The Best of the Second Best: Using Tax Breaks to Manipulate Health Insurance

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The Best of the Second Best Using Tax Breaks to
Manipulate Health Insurance

• Mark V. Pauly, Ph.D.
• ARIA Meeting
• August 7, 2006

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Goals of this talk

• To summarize the design of ideal tax incentives
  for health insurance.
• Having observed that movement to the ideal is not
  politically feasible next week, what are possible
  second best arrangements that represent
  improvements if not perfection?
• How do these alternatives compare on efficiency
  (where I am an expert) and on political
  likelihood (where we are all amateurs)?

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Ideal Insurance Subsidies

• No subsidy at the margin for additional coverage
  beyond the level that assures socially approved
  use and financial protection.
• Translation Dives (high income, healthy) does
  not need a subsidy, but Lazarus (low income, high
  risk) does.

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Ideal Subsidies in Detail

• Subsidize the premium of the minimum policy
  needed to produce ideal use probably larger for
  lower incomes and higher risks.
• Make the subsidy fixed dollar people can buy
  whatever insurace they prefer as long as it is
  more at the minimum but with no marginal subsidy.
• Deal with insurance risk change through GR or
  other devices.

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What Current Subsidies Do

• Subsidize high incomes more than low.
• Subsidizes employment based coverage so employers
  choose rather than individuals.
• Offers an open-ended subsidy to insurance
• HAS/CHP too little, too limited to help much so
  far.

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Where are the distortions?

• 1. Subsidize health insurance rather than out of
  pocket paymentleads to excess moral hazard.
• 2. Subsidizes health care rather than other
  goodsleads to too much health and too little
  wealth.
• 3. Bribes people to let their boss pick their
  insurance, and take it away if they get too sick
  to work.
• 4. But it is the American way.

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Second Best solution fix some but not all
distortions

• Health Savings Accounts-CHP fixes employer choice
  ( a little) and overinsurance (but crudely)
  creates bias toward high deductible plans
  (relative to Rambo HMO) in individual market.
• Cogan, Hubbard, Kessler fix bias toward group
  insurance by making all spending on care or
  insurance deductible, but this leaves bias toward
  medical care.
• Caps on exclusion fix bias toward insurance and
  health care but not toward employer choice.

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Away at the Windmill Why not first best?

• Best estimate of spending reduction is CHK, about
  6. Phelps estimate suggests eliminating the
  exclusion entirely would save 10-20 (all based
  on Rand data). As a of total spending, these
  changes are reduced by Medicare and Medicaid.
• CHK everything deductible approach still leaves
  biggest subsidies for those who need them the
  least abolishing the subsidy (and then filling
  in with credits) will be better.

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A modest proposal treat group health like group
life

• Exclusion of group life premiums are capped at
  face amount of 50K.
• This has not destroyed group life but probably
  has caused it to be lower relative to
  individually chosen life. Little reduction in
  risk pooling that we know about.
• No big fuss about the level of the cap.
• Easy for employers to offer choice of levels of
  coverage.

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The analogy

• Set up a cap at the cost of a modest plan.
• Encourage employers to offer at least that plan,
  but also alternatives.
• Increase the cap at a rate that is socially
  approved.
• Convert to refundable credit for lower income
  people.
• Might allow the exclusion to wither away and the
  credit to grow.

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Why Politics Is Hard

• I currently exclude more than 10,000 of my
  income through employer payment, cafeteria plan,
  and FSA (where I have defeated use it or lose
  it). Estimate the tax savings to be 4500.
• If I were selfish I would want to keep this.
• But if I were rational , I want you to offer me a
  4500 closed end tax cut, and then I would be
  happy to spend more frugally.
• The problem converting an inequitable but
  inefficient loophole into an efficient one makes
  the inequity too obvious to be tolerated. Since
  I can only keep my ill-gotten gains in an
  inefficient form, I support inefficiency.

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Why Middle Class Cost Containment is Also Hard

• We could get non trivial but not breathtaking one
  time spending reductions for sure by changing tax
  treatment.
• Need not have an effect on risk pooling in large
  firms, and there really is very little pooling in
  small firms relative to individual insurance with
  GR.
• But it will not obviously slow the rate of growth
  much, for very long. Some positive research but
  nothing definitive.
• We need a change of mind as well as a change of
  taxes. Face up fearlessly to rationing new
  technology or to foregoing some other growth in
  real income.