Unbiased Analysis of Today's Healthcare Issues

Bush will propose “New Tax Breaks for Medical Expenses” in his 2006 State of the Union

Written By: Jason Shafrin - Jan• 26•06

The Washington Post reports that President George W. Bush will offer “New Tax Breaks for Medical Expensesâ€? in his State of the Union speech on January 31 at 9pm ET. Part of this proposal is to make personal expenditures on health expenditures tax deductible and to expand health savings accounts.

When examining the health insurance market, policymakers often face a paradox. If the government hopes to make insurance cheaper—though measures such as making employer provision of health insurance tax deductible—individuals will desire more insurance. With this generous amount of insurance, an individual will only pay a negligible amount of their total health costs, and they may seek too much treatment (either in terms of the cost or number of procedures, additional prescription drugs, etc). This phenomenon is known as moral hazard.

President Bush is trying to correct for moral hazard by making it more attractive for individuals to either pay for medical costs out of their own pocket or to purchase high deductible insurance plans. As a given insurance plan becomes less generous, however, a risk-adverse individual becomes worse off. A debilitating illness will cost more for a person with the high deductible plan than for someone with the low deductible, ‘more generous’ plan. Further, the principles of adverse selection would indicate that the people who will purchase the high deductible plans will be healthier, younger, more affluent and less risk-averse than the average citizen. Employer provided group insurance will be left will a sicker, older, poorer and more risk-averse pool to insure. One could certainly expect group insurance rates to increase.

Another problem with the the proposal is that any policy which offers tax deductions will in essence not aid the vast majority of the poor. According a Tax Foundation report (“Fiscal Facts: Number of Americans Outside the Income Tax System Continues to Grow“, June 9, 2005), an estimated 42.5 million tax returns had zero tax liability in 2004. This represents approximately 32.4% of all tax returns filed. For the poorest and oldest, health care is provided either through Medicare or Medicaid. However, for most of the working poor who do not qualify for Medicaid, the tax break will not improve their welfare at all—since they do not owe taxes—and will likely make them worse off as their group insurance rates at work increase.

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