Health Care: Why Incentives Matter

By Kelly McCutchen

As growing numbers of small businesses drop insurance plans amid rising costs, many individuals are opting to go uninsured rather than buy individual insurance. Their decision is understandable, given that 1940s-era rules still in effect today place the purchase of an already-expensive insurance policy with after-tax dollars beyond the reach of the typical family’s budget.

In many cases, the combined impact of payroll taxes, federal income taxes and state income taxes can nearly double the cost of insurance. Money spent out-of-pocket is after-tax money, whereas paying more for an insurance policy that covers nearly everything is tax-deductible. If the policy goal is to encourage insurance coverage, why tax it?

Consider, too: Not many auto insurance policies cover oil changes. Homeowner policies don’t cover regular routine repainting of the house every few years. Why is it, then, that health insurance covers routine doctor’s office visits?

Essentially, the problem is a system of pre-paid health care. Once they make the usually minimal co-payment, patients could care less about costs thereafter. These are the ingredients for a disastrous recipe: runaway health care costs.

Untangling these mixed signals requires acknowledging a basic rule of economics: When you tax something you get less of it, and when you subsidize something you get more of it. In other words, incentives matter.

The first step is to eliminate taxes on health insurance. That includes state and local premium taxes, state income taxes, federal income taxes and payroll taxes on individually purchased health insurance policies. This would lower the cost of insurance and provide tax equity to employees who purchase insurance on their own. If government budget constraints are too tight, these tax measures could be confined to high-deductible insurance linked to Health Savings Accounts.

Critics argue that it is bad policy to encourage high-deductible insurance over traditional coverage. But research shows that individuals with insurance are healthier and less likely to end up with an expensive complication in the first place. And for an uninsured individual, isn’t high-deductible health insurance better than no insurance at all? Having grown up in a small town, I frequently saw the community come together to support a local family when misfortune struck. Pickle jars with handwritten labels appeared near cash registers at local stores and quickly filled with donations. Such community action can easily cover a $1,000 deductible for a liver transplant, but isn’t a realistic option when finding $250,000 for the entire operation.

The next step is to implement a safety net for the “uninsurable,” those few individuals who, although willing to pay more for insurance, are not insurable because of an existing health condition. A few states require insurance companies to accept these individuals at standard rates – a move akin to forcing a company to insure a house that has already burned down. The result is massive premium increases; just ask residents of New Jersey or Kentucky.

A better approach is a high-risk pool, where a broad base of funding offers partial subsidies to these individuals. As a penalty for not having insurance before they became ill, the individuals are asked to pay 150-200 percent of the typical premium rate. This provides a safety net for the 1 percent of the population that needs it without rewarding irresponsible behavior.

Third, Georgia should actively pursue a multi-state health insurance purchasing compact to open the insurance market to greater competition. Individual insurance companies are less than 15 percent of the private health insurance market nationally. Individuals may only purchase individual insurance regulated by their state, which divides this market into 50 sub-markets – of which 49 are off-limits. A broader, more competitive market would lower prices and expand options for Georgians while opening up business opportunities for Georgia insurance companies.

Fourth, instead of being reactive to ailments, programs should provide incentives to promote health and savings. With the biggest cost driver in health care being individuals with chronic disease, Georgia’s insurance plan for state employees is considering a “shared savings” program. Individuals with chronic conditions who stay healthy would receive financial rewards in a tax-free savings account. Other insurance companies are experimenting with plans that lower deductibles for individuals who meet certain requirements for nicotine levels, cholesterol, body mass index or blood pressure.

This is precisely the prescription to improve health and lower costs for individuals and taxpayers. The good news is that Georgia policy-makers are close to embracing these policies. The state needs to be bold: Without fundamental reform such as removing tax inequities, removing barriers to competition and providing incentives for individuals to take ownership of their health, the norm will continue to be unmanageable increases in the ranks of the uninsured and in health costs.

Kelly McCutchen is executive vice president of the Georgia Public Policy Foundation, an independent think tank that proposes practical, market-oriented approaches to public policy to improve the lives of Georgians. Nothing written here is to be construed as necessarily reflecting the views of the Georgia Public Policy Foundation or as an attempt to aid or hinder the passage of any bill before the U.S. Congress or the Georgia Legislature.

© Georgia Public Policy Foundation (May 5, 2006). Permission to reprint in whole or in part is hereby granted, provided the author and his affiliations are cited.