Blog of the Century

Meet “Dirty Dozen” Tax Break #7: Medical Savings Accounts

Blog Post by: Benjamin Landy, on December 19, 2012

In 2002, The Century Foundation convened the Working Group on Tax Expenditures to examine and propose reforms to the tax code. The resulting report, Bad Breaks All Around, identifies twelve tax breaks with little or no economic justification. These "dirty dozen" are no less ripe for the chopping block a decade later, as Congress finally takes up the task of simplifying the tax code. Follow along at Blog of the Century and on the "Dirty Dozen" expenditures homepage as we reintroduce each of the "dirty dozen" and explain why it's long past time to eliminate these costly tax breaks.

Since 2004, Americans with high-deductible health plans (HDHP)—a form of catastrophic coverage favored by the wealthy—have benefited from a tax exemption on savings for medical expenses held in Health Savings Accounts (HSA). These tax-free accounts, which replaced the earlier Medical Savings Account system, allow consumers to deduct income deposited into HSAs from their federal income tax, much like a traditional IRA contribution. However, both HSA deposits and investment earnings accrue tax-free, and are also tax-exempt when they are withdrawn for qualified medical expenses—a "rare triple play in the world of tax breaks," as the New York Times puts it.

With a price tag of nearly $2 billion a year in lost revenue, and a projected five-year cost of $11.8 billion by 2017, what do Americans get in return for the tax exemption on HSAs? The answer, according to health policy experts, is not much.

The idea behind HSAs for high-deductible health plans is that HDHPs give participants more "skin in the game," thereby discouraging unnecessary spending on medical procedures and putting downward pressure on the health care cost curve. However, this incentive effect only works when the majority of purchased care falls below the HSA deductible—otherwise insurance companies are picking up (and passing along) the cost. Unfortunately, the bulk of health care costs are driven by a small percentage of challenging cases, often associated with end-of-life care. This explains why nearly 80 percent of total medical outlays exceed minimum HSA deductibles. Those families that do spend less than the HSA deductible account for less than 4 percent of total medical costs.

Not only do HSAs fail to bend the health care curve in the way that advocates claim, they actually make the entire system more expensive for everyone else by reducing the social redistributive element of insurance markets: the small number of people who take advantage of high-deductible health plans and HSAs tend to be younger and wealthier than the average health insurance consumer, and a higher proportion of them are single. The tax break provided by HSAs is also greatest for those in the highest marginal income tax brackets, while providing little or no benefit to those without any federal income tax liability. Not surprisingly, GAO analysis found that the average adjusted gross income of HSA participants was about $139,000 in 2005, far above the average $57,000 for all tax filers. They also found, according to the Tax Policy Center, that "average contributions to HSAs were more than double the average withdrawals, suggesting that HSA participants were not high users of medical services or they used these accounts as savings vehicles—or both."

 

Learn more about the "Dirty Dozen" tax breaks here.