Why is health insurance tied to employment?
Health insurance is largely tied to employment in the United States. That drives most people crazy. After all, who wants starting and ending employment to be even more complex and stressful by connecting it with health insurance coverage? Why are employment and health insurance connected in the first place?
This phenomenon of employment and health insurance being largely synonymous in the United States is unusual globally. This is not the case in other countries. And that's a big clue – this isn't a natural phenomenon, it is unique to government policies in the United States.
The history stretches back to WWII
Wartime economies are infamous for high demand, widespread shortages, and increasing prices – especially for labor, because so much of the population is removed from the workforce to fight. This was certainly the case for the American economy during World War II.
The United States officially joined World War II on December 8, 1941. Almost immediately it launched a series of major economic interventions attempting to prevent "excessive price rises." First came the Emergency Price Control Act of 1942 on January 30, 1942. This imposed price controls on agricultural commodities, goods and services, and real estate.
After the first act did not sufficiently control prices, next came the Act to Amend the Emergency Price Control Act of 1942 on October 2, 1942. This instructed the President to freeze prices across the economy: "the President is authorized and directed, on or before November 1, 1942, to issue a general order stabilizing prices, wages, and salaries ... on the basis of the levels which existed on September 15, 1942." The President quickly complied. Executive Order 9250 declared there would be "No increases in wage rates, ... and no decreases in wage rates". Businesses were not allowed to charge more to customers, or pay more to employees. But, like many well-intended government interventions, these policies had unintended consequences.
Wage controls do not alleviate labor shortages. In fact, price ceilings like this actually "cause shortages" because they simultaneously increase demand and reduce supply. During WWII, employers facing worker shortages needed something other than wages to incentivize employees. Furthermore, "By slapping corporations with tax rates of 80 or even up to 90 percent on any profits in excess of prewar revenue, Congress all but guaranteed a frenzied search for loopholes."
Health insurance was the most prominent loophole. It was one of the only exceptions allowed under Executive Order 9250, which stated: "wages under this Order shall include all forms of direct or indirect remuneration ... and any other remuneration in any form or medium whatsoever (excluding insurance and pension benefits in a reasonable amount as determined by the Director)". In other words, the only way for employers to increase compensation was through insurance and pension benefits.
In 1943, the Internal Revenue Service made the insurance loophole even more lucrative. It ruled that health insurance premiums paid by an employer are exempt from taxation. This made an already attractive option vastly more attractive, given that wartime tax rates were so high. This tax exemption is what made employer-sponsored health insurance so compelling even after the wage controls expired, and continues to make it so compelling today.
In 1944, the wage controls were extended to June 30, 1945. They were not extended again, and expired on that date. (The war in Europe was already won, the war in the Pacific would be won by September, and the wage controls were not popular to begin with.) But the tax exemption on employer-sponsored healthcare was permanent, and still very attractive. In fact, in 1954, laws were passed that "made the tax advantages even more attractive" (and even exempted "the business of insurance" from federal antitrust laws).
As a result of these considerable tax advantages, health insurance coverage increased by 700% in 20 years. "In 1940, about 9 percent of Americans had some form of health insurance. By 1950, more than 50 percent did. By 1960, more than two-thirds did" (NYTimes). Most of this coverage has been tied to employment. "Today, just over 50 percent of Americans enjoy some kind of employer-sponsored medical insurance". Yes, a majority of Americans have health insurance tied directly to their employment, all thanks to federal policy.
The employer-insurance connection causes many ill effects
People hate having their health insurance – their shield against exorbitant healthcare prices – stripped from them at the sensitive time of changing jobs. But the harms of the employer-insurance connection don't end with psychological stress. They are twisting our legislation, increasing our healthcare prices, and putting downward pressure on our employee salaries.
The employer-insurance connection motivated the passage of a band-aid law called COBRA that "gives some employees the ability to continue health insurance coverage after leaving employment." This intervention was designed to mitigate the unintended consequences of the government's prior interventions. In that sense, the additional complexity of this legislation is dysfunctional by definition. But that's not the worst problem.
In 2003, an academic found, "employers' purchasing policies contribute to rising costs and block growth of economical care." The recommendation: "Employers should create exchanges ... and create serious competition based on value for money." The problem: employers aren't very motivated to do that, because the cost of health insurance is redirected from employee salaries. If health insurance gets more expensive this year, employees simply don't get as big a raise.
Is it possible to break the connection between employment and health insurance?
Economists like to say, "people respond to incentives." The tax exemption for employer-sponsored insurance (ESI) is the big incentive causing Americans to attach health insurance to employment. Removing the tax exemption will remove the incentive. After that, it's a matter of gradually unwinding the status quo so people have their own health insurance – the same way they have their own insurance for auto, home/renter, etc.
That's not to say it would be easy. The tax exemption for employer-sponsored insurance is by far the largest federal tax exemption. It saves taxpayers around $273 billion in taxes every year. Taxpayers may not want to lose that savings (even if it's not really savings in the big picture because it is one of the biggest drivers of rising healthcare prices).
Taxpayers aside, the tax exemption covers about $1 trillion in compensation that is funneled directly into the health insurance industry every year. Much of that would not be funneled into the health insurance industry without the tax exemption. The health insurance industry definitely doesn't want to lose that extra revenue. Imagine if your industry was the sole beneficiary of the largest federal tax break in existence! Imagine how much you would pay for lobbyists and advertisements to preserve a WWII-era policy that delivers you hundreds of billions in extra revenue every year. The health insurance industry will fight tooth and nail to preserve the tax exemption, dysfunctional relic though it may be.
The problem is clear; we don't like our health insurance being tied to employment. And the solution is clear; we should remove the huge federal tax incentive for tying health insurance to employment. The only question is whether we are going to follow through.
- Chicago Tribune: Employer-based health care was a wartime accident.
- CQ Press: Fringe Benefits and Wage Stabilization and Wage Control, both of which discuss the Wage Stabilization Board bowing to pressure to allow wage increases.
- NBER: Employer-Sponsored Health Insurance and Health Reform.
- NPR: Accidents Of History Created U.S. Health System.
- Tax Policy Center: How does the tax exclusion for employer-sponsored health insurance work?