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Published on Leave a comment on He Who Pays the Piper Calls the Tune

Robert Pear reported in The New York Times this week that Medicare will begin paying doctors a small bonus for reporting "how often they provide quality care, as defined by the government." Put aside your desires for a small government for a moment. If the government is going to pay for health care, it has the responsibility to ensure that its payments are resulting in quality care. Paying specifically for quality is one way of trying to do this.

Here's a description of what will happen and a little bit of the reason why:

Now, doctors can qualify for a 1.5 percent bonus in the second half of 2007 if they report data on the quality of their care, using measures specified by the government. For example, doctors could be asked to report how often they prescribe a particular drug after a heart attack or how well they control blood pressure in patients with diabetes.

With these statistics, Medicare officials say, they will , in the near future, be able to reward doctors who follow clinical guidelines and perhaps penalize those who flout such standards without justification.

For several years, Medicare officials have advocated a pay-for-performance system, noting wide regional variations in the practices of hospitals and medical specialists.

Here are some reactions quoted in the article. First up, Senator Grassley, a proponent of the bill:

“Medicare now pays the same amount regardless of quality,” Mr. Grassley said. Indeed, he said, Medicare “rewards poor quality,” paying doctors to treat complications caused by their own mistakes.

That's not the only thing it rewards, but it does pay for procedures rather than outcomes. Next, an unsurprising comment from the medical profession:

“This is a very significant step,” Catherine G. Cohen, vice president of the American Academy of Ophthalmology, said Monday. “It’s the first time Medicare has ever paid individual doctors a differential for reporting quality measures. It could impose a significant new burden on doctors’ offices.”

It's hard to imagine doctors don't already keep track of the frequency and conditions under which they apply different treatments. If they don't, that's telling us something. If they do, then it would not be a "significant new burden." And since it is voluntary, it is hardly "imposed."

I'll conclude with my personal favorite:

Representative Pete Stark of California, who will become chairman of the Ways and Means Subcommittee on Health in January, said, “The entire concept of pay-for-performance is offensive.” Doctors, Mr. Stark said, are supposed to provide “quality care” and should not be paid extra for doing so.

Shall we rephrase that as, "Doctors are supposed to provide 'quality care' and should not be paid less for failing to do so?" What's the alternative, holding your breath until they agree to provide quality care?

Gathering information on the type of care being provided is the appropriate first step to ensuring that the money being taxed from workers to pay for the care of elderly is being spent in an efficient manner. If you think that the government is incapable of doing this, then you might consider joining the group of people who think the government should get out of the business of paying for so much of the nation's health care. It doesn't have to be perfect measurement--it just has to result in better outcomes on average.

Published on Leave a comment on Working Harder, Not Smarter, in Medicine

In today's Wall Street Journal, Dr. Benjamin Brewer gives as succinct a statement of the morass of treatement incentives in the practice of medicine as you will find:

One of the problems with our medical system is the bias to pay doctors more for performing a test or procedure than for using our heads to make a diagnosis or manage a disease.

Obtaining a thorough history and physical exam and reviewing tests to make a challenging diagnosis pay much less than conducting a battery of tests or performing a diagnostic procedure.

If I spend 30 minutes in an extended office call for a patient with diabetes, high blood pressure and heart disease, I get paid an average of $69. If I remove a skin cyst off the patient's back in that same time, the minor surgery would bring $110.

If I do a screening colonoscopy at the hospital to check for colon cancer for the same patient in the same time, my average reimbursement is $478 with essentially no office overhead. It's no wonder that medical students want to go into procedural specialties like gastroenterology and fewer want to pursue cognitive specialties such as general medicine.

Fascinating. As always, there are tradeoffs involved. There are two types of errors that can be made with respect to procedures: they can be implemented when they were not medically necessary or they can be not implemented when they were medically necessary. As a society, we put a lot of weight on avoiding the latter type of error. The field of medical malpractice exacerbates this. So it is not surprising that we have poor safeguards against the first type of error given the high fees. But if we tried to improve them, we should expect to have more of the second type of error.

Brewer's point about choice of specialty is also a good one. After we had the VoxSon, it became very clear to me that the medical industry tremendously undervalues and undercompensates pediatricians, who epitomize the need for using their heads rather than tests.

Published on Leave a comment on Means-Testing Medicare

Robert Pear reports in today's New York Times about a little known feature of the 2003 Medicare Act: the premiums for Medicare Part B will now be an increasing function of a beneficiary's income. Part B is a voluntary supplement to Part A--the hospital insurance part that is covered by payroll taxes. Historically, the premiums for Part B have covered about 25 percent of program costs. The rest come out of the General Fund.

According to the article:

It is expected to affect one million to two million beneficiaries: individuals with incomes exceeding $80,000 and married couples with more than $160,000 of income. For individuals with incomes over $200,000, the premium, now $88.50 a month, is expected to quadruple by 2009.

[...]

When the transition is complete in January 2009, according to Medicare actuaries, the total premium for a person with income of $80,000 to $100,000 will be 1.4 times the standard premium. A person with income of $100,000 to 150,000 will pay twice the standard premium. A person with income of $150,000 to $200,000 will pay 2.6 times the standard premium, and a beneficiary with more than $200,000 of income will pay 3.2 times the standard amount.

If the basic premium rises 10 percent a year — a relatively conservative forecast — the most affluent beneficiaries will be paying premiums of more than $375 a month in 2009.

[...]

The Congressional Budget Office says 5 percent of beneficiaries will be affected.

[...]

The Congressional Budget Office estimates that the surcharge will raise $15 billion from 2007 to 2013.

The last excerpt suggests that we are not going to raise big money here. The reaction to the means-testing when it becomes known is likely to be as quoted here:

Theodore R. Marmor, a professor of political science at Yale, said the surcharge was more important for the politics of Medicare than for the financing of the program.

“The new income-related premium is fundamentally at odds with the premises of social insurance,” Mr. Marmor said. “Large numbers of upper-income people will eventually want to find alternatives to Part B of Medicare and will no longer be in the same pool with other people who are 65 and older or disabled. Congress will then have less reluctance to cut the program.”

It is very difficult to means-test a voluntary program. I think that problem is insurmountable here, as long as the means-testing is designed to affect only the top 5 percent or so. I am also not moved by the "fundamentally at odds" complaint. Enormous transfers from young to old under the guise of intragenerational redistribution from the healthy to the unhealthy are at odds with sensible fiscal policy.

When I got to CEA in July 2003, the Medicare bill was already in conference. I read the proposed rules for means-testing based on annual income of seniors and decided I had better get to work. I wrote a memo arguing that it was better to means-test based on lifetime income. I envisioned the tax base to be the average indexed monthly earnings of the individual (or couple), where earnings are defined as those on which the Medicare payroll tax was paid.

Since that memo stayed in DC, I outsource the commentary to Gene Steuerle (remembering him in my thoughts today), who made similar arguments in 1997:

An alternative way to apply the new fee in a progressive manner would be to base it not on annual income, but on the lifetime earnings of individuals, as reported to the Social Security Administration. Most of these lifetime earnings are currently applied to the calculation of something called average indexed monthly earnings, from which social security cash benefits are determined. The social security formula itself is progressive, and grants a higher rate of return to those with lower lifetime earnings.

There are three advantages to this approach. First, the Medicare beneficiary would easily perceive the charge as an additional fee for Medicare, not as something else. Second, the additional charge would be easily administered. Those with high lifetime earnings and higher social security checks simply would find that a higher fee was assessed against them for Medicare. They already pay the rest of their Medicare fee out of their monthly social security check, and the amount withheld is exact. No additional forms need to be filed, and no reconciliation is required at the end of a year. Next year, instead of all beneficiaries bearing an identical additional fee of say, $3, only those with lower lifetime earnings would see a $3 increase, but those with higher incomes would see a larger increase, say, up to $20.

A third advantage is that past lifetime earnings are not as easily manipulated as is annual income for those who are already retired. Like annual income, however, no one measure is perfect, and some adjustments would need to be made -- as they are in the case of social security -- for those who are measured as having low lifetime earnings because they worked in federal or other employment that was exempted from social security tax. While these adjustments would not be perfect, on average I would guess that they still would be more equitable than annual income as a base for assessing the fee.

The memo received a good hearing in the White House, and I even got to visit the conference committee and explain the ideas to the staffers. The ideas didn't prevail, though, largely because this method of means-testing does not include unearned income at any point during a person's lifetime in its defintion of the tax base. I thought that was a very minor point (particularly given the manipulability of unearned income in retirement) compared to the ease, transparency, and robustness of the alternative measure.

Published on Leave a comment on Health Insurance and the Cost of Housing

In today's Wall Street Journal, Vanessa Fuhrmans writes about a growing phenomenon: workers at large firms choosing not to enroll in company-sponsored health insurance plans. She notes:

But in recent years these big companies have also increased the premiums, deductibles and co-pays that employees must contribute under these programs, leading many workers to forgo their employers' insurance. Between 1996 and 2004, the number of private-sector employees who enrolled in the health-benefits plans offered to them declined from 87.7% to 81% at big employers, according to new government data.

She notes that one reason for the decline could be more married workers choosing family coverage at the cheaper company, rather than each worker individually insuring at his or her own company. She continues:

But the biggest reason appears to be that even company-subsidized health care is proving unaffordable or providing too little upfront value to many workers. The sharpest drop in participation rates was among large retailers, where the share of eligible workers opting for company benefits fell to 67.3% from 83.8% over the eight years. But health-plan participation in other industries also has declined, even at companies with unions, many of which have fiercely fought employers' efforts to shift more health-care costs onto workers.

And the human interest angle:

Sarah Landis, a nursing assistant at Children's Hospitals and Clinics of Minnesota, says high premiums are why she opted out of her health plan. While a spokeswoman for Children's, which employs around 4,000, says the not-for-profit hospital system has actually lowered employees' share of premiums to 30% of the total, from 50% three years ago, Mrs. Landis says the monthly payment of $543 is about one-third of her income. (A high-deductible family plan is available for $295 a month, and a middle-of-the road-plan is $359.)

"It's a choice between our house payment and health insurance," says 25-year-old Mrs. Landis, who has two young daughters. Apart from her husband's asthma, which requires the couple to pay $70 in prescription drugs each month, all four are healthy, she says. So when her husband left his job to become self-employed three years ago, the family went uninsured. He may take a law-enforcement job so the family can get coverage again soon. In the meantime, Mrs. Landis says, "we just hope we don't get sick."

There is some research to support Mrs. Landis as more than an anecdote. Three years ago, Helen Levy and Thomas DeLeire raised the questions, "What Do People Buy When They Don't Buy Health Insurance and What Does that Say about Why They Are Uninsured?" With emphasis added, they found:

Using data from the 1994 through 1998 Consumer Expenditure Surveys, we compare household spending on 16 different goods (food at home, food away from home, housing, transportation, alcohol and tobacco, interest, furniture and appliances, home maintenance, clothing, utilities, medical care, health insurance, entertainment, personal care, education, and other) for insured versus uninsured households, controlling for total expenditures and demographic characteristics. The analysis shows that the uninsured in the lowest quartile of the distribution of total expenditures spend more on housing, food at home, alcohol and tobacco, and education than do the insured. In contrast, households in the top quartile of the distribution of total expenditures spend more on transportation and furniture and appliances than do comparable insured households. These results are consistent with the idea that poor uninsured households face higher housing prices than do poor insured households. Further research is necessary to determine whether high housing prices can help explain why some households do not have insurance.

Published on Leave a comment on Wal-Mart and Health Insurance in Maryland

From Michael Barbaro of the New York Times, we learn that "Maryland Sets a Health Cost for Wal-Mart,"

The Maryland legislature passed a law Thursday that would require Wal-Mart Stores to increase spending on employee health insurance, a measure that is expected to be a model for other states.

[...]

Under the Maryland law, employers with 10,000 or more workers in the state must spend at least 8 percent of their payrolls on health insurance, or else pay the difference into a state Medicaid fund.

There are some possible loopholes in this law. The state has put a tax on payrolls--expect payroll growth to lag in coming years, whether from fewer new stores in the state or from lower raises. As it is written up here, the law doesn't seem to distinguish whose health insurance is paid for with the 8 percent--expect the company to contribute more at the margin for higher paid workers than for those most likely to take up Medicaid. The law only applies to firms with 10,000 or more workers in the state. With 53 stores and 17,000 workers in the state, perhaps Wal-Mart would sell some stores to get down below the 10,0000 threshold or try to reclassify some workers, like those who drive the trucks, as being employed by a store in a nearby state.

It will be interesting to see whether the law has its desired outcomes. Another approach the legislature might have taken would be tax any employer (regardless of size) for a portion of the Medicaid payments made on behalf of its employees or their dependents and used the proceeds to lower tax rates on all businesses. This approach of cost-sharing or experience-rating is more like what states do for their unemployment insurance programs.

Published on Leave a comment on Gilbert Gaul Earns a Voxy

We bring the Voxy out of retirement to honor Gilbert M. Gaul's series of articles in the Washington Post this week on the waste in Medicare spending. He gets off to a good start last Sunday in "Bad Practices Net Hospitals More Money," the first of the series:

As far back as 1999, federal and state regulators began to receive complaints that the heart surgery unit at Palm Beach Gardens Medical Center in Florida was a breeding ground for germs.

Dust and dirt covered some surgical equipment. Trash cans and soiled linens were stored in hallways. IV pumps were spattered with dried blood. One patient's wife said she saw a medical assistant tear surgical tape with his teeth.

State inspectors in 2002 found "massive post operative infections" in the heart unit, requiring patients to undergo more surgery and lengthy hospital stays.

In a four-year period, 106 heart patients at Palm Beach Gardens developed infections after surgery, according to lawsuits and government records. More than two dozen were readmitted with fevers, pneumonia and serious blood infections. The lawsuits included 16 patients who died.

How did Medicare, the federal health insurance program for the elderly, respond?

It paid Palm Beach Gardens more.

Under Medicare's rules, each time a patient comes back for another treatment, a hospital qualifies for an additional payment. In effect, Palm Beach Gardens was paid a bonus for its mistakes.

Medicare's handling of Palm Beach Gardens is an extreme example of a pervasive problem that costs the federal insurance program billions of dollars a year while rewarding doctors, hospitals and health plans for bad medicine. In Medicare's upside-down reimbursement system, hospitals and doctors who order unnecessary tests, provide poor care or even injure patients often receive higher payments than those who provide efficient, high-quality medicine.

This moral hazard problem exists everywhere in the economy where actions are imperfectly monitored. The problem here is that Medicare is a $300 billion a year program that is rife with hidden actions. The classic economic answer is to pay based on performance (or the quality of care), assuming that there are measures of performance that are informative about the actions taken. In an environment like health care, where there are lots of random factors that can affect outcomes, the following statistic is particularly disheartening:

Medicare has difficulty controlling waste because of deficiencies in the way it monitors and enforces quality standards. Its oversight system is fragmented, underfunded and marred by conflicts of interest, records and interviews show. For every $1,000 that it pays to hospitals and doctors, it invests just $1 or $2 to oversee and improve patient care.

Plenty of progress has beeen made in health outcomes research. Some of the most interesting work is done by a team at the Dartmouth Medical School on the geographic variation in health care spending, compiled in the Dartmouth Atlas of Health Care. This work figures prominently in the article:

One result: striking variations in what Medicare pays for care in different states, or even neighboring Zip codes. In 2001, the typical Medicare patient in Los Angeles cost the government $3,152 more than a comparable patient in the District. A patient in Miami cost $3,615 more than one in Baltimore.

Those disparities cannot be explained by differences in local prices or rates of illness, said John E. Wennberg, a Dartmouth physician and an expert on geographical variations in medical care. Rather, higher spending is related to the number of specialists, hospital beds and technology available. "If you have twice as many docs in a community," said Wennberg, "you end up with twice as many office visits."

Yet most high-spending states rank near the bottom in quality of care, Medicare data show. Louisiana ranked 50th in quality yet first in Medicare spending in 2001, the most recent year available. New Hampshire was first in quality but 47th in spending.

Medicare acknowledges that its system rewards bad care. Officials have only recently begun to address the problem.

This year, Medicare began requiring hospitals to report their performance on a handful of measures, such as how many heart attack patients received recommended beta blockers and aspirin. Officials say the reports will pressure hospitals to improve and save money. But officials don't use the data to punish poor performers or to steer patients to the best performers.

That last step is critical. A bit later in the article, we learn of more efforts underway:

Recently Medicare officials have begun an effort to transform the way the program pays for care, with a renewed focus on quality. Congress also has joined in, mandating that Medicare try ways to increase competition and link payments to quality.

Medicare has a pilot program to reconfigure how it pays for patients with chronic conditions such as diabetes, heart disease and kidney failure. While relatively small as a percentage of all patients, these beneficiaries account for about half of all money spent. Medicare is testing the idea of paying doctors a single, all-inclusive fee for managing each patient's care, linking the payment to whether the patient gets better.

Another initiative is studying the effect of paying doctors and hospitals small bonuses when they provide preventive treatments such as an annual eye exam for diabetics. Recently, Medicare also began tapping its databanks to give patients access to basic information about the quality of care provided by hospitals, nursing homes, home health and dialysis centers. Much of the information is now reported by the health care providers and posted on Medicare Web sites.

By linking payments to performance, Medicare hopes to shift the culture of medicine away from automatically doing more. In theory, that could lead to savings and improve care.

This is what we would hope for: case management of the highest cost conditions, payment based on best practices, and greater information dispersion through the customer base. The series contains quite a bit more information and good writing.

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Published on Leave a comment on Tax Credits for Health Insurance

A quick update to two posts last December about the tax treatment of health insurance: The Tax Policy Center has posted a brief and a discussion paper by Len Burman and Jonathan Gruber on the impact of various policies to provide tax credits to promote health insurance coverage. The bottom line seems to be that the President's plan gives the lowest cost per newly insured person, though reaching only a small proportion of those currently uninsured.

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Published on Leave a comment on Greg Ip Earns a Voxy

Brad DeLong often titles his posts "Why Oh Why Can't We Have a Better Press Corps?", and Andrew Sullivan often names his posts after and gives awards in (dis)honor of journalists who make outlandish statements. I would like to introduce my own award--the Voxy--to be bestowed occasionally on journalists in the mainstream media who make exceptionally lucid and thoughtful contributions to the public discussion. Feel free to e-mail me with nominations.

The inaugural award goes to Greg Ip, for his article in yesterday's Wall Street Journal, Medicare Ills Make Social Security Look Fit. Read the whole thing. I'm just going to focus on some excerpts that show why the article is noteworthy. Greg begins with an observation:

Reforming Social Security occupies countless scholars, commissions and legislators. Reforming Medicare, the program that could really wreck the budget, gets almost no attention at all.

He's right. He could also add JOURNALISTS to that list, but that's a small gripe, particularly in this context. He continues:

The mismatch between the programs' problems and the energy devoted to them is striking. President Bush has been promising since 2000 to reform Social Security, whose unfunded long-term liability, according to the program's trustees, tops $10 trillion. Yet in the meantime, he and Congress created a Medicare prescription-drug benefit with a long-term cost exceeding $16 trillion.

Yes, that's basically right, too. According to the 2004 Medicare Trustees Report (see Table II.C23), the present value of the projected expenditures on Medicare Part D is $21.9 trillion, or 2.4% of GDP. (I would have called this the long-term cost.) Beneficiariy premiums and state transfers are projected to offset $3.6 and $1.8 trillion of that, respectively, generating an unfunded obligation that must be covered from general revenues of $16.6 trillion (after rounding), or 1.8% of GDP.

There are two caveats to comparing this $16.6 trillion directly with the $10.4 trillion in unfunded obligations for Social Security. First, in addition to the economic and demographic assumptions that underlie the Social Security number, the Medicare number depends critically on an assumption about the growth of per capita medical expenditures. The disparity could be higher or lower than $6.2 trillion even if the $10.4 trillion projection is completely accurate. Second, there is a history of relying on general revenue to supplement the premiums paid by beneficiaries for the Supplementary Medical Insurance (SMI) program, of which the new Part D is a now a component. Some general revenue financing appears to be part of the design.

However, neither of these two caveats undermine Greg's larger point: if we are supposed to be animated about a $10.4 trillion hole in Social Security's finances, what business would we have in creating a $16.6 trillion hole in Medicare's finances? And for pointing out that inconsistency, Greg earns a Voxy. Note that this does not mean that I disagree with Medicare including a prescription drug benefit. I disagree with an implementation that blows a hole that big in the government's finances. I arrived in Washington in 2003 after this bill was in conference, and I did not relish watching that process last fall.

In fact, Greg retains the Voxy despite including a quote from me in his article that will render yours truly unconfirmable for future positions in government:

So how to fix Medicare? One way is to raise the age at which retirees qualify for benefits, as is often proposed by Federal Reserve Chairman Alan Greenspan and others for Social Security. "Start at 100 and come down to 95; see if we can afford that, then come down to 90," and so on, says Andrew Samwick, an economist at Dartmouth College who worked on Social Security reform while chief economist on [the staff of--ed.] President Bush's Council of Economic Advisers. "There is some age at which the system is in balance."

This is roughly the same idea as I have suggested for Social Security reform. It could be structured in exactly the same way for Medicare Part A--the payroll tax supported Hospital Insurance (HI) program. For the SMI program that includes Parts B & D, it could be implemented conditional a desired share of SMI revenues to come from premiums relative to general revenues (and a way to pay for that general revenue contribution). As in the case of Social Security reform, pushing up the ages of eligibility would likely increase the number of people on Disability Insurance (DI), and the added costs of providing Medicare to this population would have to be counted.

He keeps the Voxy because he shows where a "raise the eligibility age" strategy may come up short:

But it's not a cure-all. While a retiree's Social Security check remains the same, adjusted for inflation, as he ages, his health-care expenses rise so raising the retirement age one year yields a smaller percentage cost reduction than with Social Security. And it's politically unpalatable.

Greg's right again. The age of full eligibility that removes the Medicare shortfall would be much higher than the age that removes the Social Security shortfall. Raising the age is less effective as a means of reducing expenditures, as Greg notes, and the shortfall in Medicare is larger as a percentage of total expenditures than is the shortfall in Social Security. Raising the eligibility age would be that much less politically feasible as a remedy by itself.

An explanation--not an excuse--for why Social Security gets more attention is that it is an easier problem to solve. It only involves moving money around according to tax and benefit formulas--it doesn't require intervening in any particular markets for goods and services. This doesn't mean that it has gotten no attention. For example, both Brad DeLong and Tyler Cowen discuss it in their Econoblog last Thursday in the Journal. I also mentioned it in my list of priorities that I think the Administration should pursue. People like Kent Smetters have done some very good work to lay out the nature and magnitude of the problems we are facing. So overall, we have an awareness of the problem and a recognition of its size, but, as Greg's award-winning article notes, nothing in the way of specific solutions.

Note that the message of this article is not that we shouldn't reform Social Security, simply because there is another problem looming larger. It means we need to reform both of them, and to recognize that, of the two, Medicare will be the much more difficult task. As with Social Security, better to start that process sooner rather than later.

Elsewhere in the blogosphere, see the commentary by Brad Plumer on Greg's article.

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Published on Leave a comment on Brilliant Deduction?

A comment on my last post on the tax treatment of health insurance pointed to a December 8 editorial by John Cogan, Glenn Hubbard, and Dan Kessler in the Wall Street Journal, "Brilliant Deduction." According to the editorial:

We propose a simple change to tax law that would cut unproductive health spending, reduce the number of uninsured and promote greater tax fairness. For anyone with at least catastrophic insurance coverage, all health-care expenses--employee contributions to employer-provided insurance, individually purchased insurance and out-of-pocket spending--would be tax-deductible. The deduction would be available to those who claim the standard deduction and to those who itemize.

Is this a good idea? Maybe. Is it a better idea than eliminating the excludability of health insurance purchases from income and using the higher tax revenues to provide refundable tax credits to lower income households who purchase insurance, as I suggested in my first post on this topic? I don't think so. Here are my reasons:

  1. Both proposals eliminate the tax distortion between insurance premiums and out-of-pocket expenses. Both would serve to encourage plans with lower premiums and higher co-pays and deductibles, providing better incentives for consumers to economize on their health care purchases.

  2. Administratively, the CHK plan seems much more difficult to implement. The proposal to eliminate excludability requires only one piece of information on the W-2 form--an indication of whether the person has purchased insurance through the employer plan--or an analogous document from an insurance company in the case of non-group purchases. With the CHK plan, every purchase of health care now needs to be documented and submitted to some entity, whether the government or a benefits management company, and then reimbursed. These companies need to be periodically audited to make sure they are allowing all valid expenses (and only valid expenses). This entails a large amount of paperwork, particularly in the sort of high-deductible plans that CHK envision. My own experience with my employer's flexible spending account does not make me optimistic.

  3. In terms of equity, the CHK plan suffers from the same problems as the current system. If we believe that the income tax is supposed to tax income, regardless of how it is spent, then we judge the equity of the proposal by how much of the tax deductions for health care go to different income groups. Even under CHK, high-income households will derive the largest benefits because they have higher tax rates and greater rates of coverage. CHK argue that this is an improvement over the current system, but it is clear that it is still less progressive than the alternative--eliminate the excludability and redistribute the incremental revenues back to low-income households for refundable tax credits.

  4. In terms of efficiency, the biggest issue is that the CHK plan lowers the overall cost of health care by expanding tax deductibility. Thus, we expect more health care to be purchased (before making allowances for the improved incentives). Eliminating excludability in favor of tax credits can have the same incentive effects without lowering the overall price of a good that is already overconsumed. In a comment on the original post, Tom Miller points out (in his point #4):

    On another front, expanding tax deductibility to all out-of-pocket health expenses would indeed add new misincentives to spend more on health care than it’s worth. By making OOP spending appear to be “cheaper” with a pre-tax discount, it would dilute the cost constraining effects of the recent shift already underway toward higher levels of cost sharing (deductibles and coinsurance) in today’s employer-sponsored health plans. Unlike tax-advantaged Health Savings Accounts, it would only reward taxpayers for spending health care dollars today, instead of saving them for tomorrow. Replacing one set of third-party payers (insurers and employers) with another one (the Treasury, on behalf of invisible taxpayers) won’t make individual consumers much more sensitive to the real costs of the health care decisions they make. A better way to level the playing field is to level down, instead of leveling up, by reducing the tax rate differential imposed on everything else we earn, save and spend. Eliminating the current tax exclusion for health insurance could be swapped for an equivalent across-the board reduction of about three and a half percent in all marginal rates for personal income taxes.

    This is a reasonable point, with an alternative suggestion about what to do with the tax revenues generated by removing excludability. Tom also has some useful suggestions about how exactly to generate better incentives through the tax code.

Overall, I don't think the CHK plan is better than my alternative, but it does have one advantage politically. It lowers the individual tax burden, whereas mine leaves it about the same (by intent). In the current political climate, tax cuts can pass, but large redistributions--even ones that increase both equity and efficiency--are probably dead politically.

UPDATE: Follow the discussion elsewhere in the blogosphere, including Arnold Kling, The Lowest Deep, and Marginal Revolution.

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Published on Leave a comment on More on the Tax Treatment of Health Insurance

In a comment on my earlier post, Adam O'Neill points me to another article by Jon Gruber, this time co-authored with Michael Lettau,** that is relevant to my argument that a more rationale tax treatment of health insurance would replace the current exclusion* of health insurance premiums from income by refundable, progressive tax credits.

Quoting from the article (p. 1275):

[O]ur results imply that complete removal of the tax subsidy to health insurance spending would lead to about 15 million fewer workers being offered health insurance, and a total reduction in insurance spending on the order of 45 percent.

Note that this is a only half of the policy change that I discussed. Specifically, it does not incorporate the use of the new revenue to provide low-income workers with a refundable tax credit if and only if they spend it on health insurance. I conjecture that doing so would undo the reduction in the number of workers offered the insurance. Although I cannot speculate as to the magnitude of this offset, the Gruber-Lettau article also reports (p. 1286) that the probability that a firm offers health insurance is lowest when low-income workers are prevalent at the firm. This result obtains controlling for the tax subsidy to offering health insurance. By providing "use-it-or-lose-it" resources directly to the lowest earning groups, we increase the likelihood that they will join with higher earning workers to demand that the firm shift some compensation into group health insurance, even if the marginal tax incentive is gone.

*A comment on Brad DeLong's blog corrects my terminology--premiums are excluded from income. They are not a deduction, in the sense of an itemized deduction, from taxable income.

** My apologies to Michael--in the original post, I confused him with Martin Lettau.

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