Large-Scale Tax Reform: The Example of Employer-Paid Health Insurance Premiums

This study assesses the consequences of altering the favorable tax treatment of health insurance, and addresses the question of why it seems so politically difficult to accomplish this type of reform. To summarize the results briefly in anticipation of the detail, this study finds: (1) Special tax treatment of health insurance (compared with full taxation) has increased the aggregate health insurance premiums by at least 40 per cent for every year since Medicare was introduced, and by at least 50 per cent for every year in the last decade. This added insurance coverage has surely induced substantial extra demand for medical care, probably with little if any incremental gain in health outcomes for the United States population. (2) Major tax reform -- at the extreme, elimination of the tax preference -- would greatly affect the profitability and employment in the health insurance industry, and would markedly affect also the wealth and employment of many providers of medical care. (3) Even if the tax revenue effects of a broadened tax base were offset by a reduced marginal tax rate, so as to produce no net tax revenue gain, strong patterns of winners and losers would emerge among workers in various industries. (4) The magnitude of welfare gains from reducing overinsurance (in aggregate and for most individuals) are probably swamped by the extent of wealth redistribution generated by this tax reform. Therefore, political decisions regarding this reform will likely depend on these redistributive issues, rather than upon the potential benefit as defined in classical welfare economics. Thus, unless a low-cost and politically efficient redistributive scheme could be devised to accompany this large change in the tax code, it seems unlikely that the Congress would adopt this type of major tax reform