How much does tax-subsidized health insurance matter for health care costs?

James Kwak gives us his back-of-the-envelope estimate:

The median family household had income of $62,621 in 2008, which means it has a marginal tax rate of 15%. (We’re pretty close to the 25% threshold, so I’ll use 20% in what follows.) So without the exclusion, the typical family plan would cost about $16,000 in pretax dollars, not $13,000; the exclusion gives the median family a discount of 20%. Only about 60% of people get health insurance through an employer plan, so the average discount across the population is only 12%. Given that the price elasticity of health care is almost certainly a lot less than one (if you double the price, demand won’t fall in half), the overconsumption due to the tax exclusion must be less than 12%. Yet our per-capital health care expenditures are more than 60% above those of any other advanced country.

In other words it matters, but not as much as many people claim.

Addendum: Here is Henry Aaron's correction.


As a Psychologist, I'm obviously biased to focus on the behavioral aspects of this issue, but I think that perhaps a more important aspect of the present arrangement is people's sense that their health plans are non-monetary. If they were given a full salary and the choice of buying in at full sticker price rather than just accepting the benefit automatically, I think there's a big chance they would make different decisions, which might account for a lot more of the effect than just the discount itself.

In behavioral economics terms, this can be accounted for both in terms of loss-aversiveness (not wanting to lose the discount even if they would otherwise have chosen to spend much less on health insurance) and in terms of passivity bias (people tend not to opt out when they are auto-enrolled in something).

I think Kwak underestimates the 2nd order effects. If people had to write checks for health insurance, instead of blindly paying it directly out of their paychecks, settling for whatever provider their employer offers, then they might be more sensitive to price. Increased price sensitivity will lead to increased price competition.

Secondly, his assertion that only 60% of people get insurance through their employer is misleading. That's enough people to drive up prices. If I believe that US health care would be cheaper if everyone bought their own insurance, it doesn't follow that I personally can get cheaper health care if I drop out of my employer plan. I couldn't move the market! And neither can a minority of people, when the majority are following poor incentives in which more and more of health care expenses are paid up front, in tax subsidized fashion, without knowing or consciously deciding to pay their health insurance bill each month.

Plus, relative to the system as it stands now, if you took away the incentives to pre-pay for health care, the elasticity may very well be over 1 in the short run. If someone else is paying for the majority of my health care today, I am very willing to copay for a higher priced procedure. If tomorrow I have to pay for more of it on my own, I may not be even willing to pay today's price.

I'm skeptical that he is telling the complete story - he is treating health insurance as a binary option.

The problem with the subsidized health insurance isn't that it is causing people to overconsume healthcare per se. The problem is that it is forcing consumers to let their employer decide which plan to get.

Employers are going to get one-price-fits-all type of plans, where individuals should be a little more selective as part of the process.

An anecdote, but nonetheless - I have insurance that pays for 1 glucose meter per year for my diabetic daughter. I get a new meter every year even though I still have 5 new-in-the-box. If I had to pay for the premiums for this perk I probably wouldn't choose it (if it isn't bundled, another story) if I had to pay for it.

He is correct that elasticity is probably relatively low for individual components of health insurance. I would wager that elasticity for all-in-one packages is pretty close to one because those individual components having different importance to different people.

After reading TR Reid's book, which describes the "Bismarck" system of health care (health insurance through employers), I got to wondering: how do the other countries which use the system, like Germany, handle taxes?

These comments are wonderful but I thought a simpler issue was the proposition summarized at the end of Tyler's post that "not as much as it seems" - healthcare is roughly 17% of the US economy so if you've identified a single decision that accounts for 12% of it, you've identified a policy that accounts for 2% of the entire US economy, which in rough dollar terms is $250 - 300 billion, and that is a massive number. If with one change in law you could improve the efficiency of the US economy by $250 - 300 billion - who would be opposed???

The pernicious aspect of the tax subsidy is that it enters only through the employer side and so takes the choice of insurance plan out of consumers' hands. If I could get the same subsidy on my choice of insurance rather than my employer's, I might substitute some of the health care coverage for non-health care purchases. This is where the over-consumption creeps in.

Adam and Taxman are correct, making the true marginal tax rate much higher. Moreover, in many workplaces there is only one choice of plan and that plan tends to be chosen by someone in a high tax bracket.

All the debate above is basically nonsensical.

The basic premise is that in at least three dozen nations where everyone is covered by some form of insurance, either an insurance policy that is provided by government and paid with taxes, or policy purchased by the individual with payment ranging from out of pocket to employer paid to government paid or subsidized, health care is over consumed to a greater a greater degree than in the USA.

Fine, where is the data that says the cost of health care in those other nations is over consumed? Certainly the over consumption is not measured in cost which is in every case less than the USA. Where is the data that wages and prices are significantly lower in those nations to allow for much higher consumption of health care while being about half the cost. If free health care results in twice the consumption, then the prices in those nations must be about one-quarter of the USA.

For those who refuse to look at other nations, preferring to argue that Americans are just totally different from Germans, English, Asians, French, et al with totally different genetics, look at the uninsured populations in the USA and compare them to the insured.

Show that the involuntarily uninsured have lower health care use, procedures and price, for the same outcomes compared to the involuntarily insured. People in certain careers and demographics find it nearly impossible to get health insurance of any kind, and the jobs don't include a health benefit. On the other hand, many people are employed in jobs where an employer benefit is almost universal. And limit the study to people up to age 20, 25, or 30 - the study groups would need to be larger, but the complicating factors would be fewer.

And you need to explain why those 65-70 have higher health care costs if they didn't have health insurance from 60-65 than those who had insurance. Did those without insurance decide once they turned 65 to just see the doctor for no reason at all, while those previously insured were tired of going to the doctor all the time?

@Oreg: thanks for the correction. But what is the tax status of the employer share of the insurance premium?

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Health insurance is not health care. I believe you are comparing two different products. Health insurance is a thirty day option, where as health care services is the underlying real product. Health insurance is priced for thirty days of coverage in case you get sick, and at the end of thirty days you lose your money. You should be allowed to claim a capital loss on a derivate investment on Schedule D if you do not use the insurance plan in the thirty days it is in effect.

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People aren't getting full health benefits through their employers. I work for NJ Carpet Cleaning and have to pay 46% of my premium. Everyone I know is participating a high percentage of their income into a company health insurance plan. The only ones that are not paying out are government employees which make up a small percentage Americans.

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