Wall Street Journal Editorial Board member Susan Lee proposes in today’s WSJ ($) that the U.S. tax code be overhauled to mitigate the negative effects of the third party payor system that most Americans use to pay for health care:

Anybody who gives a few hours of thought to the current health-care system can identify the mother of these problems — the widespread existence of a third-party payer system. Third party-payers come in the form of government, employers (who self-insure) or insurance companies. This arrangement insulates consumers of health care from its true cost and encourages overconsumption.

And as Ms. Lee notes, such an inefficient system makes perfect sense under the current U.S. Tax Code:

This kind of employer-sponsored plan actually makes sense since employer payments are excluded from taxes while direct, or out-of-pocket, payments by employees are made with after-tax dollars. In fact, the tax exclusion is the chief reason that employers pay $5 out of every $6 spent in the private market.

Inasmuch as the tax system causes the unfortunate third party payor system, Ms. Lee touts a reform that economists John Cogan, Glenn Hubbard and Daniel Kessler have proposed — expand tax deductibility to out-of-pocket expenses and individually purchased health insurance. The syllabus for their proposal is here, and incorporates the recent legislation creating Health Savings Accounts (“HSA’s), which are more fully explained in this previous post. Ms. Lee points out that the Messrs. Cogan, Hubbard, and Kessler’s study indicates that such a proposal would have two effects:

The expansion of tax deductibility would have two effects. First would be the commonsense — and perverse — impact of increasing consumption and costs. Expanding tax deductibility would lower overall health care prices to consumers and thus increase demand.
But the second effect goes the other way, reducing heath-care consumption and costs. Currently, by making employer plans cheaper than individually purchased ones, the tax exclusion creates a bias toward employer plans and away from direct purchase. So extending the tax exclusion to direct purchases of health care would level the playing field. . .
For both the self-employed and those with employer-provided insurance, making out-of-pocket costs deductible will lower the price of direct health-care purchases relative to purchases made through insurance. Thus, insurance with higher deductibles and coinsurance, and fewer covered services — that requires lower premiums — will become more attractive. The shift will reduce the consumption of health- care services and reduce costs.
Lower premium prices are the key to this shift. When out-of-pocket costs are reduced by the proposed tax deduction, it will make less economic sense to pay the higher premiums charged for high deductible, high coinsurance policies. And, as it turns out, premium costs are very sensitive to the level of deductions and coinsurance.
Since low coinsurance and deductions are the engine behind rocketing costs and wasteful medical practices, providing consumers with the incentive to shift to policies with high coinsurance and deductibles is an elegant remedy. Extending the tax deductibility will do just that. Better yet, it is done without resorting to a larger government role in the health-care system.

The probable financial benefits of such a move are not insubstantial:

Although the theoretical impact of these two effects are ambiguous, the economists’ empirical work demonstrates that the second effect will very likely overwhelm the first. For the first effect — extension of the tax deduction will increase consumption and costs — the economists estimate that it will cause annual health care spending to rise by about $5 billion. Then add another $1 billion in the increased coverage coming from those who are currently uninsured, and the total increase comes to $6 billion.
As for the second effect — extension of the tax deduction will decrease costs because people shift to higher deductible, higher coinsurance policies — the economists estimate that if the average deductible rises from $250 to $500, health-care spending would decline by $43 billion. If coinsurance rates also rise to 25%, health care spending would decline by $69 billion.
The bottom line is that the net reduction of spending on health care would be $63 billion a year.

Ms. Lee then notes a study by Kaiser Permenante Institute for Health Policy staff economists Laura Tollen and Jason Lee that indicates that higher coinsurance and deductibles make health care consumers more aware of the true cost of medical services and thus, will reduce non-essential heath-care utilization. Stated simply, when consumers have more “skin in the game,” they will become more cost conscious and make better choices.
Finally, Ms. Lee notes that decreasing reliance on the employer funded health insurance system — a system that arose during World War II to attract scare labor during a time of wage controls — would have another fringe benefit:

But extending the tax exclusion has another nice effect. Under the current system, health insurance is a form of compensation to employees. That is, money wages are reduced by the amount of insurance the employer provides. Once the tax exclusion is extended, however, workers no longer have an incentive to take compensation in the form of pricey health insurance. They will shift to plans with higher deductibles and coinsurance and — given a competitive market — the savings from lower insurance premiums will be passed on to them in the form of higher money wages.

I have only one question regarding the foregoing commen sense proposal: Why isn’t either Presidential candidate embracing such a commen sense proposal?