Saturday, 11 December 2004

Institutional inertia

With exams over less than twelve hours, I wasn’t planning on doing much thinking—who knows, after reading this you might conclude that I haven’t been doing much thinking—but this is an issue I care about. So I blog.

I read a proposal in the WSJ earlier this year, which has apparently come up again, about ending the tax deductibility of health benefits and was struck by how simple it is. I wish I still had the archive from my old site so I could find the original article.

Anyway, making benefits exempt from taxable income causes people to over-consume and employers will opt for more elaborate plans for more expensive workers. They’re the ones with the bargaining power. Will eliminating this distortion, by treating different forms of income equally, cause employers to abandon health insurance as a benefit? I suspect not for two reasons.

First is institutional inertia. Employees have come to expect employers to offer some sort of health benefit and it’s one of the first things employees think about when evaluating jobs. Employers will likely continue to offer health benefits simply because employees expect the benefits.

Another reason employers will continue to offer health benefits, even without the tax benefit, is because it’s something that they can offer relatively cheaply, as opposed to having employees get their own insurance. This won’t be true in every case, to be sure, but in general employers will be able to buy insurance at a lower rate than employees can alone, therefore adding more value to a compensation package from the employee’s perpective at a relatively low cost to the employer.

Will the benefit of eliminating the propensity to over-consume that’s built into the tax code outweigh the costs of disintermediation and other considerations? I don’t know, but on its face it doesn’t make a lot of sense to me to treat one form of income as preferable to another.

More on this issue can be found here and here.

Update: click through the "here" links if you want to see actual numbers.


Any views expressed in these comments are solely those of their authors; they do not reflect the views of the authors of Signifying Nothing, unless attributed to one of us.
Will eliminating this distortion, by treating different forms of income equally, cause employers to abandon health insurance as a benefit? I suspect not for two reasons.

I’d say there’s no question that some employers will abandon health insurance at the margins, the relevant margin being employers that hire a lot of low-wage employees.

The right question to ask is whether the benefit, shifting people to high-deductible policies (genuine insurance, as opposed to pre-paid medical plans), outweigh the price of marginal employers dropping coverage (whose employees will end up getting expensive treatment in the emergency room), and people with high-deductible policies shifting from preventative medicine to catastrophic medicine.

It’s a question that can’t be answered by doing armchair economics. You need real numbers to plug into the equations. And I don’t think anyone has those.

I’m not convinced that as a nation we’re overconsuming medicine. No doubt some people are, and others are underconsuming it. And I don’t think we can lower the numbers of those overconsuming without increasing the number of those underconsuming it.

If you’re wanting to get rid of a market-distorting tax break, I suggest starting with the mortgage interest tax deduction. That’s unquestionably causing overconsumption of housing.


Also, eliminating the health insurance tax break strikes me as a total non-starter politically. Eliminate the health insurance tax break, and watch a bunch of pissed off middle class families, whose paychecks are suddenly $25 lighter, propel the Democrats to victory in the White House and Senate in 2008. (The House, of course, will remain Republican due to gerrymandering.)



There are some studies that examine this, including the one referenced by both Tyler and Brad’s sites (the links above). There solution to people that lose health insurance due to the switch is subsidies from the new revenue.

The only reasons I can think of to question whether we overconsume healthcare are: even though we spend more on healthcare than any other country as a percentage of GDP, our peers have socialized medicines and are probably underconsuming; and, since we’re the richest country on earth it only makes sense that we will buy more healthcare than others, because we have more disposable income.

As for removing the tax exemption, it’s highly unlikely as you pointed out, though since we are running a blog, there’s no reason to avoid unpopular ideas; it’s not like we’ll get run out of office for doing so.

BTW, I doubt we could even get rid of the mortgage interest deduction for second homes since most members of Congress maintain two homes. I agree with you about getting rid of it, though.


It seems likely, as you suggest, that companies would continue to buy health insurance for their employees. But I would hope not. Aside from some economies of scale (and the huge tax breaks), there’s no reason for people to have to make their choices of employer and of health-insurer as a package deal, nor is there a strong reason for people to switch health-insurers just because they switch jobs.

The problem is in the transition. If one employer tries to tell employees to go shop for their own insurance, it’s not likely to go over well.

Comments are now closed on this post.