In Defense of Deductability of All Health Care

Arnold Kling, Tyler Cowen, and Hit & Run all are wary of Bush's plan to give tax breaks for income spent on health care. Says Kling:

Evidently, the Administration believes that health care is a Giffen good, so that if you subsidize it, total spending on it will decline.

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...here is the intuition. If there were no tax distortions, I would pay for $500 of health care. With the current tax code, my employer might buy $1000 of health insurance for me, at an after-tax cost of $700. I have no incentive at the margin to conserve on health care spending, so I spend $800.

With the new tax code, I take $700 in take-home pay instead of health insurance, and I pay for health care out of pocket. Because the marginal cost of health services is no longer zero, I don't spend $800 on health care. However, because medical expenses are tax deductible, I buy $650 of health care services instead of the $500 I would buy if they were not deductible and I had no insurance. So health care spending does not drop to the no-distortion level of $500, but it still declines from the current level of $800.

I think that there are good reasons to doubt that the results would shake out this way. My guess is that people would sort themselves into tax clienteles in such a way as to increase total health care spending, not reduce it. People with high marginal tax rates would pay out of pocket, while people with low marginal tax rates would stick with employer-provided health insurance.

Cowen echoes:

This idea is slightly funny. The premise is that people don't pay enough of their medical bills when they have private insurance. The way to get them out of insurance is to...um...pick up part of their medical bill. Admittedly the percentage of third-party payment would fall, at least if this works as planned. But note we are making the government the new insurer. I also predict the tax deduction will evolve into a credit which will evolve into...Yikes!

The idea that treating all health care expenditures as tax-deductible will decrease health care spending is improbable (but far from impossible). Since health insurance is so totally tied (for no good reason) to employment, who has any idea what will happen when all health care is treated the same for tax purposes? I share Kling/Cowen's skepticism that this will lower overall spending (which is the rationale the Bush administration gives for the proposal).

However, that is not the reason it's a good thing. Hopefully, it may end the biggest constraint on health care consumer choice that exists today - the fact that you don't purchase your own health care/insurance. It strikes me as terribly inefficient to let your employers choose who is going to finance your health, and a situation just begging for consumer dissatisfaction.

I'll use myself as an example. I am a resident at a university health center. My employer purchases my health insurance from the HMO that is offered through this same health center. If I want to go to the doctor for any reason, I'm forced to see residents and attendings almost all of whom I know personally. When I'm getting a flu shot this is no big deal, but if I have a real health problem I would like to more closely protect my privacy by seeing physicians I don't eat lunch with and socialize with every day. That's just my (justifiable) personal choice. I would love to have heath insurance that allowed me to go elsewhere in town, but to buy it I would have to eat the 90% of my premiums that my employer picks up. Obviously, this is highly unsatisfactory - and quite possibly, if my employer did not have the incentive to pay my premiums before taxes, I would have the cash to pick a health insurer that more precisely fits my desires.

Of course, this specific example applies to harldy anyone else. However, everyone may have a good reason to switch health insurers; thus, the general point holds true - this proposal, aside from what it may do to overall health spending, may open the door to allow for more consumer choice in health insurance providers. And that is the best (if not only) reason to support the proposal. (Much like everything else on Bush's short list of good ideas, he tries to sell it using the wrong reasons.) If it makes overall health expenditures rise, so be it; at least well will be getting something - quality - for our money.

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What about the merits of

What about the merits of re-introducing price signals into the medical market that are closer to reality? The current system distorts perceptions of price/value of medical services, by leading the consumer to believe that an office visit only "costs" $10 or $20 (or whatever the copay). I'm willing to bet people don't think about whether a particular doctor or drug costs less in advance. Instead, they look to see who's in their plan.

Under the proposed system, even if you know you're going to be able to deduct a doctor's bill come tax time, I would think you would be a pickier consumer of health services in the first place if you have to come up with the $200-$500 for a visit.

I think this would tend to create a downward pressure on prices over time.

Thoughts?