Tax credits, insurance, and the use of medical care

Abstract

Abstract. The personal income tax systems in Canada, the United States, and elsewhere permit deductions or tax credits for out‐of‐pocket health care expenditures and private medical insurance premiums. Little is known about the effects of such tax measures on individual behaviour, in contrast to the extensive research on the tax exemption for employer‐provided health insurance. In this paper, we exploit variation in the after‐tax cost of health expenditures under the tax law to estimate the tax price elasticity of demand for prescription drugs, health insurance, and other eligible expenditures. We find evidence of moderate to large tax price elasticities, compared with traditional point‐of‐service price elasticity estimates – despite the apparent differences in the way tax subsidies are experienced by consumers. In contrast, we find no evidence the tax subsidy affects demand for health insurance on the intensive margin, which we show is consistent with the theory of optimal self‐insurance. We discuss the implications of our results for recent proposals to reform public and private health insurance systems. JEL classification: I1, H2