Cross-subsidization in employer-based health insurance and the effects of tax subsidy reform

Pashchenko, Svetlana and Porapakkarm, Ponpoje (2013): Cross-subsidization in employer-based health insurance and the effects of tax subsidy reform.

Abstract

A major source of insurance coverage for non-elderly adults in the US is the employer-based health insurance market. Every participant in this market receives a tax subsidy because premiums are excluded from taxable income. However, people have different incentives to participate in the employer-based pool - since premiums are independent of individual risk, high-risk individuals receive implicit cross-subsidies from low-risk individuals. In this paper, we explore several ways to reform the tax subsidy by taking this implicit cross- subsidization into account. Using a general equilibrium heterogeneous agents model, we find that even though the complete elimination of the tax subsidy leads to the unraveling of the employer-based pool, there is still room for substantial savings by targeting the tax subsidy. More specifically, the same level of risk-sharing in the employer-based market can be achieved at one- third of the current costs if i) the tax subsidy is targeted only towards low- risk individuals who have weak incentives to participate in the pool, and ii) employer-based insurance premiums become age-adjusted. To improve the welfare outcome of this reform, the modified tax subsidy should also be targeted to low-income individuals.

• Item Type: MPRA Paper
• Language: English
• Keywords: health insurance, tax subsidies, tax deductions, general equilibrium, life-cycle, health reform
• Subjects: D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D52 - Incomplete Markets; D - Microeconomics > D9 - Intertemporal Choice > D91 - Intertemporal Household Choice ; Life Cycle Models and Saving; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E21 - Consumption ; Saving ; Wealth; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E65 - Studies of Particular Policy Episodes; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H20 - General; I - Health, Education, and Welfare > I1 - Health > I10 - General

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