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The Small Business Survival Committee's
21st Century Small Business Policy Series
Medical Savings Accounts:
The Necessary Centerpiece
of Health Care Reform
by Raymond J. Keating
reprinted with permission
The True Health Care Crisis
A health care crisis looms in the United States. However, it is not the "crisis" we regularly read
about in newspapers, see on television, or hear from the mouths of far too many politicians and so-
The conventional wisdom regarding health care would have us believe that the marketplace has failed
consumers to a great extent, and therefore, the government needs to step in and solve the problem. The
so-called solutions range from new regulations and mandates to expanded government programs to even the
outright takeover of our health care system by government.
In fact, the major health care problems in this nation largely spring from too much government
involvement, not too little. Ironically, the looming crisis in health care is the threat that those
calling for greater regulation, expanded government programs, and socialized medicine might succeed.
The greatest strength of the U.S. health care system is that it primarily is a private system. To
the extent that health care in the United States works unencumbered by government price controls,
regulations and funding, and instead is guided by prices, profits and incentives to invent and
innovate, health care consumers become the winners.
Instead of moving toward more government, policymakers at the federal and state levels need to be
considering market-based reforms that will truly help health care consumers. Perhaps the most critical
measure would be the expansion of access to tax-free medical savings accounts (MSAs) in order to
enhance choices for consumers in the health care marketplace.
The Problem, Not the Answer
Government involvement in health care has been on the rise for decades. In fact, some kind of
government-run health care system or mandated health insurance has been under consideration on and off
since the 1930s.
After failing to achieve a complete government takeover of the U.S. health care system during the
1930s and 1940s, proponents of increased government involvement chose a more incrementalist strategy.
Disability coverage, for example, was added to Social Security in 1956 and Medical Assistance for the
Aged (MAA) was created in 1960. As health care analyst Charlotte Twight has pointed out, MAA was meant
to derail broader efforts to inject government in the health care marketplace. In reality, it only
served as another stepping stone to big government health care.
The Problem of Third-Party Payments
It must be understood that government's ever increasing role in health care vastly accentuates the
problem of third-party payments, which push the costs of health care ever higher. Insurance, of course,
makes perfect economic sense. Health insurance, properly understood, protects individuals against
large, unpredictable costs. That is, it protects against catastrophic events. However, employer-
provided health care plans and government programs have ventured far beyond the basic concept of
insurance to offer first-dollar coverage for small and predictable expenses.
When a third party-whether an employer-provided health plan or the government-picks up the tab for
reasonable and predictable health care spending, demand is driven up, and consumers and health care
providers possess few, if any, incentives to be concerned about costs. The result is higher costs. In
this sense, Americans are not under-insured, as is the conventional wisdom, but instead are over-
insured. The government's role as third-party payer has been on an unmistakable upward trend, as noted
in the following table.
National Health Care Expenditures
|Percent Private %
|Percent Public %
DATA SOURCES: Health Care Financing Administration and U.S. Census Bureau.
The increasing role of third-party payments is made most clear by noting the dramatic decline in out-
of-pocket payments by consumers.
National Health Care Expenditures: Private Out-of-Pocket Payments as a Percent of Total
|Percent Private Out of Pocket
DATA SOURCES: Health Care Financing Administration and U.S. Census Bureau
While some of the increase in health care costs in recent decades reflects the very positive
developments of better care, more treatments, and longer life spans, a significant portion clearly can
be attributed to this vast expansion in third-party payments. In particular, the aforementioned
combination of falling out-of-pocket payments and rising government funding has been a major impetus
to rising health care costs. Not only do consumers and providers have few incentives to be concerned
about costs, but the incentives in government make matters far worse as well. When spending other
people's money, politicians and government bureaucrats also possess no real incentives to watch costs.
As a result, the tab for taxpayers predictably skyrockets. Just consider Medicare, for example.
Since 1966, payroll taxes dedicated to funding Medicare Part A, Hospital Insurance, have been increased
36 times-26 increases in the applicable tax base and 10 hikes in the tax rate.
Eventually, cost control measures are attempted, namely, price controls and rationing of care. Of
course, these measures carry their own costs. Price controls diminish incentives for production,
innovation and invention, thereby threatening both the short-term and long-term health of consumers.
Meanwhile, rationing of care creates immediate, obvious dangers. After all, waiting lists literally can
be deadly. People suffer whichever path government chooses to deal with rising costs-higher taxes,
price controls and/or rationing of care. In fact, extensive government involvement in health care--as
illustrated in nations like Great Britain that have established socialist health care systems--usually
brings about all three of these dire outcomes.
Debate Over Health Care on Wrong Track
The current health care debate continues to be pointed in the wrong direction. For example, it does
not seem to be questioned in political circles whether or not Medicare should be expanded to include
prescription drugs, but only to what degree and by what means. Few, if any, elected officials seem to
disagree with the proposal that Medicare should continue to be bailed out to the tune of hundreds of
billions of taxpayer dollars in coming years. And the only disagreement on the regulatory front is how
far new mandates and regulations on HMOs should go, including an expanded right to sue health care
plans. Though often not readily apparent to consumers, the costs of increased regulation in health care
are quite real. Specifically, more mandates and increased regulation raise the costs of doing business,
increase the cost of labor relative to capital, reduce the rate of job creation, reduce salaries and/or
other employee benefits, and force many businesses to cease offering health care benefits.
Despite all the sweet rhetoric, increased government involvement in health care is ultimately a
bitter pill for consumers. Contrary to what the advocates say, increased regulation and mandates simply
drive up costs, resulting in reduced access to affordable, high quality health care.
Medical Savings Accounts
The U.S. health care system does not need more command and control through government. Instead,
market reforms are required that will spur choice and competition.
One of the most pro-consumer health care reforms would be lifting the artificial, government-imposed
constraints placed on tax-free MSAs. MSAs directly redress the woes of third-party payments, not to
mention allowing consumers-rather than some distant government or HMO bureaucrats-to make their own
health care decisions.
Quite simply, MSAs combine a traditional high-deductible, catastrophic insurance policy and a tax-
exempt savings account, or MSA. Consumers use the funds deposited tax free in their MSA to pay for
routine medical care. If they have a year with high medical expenses, use up all the funds in their
account and reach their deductible on the insurance policy, then the insurance policy kicks in to pay
remaining medical bills. If they have a year with minimal medical bills, then they keep the funds left
in the account and the interest earned.
There are enormous benefits to MSAs, including:
- The third-party payer problem is redressed. With MSAs, the traditional buyer-seller relationship
in the marketplace is reestablished. Unlike when some third party pays, consumers and health care
providers become concerned about costs with MSAs. In addition, since the funds deposited in the MSA
are the property of the individual, demand for services is not artificially juiced up. Make no
mistake, when consumers get to keep what they do not spend, they are simply more inclined to check
prices and bills, and work to keep costs down.
- All medical expenses are covered, including prescription drugs, and no limits exist in terms of
choices of doctors, hospitals, and specialists.
- Individuals and their doctors make health care decisions, not some distant bureaucrat. This, along
with the fact that MSAs are combined with catastrophic insurance policies, makes MSAs appealing to
those suffering from illnesses and the elderly.
- Given that individuals make their own health care decisions, have the ability to build up savings
through MSAs, and can spend MSA monies on IRS-approved medical expenses, incentives to obtain
preventive care are clear.
- The money left over in an MSA each year could be rolled into an IRA, allowing savings to be built
up over a lifetime for health care expenditures in later years, such as for the purchase of high-
MSAs turn out to be one of the best remedies to a host of problems plaguing our health care system,
including third-party payments, Medicare and Medicaid costs and reforms, prescription drug coverage,
the uninsured, and access and affordability. For example, as economist Milton Friedman points out in
the Winter 2001 issue of "The Public Interest," by offering a voucher option for Medicare and
Medicaid, consumers could buy into an MSA program which allowed for full choice of providers and
treatments, including prescription drugs. Friedman explains:
Medical savings accounts offer one way to resolve the growing financial and administrative
problems of Medicare and Medicaid. Each current participant could be given the alternative of
continuing with present arrangements or receiving a high-deductible major medical insurance
policy and a specified deposit in a medical savings account. New entrants would be required to
accept the alternative. Many details would have to be worked out? Yet it seems clear from
private experience that a program along these lines would be less expensive and bureaucratic
than the current system, and more satisfactory to the participants. In effect, it would be a
way to voucherize Medicare and Medicaid. It would enable participants to spend their own money
on themselves for routine medical care and medical problems, rather than having to go through
HMOs and insurance companies, while at the same time providing protection against medical
Unfortunately when tax-free MSAs were first established as a pilot program in 1996 as part of the
"Health Insurance Portability and Accountability Act," many restrictions were imposed,
The current restrictions need to be abandoned, so that consumers have more choices in the health
care marketplace. Specifically:
- The number of accounts was capped at 750,000.
- MSAs were only made available to the self-employed or to businesses with 50 or fewer employees.
Self-employed and small employers who were previously uninsured did not count towards the
aforementioned 750,000 cap, so the actual number of tax-free MSAs could exceed that number.
- Deductibles must be between $1,500 and $2,250 for individuals and $3,000 and $4,500 for families.
- Tax-free deposits into MSAs were limited to 65 percent of the deductible for individuals, and 75
percent for families.
- Either the employee or employer could contribute to the MSA, not both.
- And the program was set to expire on December 31, 2000. At the end of 2000, this pilot program was
once again extended for two more years.
- MSAs need to be made permanent.
- All caps on the numbers of MSAs should be removed.
- MSAs should be made fully available to all health care consumers, including individuals, employees
at all types and sizes of businesses, and Medicare and Medicaid recipients.
- Minimum allowable deductibles should be reduced.
- Tax-free deposits into MSAs should be allowed to cover any share of the deductibles for the
accompanying catastrophic insurance plans.
- Both employees and employers should be able to contribute to MSAs.
- In addition, as the National Center for Policy Analysis has suggested, back-ended MSAs should be
allowed. Front-ended MSAs allow for deposits to be made with pre-tax dollars, with the funds not
spent on medical care taxed upon withdrawal. Back-ended MSAs would eliminate the tax bias in favor
of medical expenses by allowing for deposits with after-tax dollars, and withdrawals made tax free
for any reason after an initial one-year insurance period.
In the end, expanded use of MSAs would reduce overall health care inflation, and restrain the costs
of government health care subsidies. Businesses would experience lower health care costs for their
employees. And health care consumers would have greater access to affordable health care, and would be
empowered to make their own health care decisions.
As noted at the outset of this policy analysis, big government is being sold as the answer to what
ails our health care system. In reality, more government involvement is poisoning health care. Pro-
market reforms-most importantly, lifting the burdensome rules and regulations placed on tax-free MSAs-
are the correct remedies.
About the Author
Raymond J. Keating serves as chief economist for the Small Business Survival Committee. He is the author of
hundreds of booklets, studies, and articles. Keating's latest book is U.S. by the Numbers: Figuring What's Left,
Right, and Wrong with America State by State (Capitol Books, 2000). He also is a weekly columnist with
The Small Business Survival Committee (SBSC) is a nonpartisan, nonprofit small business advocacy group with
over 70,000 members across the nation. For more information, please visit SBSC's website at www.sbsc.org