Last week, the House passed, by a vote of 277 to 142, a bill that would allow for more money to be contributed to health savings accounts (HSAs), for more people to have HSAs, and for HSA funds to be spent on more things — gym memberships, over-the-counter drugs, and feminine hygiene products. Supporters claim these new tax breaks, which will cost more than $40 billion over 10 years, will help make health care more affordable and less wasteful. Instead, these seemingly innocuous HSA extensions have the potential to make our health care system both less equitable and more costly.
Since 2003, taxpayers with high-deductible health plans that meet certain eligibility rules may make pretax contributions to an HSA and spend those funds on qualifying medical expenses. The money in an HSA accumulates tax-free over time and can be withdrawn tax-free and used for any purpose after retirement age. This can create an incentive for people to save their HSA funds for retirement, rather than spend those funds on medical services. Because HSAs, and the resulting tax-free retirement savings, are only available to those who choose a high-deductible plan meeting HSA eligibility criteria, these rules also provide an incentive for people to choose high-deductible health plans. High-deductible plans, in turn, could cause people to use less health care than they would if insurance covered a larger share of their costs of care.
By design, HSAs provide greater benefits to high-income people in higher tax brackets who have enough disposable income to put some aside as health savings. The U.S. Treasury finds that over 60 percent of all HSA tax benefits accrue to families earning more than $100,000 annually.
The bill passed by the House would aggravate the regressive distributional effects of HSAs, in the guise of improving access to valuable services. Consider a family’s choice between a $600 annual gym membership and a $600 TV. Lack of fitness is a real problem, especially for lower-income Americans, so subsidizing gym memberships relative to TV purchases might be a desirable policy. But it doesn’t make much sense to do it via HSAs. Under the House bill, high-income people in the top tax bracket who pay for gym memberships through their HSAs will get a 44.6 percent tax discount, meaning that buying the gym membership would cost them $268 less than buying the TV. A median-income household in a lower marginal income tax bracket would face a much smaller incentive of just $118 to do so — assuming they had funds set aside in HSAs. Most low-income people won’t benefit at all. Not only would their tax-based discounts be smaller, most won’t have funds available to put in HSAs to begin with. According to IRS data, in 2013, just 0.3 percent of households with incomes below the U.S. median claimed a deduction for making an HSA contribution.
This pattern may be an inefficient way to use scarce government money. High-income people are already likely to have gym memberships. For most, the HSA policy will just shift part of the cost from their pocketbooks onto taxpayers — a textbook example of government funds crowding out private dollars.
The provisions in the bill that focus on clinical services may also make the health care system itself more costly, with the burden felt most by lower- and middle-income families. HSAs can only be used with high-deductible plans, which discourage people — particularly lower-income people — from using care (for better or worse) because they have to pay so much of it out of pocket. In addition, high-income people can use their HSAs to not only sock away money for retirement but also to get a discount on care. This discount will lead them to increase their use of services, including unnecessary care, raising insurers’ costs and therefore premiums for everyone, at the expense of taxpayers in general. Middle-income consumers will be stuck with bigger premium bills and only modest discounts, which does little or nothing to help them afford needed care. In that way, HSAs actually undo the savings effects of high-deductible plans and increase premiums for all enrollees, including the lower- and middle-income families who don’t benefit much from the HSA tax breaks. That’s already the paradox of HSAs — and it would be aggravated by the House bill.
The bill also has a provision to allow HSAs to be used for expenses incurred before the account is even created: a “grace-period” provision. Rather than saving in case you need care in the future, as the original HSA design intended, you could first use medical care, and then decide to open an HSA – using pretax dollars. Assuming you have enough funds on hand to pay medical bills, you can get a discount equal to your marginal tax rate on an unexpected out-of-pocket medical bill.
Common sense and economic theory tell us that to achieve an equal effect on deterring unnecessary health spending, out-of-pocket costs ought to be higher for high-income people and lower for low-income people. HSAs already have that backward, with potential new provisions exacerbating the problem.
Expanding the reach of HSAs, which the House has passed and now awaits consideration by the Senate, is a policy that masquerades as harmless to most, with potential benefits to some. It’s not. It will exacerbate inequalities, increase government spending, and raise health care cost burdens on middle-income families.