TCS Daily

Who Pays for Health Insurance?

By Arnold Kling - October 27, 2005 12:00 AM

Robert "Steve" Miller, Delphi's chief executive...bluntly says that the social contract written after 1945 is being -- must be -- repealed because, given globalization, unskilled manual labor cannot be paid $65 an hour, with the cost passed on to consumers. 'When you buy a Hyundai you get a satellite radio as your option, but if you buy a Chevrolet you get social welfare as an option. Long term, the customer is going to desert you if you try to price for your social-welfare costs.'"
-- George Will

If you think that employers' health insurance costs have gotten out of hand, that's nothing. The rhetoric about health insurance costs is what I would argue is most out of control. I think that both the Left and the Right are abusing the issue, with the Left trumpeting it as a rationale for national health insurance and the Right buying into the notion that employer-provided health insurance is a major competitive disadvantage for U.S. companies.


Suppose that health insurance costs $6000 a year. For a 2000-hour work year, that means that it costs $3 an hour.


Next, suppose that the breakeven compensation for a worker in a particular industry is $20 an hour. What that means is that the most a firm can afford in total compensation, including benefits, is $20 an hour. That means that if the employer provides health insurance, the worker can only be paid $17 an hour.


Finally, consider three alternatives:


1. Workers are paid $20 an hour, and they buy their own health insurance as individuals.

2. Workers are paid $17 an hour, and the company also gives them health insurance.

3. Workers are paid $20 an hour, but $3 is taken out in taxes for national health insurance, and the government provides health insurance.


What is the difference between these three schemes? As I have described them, there is no difference. The company is just as competitive or uncompetitive, regardless. After paying for health insurance, the worker has just as much money left over, regardless.


If the employer stopped paying for health insurance, the worker would not lose anything. Of course, if the employer stopped paying for health insurance but continued to pay $17 an hour, then that would amount to a pay cut. However, if the employer can get away with a pay cut, they ought to be able to do so with or without reducing health insurance.




There are many real-world complications relative to the three alternatives, including:


  • For many workers, employer-provided health insurance could be cheaper, because of the natural risk pool embodied in the employee base.
  • Government health insurance could turn out to be either more or less efficient than private health insurance.
  • Shifting from employer-provided insurance to individual insurance could reduce (or, for that matter, increase) insurance company overhead.
  • Health benefits are currently exempt from taxes when paid for by companies, but not when paid for by individuals.
  • Individuals choosing their own health insurance might pick plans with different costs than those provided by employers.

In the real world, therefore, the results are not exactly the same regardless of whether health insurance is paid for by the worker, the employer, or the government. However, the results are not going to be as wildly different as partisans want to suggest.


American firms will not become more competitive by shedding health care costs, unless in the process they can reduce the net compensation paid to workers. Cutting health insurance benefits and raising take-home pay or payroll taxes by an equivalent amount is a wash.


Health insurance costs will not fall for American workers unless costs in the health care system are reduced. I have spent considerable time looking into this issue, and my belief is that there is no free lunch. That is, none of the usual scapegoats for health care costs -- spending on the last year of life, excess profits of suppliers, administrative overhead, malpractice lawsuits -- is quantitatively large in relation to the level of health care services that Americans consume.


The only way to bring down health care costs is to consume less in terms of health care services. That in turn will require a major cultural change. One change could be centralized rationing of health care, with supply controlled by the government. Another change would be to dampen demand by switching consumers from comprehensive health insurance to catastrophic health insurance.


In the absence of cultural change, I believe that America will continue to be the leader in Activist medicine, with heavy use of specialists and technological apparatus. Activist medicine may or may not be the right way to approach health care. But it is the reason that health care in this country consumes such a large share of our GDP.


I am in favor of getting rid of employers as the health insurance Middle Man. I believe that employer-provided health insurance is inefficient and an economic distortion. However, it is important to recognize that America's large health care bills and the competitiveness of our large firms is not going to be much affected by changing to a different system.


Arnold Kling is author of Learning Economics.


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