Why (and how) was health insurance so tightly tied to employment?
I understand that having health insurance as a benefit of employment seemed like a good idea during and after WWII, but how and why did it become such a dominant mechanism? It penalizes small businesses (smaller groups), not to mention the massive penalty on the self-employed and contractors, and overall makes very little sense. And yet I almost never hear anyone suggest breaking up the system, even within a single state, so that the "group" becomes everyone insured by the same company, or even everyone insured in that state. Is there some other mechanism that governs what a "group" is, or is it just a matter of what the underwriters have become used to?
Answer by Tom Lindholtz
Prior to about 1930 or so, there was, for practical purposes, no such thing as health insurance. Medical care was very low-tech, often delivered at home, and mostly palliative. Beginning around this time, however, Blue Cross and Blue Shield came into existence, but the need for them was not widely accepted and they grew very slowly at first.
During World War II, wage and price controls prevented employers from using wages to compete for scarce labor. Under the 1942 Stabilization Act, Congress limited the wage increases that could be offered by firms, but permitted the adoption of employee insurance plans. In this way, health benefit packages offered one means of securing workers. In the 1940s, two major rulings also reinforced the foundation of the employer-provided health insurance system. First, in 1945 the War Labor Board ruled that employers could not modify or cancel group insurance plans during the contract period. Then, in 1949, the National Labor Relations Board ruled in a dispute between the Inland Steel Co. and the United Steelworkers Union that the term "wages" included pension and insurance benefits. Therefore, when negotiating for wages, the union was allowed to negotiate benefit packages on behalf of workers as well. This ruling, affirmed later by the U.S. Supreme Court, further reinforced the employment-based system.
Perhaps the most influential aspect of government intervention that shaped the employer-based system of health insurance was the tax treatment of employer-provided contributions to employee health insurance plans. First, employers did not have to pay payroll tax on their contributions to employee health plans. Further, under certain circumstances, employees did not have to pay income tax on their employer's contributions to their health insurance plans. The first such exclusion occurred under an administrative ruling handed down in 1943 which stated that payments made by the employer directly to commercial insurance companies for group medical and hospitalization premiums of employees were not taxable as employee income. While this particular ruling was highly restrictive and limited in its applicability, it was codified and extended in 1954. Under the 1954 Internal Revenue Code, employer contributions to employee health plans were exempt from employee taxable income. As a result of this tax-advantaged form of compensation, the demand for health insurance further increased throughout the 1950s.
More details can be read here.
Answer by John Murdoch
1. Employee benefits are tax-free (the consumer tax loophole)
Health insurance is very expensive--in 2010, according to the federal government's Medical Expenditure Panel Survey, family health insurance coverage cost an average of just over $13,500 per year. When the employer provides that cost, it is not taxed as income--avoiding federal, state, and local income taxes on that amount. If you are earning between $34,000 and $83,000, that is $3,125 in federal income taxes you do not have to pay, and $1012.50 in Medicare and Social Security taxes you don't have to pay. In other words, when your employer pays the tab, you avoid $4,137.50 in taxes. (From the perspective of the Democrats, you're benefiting from $4,137.50 in tax expenditures.)
2. Employee benefits are tax-free (the employer's tax loophole)
In addition to the income taxes you don't pay, your employer doesn't have to pay some taxes as well. Employers pay a 7.5% tax on most employee wages--the employer's portion of Social Security and Medicare. So the employer avoids having to pay $1,012.50 in federal payroll taxes, as well any state or local taxes. Similarly, the employer does not include the cost of your health insurance policy in your income for purposes of paying unemployment compensation insurance or workman's compensation insurance premiums.
3. Health insurance ties the employee to the employer--depressing wages
Employees, particularly families, depend upon health insurance. Moving from one insurance plan to another can be frustrating--and many people are scared of being denied coverage for a pre-existing condition when changing plans.
Consider, for example, my nephew. He and his wife found out yesterday that they're not having a baby--they're having two. She has maternity coverage on their health plan now--but if he changes jobs, would the new insurance company view her pregnancy as a pre-existing condition, and refuse coverage? (That used to be the case, before the Health Insurance Privacy and Portability Act [HIPPA].)
That uncertainty (and the sheer hassle involved) discourages employees from leaving a job to find better opportunities elsewhere. That translates into lower costs of hiring and training new workers--and effectively depresses overage wages to employees. A gold-plated health plan becomes a barrier to leaving the employer.
4. Employer-provide health insurance limits loss exposure for insurers
Insurance companies like to insure people who are employed. Most companies have a defined sick leave policy--a week per year, two weeks per year, something like that. If you are out sick too often, you lose your job.
This means that people who are chronically sick (who tend to drive up plan expenses) are routinely eliminated from the insured pool--reducing the insurance company's payout for claims.