Suggested Legislative Reform
Although the current U.S. health care sector has made remarkable advancements in high tech medicine and surgery, it is costly and wasteful, and it leaves many people without appropriate care and the means to pay for it. Consequently, the American taxpayer is paying for it in the most expensive way. The challenge for public policy is to enable consumers and taxpayers to obtain good value for their health care dollars. Achieving this objective stands the greatest chance of success if health care markets function well. To make markets work, we recommend changes in five areas of public policy: tax reform, insurance reform, improved provision of information, enhanced competition, and malpractice reform. Our policy reforms will improve the productivity of the health care system, make insurance more affordable, reduce rates of those who are not insured, and increase tax fairness.
The power of markets is to allocate resources efficiently—power evident in every other sector of the economy—and it is part of the solution in health care. Unfortunately, several U.S. public policies prevent markets for health services from accomplishing this objective. In two areas—tax policy and health insurance regulation—government policy has actively hindered the operation of markets. In three other areas—the provision of health care information, the enforcement of antitrust laws, and medical malpractice rules—government policy has failed to adequately promote the proper functioning of markets. Correcting this public policy it is a necessary first step in health care reform at the legislative level.
Current tax policy allows people to deduct the costs of employer-sponsored health insurance but generally requires out-of-pocket medical spending to come from after-tax income. This tax bias creates an incentive for employers to offer, and workers to choose, health plans that allow workers to purchase as much medical care through insurance as they can. In practice, this has been achieved through third party payment, procedure driven insurance that covers a broad array of health services with minimal deductibles and low co-payments, instead of lump sum catastrophic coverage.
The tax preference for employer health insurance is substantial. For the typical U.S. worker, the combination of federal income and payroll tax rates raises the total marginal tax rate on wage income to approximately 30 percent and thereby reduces the effective cost of purchasing medical care through insurance, rather than out of pocket, by 30 percent. In states with high state and local income taxes, and for people with high family incomes, the effective cost reduction is even larger.
The tax preference has had a powerful impact on the way medical care is purchased in the United States; approximately 85 percent is purchased through insurance. According to unpublished data for 2003 from Anthem, a large health insurer, the average annual deductible of health insurance policies purchased by individuals ($1,250) is four times greater than that of policies purchased by large firms ($250). Although many factors could affect the magnitude of this difference, the tax preference for employer-sponsored insurance is clearly important.
Low-deductible, low-co-payment third party payment procedure driven insurance has led to today’s U.S. health care market in which a lack of cost-consciousness and an abundance of wasteful medical practices are the norm. According to the RAND Health Insurance Experiment, an increase in a health plan’s annual deductibles from $200 to $500 reduces the total amount a person spends on health care through both insurance and out-of-pocket payments by nearly 5 percent. More recent estimates of the effect of deductibles and co-payments on health spending are even larger. The fact that these changes occur without any appreciable impact on most people’s measurable health outcomes implies that the extra care attributable to over-insurance that does not provide good value for money. We propose three changes in the tax code to correct this bias.
All Americans should be entitled to deduct health insurance payments and health care expenses as long as they purchase insurance and maintain an extended tax free health savings account. In all cases, the deduction is "above the line"—available even to taxpayers not itemizing income tax deductions, or for those below 150% of poverty, equivalent tax credits. This levels the playing field among those who are buying health care directly, buying insurance on their own, and buying insurance through their employer.
Allowing out-of-pocket health care spending to be tax-deductible would raise the price of purchasing health care through insurance relative to out-of-pocket in our current system. This would induce people to shift to health plans with higher deductibles and coinsurance rates, which, in turn, would lower health care spending. The problem is that many Americans can’t afford deductibles and co-payments and they either go without medical care or food or the doctor doesn’t get paid. The reason for co-pays and deductibles derives from the fact that our conventional health insurance has a lot of inefficient moral hazard inherent in its design. It lowers the price of health care without lowering the cost of health care. The fact that our conventional insurance is third party payment and procedure driven merely magnifies the inefficient moral hazard. It makes more sense to redesign the financing mechanism of health insurance to eliminate the moral hazard than to compound the folly of our flawed conventional insurance design with more bad policy.
By using Protocol Health Insurance for all non-discretionary, necessary, and emergent care and care that is not associated with inefficient moral hazard and all medical visits, pharmaceuticals, imaging procedures, hospital stays, surgery associated with the covered event we can eliminate much of the moral hazard. In addition by designing patient induced market incentives for the doctor to recommend appropriate use of medical technology we can further eliminate moral hazard without having to use deductibles and co-payments. This new design will lower the price of health insurance. The premium difference from today’s more expensive health plans can be kept in an extended HSA as a tax free self insurance for all discretionary care, initial medical care before a diagnosis is made and any care that is associated with moral hazard. By bifurcating the payment system in this way the patient only cost shares for care that is discretionary. That means that when a patient is ill, and can not work, he can pay for his non-discretionary care and do it in an efficient manner.
Full deductibility will reduce wasteful private health spending. This result is important for two reasons. First, it implies that full deductibility is an effective policy to address rising health care cost growth and the uninsured. Second, it has important implications for the policy’s impact on the federal budget. The tax-free resources not being used for health care consumption in the extended HSA would be channeled to other, taxable, economic activities as investments. The resulting increase in tax revenues would offset a sizable amount of the revenue loss from making all HSA health care expenditures tax-free.
Full deductibility would have several additional beneficial effects. Because the tax change would allow the deductibility of out-of-pocket health care expenses only with the purchase of insurance, the proposed policy also would create a powerful tax incentive to purchase insurance. Under current law, a typical uninsured person receives no tax benefit from purchasing insurance. Under our proposal, a person who purchased a health plan with a $2,000 premium and also paid $1,000 out of HSA would not pay taxes on both the premium and out-of-HSA costs. For a person in the 15 percent tax bracket, the tax break would be worth $450—23 percent of the cost of insurance.
Although deductibility would mitigate the bias against individual insurance (because both employer-sponsored and individual insurance could be acquired with pretax dollars), it still would retain major incentives for the purchase of insurance and for the purchase of employer-sponsored insurance. Because the tax change would allow the deduction of the cost of individual insurance from the income tax base but not from the payroll tax base, the proposed policy would retain a tax incentive for the purchase of employer-sponsored insurance. Spending on insurance purchased through an employer would, as under current law, still be excludable from both the income and the payroll tax bases. For this reason, deductibility would be unlikely to increase the number of uninsured people by inducing employers to stop offering insurance to their employees.
Finally, the tax change would increase the fairness of the federal income tax system. Under current law, people whose employer declines to offer insurance are penalized because they must purchase insurance with after-tax income. Tax deductibility would replace a myriad of special health care tax deductions—such as Section 125 flexible spending accounts and Section 105 health reimbursement arrangements—with a single deduction equally applicable to all.
Deductibility would make the tax system more progressive. Although marginal tax rates are higher for higher-income people, the fact that lower-income people have higher (currently taxable) out-of-pocket spending more than compensates for this effect. Using data from the 2002 Medical Expenditure Panel Survey (MEPS), we found that the tax reductions for low-income households are three to five times as large, on a percentage basis, as those for high-income households. For example, households earning less than $20,000 per year can expect a 5.7 percent reduction in their average tax rate, whereas households earning $20,000–$30,000 per year can expect an 8.3 percent reduction. This reduction would come about because our policy would allow health expenses to be deducted "above the line." By comparison, households earning $70,000–$100,000 per year can expect only a 1.8 percent reduction in their average tax rate, and households earning more than $100,000, a 1 percent reduction.
Universal health savings accounts.
The tax code could also be changed to make it easier for individuals and families to save for expenses not covered by protocol insurance. We propose making all individuals eligible for HSAs conditional on the purchase of insurance that covers at least catastrophic expenditures. As with current HSAs, balances may be spent on the health care of a relative, and balances not spent on health care could be carried forward tax-free. Funds withdrawn for non–health care purposes would be subject to income tax. Recipients of health care tax credits (described below) could deposit funds in an HSA if they wished.
To expand the availability of HSAs, we propose three major changes. First, under current law, an employer-sponsored family health insurance plan must have a deductible of at least $2,000 to qualify its purchaser for the HSA ($1,000 for an individual plan). We should eliminate the deductible requirement. Second, the amount a household can deposit in an HSA is now limited to the amount of the health insurance plan deductible, up to $5,150 ($2,600 for an individual plan). We propose setting a $15,000.00 limit ($7500.00for individuals) on the amount that can be deposited in an HSA, annually. Third, under current law, funds from an HSA cannot be used to purchase insurance. Under our proposal, funds from an HSA could be used for any qualified health care expense, protocol health insurance, long term care insurance, and disability insurance.
The purpose of these proposed changes is to make the HSA law less prescriptive and thereby encourage greater use of HSAs. We are concerned that the high-deductible requirement under current law might serve as a barrier to the widespread use of HSAs. Under our proposal, people would be free to purchase insurance on their own rather than through an employer, all without tax penalty. Consistent with our policy of full deductibility, we believe that public policy should, whenever possible, allow individual preferences rather than government mandates to determine people’s health insurance arrangements.
Tax credits for low-income people. A third policy we propose is designed to improve the health care "safety net" for very-low-income households. Although our proposal to make out-of-HSA medical expenses tax-free offers important benefits for many low- and middle-income working families, it does not help families that pay few or no income taxes.
To address this inequity, we should offer low-income households financial assistance to purchase health services. Eligible expenses would include payments for insurance and out-of-HSA expenses. Thus, the refundable credit would be available to buy insurance through an employer or on one’s own, or to pay for out-of-HSA expenses (conditional on having insurance). It is less expensive to subsidize the poor to be able to purchase an efficient, low price insurance product such as Protocol Health Insurance, than to continue to pay for their most expensive care in the most expensive venue through cost shifting. These families would receive tax credits on a means tested sliding scale so that every American could put $15,000.00 into their extended HSA .
Regulation of markets for health insurance
The second area in need of policy reform is the regulation of markets for health insurance. Under the McCarran-Ferguson Act of 1944, states have had primary responsibility for regulating health insurance markets since the 1940s. Each state specifies the rules by which its insurance market operates, including the financial requirements insurers must meet to sell policies in the state, the services that a health insurance plan must cover, the prices that insurers can charge, the individuals or groups that must be offered coverage, and the method by which insurance companies must conduct their business operations. As with the tax preference, the unintended consequences of inefficient insurance regulation drive up costs and increases the number of Americans who are uninsured.
We propose two major changes to insurance regulation: the creation of a federal market for health insurance; and provision of a subsidy for the insurance costs of the low-income, chronically ill.
Create a federal insurance market. One particular form of state insurance regulation—benefit mandates—has expanded dramatically over the past forty years. In 1965 there were fewer than a dozen such mandates throughout the fifty states and the District of Columbia; by 2003 the number had risen to more than 1,800. Benefit mandates now require coverage of off-label drug use (thirty-seven states), acupuncture (eleven states), and chiropractic (forty-seven states). According to the Congressional Budget Office (CBO), states’ benefit mandates have raised the cost of a typical insurance plan 5–15 percent. According to one study, about one-quarter of those who lack coverage are uninsured because of the cost of state mandates alone. Oddly enough all state mandates relate to third party payment insurance only. If we change the financing paradigm to Protocol Health Insurance, all of the state mandates will no longer apply and be obsolete.
We propose that insurance companies that meet certain federal standards be permitted to offer plans nationwide, free from costly state mandates, rules, and regulations. With this change, insurance would become available to individuals and small groups on the same terms and conditions as those now available to employees of many large corporations, which, by self-insuring, are exempt from state insurance regulations and instead operate under the federal insurance law provisions of the Employee Retirement and Income Security Act (ERISA).
Given that approximately half of the privately insured U.S. population is already covered by plans that operate under federal regulations, this reform would not lead to radical or unpredictable changes in consumer protection. Federally certified health insurance products would be required to meet all federal regulations that now govern the provision of health insurance for large employers; there would be no rollback of existing protections. Insurance companies that now offer federally certified products would be required to meet financial structure and solvency requirements. In addition, states could continue to supervise day-to-day market conduct, such as consumer complaints. Finally, insurance companies that now offer federally certified products would no longer be exempt from antitrust liability under the McCarran-Ferguson Act, which would expand the federal government’s ability to police anticompetitive behavior.
This change would bring several benefits. Most importantly, it would foster a more competitive, efficient non-group health insurance market that would enable people to obtain a greater variety of lower-cost health insurance alternatives such as protocol health insurance. The lower cost would induce more people to buy insurance and thereby increase the size of risk pools—which would further strengthen markets for insurance. In addition, a federal market would increase the portability of health insurance by making it easier for people to keep their insurance when they move across state lines.
Solving the Worker’s Comp Problem and Avoiding any new Individual or Employer Mandates to Purchase Insurance
Protocol health insurance is a twenty-four hour health insurance. That means that it covers on the job as well as non job related illness and injury. Employers can make a defined contribution into an employee’s HSA of the premium he currently pays for Worker’s Comp. This then obligates the employee to purchase a Worker’s Comp policy. By purchasing a protocol health insurance policy the employee not only satisfies the existing mandate but gets twenty-four hour health insurance coverage. This has many other beneficial effects on making health insurance more efficient. Millions of dollars will be saved from trying to sort out which cases is Workers Comp and which are not. Protocol insurance will serve as an incentive to keep workers on the job instead of staying home because of “back pain” NOS since it is not a covered event and they have to not only spend their own money but lose income while they are at home.
Subsidize insurance for the chronically ill. Providing affordable health insurance for chronically ill people who have predictably high medical expenses year after year and who lack sufficient resources to finance them is one of health policy’s most vexing problems. Competitive markets for insurance, which provide good protection for unforeseen major medical expenses, do not work well for persistently high-cost patients.
States have responded to this problem in two ways, both of which have been unsatisfactory. High-risk pools, in theory, allow those who have been denied coverage or charged a high premium because of their health status to obtain subsidized insurance through the high-risk pool. According to a recent study, although twenty-eight states operated high-risk pools in 1999, they covered a total of only 105,000 people. This study concluded that the small size of pool enrollment was the result of several factors, including high costs; limited benefits; limited outreach to prospective members; and, in some cases, explicitly capped enrollment.
State-mandated premium risk bands and underwriting restrictions seek to extend coverage by limiting the range of premiums and the characteristics on which they can be based. However, a study of regulation of the small-group market found that such stringent regulations decreased the rate of coverage among workers and increased premiums for small employers. Further, most of the increase was passed on to workers through higher employee contributions—ironically worsening the problem of the uninsured.
We propose a subsidy to help people with predictably, persistently high health costs to purchase insurance in the new nationwide market through a properly designed high risk pool. A public-private partnership between the federal government and insurance companies would administer the subsidy.
This subsidy would preserve coverage for the chronically ill at a lower cost than, and without the unintended consequences and market distortions created by, its alternatives. One alternative, for example, seeks to socialize the costs of all high-cost patients. Such socialization helps the chronically ill but also subsidizes the catastrophically ill—those with unexpectedly high costs that will not persist, such as costs for people injured in auto accidents. Private insurance markets, however, work well at financing the care of the catastrophically ill; adverse selection arises only when a patient’s (high) expenditures are predictable in advance.
We also propose reforms in three additional areas: better provision of information to providers and consumers; an explicit public goal to control anticompetitive behavior by doctors, hospitals, and insurers; and reforms to the medical malpractice system to reduce wasteful treatment and medical errors.