Economics, Politics, Social Commentary and occasionally Superstring Theory.

Saturday, December 11, 2004

Health Care Reform

Andrew Samwick makes a compelling case for eliminating the deductability of health care premiums, both on the employer and employee side, here and here. Tyler Cowen weighs in here. Brad DeLong signs on with Samwick here. The crux of Samwick's argument is:

Who benefits from this deductibility [of insurance]? ...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...

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.

I have a few reservations, myself.

The above is a good argument for ending the deductability at the the employee end. If you look at the deductability as a government payout rather than an exclusion (which it is, the government is forgoing a tax it could have employed, and in doing so is putting money in your pocket) the deduction makes no sense. It does not encourage anyone to do anything. It is skewed toward the higher income brackets. Furthermore, and most importantly, the deduction has little to no effect on whether employees opt for coverage. Employees don't get to decide whether their employer offers health care. And if it's offered to them, they certainly aren't going to turn it down simply because their income gets taxed before their premium is withdrawn, instead of after. The current deduction does nothing but give people a break on however much their insurance plan might charge for a premium. Taking the deduction away allows the government to target new money towards programs that might actually fix the health care market (overconsumption and inefficient choice of services). It also puts a little bit more of elasticity on the demand side for premium increases, as employees will feel them more than they do now.

The deduction for employers needs to stay. Eliminating it means that the cost of providing health care to employees goes up. Small employers are having a hard enough time keeping up with premium increases already. Making it even more expensive by eliminating the deduction means pricing more employers out of the market, and that means more employees will be unable to receive health care. Many low-wage employees simply cannot afford private health insurance if it is not provided by their employer.

Instead of using the money saved by eliminating the deductions to create tax credits for the purchase of health insurance, as Andrew argues above, I'd rather see them put into Health Savings Accounts. The goal of the HSA is to allow employees to divert some of their paycheck, on top of their higher deductible health care premiums, to a savings account which will cover out-of-pocket expenses until the insurance kicks in. Instead, eliminate the deductibility at the employee level, but use the new tax dollars as a transfer into the person's HSA. For instance, Andrew quotes above that the average family of four in the 30-39K tax bracket gets $1,231 from the deductability. Instead of that deductability, which doesn't give the family an incentive to do anything, why not put it in their HSA? This means the family that can't afford to divert any of their paycheck to contribute to their HSA can now forego the benefit of deductability and contribute directly into the HSA. Admittedly, all this is doing is switching around the time the benefit is realized, but it ties the benefit more directly towards health care spending.

Let's take it one step further and see if we get more benefit from means-testing it. This means we provide more of the benefit to people making less money. How to do it? Well, this is the tricky part, because again there's no way to judge health care spending or family size off of income tax bracket alone. Well, first off we can cap the automatic distribution of the deduction at age 65, because that's when Medicare kicks in. You'd still be able to withdraw from the HSA, but no more automatic contribution. This will give us some more money because people at age 65 and above will still be working, but we'll be transferring the benefits of the deduction to someone who doesn't have Medicare to back them up. Second, we can correlate a number of dependents that a household has to the number of children it has. The more people in the house, the more medical expenses there should be. We tie the amount of the benefit to the number of dependents claimed. So, for every dependent a person claims in addition to themself, they get a certain multiplier of their deduction contributed into their HSA. For instance, if you only claim yourself, you get the benefit of the deduction placed into your HSA. If you have claim head of household, have a wife and three kids, you'd get your deduction benefit times X, where X = the mutiplier assigned to 4 dependents, contributed into your HSA. The money saved by means testing means we can afford to give poorer families more than their automatic deduction contribution, which means they have more money to spend on health care.

Alright, you might say, but this is not going to help out anyone during Year One of the program. The contributions into the HSAs are going to be so small that they can't possibly cover ongoing first dollar expenses. You may be right. So, let's give everyone an up-front deposit of what their estimated deduction value would be. For instance, based on the deductions you had last year, let's say you're going to get X amount of dollars next year. We'll just give it to you now. Obviously, you'd want to make the means testing for eligibility for this program tighter than you would for the ongoing program. The most effective way to do this would probably be tie eligibility to eligibility for the Earned Income Tax Credit. It's going to cost you a few billion, but it's only a one-time expense and there are worse ways to spend the money.

Finally, you might ask, how does this combat the real problems in the health care market: overconsumption and inefficient decision-making? The same way regular HSA's do, by making consumers more price-sensitive to initial expenditures. The theory goes that once you've spent enough that your insurance is kicking in, you've become less price-sensitive because there's something seriously wrong with you. The key difference in the plan above is that it allows more participation in the program by diverting a benefit no employee pays attention to, deductability of premiums, into one they can use, their HSA. It allows poorer employees with more medical liability to actually realize more than their respective benefit by means-testing it to target it to those families who need it the most. Those who are so price sensitive that they've sensitized out of the market.

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