Fixed-Dollar Tax Credits Would Reduce Individual Health Insurance Premiums

Sonia Jaffe and Mark Shepard of the National Bureau of Economic Research (NBER) have written a new paper, which compares the effects of fixed-dollar subsidies for health insurance to subsidies that are linked to premiums. They conclude that fixed-dollar subsidies reduce taxpayers’ costs and improve access. Unfortunately, the structure of subsidies in U.S. health insurance has moved in the other direction.

Tax credits that subsidize health insurance offered in Obamacare’s exchanges are based on the second-lower cost Silver-level plan in a region. Intuitively, this implies insurers will not compete too much because that would drive down subsidies. As long as subsidies chase insurance premiums, premiums will be higher than otherwise.

Jaffe and Shepard look at evidence from Massachusetts’ health reform (“Romneycare”), which dates to 2006. Its costs are still spiraling, and they estimate one factor is its design of subsidies, which is similar to Obamacare’s:

Across several simulation years and assumptions, we find a non-trivial upward distortion in the price of the cheapest plan (to which Massachusetts’ subsidies are linked) of $4-26 per month, or 1-6% of baseline prices. Although modest, these effects imply meaningful increases in government costs. For instance, the $24/month subsidy distortion (in our simulations for 2011) would translate into $46 million in annual subsidy costs for Massachusetts, and over $3 billion if extrapolated nationally to the ACA. We show that absent uncertainty, shifting to fixed subsidies could let the government achieve the same coverage at 6.1% lower taxpayer cost, or 1.3% greater coverage at the same cost.

(Sonja P. Jaffe and Mark Shepard, Price-Linked Subsidies and Health Insurance Markups, Cambridge, MA: National Bureau of Economic Research, Working Paper 23104, January 2017)

The paper is a heavy read, full of PhD-level economic theory and modelling. Nevertheless, it demonstrates that replacing Obamacare’s tax credits with a fixed-dollar tax credit to subsidize health coverage is as close to a free lunch as is possible in health reform.

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For the pivotal alternative to Obamacare, see Priceless: Curing the Healthcare Crisis and A Better Choice: Healthcare Solutions for America, by John C. Goodman, published by Independent Institute.

John R. Graham is a Senior Fellow at the Independent Institute.
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