The Incidence of Financing National Health Spending

Grant Description: The researchers sought to examine who actually pays for health care expenses and the distribution of costs across the mixed public/private financing system. Specifically, they: 1) estimated the proportion of national health expenditures paid from all sources (federal, state and local taxes, private insurance premiums, and other out-of-pocket spending) by income, age, and health status at the national level for the 2004 – 2005 period; 2) estimated how the distribution of financing varies across particular state tax systems, for different public programs, and for public versus private systems; 3) compared the incidence of financing estimates across states with different tax structures; and 4) projected how the distribution will likely change under alternative assumptions for expanding coverage (e.g. a national approach using payroll taxes, state-based expansions, or expanded employer risk-pooling). The objective of this project was to provide policymakers with a better understanding of the implications of various revenue-generating systems for the equitable distribution of the financing of the health care system.

Policy Summary: National health expenditures (2.2 trillion dollars and 16 percent of GDP in 2007) are expected to double by 2018 and reach 25 percent of GDP by 2025. Although a large portion of funds flow into the system through employers and government at each level, ultimately individuals and families bear the final burden, or incidence, of all health care spending through taxes, reduced earnings on capital or labor, and direct out-of-pocket payments. The goal of this project was to develop an economic model of the incidence of financing from all sources of national health expenditures.

Publicly Financed Health Care

Taxes to support direct spending on health care consume almost 7 percent of family income (broadly definied), while tax expenditures to support private health insurance shift an additional burden of 2 percent of family income from the private to the public sector. The incidence of federal financing is progressive across all income groups, taking a larger percentage of income as income rises. In contrast, the pattern for state funding for health spending is mildly regressive although the degree of regressivity varies across states. Publicly funded expenditures for Medicare are progressively financed. The Medicaid program, by using a combination of federal and state tax revenues, also follows a progressive incidence. Thus, tax sources used at the federal level introduce a progressive element into public health care financing. The influx of federal tax dollars to help finance Medicaid, and at a higher rate in poorer states, plays an important role in not only moderating the otherwise regressive pattern of state taxes, but actually reversing it.

Privately Financed Health Care

Total after-tax spending (out-of-pocket and premiums) for health care consumes over 6 percent of family income (broadly defined) in total and is regressively distributed. In particular, out-of-pocket private spending is highly regressive, and especially so when out-of-pocket spending for long term care populations is considered. Private spending on premiums is generally regressive and the tax expenditure for employment based health insurance benefits higher income families. However, the financing of that benefit falls heavily on families in the highest and lowest income groups. This is true because, although low-income populatons have a lower probability of having employment based coverage, the payroll tax exemption of premiums is financed by all wage earners with incomes subject to payroll taxes. Thus, the tax preference for group health is, on net, a middle class benefit.

When considering public and private financing together, the system has become slightly less regressive than prior estimates using data from the 1980s.  This is generally a function of the increased share of total spending that is financed through the federal tax system.

Implications for Policy: To the extent that vertical equity is a goal for the financing of the public sector, maintaining or increasing the share paid by federal taxes is necessary. This has implications for considering the level and structure of federal Medicaid matching rates across states. The interaction between the public and private systems through tax expenditures also results in a need for vertical equity assessments than span all funding sources for the system (private premiums, out-of-pocket payments, state taxes, and federal/payroll taxes).