Health Insurance 102

With the Obama administration and Congressional Democrats hell-bent on their attempt to further nationalize health care in America, it is important to realize that we do not have, nor have had for many years, anything close to a free market in health care.

Over 60 years of government intervention in health care have greatly contributed to the health care problems we face, and perversely have led Obama and others to argue we need further nationalization to address the problems caused by previous government interventions!

One profound problem has been the favorable tax treatment of health care benefits, which has led to overuse of health services. Health benefits do not count as taxable income for the employee, unlike wages, salaries, and bonuses which are taxable income.

This tax disparity has been around since World War II, which came about due to wage controls imposed by the Roosevelt administration (which illustrates one of the recurring elements of government intervention in the economy, in which one intervention creates distortions that give rise to agitation for more government intervention to fix the resulting problem).

For 60 years, employers and employees could increase the total all-in compensation (wages plus benefits) paid to an employee through greater health benefits, and do so in a tax-advantaged way. If the employee got a $100 raise in salary, he was taxed at full tax rates on that increase. But if the employee got a $100 increase in health benefits, he paid no taxes on the increase.

Guess what? People respond to incentives, and they responded by increasing the amount of health benefits because of its favorable tax treatment. The most common way to increase health benefits was for the insurance plan to pay for an ever-greater portion of health care costs. And as my previous column (see here) discusses, people have less incentive to keep health care costs low if they bear little or no incremental cost for using more health care services.

The result? Bad tax policy encouraged an explosion in health care spending.

Medicare has been another element in the government's intervention in the health care marketplace that has had dramatic consequences. Aside from the profound fiscal problems that Medicare is imposing on America, it has important current implications on the cost of health care.

Medicare generally has lower reimbursement rates for procedures than private health insurance, since the government is able to dictate that it will simply pay lower prices. But this means that the price health care provides must charge private insurance companies or individuals is greater, to make up for the lower fees paid by Medicare.

In effect, this Medicare cost-shifting imposes a hidden tax embedded in the cost of health care.

Another profound problem raising the cost of health insurance is that states mandate minimum insurance policies, such as requiring that mental health benefits be included in any insurance policy sold in it that state. Naturally, this drives up the cost of insurance and precludes someone from purchasing a cheaper policy with fewer benefits. It is as if a person couldn't afford a car because the state required you to purchase every car laden with options you can't afford to buy.

So when the press and politicians lament the existence of the uninsured, recognize that many who go without insurance do so because the cost of insurance is artificially raised by Medicare cost-shifting and state-mandated health insurance benefits.

Another problem is that the federal government limits the ability to charge differential costs for health benefits based on health indicators, such as whether a person smokes or their blood pressure levels.

To illustrate how big a deal this is, note the recent experience of Safeway, one of the nation's largest grocery store chains. Safeway's experience, even with limits imposed on its ability to differentiate health insurance costs based on health indicators, suggests that health care spending could be reduced by 40% with improved health.

How does this work? As this Wall Street Journal article discusses, 70% of health care costs are related to a person's behavior. Smoking, obesity, blood pressure, and cholesterol levels, for example, can be improved by changes in an individual's behavior, and Safeway lowers an employee's health insurance cost if he has healthier levels on these four measures.

The result has been dramatic. Safeway employees have responded to the financial incentives by losing weight, lowering blood pressure and cholesterol, and reducing smoking. Health care costs are lower, and health is improved.

Genuine health care reform, which promotes health and lowers costs, would address all these problems.

• The tax advantages of health benefits needs to end (offset by a broad-based tax cut so taxes are not raised in the process), to allow rational health insurance plans to flourish which protect against large costs but give the insured incentives to keep costs low.

• Medicare cost-shifting should stop, or at least shouldn't be exacerbated with more changes that make the problem worse.

• The federal government should allow health insurers to sell policies without mandated minimum benefits, to provide for low-cost insurance options which will reduce the ranks of the uninsured.

• The government should encourage Safeway's experience with differential pricing based on key health indicators, by allowing for greater differentiation and introducing such a system for Medicare and Medicaid.

We don't need to lower the demand for health care by government fiat through further nationalization, such as by introducing waiting times for service and restrictions on the use of new life saving or enhancing technologies. This is what government-run health care looks like in Canada and Europe.

Instead, we need to realize it has been 60 years of government intervention in health care which has led us to the problems we have today, and that we need to embrace freedom to have a better health care system.