Economic arguments I have never understood

Have you ever heard the claim that U.S. medical care is in trouble because we subsidize third-party insurance through the tax system? Glenn Hubbard presented this view in the Wall Street Journal this Tuesday. Hubbard writes:

Reform the tax treatment of health-care expenses. The most far-reaching and misguided government policy, established more than 60 years ago, allowed employer-provided health care to be exempt from taxation. Under this policy, medical care purchased through an employer’s insurance plan is tax-free, while direct medical-care purchases by patients must be made with after-tax income. The tax preference for employer health insurance has been instrumental in creating today’s third-party payment system. In this perverse world, true insurance, in the form of coverage for catastrophic health events, is the exception; prepaid health care, in the form of coverage with low deductibles and copayments, is the rule. The tax preference for insurance is the primary reason five out of every six dollars of health-care spending are paid by third parties…

Low copayments and deductibles fuel excessive cost growth and breed wasteful medical practice…consumers have little incentive to limit their use of unnecessary medical-care services, little incentive to shop for the health plan that best suits their needs in a cost effective way, and little incentive to evaluate their care on the basis of value.

But I’m stumped. If the argument is that tax deductibility leads to too much health care, I can see the logic. But then the problem is in the pretzels and beer markets; health care should be doing fine, albeit in bloated form.

Alternatively, it might be argued that buying health insurance involves a negative externality on others. Maybe insurance companies are intrinsically bad monitors, and more insurance corrupts the system as a whole. Grant this premise, but where do we end up?

1. We would have a good argument for taxing insurance purchases. Yet the insurance point is rarely raised with this conclusion in mind. We might have (yikes!) an argument for greater government involvement in health care.

2. If insurance companies are such poor cost monitors, why doesn’t this raise premia accordingly? The poor monitoring of the company would be reflected in policy price and thus would be internalized by the people or institutions who buy the policies. The externality should vanish or at least significantly diminish.

3. Why should insurance subsidies lead to “low copayments and deductibles”? Insurance with high copayments and deductibles is favored by the tax system as well. That being the case, why do we blame the tax system for how insurance is (perhaps) poorly structured?

All these points collapse into a more simple query: how can a simple relative price, whether a distortion or not, corrupt the cost control practices of an entire industry?

And if government provision of health care is ineffective and costly, isn’t there a positive externality from the purchase of private health insurance?

Many of the people who cite this argument about health insurance are smarter and more accomplished than I am. I will grant their greater wisdom and authority. But at the end of the day, I still don’t get it.