The Unrealized Value of The Indvidual Pre-Tax Health Insurance Benefit

Recently, a friend who is a retired industrial senior executive wrote me regarding the ongoing debates on government health care legislation,


"Have you ever done a blog on the rationale for a tax on employer-provided health care? I realize that this is a third rail in Congress, but you could make the point that people are economic animals and until an individual has his own interest in the outcome there will be no change in behavior. The government has always encouraged the provision of uneconomic fringes with its tax policy - and this has lead to the demise of the airlines, the autos and the steels."


His point is correct. Government-subsidized health insurance, by way of the tax code and so-called "fringe benefits," have led to third-party payers insulating health care consumers from the costs of their own behaviors. And they are insulated in two ways. First, by the tax-free nature of the implied compensation of health insurance. Second, by being given that benefit as a defined obligation, rather than a defined level of value.


In prior posts, I've mentioned the origin of this sorry state of affairs, i.e., Senator Harry Truman's Senate Committee freezing wages during WWII. The result was non-price competition in the form of then-novel "fringe benefits." These included paid health insurance and pensions.


Thanks to this bone-headed war-era move by Congress, businesses foolishly turned what was a controlled expense, wages, into an open-ended obligation, health insurance and pension promises.

I'm not inclined to excuse the corporate CEOs of the era for this mistake. There were other methods of enabling individuals to receive these benefits, if only by making them defined contribution, rather than defined benefit in nature.

That's really the key point. Most of the private sector has moved non-union employees from the latter to the former when it comes to pensions. It's time to do so for health insurance, as well. It's true that defined-benefit approaches to health insurance and pensions did much to sink the US auto, airline and steel sectors.

One could, as my friend does, argue for removing the tax-preferenced nature of health insurance premiums from businesses, so that they are on an equal footing with individuals who buy their own health insurance with after-tax dollars. I'm fine with doing this, too, if only, as he points out, to force individuals to pay for the implied compensation.

But I think, by far, the more important element in reforming US health care is to move corporate compensation in the form of health insurance obligation, to a cash payment as a wage component. This removes the open-ended obligation from the corporation's balance sheet and income statement, replacing it with a simpler, more easily-valued and controlled cash payment. The obligation's value then becomes the choice of individual employees.

As I wrote in yesterday's related post,

"For example, in direct contrast to several Wall Street Journal editorialists with deeper backgrounds on the subject than Buffett, he blithely declared increased spending as essentially wasteful and a crushing burden on American competitiveness.

What Buffett ignored, but others have noted, is that greater discretionary spending on health care is a hallmark of wealthier society.

Here's one way to see Buffett's error.

Americans spend more time and money on leisure activities now than they did fifty years ago. And, given the relatively lower costs, in percentage terms, of various other household expenses, almost certainly more in percentage terms, as well.

Oh my God!

We have a leisure spending crisis! Fifty years ago, nobody spent money downloading music to iPods! Now, they do.

What will we do? American businesses must be shouldering the burden of all that digital entertainment expense, mustn't they?

Buffett confuses changes in discretionary spending with escalating costs for a controlled level of consumption.

Oil prices are higher now than they were fifty years ago, too. Isn't that another crisis? Shouldn't that be tackled by Congress?

The key flaw in Buffett's argument, much as Boone Pickens' over energy costs, is to pick one input to our economy, note the rise in its cost, and declare an emergency, while failing to observe the rise as at least partially attributable to consumer discretionary spending and business use to create even higher-value outputs."

What my friend astutely notes, whether tax-preferenced, or not, is that by shielding workers from the true costs of their behaviors, they over-consume health care. It's one thing for an employee to use his cash wages to buy gasoline, food, health insurance, and save for his own retirement. When all these claims on a household budget are explicit, real lifestyle choices result.

You never hear anyone in Congress complain that gasoline or food prices are hurting US business competitiveness, do you? Why should it continue to be so with health care?

It's almost moot whether one chooses to continue the pre-tax treatment of health insurance premiums and HSA accounts for individuals, or not. The really important change is to make end users pay those amounts out of their own pockets, from a defined cash compensation amount, so that consequences of their behaviors and choices are truly owned.

It's not hard to foresee Americans eating and behaving in healthier ways, once the cost of health insurance is seen as depending, in part, on the buyers' health status.

But, most importantly, by putting the choice of how much health care end users wish to buy and consume in the hands of those consumers, and not leaving it as an open-ended corporate obligation, those consumers will experience the true and full consequences of their behaviors. Thus, as my friend noted, almost certainly changing their behaviors, bringing down the care-level-adjusted cost of US health care.

It will also simplify and separate the US health care problem as distinct from costs of doing business for US businesses.