Tuesday, 16 July 2013

Taking a Checkup on the Nation's Health Care Tax Policy: a Prognosis : Statement of Leonard E. Burman before the United States Senate Committee on Finance

library Leonard E. Burman

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Note: This testimony is available in its entirety in the Portable Document Format (PDF).

The text below is a portion of the complete document.

Chairman Grassley, Ranking Member Baucus, and Members of the Committee:

Thank you for inviting me to share my views on the state of tax policy with respect to health care in the United States.

This hearing is extremely timely. Over 45 million Americans under age 65—the overwhelming majority of them in working families—lack health insurance. They are less likely to obtain important preventive screenings while healthy, and they receive lower-quality care when sick.1 And, the public ultimately shoulders the burden of paying for the medical treatment of those lacking insurance, through either higher taxes or higher health care costs.

The tax system has played an important role in the evolution of the market for health care, and tax reform will inevitably be a part of the solution to the market's problems. Tax subsidies for health insurance and health care will reduce federal income and payroll tax revenues by over $200 billion in fiscal year 2007. Almost all of that revenue loss is attributable to the exclusion from income and payroll taxes of employer contributions to employer-sponsored health insurance. Thus, it is no surprise that most Americans under age 65 get their insurance at work. What may be surprising, however, is that even with such huge subsidies, more and more people are becoming uninsured, especially the young, those with low incomes, and those who work for small firms.

Some observers have suggested that the tax subsidies are a significant part of the problem. The subsidies encourage people to get insurance at work, stifling the individual nongroup market, and they encourage employers to provide overly generous insurance since the cost is subsidized. What's more, the subsidy is upside down—aiding most the high-income families that would probably purchase insurance under any scenario, and providing little aid to those of modest means.

Some, such as former Council of Economic Advisers chairman R. Glenn Hubbard and colleagues, have suggested that the best option would be to eliminate the employer exclusion altogether and let the market come up with cost-effective ways to supply health insurance to the public. But, in an unfettered free market, health insurance is likely to be too expensive for four reasons. First, the very act of having insurance increases utilization. People spend more when someone else is writing the check, but this causes insurance to be more expensive than it might be (a phenomenon known as moral hazard). Second, insurance is most attractive to people who expect to benefit most from it—such as those with chronic conditions and people who plan to have children. Because insurers can only imperfectly match premiums to expected utilization, they have to assume that purchasers have higher costs than the population average. That means that healthy people get a relatively bad deal from insurance—unless they can align themselves with a large group. (This feature of insurance is called adverse selection.) Third, the existence of free—even if inadequate—emergency health care for those with low incomes serves as a deterrent for purchasing health insurance, both because the free care provides a safety net and because uncompensated care raises the cost of care for those with insurance. Finally, healthy people—especially in the non-group market—can only imperfectly insure against the costs of developing chronic illnesses, because premiums for non-group health insurance increase over time for sick people.

Subsidizing individuals who get insurance at work mitigates some of these problems and exacerbates others. On the one hand, encouraging individuals to get insurance at work reduces the problem of adverse selection, because people choose employment for reasons unrelated to health status, and also offers those who work for large firms a kind of renewable insurance. But this pooling works less well for small employers whose costs may be heavily influenced by the poor health status of one or several employees. On the other hand, the tax subsidies encourage over-use of medical services because people don't face the true costs of insurance. And, as noted, the current tax subsidies are poorly targeted. The value of a tax exclusion grows with income and is worth little or nothing to those with low incomes, even though they are most likely to be deterred by the cost of insurance.

On balance, despite its failings, the current employer-based system supplies health insurance coverage to almost 70 percent of American workers under age 65. Reform should build upon that coverage base instead of eroding it. Simplistic market-based solutions, though appealing, are likely to come up short. Market reforms that ignore adverse selection, for example, or the fact that a growing fraction of Americans simply cannot afford to pay for health care and meet other basic needs are bound to fail. The best option is to retarget existing subsidies, guarantee that low-income people can afford adequate insurance and that affordable health insurance exists either at work or in a reformed nongroup market, without encouraging excessive spending. And the best option might be one that works outside the tax system.

In the rest of my testimony, I summarize the latest data on who has health insurance and who doesn't, outline the various tax subsidies that exist for health insurance, examine how those subsidies affect the market for health insurance and employment, and briefly comment on some reform options.

Notes from this section

1 Hadley (2003) estimates that mortality declines by 4.5 to 7.0 percent for people when they gain health insurance.

Note: This testimony is available in its entirety in the Portable Document Format (PDF).

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