The IRS Can Save American Health Care
Letting workers spend pretax dollars on insurance would do a lot—without requiring Congress to act.
Health care is fast becoming an unsustainable expense for American families. This year the total cost of insurance for the typical family of four eclipsed $28,000, according to the Milliman Medical Index. Rising insurance premiums are also eroding worker compensation, as companies shift increased costs to employees.
Health care in the U.S. suffers symptoms of what Justice Louis Brandeis once termed the problem of “Other People’s Money.” Often a patient ordering and receiving medical care mistakenly believes he is not the one paying for it. This misconception is due in large part to the employer tax exemption for health insurance, which conceals the true cost of coverage from most workers.
Companies that buy health insurance on behalf of workers are, in effect, giving them some of their compensation in the form of benefits. But employers get to use pretax dollars when they purchase this insurance. If workers try to buy their own policies, most don’t get the same tax break. This inequity has cemented the dominance of employer-sponsored insurance in the U.S.
It might seem like a small question, but who is buying makes all the difference. Employer-based coverage subtly drives up health-care costs by enhancing the bargaining power of medical providers. A large company must include nearly all local doctors and hospitals in its health plan’s network, since different workers will need different services. Only 8% of employers even offer a choice of a tighter network, the Kaiser Family Foundation reported last year. This gives major hospital chains that dominate local markets carte blanche to charge high prices.
The solution is simple: The Internal Revenue Service should give all workers the chance to purchase health insurance with pretax dollars—just as employers do—using Health Reimbursement Arrangements. Companies would give employees a fixed amount of money in these HRAs to go out and buy the best plans for their families on the ObamaCare exchanges. The plans there would be subject to the Affordable Care Act’s requirements on essential health benefits and cost-sharing limits. Employees could use this tax-free money only for the purchase of health insurance, but would pocket any leftover savings as taxable income.
We have run separate simulations, at Harvard Business School and Oscar Health, to project the implications of this policy, and the conclusions are similar. Giving employees the tax break would result in their buying cheaper, more-tailored policies compared with the employer plans in which they are currently enrolled. After doing so, workers would take home the extra income: $129 billion, after tax, in Oscar Health’s study and $160 billion in the Harvard Business School’s. The federal government, now taxing that additional income, would receive between $46 billion and $65 billion in new tax revenue.
The benefits would be significant. Increased competition from the influx of new consumers in the individual market would drive down premiums. Workers would have more policy options (today 81% of employers offer a “choice” of only one type of plan, Kaiser reports). Employers would be freed from the hassle of administering health benefits, a fast-growing line item, allowing them to focus on their core businesses.