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How to pay for health reform: Taxes

Posted Jul 10 2009 10:21pm

The New York Times is reporting that “to pay for a sweeping overhaul of the health care system, House Democrats will propose a surtax on individuals earning $280,000 and up and couples earning more than $350,000.”  Now, taxes in and of themselves need not be distortionary.  Let us assume that your employer takes $10,000 from your paycheck currently to pay for your health insurance.  If the government would no provide you with health insurance, you would receive $10,000 in extra wages from your employer and you pay a tax of $10,000 to the government for health insurance.  In this cases, taxes are not distortionary.

This scenario of course assumes that government and private health insurance are of equal value.  If private health insurance is of higher quality, this could result in a decrease in efficiency; if government health insurance is of higher quality, this could be an efficiency improvement.

However, taxes are charged according to health insurance demand or even in a lump sum fashion.  Instead, the rich will pay more in taxes than they will receive from government health insurance benefits and the poor will pay less in taxes than they will receive in health insurance benefits.  Further, since the proposed tax is only on those individuals earning $280,000 or more, the tax will almost certainly be distortionary in some manner.  Although this progressive tax will create some distortions, it could cure others.  For instance, government health insurance could help to reduce labor market inefficiencies caused by Job Lock and Job Stretch.

I wonder how many doctors will support health reform now?   A public plan will increase their revenues as more of their patients receive insurance, but a higher percentage of their profits will be taken by the government due to the proposed surtax.  As any economist knows, life is full of tradeoffs.

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