Health Insurance and Tax Policy

Abstract

The U.S. tax policy on health insurance favors only those ofiered group insurance through their employers, and is regressive since the subsidy takes the form of deductions from the progressive income tax system. The paper investigates alternatives to the current policy within a framework of a dynamic general equilibrium model. We flnd that despite the issues about the current policy, a complete removal of the subsidy results in a partial collapse of the group insurance market and a signiflcant reduction in the insurance coverage, negatively afiecting the welfare of many. There is, however, room for raising the coverage and signiflcantly improving welfare by extending refundable credits to the individual insurance market. Our work is the flrst in highlighting the importance of studying the tax policy associated with health insurance in a general equilibrium framework with an endogenous demand for the insurance. We use the Medical Expenditure Panel Survey (MEPS) to calibrate the process for income, health expenditure shocks and health insurance ofier status through employers and succeed in producing the pattern of insurance demand as observed in the data, which serves as a solid benchmark for the policy experiments.