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Optimal Health Insurance and the Distortionary Effects of the Tax Subsidy

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  • David Powell

Abstract

This paper introduces a model of optimal health insurance. This model provides theoretical guidance of the relationship between household preferences, cost-sharing, and premiums. It applies this model to understand how the income tax subsidy distorts optimal cost-sharing in health insurance. Typically, insurance protects individuals from financial risk. Health insurance plans, however, are frequently designed to provide coverage at non-catastrophic levels of financial loss. The presence of a health insurance subsidy in the United States tax code, which enables individuals to pay premiums in pre-tax dollars, encourages the purchase of more generous health insurance plans. Little is known about how the tax subsidy affects preferences for the structure of cost-sharing in private plans. This model illustrates how the tax subsidy can distort the optimal cost-sharing schedule. The model is tested empirically using claims data in the Medical Expenditure Panel Survey and a regression discontinuity strategy that uses discrete changes in the marginal tax rate at the Social Security taxable maximum for identification.

Suggested Citation

  • David Powell, 2013. "Optimal Health Insurance and the Distortionary Effects of the Tax Subsidy," Working Papers WR-975, RAND Corporation.
    • Handle: RePEc:ran:wpaper:wr-975
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    References listed on IDEAS

    as
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    More about this item

    Keywords

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    JEL classification:

    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household
    • I13 - Health, Education, and Welfare - - Health - - - Health Insurance, Public and Private

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