UNEMPLOYMENT AND WELFARE IMPLICATIONS OF THE CURRENT U.S. TAX TREATMENT OF EMPLOYER-PROVIDED MEDICAL INSURANCE

Abstract

The U.S. tax system currently provides an incentive for individuals to obtain medical insurance through their employers. This unique tax treatment is widely excoriated as resulting in high costs and distorting consumption decisions. To study this issue, we develop a general equilibrium search model with endogenous health accumulation and a unique feature of the U.S. tax code, which exempts employer-provided medical benefits from taxation, to jointly account for the U.S. long-term unemployment rate and medical expenditure-to-aggregate consumption ratio. Through various counterfactual experiments, we find that (1) eliminating the employment-based tax subsidy lowers medical expenditure but, via a general equilibrium labor market effect, increases unemployment and lowers output, and contrary to conventional wisdom, lowers welfare; (2) having government raise taxes to finance the provision of medical care substantially increases the unemployment rate, while reducing income and welfare.