Want to Fix Health Insurance? Start With the Tax Code

Underneath the tribalistic bullheadedness and partisan signaling lies a common enemy: employer-sponsored health insurance.

In March, President Trump tweeted, “The Republican Party will become ‘the party of healthcare!’”

Given the GOP’s inability to deliver on that promise over the better part of the past decade, many have remained despondent. After all, health care policy may be the one area where such disparate visions would make any attempt at compromise futile and, perhaps, even counterproductive. But underneath the tribalistic bullheadedness and partisan signaling lies a common enemy: employer-sponsored health insurance.

Employer-Based Coverage

Since the beginning of this year, 175 million Americans have received their health insurance through employer plans. Employer-based coverage (distinct from the individual insurance market) arose during World War II through wage controls in the form of preferential tax treatment. Because of that, employers enjoyed the benefits of offering tax-exempt health coverage, but this has come at the expense of consumers in the health care market.

Rather than negotiating with insurance companies directly, employees have outsourced their negotiating capacity to their employers.

One study conducted by health care policy expert Avik Roy measured the benefits of a variety of health insurance programs through a comprehensive grading scale that, among other metrics, included underlying cost, freedom of choice, and annual premiums. In the end, they concluded that employer health insurance ranked far below individually-purchased insurance and Medicare Advantage.

Rather than negotiating with insurance companies directly, employees have outsourced their negotiating capacity to their employers, and the ideal insurance plan might not be the same for everyone involved. After all, not only does this put employees in job-lock, as lamented by Democrat and Republican politicians alike, but it also undermines consumers’ sensitivity to price—a necessary component in a functioning free market.

Let me explain.

Out of Pocket Payments Are Ideal

Ideally, health procedures and expenses would be paid out-of-pocket instead of being covered through a bloated insurance plan. While this may seem like a more costly method for individual people, allowing routine expenses to be paid out-of-pocket would end up lowering the cost of premiums and the cost of such expenses. It’s similar to the way car insurance doesn’t cover routine oil changes. It’s how they keep their car insurance plans from being completely unaffordable. But our current health care system doesn’t operate like that. In fact, it continues to cover some of the most rudimentary services—and continues to be outrageously pricey.

Since insurance companies, not consumers, are negotiating prices and payment, consumers are left in the dark about the true cost of health care services. Economist John Cochrane explains that “with little price discovery left in health care, health insurers have to do all the price negotiation in a vacuum.” All that does is protect health care providers from competing with one another and ultimately cutting their prices.

Employers are incentivized to direct a big chunk of employee compensation to their bloated insurance plans.

Further, since employer-sponsored insurance enjoys preferential treatment in the tax code, employers are incentivized to direct a big chunk of employee compensation to their bloated insurance plans. This helps them circumvent taxation, and price insensitivity becomes worse and worse.

The prevalence of employer-based health insurance is largely responsible for the pre-existing conditions crisis that has dominated our national discourse for the last decade. Because of the overuse of employer-sponsored insurance, the individual health insurance market has been under-utilized despite offering greater protections for patients with costly illnesses.

As health care policy expert Michael Cannon notes,

high-cost patients with guaranteed-renewable coverage are roughly half as likely to end up uninsured as high-cost patients with small-group coverage, and unlike employer-sponsored coverage, the risk of losing guaranteed-renewable coverage does not rise with health risk.

In other words, tying health care to an employer greatly puts one at risk if a serious illness is developed. And if that illness precludes one from working, that individual loses the employer-sponsored insurance.

Individual Health Insurance Market

This, of course, ultimately led to the popular yet misguided pre-existing provision of “Obamacare,” which barred insurers from discriminating against people with pre-existing conditions. While noble in its intentions, this regulation created a negative spiral in which the increased premiums prompted healthy individuals to forgo picking up health insurance, which further increased the cost of premiums, and so on.

A positive and permanent solution would be cultivating an individual health insurance market where plans would have guaranteed renewability and a total satisfaction guarantee. Under these stipulations—and unlike employer-sponsored coverage—individuals would be able to retain their insurance moving between jobs, premiums would not increase if you got sick, and you could change insurance plans without the risk of higher premiums.

Republicans routinely insist that a free insurance market is the solution to rising premiums and bureaucratic inefficiencies.

If the preferential tax treatment ends, employees would see their cash compensation rise. With the increase in wages, people could shop for insurance that best fits their needs. Or, alternatively, employers could fund health reimbursement accounts, effectively allowing employers to divert pre-tax cash that would otherwise go toward buying employee insurance into employee accounts that would be used by employees to purchase insurance in the individual market.

Republicans routinely insist that a free insurance market is the solution to rising premiums and bureaucratic inefficiencies. This, realistically speaking, can’t happen unless Congress dispenses with the preferential tax treatment for employer-sponsored health insurance.

Further Reading

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