Health Care: Do Tax-based Subsidies Reduce Costs?

Kash has promised to spend a fair amount of time discussing the health care debate – a topic he assuredly knows far better than yours truly. My contribution to this debate is to toss out a query that has been bugging me for quite a while and this article by Peter Gosselin of the Los Angeles Times helps me both form the question and provides one possible answer to it:

From the moderate right, Douglas Holtz-Eakin, a former Bush economic advisor and Republican-appointed director of the Congressional Budget Office, described the idea of tax deductions for people’s out-of-pocket medical expenditures as “really bad tax policy.” Holtz-Eakin, who is a fellow with the Council on Foreign Relations, warned that the deduction would tempt people to treat almost all of their spending as health-related and wreak havoc at the Internal Revenue Service. “I could make an argument that my running shoes are a health expense,” he said. “They’re preventive medicine.”

Holtz-Eakin is asking the same question that I have. The standard competitive model suggests that subsidies increase total expenditure on a product. It is true that the price to consumers might fall from a subsidy but the price received by suppliers increase with the differential picked up by taxpayers. The usual defense of subsidies in perfectly competitive markets (not that I’m saying the health care market is perfectly competitive) is that we assist poorer people by taxing the more well to do. Since I own a few shares of Nike and happen to be a runner, I love this example. Would it make sense to increase the tax burden on the working poor in order to subsidize my running and to increase Nike profits? Well, the Bush approach seems to be subsidizing the health care needs of the well to do with a subsidy that would benefit doctors and pharmaceutical companies. Who will pick up the tab for all of this?

But, but, the plan is supposed to reduce health care costs you say. How so:

Bush’s supporters say that the changes would help tame rocketing medical costs by encouraging people to buy their own healthcare insurance and become smarter shoppers, rather than relying on employers or government programs such as Medicare and Medicaid to cover their health costs. Critics argue that Bush’s expected proposals would undermine the employer-provided health insurance system that covers most working Americans. And, they say, it would encourage them to switch to the Bush-authored Health Savings Accounts, established in 2003, under which they would bear more of the financial risks of illness and injury.

I see – the working poor have too much insurance. For more on this theme – see Kevin Drum who is not being timid about his criticism of Bush’s proposal.

Update: David Altig has two interesting points in one. He notes the possibility that the income elasticity of health care spending may be greater than one, which could also mean that observing a time series as to what share of our income we spend on a product (such as health care) may be a poor metric for evaluating the efficiency or inefficiency of that particular market.