Chap010 - Part 2 Analysis of Public Expenditure Chapter 10...

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Part 2 – Analysis of Public Expenditure Chapter 10 – Social Insurance II: Health Care 1. 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 health care per se. 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 services. Thus, employment in the health care sector is not desirable in itself. It is desirable to the extent that it is associated with the production of an efficient quantity of health care services. 2. a. 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. The cycle continues until the price is so high that virtually no one purchases the policy. b. Employer-provided health insurance is deductible to the employer and not taxed to the employee. c. 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 $1,000. 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 $3,936. 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 expenses). In principle, the high deductible plan is unambiguously better. But the 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
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Chap010 - Part 2 Analysis of Public Expenditure Chapter 10...

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