Wednesday, November 11, 2009

Employer-Provided Medicine Is Completely Illogical

Two simple observations are key to explaining both the high level of spending on medical care and the dissatisfaction with that spending. The first is that most payments to physicians or hospitals or other caregivers for medical care are made not by the patient but by a third party—an insurance company or employer or governmental body. The second is that nobody spends somebody else’s money as wisely or as frugally as he spends his own.

No third party is involved when we shop at a supermarket. We pay the supermarket clerk directly: the same for gasoline for our car, clothes for our back, and so on down the line. Why, by contrast, are most medical payments made by third parties? The answer for the United States begins with the fact that medical care expenditures are exempt from the income tax if, and only if, medical care is provided by the employer. If an employee pays directly for medical care, the expenditure comes out of the employee’s after-tax income. If the employer pays for the employee’s medical care, the expenditure is treated as a tax-deductible expense for the employer and is not included as part of the employee’s income subject to income tax. That strong incentive explains why most consumers get their medical care through their employers or their spouses’ or their parents’ employer. In the next place, the enactment of Medicare and Medicaid in 1965 made the government a third-party payer for persons and medical care covered by those measures.

We have become so accustomed to employer-provided medical care that we regard it as part of the natural order. Yet it is thoroughly illogical. Why single out medical care? Food is more essential to life than medical care. Why not exempt the cost of food from taxes if provided by the employer? Why not return to the much-reviled company store when workers were in effect paid in kind rather than in cash?

The revival of the company store for medicine has less to do with logic than pure chance. It is a wonderful example of how one bad government policy leads to another. During World War II, the government financed much wartime spending by printing money while, at the same time, imposing wage and price controls. The resulting repressed inflation produced shortages of many goods and services, including labor. Firms competing to acquire labor at government-controlled wages started to offer medical care as a fringe benefit. That benefit proved particularly attractive to workers and spread rapidly.

~Milton Friedman in his 2001 article "How To Cure Health Care."


At 11/11/2009 9:57 AM, Anonymous CompEng said...

And of course, Friedman is correct. The closer we get to this model, the more efficient and effective health care (which is currently very broken) will be.
Health insurance, as properly understood, like any other disaster insurance, should not enter the equation in the common case..

At 11/11/2009 11:01 AM, Anonymous Anonymous said...

I think the same argument could be forwarded for the cost of a college education and the cost inflation that exceeds the general level of inflation. Through gov't subsidized borrowing, the student somewhat gets the erroneous feeling that someone else is paying; not fully appreciating the fact that he/she will be expected to repay the loan after graduation.

At 11/11/2009 11:37 AM, Blogger Bruce Hall said...

This does hit the nail on the head.

But of course the government "cure" for "inequities" of employer-provided insurance is a larger morass of government-provided insurance.

Taxes lead to efforts to avoid taxes and bad tax legislation leads to illogical results in the marketplace... whether it is health care or decisions to hire or not.

At 11/11/2009 12:53 PM, Anonymous morganovich said...


if you set your life up such that you can file your taxes as a sole proprietor, you can deduct all your medical expenses.

alternately, incorporate flow all your income through that entity.

i grant that it's stupid that the system is set up this way, but it is, so might as well make the best of it.

At 11/11/2009 12:53 PM, Anonymous morganovich said...

should read "incorporate and then flow"

At 11/11/2009 3:16 PM, Anonymous Anonymous said...


Thanks for the tip. :)

At 11/11/2009 4:13 PM, Blogger juandos said...

I sort of have to disagree here though I have no argument with Milton Friedman's premise or logic...

Employer provided medical care was (not nearly so much over the last decade and a half or two decades now) in a sense the company store since it was the ONLY store in the state for those jobs...

Having employees tied to the work place in a manner of speaking was at one time considered and good way to hang onto needed human capital...

It didn't work for all companies in all places but company provided health insurance was a nice way to tie down employees with special skill sets that were hard to come by...

At 11/11/2009 4:48 PM, Anonymous improbable said...

morganovich: it doesn't solve the problem to pay for your own health care a different way. If everybody else is paying with someone else's money, the doctor's prices (and use of tests etc) will still reflect this marketplace.

At 11/11/2009 6:05 PM, Blogger Alex said...

Begs the obvious question - why not company provided groceries? Surely food is the #1 human right?

At 11/11/2009 7:51 PM, Blogger Unknown said...

I don't agree that it's illogical to acquire health insurance through the employer. The employees of a company are a natural group and employer provided coverage existed long before the tax incentive to provide it.

Unfortunately, the tax advantages afforded employers don't extend to any other group. Thus, I think what's unnatural is that the employer is the only group through which one can get tax advantaged health insurance.

The distortion in the market from the tax subsidy is what's unnatural, IMO.

At 11/11/2009 7:54 PM, Blogger Unknown said...

Begs the obvious question - why not company provided groceries?

Well, why not? As an employer, why can't I provide certain goods as incentives to my employees?

Employers often provide per diems and apartments to induce employees to work in certain places, for instance.

It's just that you shouldn't ONLY be able to get housing and food through your employer. That's so Soviet.

At 11/11/2009 8:09 PM, Blogger Alex said...

My point is that if we lived in a true free market, companies would be free to provide or NOT provide fringe benefits. Also we wouldn't be taxing productive people to pay for parasites. Yeah I'm in a BAD mood today.

At 11/11/2009 8:59 PM, Anonymous morganovich said...


oh, i totally agree. third party payment short circuits the market mechanism in a very important way and keeps competition/demand modulation from lowering price. of that there can be little question. price reductions in cash pay elective procedures provide a stark counterpoint to the massive cost increases of insured care.

i was discussing only the tax advantaged nature of employer provided care and how to achieve the same thing oneself under the current regime.

don't take my seeking to reduce my own costs to mean i think the current system is a good one.

At 11/12/2009 3:38 AM, Anonymous improbable said...

morganovich: Thanks for the reply.

That's a good point that sometimes there is a very different cash price. Willingness to offer that is a step in the right direction, at least: the same hospital is then trying to compete in both markets.

At 11/12/2009 6:56 AM, Anonymous Anonymous said...

The cash price better be higher than the insurance price or that's insurance fraud. Dr.s get thrown in prison for fraud. Dr.s can, however, offer a discount for imemdiate payment which would be a discount to a cash-paying patient. Very few insurance companies, probably none, pay the day the service is rendered.

At 11/12/2009 10:47 AM, Anonymous Anonymous said...

Friedman hits the core issue in this brief summary. Unfortunately, there are so many entities with vested interests in the current system that it may be impossible to change.

Bottom lines is that need to find a way to stop the looting of wealth by the government.

At 11/12/2009 2:49 PM, Anonymous Anonymous said...

Alex, I am an old man from deep in South Louisiana. I grew up on a plantation.... There were still some company stores in business in the early 60's. The purpose of the company store was two fold. First it made money for the plantation, although usually not a lot, and secondly, in kept your worker on the plantation. Oh I almost forgot, until the practice was outlawed by the Sugar Act, it reduced labor costs when a portion of the wages were paid in tokens...good only at the company store.

I am macquechoux

At 11/12/2009 6:35 PM, Anonymous Matt said...

Friedman is completely right - employer provided healthcare is illogical, but the reductio he proposes doesn't hammer the message home.

Why would you want a system whereby quitting or losing your job also means quitting your healthcare.

Although mutual aid societies and trade unions might be the way to go when it comes too pooling of risk:

At 11/17/2009 12:34 AM, Anonymous Anonymous said...

How to fix health care? Let us keep our own money!

Why does our employer or why do we give 100% of our monthly premiums to health insurance companies who then decide which treatment they will pay for with our money? Could we create a system where employers send 50% of employees’ health care premiums to their employees’ health care savings account (HSA) and 50% to a quasi-governmental organization (QGO) instead of giving 100% of our premiums to health insurance companies?

Eliminating the middlemen, health insurance companies, by giving people the power to manage health care through HSAs will be a more efficient system bringing better health for America. We the people can better decide how to spend on our health care needs.

The HSAs would be similar to bank savings accounts, with the money in the accounts available to pay only for health care needs (until age 70 when the funds could become a retirement account, too).

The consumers/patients would decide how the funds in their HSAs would be used to manage their health care. People would use their HSAs to pay for the medical services they receive and the QGO would cover anyone who has exhausted their HSA or who are unable to take care of their own health care.

The payment process would be as simple as using a credit/debit card. Doctors, hospitals, therapists, and other health care providers would have care card readers that consumers/patients would use to pay for services. That is, after patients are treated by their doctors the patients would slide their health care account card to pay the doctor. The patient would approve the charges and receive a receipt describing the charges as well as the new balance in their HSA. Obviously, the transactions would be secure and would require a pin number and photo ID.

This new approach to health care would encourage personal responsibility while containing costs by eliminating money hemorrhaged to the middlemen/health insurance companies.

Health insurance companies, in the end, obstruct health care. Not only do they take our money with a promise to pay if we are sick or injured, when the time comes, they often refuse to pay. Health insurance companies have numerous excuses for not paying while at the same time charging a small ransom to be covered under their health plan.

The health insurance companies often claim that rates are high because of the ballooning cost of treating the elderly. This argument is a ruse as the elderly are already covered under Medicare! Furthermore, as we age, insurance companies charge us more because, potentially, we could cost the insurance companies more money, but in reality we should be given credit or lower premiums for all of the money/premiums we have paid to the health insurance companies over our entire lifetime.

We do not need health insurance companies. Without them, employers could send 50% of employees’ health care premiums to their employees’ HSAs and 50% to the QGO. We would use our own money in our HSAs to pay the doctors directly from our HSAs.

Using the 50/50 health care plan, health care costs would be reduced and everyone would be covered. There will no longer be a “hidden tax/cost” caused by the overhead of health insurance companies and corporate greed. Furthermore, there would be no more of the many disagreements with insurance companies over services or payments. Patients and doctors would decide the treatment that is necessary and the patient would pay for the services through either their HSAs or the QGO. No more billionaire insurance executives denying claims and the patient would have control over his/her money and health care.

By eliminating the middle-men (the health insurance companies), and by giving people the power to manage their health care through their HSAs we will have a more efficient and effective health care system and healthier lifestyles, since people are more prudent with their own money.


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