|[February 07, 2013]
Stanford and Columbia Scholars Propose Novel Tax Plan that Could Reduce Private Health Care Spending by $86 Billion a Year
STANFORD, Calif. --(Business Wire)--
Long before Democrats passed their sweeping health care reform in 2010,
economists across the political spectrum had argued that bad tax
incentives were a major contributor to the soaring cost of American
Unfortunately, the main target of that ire was also the biggest and most
politically untouchable tax subsidy in the entire code: the exclusion
for employer-sponsored health insurance.
Now, a group of top health care economists at Stanford University and
Columbia Business School has come up with a tax proposal that they say
could break the political logjam and reduce waste even more than earlier
proposals. It could even mesh with "Obamacare."
The idea comes from four veterans in the health care wars: John
Cogan, a former adviser to President Reagan and a senior fellow at
Stanford's Hoover Institution; Joseph
Bankman of Stanford Law School; Daniel
Kessler of Stanford's Graduate School of Business, Law School, and
Hoover Institution; and R.
Glenn Hubbard, dean of Columbia Business School and chairman of the
Council of Economic Advisers under George W. Bush.
The tax exclusion for employer-paid health insurance is the nation's
biggest tax break, and costs the Treasury about $300 billion a year.
It's also the anchor of American health care finance. The vast majority
of Americans who have health insurance get it through a tax-free,
companysponsored plan. Many employees also get to deduct their
out-of-pocket expenses up to a limit, which in 2013 is $2,500.
Economists have complained that these tax breaks, especially the larger
employer tax deduction, create perverse incentives for everybody
involved - employers, workers, doctors, and hospitals. Employers have an
incentive to offer gold-plated health insurance, because the after-tax
cost is lower than paying workers the same amount of money in higher
Employees have an incentive to spend more than they need, or even want,
because they pick up only a small part of the bill. Health care
providers, if paid on a fee-for-service basis, have a big incentive to
prescribe extra tests and treatment.
Conservative politicians have tried to chip away at this, without much
luck. Republicans have pushed through modest tax deductions for
out-of-pocket costs, but didn't touch the basic system. In the 2008
presidential elections, U.S. Senator John McCain essentially proposed
replacing the employer-based tax break with a much bigger individual tax
deduction for out-of-pocket expenses. But McCain lost that election, and
Republicans haven't pushed it.
Even President Obama ran into trouble when he proposed a limited surtax
on "Cadillac" insurance plans to help pay for health care reform. Labor
unions fiercely objected, and Democrats effectively limited the surtax
to what you might call "Rolls Royce" insurance.
In a new paper for the National Bureau of Economic Research, the four
economists propose an alternative fix. Instead of replacing the
employer-based exclusion, they propose neutralizing much of its moral
hazard by adding a novel tax deduction for out-of-pocket medical
Unlike previous proposals for a deduction on all actual out-of-pocket
expenses after an individual incurs them, the new deduction would be an
upfront benefit based on that individual's estimated out-of-pocket
costs for the coming year.
The economists argue that the task would be easier than it sounds, and
outline a formula based on insurers' own calculations about the
actuarial value of their policies. Under the formula, estimated
out-of-pocket costs would depend on commonly available statistics about
insurance policies like their premium, co-payments and deductibles, and
enrollees' average age and health status. People with more comprehensive
insurance would get smaller tax breaks than those with higher
One advantage of a tax break for estimated out-of-pocket costs is that
it would be simpler: People wouldn't have to save receipts and document
expenses in order to get the tax benefit. They would simply get their
deduction, regardless of how much they spent.
Most people would still keep their company-sponsored insurance, the
economists predict. But some people would have an incentive to take on
more of the cost sharing, because their tax breaks would be higher if
they chose plans that require higher co-payments and deductibles. That,
in turn, would discourage wasteful spending, the economists argue,
because those who pay more out of pocket will be more likely to keep
total spending down.
Cogan, Kessler, Bankman, and Hubbard argue that their new twist would
also eliminate more of the perverse incentive for waste, since a
deduction for actual expenses is only valuable if an individual runs up
medical bills. A deduction based on estimated expenses would be valuable
whether or not an individual runs up bills - there's no "use it or lose
it" element. If patients feel they don't really need a particular
treatment, they can spend their tax benefit on something they want more.
The risk is that an individual's actual out-of-pocket expenses might
turn out to be much higher than the estimate. But the economists argue
that the risk would be modest, because people would still be relying on
traditional insurance for most of their health care.
How much would the new deduction cost taxpayers The economists estimate
that the cost would be relatively modest, about $5 billion a year,
because the revenue loss would largely be offset by the declining use of
the exclusion for employer-paid insurance.
Meanwhile, the economists estimate that the altered incentives could
reduce private health care spending by about 8.5% or $86 billion a year.
If that reduction in demand were to put a brake on overall health care
spending, which has chronically climbed faster than general inflation,
the changes might dent the biggest government spending spiral of them
all: Medicare and Medicaid.
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