The Tax Loophole That Made U.S. Health Care Unaffordable

The employer insurance exclusion has chained workers to their employers, practically eliminated consumer price sensitivity, and suppressed wages.

America's health care system consistently ranks as the most expensive in the developed world. It's not, as some politicians claim, expensive because markets have failed. It's expensive because the market has been repeatedly blocked from succeeding. Until we're honest about that, any potential reforms will only address symptoms while ignoring the disease.

The health care market is hindered in many ways, but the core structural problem is simple: The person receiving care is almost never the person actually paying for it. Roughly 90 cents of every dollar is covered by a third party—an insurer or the government.

The arrangement severs the give-and-take relationship between provider and customer that disciplines every other sector of the economy. When someone else pays, no one shops around, no one compares prices, and no one asks whether a service is worth it. When someone else is paying, there is no reason to restrict one's consumption. The result is predictable: opaque pricing, resistance to competition, and no discipline to keep costs aligned with benefits.

Thus, this is not a debate about who should have coverage. It's about whether the architecture of American health care creates any living, breathing incentive for affordability.

This fiasco didn't happen naturally. It was built by the tax code—specifically, the exclusion of employer-sponsored health insurance from taxable income. As Michael Cannon of the Cato Institute has documented, the exclusion is roughly as old as the income tax itself, rooted in early Treasury rulings that predated modern health insurance.

In the early 1940s, wartime wage controls gave the concept practical force. Employers who couldn't compete to hire workers with wages started using health benefits, which were exempt from the controls, as a workaround. But employer-purchased health insurance did not see robust growth until after wage ceilings were lifted in 1953. Congress then codified the exclusion in 1954, cementing employer-based insurance as the dominant model, a consequence few anticipated at the time.

The tax break is projected to reduce income- and payroll-tax revenue by $487 billion this year. The consequences have been a calamity. Cannon has convinced me that this single provision is the most damaging in the entire tax code. And it's not just because of the fiscal cost—it is three times larger than the next tax break in the code—but because of the behavior it has shaped over eight decades.

The provision has chained workers to their employers. It has practically eliminated consumer price sensitivity. It's suppressed wages that could have been paid in cash instead of in the form of health insurance. Altogether, it's systematically crowded out the direct, consumer-driven health care spending that creates genuine market pressure to limit costs.

Under the ideal tax system—one that taxes income once and only once, with no loopholes, no double taxation, and no provisions favoring one activity over another—the employer insurance exclusion would not exist.

However, eliminating the exemption is politically difficult. So for now, the practical baby step is more health savings accounts (HSAs), which allow individuals to save pre-tax dollars and spend them directly on medical expenses. They put patients in the role of paying customers who compare prices, question the need for certain procedures, and seek value.

The evidence suggests that people with HSA-linked plans spend less on care and engage more with wellness programs, though it's hard to say how much of this reflects the plans themselves versus the characteristics of the people who choose them. What's clearer is the structural logic. When people are in charge of their own money, they ask the right questions.

Unfortunately, HSA eligibility is restricted to people enrolled in high-deductible health plans and excludes millions of Americans with other coverage who would benefit most from these exact same incentives. The 2025 One Big Beautiful Bill Act made genuine improvements by expanding HSA contribution limits and broadening the range of qualified expenses. But the bill left the eligibility restriction intact. Another central structural flaw in our system remains.

The consumer-directed model should follow the consumer, not the regulatory category of their plan. Millions of Americans have opted out of the Affordable Care Act market entirely, choosing short-term plans, health-sharing arrangements, or other alternatives precisely because they want more control over their spending. An HSA regime should reach them too.

Expanding HSA eligibility is not just another bandage-style health care reform. It's a step toward a more coherent tax code. It will lower prices by allowing individuals to accumulate health care savings over their working lives. It will help restore a direct financial relationship between patients and providers.

That's good tax policy as much as good health policy.

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