Reforming the U.S. Health Care System

Policy Backgrounders | Health

No. 149
Monday, April 26, 1999
by John C. Goodman & Merrill Matthews


VI. Incentives To Reduce Waste And Inefficiency

A. Giving Employers And Employees New Opportunities To Reduce Health Care Costs

  1. Under the tax exclusion system, employees can reduce their tax liability by choosing (through their employers) more expensive health insurance plans.
  2. In this way, the federal tax system encourages overinsurance and waste: An employee in a 50 percent tax bracket (including state and local taxes) will tend to prefer a dollar's worth of health insurance to a dollar of wages even if the health insurance has a value of only 51 cents.
  3. By contrast, under the tax credit system no one will be able to reduce his or her taxes by purchasing more expensive health insurance.
  4. Since marginal improvements in a health benefits package under the tax credit system can be purchased only with aftertax dollars, no one will spend an extra dollar on health insurance unless it produces a dollar's worth of value.

"Everyone could contribute to a Roth MSA -- to pay medical bills not payed by insurance."

B. Allowing Employees To Manage Some Of Their Own Health Care Dollars

  1. Current tax law rewards employees who turn over all their health care dollars to an employer health plan (by excluding such money from taxable income), but penalizes (by taxing) income placed in a Medical Savings Account; the exception is the pilot MSA program for the self-employed and employees of small businesses.
  2. As a result, current law favors the HMO approach -- in which the health plan controls all the health care dollars and makes all the important decisions -- even though individuals might in many cases be better managers of their own health care money.
  3. Under the new plan, individuals who choose the tax credit option will be able to deposit a certain amount of aftertax income -- say, $2,000 per adult with a $5,000 family maximum -- into a Roth MSA.
  4. Contributions to Roth MSAs will be allowed only for individuals who have at least catastrophic insurance.
  5. A Roth MSA is a "wraparound" account, designed to fund the purchase of any medical expense not covered by a health plan; it can be used in conjunction with an HMO as well as fee-for-service insurance.
  6. Funds in a Roth MSA may be used only for medical care or must remain in the account to back up a health plan for at least one year.
  7. At the end of the one-year insurance period, Roth MSA funds may be withdrawn without penalty for any purpose, left in the account to grow tax free or rolled over into a Roth IRA.

C. Putting Third-Party Insurance And Individual Self-Insurance On A Level Playing Field Under The Tax Law

  1. The Roth MSA option will correct the bias in the current tax law.
  2. Beyond a basic level of insurance, funded by the tax credit, individuals will choose to spend their aftertax dollars on more insurance benefits or place those same dollars in a Roth MSA.
  3. Under this plan, no one will have an incentive to turn over additional dollars to a health plan unless they judge that the extra benefits they are purchasing are more valuable than the value of depositing an equal amount in a Roth MSA.

"Employers would have an option: stay in the current system or switch to the tax credit system."

D. Ending Incentives To Overconsume Through Flexible Spending Accounts

  1. Just as the tax exclusion for employer-provided health insurance encourages people to overinsure, the current system of Flexible Spending Accounts (FSAs) encourages people to overconsume.
  2. Under the system, employees make pre-tax deposits to an FSA to pay their share of premiums and to purchase services not covered by the employers' health plan.
  3. A use-it-or-lose-it rule requires that employees spend the entire sum or forfeit any year-end balance in the account.
  4. This rule encourages wasteful spending on medical care at year-end.
  5. Under the new plan, employees who are in the tax credit system will no longer have an FSA option.
  6. Instead, they will have a use-it-or-save-it Roth MSA option.

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