Code Red: Two Economists Examine the U.S. Healthcare System

July 17, 2015

Hillary Clinton Takes One Step Backward as the Health Economy Takes One Step Forward

Filed under: Uncategorized — David Dranove and Craig Garthwaite (from Oct 11, 2013) @ 9:37 am

Two related news items caught our attention this week.  The first was a statement by Hillary Clinton that she would consider scrapping the ACA Cadillac tax on the most expensive health plans.  This tax applies to the value of health insurance packages over a certain limit ($10,700 for individuals and $27,500 for families).  Senator Clinton worries that “it [the Cadillac Tax] may create an incentive to substantially lower the value of the benefits package and shift more and more costs to consumers.”  Well, that was half (or maybe all) of the point of the tax in the first place, wasn’t it?

There are few things about which health economists are in near total agreement, but we can think of two.  First:  The tax exempt status of employer sponsored health insurance is regressive, inefficient, and a major contributor to this country’s high health spending.  Thanks to the tax exemption, Americans have excessively generous health insurance and do not face the costs of their medical decisions. So yes Ms. Clinton, the whole purpose of the Cadillac tax was to lower the value of benefits and shift costs onto consumers.  You are smart enough to realize this, so why are you feigning ignorance?  We suspect it has something to do with the second point of agreement: The tax exempt status of employer sponsored health insurance is a middle and upper class giveaway, especially favored by unions whose members tend to have the most generous and expensive health insurance coverage of all.

As a result of its popularity it is almost impossible for politicians to eliminate.  And so it was quite the political coup when President Obama inserted the Cadillac tax into the ACA.  Over time, as medical spending continues to grow, this tax will incrementally apply to more insurance packages.  In this way, it is like a slow phase-out of the tax deductibility of health insurance and represents one of the best means for the ACA to actually do something about health spending. It may only have been a baby step towards eliminating tax deductibility, but it was a step nonetheless.

Of course, unions and other beneficiaries of the regressive tax exemption have been up in arms about the Cadillac tax.  Ms. Clinton is sure to pick up a few more votes (and lots more union money) with this politically shrewd, and economically reckless, policy statement.  But in the process, she is going to hamstring the ability of the ACA to meaningfully address cost growth.

The second item in the news was a report on the further erosion of employer-sponsored health insurance.  According to the federal Agency for Healthcare Research and Quality, just three years ago, 78.2 percent of working Americans were eligible to purchase health insurance from their employer.  Last year that figure dropped to 75.4 percent.  Almost all the drop occurred in 2014.  As we (and others) have predicted, employers are dropping coverage and letting their workers fend for themselves on the exchanges.

The AHRQ report is mercifully devoid of commentary…many are likely to bemoan this decline. (Ms. Clinton, we are thinking of you!)  But we view this as an encouraging trend. As we have blogged in the past, it is high time that we decouple health insurance from employment.  The exchanges give us our best chance to do this.  Of course the ACA still ties the hands of large insurers, who must continue to offer health benefits, but we can be grateful for this little bit of progress.

Though we do note that we must approach this move to a heavier reliance on the ACA exchanges with great caution.  Every individual that earns less than 400% of the poverty line is eligible for subsidies from the federal government if they purhcase insurance on the exchange (and don’t have an offer of insurance from their employer). While making subsidies available to these individuals increases the horizontal equity of this tax and transfer program, it also further increases government obligations.  Given the relatively generous minimum insurance packages under the ACA, these costs could grow well beyond our capacity to pay them.


  1. There certainly is agreement that the tax exempt status of employer-sponsored health insurance is a regressive tax policy, but that does not extend to agreement that generous coverage is why the United States spends so much more on health care than do other wealthy nations. The volume of health care services provided in the United States is not that much different from the volume in other nations – nations that on average spend half per capita of what we do.

    Two much more important contributors to our high costs are our very high prices and the profound administrative excesses that characterize our fragmented, multi-payer financing system, both of which set us apart from other nations.

    Although moral hazard exists, its impact is very small, except at the margin. Increasing consumer empowerment would have little impact on where most of the spending occurs – the 20 percent of people who use 80 percent of our health care services.

    Rather than depending on health care shoppers to control spending, it would be far more effective to establish a public monopsony which would control prices much more effectively while dramatically reducing the administrative waste of the payers and the waste of the administrative burden placed on the providers.

    Comment by Don McCanne — July 17, 2015 @ 11:15 am

    • Even if there was no quantity effect due to moral hazard there is almost surely a price effect due to moral hazard. (Aside: we are unaware of the evidence that the commenter is alluding to concerning moral hazard being “small on the margin” — evidence that would directly contradict the RAND study.) Canada and Europe largely regulate prices but (with the exception of traditional Medicare and Medicaid) the US relies on markets. But generous insurance limits the effectiveness of markets, because insured patients have little reason to shop around. And the managed care backlash, combined with growing provider concentration, limits the ability of insurers to shop around. With less generous insurance, we would expect patients to become more price sensitive. And without the tax exemption, patients would be more forgiving of narrow network plans. This would lower prices and reduce health spending.

      Regarding a public monopsony…well that raises a whole new set of issues that we will leave aside for now.

      Comment by David Dranove and Craig Garthwaite (from Oct 11, 2013) — July 17, 2015 @ 11:42 am

  2. Thanks for the post. One observation and one disagreement:

    1. . I believe that the Cadillac tax kicks in when the cost of family insurance exceeds $27000 a year.(and when the employer pays 100%, I think.)

    I am probably naive and I live in rural MN, but outside Harvard and the stage hands unions et al, can there really be that many plans which are so generous?

    If the average employee in a firm makes $100,000, I can believe Cadillac coverage. But how many firms or unions are that rich?

    2. Your comment that ACA subsidies may be ‘more than we can afford’ seems wrong to me, We can afford $600 billion a year for seniors, $500 billion Medicaid for the poor and poor seniors, probably $100 billion for federal employee health insurance…………..
    therefore, we can certainly afford perhaps $150 billion for working adults without employer coverage. We could raise the wage cap a little on FICA taxes and handle this with ease.

    Comment by Bob Hertz — July 19, 2015 @ 9:11 am

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