Simply put: Employer-sponsored insurance tax subsidy

Simply put” is an ongoing series. See the introduction for an explanation of the series and the full list of topics that have been or may be covered. Feel free to suggest other topics in that post.

Every dollar an employer pays directly toward health insurance is not taxed. Many, but not all, of the dollars employees contribute toward their premiums are not taxed either (it depends on how their health benefits programs are structured). It’s been shown in many studies that what an employer doesn’t pay in health care premiums, it does in wages. That is, if an employer pays a dollar less in premium, it’s employees earn a dollar more in wage, on average.

But, unlike employer-paid premiums, wages are taxed. That difference makes health insurance relatively more attractive than it might otherwise be. Employees get a discount through the tax system. That gift from Uncle Sam costs the government $250 billion per year, no chump change!

What does Uncle Sam, through our individual actions, buy with that tax expenditure? Two things: (1) more firms offering employer-based health insurance plans and (2) the offering of more generous plans.

Economists have estimated the effect of the tax subsidy on these two phenomena. The classic result, from Gruber and Lettau is that a one percentage point increase in the tax subsidy leads to a 0.25 percentage point increase in employer offers, but a much larger proportional increase in the generosity of plans offered. That is, the tax subsidy has a bigger effect on plan generosity than on whether a plan is offered.

Recently, in work with Steve Pizer and Lisa Iezzoni, I re-estimated the effect of the tax subsidy on employer offers and found it to be twice as large as what Gruber and Lettau found.

Either way you slice it, the employer-sponsored health insurance tax subsidy supports the employer-based insurance system and encourages more generous health plans than would otherwise exist. The consequence is more people are covered, but they also spend more through their insurance plans than they would otherwise.

Further Reading

Pizer S, Frakt A, Iezzoni L. (2011). The Effect of Health Reform on Public and Private Insurance in the Long Run. HCFE Working Paper.

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