Health Affairs Analysts Stir Up Controversy

Published December 1, 2002

An October Health Affairs report by Mark Pauly and Len Nichols, calling itself “a roadmap through the areas of agreement and disagreement in a critical debate on how to solve the problem of too many uninsured Americans,” attracted a flurry of reaction papers and spawned a day-long conference on the topic by the Center for Studying Health System Change.

Economists Pauly and Nichols contend tax credits for the purchase of individual health insurance could stimulate the growth of that shrinking insurance market, helping to reduce the number of uninsured Americans. Sorting through the economics of tax credit proposals is fairly easy … but sorting through the politics is a more complex matter.

The idea of refundable tax credits, as President George W. Bush has proposed, has thrown the usual political alignments out of whack. Initially there was considerable support for the idea from the more liberal wing of the Democratic Party. Even Reps. Pete Stark (D-California) and Jim McDermott (D- Washington) were attracted to the idea.

Fixed refundable tax credits targeted at the lower-income uninsured would be (in their eyes) a wonderfully progressive approach, especially when compared to the exclusion from taxable income that benefits the employer group market. The exclusion is hideously regressive, benefitting wealthier people with richer benefits far more than it benefits lower-income people with modest benefits. Moving from a regressive tax structure that benefits the wealthy to a more progressive one that helps the low-income is an essential element of Democratic orthodoxy.

On Second Thought

As attractive as refundable tax credits appeared to be, the Left was suspicious that such an idea would be offered by a conservative Republican President. There must be something wrong with the idea … what could it be? Wait a minute. Of course! How could we be so foolish? A tax credit of $3,000 per family would induce many to purchase health insurance, thereby lowering the numbers of uninsured and gutting the argument for a national health insurance program.

For the Left, the plight of the uninsured is the key argument favoring government-run health insurance. A refundable tax credit would be a dagger in the heart of that long-cherished goal. So even if it means sacrificing a gift of $3,000 a year for low-income families, the Left finds it must put a stop to the tax credit idea.

  • First, they’ve argued it “doesn’t go far enough.” That has worked in the past on a wide range of issues. Yes, $3,000 is a lot of money, but it’s not enough.
  • Next, they’ve rolled out the old “healthy and wealthy” argument–with a twist, because the tax credit is aimed at the poor rather than the wealthy. Call it the “young and healthy” argument. Tax credits might be good for the young and healthy, but how do they help the 62-year-old diabetic?
  • Finally, they’ve challenged the plan for putting people at the mercy of the “evil insurance companies.” Far better, the Left argues, to assign them to a kind and benevolent government program like Medicaid than subject them to the vagaries of the market.

Having stumbled on the “evil insurance companies” argument, all that remained for the Left to do was discredit the individual insurance market. They got lots of grants from friendly foundations to prove their case, most often through heartstring-tugging anecdotes about how Betty and Paul were not well served in the individual insurance market.

Of course that approach has put the Left in the awkward position of supporting a regressive employer insurance market that it has been criticizing for at least 20 years. But the hypocrisy will be only temporary, they say. Once they kill the tax credit idea, they expect to get right back to supporting mandates, the Patients’ Bill of Rights, and a slew of new regulations because employers can’t be trusted to do a good job of providing benefits.

So, there you have it. For the past year or so we have been besieged by a host of reports and studies claiming $3,000 isn’t enough money (it won’t pay full cost for a “comprehensive” policy), that it especially won’t help the old and the sick (even though most of the uninsured are young and healthy), and that the individual insurance market is mean to some people (even though these people don’t appear to be very well served by the employer group market, either). Finally, the studies point out that administrative costs are higher for individual health insurance than they are for General Motors (well, duh!).

The Rest of the Story

The proponents of tax credits have responded early and often to the Left’s challenges. Proponents note:

  • Tax credits are not intended to pay the full cost of comprehensive coverage; it’s hardly fair to attack the idea for failing to do something it’s not intended to do.
  • Tax credits may not, by themselves, secure coverage for the sickest and poorest of the population, but they could reduce the numbers of uninsured dramatically, by as much as 80 percent.
  • People who are “rated-up” (charged a higher premium) or “ridered-out” (excluded from coverage) because of a pre-existing condition can nevertheless get coverage that is of value to them. Such provisions in the individual insurance market encourage people to get coverage while they are healthy, instead of waiting until they become sick.
  • Administrative cost comparisons are misleading. Most of the uninsured work for small companies, not General Motors. Moreover, those who make such comparisons fail to consider the possibility of non-employer groups; fail to consider the potential efficiencies of direct sales and Internet marketing; and fail to account for the administrative costs large companies absorb in general overhead.
  • Finally, tax credit proponents argue that, if the individual market were provided with the tax advantages of the employer-group market (including a 40 percent tax subsidy and additional subsidies in the form of employer contributions to premiums), there would be a flood of new, actively-at-work, well-subsidized, financially stable, and healthy applicants who would reduce the need for underwriting and risk assessment by carriers.

Sorting it Out

In their Health Affairs report, Pauly and Nichols sort through the arguments pro and con, identifying those points around which there is agreement and defining the areas where there is disagreement.

According to the economists, the points of widespread agreement include:

  • Administrative loads (expenses) are higher in nongroup markets. Typical administrative costs run between 30 and 40 percent of premiums, although that figure seems to be dropping.
  • Adverse selection is likely in the nongroup market. People who know they need coverage are more likely to buy it than people who feel they do not need it. The problem of adverse selection is most severe in states that impose community rating or guaranteed issue mandates on insurance companies.
  • The nongroup market is small and shrinking. Expansions of group enrollment, Medicaid, and SCHIP have drawn people out of the market.
  • Policy interventions inevitably produce trade-offs. Every change in regulation helps some people but hurts others.

There are disagreements around both factual issues and policy judgments. Pauly and Nichols devote much attention to the broad issue of “tough choices,” which include the willingness of people to pay more for coverage or to accept restrictions on their coverage. For instance, they discuss exclusionary riders in which coverage is offered except for some specific pre-existing condition.

They make the very interesting observation that some people may discover they are better off not having a condition included in their insurance coverage, because they can afford to pay directly for the services and those cash payments are not subject to the administrative load. So they get full value for the money spent, rather than having 30 or 40 percent removed for insurance administration.

The authors discuss in some detail the difficulty of measuring premium costs, and the risk profiles of covered persons. For instance, they find people known to have chronic conditions are far more likely to “take-up” coverage in both the group and nongroup markets, but the opposite is true for people who self-report fair or poor health status.

Older people are far more likely to purchase nongroup coverage than younger people, at least if they are non-poor (with incomes more than 200 percent of the poverty level).

The authors address a number of other issues as well. The individual market is sometimes criticized for allowing people to customize their benefits, but they note that in the group market satisfaction seems to be correlated with choice. “Having more variety is a benefit that could compensate for having to pay the higher loads in the nongroup market,” they write.

Pauly and Nichols also discuss high-risk pools, concluding, “There is some evidence that the presence of a high-risk pool increases the likelihood of private coverage in a state.” They are very clear on their opinion of the state-based “reforms” that have been enacted in the past decade, “… guaranteed issue and restrictions on allowed premium variance in any form have uniformly reduced coverage in the states that have tried it.”


Overall, it appears from the Pauly/Nichols research that the nongroup market does a pretty good job of serving higher-risk people (older and with chronic conditions). If anything, according to the authors, it may do less well at serving younger and healthier people, by failing to adequately identify them and offer coverage at a price they are willing to pay. Nevertheless, the authors write, “the nongroup market produces actuarially acceptable offers for roughly 80 percent of nongroup candidates…”

“The major policy question,” they continue, “is this: How can the nongroup market’s performance for the unlucky 20 percent be improved without reducing its solid performance for the roughly average-risk 80 percent?”

They conclude, “Our judgment is that the nongroup market is simply ill suited to absorb the sickest fraction of any population, and that forcing market reforms on it for the purpose of enabling it to do so will probably make the overall outcome unacceptable to much larger numbers of people who are using it now than the new policy would help. For the uninsurable, high risk pools or subsidized public coverage are better.”

Greg Scandlen is senior fellow in health policy at the National Center for Policy Analysis – Dallas (NCPA) and assistant editor of Health Care News.

For more information …

The Nichols/Pauly report is available through PolicyFax. Point your Web browser to, click on the PolicyBot icon, and request document #10745.

Health Affairs published a dozen papers reacting to the Nichols/Pauly report, written by people with a wide range of viewpoints. All are available on the Web at

A transcript of the October 23, 2002 “Individual Health Insurance: Fact, Opinion, and Policy” conference, sponsored by the Center for Studying Health System Change, is available on the Internet at