How to, Once and For All, (Mostly) Fix Health Care

by Naomi Lopez
April 19, 2018

Healthcare is complicated, but a decades-old policy continues to burden reform efforts. It started when the federal government imposed wage controls during World War II.

To attract and retain employees without illegally paying them more, employers began offering health insurance to increase the compensation of workers. Then a 1943 tax ruling (later codified by Congress) established that employers’ contributions to group health insurance do not constitute taxable income.

That is how the tax preference granted to employer‑sponsored health benefits remains – to this day – the single, largest ailment of the American health care system. About one-half of the U.S. has employer-sponsored health insurance coverage.

A new paper by healthcare policy expert, Yevgeniy Feyman, for the Regulatory Transparency Project of the Federalist Society discusses how this third-party payment system falls short of a cost-effective and patient-centric approach to healthcare.

Feyman states that “We need a health insurance market that is accountable to patients, doesn’t push up health care prices unnecessarily, and one that provides a product that follows a person regardless of their employment situation.”

Today about half of Americans receive health care through their employers as part of a non‑cash compensation package. Because health insurance is not treated as income, it is not subject to federal and state income taxes or payroll taxes. Additionally, employers may deduct health‑care expenses for their employees as an operating expense, reducing the profits on which they pay taxes. This subsidy distorts incentives in important ways.

Most important, employees are much less sensitive to the price of insurance than they would be if they purchased it on their own, which encourages over‑insurance and, thus, overutilization of health‑care services ‑- leading to higher costs for all.

Feyman advocates eliminating the exclusion. He maintains that “the biggest benefit of eliminating the exclusion won’t simply be higher wages. The biggest benefit will be to begin the move away from a health insurance system tied to employers. Instead, a more flexible and patient-centered system will take its place. Ultimately, the goal will be for employees to purchase insurance independently of their employers. While many employers might still want to offer health insurance or assistance with purchasing health insurance, the incentives to do so will be greatly reduced.”

While there are numerous steps both federal and state policymakers can take to achieve better healthcare access and affordability, eliminating the tax exclusion in the most important.

According to Feyman, “With a health insurance system that caters to individual patients, benefits would be right-sized to what patients actually want. In turn, providers of health care will have to think more carefully about how to price their services and what services to offer.”

Naomi Lopez is the director of healthcare policy at the Goldwater Institute.