In January, President Bush appointed former senators Connie Mack and John Breaux to head a bipartisan advisory panel on tax reform. For the past couple of months, the panel has toured the country, hearing testimony on how to make America’s tax code simpler. Here’s the $200 billion question: What will they say about health care? While the two issues may seem to have little in common, the tax code has had a profound influence on the structure and cost of American health care–and if President Bush is serious about tax reform, he must also reform health care.
Most Americans receive their health insurance from their employer. Few pause, however, to contemplate why. As part of the war effort, the FDR administration imposed wage and price controls. Employers, seeking a way to provide workers with competitive salaries without violating the law, began offering health benefits. On October 26, 1943, the IRS legitimized the practice, ruling that health benefits would remain tax free.
As a result, it has historically made sense for firms to offer health benefits–and lots of them. If an employer offers his manager a raise of $1,000 a month, after income and payroll tax, he’ll probably take home $600. But if the employer offers $1,000 more of health benefits, the employee gets every dollar’s worth. Many company plans, thus, offer sunglasses, massage therapy, and marital counseling–not essential ingredients for wellness but rather disguised income.
Employer-based health coverage may be a good deal for employees but not for Washington. According to calculations by John Sheils and Randall Haught, both of the Urban Institute, tax-free health insurance cost the Treasury nearly $200 billion in 2004–more money, incidentally, than the tax subsidy for mortgages.
Much is spent, but hardly wisely. The health-tax exclusion is regressive, helping the CEO far more than the mail clerk. For someone earning $100,000 a year, the government spends nearly four times more on health insurance than for an employee who makes just $20,000.
Employer-funded health insurance is a quirky development of FDR’s wage and price controls. An alternative would be a health-care system built on individuals and families purchasing their own health coverage. The advantages are numerous:
Portability. Presently, changing jobs means changing health plans and, often, that means changing family doctors. Given that workers in small and mid-sized firms typically stay with an employer for 15 months, many Americans are constantly changing their insurance–and their health providers. Worse, a spell of unemployment may mean going uninsured. If health insurance weren’t job dependent, job status wouldn’t affect health coverage.
Choice. According to the Kaiser Family Foundation, about four in ten American workers with employer-financed health insurance have no choice of plans, meaning that they are stuck with one-size-fits-all coverage. Another 13 percent must choose between only two plans. Worse, these plans are often best suited to the employers’ interest, not the employee’s. In contrast, if insurance decisions fell to the individual, not his or her firm, there would be many options and people could pick what best matched their needs.
Freer labor. In a recent study, University of Wisconsin economist Scott Adams demonstrates that the American workforce is significantly less mobile because of employer-financed health insurance. Many workers–Adams estimates 20 to 30 percent of non-elderly men–worry enough about losing their health insurance that they stay put. If health insurance weren’t based on employment, the labor force would be more mobile.
Health reform. Because the tax code rewards employers who provide lavish health benefits, Americans tend to be over-insured. For every dollar spent on health care, people spend just 14 cents out of pocket–and Americans rarely consider factors like price and quality. But if Americans had a more direct interest in the payment of health insurance, they could, and most would, economize.
What to do with the health-tax exclusion? Economist Milton Friedman suggests eliminating it. “There is no more reason for medical-care expenses to be tax deductible than for food, clothing, and housing expenses to be tax deductible,” he says. “A minimum deduction for all of them is provided in the personal exemption.” Given the political environment, Congress is unlikely to take this step. A more acceptable approach would be for the federal government to end the tax code’s discrimination in favor of employer-based health coverage. In the short term, this could be done quickly and easily: allow individuals and families buying insurance to deduct the premium without itemizing.
A more radical prescription would be to phase out the health-tax exclusion and replace it with a system of refundable tax credits. If Washington is going to be in the business of subsidizing health insurance, at least it should do so smartly. People could then choose to get their health insurance through their employer, through other groups (like their church), or simply use their tax credit to buy insurance for themselves. A sliding-scale for the tax credits would also help lower-income Americans. Because of the hesitation in promoting a major health-care proposal post-HillaryCare, the credits-for-exclusion change could be phased in over several years.
For too long, Washington has considered tax reform and health-care reform two separate and distinct issues. President Bush wants tax reform. If he and his panel are ambitious, that could mean the most significant health reform in six decades.
–David Gratzer, a physician, is a senior fellow at the Manhattan Institute.