Taxing Employer-Paid Insurance Premiums

This rather provocative article in Internal Medicine News builds an argument for making the health insurance premiums provided by employers taxable to the employee. Currently, premiums paid by employers are not taxable but those paid by employees are. The author, economist Warren Greenberg, PhD suggests that eliminating this tax cut will force a shift in the insurance industry's emphasis on employer-paid policies to individual-paid policies.

Why is this important?

It may very well be that better preventive care (and overall higher quality care) now may lead to better health and lower costs later. Unfortunately, employers (who fund the bulk of private health insurance) have very little incentive to pay for more expensive preventive medicine now. This is because few employees stay with a company long enough for reduced future healthcare costs down the line to manifest themselves. Greenberg cites an average 12 to 16% rate of employee turnover.

Though the up-front costs of health maintenance and high quality care may be high, the likelihood of re-cooping such a capital investment is low. Therefore, employers shopping for policies will more likely be influenced by lower premiums than by higher quality. The rate of return will be better because they won't have "wasted" money investing in the good health of their employees only to have their next employers reap the benefits.

Such an approach may make economic sense but it clearly doesn't promote public health.

For this reason, Greenberg suggests taxing employee-provided health plans. Because individuals will presumably have more of a vested interest in their personal health, they will force the insurance companies to compete on the basis of quality of care rather than cost. Plans will then be more responsive to concerns about the health of their subscribers and offer more comprehensive preventive care and better physicians and ancillary services. Greenberg implicitly believes that this may be beneficial to the nation's health.

I have several problems with this line of thinking.

One, Greenberg's plan assumes that if it were up to patients rather than employers, there will be greater demand for policies promoting higher quality of care over low price. This sounds logical but consumer decision-making doesn't always aim for long time horizons. (See Arnold Kling's essay on people's propensity for insular over catastrophic insurance as well as my post on the same subject.) Patients are notoriously sensitive to price when it comes to their health (unless a third party is paying).

Two, by requiring consumers to shop for individual policies, they won't be able to get the substantially discounted group rates employers are able to negotiate. Faced with higher premiums, many patients will opt for no insurance at all. Again, review the two links above for some insight on this behavior.

Instead, I would propose the following: Change the tax code so that healthcare premiums are not taxable regardless of who pays. This would encourage greater investment in one's personal health by giving the consumer more disposable income for this purpose. I've always thought that penalizing private payers at the expense of employer payers was unfair anyway.

Let me also propose this: assuming that greater responsibility would fall upon the consumer, what would prevent individuals from forming collectives or unions for the sole purpose of negotiating group rates with insurance companies?

Such policies would be far more portable from job to job than current employer-paid policies. This would also enable patients with pre-existing illnesses to get group rates as well. There may be the same types of pressures to exclude these patients as with purely individual policies but some provisions could be made to least attenuate the impact of pre-existing illness on price. Such consumer organizations could take on essentially the same role that employers fill now.

Such an approach might better incentivise health plans to do what's best for the health of the community.

There is one other point that should be made. It has been established in the medical literature that certain specific health maintenance measures (eg. controlling hypertension) will improve clinical outcomes. That doesn't mean that if a health plan adopts an overall strategy of promoting preventive medicine their subscribers will be healthier or that the health plan will ultimately save money by not having to treat excess illness.

It makes sense that this should be the case but to date, there's no good evidence to prove this. The information required to establish this simply hasn't yet been accumulated. Surprising huh?