Normally, when workers are compensated for their labor, we tax their compensation. We call this radical idea an “income tax,” and with the advent of tax withholding in 1943, it became an almost ubiquitous feature of the American economy.
I say “almost” ubiquitous because there is one notable area in which labor compensation remains woefully behind the times. Due to World War II wage and price controls, and an accident of history, “fringe” benefits, like health insurance, became statutorily exempt from income taxation.
Of course, once exempted from taxation, those fringe benefits became more than just fringe — when given the option of being paid with 70 cents of legal tender or a full dollar of medical services, most employees readily gave up wages to cash in on the government’s oversight. The distortionary tax policy compounded the moral hazard problem inherent in insurance and led to a gross overconsumption of health care.
Worse still was the redistributionary effect — like virtually all tax exemptions, the employer health care exemption is as regressive as the federal income tax is progressive. High-income workers receive greater benefit from the exemption than low-income workers because their marginal tax rates are higher, but the health care tax exemption goes even further than that. Because the giveaway is only available to the employed, and, of the employed, only those whose incomes are above the minimum wage (you can’t offset monetary income with health care if the government doesn’t let you), it offers no relief to the segment of our society most in need of it.
Still, until the passage of Obamacare, this messy accident of history was a happy one. Health insurance markets, absent intervention, are susceptible to adverse selection — if an insurance company offers insurance at the same price to all people, the healthiest individuals will opt out. As these individuals opt out, the cost of insurance will rise to reflect the relatively less healthy population being insured. This price increase triggers more healthy individuals to leave, triggering further defections, and so on, until the death spiral bottoms out with only the sickest individuals being insured at exorbitant prices. Employer-based insurance became the norm in the United States because the de facto subsidy of health insurance and difficulty in picking employers purely based on their offered health care benefits encouraged employees to opt-in and stay opted-in, even if it meant subsidizing the insurance of their less healthy colleagues. Those outside of the system faced a full-blown market failure, but for the majority, the government’s inertial decision to throw money at the problem meant a functioning health care system.
One of the greatest features of Obamacare is that with an individual mandate, the employer health insurance exemption has lost its raison d’être. Obamacare replaces employer-based insurance pools with a national pool — it substitutes the messy system of across-the-board subsidization with targeted subsidies to the poor and penalties on those who opt-out. Built as a solution to the market failure plaguing the non-group insurance market, it doubles as a replacement for our multi-trillion dollar boondoggle.
This is no small accomplishment. The health care tax exemption is projected to cost the U.S. government $177 billion this year, and as much as $249 billion by 2015. All told, if we started taxing employer-provided health insurance in 2014 (the year in which Obamacare’s individual mandate goes into effect), we could expect to collect an additional $2.4 trillion between from now and 2021.
Obamacare was billed as a health care reform that would let Americans keep their insurance, as is. Politically, that might have been wise (a conclusion belied by the law’s continuing unpopularity), but from a policy perspective it is absurd. We should hate the status quo, and a reform package that allows us to do away with our zombie health care system should be embraced.
ACTION: End tax preferences for employer-provided health insurance from 2014 onward. 10-YEAR SAVINGS: $2.4+ trillion