A Defense of the Current US Tax Treatment of Employer-Provided Medical Insurance

The US tax system currently provides an incentive for individuals to obtain medical insurance through their employers. This feature introduces a distortion which encourages households consume more medical services than they otherwise would, and likely results in the medical consumption taking up 17 percent total consumption, which is much higher than in other advanced economies. This unusual and unique tax treatment is widely excoriated as resulting in high costs and distorting consumption decisions. This paper presents a simple general equilibrium model to compare the outcomes for different systems for the provision of medical services. It is shown that the current tax system may be superior to an identical system in which the tax subsidy is absent. It also is shown that eliminating the tax subsidy for employer-provided medical insurance results in higher unemployment, lower output, and lower welfare. Furthermore, having the government raise taxes to finance the provision of medical care results in substantial decreases in employment, output and welfare.