Fix That Tax Quirk

The Washington Post, Tuesday, July 21, 1998; Page A19

Congress hasn't done much this year, which is the big reason both parties are rushing to pass legislation to place more mandates—that is, regulations and restrictions—on HMOs and other providers of managed care.

Politicians are hearing complaints—and no wonder. Our absurd health insurance system, the result of a quirk in the tax laws that goes back a half-century, deprives the vast majority of Americans of reasonable medical choices. Instead, most of us have to buy insurance through our employers, who, naturally, offer one-size-fits-all solutions.

But the answer isn't more mandates—euphemized into what politicians are calling a "Patients' Bill of Rights." No, the answer is to repair the tax quirk that's at the root of the problem, so that health care can operate as a more efficient market.

But politicians can't resist playing doctor, offering prescriptions that include forcing HMOs to pay for referrals to specialists, to allow women to designate gynecologists as their primary doctors, and much more. While many of these mandates seem sensible, they represent the worst possible way to solve the nation's health care problem. First, in a market free of distortions, these benefits would be provided as options anyway. So let's end the distortions—that is, the tax subsidies.

Second, politicians know nothing about the details of medicine. They respond to their noisiest constituencies, which is why one of the bills requires health plans to pay for 48-hour hospital stays for one specific procedure: mastectomies.

Third, when you require a provider to offer something, you raise the cost of the product for everyone—even people who don't want the new feature. The result with health care—where thousands of mandates have already been added by states—is to price employers out of the market. They simply drop coverage, and the number of uninsured Americans mounts.

How did we end up in this mess? During World War II, wage and price controls prohibited businesses from raising pay. Labor was short, so to attract workers, some companies seized on the idea of offering health insurance as a perk. The IRS ruled that the cost of the insurance was deductible for the business and not taxable as income to the employee. In 1954 the GOP Congress enshrined the income "exclusion," as it's called, into law.

The perverse results of this tax subsidy:

(1) Employers today foot most of the bills for health insurance, so they determine the policies their workers get. As costs soared in the 1980s, employers turned to HMOs and managed care, restricting their workers' choices.

(2) Health insurance policies aren't really "insurance"; their purpose is to pre-pay medical costs that are predictable or inexpensive, like check-ups and flu visits. This is like auto insurance paying for an oil change. But since Uncle Sam is footing a big part of the bill, it makes sense for health "insurance" to be all-inclusive, with low deductibles.

(3) Employees have little incentive to self-ration the care they get. Imagine a tax subsidy for food insurance, provided by your employer. You would, naturally, buy steak instead of chicken. Soon, however, the insurer would respond, by limiting your steak-buying to once a month or by forcing you to buy all your food at a specific grocery chain (HMO Mart) with no steak in its coolers. Given this restricted choice, you would probably rush to a politician to complain.

The solution for health insurance is to end the tax subsidies, which currently cost the Treasury more than $100 billion a year. Instead, give that money back to individual Americans either through tax credits or rate reductions that would leave more in their pockets. We should probably require everyone to have some kind of catastrophic insurance (say, for expenses over $2,500), and the government should foot the bill for the poor, through insurance vouchers (like food stamps).

Then we'd have a real market, with far less paperwork and with people buying the sort of insurance they really want—fee-for-service, HMOs, PPOs, whatever—not just what their employers force them to take. The final insult of the tax exclusion is that it mainly benefits those who need it least. The Lewin Group found that 64 percent of subsidies in 1996 went to families making $50,000 a year or more, while 11 percent went to those making less than $30,000.

Instead of pandering to fear, politicians should level with voters. End the tax exclusion and let people buy their own health policies. Insurance companies, which benefit from billions in subsidies, might howl, but choices would broaden, costs would fall, paperwork would be drastically reduced and the destructive cycle of excess, cutbacks in care and political intervention would finally end.