Sindhu Kubendran
Senior Research Analyst, Health Economics Research
Sindhu Kubendran is a senior associate and research analyst at the Milken Institute who focuses on areas of public health that include prevention, wellness, chronic disease, and longevity. At the Institute, Kubendran is a co-author of the reports, “Healthy Savings: Medical Technology and the Economic Burden of Disease,” which examines...
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Retiring a World War II funding mechanism for health care
By: Sindhu Kubendran
July 23, 2013

As has been stated too many times to count, the United States healthcare system is complex, confusing, and hugely expensive. The familiar stats: not only is it the biggest share of government spending, but it will only increase, with total health expenditures projected to reach 4.78 trillion dollars, or nearly 20 percent of projected GDP, by 2021. ItaEUR(TM)s well known that though the U.S. spending per capita on healthcare exceeds all other developed nations, the indicators of quality do not reveal a positive return on investment. A significant driver of costs lies in the structure of the U.S. system.

A unique aspect of U.S. healthcare is the deductibility of premiums for employer-sponsored health insurance (ESI). Unlike other programs funded through payroll deduction, such as Social Security and Medicare, health insurance is exempt from income and payroll taxes. For only those 162.5 million Americans receiving ESI, health insurance is paid for with pre-tax, not post-tax dollars. This sums to approximately $250 billion dollars per year in lost revenue to the government, making it the largest expenditure of tax revenue, in the form of foregone income.

These subsidies are a relic of World War II, when the government imposed wage controls to prevent workers back home from making too much more money than soldiers serving overseas. Businesses began to offer fringe benefits, such as health insurance, to remain competitive and attract employees. The exempt status of health benefits was written in to tax code, ultimately contributing to the growth of this employer offering.

ESI is now central to our healthcare system, and the government continues to fund this subsidy though forgone income even though the reason for its development is no longer relevant. Despite its prevalence in the headlines, war does not consume our country as it did in World War II. Today unemployment is more than two times the WWII rate, and the traditional American family structure, typically with one bread-winner and one non-working spouse, is far less prevalent.

The ESI tax exemption is both regressive and inequitable. It is regressive because 80 percent of the benefits is enjoyed by the top half of earners. While a worker earning less than $20,000 per year would see a $319 benefit, someone earning more than $200,000 per year would see a $2,823 benefit, according to M.I.T. economist John Gruber. It also benefits only those who have the option of employer sponsored care. People whose employers do not offer healthcare, people who purchase healthcare for themselves, and single parents unable to obtain spousal insurance are at a disadvantage.

Due to the less than obvious nature of both the tax exemption and healthcare spending in general, people often do not realize the full cost of their care. Because costs are cloaked, too many people visit the doctoraEUR(TM)s office and emergency room too often and unnecessarily. This leads to a cycle of increased demand, increased capacity, and increased prices. Research shows that more care does not fundamentally lead to better outcomes, and inefficiencies within the system add to the nationaEUR(TM)s debt.

With a growing need for access and transparency in healthcare, linking employment to health insurance seems to make less and less sense. While Republican and Democrat politicians alike have considered removing these tax subsidies as a funding mechanism to increase overall coverage, such a notion has never gained traction.

A solution to this subsidy issue must involve a systematic analysis of the current effects of the tax exclusion and the potential outcomes of policy changes. Efforts to repeal or cap the subsidy alone may lead to a decrease in ESI coverage, and so these should be combined with a reassessment of employer incentives and improvements in the availability of non-employer based health insurance. Any progress could increase equity in healthcare.


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