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Dec 5, 2008

Company Paid Health Insurance is Part of Your Salary

You pay for your insurance now. You deserve to control it.

Here is the central point and main confusion of the healthcare debate. People think that their employer-paid insurance is a gift of employment. They correctly compute that they can't pay for that insurance out of their take-home pay. So, they want either more rules on employer-paid insurance, or insurance provided by the government.

People don't understand that they are already personally paying for their "employer-paid" insurance. Employers buy health insurance with part of the salary earned by the employee. Employees don't buy this insurance directly so it doesn't attach to them when they change jobs, and they can't shop around to select the insurance they really want.

We have to untangle the tax mess in healthcare. It is a tangle originally imposed by government, and now maintained by government policy. Healthcare is now tax-free when purchased indirectly through an employer, but mostly taxable in all other ways, including individually purchased insurance and direct payment for medical services.

Untangle the tax mess, remove employers from the middle, and salaries would go up in the amount of the "free" healthcare benefit through employers. Then people would have enough take-home pay to buy their own health insurance. That is what healthcare reform should be all about.

The main point for true reform is to remind ourselves that we already pay for our health insurance, but we currently have little choice about what we are buying, and true reform could put that money into our hands.

Insurance Is Not a Free Benefit

Health insurance bought through his/her employer is the cheapest insurance an employee can buy now, because he is buying it mostly tax free.

Isn't the insurance a free benefit? Why do I say that the employee is paying for all of his insurance benefits? Because, the company correctly sees the cost of providing health insurance as part of what is paid to the employee.

Companies compete to pay employees for their productivity. If the cost of health insurance disappeared for the company, salaries paid would rise by the same amount that companies currently pay to provide insurance. Then, you could personally buy insurance of the same quality, that would stay with you, and not depend on your employer. Your remaining salary would be the same as it is now.

Better, you would be free to buy more or less insurance, or a different type (catastrophic coverage vs. first dollar owed), depending on your preferences. You would have a personal insurance broker to advise you, rather than the clerk in the HR department.

Objection: Companies Won't Pay More

You might object that you won't be paid any additional salary if you refuse company provided health insurance, so you are stuck. That is currently true. Insurers contractually require companies to offer group insurance to every employee, and to not offer incentives for refusing insurance (so no extra salary for refusing).

The insurers do this so they get premiums (monthly payments) for almost everyone employed, sick or well. They reason that healthier employees would opt out if they could get more salary, leaving only the participation and expenses of the less healthy.

Changes to the tax law would create a market for insurance that would remove the special role for employers. Some people who are insured through company groups would have to pay higher premiums in the more open market, and some would pay lower premiums. All would have the benefit of not losing their health insurance because they changed jobs, were fired, or became too sick to work. The same is true for long-term disability insurance.

How the Taxes Work

When companies pay $13,000 per year for an employee's family health insurance, it is a usual expense to the company, and it is not taxed as income to the employee. It is deducted "before tax".

When an individual buys health insurance personally, he is not given a tax deduction, and the insurance cost is paid out of net income after tax. That is a large difference. That $13,000 policy paid by the company out of pre-tax income, would cost the individual $17,333. That is $4,333 (1/3rd) more in pre-tax income if the individual is in the 25% tax bracket.

Put another way, you would need $17,333 of salary (pre-tax), and pay 25% in tax on that part ($4,333), to have $13,000 remaining to pay for the insurance.

By the way, the McCain health insurance proposal was badly explained, and misunderstood. He proposed giving a $5,000 tax credit to cover the tax incurred on health insurance purchased by individuals. This would have removed the taxes from a typical $13,000 family policy.

Rising Insurance Costs

As insurance costs go up, and under current rules, it would be best for the employee if the company paid all of the insurance cost, and decreased the employee's salary by the same amount. Then, the employee would pay everything pre-tax. (I am ignoring any raises, which would be added to his salary). This would be the most tax-efficient way for the employee to get that insurance. The tax savings is why a company pays all or some of the insurance costs today.

This is an accounting game. For example, say the company is paying an employee $46,000 salary + $13,000 health insurance, for a total payment of $59,000. It is all just dollars to the company; it doesn't matter that some part is a health "benefit" and the other part is "salary". But, the government taxes only the $46,000, seeing the $13,000 as a tax-free benefit. Only companies can buy health insurance for you tax free. This is a holdover from World War II wage and price rules.

If the insurance cost goes up by $2,000 to be $15,000, the best tax result would be to adjust the split on the $59,000 salary, paying $44,000 salary + $15,000 health insurance. That is $2,000 less cash and $2,000 more health insurance. The employee pays the least tax this way.

But, most companies are not doing this. Instead, they assign some or all of the $2,000 as part of the "employee paid" portion of the health insurance cost. I will guess why.

Employee Preferences

Employees are rejecting the high cost of health insurance without understanding what is really going on. They wrongly see the "employer paid" part of the insurance as a gift, instead of rightly seeing it as part of their earnings, part of what they could control. They see insurance benefits as a gift that "good" employers provide. They want the insurance, but they don't want less take-home pay.

The companies are squeezed by insurance costs that are rising faster than total salary, and they can no longer maintain the myth that all of the insurance is a gift/benefit. So, they say "we are not lowering your salary, but you will have to pay part of your insurance". They can also offer the higher salary in advertisements, ignoring the mandated cost.

This is not tax efficient, but it may be good overall. People have respect and concern for what they earn and spend. This could move them to a better understanding that they are earning and paying for everything they receive, including insurance "benefits".

Tax Fairness and the Insurance Market

A company deducts ordinary and usual expenses that are needed to operate. It doesn't pay tax on what it spends to stay in business.

Individuals are the "little companies" of the economy. We should be able to deduct (pay tax free) all of the insurance costs and medical expenses that are ordinary and reasonable to keep us in business. Then, we could choose the amount and quality of our insurance and health care independently of corporate bosses and plan administrators who have their own incentives different from ours.

Health Insurance Or Cash
08/26/12 - Adam Smith Institute by Tim Worstall
Based on research by Kolstad and Kowalski.National Bureau Of Economic Research, March 2012
"Mandate-Based Health Reform and the Labor Market", page 3.

[edited]  Essentially, if you get $6,000 worth of health insurance from your employer, then you don't get $6,000 of wages.

Health insurance is usually an employer provided benefit in the US.  Health care costs have been rising in recent decades, from 9% of GDP to about 17%. Cash wages have been about constant, but total compensation has been rising. The increase has been paying for those rising health insurance costs.

Mandated Employer-Paid Health Insurance
12/05/08 - WhiteCoatRants. This post inspired my post above.

Among many "changes" advocated by President-Elect Obama is a plan for mandated employer-based health insurance. I can't find a clear description on exactly how the plan is going to work (the plan is outlined on Obama's site, and there is an NEJOM summary), but there are many opinions out there on what the effects of the plan will be. See posts at Hot Air Blog, The Health Care Insurance Reform Blog, The Cato Institute, and John Goodman's Health Policy Blog.

I'm all for changing the current system, and I'm committed to giving Obama a chance to turn things around, but is mandating that employers pay for insurance going to improve healthcare in this country? I admit that I haven't taken an in-depth review into the pros and cons, but in principle, I think it's a bad idea. Reminds me too much of the "Hats" post I put up last year.

If you're an employer whose bottom line is hit by a tough economy and you're now forced to spend additional money to either "pay" a percentage of your payroll into a national plan or to "play" by purchasing "health insurance" for your workers, what are you going to do? You're going to find the cheapest way out.

Congress Fails Econ 101
07/24/09 - Insureblog by Henry Stern

Left : The "Public Option" will offer low cost insurance as a last resort.
Right: Employers will drop their health plans. Everyone will be on the Public Option.

Left : Employers will pay an 8% fine on payroll if they do that.
Right: No, the employee will pay that fine as an 8% lower wage.

[edited] Employers won't pay that 8% fine any more than they pay for employee's group coverage in the first place. It is a cost of doing business that comes out of the employee's gross wages. Payments on behalf of employees are simply deducted from the employees' wages when calculating the total cost of employment.

Likewise, these "fines" will be passed along to employees in the form of lower wages and to consumers in the form of higher costs.

Governments impose taxes on employment. Say a company is willing to pay $20/hour overall to employ Fred. It pays $6.50 ($13,000 per year) to buy health insurance for Fred, and gives Fred $13.50 in cash. The government then takes other taxes, leaving Fred with $12.

Say the employer drops its health plan. It is still willing to pay Fred $20 overall. It pays a fine of $1 ($2,000 per year), and pays Fred the remaining $19. If Fred wants insurance, he must pay part of that to a government approved insurance company, or pay a fine for not buying insurance. Fred's ovearall pay is constant for his market value, and the costs of his employment are deducted from his overall pay to give him his cash take-home pay.

Unintended Consequences
01/09/06 - InsureBlog by Henry Stern

A longer discussion of how employment taxes and the costs of employment relate to cash wages.

ObamaCare Will Increase Premiums, Change Coverage, and Reduce Wages
06/14/10 - Cato @ Liberty by Michael F. Cannon

Quip Fred:  I took this job because of the great healthcare plan, even though it paid less.
Mike:  So, be happy. Now you will get Obamacare, and you will be paid even less.
- -
06/14/10 - Cato@Liberty by Michael F. Cannon
  [edited]  ObamaCare increases health insurance premiums and requires the employer to pay that increase. But, the employer pays this cost out of the production of the employee. So, the employer must offer a lower wage or fire the employee. The employee will likely blame the employer, not ObamaCare.

[edited]  ObamaCare will raise health insurance premiums even higher than they would have risen. If employers or consumers try to reduce their coverage and costs, they will lose their “grandfather” protections, and be forced to purchase even more coverage under ObamaCare mandates.

Employers are required to sustain "their" contribution to the cost of health benefits. This hides ObamaCare’s effect on health insurance premiums.

Health economists almost all agree that the “employer contribution” is a fiction. Employers merely deduct what they pay for health benefits from the overall compensation offered to employees. In other words, the employee pays for his own health benefits. [The employer only writes the check for him.]

ObamaCare’s increasing costs will appear as lower wages offered. Workers would likely blame ObamaCare for rising insurance premiums, but are less likely to blame ObamaCare for stagnant take-home pay.

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