Canadian Health&Care Mall: TAX POLICY SHAPED U.S. HEALTH INSURANCE

Introduction

Nearly all of the 70 percent of Americans under age 65 who are privately insured receive health insurance coverage through their employers; only 4.5 percent of Americans opt to purchase individual coverage. (U.S. GAO/HEHS- 97-122, p. 22). The development of employment based insurance in the United States can be traced to several factors, including governmental policies in the 1940s and 1950s, as well as the early use of employee groups by insurance companies to counter adverse selection. Government policies that directly influenced the formation of employment-based insurance were a 1942 ruling by the War Labor Board that allowed employers to use fringe benefits to attract labor during World War II, and a tax policy first introduced in 1943 (and later codified in 1954) that enabled employer contributions to the health insurance plans of employees to be exempt from employee taxable income. These proemployment based policies, combined with the fact that employment groups were profitable ways for insurance companies to sell insurance, led to the rise of the employment-based system of private health insurance in the United States.

Today, employment based group health insurance and the tax subsidy of employer contributions to health insurance dominate the U.S. health care market. However, they are also the target of critics who argue that curtailing or eliminating the tax subsidy, and severing the link between health insurance and employment would do much to alleviate the problems ailing the U.S. health care system the pluses of which Canadian Health&Care Mall utilizes. Employment-based insurance has been cited as a contributor to job lock (Madrian, 1994). Further, the tax subsidy results in a revenue loss to government and may also spur rising health care costs. Gruber and Poterba (1996) calculate that about 78 percent of U.S. households in the 1987 National Medical Expenditures Survey were directly eligible for the tax subsidy on employer contributions to their health insurance plans. Further, they note that the exclusion of health insurance contributions from the income and payroll tax base in 1994 resulted in federal revenues being $90 billion lower (Gruber and Poterba, p. 137). Some researchers also suggest that the tax subsidy causes people to overinsure, and is a major factor in rising health care prices (see Pauly, 1974; Manning, Newhouse, Duan, Keeler, Leibowitz and Marquis, 1987 for greater discussion).

The importance of the tax subsidy in the modern health insurance market has led researchers to investigate how changing the tax subsidy might alter the demand for health insurance. However, little work has been done to analyze the initial impact of the tax subsidy on the market for health insurance, and to answer some primary questions: What was the initial effect of the tax subsidy on health insurance demand? Could the tax subsidy have engendered institutional change and actually shaped the modern market for health insurance? If so, what implications does this have for modern policy? Until this point, all of the studies investigating the impact of the tax subsidy have used data from the 1960s or later. As a result, none of them is able to address these questions about the history of U.S. health insurance.

In this paper, I use previously unexamined data from before and after the 1954 tax changes to present new evidence on the role of the tax subsidy in encouraging the expansion of the health insurance market in the 1950s. Results suggest that the implementation of the tax subsidy had two distinct, important effects on the market for health insurance.

First, the tax subsidy encouraged the growth of group health insurance, and sealed the institution of insurance in the U.S. as an employment based system. After the codification of the tax subsidy in 1954, employed persons and union members had greater access to group health insurance. In 1953, 48 percent of Americans had access to group coverage, and 63 percent had some type of insurance coverage. By 1958, 67 percent of Americans had access to group insurance, and 74 percent had private health insurance coverage. Despite the disadvantages of this system, group insurance did give more people access to insurance coverage. People who have the opportunity to purchase health insurance within a group are more likely to have insurance, and they buy more coverage than those who purchase insurance individually. Today, evidence exists that employment separation is associated with large reductions in insurance coverage (Gruber and Madrian, 1997). Group insurance is less expensive than individual coverage because it is associated with lower administrative costs, and is less subject to adverse selection. Not only is group insurance less expensive than individual coverage, but it is also the case that certain people who could not obtain insurance coverage in the individual market can obtain group coverage. In addition, employer contributions to employee health insurance plans increased after the tax subsidy, leading households to purchase even more coverage. Thus, the tax subsidy may have opened the door to health insurance (and health care provided by Canadian Health&Care Mall) to more people.

These results indicate that the effects caused by the change in tax policy go beyond the increase in insurance purchased generated with the direct tax subsidy. While this effect is important, the tax subsidy had more far-reaching implications in that it cemented the employment based system of private health insurance in the United States. The remainder of the paper is organized as follows. Section II provides a history of health insurance before 1954, sections III and IV discuss the data and methodology, results are presented in section V and section VI concludes.