Last year Congress made tax-free Medical Savings Accounts (MSAs) available to 750,000 American workers and their families. Under a provision of the Kassebaum-Kennedy health insurance reform bill, small employers (50 or fewer employees) and the self-employed can purchase less expensive high-deductible health insurance policies and make tax-free deposits to an MSA. They can use their MSA money to pay small and routine health care expenses, reserving insurance to pay large, catastrophic expenses. Money that remains in the account at year's end earns tax-free interest.

People can use MSA money to pay their health insurance premiums during a job change. This should reduce job lock, a situation in which people do not change jobs for fear of losing their health insurance.

Expand MSA Availability. By limiting the availability of MSAs, Congress limited their ability to meet people's health care needs. Several new bills would solve that problem by removing the restrictions on MSAs, allowing them to address many of the problems in the health care system for which Congress is considering additional legislation. For example, with Medical Savings Accounts in widespread use, there would be no need for President Clinton's proposed $10 billion grant to help workers make their premium payments during job transition.

Last year's legislation was only a beginning. There are many more opportunities to take advantage of MSAs.

Offer MSAs to Federal Employees. MSAs should be an option for the nine million federal employees and dependents covered under the Federal Employee Health Benefits Program (FEHBP).

Currently, federal employees can choose among a wide array of health insurance plans and health maintenance organizations. Because the government pays a fixed amount towards the premium, federal workers must bear the cost of more expensive plans out of pocket - which makes them more cost-conscious. As a result, the program is often cited as a model for health insurance reform. Giving federal employees one more option can only enhance the program.

In addition, allowing federal employees to have MSAs would make the demonstration project more reliable. One reason why only a limited number of MSAs are available is that Congress wanted to determine whether MSAs would fragment the health insurance system, with only healthy people choosing MSA plans and sick people choosing traditional low-deductible health insurance. Ironically, small employers almost never offer their employees a choice in health plans. In these cases there can be no "adverse selection," since everyone is in the same pool. According to a 1995 article in the Labor Monthly Review by two economists from the Bureau of Labor Statistics:

• 94 percent of small employers (defined as those with fewer than 100 employees) offer no health insurance or only one policy.

• Only 6 percent offer more than one health insurance option.

Allow MSAs for Medicare. Congressional Republicans and Democrats agree that they must slow Medicare's rate of growth and offer seniors more private-sector options. MSAs should be one of the options.

Currently, Medicare gives 95 percent of the average annual per-person outlay to an HMO in exchange for a senior's comprehensive medical care. If an MSA were an option, part of the senior's Medicare allotment would purchase a high-deductible policy and the remainder would be deposited in the individual's Medicare MSA.

Health policy analysts assert that the reason Medicare costs are growing so fast - about 10 percent in 1995 - is that seniors have no incentive to be prudent shoppers for health care. A Medicare MSA would give them a financial incentive to avoid waste.

Create Super IRAs. President Clinton proposes expanding IRAs so more people can save for their retirement years - a good idea given Social Security's questionable financial future. Clinton also proposes more options for penalty-free withdrawals. For example, his proposal would allow individuals to withdraw IRA money without penalty or taxes to pay for health care - in effect using their IRA as an MSA.

One problem with the president's proposal is that working families would have to come up with additional discretionary money to fund their IRAs. By contrast, employers usually provide the funds deposited in MSAs, and the experience of employers offering these plans indicates that, on the average, employees with MSAs have about half the deposit left over at year's end.

If the president's proposal worked like an MSA, remaining balances could go into the employees' accounts, integrating the MSA concept into a Super IRA.

Unspent contributions would be automatically rolled over each year, and if health expenditures in a given year were unusually high - e.g., for experimental medical procedures or cosmetic surgery not covered by the high-deductible insurance policy - people would be able to withdraw money from their Super IRA to pay those bills.

Permit Backended MSAs. Under a frontended MSA, deposits are made with pretax dollars and the funds not spent on medical care are taxed upon withdrawal. Although these accounts are a substantial improvement over third-party payment of every medical bill, they retain some of the current system's incentives to overconsume medical care. Funds spent on medical care are tax free. But funds withdrawn to purchase other goods are subject to taxes and (in some versions of legislation) penalties.

This problem is eliminated with a backended MSA. Deposits are made with aftertax dollars and withdrawals are made tax free. As Figure I shows, this allows people to make unbiased choices between medical care and all other uses of money. After an initial one-year insurance period, accumulated funds can be withdrawn at any time for any reason without penalty.

Conclusion. Giving individuals more control over their health care dollars is the logical next step in health care reform. Medical Savings Accounts help achieve that goal. Even if Congress is unwilling to make MSAs more widely available in the private sector, it can still expand MSAs in the public sector through the FEHBP and Medicare and can permit backended MSAs.

This Brief Analysis was prepared by National Center for Policy Analysis President John C. Goodman and NCPA Vice President of Domestic Policy Merrill Matthews Jr.