Tax Subsidies: The Hidden Part of Government Health Care Spending

Excerpted From: Briefing Book on Health Care

January 9, 1995
W3

Tax Subsidies: The Hidden Part of Government Health Care Spending

The primary reason, U.S. health care costs have been rising is because Americans are usually spending someone else's money when they consume medical care. And out-of-pocket spending has been falling because government health insurance and tax subsidies for private health insurance have soared.

Government Spending vs. Private Spending.

The United States has been devoting more and more of total consumption to health care. Between 1960 and 1990, personal health care as a fraction of total consumption grew at a rate of 2.6 percent per year. The portion of health care paid by the private sector " out-of-pocket costs plus private insurance, net of tax subsidies " grew much more slowly. As Figure I shows:

Over the past three decades, the share of private health care spending in total U.S. consumption grew at an annual rate of 1.3 percent.
The share of government health care spending in total U.S. consumption grew at three times that rate. Similar patterns exist for specific types of medical services. Figure I shows that in some cases government spending has been growing at five to 10 times the rate of private spending.
Government spending (as a share of total consumption) in the hospital sector has been growing 2-1/2 times faster than private sector spending.
Government spending on doctors has been growing five times faster than private spending.
For pharmaceuticals, government spending has been growing 10 times faster than private spending.

"Health care spending rose modestly until Medicare and Medicaid were established."

The Size of the Public Sector.

People who look to government to solve our health policy problems may be unaware of how large a role the government already plays. When federal tax subsidies for health insurance are combined with direct spending, government at all levels (federal, state and local) spends more than half of all health care dollars. Overall:

Direct government spending has increased from 24 percent of all health care spending in 1960 to 40 percent in 1990.
When tax subsidies for health insurance are included, the government's share of health care spending has increased from 34 percent in 1960 to 51 percent today. [See Figure II.]

"Government health care spending has grown three times as fast as private spending." Government is the major player in the health care market. It influences the market through direct spending programs, tax subsidies and regulation.

Direct Spending Programs.

The two largest programs " Medicare and Medicaid " subsidize hospital and physician services for the elderly, the disabled and those on welfare. They are financed through general revenues and earmarked payroll taxes. In 1990, Medicare and Medicaid accounted for 67 percent of total government health expenditures. Other programs include health care provided to veterans and military personnel, public health measures and support for research and construction.

"The government's share of health care spending has risen from 34 percent in 1960 to 53 percent today." As noted above, direct government spending programs reduce the cost of medical care for those eligible. This is the primary reason the cost of these programs has grown so dramatically over the last three decades. Moreover, as the Medicare and Medicaid programs have expanded, health care spending in the United States has ballooned:

Between 1940 and 1960, health care spending rose modestly, from 4 percent of GNP to 5.2 percent.
Since 1960, however, the percent of GDP spent on health care has almost tripled - rising to 14.1 percent in 1992.
Spending on Medicare and Medicaid has skyrocketed from 5.9 percent of total health care spending in 1967 (the first full year of Medicare and Medicaid expenditures) to 28 percent in 1990.

"We are spending $8,821 per household per year."

"Tax subsidies for employer-provided insurance now total about $94 billion per year."

Tax subsidies.

As noted above, the primary tax subsidy goes to employer-provided health insurance. Workers exclude the value of health benefits they get through their employers from taxable income, paying neither income taxes nor Social Security payroll taxes on the coverage. The other tax subsidy allows taxpayers who itemize on their federal income tax returns to deduct extraordinary medical expenses. Taxpayers today can deduct medical expenses in excess of 7.5 percent of their adjusted gross income (AGI). As noted above, these two tax subsidies are very valuable:

In 1994, the exclusion of employer-provided health benefits from income will reduce federal income and Social Security taxes $83.9 billion and will lower state income taxes $9.7 billion.
The medical deduction will reduce federal income taxes $7.5 billion and state income taxes $1.7 billion.
Thus, total tax subsidies in 1994 will equal $103 billion.

Overall Effect of Government Subsidies.

Tax subsidies lower the private cost of health care and raise the public cost. Over the last thirty years, health care tax subsidies lowered the private sector's share of health care spending by 10 to 15 percent and raised the public sector's share by 25 to 40 percent. Including these subsidies, federal, state and local governments have accounted for more than 50 percent of U.S. health care spending since 1973.

Hidden Costs.

One consequence of the rise in third-party payment of medical bills is that most people have no idea how much they personally are contributing to cover the nation's health care costs. As Table I shows, in 1992 national health care spending was equal to $8,821 for every U.S. household. This burden was largely disguised, however:

For an average working-age family, the visible outlays in 1992 were $1,715 for out-of-pocket expenses and $574 for health insurance premiums.
These direct expenses amounted to only about one-fourth of total health care spending per family.
The remainder of the $8,821 burden was hidden in taxes and reduced wages.

"Most people have no idea how much they are contributing to the nation's health care bill."

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Excerpted From: Briefing Book on Health Care