Do we really want to control health care costs? By Scott Sumner

In America, the government heavily subsidizes the provision of “health care.” (The scare quotes will be explained later.) For example, roughly 40% of the cost of health insurance for middle class families is paid for by the government, via tax deductions for health care costs. This partly explains why Americans spend far more on health care than residents of other countries. One of the few good provisions in Obamacare is a tax on “Cadillac” health plans, which is scheduled to begin in 2018. This will basically offset the subsidy, so that consumers would face the true cost of the health insurance they purchase (at the margin.)

Here’s an example of waste. One of my few luxuries is daily wear soft contact lens, which cost about $600/year. That’s actually more than I’m willing to pay for a slight improvement in quality of life, but this cosmetic purchase is considered “health care” and thus taxpayers pick up 40% of the bill via a “flexible benefits program.” At a price of $360/year, it’s worthwhile for me to buy this product. Indeed most of the health care expenditures that I’ve made over my life would not have been incurred if I had to pay out of pocket, even though I could have easily afforded all of them. The subsidy was the deciding factor. Economic inefficiency.

When Obamacare was being debated I got into some arguments with commenters, who told me that I should support the plan because it had the sort of cost controls I favored. I replied that the controls were delayed until 2018, which meant they probably were not going to be implemented. This tax is an arrow aimed right at the heard of the medical industrial complex, which absorbs 18% of GDP. I found it hard to believe that this sort of cost control could survive special interest politics. Here’s a story that suggests there is increasing opposition to the tax on expensive health care plans, just as I expected:

The so-called Cadillac tax was meant to discourage extravagant coverage. Critics say it’s a tax on essentials, not luxuries. It’s getting attention now because employers plan ahead for major costs like health care. With time, an increasing number of companies will be exposed to the tax, according to a recent study. The risk is that middle-class workers could see their job-based benefits diminished. First to go might be the “flexible spending accounts” offered by many companies. The accounts allow employees to set aside money tax-free for annual insurance deductibles and out-of-pocket health costs. That money comes out of employees’ paychecks, and they’re not able to use it for other expenses. Savvy consumers see it as a way to stretch their health care dollars. The catch is that under the law those employee contributions count toward the thresholds for triggering the tax. There are other wrinkles: Companies in areas with high medical costs, such as San Francisco, are more likely to be exposed to the Cadillac tax than those in lower-cost areas like Los Angeles. Ditto for employers with unionized workers who won better benefits through bargaining. Republicans in Congress and a sizable contingent of Democrats are calling for repealing the tax. Hillary Rodham Clinton, the front-runner Democratic presidential candidate, says she’s concerned and would re-examine the tax. Since it doesn’t take effect right away, it’s an issue for the next president. “As currently structured, I worry that it may create an incentive to substantially lower the value of the benefits package and shift more and more costs to consumers,” Clinton said in response to a candidate questionnaire from the American Federation of Teachers.

Oddly, this story makes me slightly more optimistic that I was wrong, and that real cost controls will occur. Note that Hillary Clinton says she would “re-examine” the tax. That suggests to me that she supports it, as otherwise she would have taken the politically popular stance. But I remain concerned that it will be watered down under pressure from the health care industry. Even worse, I expect them to make it more complex, carving out exemptions for favored types of health care.

The GOP opposition is disappointing, but the Democrats also share some of the blame. In 2008 John McCain proposed switching the tax deduction for health insurance into a lump sum credit, which would have controlled costs even more effectively than the Obamacare plan. Obama opposed the idea. In addition, McCain’s proposal was intended to be more revenue neutral, whereas the Obama approach incurred the wrath of Republicans by raising taxes. Nonetheless, the GOP would make a big mistake if they repeal the tax, as the rising cost of healthcare is one reason why living standards for the middle class have risen more slowly in recent decades. Some of the increase in “real total compensation” is being gobbled up by rapidly rising health care costs.

PS. Just to be clear I have nothing against rising health care costs, if they reflect the decision of consumers who bear the cost of their purchases. My concern is that the massive government subsidies (as well as other policies like barriers to entry into health care provision, and mandates that health insurance cover all sorts of ordinary expenditures that shouldn’t require insurance) have led to an enormous amount of wasteful excess spending.

PPS. I despise flexible saving accounts. For me, the benefits in tax savings are almost entirely offset by a lot of annoying and confusing paperwork. It’s what economists call a “deadweight loss”, just pure economic waste produced by foolish government policies. The private sector has these too, with things like $25 rebates on the contact lens, but only after lots of silly paperwork. I do see the price discrimination argument in favor of rebates, but if my time filling out the forms is worth $24 it’s worth doing, and yet almost a complete waste of resources from a social perspective.