Approximately one week ago was the sixtieth anniversary of the IRS enacting a generous tax exemptions and benefits that allowed for employer-sponsored health insurance to thrive. What the Internal Revenue Code of 1954 did was exempt certain health-care uses of income from being considered taxable for purposes of collecting income and payroll taxes. This tax exclusion really took practice as an exemption starting back in the World War II era to avoid wartime wage controls. What a surprise: the government creates one problem with an onerous law, only to create another [arguably bigger] problem with another onerous law, which has now become the nation's largest tax break. What's sad is that the problem behind employer-sponsored health insurance is nothing new. The Cato Institute has been harping on this at least since 1999, and the Richmond Federal Reserve Bank pointed out back in 2004 how it distorts the health care market. Even the New York Times has recently pointed out the ridiculousness behind the concept. Why is it that I have such a problem with the government providing tax breaks for employer-based health insurance? Sure, it comes with advantages like encouraging workers to take health insurance, reducing health care costs for those who have employer-based insurance, and quite possibly could give a small boost to the GDP (although the latter does not take efficiency gains into account). It sounds like there are less taxes being paid and is a financial win-win, but is it really?
The so-called free money has to come from somewhere, and in this case, it's the workers' wages. This gives employers control over a significant amount of workers' earnings. If the government had taken $12,000 per annum in taxes to provide workers with health insurance, that would be called a tax increase. But when government drives a wedge between workers and a significant amount of their earnings, it suddenly becomes a tax "cut." What's worse is that the unintended consequence is that the worker feels as if they were spending someone else's more money. Since people tend to spend more liberally when it comes to other people's money (even if it's merely the perception thereof), they consume more health care than they need. What happens when you artificially increase demand like that? Health care costs skyrocket, which is why this tax exclusion is arguably one of the primary drivers of health care costs in the United States (Gruber, 2010).
This tax exclusion can hardly be considered fair. The only ones who receive benefit are the ones who are lucky enough to have access. Everyone else has to pay out-of-pocket with after-tax dollars, which is an even more sizable percent of one's earnings. It's also inequitable because the ones who need the tax benefits the least gain the most. There's also the consideration that employer-based health insurance is tied to one's current employment. If you get laid off, fired, or decide to quit, your health insurance would go along with your job. And don't get me started on the negative effects on entrepreneurship (Fairlie et al., 2010) or other market distortions.
We need to see the real prices of health care instead of obfuscating them with government policies that keep health care costs high. This is why we need to treat health care like a good instead of categorizing it as "special interests that only the government can handle" or a charity case. We need to sever the connection between employment and health insurance. Health insurance needs to be portable from job to job if we want to remove the market rigidity and stop the rise in health care costs.
Here are a few suggestions: health care vouchers, cap the tax exclusion (see here, here, here, and here), create need-adjusted tax credits (Miller, p. 16), create more neutrality by allowing out-of-pocket health care expenses and individual insurance to be tax deductible, or eliminate the tax exclusion all together and replace it with a paid-claims tax instead (Bipartisan Policy Center, p. 77-82). I do worry about the potential of the increased tax revenues being used to fund single-payer system, but I would recommend a revenue-neutral offset. Just lower taxes to offset the elimination of the exclusion or by implementing a health savings account (also see here). Whatever the combination of policy reforms ends up being, we need to put an end to this World War II relic.
10-15-2014 Addendum: The Mercatus Center recently published findings as to how employer-sponsored health insurance is a major driver of income inequality.