McCain and Obama Health
by John Goodman
Issue 118 - October 22, 2008

Here are two radically different approaches to health reform:

• The McCain health plan subsidizes, dollar-for-dollar, the core insurance everyone should have, forcing people to buy additional coverage (all the bells and whistles and items of questionable value) with their own funds.
• By contrast, a Commonwealth-Fund-Center-for-American-Progress-and -maybe-also-Barack-Obama approach forces people to buy core insurance with their own funds, leaving them free to purchase the bells and whistles and items of questionable value with taxpayer money.

You might think this second idea was produced late at night after too many glasses of wine. But no. I found it at their Web sites here and here in the sober light of day. It has even been in Health Affairs here [gated but has abstract]. (Whatever happened to peer review?)

For ease of exposition, let's call the Commonwealth-Fund-Center-for -American-Progress-and-maybe-also-Barack-Obama approach the Axis of Goodness idea, in honor of Milton Friedman's observation that most bad laws are the result of trying to do good with other people's money.

Creating a Parallel Market. For people who do not get insurance from an employer or Medicare or Medicaid, etc., the Axis would create a parallel market---organized like the federal employee health benefits program. Private plans would compete, along with a Medicare look-a-like plan. What concerns us here are not the plan specifics but the costs.

Limits on Spending. The idea behind the Axis approach is to limit everyone's out-of-pocket cost to 5% or 7½% or 10% of income, depending on the version---with 5% reserved for the poor and the higher numbers for everyone else. Once these income thresholds are met, taxpayers will be responsible for the remainder. I know what you're thinking: Where did these numbers come from? I second that question.

Just to remind, the nation as a whole is spending 16% of national income on health care. The average family is spending 19% of its consumption dollars on health care. That's worth repeating: we are spending almost one out of every five consumption dollars on medical care.

Disguising Spending. Of course, the average family doesn't know it is spending one-fifth of its consumption on health care. The reason: the bulk of that spending is hidden in non-ear-marked taxes, lower wages, and cost-shifted health insurance premiums. But isn't that the whole problem? Of all the things that are not transparent in the health care system, the one thing that is the least transparent is how much each of us spends. The McCain plan is transparency par excellence. Every family will have to be aware of the first $5,000 of spending (in order to claim their tax credit) as well as all subsequent dollars (because that's out-of-pocket). By contrast, the Axis approach would make real costs less transparent than they are now---disguising as much as three-fourths of what people actually pay.

Subsidies for Everyone. What exactly are we talking about here? Since the average cost of employer family coverage is $12,000, income would have to be $160,000 before a family would have to pay full fare. In other words, 95% of the population in the parallel market would have their premium payment capped!

Perverse Incentives. The current system encourages people to wastefully overinsure. The reason: employer-paid premiums escape income and payroll taxes. Given a 25% federal income tax rate, a 15% payroll (FICA) tax and a 6% state and local tax, government is paying almost half the cost of the insurance. Put differently, a dollar of insurance needs to be worth only 55 cents in order to be preferable to a dollar of taxable wages.

The McCain plan completely removes this perverse incentive, since marginal insurance dollars are not subsidized at all. By contrast, the Axis would raise the subsidy to 100%. An additional dollar of insurance could be almost worthless and still look attractive to the buyer.

Eroding Employer-Based Coverage. The McCain approach creates a level playing field under the tax law for individual and group insurance. Employers will offer insurance only if they can provide something people cannot get on their own (e.g. cheaper and better insurance, say, because of economies of group buying). By contrast, the Axis would keep the current system in place for group insurance and create a parallel market where the income caps are operative. Yet these caps amount to a 73% subsidy, say, for a $60,000-a-year family---far more generous than the current system's tax subsidies at work.

Even with a pay-or-play mandate on employers (of the type advocated by Commonwealth), I have calculated [see link] that most people would be better off if their employers dropped their current coverage; paid cash wages instead; paid income and payroll taxes; and paid the pay-or-play fine!

John Goodman is President of the National Center for Policy Analysis