U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2104 Mail: Stop IDCC, Washington, DC 20402–0001

58–428—PDF 2008

S. HRG. 110–1081

HEALTH BENEFITS IN THE TAX CODE:

THE RIGHT INCENTIVES?

HEARING

BEFORE THE

COMMITTEE ON FINANCE

UNITED STATES SENATE

ONE HUNDRED TENTH CONGRESS

SECOND SESSION

JULY 31, 2008

(

Printed for the use of the Committee on Finance

COMMITTEE ON FINANCE

MAX BAUCUS, Montana, Chairman

JOHN D. ROCKEFELLER IV, West Virginia

KENT CONRAD, North Dakota

JEFF BINGAMAN, New Mexico

JOHN F. KERRY, Massachusetts

BLANCHE L. LINCOLN, Arkansas

RON WYDEN, Oregon

CHARLES E. SCHUMER, New York

DEBBIE STABENOW, Michigan

MARIA CANTWELL, Washington

KEN SALAZAR, Colorado

CHUCK GRASSLEY, Iowa

ORRIN G. HATCH, Utah

OLYMPIA J. SNOWE, Maine

JON KYL, Arizona

GORDON SMITH, Oregon

JIM BUNNING, Kentucky

MIKE CRAPO, Idaho

PAT ROBERTS, Kansas

JOHN ENSIGN, Nevada

JOHN E. SUNUNU, New Hampshire

RUSSELL SULLIVAN, Staff Director

KOLAN DAVIS, Republican Staff Director and Chief Counsel

(II)

C O N T E N T S

OPENING STATEMENTS

Page

Baucus, Hon. Max, a U.S. Senator from Montana, chairman, Committee

on Finance ............................................................................................................ 1

Grassley, Hon. Chuck, a U.S. Senator from Iowa ................................................. 2

WITNESSES

Kleinbard, Edward, Chief of Staff, Joint Committee on Taxation, Washington,

DC .......................................................................................................................... 4

Gruber, Jonathan, Ph.D., associate head, Department of Economics, Massachusetts Institute of Technology, Cambridge, MA ............................................ 6

Baicker, Katherine, Ph.D., professor of health economics, Department of

Health Policy and Management, Harvard School of Public Health, Boston,

MA ......................................................................................................................... 9

ALPHABETICAL LISTING AND APPENDIX MATERIAL

Baicker, Katherine, Ph.D.:

Testimony .......................................................................................................... 9

Prepared statement .......................................................................................... 29

Baucus, Hon. Max:

Opening statement ........................................................................................... 1

Grassley, Hon. Chuck:

Opening statement ........................................................................................... 2

Prepared statement .......................................................................................... 35

Gruber, Jonathan, Ph.D.:

Testimony .......................................................................................................... 6

Prepared statement .......................................................................................... 37

Kleinbard, Edward:

Testimony .......................................................................................................... 4

Prepared statement .......................................................................................... 39

COMMUNICATIONS

Business Coalition for Benefits Tax Equity .......................................................... 47

Center for Policy Analysis and Rekindling Reform .............................................. 52

Employee Benefit Research Institute (EBRI) ........................................................ 55

National Association of Health Underwriters ....................................................... 62

National Business Group on Health ...................................................................... 76

National Federation of Independent Business (NFIB) ......................................... 83

(III)

(1)

HEALTH BENEFITS IN THE TAX CODE:

THE RIGHT INCENTIVES?

THURSDAY, JULY 31, 2008

U.S. SENATE, COMMITTEE ON FINANCE, Washington, DC.

The hearing was convened, pursuant to notice, at 10:05 a.m., in

room SD–215, Dirksen Senate Office Building, Hon. Max Baucus

(chairman of the committee) presiding.

Present: Senators Lincoln, Wyden, Stabenow, Salazar, and

Grassley.

Also present: Democratic Staff: Bill Dauster, Deputy Staff Director and General Counsel; Elizabeth Fowler, Senior Counsel to the

Chairman and Chief Health Counsel; Cathy Koch, Senior Advisor,

Tax and Economics; Shawn Bishop, Professional Staff Member;

Neleen Eisinger, Professional Staff Member; and Bridget Mallon,

Detailee. Republican Staff: Mark Hayes, Health Policy Director and

Chief Health Counsel; Christopher Condeluci, Tax and Benefits

Counsel.

OPENING STATEMENT OF HON. MAX BAUCUS, A U.S. SENATOR

FROM MONTANA, CHAIRMAN, COMMITTEE ON FINANCE

The CHAIRMAN. The committee will come to order.

The Yale literature professor Peter Brooks once wrote: ‘‘We live

immersed in narrative, recounting our past actions, anticipating

our future projects, situating ourselves at the intersection of several stories not yet completed.’’

Here in this committee we have lived immersed in separate narratives, anticipating health care reform and tax reform. Today we

situate ourselves at the intersection of these two stories not yet

completed.

Today, we focus on tax subsidies for health benefits. As our

health care and tax reform narrative progresses, I expect that we

will be hearing more and more about this particular story. The tax

code includes many provisions that affect health care: FSAs, HSAs,

the TAA Health Coverage Tax Credit, and the deduction for medical expenses in excess of 7.5 percent of AGI, a virtual alphabet

soup of provisions.

But the tax subsidy most relevant to today’s hearing is a provision that one of our witnesses has called ‘‘the third largest government entitlement for health care,’’ that is, the exclusion of

employer-sponsored health benefits from individual taxation.

One hundred and sixty million Americans, three-fifths of the

non-Medicare population, receive health benefits through the workVerDate 11-MAY-2000 14:10 Oct 18, 2010 Jkt 000000 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 58428.000 TIMD PsN: TIMD
2

* For more information, see also, ‘‘Tax Expenditures for Health Care,’’ Joint Committee on

Taxation staff report, July 30, 2008 (JCX–66–08), http://www.jct.gov/publications.html?func=

startdown&id=1273.

place. The tax code does not count the cost of this health insurance

coverage as income, and as a result the Federal Government receives about $200 billion less revenue each year.

Economists have long recognized that the tax exclusion for

health benefits is regressive. In 2004, nearly 27 percent of these

tax expenditures accrued to families with annual incomes above

$100,000, although this group accounted for only 14 percent of the

population.

At the other end of the scale, only 28 percent of these tax ex- penditures went to families with incomes below $50,000, although

this group represented nearly 58 percent of households.

Not only do higher-income families receive more benefits due to

their marginal tax rate, but they are also more likely to receive

health care benefits from their employer. Economists also tell us

that the tax treatment of employer-sponsored health benefits creates an incentive for over-insurance, and they tell us that this incentive, in turn, promotes health care cost inflation.

The current system is a result of evolution dating back to World

War II. We have the system that we do by chance, not by design.

If we were designing a health system today, we would do things

differently.

That said, we have also learned, from past attempts at health

care reform, that too much disruption can backfire, too much

change for those who already have health coverage can cause a

backlash, and since the majority of Americans get their health care

coverage through their employer, any changes to the current tax

subsidy should be done carefully and deliberately.

We need to have a full understanding of the advantages, disadvantages, and consequences. Some have proposed transforming

the current system into a system where individuals need to purchase their own insurance and employers no longer have a role.

That would be no trivial matter. That might be too much change.

All of us here recognize that our system is unsustainable. We

cannot continue on our current path, but we must strike a balance.

We need to fix what is broken without breaking what is working.

Thus, tax subsidies for health care stand at the intersection of

health care and tax reform. As we anticipate our future projects,

let us think about what role these provisions will play in our unfolding narratives. Let us consider ways to change the system as

much as appropriate, but not more so. Let us try to find a happy

ending for our several stories not yet completed.*

Senator Grassley?

OPENING STATEMENT OF HON. CHUCK GRASSLEY,

A U.S. SENATOR FROM IOWA

Senator GRASSLEY. Yes. First of all, I will apologize to the audience and to our witnesses, because I may go down the hall to participate in a Judiciary Committee meeting just as soon as they get

a quorum, so I may have to submit questions—and I have a lot of

questions—for response in writing if I do not get back.

3

I commend Chairman Baucus for holding this hearing. It is a

continued examination of our health care system, and one that

needs to be examined. I would also acknowledge how much I appreciate this hearing because the tax treatment of health insurance

has kind of been an elephant in the room that nobody wanted to

talk about.

The most commonly recognized things we talk about with government and health care are Medicare, Medicaid, and SCHIP. We

often overlook the Federal subsidy program for health care that is

run through the tax code, and the tax code subsidizes private

health care spending. The Congressional Budget Office has estimated that 55 percent of our Nation’s health care spending is made

up of private health care spending, and this means that the rest

of it, the 45 percent, is the government programs I just mentioned.

So while Congress has entered into long and often pointed debates on how we can slow the growth of public health care spending, we have not fully debated the growth of private health care

spending. If efforts are not taken to slow that growth, both public

and private, we are told that by 2025 it is going to take up 25 percent of our economy, and that could easily be 50 percent another

60 years down the road.

So I am glad we are doing here what needs to be done. We are

taking a first step towards recognizing this elephant I’ve referred

to. That is, we are all coming together to examine the third largest

Federal subsidy program for health care, the tax code.

Before we begin our examination, it is important for people to

understand—that employers, unions, and the public at large understand—what the current tax rules are. We all have to understand

how they work, and most importantly, how they are going to affect

economic behavior.

There are three important points. First, many economists argue

that preferred tax treatment gives people an incentive to overinsure. In the current tax treatment of health insurance, if it

makes people exercise and use the health system more often, we

need to understand what changes in our tax rules might affect

that. I will bet that if you ask the American public whether they

want more affordable health insurance, they want Congress to fix

the rules.

Second, based on economic evidence, it is clear that the employer

contributions towards an employee health insurance are not provided as a gift; rather, it is part of the package, and we need to

understand how people feel about that as part of their wage package, whether or not they want more disposable income or they

want it through their health care plan.

Then, third, we need to look at the current tax treatment of

health insurance, if it is inequitable from the standpoint that it is

more of a benefit to higher-taxed people than lower-income people.

So these are the questions we have to look at at this hearing.

I would like to put my entire statement in the record, Mr. Chairman.

The CHAIRMAN. Without objection. Thank you very much, Senator.

[The prepared statement of Senator Grassley appears in the appendix.]

4

The CHAIRMAN. I thank all of our witnesses for coming to the

hearing today. This is very important. It is kind of, I think, at the

heart, or one of the hearts, of health care reform. I thank you very

much for your efforts.

Our first witness is the Chief of Staff of the Joint Committee on

Taxation, Ed Kleinbard. Next, we have Jonathan Gruber, professor

of economics at the Massachusetts Institute of Technology. Dr.

Gruber helped to design the Massachusetts health reform plan and

served on the board of the State’s Insurance Connector implementing body for the health reform effort. The third witness is

Katherine Baicker, professor of health economics at Harvard. From

2005 to 2007, Dr. Baicker served on the President’s Council of Economic Advisors. Thanks, all, for taking the time. We deeply appreciate it, and I urge you to just let ’er rip. Do not pull any punches.

Tell us what you think.

Mr. Kleinbard?

STATEMENT OF EDWARD KLEINBARD, CHIEF OF STAFF,

JOINT COMMITTEE ON TAXATION, WASHINGTON, DC

Mr. KLEINBARD. Thank you, Mr. Chairman and members of the

committee.

I would like to use my time with you this morning to review how

we use the tax code to deliver Federal subsidies for health care and

why this choice of a subsidy delivery system has important consequences, both for health care and for tax policy.

Let us begin with a chart that my staff has prepared showing the

sources of insurance coverage for Americans under age 65. To me,

there are several remarkable lessons to draw from this chart. First,

of course, is the critical problem of 44 million Americans who have

no health insurance at all. You can see them in the top left of the

pie chart before you.

Second is that almost all Americans who do have health insurance obtain that insurance with the help of Federal subsidies. Only

about 8 million Americans acquire insurance without any form of

Federal assistance, and they are the group labeled ‘‘non-group’’

down in the bottom left there.

The third point that I draw from this chart is that Federal subsidies come in two basic flavors. There are direct subsidies like

Medicare and SCHIP, and there are indirect subsidies that we deliver through the tax system.

Finally, what I infer from this chart is that by far the largest

number of Americans who do have health insurance obtain it

through an employer-sponsored insurance in which Federal subsidies are delivered through the tax system.

Let us now focus on those subsidies that, in fact, we deliver

through the tax system. Perhaps we could have the next chart, if

you do not mind. Again, my staff has prepared a chart that summarizes the situation. What this chart does is summarize the dollar

value of the annual Federal subsidies for health care that we deliver to Americans through the tax code rather than directly by

writing out the checks or providing medical services to them.

Here again, we can see when we look at these Federal health

care subsidies delivered through the tax system that employersponsored insurance is by far the most important component. Not

5

only is that Federal subsidy running at the rate of $245 billion a

year, but it is coming from both our general Treasury funds—that

is, from general tax revenues—and from reductions in trust fund

collections.

I would also like to point out that the technical term for what

I am trying to describe here, that is, the idea of Federal subsidies

delivered through the tax code, is what tax policy professionals call

a tax expenditure. It has been a theme of the Joint Committee for

the last year to try to emphasize the relevance of tax expenditure

analysis in looking at tax policy questions.

So what do we draw from these two charts? We conclude that

employer-sponsored insurance dominates the health care picture,

both in terms of the numbers of covered Americans and in terms

of the number of dollars spent by the Federal Government.

The mechanism by which we use the tax code to deliver subsidies

for employer-sponsored insurance is very simple, as the chairman

has already described. Employers can deduct the cost of the insurance that they buy for their employees, but employees do not have

to include this particular form of compensation in their income.

The result is a favorably asymmetrical tax regime. There is substantial evidence that this favorable tax environment explains why

employer-sponsored insurance dominates the health care coverage

picture.

Now, having said that, the question is, is that a good or a bad

place for this country to be? Well, it turns out that employersponsored insurance has some very powerful non-tax advantages.

Employer-sponsored plans are group plans, and there are some

very powerful advantages to group plans.

The group deals with the issue of adverse selection, the fundamental problem that, if everybody buys insurance individually,

those who need insurance the most are the first in line, and therefore those who are young and healthy tend not to buy into the system.

The group has superior negotiating power with an insurer than

a single consumer might, and the group can achieve significant administrative savings. So these are powerful advantages of

employer-sponsored insurance, or any other group insurance plans.

Having said that, then what is wrong with employer-sponsored

insurance? That is, once we have decided that the Federal Government will subsidize health care, why not deliver the Federal subsidy through the tax incentives, just as we do today?

I think there are three clusters of issues for this committee to

consider in this respect. The first is that employer-sponsored insurance, or any other tax expenditure, distorts our picture of the government, and it distorts the economy. It distorts the apparent size

of our budget in our government by making the official Federal

budget and the overall size of government look smaller than they

really are, because the foregone revenues, the $250 billion that we

do not collect every year from employer-sponsored insurance, does

not appear in our budget as an inflow followed by an outflow. It

simply is not there at all. That is also true of every other form of

targeted tax relief, that is, every tax expenditure.

Employer-sponsored insurance plans also distort taxpayer behavior, as the other witnesses will, I believe, develop in detail. These

6

have important economic costs. It is not merely an inconvenience,

but adds economic costs. It reduces the welfare of the American

citizens.

Second, employer-sponsored insurance, as currently constructed,

means the government cannot control its own subsidy. There is no

cap on the value of the employer-sponsored plans, and there are

very few limitations on the design of the plans. So it is employers

and employees collectively, not the Federal Government, that define how much Federal spending there will be in this area.

The subsidy also, as the chairman has pointed out, varies with

the tax brackets of the employees. This is sometimes known as the

upside-down subsidy problem, where people in higher brackets get

a larger subsidy than people in lower tax brackets. Of course, this

also means that the amount of the Federal subsidy will change

every time tax rates for individuals change.

Finally, the third cluster of issues to consider is that the subsidy

is not universally available. Everyone pays indirectly for the subsidy for employer-sponsored insurance in the form of higher tax

rates to fund the $245 billion a year in implicit subsidy payments,

but the subsidy is not available to everyone.

It is not available to employees of employers who do not offer

plans, it is not available to part-time employees, and so on. So, only

employees of employers that offer these plans can obtain the subsidy. We should contrast that with the classic medical expense deduction which, if you are unfortunate enough to have very high

medical expenses relative to your income, at least is universally

available.

And, finally, what follows from the fact that this subsidy is not

universally available is, in addition to the question of fairness that

we all pay for something that not all of us can obtain, we have the

phenomenon of job lock in which employees, in effect, stick with

jobs and careers they do not necessarily want simply in order to

preserve the employer-sponsored insurance that they have.

Thank you, Mr. Chairman.

The CHAIRMAN. Thank you very much, Mr. Kleinbard.

[The prepared statement of Mr. Kleinbard appears in the appendix.]

The CHAIRMAN. Dr. Gruber, please.

STATEMENT OF JONATHAN GRUBER, Ph.D., ASSOCIATE HEAD,

DEPARTMENT OF ECONOMICS, MASSACHUSETTS INSTITUTE

OF TECHNOLOGY, CAMBRIDGE, MA

Dr. GRUBER. Thank you very much, Mr. Chairman and the committee, for allowing me to testify today.

What I would like to do today is to cover three things in my testimony. I would like to briefly discuss the existing treatment of

employer-sponsored insurance, or ESI, by the tax code; I would like

to review the problems caused by that treatment; and I would like

to discuss complementary policies that can blunt the effects of

changing this tax treatment.

As both Senator Baucus and Senator Grassley mentioned, the

tax exclusion of employer-sponsored health insurance expenditures

from the income and payroll tax is the third largest government

health program in America after Medicare and Medicaid at a cost

7

of over $250 billion a year. It is important to remember that this

is a tax break to individuals, not to firms. So, when MIT pays me

in cash wages, I am taxed on those wages. When MIT pays me in

health insurance—MIT spent about $10,000 this year on my health

insurance—I am not taxed on that. That is a $4,000 tax break to

me.

To be clear, it is not a tax break to the firm. MIT is indifferent

whether they pay me in health insurance or in wages; either way,

they deduct that from their expenses. It is a tax break to the individual, to me, in the amount of about $4,000 a year.

Now, this tax exclusion has three important problems with it. The first is, $250 billion a year is an enormous sum of money that

might be devoted much more effectively to addressing the needs of

U.S. citizens. Second, this is a regressive entitlement, as has been

mentioned, with more of the benefits going to the upper half of the

income distribution. Finally, this tax subsidy makes health insurance artificially cheap because it is bought with tax-sheltered dollars as compared to other goods which are bought with after-tax

dollars, leading to over-insurance for most Americans. As a result

of these limitations, no health expert in America today would ever

set up a health system the way that we have it set up.

Now, that is different from saying that we should just remove it,

we should remove the tax exclusion. Technically, it would not be

that hard to remove the tax exclusion. Employers could declare on

your W-2 what they spent on health insurance, you would then be

taxed on that as if it was wage income. However, the problem is

that our existing system is predicated on this tax bribe. The reason

that the majority of people get their health insurance through their

employer is because of this tax bribe, and so just pulling that out

will cause severe dislocation.

Now, there are two reasons why this might be considered a problem by yourselves, and I am here to tell you one reason is wrong

and one reason is right. The wrong reason to care about employers

leaving the system is that we might lose employer dollars providing

health insurance. Both economic theory and economic evidence is

clear on this: there are no employer dollars. It is the employee dollars that are at stake here. If employees get health insurance, they

get less in wages.

So, if employers drop out of providing health insurance, over a

period of years they will make that up by paying higher wages to

their employees. So the issue is not, we often hear the term about

‘‘keeping employers in the game’’ or ‘‘shared responsibility.’’ It is

important to remember, those are political notions, not economic

notions. If employers stop offering health insurance, that will just

be shifted to other forms of compensation. That is not going to ultimately affect the employer’s bottom-line obligation. That is the

wrong reason to worry.

The right reason to worry is that the erosion of employersponsored insurance will cause sicker and older individuals to move

from a system, as Mr. Kleinbard mentioned, where they are pooled

and fairly priced to one where they are not. The existing non-group

insurance market in America is a disaster today in most States.

Sicker and older people can be excluded from insurance altogether,

they can be charged many multiples of healthier people, or they

8

can be charged a low price when they are healthy and then

dropped when they get sick. That is not the way insurance is supposed to work. The problem with an erosion in employer-sponsored

insurance is that these sicker and older individuals could end up

facing a very harsh environment if they are dropped by their employers.

So what I want to do is conclude, then, with four directions we

might go to deal with reforming this enormous tax subsidy. The

first is to remove the exclusion either slowly or partially. So, for example, as a way of phasing this in, President Bush’s tax panel, in

2005, recommended capping the exclusion at the average level of

health insurance premiums and then tying that cap to the CPI, not

health care inflation, so it would essentially slowly erode over time.

Alternatively, we could tax individuals on a part of their tax exclusion, not take away all of it. There are a number of options, and

I would be happy to discuss them further, for sort of phasing into

getting rid of this tax exclusion.

The second would be to reform the outside market so that individuals have better options should they lose their employersponsored insurance, in particular, reforming the ability of insurers

to charge excessive prices to sicker and older individuals. Of

course, this reform cannot happen in a vacuum, because if it did

that could lead to a large rise in prices in the non-group market.

That leads to my third suggestion, which is a complementary policy with mandates on individuals to buy health insurance. As was

shown in my home State of Massachusetts, such a mandate can

lead to low prices for non-group insurance with broad health insurance coverage. Moreover, one of the most striking findings from our

early analysis of the Massachusetts plan is that we have raised

employer-sponsored insurance coverage in Massachusetts, not lowered it.

Employer-sponsored insurance in Massachusetts is up almost

100,000 people, despite falling in every other State in the Nation,

and the reason is the individual mandate. The reason is, people

have gone to their employers and said, hey, I need health insurance now, and employers are offering it. So that could be a natural

complement that can offset any dislocation from getting rid of the

ESI exclusion.

Finally, a natural alternative is to move from subsidizing individuals to subsidizing firms. That is, rather than this implicit hidden

subsidy that Mr. Kleinbard talked about, if we are really worried

about employers leaving the game, then we could subsidize those

employers to stay in the game. In particular, there is a clear group

of firms that does not offer health insurance: small and low-wage

employers. Therefore, a tax credit that is tightly targeted to small

and low-wage employers can effectively promote their offering

health insurance.

I just want to conclude by emphasizing this must be tightly targeted, but a tax credit that was, for example, focused on firms of

less than 25 employees, where the average workers earn less than

$30,000 a year, could dramatically expand health insurance coverage without actually costing a huge amount of government resources.

9

So I want to thank you again for allowing me to testify today,

and I am happy to discuss any of these points further.

The CHAIRMAN. You bet. Thanks, Dr. Gruber.

[The prepared statement of Dr. Gruber appears in the appendix.]

The CHAIRMAN. Next, Dr. Baicker.

STATEMENT OF KATHERINE BAICKER, Ph.D., PROFESSOR OF

HEALTH ECONOMICS, DEPARTMENT OF HEALTH POLICY

AND MANAGEMENT, HARVARD SCHOOL OF PUBLIC HEALTH,

BOSTON, MA

Dr. BAICKER. Thank you very much for the opportunity to speak

with you here today and to serve with such distinguished panelists.

I agree with almost everything that has been said so far, and I

will choose to elaborate a little bit on what I think are the real disadvantages of the way we are financing health insurance in the tax

structure today, and some of the advantages of moving to another

way of using that vast pool of resources.

As people have already mentioned, the tax structure today is

both unfair and inefficient. There are not that many opportunities

for reforms that would both improve the distribution and improve

the efficiency with which those dollars are spent, but this is one of

them.

It is unfair because the current tax advantage is only available

to people who get insurance through their jobs, for the most part,

and is higher for people with higher incomes and higher for people

with more comprehensive benefits. I do not think anyone would

stand up today and say, I would like to design a new system where

the benefits go disproportionately to wealthier people with better

jobs and better sources of insurance. That does seem like an

upside-down subsidy.

But it is also inefficient in another way in that it promotes the

type of insurance policy that encourages over-use of care of really

questionable benefit. That is because the care that you consume

through a policy that you get through your employer is subsidized

through the tax code, being exempt from both payroll and income

taxes, whereas care that you consume on your own, either because

you are purchasing health care directly or because you do not have

an employer policy, is usually paid with after-tax dollars.

So, if you have a choice, you would like to get an employer policy

that covers as much as possible. You would like every doctor’s office

visit to be covered by your employer policy because it would be so

much cheaper to consume a doctor’s office visit that way than to

have to pay for it with after-tax dollars.

That is one of the reasons that I think health insurance looks so

different from other kinds of insurance that people purchase today,

different from auto insurance, different from homeowners’ insurance. It covers a lot of routine care that would not normally need

to be insured against with very low co-payments, because that is

what the tax code promotes.

Now, that is not so bad in the sense that insurance is giving people valuable financial protection from really big expenses (by having a more affordable fixed premium) that they would incur in the

unfortunate case that they have ill health and need to consume a

lot of health care. But, at the same time that they are getting that

10

financial protection, they are also being encouraged to consume

care of really questionable value. This is particularly problematic

in a world where there are lots of people without access to insurance and basic care of very high value.

Our system is producing under-use of basic care at the same time

that it is producing over-use of care that really comes with very low

health benefits. That is one of the big advantages of reforming the

tax code. Not only would you be able to redistribute these $250 billion plus of resources in a way that is more equitable, but you

could also use them to ensure that everyone has access to basic

care, while not subsidizing an infinite amount of care for a subset

of people. Every extra dollar that is spent on health care through

the form of employer-provided insurance is being subsidized, while

some people are then going without very necessary care.

So, what would the ideal world look like then? How could you

use this pool of resources to stretch our health care dollars further?

First, you could remove the incentive to get extra care on the margin. Second, you could leave in place an incentive to be insured, so,

on the extensive margin of having insurance, we have a strong interest in subsidizing the purchase of at least basic coverage for everyone in society.

Why is that? Well, there is, first, the altruistic motive of caring

very much about the well-being of people who cannot afford health

insurance, and thus cannot afford care that they need for vital

health expenses. But also there is a less altruistic motive of ensuring that care is consumed in a more efficient way. Uninsured people who go to the emergency room or who forgo preventive care

that would have really high payoffs then end up imposing a lot of

costs on the insured through uncompensated care at hospitals or

through less efficient use of resources. So all of this means that our

dollars could go further, given that we are going to help take care

of people in emergency situations, if we could strongly encourage

people, either with carrots like subsidies or sticks like mandates,

to be insured.

Insurance markets function best when everyone is covered by

them, so that is the motivation for continuing to subsidize the purchase of at least basic policies, especially for low-income people.

What we do not want to do is to keep subsidizing extra care on the

margin. Once people are covered by a good insurance policy, we do

not want to keep using tax dollars to subsidize more, and more,

and more health care consumption, especially if it has potentially

very low health benefits for people.

One way you could do that is by having a flat tax benefit, a tax

benefit that is the same for everyone and does not increase if you

consume a more expensive health insurance policy or more health

care. As Jon alluded to, there are lots of dangers of completely

shredding the existing system and rolling it over immediately into

a flat tax benefit, but those risks could be mitigated by complementary policies.

One of the most important sets of complementary policies that I

will just mention briefly is ensuring that, when people go to the individual market to buy health insurance, their premiums will never

rise if they fall sick. Insurance is not just about protecting you

against high expenses today. It is also about protecting you against

11

the risk of falling ill and having predictably high expenses that

would otherwise raise your premiums tomorrow.

We thus have a responsibility to ensure that, as we encourage

people to go get health insurance through their employer or on

their own, no matter where they are getting their insurance, once

they have insurance they then do not face this risk of higher premiums if their costs go up because of poor health. It is particularly

important, as people move from an employer market that has

group rates to an individual market, that they then buy into a market that affords them that kind of protection.

I thank you again for the opportunity to speak with you and

would love to answer any questions you might have.

The CHAIRMAN. Thank you all very much.

[The prepared statement of Dr. Baicker appears in the appendix.]

The CHAIRMAN. One question I have is, if there is a reasonable

cap placed on the exclusion, what are some of the unanticipated

consequences that are going to flow from all of that? Some are anticipated, and almost by definition you cannot enumerate the unanticipated. But what are some of the concerns? Because that is a

pretty big step. Things happen. Insurance companies, employers,

employees adjust. But I am trying to figure out what some of the

adjustments will be, so there is some sense of what we might be

doing if we were to cap, say, the exclusion.

Dr. GRUBER. I think it is hard to list what is anticipated and is

unanticipated. I think it obviously depends on the level of the cap.

But, if you were to cap it at a fairly high level, then I do not anticipate you would see an enormous reduction in the number of employers offering insurance and the number of employees taking it.

The CHAIRMAN. But for a cap that starts to squeeze it a little bit,

then what are some of the consequences?

Dr. GRUBER. Basically, as the cap starts to squeeze, then you are

going to see that employers are going to react in three ways: first,

they will be less likely to offer health insurance because the fact

we are bribing them is now mitigated; second, they will shift more

of those costs to employees in the form of higher employee contributions; and third, they will reduce the generosity of the insurance that they buy. Employers react in all three ways.

I think what is very important to remember is, how that will

play out depends very much on what you do with that money. As

you are squeezing it, you are raising more money. If that money

is just going to highways, then we are done and you can do what

I explained. But if the money is actually going back into reforming

insurance markets and other things, then that itself has feedback

effects on employers. I mentioned the individual mandate. That

could mitigate a lot of the effects I just talked about. So I think

capping the exclusion itself would have those three main effects,

but I think you have to think about what you would actually do

with the money, because it would then have secondary effects as

well.

The CHAIRMAN. So, all things being equal, what might you do

with that extra money in the health system?

Dr. GRUBER. Well, I think basically what you would ideally like

to do is a lot of what Kate mentioned, which is basically, you would

like to take that money, which right now, as Mr. Kleinbard said,

12

is a hidden subsidy that is encouraging generous insurance. You

would like to take that money, give it to individuals in a more progressive fashion.

You could do it through a flat credit, or, as we have done in Massachusetts, you could actually do a progressive subsidy system, give

it to the lowest-income people to help them afford insurance, and

then reform insurance markets so that, when people do actually

leave this employer system, they have some place to go.

The CHAIRMAN. Yes. Do not misunderstand, but some of your answers might be in the context of the Massachusetts plan. I am just

curious, apart from the Massachusetts plan, what would some of

the consequences be in the rest of the country? I guess you have

probably answered that question. I guess, in Massachusetts anyway, you do not have a cap. We are talking about Federal.

Dr. GRUBER. No, no. We have not touched the tax exclusion. I

think the general point is, I think the general effect is, the more

you squeeze the employer system, the more employers are going to

react by getting out of the system.

The CHAIRMAN. Some employers stated actually that the current

system is beneficial in the sense that it causes them, employers, to

be much more efficient in the health care coverage they provide for

their employees, namely that they are forced to have wellness

plans, they are forced to have policies within the firm which encourage better health, focus on obesity, cigarette smoking, et

cetera. It is because, even though they get the exclusion, it is an

exclusion, not a credit. So it is beneficial for them. It helps their

bottom line, the more they have healthy employees. That is another

advantage I have heard some employers suggest. Do you think that

is valid or invalid, anybody?

Mr. KLEINBARD. I would argue that that is not entirely valid.

There is actually another hidden tax subsidy at work that we need

to identify. Obviously employers want to deliver to employees the

most bang for the buck, and so a plan in which you can give employees both as high a cash compensation and as good a value of

insurance as possible, is a more attractive compensation package

than an insurance package that you tell your employees is very expensive but is not delivering a lot of value to them. So in that

sense, yes, employers are going to want to have a more attractive,

leaner system. But ultimately, as Dr. Gruber says, it is the employee’s money. The question is whether the employers are spending it

wisely or not.

There is, however, another tax subsidy that is not often appreciated. It is not at the Federal level, it is at the State level. For

large employers, there is a tax reason to prefer to self-insure. Once

you self-insure, then, Mr. Chairman, all the points you make, of

course, become absolutely true. Once you self-insure, then the employer, as insurer, wants to cut down on claims.

The CHAIRMAN. It is more than being self-insured.

Mr. KLEINBARD. I am sorry, sir?

The CHAIRMAN. You are right. Self-insured companies.

Mr. KLEINBARD. And the tax reason to do this is that, when employers buy insurance policies, they have to pay State insurance

premium taxes. When they self-insure, they avoid the State taxes.

That is a significant thing.

13

The CHAIRMAN. Thank you very much.

Senator Wyden?

Senator WYDEN. Thank you, Mr. Chairman. You are following

through again by tackling the big issues, and I really appreciate

your doing that.

We have three of the all-stars here in health care, and I have appreciated your testimony.

It seems to me, more than anything else, the unfair, out-dated

Federal health care rules show how broken the health care system

is. These rules are now being used so that, if you are well off, you

can get a Cadillac health plan and get a Federal tax subsidy for

your designer smile or your designer eyeglasses. But, if you are

poor and you have no health plan, you get nothing.

So, what 16 of us here in the Senate have done, 8 Democrats and

8 Republicans, is we have said, through the Healthy Americans

Act, we are going to take away the subsidies for the Cadillac health

plans and use that money so that every family in America would

have a progressive deduction of $15,000 annually. We think this is

a trifecta. It gives the health care system more efficiency, it is fairer, and there would be a progressive way to expand coverage. I

think all of you have essentially said that.

I want to start with you, Mr. Kleinbard. I have appreciated your

good work. The typical family, statistics indicate, spends about

$12,000 a year on health insurance. With our progressive $15,000

a year deduction, it looks to me like 80 percent of America would

get a tax cut right out of the gate. Is that in the ballpark of being

correct?

Mr. KLEINBARD. From memory, I think that is correct, sir.

Senator WYDEN. All right.

The second point then deals with the very important issues Senator Baucus talked about, which is this question of disruption. How

do you do this so that people do not just walk away with a sense

of bedlam and confusion? So what we do is, we say, anybody who

wants to keep their employer package and any worker who wants

to keep their employer package, they could do it.

But, if you wanted to go to a best-of-both-worlds approach, where

you could be part of a group in effect, so you would have some

clout, but you would have more individual control so that you could

get the financial rewards of shopping, we think you ought to have

that option.

Mr. Kleinbard, is that not what you and Dr. Orszag scored when

you did the report for us? I am looking at the report. It says we

would be budget-neutral 2 years in, and in the 3rd year we would

start generating surplus. Is that not what you scored for us, something that attempts to address the best-of-both-worlds approach?

Mr. KLEINBARD. Yes, sir. What we attempted to score was your

proposal, which of course you have ably summarized, as nonpartisan resources. We did not label it the best of both worlds.

Senator WYDEN. I will not stick with you having to describe it

my way.

Mr. KLEINBARD. But obviously you have ably described it. I

would just add as a footnote that the program that we scored has

a tremendous number of details that in effect were part of the reason that we had some confidence in our numbers. An awful lot of

14

ideas are expressed in a very inchoate way. What you had was a

12- or 13-page term sheet that went through, with quite a high

level of precision, how you would exactly deliver these benefits

without the money sort of dissipating along the way. I just cannot

emphasize enough the importance of thinking through those kinds

of rather dull, but very important, administrative details in any

new proposal.

Senator WYDEN. Fair enough. I share your view.

So then, it allows me to wrap up with the two of you, Dr. Baicker

and Dr. Gruber. We are all rooting for Massachusetts. It is so important that this be successful. You all, for 25 years, have put tremendous effort into trying to tee this up.

Would something like what we are talking about not be a real

opportunity for States to have some of the additional dollars, particularly by reconfiguring this tax system so that you can make the

transition that you all have tried to do, which strikes me as the

best-of-both-worlds kind of approach on the State level. If you do

not have those dollars, it seems to me States are very strapped,

both in terms of having the tools to contain costs and having some

of the money for subsidies for low-income people. Would not a financing approach like this be of help?

Dr. GRUBER. Senator Wyden, I think that is an excellent point.

A very wise man once said to me that States trying to reform

health care on their own are like a basketball player trying to jump

with cement in his shoes.

Senator WYDEN. Who was that?

Dr. GRUBER. I am not sure. I do not recall. Basically, Massachusetts was in a unique financial position. It cannot be emphasized

strongly enough. We had a large Federal grant that could finance

part of our reform, and we had existing taxes on providers that

could finance part of our reform. We really were the most able

State in the country to do this, financially.

Most other States do not have those advantages. I work very

closely with Governor Schwarzenegger and the legislature in California. They clearly did not have those advantages, and ended up

with an enormous price tag on their reform which just could not

be met. So I agree there needs to be a major Federal effort of the

kind that your bill proposes, or of other kinds, to make this possible.

I think a very interesting question you are raising is, what is the

interface between the Federal Government and the States, ranging

from—essentially the Federal Government gave seed money to

Massachusetts to make our plan happen—ranging from the Federal

Government giving that kind of seed money to other States on the

less ambitious side, to your plan on the more ambitious side where

States would raise resources, partly because States would get tax

income now on health insurance benefits. Ed maybe has numbers

on that.

But States would raise money from that as well. They would be

freed up because many of their publicly insured citizens would

move to private insurance. So a plan like yours would free up a lot

of State resources. I think a key issue, as this committee and others work forward, is how you want to interface with the State and

Federal responsibility.

15

The CHAIRMAN. Senator Salazar?

Senator SALAZAR. Thank you very much, Chairman Baucus, for

continuing to focus on this major issue that faces our country.

My question to you, Jonathan and Kate, has to do with what the

reaction would be if you take 165 million Americans and you say

this ‘‘tax bribe,’’ as you call it, Jonathan, is going to be taken away,

so we are going to tax you on your $10,000 of health care, which

now we are going to consider as income.

How, in the context of trying to reform a health care system,

does one go out and explain to people who have been the beneficiaries of a system which now has been in place for more than a

generation, for more than 50 years, how do you explain to them

that what you are doing is, they may still continue to get health

insurance through their employer, but now they are going to have

to pay an additional—as in your case at MIT, Jonathan—$4,000 in

taxes?

Dr. BAICKER. You are raising a very important point, that it matters a lot what you do with those resources that had been going

to subsidizing employer-provided insurance in this particularly unfair and inefficient way that we have talked about. If you just removed it whole cloth, with no substitute and no extra help for people, there would be a lot of people who could no longer afford the

policy that they had been getting through their employer, and

there might be an increase in the number of uninsured people.

Alternatively, you can take that pool of resources and devote it

to subsidizing health insurance purchases, but maybe in a more efficient way, in a way that is devoted more to people at the low end

of the income distribution than the currently regressive subsidy

that we have now, but where employers themselves are not paying

any more or less in taxes depending on the mix of wages and

health insurance that they give.

Most people’s tax bill could go down depending on how much

they had been spending on health insurance. The people whose tax

bill would be most likely to go up would be the highest-income people and the people with the most expensive health insurance policies, which is not always high-income people, but is disproportionately high-income people.

If you left in place a big subsidy for the purchase of any health

insurance through, say, a tax credit that could be flat, could be progressive, could be structured a lot of different ways, then a lot of

people would be getting at least as much help with the purchase

of health insurance as they are today, and a lot of those resources

could be redirected to people who do not have health insurance

today because they are not currently getting any help.

I do not think that anyone could put forward a plan where

everybody’s tax bill goes down and more people are insured. You

have to put resources into the system to increase the number of insured people, but hopefully you can do that in a progressive way

that ends up with most people better off, and the people who are

paying a little bit more are the people who can most afford to do

so.

Senator SALAZAR. Dr. Gruber?

Dr. GRUBER. Yes. I think what Kate said is exactly right. I think

the important thing is to emphasize what she said at the end:

16

there is no free ride here. If we are going to cover 48 million Americans with insurance, it is going to cost money. I have estimated

that we could get rid of the tax exclusion and have universal coverage in America, and have about $50 billion a year left over to

play with, do other fun things with. But in a plan like that, essentially the top half of income taxpayers would be losers and the bottom would be winners, and that is very difficult to do.

So basically it is just an issue of how you transition. You raised

a very important and difficult issue. If you are going to take this

away—Senator Wyden said he has a plan where maybe 80 percent

of people win. That is still 20 percent of people who lose. How you

are going to deal with those losers, I think, is why you cannot just

take this tax exclusion away in a vacuum.

Senator SALAZAR. I have 1 minute left. A question with respect

to small businesses, as you described them, under 30 employees,

with employees making under $30,000 a year. If you were to go

after those small businesses and provide a tax credit, how would

you go about doing that and how effective do you think it would

be in terms of bringing those uninsured people into coverage?

Dr. GRUBER. I think it would be very effective. The main reason

people do not have insurance in America is because it is not offered

by their employer. Most people who are offered insurance, take it.

So I think it would be very effective.

Moreover, what is nice about this is, it is a very clear subsidy

that firms are not offering. All large firms offer, all high-wage

firms offer. It is the small, low-wage firms that do not offer. So I

think you could have a targeted credit which would be effective,

and it would not at all get the majority of the 48 million, or even

close to it. But it could be part of a larger package that could help

address the dislocation from getting rid of the exclusion.

Senator SALAZAR. Mr. Kleinbard, on that answer, do we have any

estimates of how much it would cost the government to create that

kind of a tax credit?

Mr. KLEINBARD. We have looked at a number of proposals along

that line, Senator Salazar. But as you know, every estimate that

we do is a confidential project for the individual member who requests it. Senator Wyden chose to take his proposal and publicize

it. I will say that—

Senator SALAZAR. He is very public about the Healthy Americans

Act. [Laughter.] I have noticed that.

Mr. KLEINBARD. But that was his choice and not ours, so I cannot give you a number that has not been otherwise released to the

public. I can say that there are very difficult administrative issues

which are very tedious, very difficult: how small is small; how low

is low; how are you going to deal with regional differences across

the country? A lot of our work in this area with members has been

trying to help them understand those issues and help them specify,

at the right level of detail, how exactly a proposal like that would

work.

Senator SALAZAR. Thank you. My time has expired. I will only

note that Senator Lincoln and Senator Durbin have been real leaders in terms of trying to address that issue with small businesses,

and it is something that I very much applaud them for.

Thank you.

17

The CHAIRMAN. Senator Stabenow?

Senator STABENOW. Thank you, Mr. Chairman, very much.

Thank you to all of you. This really goes to the heart of the issue

that we have to, I think, tackle in the coming year. I want to start,

Mr. Kleinbard, by thanking you for the chart looking at the fact

that, whether it is directly or indirectly, the public sector, the government, is involved in funding health care.

I always kind of smile when I hear folks say, we do not want government involved in health care, we do not want government involved in my Medicare, and of course Medicare is a universal

health care system. I seem to remember someone quite high up in

our government saying that before. So I do think it is important

that we all convey to folks that, whether it is directly or through

the tax system, the public sector is deeply involved, and taxpayers

are deeply involved.

I come from a State where there are a lot of folks who have

employer-based health insurance. The reality for them is, in fact,

their wages are not going up, they are going down. In many ways,

they are taking wage cuts in order to be able to keep their insurance. It is a very, very tough situation. At the same time, I very

much appreciate what Senator Wyden is doing. I think we only

really get to lowering costs when it is a universal system and people stop using emergency rooms inappropriately and actually can

go to the doctor. So, it is important that we have a universal system.

I have talked to Senator Wyden a lot about the fact that, for me,

to go to a broad system, it is important that people who have their

current insurance are able to keep it if they wish to do so. So, a

couple of questions.

Mr. Gruber, I would ask specifically on Massachusetts, a couple

of things. Is that an option for people in Massachusetts, and how

does that work? Second, you said, which I found intriguing, that

going to the system in Massachusetts, that more employers actually were expanding their coverage. I wonder if you might talk

about how that happened. Explain to me how that is happening in

the context of your system.

Dr. GRUBER. I think, Senator, you raised a really important

point. And really, I think a fundamental lesson I feel that many

of us learned from the early 1990s is, if you try to sort of overextend and try to take away things that people are happy with, it

is going to make life difficult politically. I think a realistic plan

needs to recognize that most Americans who get their health insurance from large firms are pretty happy with it. They wish it cost

less, but they like the choices, et cetera.

So, I think it is important. It is a movement I have been calling

incremental universalism, which is to incrementally get to universal coverage. By that, I mean to build on what is there. That

is just what we do in Massachusetts. Most people in Massachusetts

are not at all affected by our reform. If you have employersponsored insurance, which is the vast majority, higher than most

States, you are absolutely unaffected by the reform.

What it is simply doing is trying to fill the cracks around that

employer-sponsored system. The main crack it is trying to fill is for

low-income people who do not have access to employer-sponsored

18

insurance, and right now we have about 170,000 of them, who are

now getting highly subsidized government insurance.

Now, if you asked me, as an economist and modeler, gee, if we

put a system like that in, what is going to happen, I would say,

well, it is pretty clear what is going to happen. Since you now offer

subsidized insurance to low-income people, those employers with

low-income people will stop offering health insurance, and it has

not happened.

Senator STABENOW. And why is that?

Dr. GRUBER. I am as surprised as you are. The only real answer—we have to study this more—I can give is, it must be the

mandate. I mean, if you watched every single Red Sox game during

last summer, the Red Sox supported advertising for the program

and said you have to have health insurance. Everyone in Massachusetts knows you have to have health insurance. The only thing

I could think of is that these people went to their employers and

said, gee, I am seeing on the Red Sox games I have to have health

insurance, I do not know what to do.

The CHAIRMAN. What happens if the Red Sox are losing? [Laughter.]

Dr. GRUBER. They did it the first inning. They were very smart.

[Laughter.]

The CHAIRMAN. All right.

Dr. GRUBER. They went to their employer and said, I have to

have health insurance, my friends all get it from their employers,

I should get it from you. That is the only thing I can think of. I

think we will know more in a year about what is happening. I wish

I had a better answer for you.

But it is as surprising to me as it is to you, and the only explanation is the power of compulsion, the power of people saying,

there is this new social contract in Massachusetts, you have to

have health insurance, and employers are a good place to get it for

reasons other—partly because of the tax subsidy and partly for

other reasons, and that is why it is happening.

Senator STABENOW. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, Senator.

Senator Lincoln?

Senator LINCOLN. Thanks, Mr. Chairman. I think all of us owe

you a tremendous debt of gratitude for really bringing out this

issue this year for great conversation with the intent of getting us

all energized for next year, to be really able to tackle some of these

issues. Our 1-day conference was a great bipartisan effort in terms

of really looking into what the concerns are, what the problems are,

and where we go for the answers. You have, here, compiled a panel

that has been tremendous. I feel like I have had a tutorial from

each one of you in your writings and in your work.

Without a doubt, Mr. Kleinbard, I want to thank you. As you

have mentioned, the way that you walk through with members in

terms of what kind of information we need to give you for you to

be better helpful to us, is tremendous. I appreciate you and your

staff. I know Tom Barthold has done the same with me. So, thank

you very much. You really do go the extra mile to make sure that

we understand what we are asking so we will understand what you

give us back, and that is critically important.

19

But again, thanks to the chairman for really getting us teed up

for next year, because I think it is going to be really important. I

think you have us all energized, excited, and ready to go.

I know, reading through the materials for this, I became frustrated, looking at what we are spending as a Nation in terms of

health care expenditures every year, that $250 billion, Dr. Baicker,

that we talk about and whether or not we are getting the best efficiency out of those resources and those dollars that we are spending. I am such a firm believer that the tax code can be helpful to

us. I think we want desperately in this committee to really be able

to try to make that happen.

I want to try to do what Senator Salazar does, and that is to get

all the questions out real quickly and let you all try to answer

them.

I have one for each of you, really, to talk about. Again, Dr.

Gruber, thank you. You have been enormously helpful to myself

and my colleagues, Senators Snowe, Durbin, and Coleman, as we

have worked through really looking at this issue. Really, 3 in 5 individuals without insurance do work. They are in the workforce.

The practical idea of being able to help deliver it through employers is critically important, and it is a tool we know works if we can

figure out a way to incentivize it and make it work.

We feel like, in our Small Business Health Options Program bill,

our SHOP Act, that we have really worked at including in the tax

code the incentives that need to be there to really get small businesses engaged, but also to make sure that they are getting value

in the product that they get, that it is a meaningful coverage that

people will want to use, but to use responsibly, to not over-utilize,

but to use in a way that really helps. We do that by phasing in

the ban on the health status ratings and some of the other things

to create good pools, both in the State and nationally, if we can.

So I would just like, for Dr. Gruber, to discuss how economists

are factoring in the relative value of health care dollars in the

group versus the non-group markets when they look at the modeling effects of tax exclusions. I mean, when we take that tax benefit away from the employer and we send the individual out into

the marketplace, do they still have the value of what that employer

had and what do they find when they get into that small group

marketplace?

Then also, the health savings accounts that have been mentioned. I am curious as to you all’s opinion about their utilization

in the next several years, and what does that do? Will they become

more common? If so, is it something policymakers should be paying

attention to in the context of the impact on the group market, because it is going to certainly put people into a place where—unfortunately, fewer people in Arkansas have the expendable dollars to

get into HSAs, but then they get into an emergency situation or in

other situations, maybe it is well care or preventive care, and they

really do not have the resources to do what they need to do.

And I guess the under-insured would be the last one, Dr.

Baicker, and certainly Dr. Gruber. You all may want to comment

on that. Forty-two percent of all working age adults were either uninsured or under-insured. I think that is a big question for us all.

Maybe you could discuss the problems of under-insurance as it reVerDate 11-MAY-2000 14:10 Oct 18, 2010 Jkt 000000 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 58428.000 TIMD PsN: TIMD
20

lates to existing tax expenditures and what we are spending there,

as well as those that are being considered in various reform proposals that are out there. So, we appreciate very much all of the

work you have already done to help us get to this problem, but we

are going to need your help, definitely, as we move forward next

year.

Thanks, Mr. Chairman.

The CHAIRMAN. Thank you, Senator.

Senator LINCOLN. Can they just answer quickly? I am sorry.

The CHAIRMAN. I am sorry.

Dr. GRUBER. Senator Lincoln, thank you, and Senator Durbin

and others, for your leadership on the SHOP bill. I think that is

an excellent bill that addresses a lot of issues. I think you raised

the key issue, which is, when you move from a group to a nongroup setting, you move from a place, as Mr. Kleinbard mentioned,

where people buy insurance in pools that ensure that it is fairly

priced and the sick do not get priced out, to a market where that

does not happen.

Senator LINCOLN. Right.

Dr. GRUBER. You addressed that in your bill by reforming the

market. I think the big issue that one has to think about is, is that

enough? Does market reform work in a vacuum? Do you need either more dollars or a mandate to make it really work? We have

known States that have tried to reform the non-group market, like

Massachusetts before our reform, New York, New Jersey. Their

non-group market prices have gone through the roof because only

the sick buy, and the healthy do not. The fundamental issue you

all face going forward is, can an incremental approach work or do

you need a big jump to make it work? Your SHOP bill is a terrific

incremental bill. I think it does a lot of things right with subsidies

and reforming the market. The big issue is going to be, is that

going to be enough to make it work?

I will let Kate talk about HSAs, since she is the expert on that.

Let me just mention one thing on the under-insured, because I cannot resist. We have 48 million uninsured in America, we have 200

million over-insured in America. Under-insurance is not our problem in America, over-insurance is our problem in America. I think

we need to worry about the uninsured and we need to worry about

the over-insured. The under-insured are not nearly as big a problem as either of those two. Let us make sure we get the money

from the over-insured to help with the under-insured going forward.

Senator LINCOLN. Right. Thanks.

Dr. BAICKER. I will be very brief, but I very much appreciate

your emphasis on getting value out of the system, because we do

have these two simultaneous problems, that there are some procedures that are wildly overused, and then other parts of the population not getting basic care that would be of very high value. I

think part of the goal of an HSA-type policy is to move some of the

resources from over-use on care of questionable value to that high

value, under-used type of care. It is one step in the direction of leveling the playing field.

The goal of these policies is to put out-of-pocket spending on

equal footing with insured spending to try to partially remove the

21

bias in the tax code against out-of-pocket spending versus other

ways that insurance companies could lower premiums, like better

management, tiered formularies, or different physician networks.

Those are all at a disadvantage relative to co-payments today.

Now, that is just one step in that direction. There is no reason

to think that HSAs are the perfect way to solve the problem, and

there are many ways you could reform the tax code to try to level

the playing field between employer insurance, out-of-pocket spending, and non-group market insurance. The extent that HSAs will

proliferate, I think, will depend on other reforms that might go

even further in leveling the playing field to get higher value.

Senator LINCOLN. Thank you, Mr. Chairman.

The CHAIRMAN. Thank you, Senator.

I am trying to get to the question of over-utilization. It is a big

problem. I guess, what is it, Jack Wennberg up at Dartmouth University did geographic variation studies, for example, and others

that point out the problem with over-utilization in some parts of

the country. It is an excess supply problem: more doctors, more utilization. It is very simple.

So my question is the degree to which we could attack that with

changes in the exclusion or, say, the comparative effectiveness efforts. Many of us here are thinking about kind of a separate entity,

somewhat like the Federal Reserve Board, but it is private and

public.

It looks at comparative effectiveness of drugs, of procedures, of

medical equipment, and also Medicare reimbursing based on value

rather than volume. If you look at all the ways to get at overutilization in this country, which solutions or attempts to solve it

do you think are most effective compared with those that might not

be effective at all? Anybody?

Dr. BAICKER. I would love to start. I spent 6 years on the faculty

at Dartmouth and worked a little on this.

The CHAIRMAN. Oh, did you?

Dr. BAICKER. Yes. And I am such a huge fan of the work that

they are doing up there.

The CHAIRMAN. Yes.

Dr. BAICKER. What I think is particularly illuminating about it

is that they show really wide variation in both utilization and

costs, even within the Medicare program, where everyone has the

same insurance.

The CHAIRMAN. Yes. Correct.

Dr. BAICKER. They are all in the same fee-for-service pool. Yet,

there are parts of the country that spend 2 or 3 times as much on

Medicare beneficiaries, and those are the parts of the country

where those beneficiaries are the least likely to get high-quality

care, not the most likely.

The CHAIRMAN. In fact, CBO did an analysis. If the entire country were to track the utilization and the better outcomes that occur

in some parts of the country versus the other, the savings would

be 29 percent. That is $700 billion.

Dr. BAICKER. That alone, I think, is evidence that insurance or

tax reform alone is not enough to solve all of the problems. But I

do think it suggests that part of the reason that variation persists

is because of the insurance system that we have that is fostered

22

by the tax code. If we were not allowing an indefinite subsidy of

any kind of care, then I do not think those differences would be as

persistent.

The CHAIRMAN. So how much would comparative effectiveness efforts help?

Dr. BAICKER. I think that they would help a lot, because I think

we lack information about best practices. We are not sure, in a lot

of realms, what best quality is, let alone what is most cost-effective.

So more information for providers would be really helpful in figuring out the cost-effectiveness of different treatments, and then

passing that information on to patients.

I think it is very hard to learn about the quality of the provider

that you are going to. We have seen in the Wennberg, et. al. studies that the quality variation across different parts of the country

is really shocking, even in the areas of Medicare where we do know

what high-quality care is.

The CHAIRMAN. Dr. Gruber?

Dr. GRUBER. I guess I want to make two points. One is, you

raised the fundamental question of, if we are going to try to control

costs, do we do it on the demand side by affecting what people

want by maybe making them pay more for their medical care, or

on the supply side, through comparative effectiveness and other

things? I think there is no doubt it has to happen on the supply

side, but I think the demand side is an important predicate. What

I mean is the following: ultimately, if we are going to control medical costs, we are going to have to tell people they cannot get some

medical care they now want.

If we continue to make it free, they will say, no, I want it. So

if we could, on the demand side, make people realize some of the

financial costs of over-consuming medical care, that will make supply side reform possible. So I really think they work hand in hand.

The tax exclusion alone is not enough.

But by reducing the over-insurance that comes with the tax exclusion, you make the supply side reforms more possible because,

if people are paying more, they will say, wow, or if they realize

what their employer is paying for their insurance they will say,

gee, maybe I ought to get costs down.

Now, in terms of comparative effectiveness, I mean, what is not

to like? It is a wonderful idea. I think it is terrific. I love that CBO

has been pushing it, and I love the efforts that you and others have

been making about it.

I think, to be realistic, the question is what you do with it. I

mean, I think we are all for gathering more information. The question is, is that enough, or what is the next step? In particular, to

what extent can you actually compensate providers and tie the actual functioning of the health care system to that comparative effectiveness information? So I think it is a great direction, a great

idea.

When you say, how will it go, that is a hard question to answer

because it depends on what you do with that information. If you

are aggressive and take that information and say, we are not going

to pay the low-value providers, we are going to compensate the

higher-value providers more, I think you would have a fundamenVerDate 11-MAY-2000 14:10 Oct 18, 2010 Jkt 000000 PO 00000 Frm 00026 Fmt 6633 Sfmt 6633 58428.000 TIMD PsN: TIMD
23

tally transformative effect on the system. But if you just collect it,

it is more for academic studies.

The CHAIRMAN. Right. So how can you compensate, more along

the line of payments for quality service?

Dr. GRUBER. I am not an expert in this area, but basically we

have a lot of evidence on things that work, things that do not, and

things that are cost-effective and not.

Basically, you can, both on the patient side in terms of what patients pay, and the provider side in terms of what you are reimbursed, tie that to what is effective. So a great example would be

back surgery, the thing everybody likes to pick on. So what do we

know about back surgery? We know that, if you have back pain,

whether you have back surgery or not has no effect 6 months later,

it just gets you better a little bit quicker.

So that seems like the kind of thing where, if I am a rich guy

and I want back surgery, I should get to have it. But there is no

reason that the government insurance should be paying for me to

feel better somewhat quicker than not having it. Likewise, why

should a provider be compensated very highly for doing that back

surgery when, in fact, 6 months later it is not going to make any

difference? I think that is exactly the kind of—I was much too

vague for Ed to score it, but that is the kind of direction that I

think we would have to go with this information.

The CHAIRMAN. All right.

You’ve probably given some thought to the next question. How do

you start to limit the health care benefits that people are going to

receive—I am addressing the demand side that you talked about a

few minutes ago—in a way that is politically palatable?

Mr. KLEINBARD. Mr. Chairman, one of the adages of tax policymakers is that ‘‘an old tax is a good tax.’’ The reason is, everybody

has become habituated to it, it is priced into the economy, and by

virtue of its longevity, we have sort of accepted it as part of the

background environment. Arguably, the same can be said of preferences, like the employer-sponsored insurance. The old preference

is a good preference, in the sense that it is fully priced into the system and into our behavior.

Therefore, I think what follows from that is that there needs to

be very close attention, not just to where we are now and where

we will be several years hence in the new world order, but to the

transition period.

In particular, I think that there is a lot of virtue to a long transition period, as a general rule of thumb, wherever it is feasible, so

the markets and behaviors can gradually habituate to the new

world. We tend to look at these kinds of issues as turning on a

light switch: that we are in the dark today, we will turn on the

switch, and tomorrow it will be bright. But in fact it might be more

of a rheostat kind of phenomenon, where we do things quite gradually over a number of years that might cushion the transition.

The CHAIRMAN. I am sorry. I am not sure I quite got that. How

do you reduce benefits?

Mr. KLEINBARD. Well, for example, go back to the idea that you

might want to put a cap on employer-sponsored insurance. Just

take that as a free-floating idea. You could decide that, here is a

target number that you want to get to, but you do not have to get

24

to that number the next day. You can gradually phase in a cap

over a period of years.

The CHAIRMAN. Frog in the water.

Mr. KLEINBARD. I am sorry?

The CHAIRMAN. The frog in the water that goes to a boil? I do

not understand.

Mr. KLEINBARD. Well, you wanted, let us say, to have a cap of

$8,000 a year. You could just say, the first year the cap is $15,000,

the next year it is $12,000, the next year after that it is $10,000,

and then finally we get to $8,000.

The CHAIRMAN. Yes.

Mr. KLEINBARD. By doing a transition, people can adjust, the

markets adjust, behaviors adjust. The one place where, unfortunately, you get hurt by long transitions is in the budget process.

If the net effect is to raise taxes, if you push it outside the 10-year

window, you do not get credit for it. That is a fundamental problem

of a cash flow budget process.

The CHAIRMAN. Right.

Could you address mandates, both individual and employer mandates, and their consequences? Give advice on which we might look

more seriously at, and why.

Dr. GRUBER. Yes. I actually do not like the term ‘‘employer mandate’’ because I think it gets mixed up with ‘‘individual mandate.’’

An individual mandate is clear: it is a requirement that people buy

health insurance. Employer mandate, I think, really should be

known more as a play-or-pay type of restriction where, say, employers either can offer health insurance or pay income tax.

The CHAIRMAN. And why?

Dr. GRUBER. Why?

The CHAIRMAN. Why not an employer mandate?

Dr. GRUBER. Because really no one has actually proposed an employer mandate, where literally you would go to jail if you did not

offer health insurance. Typically it is, you are an employer, you

have to offer health insurance.

The CHAIRMAN. But would you go to jail if you do not individually buy health insurance?

Dr. GRUBER. No. No, you do not, either.

The CHAIRMAN. All right.

Dr. GRUBER. But basically, I think essentially an employer—both

can play a role. I think with the individual mandate, that is essentially the one that gets to universal coverage. There is simply no

way to get to universal coverage without requiring individuals—either making it free for everyone or requiring individuals to buy

health insurance.

The CHAIRMAN. Now, on that point, when we had a conference

at the Library of Congress—again, this committee is just trying to

ramp up for next year. That is why we are having all of these hearings, et cetera. Over at the Library of Congress, at the end of the

day, a couple of Senators on the Republican side said, gee, we do

not like a mandate. Why? Because that is the nature of an entitlement, another entitlement. I said, what is wrong with that? The

answer is, well, it prevents people from being individually responsible for their health care. If it is a mandate—I am just telling

25

what the thinking is so far. It may be early on in the development

and understanding, but that is just what it is so far.

So I asked, what if we do not call it a mandate? What if we do

not call it an entitlement? Should every American have health insurance? Oh, yes, I think I could go along with that. So a lot of this

is terminology, how you package a lot of this stuff. What is your

response to those who say, gee, we should not have a mandate because that sounds like an entitlement, and we have enough entitlements as it is? If you have another entitlement, people are not

going to take care of themselves. They are just going to get this

free health care. That is part of the answer right there. It is not

free. Your thoughts?

Dr. GRUBER. I mean, I think it is an ironic criticism, because it

is sort of the opposite of what a mandate is. A mandate is not an

entitlement. It is a requirement that you buy health insurance. So,

in fact, the real issue is, the entitlement comes on the spending

side of it and how much subsidies you are going to give to people

to make it affordable.

So I guess one way to construct their argument would be, gee,

you cannot really mandate health insurance on people unless it is

affordable, therefore, a mandate, by definition, comes with a financing stream because you have to make it affordable to the mandate.

So that may be what they have in the back of their mind when

they construct that argument.

The mandate itself is not an entitlement, but it is true, if you require Americans to buy health insurance, that is going to cost

money. For a family in poverty right now, health insurance is 50

percent of their income. You cannot require a family of poverty to

buy health insurance and spend 50 percent of their income on

health insurance. It is going to have to come with a financing

stream.

But I think you are exactly right. There is some terminology here

which is unnecessarily scary, and I think that the point is that, if

you want to have fundamental reform, if you want everyone to

have health insurance coverage, if you want market reform to work

so you can get to a situation where the sick do not pay many multiples of what the healthy pay, that is going to require a requirement that everyone have health insurance. I would leave it to experts like yourself to think about how to best label that to get

around the problem, but I think the notion that a mandate is an

entitlement, I think is sort of backwards.

The CHAIRMAN. A lot of people are kind of scared about how

much all this is going to cost. I do not know what the exact number

is, but some say that the American health care system is, what, 50

percent more expensive per capita than the next most expensive

system in the world. This is not relevant, but our administrative

costs are so much higher than are systems in other countries. We

are not talking about ‘‘health care reform.’’ You have the Massachusetts background, where it is different than other States, as you

indicated. We spend, what, $2.3 trillion annually on health care in

America today—public, private.

So my question is, if we have ‘‘health care reform,’’ can we do it

in a way that is there but which lowers the cost, does not increase

it? If we were to do it in a way that lowers the cost, what would

26

some of the trade-offs be that come to your mind? I do not know

that this Congress is going to want to adopt a system that increases health care. Some will. There is a bit of a debate. It has

not emerged yet, but you can feel it bubbling up from the surface.

Do we spend more for health care reform or can we have health

care reform without spending more?

Dr. GRUBER. I think that is an excellent question. The important

point to remember is, the entire cost of covering all the uninsured

in America is about 1 year’s health inflation. So you could cover all

the uninsured in America for about $150 billion. That is maybe 1,

11⁄2 year’s health inflation. So one way to think about it is, we are already spending $2.3 trillion, we are going to add another $150

billion. Is there not some way to sort of—it seems like, you are exactly right, there should be some way to re-jigger that pie to add

the extra $150 billion in without raising the size of the pie.

Senator Wyden has proposed one way that CBO and JCT have

scored as budget-neutral. There are basically a lot of different directions one could go. I think to actually make it work, we have

to remember that, if you are going to actually cover people with insurance, it is going to cost money, so you need to get that money

from elsewhere. You can get it from the exclusion or you can get

it from more fundamental efforts, like a real comparative effectiveness effort, like you have mentioned.

The CHAIRMAN. Well, this has been very helpful. Unfortunately,

I am going to have to close this hearing down pretty quickly due

to time constraints. But I want to thank you all very, very much.

When the Senate reconvenes after the August break, I intend to

continue our series of hearings. We are going to have a lot of hearings on this subject.

Frankly, this hearing today is both rewarding and frustrating because we are just starting to scratch the surface here on a lot of

very important issues, and I have tons of other questions I would

like to ask you. But thanks so much. I have a hunch that all of

us are going to continue this dialogue for some time.

Let me now turn to Senator Wyden for any questions he might

have.

Senator WYDEN. Mr. Chairman, do you have time?

The CHAIRMAN. Sure.

Senator WYDEN. That would be great. I just had a couple of extra

ones.

Dr. Baicker, I did not get a chance to ask you about the nature

of insurance reform. What we have tried to say is, you have to have

an integrated system. In other words, you need to reform the tax

code. We have all been talking about it here today. But if, as a result of making those tax code changes, people then go out into the

broken insurance market, what you have is a lot of cherry-picking,

and essentially only healthy people get covered and sick people go

to government programs more fragile than they are. I think you

are talking about putting insurance reform as a high priority, as

a way to encourage innovation. Do you see the kinds of reforms I

am talking about being part of a package that would also include

the tax reforms?

Dr. BAICKER. Yes. One of the things that I think is particularly

attractive about the package that you have put together is the flat

27

nature of the assistance that people get in buying health insurance

with respect to the cost of the health insurance. That kind of reform of the tax subsidy, I think, is the most likely to promote highvalue care by not subsidizing care on the margin, but rather subsidizing people to get insurance that is at least at a certain level,

and then letting them choose above that level.

So that feature would then go hand in hand with reforms of the

insurance market that would let people take the benefit to a market that gave them policies that guaranteed protection against future cost increases, as well as costs they might incur this year. So

I agree with you that those two should go together and that reforming the tax code is absolutely a necessary component of a

broader raft, but is not sufficient on its own.

Senator WYDEN. We are going to be calling on you, I know, often.

Because the chairman’s time is short, I would just ask one other

quick one. That is, both of you, I think, have written on this question that a substantial portion of the uninsured in this country, it

might even be 25 percent, are people who are clearly capable of

paying for health care. They are people with $50,000, $60,000,

sometimes incomes well over $70,000. I think the chairman raised

this question of debate about a mandate and personal responsibility.

How do you see government—and Massachusetts, I know, has

been wrestling with this—dealing with this group that, for a whole

host of reasons, seems to just insist on using the hospital emergency room as the principal place for where they get their health

care? I would be interested, both in you, Dr. Gruber, and Dr.

Baicker.

Dr. GRUBER. I think that you raised a very important issue, Senator, which is one of the arguments for a mandate, which is, there

is some free riding going on. There is a set of the population, particularly young, healthy, and well-off people, who say, look, I do not

need health insurance now, I can always get it when I am sick or

go to the emergency room, and I am not going to get it now. They

are escaping sort of the social contract we are trying to set up in

Massachusetts. At the same time, it is controversial to tell people

they have to do things.

I think that comes to Senator Baucus’s question of how you put

this package together, and explain that we are all in this together.

One comforting thing of note is that the Massachusetts reform remains wildly popular. We have about a 70-percent approval rate in

our State. People had to file a new tax form this year to show they

had health insurance, or at least declare that they were exempt on

income grounds, and 98.6 percent of people filed that tax form for

the very first year. So I think it can be made to work, but I think

the kind of arguments you make are going to have to be made very

compellingly to address the issues that Senator Baucus brought up.

Dr. BAICKER. Just to build on that, I think you do need a strong

incentive to get the young and healthy insured. Insurance is about

pooling risk. If you do not get the low-risks in the pool when they

are healthy, then they will lack that protection and they are likely

to free-ride on the system, just as Jon said. That could be a really

big carrot or a really pointy stick, or some combination of both. But

28

without that incentive, you face the kind of risk selection that undermines the availability of really good insurance for everyone.

I would also echo Jon’s distinction between employer mandates

and individual mandates. Individual mandates really do get everybody in the system. They are one form of stick that encourages that

risk pooling. Employer mandates come with some attendant risks

that are different. If benefits are tied to employment and, for example, employers with fewer than 20 people are excluded from the

mandate, then small firms might want to avoid getting big enough

to have to be subject to that mandate. If firms can avoid falling

under that mandate by out-sourcing their jobs to other firms or

smaller firms, they are going to shed workers who would be unprofitable to employ if subject to the mandate.

As Jon said, there are no real employer dollars in the system;

there are employee dollars in the system. Employees bear the cost

of health insurance through the form of lower wages, or, when

their wages cannot adjust down, through the form of fewer jobs. So

that is something that you would be very concerned about in designing an employer mandate that is different from an individual

mandate, and part of the reason that the word ‘‘mandate’’ in both

of them is a little confusing.

Senator WYDEN. Mr. Chairman, you have given me a lot of time

this morning. I know you have a lot on your plate. We have had

three of the all-stars. It has been a great panel.

The CHAIRMAN. It has been wonderful. Thank you, Senator.

I thank all of you very, very much. We will be in touch. Thank

you. The hearing is adjourned.

[Whereupon, at 11:29 a.m., the hearing was concluded.]

(29)

A P P E N D I X

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

30

31

32

33

34

35

36

37

38

39

40

41

42

43

44

45

46

(47)

COMMUNICATIONS

48

49

50

51

52

53

54

55

56

57

58

59

60

61

62

63

64

65

66

67

68

69

70

71

72

73

74

75

76

77

78

79

80

81

82

83

84

85

Æ