Federal Health-Insurance Tax Exemptions to Top Half-Trillion Dollars

Published August 22, 2018

Tax exemptions benefit employees while giving them little choice in how to spend the money they get to keep under the exemption, which is designed to be used for health care purchases. That effectively removes the individual from making health care decisions and provides the foundations of the modern health care and insurance landscape dominated by third-party payment systems, says Devon M. Herrick, a health economist and policy advisor to the Heartland Institute, which publishes Health Care News.

‘This Deal with the Devil’

The federal tax exemption for employer-sponsored health insurance, which makes such insurance more attractive than other kinds of health care spending, is behind much of the dysfunction in the U.S. health care system, Herrick says.

During World War II, the National War Labor Board allowed the Kaiser Shipyards to provide health insurance to workers as a fringe benefit in lieu of cash wages in order to attract and retain labor, because businesses could not raise salaries under the federal government’s wage controls. Ultimately, this led to a situation where a bulk of all medical care is paid for by someone other than the patient, creating a perverse situation of skyrocketing prices and bureaucratic inefficiencies, Herrick says. 

 “The result of this deal with the devil is our modern, convoluted heath care system,” Herrick said. “Most workers now get their health coverage through their jobs and pay for their health care through their health plan.

“The consumer is now almost completely divorced from the payment process, and medical care purchased through one’s job is 40 percent cheaper than care paid out of pocket,” Herrick said. “Since providers are no longer competing on price for customers’ business, they compete on maximizing revenue against insurance reimbursement formulas. The result is a health care system that is not competitive.”

Calls for Expanding Options

Merrill Matthews, a resident scholar at the Institute for Policy Innovation, says the policy solution to this government-caused economic distortion is to let people use their tax exemptions for any way they pay for health care.

For example, Matthews says, employers could deposit what they would otherwise spend on an employee’s health insurance in a tax-free health savings account (HSA) the employee could then apply to his or her health care needs.

“Allowing employees to have health savings accounts would help reduce some of the consequences of the tax exemption,” Matthews said. “Economist Milton Friedman used to argue the tax break for buying health insurance should be eliminated completely, just as individuals get no tax break for auto or life insurance. That’s still the best idea, but given how difficult it would be to pass such legislation, letting individuals control how they spend this half a trillion dollars is the next best option.”



Chris Conover, “Federal Health-Related Tax Expenditures Will Exceed One Half Trillion Dollars by Next Year,” Forbes, May 31, 2018: https://www.forbes.com/sites/theapothecary/2018/05/31/federal-health-related-tax-expenditures-will-exceed-one-half-trillion-dollars-by-next-year/#1f7df75f310a