Effect of FairTax on HealthCare
Hayden requested a discussion on Heathcare (see first post).
The current tax system is a large factor that drives the structure of the existing health care system. We have a health care market that is subject to only restrained price competition and has almost no publicly available information concerning the quality of health care providers. Insured consumers do not bear the financial burden of their purchase decisions and have virtually no incentive to economize in their use of health care services. The change to a federal sales tax system will have a major impact on the health care industry.
The FairTax eliminates tax preferences for employer-provided health insurance. Health insurance and medical care are treated for tax purposes like all other goods and services. This changes considerably the structure of the health care delivery system over time. There is no longer a large tax reason for employers to provide health insurance, although many would probably continue to do so to remain attractive to potential employees. Some employers would undoubtedly choose to get out of the health insurance purchasing business and provide money to their employees to buy their own. Individuals could purchase high-deductible policies and use their time to shop more aggressively on price or minimize their use of health care, introducing more aggressive price competition to the health care marketplace.
See The Impact of the FairTax on HealthCare for more information.
Here is one area that I do not believe has received any real scrutiney, but when you examine it you will see that the FairTax will really screw the middle class in term of health care expenses.
Here’s why. First, I am assuming that the FairTax will be 40% on a tax-exclusive basis (consistent with the Rice study, that found this to be the MINIMUM rate that would be required. Second, I am going to assume that retail prices will rise by the full tax-exclusive rate (which is consistent with Kotlikoff/BHI’s belief as to the most likely result). Obviously, folks might quibble with these assumptions, I just want to explain where I’m coming from.
Third, I am assuming that health insurance for a family of four costs an average of $12,000.
With those assumptions, here’s my analysis.
1. Currently, most Americans get their health insurance through their employers, who get a tax deduction for providing health insurance. I believe most employers pay an average of 1/3 of health care premiums for their employess. So, in my example, an employer would pay $4000 and the employee would pay the remaining $8,000 (plus, obviously, the deductible and co-payments).
2. Under the FairTax, health insurance premiums will no longer be tax deductible to the employer, so it will have no financial incentive to provide health insurance. So, we should assume that companies will push the full cost of health insurance on to their employees. (The employees might receive a raise, since the employer is no longer paying any portion of the heath insurance costs, but the amount of the raise would not equal the retail price of health insurance.)
3. Thus, we must assume that the employee’s health insurance premiums will be at least $12,000 per year.
4. However, the cost of health care will rise by 40% under the FairTax. So, if cancer treatment costs $100,000 today, it will cost $140,000 under the FairTax system. Thus, health insurance companies will need to raise their premiums by 40% in order to pay for these added health care costs. Thus, heatlh insurance premiums will rise to $16,800 per year (i.e., $12,000 x 140% = $16,800).
5. But that’s only the PRE-TAX cost of the premiums. When you add the Fairtax, the annual premiums will rise to $23,520 (i.e. $16,800 x 140% = $23,520).
So, under the FairTax, the average family will see their health insurance costs increase from $8000 per year to $23,520 per year. Almost triple! In addition, unreimbursed health care expenses will rise by 40%. A double whammy.
What will be the result? Obviously, more families will do without health insurance, which will mean that more folks will go to emergency rooms or rely on Medicaid, etc. and become a burden on the county or the state. But, since we know that expenditures by the county or the state goverments are taxed under the FairTax (including care for indigent health care costs, Medicaid, etc.), the additional tax burden will fall on all of us who are paying taxes.
Another unintended consequence of the FairTax. Anybody want to comment on my analysis?
Hayden, I don’t think that you would get a double tax affect since you’re paying for the same service. I think healthcare paid by an insurance company (on behalf of the insured client) would be a b2b untaxed transaction. The final consumption is paid by the insured client through the monthly premium. It’s likely that if insurance did not cover the full cost, you would have to pay the FairTax on the remaining total billed by the hospital. If you do not have insurance, you would pay the hospital directly, who would charge the tax. You seemed to leave out that a full accommodation as described would result in an similar windfall to income (along with the prebate). I also question if BHI believes full accommodation as the likely outcome as they expressed otherwise to me (and in publication). I thought Kotlikoff had a similar view, but perhaps prefers full accommodation as it presents as more progressive on assets.
Hayden,
This is a topic I’ve long thought deserves a thread. Good job in suggesting it. However (as you might expect), your analysis as to how the fairtax would hurt healthcare is completely the opposite of how I think it would help healthcare. So without responding specifically to your claims, I’ll make a few of my own.
Currently, the health insurance market is completely distorted by the federal government allowing corporations to deduct health insurance premiums against profits. This does a couple of things. First, it cost a corporation $0.65 to buy $1 of health insurance for an individual. Or in other words, the corporation can give an individual $1 (towards health insurance) for only $0.65. It’s no wonder about 60% of Americans receive their health insurance through their employer. What this does is artificially raise health care costs about 53% because employers are still willing to expend the same amount of funds towards healthcare. It’s analogous to the home mortgage credit. People are willing to pay a certain amount per month for living expenses. If you give a tax deduction, they will be willing to pay the same amount, only they will discount that amount based on the tax savings.
Second, this forces employees into a large pool. So young employees have to pay the same amount for insurance as older employees. This also means older employees have to pay for services such as in vitro fertilization, i.e. it completely distorts the market.
If the fairtax were enacted, the only incentive to provide health insurance would be pooling. Still an advantage, but much less than a (puesdo) 35% discount.
Imho, this would mean less employer provided insurance (and retirement) and more insurance purchases directly made by consumers. This would undoubtedly lead to the lowering of prices which is the worst aspect of our healthcare system (since besides price, we have the best healthcare system in the world statistically).
In conclusion, the fairtax would actually help our current healthcare situation (as well as many other tax distorted industries) greatly.
I’ll respond to your assertion later.
The analysis, within its own four corners, could be correct, but it disregards the fundamental problem that got us into the health care crisis in the first place. We start with a rhetorical question: what is the single area of health care whose costs have not risen more rapidly than the general rate of inflation? Answer: cosmetic surgery. It so happens that insurance does not pay for this medical procedure.
The genesis of the health care crisis today is the third-party payor system, fed in part by the tax code and in part by Medicare/Medicaid. People over-utilize minor services because their own money is not in play.
The problem started at the end of World War II when the country entered a period of high inflation, and the government capped wages. Employers, to attract employees, lobbied Congress and got today’s tax shelter in which employee benefits are tax-deductible to the employer but not tax-includable to the employee. Thus the system of health care insurance through employment got its start. Fiscal conservatives can argue that our current system of employment-financed health care insurance, like business taxes, are what is making our companies uncompetitive in world markets.
If an employer today seeks to have his employee participate in his own healthcare costs in a meaningful way and at a level the employee can afford, the employer is wasting a tax shelter. The distortion therefore subsists.
The first step towards solving this problem, long-term, is to put employer-purchased health care insurance on an equal tax footing with individually-purchased health care insurance. The Fair Tax accomplishes this objective through its proxy-buying rules. At Title II, Section 901 the legislation provides that, if a business provides taxable property or services to a person as remuneration for employment, and if the taxable property or services were not previously subject to taxation, then the provision of such taxable property or services is considered a conversion to personal use and is subject to tax.
Section 901 therefore puts employer-provided health care insurance on the same tax footing as individually purchased health care insurance. Employers can continue to offer health care insurance as compensation for employment, and some will retain the ability to purchase it more economically through greater purchasing power. But employees will be better able to evaluate the tradeoff between cash compensation and compensation in kind through such vehicles as insurance.
If we want to solve the health care crisis long-term, the Fair Tax is the best start.
~Jim Bennett
Summit, NJ
Wow, this has got to be a first! I (sort of) agree with Andrew and Jim.
I actually agree that tax-deductions for employer-provided health care don’t make economic sense and have lead to distortions in the market for the reasons you point out. I also believe that high-deductible policies (such as health-savings accounts) would bring down the price of health care as people would be more selective in its use. (Alas, however, we all know that some folks would fail to vaccinate their kids and the like in order to save a few bucks, which would have other consequences, but let’s not debate that here.)
So, I am not against eliminating the employer tax deduction. (Although, if they do so they had better make sure that health insurance policies are completely portable and you don’t lose you shot at coverage due to a pre-existing condition.) However, I am pointing out that one of the consequences of the FairTax is that the cost of health-insurance coverage to most Americans will rise dramatically.
Now, as Morph points out, the cost will be at least partially offset by the pre-bate and “keeping 100% of your paycheck.” And maybe the cost won’t go up by the full 40% (or whatever), but the cost will definitely go up, at least in the short run until and unless healh-care efficiencies kick in. (And, part of those efficiencies will be the ability of insurance companies to deny coverage to higher-risk individuals, unless there is regulation preventing that, which will then increase the price of insurance for the “healthier” population.)
Anyway, my point in this is that health-care is something that people cannot do without in order to minimize their tax burdens. People can do without new homes. They can do without new cars. So they will be able to avoid paying the FairTax on these items. But they can’t do without healthcare, so that’s where the government will need to get its tax revenue from. (I thought about that after the debate, when Linder said that 80% of “service dollars” went to health care.)
By the way, Andrew, one reason cosmetic surgery has not increased as much as other procedures is because people can vote-with-their-feet. Cosmetic surgery for Americans is big business in Brazil, India, and Thailand among other countries, where the cost is much less than in the U.S. People might not be quite so willing to try out a Thai surgeon when it comes to cancer, particularly if health insurance will cover the cost, but if millions of folks with pre-existing conditions lose their health insurance coverage due to the elimination of employer-provided health insurance, then you will see a surge of patients going for treatment in other countries. They won’t have any other choice!
Did you see the Bunk study stating 2/3 of doctors in America want National Health Care. The doctors who did this study also conducted one in 2002 and found that the majority of doctors did not want national health care, the problem with this is that the 2 question surveys drastically differ in there 2nd question. I found this article, 60% of Physicians Surveyed Oppose Switching to a National Health Care Plan, It’s worth a read.
Hayden,
It was actually Jim with the cosmetic surgery stat, but I think both of your points are correct. Cosmetic surgery seems to benefit from costs being placed directly upon the party using the service. If it were generally covered by employer provided medical insurance, the insurance would undoubtedly be higher as well as the out-of-pocket medical expense.
Again, your analysis seems to imply that real costs will be higher. They will not be, unless healthcare is under valued due to the current market distortion. It is not. It is over valued (because 77% of all healthcare spending is done by a third party payer, there is the agreed upon employer tax distortion, etc.) The fairtax can’t do away with all of the overvaluing, but it can hit a majority.
Insurance companies paying my medical bills don’t get to claim that as a business expense, i.e. the 140% * 140% = 196%? That sounds like something that would definitely distort the cost of all insurance upward assuming that is how the law is written. Forgive me if I request independent verification before making a final judgement.
The $4000 will go to employee. If the market gives that $4K as compensation today, there is no reason it would not under the fairtax.
So in a nutshell, the only new argument you’re bringing to the table with healthcare is the fact that health insurance is subject to cover costs with the fairtax, plus have the fairtax applied to premiums. Imho, even with this double taxation issue, the gains from removing the huge market distortions in our current healthcare system completely outweigh any negative benefits.
None of this even addresses the added fluidity to the labor market due to consumer owned healthcare, retirement, etc. Or in other words, no one will be afraid to change jobs because of healthcare or retirement compensation.
Andrew, I don’t believe there is a double tax effect. I think the insurance companies do get to claim that as a business expense - the individual is the final retail transaction. I believe we would have to pay the tax on charges that the insurance company did not cover though, or if we purchased the care directly from the hospital. That tax will either be charged by the hospital or the insurance company, but not both on the same healthcare service. You don’t tax the tax.
On another note, the prebate is index to inflation - so if they did do a full accommodation that resulted in a 40% price change, the prebate would also be increased to reflect the change in poverty level spending. Also note, the 40% figure (Zodrow & Diamond) maintains the Earned Income Credit and the refundable Child and Dependent Care Credit, which would additionally offset tax costs for lower income households.
Morph — I am not going to go through the entire legislation to find the answer to this question, but I think I am right.
Look at it from the perspective of home remodeling. If I remodel my own house, I need to pay the FairTax on that remodeling job. If a third party (say, a relative) pays for my remodeling job, they will also need to pay the FairTax. So, presumably, if an insurance company pays for the remodeling (due to a flood or insurable damage to my house), it will need to pay the FairTax as well. I do not see why that would constitute a tax-exempt “business expense” since the ultimate beneficiary (i.e., me) is a consumer.
Thus, since the costs to the insurance compay will go up, it will need to raise my premium to cover these additional costs. In addition, I will need to pay the FairTax to the government in addition to the premiums. I don’t see any other possible result.
Andrew — The employee would not get an additional $4000 from its employer. Currently, the employer provides $4000 of insurance to its employee at a cost of $2600 (due to the tax deduction the employer gets). If the tax deduction is eliminated (which would occur under the FairTax) and the employer therefore stopped paying a portion of the employee’s health insurance, the most the employer would raise the employee’s salary would be $2600 (if that much).
A quick question for Hayden then. If “the 40% figure (Zodrow & Diamond) maintains the Earned Income Credit and the refundable Child and Dependent Care Credit”, but the fairtax law does not, how can you use the 40% figure (at least without discounting it). Aren’t you proving Boortz’s point that opponents using are the higher rate aren’t using a study of the fairtax? Please explain.
Hayden,
I agree the real cost to employer is $2600, but that is the distortion. That is exactly why prices are so high. Like when I pay my mortgage. I discount it against the tax deduction.
But you are correct. The employer will only have $2600 to give to the employee. I’ll change my comment, but with the new assertion that the employee only needs the additional $2600.
Hayden,
See the definition of “Produce, provide, render or sell taxable property or services.”
Taxable property or services purchased on behalf of an insured person (policyholder) are treated as purchases for business purposes and are not taxed if sales tax was paid on the premium for the insurance contract under which the claim was paid.
See also Chapter 2, Section 206, Insurance Proceeds Credit.
~Jim
Andrew — The 40% that Zodrow & Diamond found assumes no tax avoidance. They admit that their number is the lowest possible rate. All other independent studies and estimates gave a much higher rate. So I thought I was being generous with the 40%.
Jim — If I understand the quote correctly, that would mean that the payments from the insurance company to the doctor/hospital, etc. would not be taxed.
Now, that brings up a VERY interesting question. When the various economists calculated the FairTax rate, did they exclude health care paid by insurance from their calculations of the required rate? I don’t believe they did. If they didn’t, that means that the tax rate will be much higher than they calculated, because health care is such a high percentage of our economy (like 1/6 of the total economy).
Hayden, I expect the National Income and Product Account figures by the U.S. Bureau of Economic Analysis (used in the rate studies) do not double count the consumption of these services. The premium for the insurance contract is value add on the service of healthcare - a percentage of the total cost, not an entirely new base of consumption. In your example, you would have to assume that heathcare insurance made up 1/6 as well. So healthcare insurance and healthcare services make up 2/6 of the economy? I don’t think so. The two are one in the same - they represent the same 1/6th and it is taxed once.
I think that might be worth asking someone. I wonder of Zodrow or Diamond would answer that one.
Hayden,
Imho, you just add fuel to the Boortz fire when you use a study that “isn’t the fairtax.” Yes they don’t consider evasion nor do they consider economic growth. Don’t any of the other independent studies more closely resemble what the fairtax represents?
As you know, I’m not too hung up on the rate because I believe it is what we are all effectively paying today. Can you point to which studies in the research list you think are really representative?
I classify three studies as trying to follow the FairTax. Gale, Zodrow & Diamond, and BHI. These also happen to be the only studies available for peer-review which provide a detailed methodology for computing the rate. Each analysis made different assumptions and exclusions regarding the taxable base. I think the Z&D study (which we talk about here) does the best job in describing some of these assumptions (as it compares Gale and BHI), but I don’t necessarily agree with all their choices. As stated earlier, both Gale and Z&D maintained the Earned Income Credit and the refundable Child and Dependent Care Credit, which costs around 50 billion and changes the tax burden distribution. Z&D did do a partial dynamic analysis - so they did try to account for some economic growth.
Probably the largest assumption that affected the rate on the Gale and Z&D study was in regard to state and local spending. Gale and Z&D excluded a good deal of state and local spending (300 billion), which results in an increase to the FairTax rate rather than an increase in the state and local tax rates. BHI left much of this for state and local governments to adjust their tax policy or spending policy as needed to accommodate paying the FairTax. This could be stated as deceptive as it hides part of the rate in a state and local tax increase, or this could be argued that it removes the current deception and reveals the true cost of local government services (relative to private industry providing the same services). So with the BHI study, we would see a larger impact on state and local policy, and less so with Gale and Z&D who include this in the FairTax rate. This does have an effect on measurements of tax burden - as state and local governments may choose any number of ways to generate the revenue by being more or less progressive than the FairTax (or even adopting the FairTax model).
To Hayden’s point though, the studies did not account for avoidance and evasion. I think we would have to cut back on spending if we use a 23% rate. I don’t expect this would break many hearts on this blog though.
Morph — You lost me with the state/local spending stuff. Can you be more specific?
Hayden, Here is the statement from the D&Z study and my comments follow.
I’m not sure it matters who is right or wrong here with inclusion / exclusion of these figures but it is a large amount in the base. If you add this back in and take out the tax credits, you’re at about a 26.5% rate (36% exclusive). So this state and local exclusion is a bit over 1%, which represents almost 1/3 of the state / local expenditure. Now, I believe this 1% exists in either case - it’s just a matter of who collects the tax. If the state/local expense is not included in the tax base, than the FairTax rate is higher. If it is included in the tax base, than the FairTax rate is lower but state and local taxes are higher.
BHI states that purchasing power is transferred to state and local taxpayers from state and local governments. To recapture the lost revenue, state and local governments would have to raise taxes in order to continue collecting the same real revenues from their taxpayers. If the state / local pays the tax on the 300 billion, than they state will have to raise a similar percentage to maintain real revenue. If the state doesn’t pay taxes on this 300 billion of consumption, the FairTax rate must be higher to collect more revenue from the rest of the tax base. So it’s one or the other, but we’re still going to pay it. D&Z put the remaining tax base on the state and local government at 2.8%. I’m not sure where these things will fall out, but my point was that in the Gale and D&Z study, they’ve excluded some of the state and local base (right or wrong), which changes where the tax is reflected (fed or state/local).
OK. All I want to know is this: If my company decides to no longer offer health insurance and I have to buy my own, and no insurance company will cover anyone with anything more serious than a hangnail, where does that leave me, and hundreds of thousands like me, who won’t be able to get insurance without the protective umbrella of a big corporation?
Jodi, I would not assume the current structure, that was created as an influence of our tax system, would not change to fit the needs of people when that tax influence is removed. You can also be pretty confident that if such a situation was to present itself, either administration would react by requiring certain levels of coverage or maintaining coverage, just as they are proposing today. It seems clear that the American people are demanding affordable and available health care coverage... whatever tax climate we are in. Government seems determined to subsidize health care, if not take it over all together.
If you guys have iTunes, there is a cool podcast on economics called EconTalk, which you can download for free. A few months ago they had on the CEO of a regional hospital in St. Louis to talk about the costs associated with health care. IT was VERY interesting. It’s about an hour long but I definitely recommend it to all of you who are interested in our health care system.
To basically summarize what he talks about, the 2 main causes of rising medical costs are government programs like medicaid and medicare, and insurance companies. Not surprising, I know. He goes into detail about the procedures the hospitals go through to budget for the year and how that drives up prices and so on and so forth.
It’s definitely worth a listen.
Nothing shows the lunacy of “Fair tax” quite like health care. How on earth do you guys think the parents of a child with leukemia will pay the highest sales tax on earth, on their child’s chemotherapy and other cost?
How will nursing home patients pay 12-20 thousand EXTRA a year, just in TAXES?
And remember — according to the lulnatic Fairtax plan, even the government pays this tax, on anything it pays for — including health care. Because ALL — repeat — ALL health care is taxed under Farce Tax, er, I mean Fairtax. There ARE no exemptions, at all, for ANYONE getting ANY health care.
So the government will have to pay itself a huge tax on all the medical cost it pays for — soldiers coming back from war need surgery and care — government would have to pay the llunatic fairtax.
Please pass this farce, please.