Employer-provided health insurance in the United States is a creature of government policy. In 1940 only about 20 million people in the United States were covered by health insurance. By 1950 more than 140 million people had health insurance. What changed?
Three policies were instrumental in creating the private health insurance market in the United States. In 1942 the Stabilization Act limited the wage increases that employers could offer to employees but permitted insurance plans and did not limit their increase. In 1943, hungry for revenue to pay for World War II, the U. S. government implemented payroll withholding and for the first time in American history there was substantial compliance with the income tax. Revenue rose from $7 billion to $43 billion. Employer-paid health insurance was not subject to the income tax or withholding. Consequently, health insurance became a way of compensating employees that wasn’t subject to the income tax.
Finally, in 1949:
the National Labor Relations Board ruled in a dispute between the Inland Steel Co. and the United Steelworkers Union that the term “wages” included pension and insurance benefits. Therefore, when negotiating for wages, the union was allowed to negotiate benefit packages on behalf of workers as well. This ruling, affirmed later by the U.S. Supreme Court, further reinforced the employment-based system.
Note the discrepancy. While for the purposes of labor negotiations wages includes pension and insurance benefits, which from an economic standpoint is quite correct, for the purpose of taxation it does not. This was reaffirmed in the 1954 Internal Revenue Code which explicitly exempted employer contributions to employee health insurance plans. Consequently, such plans became a form of tax-advantaged compensation.
The rest is history. The cost of health insurance has risen to the point where, all but invisible to the employee, it has become as much as a quarter of an employee’s total compensation. But it’s still compensation and it’s a lot of compensation and, unsurprisingly, health insurance has become a candidate for taxation to get the revenue to pay for the Obama Administration’s plan for health care. After cataloguing a list of new excise and other taxes from which a relatively trivial amount could be derived the Wall Street Journal observes:
By contrast, the employer-based exclusion offers a huge money pot — an estimated $226 billion in 2008. Yet as liberal MIT economist Jonathan Gruber recently told Mr. Baucus’s committee, “no health expert today would ever set up a health system with such an enormous tax subsidy to a particular form of insurance” (his emphasis). It creates a coverage gap between workers who receive it from their employers and those who pay — or can’t afford to pay — with after-tax money.
The tax exclusion is also one reason health costs continue to rise. It encourages workers to take an extra dollar of compensation in fringe benefits instead of cash while also routing low-deductible health spending through third parties. Some 84 cents of every medical dollar is spent by someone other than the patient. The insured have no incentives to make cost-conscious decisions about care.
The irony of this is delicious. The exemption created our present system of health insurance. That, along with the distortions created by Medicare and Medicaid, is the foundation of our particular hybrid health system.
But it’s where the money is.