Mitt Romney, Republican presidential candidate, has proposed recent health-care reforms based on free-market principles and federalism.
His plan focuses on overhauling the tax code's discrimination against cost-effective private insurance. He proposes to allow individuals to deduct out-of-pocket health-care expenditures from their taxable income, allow individuals who purchase health insurance premiums on their own -- rather than through their employer -- to deduct health insurance premiums, and to expand Health Savings Accounts (HSAs) by eliminating the requirement that a qualifying health plan contain a high deductible.
Many have argued that the U.S. tax preference for employer-provided health insurance encourages over-consumption of health services. First, it creates a large financial incentive for workers to purchase as much medical care as they can through their employer's insurance plan. In practice, workers do so by enrolling in health plans with high-premiums, but low-deductibles and coinsurance payments. Such plans, by making the purchase of health-care services appear to be less costly than they really are, create a "moral hazard" that leads to over-consumption of health-care services. Second, the tax preference makes health care look cheaper compared to all other goods and services.
The tax preference's impact has been profound. It is the principal reason why nine out of every 10 private health-care plans in the U.S. are purchased through an employer. It is the principal reason why six out of every seven dollars of health-care spending is made by someone other than the person receiving the care. And, it is a key reason for the U.S. health-care system's excessive cost and waste.
Many economists have emphasized the large benefits to health care of revoking the tax preference. Yet elected officials have repeatedly failed to enact the change because of strong political opposition.
Over the past 30 years, Congress has instead opted for a second best policy. On a piece-meal basis, Congress has gradually leveled the "tax playing-field" between employer insurance and out-of-pocket expenses by expanding the tax preference to out-of-pocket expenses rather than by eliminating the preference for employer provided insurance.
Mr. Romney's proposal to allow individuals to deduct out-of-pocket medical expenses is a significant advance from what has occurred in the last 30 years to a level tax playing field between out-of-pocket expenses and insurance. And a more level tax playing field would encourage individuals to choose health plans with lower premiums and higher co-payments for their routine health-care purchases. With more "skin in the game," individuals would exert more control over their choice of health-care services. The health-care savings would be large. We estimate that a proposal such as Romney's would reduce private health-care spending by 6%.
Some critics have argued that allowing out-of-pocket expenses to be tax-deductible will raise, not lower, health-care spending because the policy will make the price of direct medical-care purchases cheaper relative to all other goods and services. According to Wall Street Journal empirical analysis with Daniel Kessler demonstrates, the critics are wrong. The cost-reducing impact on health-care expenditures of individuals shifting into health plans with higher co-payments swamps by a large margin the cost-increasing impact of making out-of-pocket purchases cheaper.
The benefits don't stop with reducing the growth in health costs. As employer premiums decline, the savings will accrue to workers in the form of higher money wages. In competitive labor markets, workers -- not employers and not insurance companies -- bear the burden of paying