A Baucus Proposal Republicans Should Be Open To
Senator Max Baucus wants to limit the amount people can deposit into tax-free Flexible Spending Accounts to $2,500 a year. His goal: increase federal revenues to fund health reform. Ordinarily this would be a bad idea. However, if Baucus were to agree to allow unspent balances to roll over year-to-year in return for the cap, it’s a deal worth doing. The reason: It would revolutionize consumer-driven health care.
What’s Wrong with FSAs? Superficially, Flexible Spending Accounts (FSAs) seem similar to Health Savings Accounts (HSAs). In fact, many people get them confused. But the economic incentives these accounts create are profoundly different. The former encourages spending. The latter encourages saving. The FSA is what you would use if you know you are going to have health expenses and you want to pay them with untaxed dollars. The HSA is what you would use if you don’t know what your expenses are going to be and you perceive that self-insurance makes more sense than third-party insurance.
Under current law, only employers can offer FSAs. Once in place, employees can make monthly pre-tax deposits to their own account in order to pay medical expenses not covered by their health insurance plan. In principle, the amount of the deposit is unlimited. But because employers have to navigate various anti-discrimination rules, most limit the amount to $4,000 or $5,000 a year. Ironically, employees must decide how much to deposit into these accounts by the beginning of the year — before they know for sure what their actual health care expenses are going to be. Then they face a use-it-or-lose-it rule at year end, under which they must forfeit any unspent balances.
There are several reasons why economists tend not to like these accounts as they are currently structured. First, since they allow people to consume health care with pre-tax dollars, they encourage people to wastefully overconsume health care at the expense of other consumption. Second, the use-it-or-lose-it provision encourages additional waste at year end. Even if health care goods and services have very little value, people are encouraged to purchase them as opposed to forfeiting their remaining funds. They may buy designer eyeglasses, for example. One of our friends and his wife once scheduled his-and-her colonoscopies.
Superficially, it appears that FSAs could be an alternative to over-insurance through third parties. In practice, they do not function that way. Although the law allows employers to make deposits to these accounts, almost none of them do so. The reason: These accounts encourage wasteful spending rather than prudent self-management of health care dollars on the part of the employees.
What’s Wrong with HSAs? The law governing HSAs is way too restrictive, and that is why so many employers have been reluctant to take advantage of them. I once drew the diagram below for Bill Archer. It’s an example of one way to design an HSA plan. It’s not bad if you’re just starting out. But with the passage of time many people have discovered ways to improve on it. In the future, many more improvements will emerge. Unfortunately, Archer’s Ways and Means Committee codified the diagram when it created the Medical Savings Account pilot program in the 1990s. Bill Thomas’s Ways and Means Committee codified it again (with a few exceptions) in the 2003 legislation that created HSAs. Basically, federal law doesn’t allow you to have an HSA unless you have an across-the-board high deductible with the savings account below it.
What’s Wrong with HRAs? About the time that HSAs were getting underway, a favorable Treasury Department ruling permitted employers to create Health Reimbursement Arrangements (HRAs). Unlike HSAs, these accounts are completely flexible. There is no requirement of any deductible anywhere. In principle, they can wrap around any third-party insurance plan — paying expenses the plan does not pay for — as the diagram below illustrates.
The HRAs, then, have all the flexibility that HSAs lack. There is only one problem: employees can never cash out. They can only use HRA unspent balances for health care or health insurance premiums. And this restriction weakens the incentive effects that are needed if individual self-insurance is to become a full fledged alternative to third-party insurance.
Solving All These Problems with FSA-Plus. One simple change could convert FSAs that give people perverse incentives to overspend into a savings account which can function as true self-insurance: allow year-end account balances to roll over and grow tax free. Such a change would make the new account, call it FSA-Plus, better than either an HSA or an HRA. As explained here and here, FSA-Plus Accounts would have all the flexibility of the HRA and all of the cash withdrawal benefits of the HSA. And, whereas HSA and HRA holders number about 6 million each, there are about 35 million FSAs.
I acknowledge that we are still in a second best world. The ideal approach was outlined by Mark Pauly and me about a decade ago in a Health Affairs article. It requires lump sum tax credits and Roth Health Savings Accounts. But in the meantime, FSA-Plus Accounts would be a huge improvement on the current system.
I agree that FSA’s should have the roll over feature. It would simplify many aspects of health care administration and thereby the attendant costs. The other provision they are suggesting is to eliminate the eligibility of OTC drugs.
I am not in favor of this for the reason that as drugs go over the counter it gives greater advantage to their still prescription therapeutic equivalents.
See http://www.healthexpertease.org for more details on how this OTC restriction adversely impacts health care consumerism.
I agree FSA balances should roll over. But the perversion here is our tax laws themselves and the social engineering politicians try to accomplish through their manipulation. Fundamentally, our tax laws oppressive, confiscatory, unfair, and anti-competitive.
As for healthcare costs, it’s all about lifestyles; obesity, diabetes, diet and exercise.
Additional info on these plans.
FSAs are considered employer-sponsored health insurance. Even though the employee must make a twelve month commitment to whatever monthly amount that he wants to contribute through payroll deduction, technically the employer is on the hook for the annual funds to be contributed even if the employee leaves the company during the plan year. For example, if an employee commits to pay $100 and he has contributed for 2 months, and has a medical event with receipts totaling $1200, the employer must give him the full amount. If the employee quits the following month, the employer cannot recoop the funds from the employee. To help compensate the employer for this, the law provides that any unused funds at the end of the plan year return to the employer. Some would argue that letting these funds roll over or become portable, leaves the employer on the hook.
Many employers are moving to HDHP/HSAs(8 million people now). We are seeing companies drop their FSAs,partially because HSAs cannot be used in conjunction with an FSA unless it becomes a limited FSA. HSAs are becoming more popular because of fewer restrictions than FSAs:the funds are portable, earn interest, and do not require an annual commitment from employer or employee, and little, if any, cost for administration, unlike TPA fees for FSAs. HSAs are not considered employer-sponsored health insurance.
I should mention that HRAs can also cause waste, though not to the degree of FSAs,since the employee can’t cash out. Who wants to leave “Daddy’s money” on the table?
John — Your article seems to paint quite a negative picture of FSAs. Many of us regular FSA users know how to estimate our annuual election and therefore don’t forfeit eligible election dollars. This is the only tax avoidance program for the common man other than HSAs but it definetley is for an entirely different purpose than your HSA. We FSA users love our FSAs. I think you are attempting to be overly simplistic in your discssion when you refer to “depositing” funds in an FSA. No one deposits funds in an FSA. They are salary reduction programs and as such, there are no funds to be deposited anywhere. The entries an employer makes are all just journal entries. Further, the use it lose-it requirement is “over studied.” So long as a user has qualified expenses within 25% to 35% his election amnout (whatever his effective tax rate is) he will not have lost any ground on what would have been sent to Uncle Sam anyway. HSAs are great but don’t disparage FSAs.
Jerry, just because the system benefits you does not mean that it is socially good.
I absolutely must go see a shrink. This is the second time I agree with you.
To make it perfect, everyone putting money into an HSA should get a 30% tax credit. It irks me that you get a higher tax rebate. (Professors, of course, are in a lower marginal tax bracket.)
$2500/yr? My out of pocket has been $5000/yr several years running, except this year I am projecting $10000! And I have full fledged University insurance!
A problem with FSAs is that they can only be used during a short time horizon. Currently, you can set funds aside you estimate your family will need this year. If balances could be rolled over, you could set aside funds you know you will need two decades from now. Instead of gouging young people to cross-subsidize older, less healthy individuals, we need to give young people a vehicle to pool their own health risk across their productive lives. Repealing the use-it-or-lose-it provisions would go a long way to helping individuals save for health needs that will inevitably come later in life.
Is Professor Reinhardt asserting that Dr. Goodman is in a higher tax-bracket than Prof. Reihnhardt is? I hope all the scribblers on this blog are not going to have to disclose our incomes, like politicians do!
I suppose that it is just a consequence of the institutions of the American republic that “reformers” very seldom have the oportunity to wipe the slate clean and start over, like they might in a parliamentary system. Rather, as the shortcomings of previous “reforms” become evident, new bells and whistles are added to the machinery, without eliminating the incumbent shortcomings.
Look at how needlessly complex defined-contribution retirement savings is: 401(k)s, 403(k)s, IRAs, Roth IRAs, Rollover IRAs,…..
Because FSAs were the first attempt to give employees pre-tax dollars to spend on health goods and services of their own choice, I suppose they have the greatest shortcomings.
Employers should embrace the proposal of “FSA-Plus”, if only because it would allow them to motivate more employee loyalty.
He’d need to change the “use it or lose it” provisions as well as the employer forfeiture provisions.
@kerbo
Its not that FSAs are bad, because as you say many users know their costs. However done correctly they could revelutionize the consumer driven health market as Dr. Goodman points out.
I think of both FSAs and HSAs as mainly stopgap fixes to an insane tax system. Does it make sense to allow rollovers? Of course, but insignificant compared to reforming the tax treatment of health insurance.
In an ideal world I’d like to see migration toward a flat 20- to 25-percent tax credit toward premiums for health insurance that follows roughly the same rules as today’s employer-provided insurance, and a 10- to 12-percent tax credit toward HSA contributions (to split the difference between insurance-paid expenditures and non-health spending).
I believe that the “ideal approach” is to eliminate the tax exemption for health insurance entirely. This is what Milton Friedman believed.
There is no more reason for an employer to provide his employees with medical care than there is for him to provide them with food or clothing or housing… The best reform would be to eliminate the tax deduction of any medical care expenses. There is no more reason for medical care expenses to be tax deductible than for food, clothing, and housing expenses to be tax deductible.” (Milton Friedman Nov. 2004 – personal correspondence with David Gratzer published on page 186 of The Cure: How Capitalism Can Save American Health Care).
Put health insurance on a level playing field with other goods and services within our economy. Other things promote or preserve health and are not tax exempt. For example, large SUV’s are safer than small less expensive vehicles but don’t get a tax exemption under FSA’s, HRA’s, or HSA’s.
In addition, these tax gimmicks give policy wonks and university professors a tax advantage over self-employed lower middle class folk (the kind that pay for services post-tax at my medical practice) like carpenters, mechanics, farmers, and beauticians. The law currently excludes them from such benefits. In addition, they don’t keep up with the arcane minutiae of health insurance tax policy – most have not even heard of HSA’s, HRA’s, or FSA’s much less be able to distinguish among their provisions. Why should employees of large organizations and policy wonks benefit at the expense of kind of people who pay full price for their medical care but are less able to do so?
Simply the tax code by eliminating the tax exemption for health insurance completely so that the well connected and knowledgeable don’t benefit at the expense of people who build our houses, fix our toilets, and cut our hair.
Provider, I had to split this reply in two as directed by the site aiaindstrmtor. Here is the second half:Any individual who does not have acceptable healthcare according to the government will be taxed 2.5%p. 167Any non-resident alien is exempt from individual taxes (you and I will pay for them)p. 170, lines 1-3Officers and employees of healthcare administration (government) will have access to all Americans’ Financial and personal recordsp. 195The tax imposed under this section shall not be treated as tax p. 203, lines 14-15Government will reduce physicians’ services for Medicaid seniors, poor and low income will be very affectedp. 239, lines 14-24All doctors no matter what specialty will be paid the samep. 241, lines 6-8Government will set the value of doctor’s time, professional judgements literally the value of human lifep. 253, lines 10-18Government mandates and controls productivity for private healthcare industriesp. 265, sec 1131Federal government regulates rental and purchase of power driven wheelchairsp. 268, sec 1141Treatment of certain cancer hospitals cancer patients welcome to rationingp. 272, sec 1145Government will penalize hospitals for what the govt deems preventable re-admissionp. 280, sec 1151Prohibition on ownership and investment-the govt tells doctors what and how much they can own p. 317, lines 13-20Prohibition on expansion govt mandates if hospitals can or cannpt expandp. 317-318, lines 21-25, 1-3Hospitals have the opp’ty to apply for exception but community input is req’dp. 321, lines 2-13Rationing gov’t mandates establishment of outcome-based measures healthcare the way they want itp. 335, lines 16-25 & pp 336-339Gov’t has authority to disqualify medical plans, HMO’s, etc, forcing all into the govt’ healthcare planp. 341, lines 3-9Government will restrict enrollment of special needs individualsp. 354, sec 1177Government creates MORE bureaucracy: telehealth advisory committeep. 379, sec 1191Gov’t mandates advanced care planning consultation srs will be interviewed every year for health issues and decisions made as to what care they can and cannot receivep. 425, lines 4-12Gov’t will instruct and consult regarding living wills and durable powers of att’y this is mandatoryp. 425, line 17-19Gov’t provides approved list of end of life resources guiding you in deathp. 425, line 22-25; 426, lines 1-3Gov’t mandates program for orders for end of life the gov’t has a say in how your life endsp. 427, lines 15-24Advanced care plannning consultation will be used frequently as patients health deterioratesp. 429, lines 1-9Advanced care consultation may include an order for end of life plans an order from the gov’tp. 429, lines 10-12Gov’t will specify which drs can write an end of life orderp. 429, llines 13-25Gov’t will decide what level of treatment you will have at end of lifep. 430, lines 11-15There will be community-based home medical services such as ACORNp. 469There will be one monthly payment to such community-based organizationsp. 472, lines 14-17Gov’t will cover marriage & family therapy which means they’ll insert gove’t into your marriagep. 489, sec 1308Gov’t will cover mental health services including defining, creating and rationing those servicesp. 494-498 2 trillion dollar price tag
I have a hypothetical sitiotuan for you. Lets say you decide to exercise your right and do not take healthcare. Now lets say you get into an accident or discover you have cancer or just randomly drop with a heart attack. You will now be responsible for all the doctor, hospital, and medical fees associated with this incident. Now let say you do not have to money to pay for these bills (most Americans) which can come to millions of dollars. Who will be responsible for paying these fees? Certainly the doctors will not be giving away their services for free. This is where everyone who pays for health insurance will be responsible to foot your bill. Seems pretty hypocritical to expect other people to pay for services you receive for free while never contributing your share. I’m all for giving people the right to buy or not buy insurance, but with that right I think people who do not elect for insurance should not be allowed to use ambulances, hospitals, etc. that my insurance premiums help pay. So you can elect to not have insurance and then if something terrible were to happen to you, you will not be able to get medical help in any form, this IMO is much less ethical, constitutional or moral than simply making everyone be insured.
This information would be more hpfulel if you included the cost of the healthcare in both societies. I could live a far more comfortable life if I maxed out six credit cards today. I would have much better living, eating, and playing conditions. I may even prefer living that way. Overall, would you say I’m ahead of someone who lives beneath their means and pays cash, even if it means a less luxurious lifestyle right now? I’d recommend checking out John Stossel’s video on healthcare. Just search Youtube for it. By far some of the best information about how insurance for every single medical need drives up the cost of medicine. Not to mention since medicine is hugely R&D, it costs a lot of money to get the latest treatment. But try telling someone suffering from some illness to get a less expensive, older treatment. I can tell you exactly how likely they are to opt out of the most expensive option available.