HSAs I am much more positive about, since they lack that wasteful provision. (Spending accounts vs saving accounts.)

Unfortunately the Cadillac tax also hits HSAs-- but only when the contributions are through payroll deduction, including employee chosen. HSAs done through the more complicated strategy of post-tax contributions following by deducting on your taxes will be immune. That's at least according to the current IRS proposed regulations.

RPLong writes:
40% of the cost of health insurance for middle class families is paid for by the government, via tax deductions for health care costs.
To me, this is a lot like saying that government subsidizes licorice by taxing it differently than cigarettes.

By taxing income, the government has created a perverse incentive for the increased provision of non-income fringe employment benefits. That's not the same thing as "subsidizing" those benefits. I am puzzled why people (it's obviously not just Scott Sumner) choose to see it that way. It isn't economically equivalent. The absence of a tax is not a subsidy. The real problem here is that income taxes are too high - if they weren't, then the incentive to provide tax-free benefits would be much lower than it is, and "cadillac plans" would be almost non-existent.

The problem here isn't that health insurance is subsidized, but that over-reliance on health insurance has artificially inflated the prices charged by medical practitioners. By describing things in terms of a subsidy, I feel we're getting further away from understanding the fact that there is no downward pressure on health care costs because there is an entire economic segment that profits by preventing consumers from being directly exposed to prices.

Which brings me to the real problem with Obamacare: It forces (almost) everyone to use health insurance rather than cash; cash payments are the only free market means of controlling health care prices, and Obamacare strangulates this mechanism in favor of rationing.

Limits to "cadillac plans" are, in fact, rationing, but this is not obvious if you see the absence of a tax as a "subsidy."

bill writes:

Your PPS on the dead weight loss is exactly right and something that has always bugged me. Add to that the payments to the middle men of this dead weight loss. And the fact that the dead weight loss is so friggin dead that small businesses can't afford to participate (ie, the fees to the middle men exceed the benefit of the tax arb. And that's before adding in the silly paper work and time costs to the participants). I say this as someone who hated these accounts philosophically when I worked for a large company and then started a small business later.

Vivian Darkbloom writes:

@RP Long

"To me, this is a lot like saying that government subsidizes licorice by taxing it differently than cigarettes."

If the standard starting point is that all "income" is taxed, then making a (relatively rare) exception to the general rule if one puts aside that income for a particular thing is, in my view, a "subsidy", not only for the consumers but also the providers of that particular thing. Call it what you want, a "subsidy" or an "exception to the rule", but, whatever, it is certainly preferential treatment. This is a relative concept because health care is the exception and licorice is not. Current policy prefers one sort of consumption (health expenditures) over almost all other types. And, with regard to FSA"s (as opposed to say, IRA's) that income is not merely deferred, it's permanently excluded income from the tax base only because it supports one type of government-favored consumption over almost all other types .

Of course, the Cadillac tax is an idiotic idea, born only from political expedience, as it is an indirect and rather inefficient means of countering the real problem: in the first instance, the tax deductibility/exclusion of health insurance and health care expenditures and income earmarked for such. (And, perhaps. a less noble objective--to obliterate employer-provided health insurance). But, indirect and complex measures designed to obscure one's actual intentions are very popular and effective techniques of politicians of all persuasions. Was it Shakespeare who wrote "by indirection find direction out"? The political corollary might be "get desired results by indirect means, even if those indirect means are inefficient and cause huge deadweight costs". And this is a rather perverse example of countering one source of deadweight costs by piling on another such source.

Scott Sumner writes:

J Hanley, Can't argue with that.

Ken, I wish I had that card.

John, Good point about use it or lose it, which I forget to mention. Most true health care expenses are unpredictable. By forcing you to set aside a fixed sum ahead of time, they virtually force people to use the money for routine expenses, which defeats the entire purpose of insurance.

RPLong, You said:

"To me, this is a lot like saying that government subsidizes licorice by taxing it differently than cigarettes."

No, that's a very poor analogy. If I buy $1 in licorice, and the product is taxed, my net worth falls by more than $1.

If I buy $1 worth of health care, that decision causes my net worth to fall by about 60 cents. The two cases are totally different. Under the McCain proposal, we'd pay about the same amount of tax, but health care would cost far more at the margin, reflecting its true cost to society.

My claim that health care is effectively subsidized is not controversial, as far as I know all health care experts agree with me on this point. This subsidy encourages me to consume more health care. In a sense the question of whether you call it a "subsidy" is irrelevant, the key point is that it makes health care dramatically cheaper, and leads to overuse. That's true whether you use the term 'subsidy' or not.

RPLong writes:

Prof Sumner, my claim is that health care is not over-used, but rather under-supplied. This, too, is uncontroversial. But rising costs are typically more characteristic of the latter rather than the former. Furthermore, it isn't contact lenses that drive health care costs, it's medications like statins and beta blockers, chronic medications that add up over time. The health economics literature will attest to this. This is the key insight that will help us improve the system. We don't need more impediments to health care access, we already have plenty. What will help is a robust price mechanism.

Wintercow20 writes:

A friend of mine has managed to use his Flexible Spending Account to pay for ... his son's travel ice hockey season fees, all in the name of health care. That's somewhere in the $2,000 range for the hockey.

Levi Russell writes:

The actual solution to all this is to end the incentives for buying "insurance" for routine medical care or relatively minor expenses. Direct patient care practices actually make this sort of thing possible for the middle class.

And of course the mutual aid societies that helped poorer Americans pre-1950s were pushed out by crony medical regulations. There's no reason they can't be allowed to come back in some form or another.

Nathan W writes:

The USA spends more on health care than any country on the planet, regardless of the measure used, but achieves worse average results than most other wealthy countries on almost every measure.

Something is not working.

My personal opinion is that state-level public health care (perhaps with federal top ups to address regional inequality, along the lines of the Canadian model) would save a lot of money, but I don't think that will happen because to many special interests with a great deal of experience in lobbying and public persuasion will prevent it from happening.

In Canada, you would still get to write off your contacts, so long as total medical expenses exceed the threshold of

Scott Sumner writes:

RPLong, I agree that we need fewer restrictions on supply, but the tax subsidy to health care is still unquestionably a disastrous policy, which increases demand sharply and drives up costs. Why should people care about all these expensive and useless tests and procedures, when they don't have to pay? The medical industrial complex takes advantage of consumer apathy, and grossly overcharges. Even with more competition, why would you want to go to the cheaper provider? You can get cheap (good quality) health care in Thailand right now. But why bother?

Wintercow, I'm not surprised, it's a crazy program.

Levi, HSAs are also a good option.

Nathan, The Canadian model may be better than the US model, but the Singapore model is better than both of them. In Singapore most health care expenses are paid out of HSAs. Health care is inexpensive, and Singaporeans live longer than Canadians. (Actually, life expectancy is not a good test, but it's the data point cited by fans of the Canadian system.)

Floccina writes:
as well as other policies like barriers to entry into health care provision, and mandates that health insurance cover all sorts of ordinary expenditures that shouldn't require insurance

I do not know for sure that reducing barriers to entry would make a huge difference in spending but it amazes me how little the politicians speak about barriers to entry.

ThomasH writes:

The basic problem is that the tax base is income rather than consumption, but given that, the problem is that it is a tax deduction rather than a tax credit so the tax preference is more valuable to those with high incomes.

Tax treatment ought to make the employee indifferent to receiving cash wages and buying insurance or having the employer purchase the insurance. [It would have the added benefit of making more transparent the absurdity of the employer deciding on the employee's insurance coverage based on the employers's religious beliefs.]

Another dimension of the problem is that doctors go along with patients' demand for tax subsidized treatments rather than prescribe according to un-subsidized costs and benefits.

Khodge writes:

It is a subsidy as sugar restrictions, Ex-Im bank, Pell grants, and solar energy are subsidies. In each case, business and personal decisions are affected by the tax code or some other government regulation.

With healthcare, since when is it legitimate to call dollar one reimbursement (e.g. free birth control) "insurance?"

With Ex-Im we can see how difficult it is to unfix government solutions, especially when politicians see tax money and political favors as theirs to distribute at will.

The Original CC writes:

My objection to the Cadillac Tax was that it always seemed like a backdoor way to grant political favors. For example, clearly unions should be exempt from it, right? :) It also just seemed crazy to have a law exempting XYZ from taxes and then having a separate law taxing XYZ.

Jeff writes:

Barriers to entry are very important. The existence of medical tourism proves it.

I suspect that even if heath insurance were not tax-advantaged, we'd still see a lot of it because of the disparity in bargaining power between consumers and providers of health care. I have seen hundreds of EOBs (Explanation Of Benefits) from my health insurers over the past several years, and the most striking thing about them is the difference between what the providers bill for versus how much they actually get paid. The former is either a great big lie, or it represents the price you would be charged without insurance, and it is often three or more times more than the price negotiated by the insurer.

Mike W writes:

Scot Sumner writes: Why should people care about all these expensive and useless tests and procedures, when they don't have to pay? The medical industrial complex takes advantage of consumer apathy, and grossly overcharges.

Could consumers ever have the knowledge to know if these tests are useless? Contact lenses can be a discretionary expenditure for the consumer but are PSA tests and MRIs?

Is there an example of any developed country where consumers have the knowledge necessary to make informed choices about health care? Or does the "medical industrial complex" restrict this information from reaching consumers?


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