Would you agree or disagree with the following statement, "The single most important health policy choice in the United States over the past five decades has nothing to do with the Department of Health and Human Services, but rather with the Internal Revenue Service." What evidence can you cite to support your position?

businesses A parallel job lock issue pertains to peop n insurance comes through a "Startups" are a key form of economic innovation. If access to h large employer, the "preexisting condition" concern prevents some potential entrepreneurs fro starting new enterprises. One recent analysis concluded that entrepreneurship lock" cut the annual rate of people leaving large firms to start their own businesses from s to 2 percent he year-a one-third reduction in the rate of entrepreneurial startups (Fairlie, Kapur, and Gates, 201 9 Avoiding self-selection in insurance plans seems to be an important function of the work group arrangement for selling insurance. A key to making this system work is that the work group must all use the same insurance plan, so the preferences of the "median" worker dominate the choice of plan. Probably for this reason, a minority of employer groups offer choice of more than one insurance plan to their employees.25 Finally, we should note that the issue of self-selection and market stability may matter considerably more in such areas as long-term care insurance than in more traditional hospi- tal insurance. Long-term care insurance is mostly viewed as pertaining to the elderly. If the demand for such insurance mostly arises from retired people, then the mechanism of the work group is not available to stabilize the market. How much this matters remains to be seen because these markets are still relatively new and learning about enrollees' use of long-term care services. However, the very fact that such markets have formed slowly and incompletely may address the question. 10.6 Income Tax Subsidization of Health Insurance The other important part of the "price of insurance" for most health insurance purchases in the U.S. is the income tax system. We noted earlier that employers pay for a significant fraction of all workers' health insurance premiums in the U.S. The employer's share peaked at about 80 percent of total premiums in the early 1980s, then began to decline slowly, partly in response to changes in the magnitude of the tax subsidy.26 Because modern economic analysis tells us that the worker really ends up paying for this premium anyway in terms of lower wages, why go through the extra step of having the employer pay for it? The answer lies hidden in the bowels of the Internal Revenue Code. Employer payments for health insurance are not taxed as income to the employee but also remain a legitimate deduction for the employer. Thus, these employer premiums escape the tax system. As a result, they make health insurance cheaper than any other good or service the employee might buy because the employer purchases the health insurance with before-tax dollars. Relative to everything the employee might purchase with after-tax dollars, health insurance costs only (1 - t) as much, where t is the employee's marginal tax rate. Suppose the insurer pays a share s of the total premium cost, and the employee pays (1 - s). Defining the expected insurance benefits as B and the loading fee as L, the premium can be defined as R = (1 + [)B.27 The insurance costs the employee (1 - s) R for the employee's share and s(1 - t) R for the employer's share, which is not reported as taxable income. The subsidy is the marginal tax rate t on the employer's share. It is easy to show that the effective cost of the insurance is R = (1 + L)(1 - st)B. Econ omists normally speak of the loading fee L as the price of insurance. If L = 0, the insurance function is "free." But the subsidy t applies not only to the loading fee, but rather to the entire portion of the policy paid by the employer. The most recent data available show thatChapter 10 The Demand for Health Insurance 279 (on average), s - 0.16. For many persons (particularly those purchasing coverage for only the worker ), s = 1, i.e., the employer pays the entire insurance premium. The U.S. tax system has many components affecting the marginal income tax rate , including federal income taxes, federal deral Social Security (FICA) taxes (which have an income cap ), the Medicare payroll tax (which is uncapped), plus any state and local income taxes. "x 10.2 provides a discussion about the complexity of calculating marginal tax rates in the further detail . pis., and an online supplement to this book (see www.routledge.com/cw/phelps) provides BOX 10.2 CALCULATING MARGINAL TAX RATES What constitutes the "marginal" tax for a household? If each worker's wages are under the FICA imit (which is the case for a very large fraction of U.S. workers), the marginal tax is the sum of the household members' federal income tax marginal rate plus the 6.2 percent FICA tax twice (employee's and employer's share), plus the 1.45 percent Medicare FICA tax twice, plus (an almost-final complication) either part or all of their state income marginal tax rate. Because state income taxes are deductible when calculating federal income tax liability, for people who itemize their federal income tax calculation (rather than using the simplified short form), the appropriate marginal state tax is (1 - t)t, where if and t, are (respectively) the appropriate federal and state marginal tax rates as shown in the tax code. The last wrinkle, relevant only for high-income fam- ilies, is a formula that reduces the value of some deductions as income rises, thereby effectively increasing the marginal tax rate for those families by another few percentage points. Calculating marginal tax rates has become increasingly complicated, with recent tax reforms and the growing applicability of the alternative minimum tax (AMT). * As of the most recent tax brackets available (2012) at this writing, the marginal tax rate ranges in steps through 0, 10, 15, 25, 28, 33, and a top rate of 35 percent. For a very detailed analysis of marginal tax rates, the truly eager reader can digest the data in Congressional Budget Office (2005). On top of that, Social Security wage taxes (which appears as the Federal Insurance Corporation of America, or FICA, on paycheck stubs) add an additional 6.2 percent tax on earned wages up to an annual maximum that is indexed by inflation. For example, in 1995, that cap was $61,200 and by 2001 the cap had increased to $80,400. In addition, on all wage income, there is an additional tax of 1.45 percent to support the Medicare system. Both the employer and the employee pay both of these wage taxes. Finally, state income taxes (and city income taxes in cases such as New York City) add to the marginal income tax rate. State income taxes are also normally graduated, ranging from lows of percent (Alaska, Florida, Nevada, New Hampshire, South Dakota, Tennessee, Texas, Washing- ton, and Wyoming have no state income taxes) to other states with top marginal tax rates in the vicinity of 10 percent or higher. A supplement on the publisher's website provides some extended examples of these calcula- tions. See www.routledge.com/cw/phelps. The AMT was designed to catch a few (fewer than 200) wealthy individuals who avoided income taxes with arge deductions, but the Congressional Budget Office now says, "In 2010, if nothing is changed, one in five taxpayers w have AMT liability and nearly every married taxpayer with income between $100,000 and $500,000 will 000 will owe the alternative tax" (CBO, 2004, p. 8). The AMT phases out (through incomes of $150,000-415,000) the taxpayer's ability to take many otherwise legal deductions, preserving only a few donation is, happily for colleges and universities, and homeowner interest are the key deductions remaining). For persons with incomes of more than $415,000, the top marginal tax bracket is 28 percent, out for those in the range of phaseout of deductions, the effective rate can reach 35 percent. The Wikipedia try on AMT is qu encyclopedia entry on / T is quite useful to help the reader understand the nuances of the AMT.280 Chapter 10 The Demand for Health Insurance the Congressional Budget Office (CBO, 2005) estimated the average (over all filed income tax returns) of the effective marginal tax rate (t in the above discussion). Figure med shows the distribution in more detail. The lower solid line shows the distribution federal income tax marginal rate. The dotted (intermediate) line shows the combination of the income tax and Social Security and Medicare ("payroll") taxes. The top solid line adds ; state income taxes. The average of the effective marginal tax rate is about 35 percent. Thin since employer-paid insurance escapes income taxation, the tax system in the U.S. effectively subsidizes over one-third of employer-paid premiums. Coupling that with the average share paid by employers(s), we can see that the overall effect is (on average) about a 25 percent subsidy on health insurance. FIGURE 10.11 CBO estimates of marginal tax rates, using person-weighted measure 60 50- Federal Income, Payroll, and Federal Income and State Income Tax Rate 40 - Payroll Tax Rate 30 - 20 - Federal Income Tax Rate MTR = 25% MTR > 25% (12%) (18%) MTR = 15% Tax rate in percent 10 - MTR = 10% (29%) MTR = 0 -10 - 9%) -20 - 1 MTR