Why Call It a “Tax Subsidy”?

A reader was confused as to why the special tax treatment of employer based health insurance premiums is considered a “tax subsidy.” I appreciate the question. It isn’t obvious that this is the right terminology. But it is standard, as is “tax expenditure.”

The confusion may stem from the fact that the subsidy isn’t explicit. It’s not as if Uncle Sam sends you a check for purchasing employer based insurance. Instead, what Uncle Sam does is cut you a tax break. If you declined employer based coverage and took the premium as wage it would be taxed. Then if you were to use those dollars to buy non-group coverage you would not get a break on your taxes.

So, relative to taking the compensation as wage and relative buying coverage in the non-group market, employer based coverage is treated differently. All other things equal, it is cheaper thanks to the tax rules. The difference in what it would cost without those favorable rules and what it does cost is the tax subsidy.

Some may object to the terminology on the grounds that it has a bias toward taxation. That is, if one is inclined to think that employer health insurance is “getting a break” then one is led to wonder how that can be justified. On the other hand, if one views the lack of taxation of compensation in the form of health insurance as appropriate government restraint from meddling, then the notion that lack of taxation is a subsidy might be offensive.

I contend that if one thinks government should not tax health insurance then one should think it ought to exempt non-group coverage too. It’s not necessarily a crazy idea. But to put it on sound intellectual footing one ought to tell a good story as to how encouraging compensation in the form of insurance as opposed to wage is welfare improving. That’s a hard story to tell, as I’ll illustrate next week.

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