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Three Steps to Better Healthcare

Henry J. Aaron

Healthcare analysts have long deplored the linkage between health insurance and employment. It makes no sense for one’s health insurance to end if one leaves a job. Various state reform plans, including that of California Gov. Arnold Schwarzenegger, deal with the healthcare system as a whole. But President Bush’s proposed fix does not go far enough.

The workplace-healthcare connection arose primarily because of a tax quirk. Premiums paid by the employer are excluded from the employee’s personal income and payroll taxes. If employees buy the insurance themselves, they pay for it with income that has been taxed. The president proposes to eliminate that differential and replace it with a deduction for insurance, however it is financed. If coverage meets certain standards, the worker would receive a tax deduction – $7,500 for singles, $15,000 for couples and families.

This change is a step toward “leveling the playing field.” But is it an improvement if that is all that is done? The answer is no. To replace employment-based health insurance, it is necessary to have something else that works. In particular, it is necessary to have a well-functioning market in which individuals can buy insurance at a reasonable price. Currently, the individual health insurance market is a disaster.

It’s a mess because it does not adequately pool risks. Pooling risks means grouping people with high and low expected health outlays. Premiums are then based on the average of the group. When people seek coverage as individuals, an insurer that wants to stay in business has to charge a premium that covers the costs each particular customer is likely to generate, plus enough extra to cover selling costs and profits. For healthy 30-year-olds, those costs are very low. For the cancer patient in remission or the 60-year-old whose parents died in their 40s from heart attacks, those costs are dramatically higher. The premiums for the latter may be so high that few can afford them.

Pooling makes health insurance affordable for the average person. The workplace serves that function – not ideally but adequately. Workplace pooling works best for large companies, for those with relatively high average wages and for those with stable labor forces. For a small company, one very sick employee can drive up costs. High turnover raises administrative costs. And where wages are low, typical premiums for family coverage equal the total earnings of a full-time minimum-wage worker.

So, what is right and what is wrong with the president’s plan? What is right is that it would extend to individually purchased insurance a tax break similar to the one now available only on employer-financed coverage. It would do so in a way that would not add to the federal deficit measured over 10 years, although it would boost deficits initially. Unfortunately, the plan would continue the incentive of bigger tax breaks for high earners even though most of the uninsured are low earners.

A better plan would be a tax credit that offered the same tax relief per dollar of insurance to people at all income levels. Better still would be offering larger credits to low-income households, which need help, rather than to high-income households, which don’t.

The bigger problem with the Bush plan is that it would not ensure that people would be able to find insurance at a reasonable price. The plan would produce millions more such shoppers because it would make it much easier for employers, bedeviled by rising premiums, to stop sponsoring coverage. Generous employers might give employees a raise equal to what the employer had been paying for insurance, but employees would still have to find a plan they could afford.

To be sure, the Bush plan would permit states to shift some funds to help subsidize high-risk patients. But it does not ensure that high-risk individuals would be able to find an affordable plan. As a result, it is likely to leave some older and sicker people, who now have insurance by grace of employer coverage, uninsured and unable to afford care.

The Bush plan could have provided that assurance by allowing working-age Americans to buy insurance from the plans offered to federal employees at the same prices that federal employees pay. Or it could have permitted them to buy Medicare coverage at a premium determined on a communitywide basis. To make insurance affordable for low earners still would have required additional help. However, the plan enacted by the Massachusetts legislature and Schwarzenegger’s proposal clearly show that there are ways to do this.

If Bush’s one-step plan were enacted, the nation would step into a very deep hole. Two additional steps are necessary for genuine reform: measures to make the individual health insurance market work, and assistance to low-income households that makes insurance affordable. The nation should not be satisfied with one step that makes things worse when two more would make them so much better.

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