The HSA Mirage


Feb 20, 2006

This commentary originally appeared in United Press International on February 20, 2006.

WASHINGTON, Feb. 20 (UPI) — Just about everyone agrees that the current health care system in the United States costs too much and doesn't do a good enough job serving those who need care.

Americans are ready for substantive health care reform, but reform only makes sense if it is effective.

During his State of the Union speech, President Bush proposed expanding the use of tax-subsidized health savings accounts (HSAs) as a controversial solution for one of the most intractable challenges in health care - controlling rising costs.

The president's proposal would give individuals that purchase HSAs on their own the same tax advantages as those with employer-provided insurance and would eliminate all taxes on out-of-pocket spending through HSAs.

Such proposals put individuals who buy HSAs on their own on a level playing field with those who get coverage from their employer. That's fairer than the current system, but it won't have a major effect on health care spending.

Research we conducted at the RAND Corporation shows that HSAs will fail to accomplish the president's objectives, and also shows that fears expressed by some opponents that only healthy and wealthy people would take advantage of this tax break are unfounded.

We found that the prototypical HSA user will only be slightly wealthier than those in conventional insurance, and HSAs would be attractive to the seriously ill in high tax brackets precisely because of this tax break.

Participants on both sides of the HSA debate frequently cite evidence from the RAND Health Insurance Experiment, one of the largest controlled experiments ever attempted in this country. This study from the 1970s randomly enrolled more than 2,700 families in health insurance plans that ranged from free care to 95 percent co-insurance. The results definitively demonstrated that when people have to pay for more of their care out of their own pockets, they will use fewer medical services.

If the goal of reform is to save health care dollars and reduce distortions in the tax code, the debate over HSAs misses the point. The biggest distortion in the tax code is the exemption of employer-paid health insurance premiums from taxation. Closing that loophole would raise billions of dollars that could be used to cut taxes or cover the uninsured. It would also remove incentives to over-insure, thereby eliminating the need for HSAs.

Economists have urged this approach for many years, but because taxing health benefits is a politically risky move, these pleas have largely fallen on deaf ears. More modest proposals could cap the tax deduction at the cost of a catastrophic plan and still save billions of dollars and reduce the incentive to over insure. Yet these also appear politically unpalatable.

But sometimes a politically unpopular course can make the most economic sense. With an HSA, individuals or their employers would purchase an inexpensive, high-deductible insurance plan (otherwise known as catastrophic insurance). Tax-free funds could then be set aside in an HSA to pay medical expenses until the deductible is met. Unused funds would revert back to the consumer at age 65.

Proponents of HSAs argue, based on the results of the RAND experiment, that these accounts would give people a strong incentive to economize on their care.

This pro-HSA argument ignores the favorable tax treatment given to HSA withdrawals — a policy that provides a hidden stimulus to health care spending. The reason is that the health care spending from an HSA is made with pre-tax dollars. Currently, health expenditures not covered by insurance are made with post-tax dollars. So, for example, when an employee goes to the doctor and makes a $10 copayment, he is using money from which his employer already deducted Social Security payroll taxes, income taxes, and the like.

With an HSA, the employee can bypass these deductions by using money in a special account. The HSA thus lowers the effective price of care. And, like any discount sale, it will encourage the use of minor services. This is especially true for those medical services such prescription glasses, in vitro fertilization, eye surgery and psychotherapy, that are covered by HSAs but are not covered by most health insurance plans.

People who benefit the most from HSAs are those for whom tax rates are highest on the next dollar earned and who expect the highest spending. This group includes employees earning under the $94,200 Social Security ceiling -- certainly a well-compensated group but hardly the CEOs of America.

While this example applies to those with relatively low health care costs, our research also demonstrated that similar savings accrue to people with high health care costs. Only in cases of moderate health expenses do HSAs actually impose greater cost-control than conventional plans. Ultimately, the overall effect of HSAs on spending depends on whether the mandated catastrophic policy is stingy enough to offset the increased use flowing from the tax deductibility of spending.

Under current law, health insurance plans must have deductibles of at least $1,050 for individuals or $2,100 for families to be eligible for use with an HSA. Those deductibles just aren't high enough to cause major changes in consumers' behavior. So while it may level the paying field, it won't do much else.

Outside View © 2006 United Press International

Dana Goldman is director of health economics at the RAND Corporation, a nonprofit research organization. Jesse Malkin, a former associate policy analyst at RAND, is enrolled in an HSA.

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