Your medical benefits are taxed

One of the trial balloons the Obama administration floated in the healthcare insurance issue was taxing the dollar value of employer-provided health insurance. However, they beat a fast retreat, not because the proposal didn't make sense (that benefit is, after all, part of an employee's total compensation), but because the unions said they'd have none of that.

But that fact is that your health insurance benefit, employer-provided or not, is already taxed indirectly by the federal government. Econopundit has the data, though his focus is less on taxation than insurance-company profits.

Here are two telling charts. First up, revenue, income and taxes:


Note that Wellpoint and Aetna each paid about $800 million in corporate income taxes. Humana, being smaller, paid about $350 million. Where did the money to pay those taxes come from? From your premium payments, that's where. Like any other business, the health-insurance companies charge their customers an amount that will, in aggregate, cover their expenses, including taxes. As I have written somewhere before, in a free-market, consumerist society, ultimately all taxes are paid by individuals. The money businesses use to pay their taxes comes from our pockets. It's a sort of reverse value added tax.

So (work with me here) if the healthcare companies were not subject to those taxes, they could reduce premiums by those amounts - good for employers and employees alike - and still maintain their same obscene profit margins.

Oops, did I say obscene profit margins?


Four percent! That's just over half the margin of Exxon-Mobil, IIRC, and not even a third of Apple Computer's margins. Heck, the grocery store I worked in as a teenager had a profit margin several points higher than that.

So what is driving high medical costs, since the insurance companies' profit margins aren't?

1. Lack of insurance options for consumers. The Manhattan Institute's Center for Legal Progress found in 2006 that price gouging (padding margins, in other words), can occur only where "insurance industries [are] exercising monopoly power. We find that states with more concentrated insurance industries actually have lower premiums." Which is to say the obvious: industry competition drives down consumer costs.

2. Skyrocketing malpractice premiums, paid not only by doctors but by all hospitals and medical institutions.

Like physicians, hospitals also must purchase medical malpractice insurance that covers their staff plus any physicians employed by the hospital. Hospitals report that the growing premiums are cutting into their operating budgets and threatening to drain money away from other areas of the hospital. The survey shows that hospital medical malpractice insurance premiums, as a portion of total hospital operating budgets, have nearly doubled in the last four years.

In fact, 10 percent of the costs consumers pay for medical care goes directly to pay medical malpractice premiums.

According to Towers Perrin, a global professional services firm, malpractice litigation costs $30 billion a year and has grown at more than 10% annually since 1975. But that's less than half the story. To avoid being sued, doctors use excessive tests and other procedures to avoid lawsuits, and stay out of certain areas of medicine. The result is higher costs for medical care.

The 1,000-plus page health-care bill under consideration in the House of Representatives mentions the word "malpractice" only once, on page 263, in the context of "malpractice geographic indices" for determining physician reimbursements for Medicare services. Yet crafters of the health care bill cannot find a single section to limit costs of lawsuits.

Rather, Democrats have sponsored three bills to broaden the scope of malpractice suits.

In today's WSJ, Harvard Prof. Martin Feldstein writes how the tax structure related to health insurance and care warps the costs.

[H]ealth-economics experts agree that private health spending is too high because our tax rules lead to the wrong kind of insurance. Under existing law, employer payments for health insurance are deductible by the employer but are not included in the taxable income of the employee. While an extra $100 paid to someone who earns $45,000 a year will provide only about $60 of after-tax spendable cash, the employer could instead use that $100 to pay $100 of health-insurance premiums for that same individual. It is therefore not surprising that employers and employees have opted for very generous health insurance with very low copayment rates.

Since a typical 20% copayment rate means that an extra dollar of health services costs the patient only 20 cents at the time of care, patients and their doctors opt for excessive tests and other inappropriately expensive forms of care. The evidence on health-care demand implies that the current tax rules raise private health-care spending by as much as 35%.

The best solution to this problem of private overconsumption of health services would be to eliminate the tax rule that is causing the excessive insurance and the resulting rise in health spending. Alternatively, Congress could strengthen the incentives in the existing law for health savings accounts with high insurance copayments. Either way, the result would be more cost-conscious behavior that would lower health-care spending. ...

Like virtually every economist I know, I believe the right approach to limiting health spending is by reforming the tax rules.

There are, of course, other cost drivers. But these three facets are the most significant contributors to rising healthcare costs for patients.

Endnotes:

1. No, I am not actually proposing that healthcare insurance companies be exempt from paying taxes like every other corporation does. I am merely pointing out that we consumers pay taxes on the dollars we use to pay our co-pays, then those dollars are taxed again as corporate earnings. This means that we medical consumers are spending between $1.40-$1.80 to get one dollar's worth of care.

2. The total amount of medical malpractice awards amounts to a tiny fraction of the total healthcare costs of the country. Even if you could by fiat reduce malpractice awards to zero, total healthcare spending would decrease by a barely noticeable amount. But that's not the point. The deleterious impact of high malpractice premiums is their effect on hospitals' and physicians' budgets, of which they consume a large and increasing percentage. This is money better spent on providing better care or reducing costs than on insurance.

Update: Well, the cat's out of the bag: "Video: Dem wants to eliminate private health insurance altogether."