The Complex Relationship between Taxes and Health Insurance

Abstract

Our current system of tax preferences for the purchase of health insurance and for unreimbursed medical expenses has few fans, particularly among economists. Economists argue that excluding the cost of health insurance from taxable income leads individuals to purchase more health insurance than they would if they were bearing the full cost of such coverage. The resulting “over insurance” leads to individuals consuming more medical care than they would if they had purchased optimal insurance. This over consumption increases health care costs and therefore health insurance premiums. Similarly, preferencing the consumption of medical goods and services over other goods and services through various tax-advantaged vehicles such as flexible spending accounts distorts decision making and leads individuals to consume more medical care than they would in the absence of a subsidy.

After examining these efficiency-based arguments against our current tax treatment of health insurance and unreimbursed medical expenses, this paper argues that focusing solely on efficiency concerns in this context fails to take into account the complex relationship between taxes and health insurance. The final section of the paper examines how the Patient Protection and Affordable Care Act impacts the relationship between taxes and health insurance in terms of both efficiency and broader reform goals.

Keywords: health reform, health insurance

JEL Classification: H21, I18, K32, K34