It’s well known that employer sponsored health insurance took off during World War II when the federal government’s wage and price controls did not extend to “non-cash” benefits. Moreover, the federal tax code has excluded employer sponsored health insurance premiums from taxation. As part of the consumer driven health care movement, a number of policymakers, including the President’s Advisory Panel on Federal Tax Reform, are recommending that the tax landscape which now continues to favor employer sponsored health insurance over individually purchased health insurance be levelled out. In fact, this in one component of the President’s recent package of health savings account improvements.
“The assertion that the tax subsidy of employment-based coverage distorts
the market for health insurance and therefore creates an inefficient allocation of resources is based on the assumption that the tax subsidy is the only reason the market for health care services is inefficient. If there are other factors preventing the health care financing and delivery system from performing optimally, however, the “theory of second best” suggests that removing the tax incentive may not increase social welfare. Since health insurance coverage produces a number of positive external societal benefits, withdrawing the current tax incentive implicitly would suggest that individuals would obtain less-than optimal medical care. Currently, that incentive is provided through an employment-based system that has systemic efficiencies that an individual-based system would not be able to equal. “