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Since 2008 – Progress Through Politics

Paying for Health Care

By: Inoljt

One of the most important health care reforms would be to get rid an inefficient, outdated tax exemption that is still a fundamental part of U.S. policy.

This is how it works. If a company provides health insurance to its employees, the federal government does not tax the health benefits that are being provided. Say you have an insurance policy worth $5,000. Said company deducts a part of the employee’s salary – say, $1,000 – for “health insurance.”  But the majority of the cost – the other $4,000 – is hidden, because the company negotiates with health providers itself. This is an enormous tax exemption, amounting to the biggest the federal government gives.

On the surface, it sounds like a good idea. Who wouldn’t want to encourage a companies to provide health insurance?

The problem lies in the unintended consequences of this tax exemption.

More below.

An employee who gets his health insurance from a company has an incentive to get the most expensive, technologically new treatment possible – even if such treatments are not proven to be effective, as is far too often the case. After all, the company’s paying for most of the cost. And who wouldn’t want to get the costliest treatment possible if you’re not paying for it?

Except the employee is paying for that other $4,000 – just not directly. He’s paying in the form of lost wages that the company would have given him were it not for the health insurance it provides. For example, instead of paying Sam $50,000 in wages, Company A decides to offer everybody a $5,000 health insurance packet and pay Sam $45,000 (and put a $1,000 heath insurance deduction on his paycheck), due to the government tax exemption.

But Sam doesn’t know how much more he could have made without the tax exemption. All he knows is that he’s getting cheap health insurance, and that he’d better use it on the most expensive, new treatment possible.

In effect, Sam is spending $5,000 of his own coin in an inefficient, wasteful manner. But he doesn’t know this – doesn’t consider it his money – because of the way our health care system works. If said employee was given $5,000 in wages instead of a $5,000 health insurance plan that looks like it costs $1,000, he’d probably be less likely to seek that $100,000 prostate cancer detection test (which studies show doesn’t work anyways). And we’d all be better off for it.

There are two other complications that arise from employer health benefit tax exemptions, as all the above weren’t enough. The first problem is what happens when you lose your job. That’s when health insurance is most necessary – and when it’s often missing. Moreover, employees are discouraged from switching jobs because of the possibility of lower health insurance. That reduces productivity and market efficiency on a macroeconomic scale.

The second problem is that, due to the tax exemption, the government helps the rich and hurts the poor. The rich are far more likely to have employer-provided health insurance than the poor. Goldman Sachs probably gives its bankers gold-plated insurance, whereas a common contract construction worker probably doesn’t have any company insurance at all. In effect, the government is giving a tax break to the rich and well-off.

Ending this tax break is not only sensible, but necessary. It would greatly reduce costs and raise hundreds of billions at the same time. It would help consumers. It would end a regressive system that helps the rich and hurts the poor. Senator Ron Wyden of Oregon has made this a centerpiece of his health care bill (not all of which I agree with).

The current Senate bill has adopted a measure aimed at ending tax breaks for the most expensive health care plans – the so-called Cadillac tax. While not the optimal solution (which would end the tax break for all plans), it is much better than nothing. Many liberals, especially in the House, however, stand against this tax.

Why? The answer lies with unions, a solid core of the Democratic base. For unions, this tax exemption remains one of their most holy accomplishments throughout the years. Taking it away would be anathema to them. In fact, several unions have run ads against Senator Wyden for proposing to tax health benefits.

Nevertheless, Barack Obama is supporting this reform. Not only is it good policy, it is also good politics. I am not one to call for completely unrealistic political reforms, nor am I one to advise him to rashly abandon union support.

There are several things the president can do. Firstly, he can take his time and effort to convince unions to support a reform they do not like. There is a strong case to be made that these tax exemptions don’t actually help workers. Company health insurance plans are paid for not in corporate profits, but in lost employee wages. Unions might buy this argument. Obama is doing the same thing with other organizations sceptical of his plan. He’s been in deep discussions with the AMA (the doctor’s lobbying organization), for instance.

Secondly, there are other political considerations apart from just unions. Due to the financial crisis, Obama won a fairly large victory last year. All things considered, he’s probably going to get re-elected. He doesn’t owe unions or anybody else a big political favor. Moreover, if he puts support behind a plan like Senator Wyden’s, Obama can claim the mantle of bipartisanship he’s been seeking ever since election day. Wyden’s plan has a number of Republican co-sponsors. It might get a fair number of Republican votes. I can see Republicans being cynical enough to vote against the plan just to deny the president a political victory in health care. But even then, Obama is left in a far better position to argue than he is in now.

Finally, there is the question of legacy. Unions might not be happy. But a good, effective bill is going to leave somebody unhappy. The 1964 Civil Rights Bill left the South pretty unhappy, but today it’s regarded as LBJ’s greatest accomplishment. If Obama ends tax breaks for company-provided health care, he’ll have done much to fix the health care system we have now. In 20 years, nobody will remember how many senators voted for Obama’s health care bill or who opposed it. They’ll remember whether it worked.


  1. I don’t get this: isn’t this a form of socialism?

    Bizarre how the free market right always complains about government intervention in the marketplace – except when it suits their interests. Like your mortgage relief exemptions (phased out in the UK a decade ago) these tax incentives actually distort the market, and create speculative bubbles.

    We’ve seen it in house price asset inflation. This kind of subsidy cannot help to damp down the inflation of medical and insurance costs.

    Good points Inoljt. And welcome to the Moose.  

  2. creamer

     The left didn’t get the Public Option, is getting abortion langauge it doesn’t like, no extended Medicare. If you were to go further than taxing “cadillac plans”, the unions and their supporters would go nuts.

     I guess I’m not familiar enough with Wyden’s bill, but if you take away the tax break, wont companies simply make that up off of employee pay/benefit packages?

  3. DTOzone

    and I’m 30, I’m getting healthcare! My new job offers it, it will cost me somewhere around $650 a month, which is roughly 16% of my post-taxes income.

    My first thought was “ugh, I don’t want to pay $650 a month” and then I realized…now I don’t have to hobble around in knee pain like I’ve been doing and can actually go to the doctor and get this rather irrating and sometimes painful skin tag on my left side removed.

    I’ll deal.

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