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December 07, 2004

Eliminating the Deductibility of Employer-Sponsored Health Insurance

Now comes Andrew Samwick with a proposal for eliminating the deductibility of employer-sponsored health insurance that I can endorse: "[Tax] deductibility is a terrible way [to provide incentives for the purchase of health insurance]... for equity reasons.... Subject... all [employer-sponsored health coverage] to tax, and take some portion of the $100 - $200 billion saved and use it to provide refundable tax credits to purchase health insurance, whether through an employer or an individual policy. The credits should phase out at higher income levels..."


Vox Baby: There are two ways to remove this distortion--by allowing both types of expenses to be deducted or by allowing neither type to be deducted. The introduction of Health Savings Accounts (HSAs) in the Medicare bill last year was a way to do it based on the former. I favor the latter. Here's why.

The deduction exists because there is a notion that the government ought to encourage people to get health treatments that they need. Deductibility is a terrible way to do this, on equity grounds. Take a look at Exhibit 1 in the paper by Sheils and Haught. It estimates that $209.9 billion of tax receipts are foregone in 2004 because of deductibility, with $188.5 at the federal level and $21.4 billion at the state level. Of the federal portion, $101.0 billion is due to the income tax deductibility, with another $66.4 billion due to exemption from the payroll tax for Social Security and Medicare. That's one large chunk of change.

Who benefits from this deductibility? Exhibit 2 in their paper shows that the average family with $100,000 or more in income receives a benefit of $2,780. Compare this to an average benefit of $1,231 for a family with $30,000 - $39,999 in income. Because tax rates are higher at higher income levels, and those with higher incomes are more likely to have coverage, the benefit goes up with income. Exhibit 3 in their paper estimates that, in the aggregate, the 14 percent of the families with incomes over $100,000 receive 26.7 percent of the federal tax benefits, compared to 28.4 percent of the benefits received by the 57.5 percent of the families with incomes below $50,000.

The portion of this disparity that is due to the progressivity of the tax system is ridiculous. Subject it all to tax, and take some portion of the $100 - $200 billion saved and use it to provide refundable tax credits to purchase health insurance, whether through an employer or an individual policy. The credits should phase out at higher income levels. (Credits offset a tax liability dollar-for-dollar. Deductions offset taxable income dollar-for-dollar, and are those more valuable to people who pay higher tax rates on that income.) This is a far more equitable way to use tax revenues (or their absence) to promote health insurance coverage, in addition to its efficiency consequences for reducing moral hazard.

Brad's concern, which is expressed in the other 4 pieces of economic theory that he says are relevant for the article in the Post, pertain to possible consequences of making such a shift. He writes: "The other four principles of economic theory strongly suggest that trying to push the country out of its current pattern of health-care financing into one in which individuals bargain one by one with insurers for their coverage would be a very bad idea." It is worth pointing out that replacing deductions with credits as I have described does not necessarily push us to a situation where there is no group coverage....

Posted by DeLong at December 7, 2004 04:37 PM

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There's an interesting debate raging on the potential effects of eliminating the income tax exemption of employer-provided health benefits to which I want to add some clarifying points. First, eliminating the exemption outright (without implementing ... [Read More]

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Tracked on December 10, 2004 11:33 PM

Comments

If I am reading this correctly, Samwick is saying that we should essentially tax those on the higher end of the income scale and use the money to give those who don't have insurance credits to buy it. Is that correct?

How does this differ so greatly with what Bush is proposing?

Posted by: Brian at December 7, 2004 05:31 PM


Actually, the original reason medical expenses were deductible was that they involuntarily reduce the "ability to pay" that taxable income tries to measure. Health insurance is *excluded* from income (which is better than just being deductable) for obscure reasons that originally had to do with non-cash compensation as a way to avoid WW II price and wage controls.

Doesn't this proposal just compound the problems of employment-linked access to health care? And why have the credit phase out above some unspecified income level? Phase-outs are the bane of the tax system: they result in a marginal rate structure that looks like a sawtooth. If you want to tax high incomes, do so directly, not thru gimmicks.

Posted by: Robert at December 7, 2004 05:50 PM


Interesting discourse, but possibly tangential to the problem.

he biggest problem of coverage is getting an affordable policy. Anyone with experience will tell you that large companies offer policies at much lower costs to employees than small companies, which in turn are cheaper for the same policy than individual purchase. Whether this is due to better risk pooling or buyer power, I don't know. But clearly the best solution is to offer individuals a policy from a large risk pool. This inevitably leads to coverage by government, as they are the largest possible pool.

There are 2 nice effects of this. Firstly, policies become portable, increasing job mobility, much like the situation when personal pensions became available.

Secondly, this prevents the cherry-picking by insurers, where you can't get insured if you have poor health, a problem that will be very problematic as genetic testing provides some insight into health outcomes. The Economist did a nice special on this problem a few years ago and suggested that insurance providers would shift from the private sector to government. Kerry was clearly on the right track with regards to insurance coverage, although the deeper problem of demand and cost of supply remains to be solved.

Posted by: Alex Tolley at December 7, 2004 06:21 PM


You're just missing out on the secret Bush administration plan. It's really simple. Make the existing tax cuts permanent. Eliminate the capital gains tax on top of that. Come up with a "tax reform" that further favors the wealthy. I promise you that their reform will have that effect. Then you count on the tooth fairy to deliver their salary to all government employees including the military and Santa to bring them their needed hardware. Hey, it's as realistic as any other economic ideas coming out of the White House.

Posted by: Jim S at December 7, 2004 06:25 PM


"essentially tax those on the higher end of the income scale and use the money to give those who don't have insurance credits to buy it. Is that correct?

"How does this differ so greatly with what Bush is proposing"

It differs from the Bush proposal in 2 ways:

(1) tax those on the higher end of the income scale, and

(2) use the money to give those who don't have insurance credits to buy it.

Other than those two things, the two proposals are identical . . .

Posted by: rea at December 7, 2004 07:07 PM


"The biggest problem of coverage is getting an affordable policy. Anyone with experience will tell you that large companies offer policies at much lower costs to employees than small companies, which in turn are cheaper for the same policy than individual purchase."

Yes -- "anyone with experience." I expect there's a connection between Samwick's perspective and the fact he's a tenured professor. I'm always amused by the ferocious admiration for free markets among economics professors who don't experience them.

Posted by: A Tiny at December 7, 2004 09:04 PM


A Tiny, I don't understand what point you're trying to make, unless it's just to be snarky.

I am not a tenured professor. I am not a professor, or a teacher, or employed by any educational institution. And I can tell you that, the larger the group, the smaller the premiums insurance companies charge.

Anyone who's ever been insured by an employer, who then loses that job and tries to get the same policy by the same insurer, knows what happens to the premiums. They go from a $45/month employee contribution to a $350+/month go-it-alone premium. And that's for a single person with no kids.

Oh, and if you're referring to what the employer pays, I can answer that one, too. When I worked for a sole practitioner attorney, we were insured through a Bar Association pool. The premiums he paid as an employer averaged about $275/person per month, with no employee contribution. When I left that job and got my COBRA letter, the premium I would have had to pay for the same coverage was $375.

Posted by: Palladin at December 7, 2004 09:54 PM


Uh, Brad, just what makes you think UCB is going to offer you and your family health insurance after the changes you propose? And by the by what makes you think any insurance company is going to accept you? You look kinda chubby on the photo - are you sure you do not have high blood pressure or something? And how about your kids - they 100% healthy or what?

Posted by: a at December 8, 2004 01:16 AM


Palladin:

Brad’s employer, the University of California, pays $407 per month to insure an individual under Blue Cross PPO. UC pays $289, and the employee pays $118. Your $350/month go-it-alone premium seems on the low side, or perhaps it’s coverage for an HMO. UC should be one of the biggest employers outside of the federal government. Of course, most everything seems to cost more in California: automobile liability insurance, gasoline, electric power, water, trash pickup etc. And of course medicine.

Posted by: A. Zarkov at December 8, 2004 02:42 AM


I do not understand how setting women and men on their own in buying health insurance will improve encouraging large group purchases by offering an employer tax deduction.

Posted by: anne at December 8, 2004 03:08 AM


Palladin wrote, "And I can tell you that, the larger the group, the smaller the premiums insurance companies charge.

"Anyone who's ever been insured by an employer, who then loses that job and tries to get the same policy by the same insurer, knows what happens to the premiums. They go from a $45/month employee contribution to a $350+/month go-it-alone premium."

But you're conflating the individual contribution with the total premium.

I once worked on a project studying small group health plans for small businesses. The overriding impression I got was that the most important reason small businesses don't offer health insurance is that (on average) their employees make a lot less money than those in large businesses. (Mostly because they are in different industries, have different capital-to-labor ratios, etc. Put another way: how many restaurants are going to offer their employees health insurance?)

While you'd think premiums for smaller groups are larger (because of the larger risk involved, adverse selection, etc), I don't see that much evidence that it's the *number one factor*.

Posted by: liberal at December 8, 2004 03:29 AM


The essential problem with removing employer deductions for health insurance is that no conceivable system of credits or personal deductions will make up the difference. For example, my wife and I are able to get our policy through our business, and that costs us $6,500 a year. If we didn't have the business, it would cost us more than $10,000 per year.

In order to make this work so that the tens of millions who will lose their employer-provided insurance will have their own personal coverage, the size of the credits will end up exceeding what many of these people currently pay in taxes. That doesn't sound very revenue neutral to me.

And, of course, one must wonder what will happen to the health-insurance companies when 90 percent of their customer base (businesses) suddenly stop buying their product.

Posted by: Derelict at December 8, 2004 06:00 AM


This really does ignore the primary advantage of employer-based health insurance, the cost benefits of having a group plan. This tax distortion talk is really silly.

Posted by: Atrios at December 8, 2004 06:01 AM


Probably over my head here but I thought I'd share some thoughts I had reading the two posts.


Interesting discussion. I think that Samwick's heart is in the right place and I'm also quite aware that employer-linked health insurance has multiple problems (although the biggest issue I have with it is the targeting of it (and the barrier that it creates to real reform) rather than any economic inefficiency it produces), but I think he's leaving out topic specific issues that are relevant to any discussion health insurance market reform. One that popped up immediately while reading this was take-up. While Samwick believes that the group market won't disappear, it's not inconceivable that many firms would shed their current role of playing the matchmaker between insurance companies and consumers of insurance. This role has some sort of administrative cost associated with it and while some players, like Cal and Dartmouth, might find this cost worth the benefits it has in keeping/drawing workers, firms that operate with a much less flexible labor pool would no doubt scrap their role in this market in a future round of cost cutting. Chances are these are the firms that employ those on the "wrong" end of the income distribution. These workers will then be required to purchase insurance in the individual market. This is a process that has considerable cost to the individual. There is a real cost of obtaining information and actually signing up for insurance, costs that will end up inducing one to forgo the benefit even though it is now lost to them. Also, any increase in the individual market will require additional regulation by the government. In addition, how will this subsidy be transferred? Any subsidy that needs to be reconciled at year end (taxes) is doomed to be a failure for those that, I believe, Samwick wants to help most....the less-well off. Any subsidy that transfers real benefits up front to individuals to purchase insurance is something that will have real cost to whomever it is administrating this program.

Anyway, maybe I'm wrong....that's actually a safe bet since I didn't put too much thought into this....but I think that there are probably a lot of other issues that weren't touched on in Samwick's post that would need to be addressed before one can state we'd have "a more efficient means of delivering the care".

Posted by: Sean at December 8, 2004 06:58 AM


I love the convuluted arguments these people are coming up with to demonstrate that the best solution to the health care proble is to raise taxes. How come none of the supply siders use these arguments for the rest of the economy?

Posted by: spencer at December 8, 2004 07:36 AM


We should, of course, do exactly the same thing with home mortgages. The mortgage interest deduction does little to encourage ownership (people at the margin generally do not itemize, and because they finance heavily with debt, do not get the benefit of untaxed imputed rent), but it does encourage people like me to buy bigger houses. The overwhelming majority of the benefits accrue to high income households.

Homeownership is a good thing--we have a lot of empirical evidence to support the idea that it creates positive externalities. So a refundable credit homeowning credit that phases out at high incomes would be progressive, encourage ownership, and discourage wasteful spending on housing.

Posted by: Richard Green at December 8, 2004 07:48 AM


If a Yugo is the only transportation you have, you don't blow it up just because it is a lousy vehicle. Eliminating the (badly flawed) employer-based health insurance system would cause insurance levels to drop, from simple negligence and shortsightedness of some consumers among other reasons, to the serious detriment of an already detriment-ridden system. Buy a road-test a Toyota first, then blow up the Yugo.

Posted by: Ken at December 8, 2004 08:07 AM


Speaking of insurance, weren't the Sept2001 WTC attacks recently ruled to be two seperate attacks and two seperate insurance liabilities?

Respectfully OT;

http://www.intelligence.org.il/eng/var/am_sup.htm

http://instapundit.com/archives/019440.php

http://littlegreenfootballs.com/weblog/lgf-fallujahchem-slideshow.php

Posted by: polltroll at December 8, 2004 08:56 AM


rea,

Okay, so I wasn't missing something. I thought I was, because if Bush was proposing what Samwick was proposing and DeLong was getting behind, it seemed unreasonable to be so hostile to it.

Now that I know he's not doing it, however, I still believe he's essentially forcing people into Health Savings Accounts.

Posted by: Brian at December 8, 2004 09:15 AM


As a self employed individual who has to purchase insurance, it seems to me all of the debate on the heath insurance/issue are ignoring several factors that seem critical to any debate.

Insurance no longer operates on anything recognizable as a market system. Policies are designed to differ and are written in such wildly different manners as to make any side-by-side comparison impossible. The current trend of consolidation in the industry, is making the apparent options out there are even smaller. An environment of collusion is the rule in the industry, and there appears to be little interest in doing anything about it. The only sort of competition I’ve seen is in large contracts with employers. To be able to sell only to individuals, who have no real bargaining power, where anyone with anything that might be considered a risk can be excluded, is an insurance company dream.

Costs continue to rise at alarming rates. At the rates of increase in my policy seen in the past few years, it is possible to see my insurance cost exceed the monthly mortgage payment. The issue of employee provided insurance will be tested, as rather than a yearly cost of living raise, many employees see a yearly cut to cover the increased cost of insurance, or more likely, a raise that doesn’t cover their increased out of pocket costs.

Every seems to work for wonderful companies that will immediately turn over the full cash equivalent of their portion of health care costs to their employees should they stop providing insurance as a benefit. This is truly an “ivory tower” assumption.

Posted by: Celcus at December 8, 2004 12:01 PM


Isn't this just another example of their shifting the tax burden to labor?

Posted by: spencer at December 8, 2004 12:51 PM


Now we've got Cogan, Hubbard, and Kessler telling us that not only will this not reduce the number of people who are insured, it will actually increase it by a few million. More than that, it will lead to higher wages.

What the hell are we expected to believe?

Posted by: Brian at December 8, 2004 01:14 PM


Thank you, Rea.

"essentially tax those on the higher end of the income scale and use the money to give those who don't have insurance credits to buy it. Is that correct?

"How does this differ so greatly with what Bush is proposing"

It differs from the Bush proposal in 2 ways:

(1) tax those on the higher end of the income scale, and

(2) use the money to give those who don't have insurance credits to buy it.

Other than those two things, the two proposals are identical . . .

Posted by: lise at December 8, 2004 01:21 PM


So, suddenly we are each set on my own against health insurers who have no interest at all in competing for our premiums in other than advertising. Employers have no responsibility to employees in yet another benefit area, and we are supposed to be better off how? The heck with pensions, the heck with health care. Huh?

Posted by: anne at December 8, 2004 03:55 PM


In my opinion the health insurance question at hand is whether the federal government is willing at any level to enforce usury and fiduciary laws. Insurance companies basically gamble the money they take in as payments from the insured in investments that under ideal circumstances will yield enough money to cover claims against let policies and a profit for investors who put up a pool of liquid assets at the beginning. In order for the insurance companies to beat the rising cost of medical treatment and maintain the unrealistic profit margins expected by investors, they deny treatment, invest in increasingly risky debt and investment instruments like derivatives, and cut and outsource their staffs shifting the burden of processing claims to doctors, hospitals, and patients.
Clearly another market failure to throw in the face of the "free market" fundamentalists and laissez faire capitalists. The right time will be the next flu pandemic to arise in Asia which cannot seem to pry its people from cohabiting with flu harboring livestock. See Edgar Allen Poe's "Masque of the Red Death" for illustration of the class-levelling power of epidemic disease.

Posted by: bigfoot at December 9, 2004 02:27 AM


I'm sure there is something I'm overlooking, but let me offer the "modest proposal".

Why can't health policies be packaged and re-sold like CMOs? This would require insuers to offer a limited menu of standard policies, varying mostly with regard to deductability. The policies would be bundled into units to pool the risks and sold on the market. Market players would limit moral hazard simply by refusing to buy from companies that tried to dump poor risk policies into the units, much as they do with CMOs.

The consumer would benefit because these policies would be more comparable (see David Wessel's article in WSJ Dec 9th about this issue). There would be less incentive to cherry-pick buyers and thus policies could be more available and affordable.

The health care providers would benefit because the consumer would just need to show identification that they owned one of these policies whose terms are payments were well understood.

Because the market is open, there would be nothing preventing insurers offering their existing plans or companies doing special deals. But clearly the standard offerings would be increasingly attractive.

The only government intervention would be to enforce individual coverage and ensure that even poor risks are covered. (I recall as a student in Canada in the late 1970's that I had to by an OHIP policy for access to healthcare)

Perhaps someone from the industry could explain why this scheme wouldn't work?

Posted by: Alex Tolley at December 9, 2004 08:24 AM


Having spent half my life in Canada, these Rube Goldberg economic tools seem silly. The health system there works fine. Americans hear a lot of stories about rationing and about people going outside the system for elective surgery and whatnot. That's fine, that should be allowed. But for Canadians in everyday life, this is a non-issue. Most people never experience any rationing. Compare that to the States, where almost everyone I know has held back on getting crucial health care -- like going to the hospital after a car crash -- because it is going to be too expensive. The U.S. rations health care, but we do it by income rather than by medical necessity.

In terms of economic efficiency, the Canadian model is tremendous. It allows people to quit lousy jobs and start their own businesses without fear of losing health care. It even helps keep skilled workers in the country -- my father and stepmother would love to emigrate to the U.S. for the weather and culture and to be closer to some American family, but they remain in Canada because my diabetic, blind stepmother would be destitute here. In Canada she is a regular middle-class homeowner.

Posted by: Boz at December 11, 2004 01:45 AM


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