Document Type

Working Paper

Publication Date



Tax Policy, Health Insurance, Income Inequality, Consumer-Driven Health Care


Because current tax laws exclude employer-paid health insurance premiums from employees’ taxable wages and income, employer-sponsored insurance remains the primary source of health insurance for most employed Americans. Economists have long blamed the employer-based insurance tax exclusion for inflating health care costs, and, more recently, for constraining income growth and exacerbating income inequality.

We execute a simulation to test the effect of permitting employees to receive their employers’ premium contribution directly and then purchase health insurance themselves, using tax-free funds. Employees could deduct for income tax purposes the amount used for insurance and, if they spend less than the amount transferred, take the remainder as taxed income.

Our simulation indicates that in this consumer-driven system many workers would trade some insurance dollars for higher income, even if the latter is taxed. Our alternative tax treatment causes annual after-tax household income to grow by more than $160 billion and federal tax revenues by more than $46 billion. Along the way, take-home pay inequality is reduced, and the greater take-up of slimmed down policies could lead to greater cost control.

We conclude that a simple change in the tax treatment of employer-sponsored health insurance can give workers the flexibility to economize on health insurance purchases. With this flexibility, many workers will select health plans that are less expensive than those now chosen for them. This will inject much-needed price competition in health insurance markets. It will also allow workers to enjoy more take-home pay, thereby counteracting the negative and regressive effects of escalating health care inflation. These results cannot be achieved from granting tax credits for the purchase of health insurance because such credits do not permit workers to trade insurance dollars for wages.

Library of Congress Subject Headings

Health insurance, Cost of medical care, Consumer-driven health care, Taxation, Income distribution