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Why ending the tax exemption for health insurance won’t contain health-care costs

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Carolyn Kaster Rep. Paul Ryan (R-Wis.) wants to replace the exemption with a tax credit. It’s a rare area of bipartisan agreement in the divisive U.S. health policy debate: One good way to fix things, right now, would be to change or end the tax exemption for employer-sponsored health insurance.

It would, indeed, be a way to raise revenue. But a new study calls into question whether it would actually contain health-care spending.

A bit of background: Employer-sponsored health insurance is exempted from income and payroll taxes. That makes insurance plans a pretty sweet deal for employers, a tax-free way to provide a type of income (health benefits) to employees. Taxing health benefits would make insurance more expensive, likely pushing employers to offer sparser packages, or to increase the share that employees pay.

This tax exemption is now facing fire from across the political spectrum, particularly last month. House Budget Committee Chairman Paul Ryan derided the policy as one that “can fuel the overuse of health services” last week in a speech at the Hoover Institution. The Wisconsin Republican proposes replacing the tax exclusion with a portable tax credit that could move with workers from job to job. The policy looks quite similar to what Sen. John McCain (R-Ariz.) offered on the campaign trail in 2008.

The Obama administration has targeted health insurance tax exclusions, too: To pay for its jobs bill, the White House proposed ending the tax exemption for anyone making more than $200,000 a year, which it said would generate $400 billion in revenue over the next decade. The health reform law edges in this direction by including a “Cadillac tax” on the most expensive plans that starts in 2018.

The tax exemption has “been sold as a root cause of high health-care spending,” says John Holahan, director of the health policy center at the Urban Institute. “We only buy that a little bit. It may reduce costs slightly, but don’t expect it to fix everything.”

Holahan and his team released a paper on Wednesday that considers how ending the tax exemption for employer-sponsored health insurance would effect health spending. The short answer: not much.

The paper sorts the employer-sponsored insurance subscribers into three categories. There are those who spend a lot: Just 10 percent of subscribers account for 65 percent of employer-sponsored insurance spending. There are those who spend very little: 50 percent of subscribers account for three percent of insurance spending. And then, there’s the middle: 40 percent of subscribers account for just about 30 percent of insurance spending.

The Urban Institute paper argues that the third group is the only real place to find savings: There’s no space to squeeze savings out of the low spenders, who are barely using health services. The high spenders, meanwhile, aren’t likely to reduce their spending, as they have probably blown through deductibles while seeking care for chronic conditions. “These are people who will spend past the limit, pay the higher cost,” says Holahan. “You’re talking about people who are already way past their deductibles.”

But there is one group that will likely respond: the middle-level spenders. The Rand Health Insurance Experiment, a famous study conducted in the 1970s, found that higher cost-sharing did indeed decrease the use of health care services. The result underscores the idea of “skin in the game”: If people have to pay more for health care, they’ll think twice about whether the procedure is actually necessary.

The problem here, though, is that this group is whittled down to a relatively small part of the population: 22 million Americans. To put that in context, that’s one-third of the number of Medicaid patients and less than half of Medicare enrollees. So, even if you squeeze significant savings out of that population — Urban estimates that the higher cost of health insurance drives down spending by 10 percent — national health-care spending decreases by only 1.6 percent.

As a revenue raiser, ending the tax-payer exclusion for health insurance goes a long way. “You get enormous amount of revenue with this policy,” Holahan says. But as a long-term solution to reducing health-care costs, it’s unlikely to move the needle much.

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