Large HSAs Trump ‘ObamaCare‐​Lite’ Tax Credits at Delivering Better Health Care

A group of prominent conservatives recently released an ObamaCare replacement plan that would replicate many of that law’s worst features.
December 10, 2015 • Commentary
This article appeared on Forbes​.com on December 10, 2015.

If you’re a conservative and you’re reading this, chances are good you have a gun to your head. Conservatives are so averse to health policyNational Review‘s Ramesh Ponnuru once quipped that “Republicans will do anything to repeal ObamaCare–except think about health care.” This is no small problem. Indeed, it is how we got ObamaCare in the first place: conservative neglect enabled a raft of very un‐​conservative health care ideas to germinate at the Heritage Foundation for a decade and a half. By the time Democrats picked up those ideas and ran with them in 2009, it was too late. Conservatives were powerless to stop them.

Conservatives may indeed be just one election away from repealing ObamaCare, which is all to the good. But some conservatives have proposed replacing ObamaCare with refundable tax credits for health‐​insurance. Tax credits are ObamaCare‐​lite. They would cement in place many of ObamaCare’s worst features, and replicate its awful results. If those features acquire a bipartisan imprimatur, we will never in our lifetimes be rid of them. Unless conservatives give tax credits the scrutiny they should have applied to the Heritage Foundation plan in the 1990s, they will make the same mistake all over again.

Conservatives don’t have to repeat history. A better set of reforms offers a clear path toward a market system, and away from ObamaCare, by building on the bedrock conservative idea of health savings accounts (HSAs). “Large” HSAs would deliver better, more affordable, and more secure health care, particularly for the most vulnerable. At the same time, Large HSAs would give workers a larger effective tax cut than all the Reagan and Bush tax cuts combined,., and nine times larger than repealing ObamaCare

America’s Health Care Woes Pre‐​Date ObamaCare

One of the chief problems with American health care, one that predates ObamaCare, is how the federal government uses the tax code to control where workers purchase health insurance and what kind of coverage they purchase. When employers purchase coverage for workers, the federal government excludes those payments—on average, almost $13,000 per worker with family coverage—from both income and payroll taxation. So if workers sign up for an employer plan, they get $13,000 worth of health insurance, tax‐​free. If they instead take that compensation as cash, the tax bite shrinks that $13,000 to maybe $8,000 or less. As a result of this so‐​called “tax exclusion for employer‐​purchased health insurance,” nearly 90 percent of Americans with private health coverage lose control over thousands of dollars in income, and their choice of health plan, to an employer. Absent reform, over the next decade employers will control about $9.1 trillion of their workers’ earnings.

The exclusion delivers the same high costs and low quality we would expect from any government program. It drives prices higher, encourages wasteful spending, and makes coverage unaffordable for millions. It strips workers of their coverage when they need it the most: when they get so sick they cannot work anymore. A 2008 study found employer‐​sponsored coverage “leaves a person who becomes a high risk more vulnerable to dropping or losing any and all coverage than does individual insurance.” For some workers with high‐​cost conditions, it doubled their risk of becoming uninsured.

Congress needs to return that $9 trillion to the workers who earned it, and let them choose how to save or spend that money on their health care needs. Imagine 200 million Americans bringing cost‐​consciousness to the nearly $1 trillion they spend each year on medical care. Health care prices would fall as patients demanded price competition and cost‐​saving innovations, just as prices have already fallen in corners of the health care sector like cosmetic laser‐​eye surgery where patients are cost‐​conscious. Consumers would demand health plans that make access to care more affordableand secure, driving competition and innovation on quality as well as cost. Everyone would benefit, but none more than the poor and the sick. Not only would more Americans be able to afford health care on their own, but with lower prices it would be easier for the rest of us to care for the shrinking number of patients who still could not.

“Large” Health Savings Accounts

Congress can return that $9 trillion to workers by creating “large” health savings accounts. Large HSAs would preserve the current exclusion but apply it instead to $13,000 (or more) that a worker—or, at the worker’s direction, her employer—contributes to a tax‐​free HSA.

To take advantage of the reformed exclusion, workers would demand that employers add that $13,000 to their wages. A typical worker with family coverage who now earns $50,000 would see her salary rise to $63,000 overnight. Workers would then decide how much to deposit tax‐​free into a Large HSA, and use those funds to pay the premium for their employer’s plan, to purchase another health plan of their choice, or to purchase medical care directly, or to build up savings, all tax‐​free.

Returning $9 trillion to the people who earned it would be an effective tax cut larger than all the Reagan and Bush tax cuts combined, and nine times larger than repealing ObamaCare. On top of that, Large HSA contribution limits could be calibrated to ensure deficit‐​neutrality, and would finally cap the exclusion—something economists have advocated for decades—via a huge net tax cut, not a tax increase like ObamaCare’s Cadillac tax. In addition, Large HSAs would facilitate fundamental tax reform that removes all tax preferences for health care (and everything else).

It is difficult to imagine an idea more in line with conservative principles.

Misplaced Criticisms

Nevertheless, some conservatives are pushing one of the very ideas Democrats used to tighten ObamaCare’s grip on consumers: refundable tax credits for health insurance. One or two have even criticized Large HSAs, though in ways that make me think they haven’t bothered to read the plan. Conservatives need to be clear‐​eyed about both proposals.

One criticism is that Large HSAs would impose a mandate on employers. Jim Capretta of the Ethics and Public Policy Center claims Large HSAs would “force all employers in the country to divert the funds they had been spending on health‐​insurance premiums into HSAs on behalf of their workers.” Perhaps he got this idea from John Goodman of the Independent Institute, who earlier wrote that this idea “would require employers to put the dollars they now pay out in premiums into ‘large Health Savings Accounts.’”

This is one of those criticisms that make me think Capretta and Goodman haven’t read the plan. First, it is bizarre and backward to describe letting workers keep $9 trillion of their own money as somehow “diverting” those funds. Second, Large HSAs would impose no mandate on employers at all. It would be closer to the truth to say they would remove a mandate that employers divert that $9 trillion away from workers. But not even that is strictly accurate. Whether we are talking about how employers shift compensation under the current tax exclusion or a reformed exclusion for Large HSA deposits, what employers are actually doing is responding to what their employees demand. That’s not a mandate. Finally, employers would have no say over whether or how much of that money would go into their workers’ Large HSAs. The whole point of Large HSAs is that workers would make that choice themselves.

I also wonder if Capretta has read the plan when he claims Large HSAs “would do nothing…for those without access to an employer plan.” The tax benefits of Large HSAs would be available to all workers–part-time or full‐​time, employee or self‐​employed, from Uber drivers to union members–regardless of whether they have an employer who offers coverage or facilitates Large HSA contributions. They would completely level the playing field between those who do and do not have access to an employer plan. I discuss how here. Read the plan.

Goodman complains Large HSAs would let the uninsured save money tax‐​free for their medical needs on the same terms as those who buy coverage. It is ironic that Goodman identifies this feature for criticism. First, coming from Goodman, it’s actually implicit praise. It means he recognizes and appreciates that Large HSAs would end all tax distortions between purchasing medical care directly, purchasing it through health insurance, and saving for future medical expenses (i.e., self‐​insurance). Goodman successfully led the charge to reduce those distortions with HSAs; Large HSAs would eliminate them completely. Second, Goodman inadvertently highlights a relative weakness of refundable tax credits, including those he supports: tax credits would preserve and in some cases deepen the distortions between third‐​party insurance and direct payment or saving–even if, in theory, the amount of the credit exceeds your premium and you can deposit the balance in a current‐​law HSA.

Third, Goodman’s criticism also inadvertently highlights why even a Republican tax credit would increase the cost of health coverage as much as ObamaCare’s tax credits and individual mandate do. Tax credits for health insurance provide no tax relief to the uninsured. You buy health insurance, or you get nothing. So if Congress requires tax‐​credit‐​qualified health plans to include coverage for contraceptives, infertility treatment, etc., consumers would have little choice but to buy the unwanted coverage. To refuse would mean losing a tax credit worth thousands of dollars. And here’s the key: knowing this, special interests will be eager to spend resources lobbying Congress to impose such requirements. They will know the money they spend lobbying will come back to them many times over. Even if Congress defined qualified coverage as any health plan licensed by any state–as permissive a definition as one can devise–the economic gains available to special interests are simply too great for such flexibility to last. A Republican tax credit would end up increasing premiums and forcing consumers to purchase as much unwanted coverage as ObamaCare’s tax credits and individual mandate do.

The fact that Large HSAs provide tax relief on an equal basis to the insured and uninsured alike is a feature, because it would make health coverage more affordable than tax credits would. Large HSAs likewise require the government to define qualified coverage for purposes of determining what taxpayers can purchase tax‐​free with Large HSA funds. Yet if Congress said that only health plans covering contraception and infertility are eligible for purchase with tax‐​free Large HSA funds, taxpayers could avoid that unwanted coverage by not purchasing health insurance without forfeiting the tax benefits of Large HSAs. Here again is the key: special interests would know this, and would therefore be far less likely to spend resources lobbying for such requirements in the first place, because they could not be sure to recoup their investments.

In addition, unlike tax credits, Large HSAs would create countervailing political pressure to block such requirements. Hundreds of millions of consumers would pay every penny of their premiums themselves, and would therefore lobby against legislation that would increase their premiums. Insurers would do the same, because they would know that if such requirements became burdensome, consumers could drop their coverage.

The very feature of Large HSAs that Goodman criticizes would offer consumers better, more affordable, and more secure health coverage—products like pre‐​existing conditions insurancetotal‐​satisfaction guarantees, and other innovations–in a way that tax credits simply cannot.

Still another criticism that makes me wonder whether the critics have read the plan comes when Goodman worries about how employers will return that $9 trillion to workers. Should an employer “cash out” every worker the same amount (e.g., $13,000), or should sicker employees get more and healthy employees less? I discuss this question at length in my original journal article on Large HSAs, but here are the highlights. Employers should pay employees according each employee’s marginal productivity, and competitive labor markets constantly push total compensation toward that target. Thus, there is no need for the government even to get involved in this question. After the switch to Large HSAs, employers will come closest to that target by cashing out employees in proportion to the value each had been receiving from the company plan—i.e., by giving older/​sicker workers more and young/​healthy employees less. If employers miss the marginal‐​productivity target, which they do all the time, it is a minor concern that labor markets will soon enough correct. Any temporary unfairness pales in comparison to the unfairness of not giving workers their $9 trillion back.

This brings us to another criticism. According to Capretta, Large HSAs would “end employer‐​sponsored health care for tens of millions of people.” Goodman is even more alarmist: Large HSAs would “push an additional 150 million people out of their employer plans”! As discussed above, Capretta and Goodman don’t appear to have read the proposal or to understand how Large HSAs would affect employers. So one should take this demagoguery with a grain of salt. Still, they draw attention to an important issue facing all proposals to reform the tax treatment of health insurance, including their own, which is how they would affect employer plans. So let’s take a reasoned and careful look at it.

As I mention above, Large HSAs allow workers who want to stay in their employer’s plan to do so without interruption, provided the employer wants to continue offering coverage. But if employer‐​sponsored insurance no longer enjoys a tax advantage, whether because Congress enacted Large HSAs or a tax credit that leveled the playing field, would employers want to keep offering coverage? A lot of people suspect they won’t, but no one really knows.

Perhaps inadvertently, Capretta points to one reason why we shouldn’t be afraid of employers dropping coverage. If employees can move freely between employer plans and the individual market, “employers aren’t going to keep running a health plan when they have no ability to control who enrolls in it.” If the only thing holding an employer plan together is the employer’s ability to control its workers’ health‐​insurance decisions, that is a problem. It means the employer is forcing them into the wrong health plan(s), and employees are suffering real losses as a result. That is not a desirable or sustainable scenario. We absolutely should give those workers their money back and free them to find better, more affordable, and more secure coverage.

The real issue is the small number of people with high‐​cost conditions in those employer plans, who would not be able to afford coverage on their own. This is the biggest challenge facing proposals to reform the tax treatment of health insurance, including Capretta’s and Goodman’s tax‐​credit proposals, not least because it lends itself to the sort of demagoguery that Barack Obama leveled against John McCain’s tax‐​credit proposal (and that Capretta and Goodman now level against Large HSAs). The important question is, what would each proposal do for those workers? How would it respond to the inevitable demagoguery?

Large HSAs would help those workers by giving them an additional $13,000; a wider range of more affordable and more secure health insurance choices; a tax break they can use even if they don’t have coverage; and falling health care prices. Large HSAs would therefore minimize as much as possible the number of affected workers who cannot afford coverage and medical care on their own. A cool $13,000 cash isn’t going to solve everybody’s health care problems–but it is going to solve an awful lot of them. Congress could help the small number of workers who still could not afford coverage through some form of assistance, like high‐​risk pools, that do not impede the market’s ability to deliver more affordable and more secure health‐​insurance products.

What would the leading tax‐​credit proposals do for such workers? Unable to compete with Large HSAs on any of the above dimensions, they turn to government price controls. Each proposes a type of health‐​insurance price control called “continuous coverage protection” that says that if a worker has maintained continuous coverage for most of the previous few years, then when they shop for new coverage basically ObamaCare’s community‐​rating price controls would apply. These new “conservative” price controls, like ObamaCare’s, would require insurers to sell coverage at premiums that are below an actuarially fair premium. Like ObamaCare, they would therefore create a race to the bottom that forces insurers to compete to avoid, mistreat, and dump the sick–as Capretta and especially Goodman well know.

Health‐​Insurance Tax Credits Are ObamaCare‐​Lite

Indeed, as I have written elsewhere, refundable health‐​insurance tax credits bear so many similarities to ObamaCare that they amount to ObamaCare‐​lite. In addition to the similarities I describe above, the “refundable” part of such credits is not a tax cut at all but government redistribution. Goodman admits he does not want to repeal ObamaCare’s new spending because he needs that money to fund new that new spending.

As Goodman concedes, a tax credit is also the functional equivalent of an individual mandate. If you buy a government‐​designed health plan, you pay less to the government; if you don’t, you pay more. (Goodman calls tax credits a “financial mandate.”) In fact, tax credits are arguably more coercive than ObamaCare’s individual mandate in two ways. The effective penalties are higher–$2,500 per adult/$8,000 for a family of four under Goodman’s plan–and the IRS can actually come after you if you don’t pay it.

Goodman claims that Large HSAs look an awful lot like ObamaCare—if you layer ObamaCare on top of them. I guess that’s true. But it sounds to me like a concession that, unlike tax credits, Large HSAs actually bear no resemblance to ObamaCare at all. (I agree.)

I hope Goodman and Capretta will give Large HSAs a fresh look. I encourage them, and all conservatives, to read the plan. Think about the resemblance tax credits bear to ObamaCare; about how tax credits and Large HSAs would affect consumer behavior at every margin; about the powers the federal government would have under each proposal; about how public‐​choice dynamics would influence whether and how the government would exercise those powers; and about the wisdom of begging Congress to preserve entitlement spending that it just voted to repeal.

The stakes are too high for conservatives to make the same mistake twice.

About the Author