Part 2 – Analysis of Public Expenditure
Chapter 10 – Social Insurance II:
The quotation contains several serious errors.
First, concern with health care costs does
not mean that health care is not a “good.”
Economists do not care about the cost of
Rather, the issue is whether there are distortions in the market that
lead to more than an efficient amount being consumed.
Second, it makes a lot of
difference how money is spent.
One can create employment by hiring people to dig
ditches and then fill them up, but this produces nothing useful in the way of goods and
Thus, employment in the health care sector is not desirable in itself.
desirable to the extent that it is associated with the production of an efficient quantity of
health care services.
Those who have a relatively high probability of needing the insurance are the ones
who are most likely to buy it.
This raises the premium, which in turn, leads to
selection by people who have an even higher probability of using it.
continues until the price is so high that virtually no one purchases the policy.
Employer-provided health insurance is deductible to the employer and not taxed to
Because of the tax subsidy, individuals may purchase more than the efficient amount
of health insurance.
That is, they “over-insure.”
An interesting example of how
the tax system leads to overinsurance is given in a recent
Wall Street Journal
(January 19, 2004) article by Martin Feldstein.
He gives an example of two
different California Blue Cross health plans – identical in all respects except for
the deductible and annual premiums.
The low-deductible plan (the “generous”
plan) has a deductible of $500 per family member, up to a maximum of two and
an annual premium of $8,460.
Thus, the maximum out-of-pocket expense is
The high-deductible plan (the “less generous” plan) has a deductible of
$2,500 per family member, up to a maximum of two, and an annual premium of
Thus, the maximum out-of-pocket expense is $5,000.
Note that the
premium savings of $4,524 actually exceeds the maximum incremental deductible
payment of $4,000 (which would only occur if the family had very high health
In principle, the high deductible plan is unambiguously better.
traditional tax rules could lead an employer to choose the low deductible policy.
If the employee faced a marginal tax rate of 45% (the sum of federal, state, and