How Do We Pay for It?
by Edie Rasell, M.D., Ph.D.
Physicians for National Health newsletter, September
While universal insurance coverage has been the goal of health
care reformers for many years, the specifics of how to equitably
finance such a system are less well understood. One way to more
equitably finance health care would be to replace current out-of-pocket
spending and households' purchases of health insurance premiums
with revenues from an increase in the federal personal income
tax. For the average, middle-income household, this would mean
a tax increase of $731 in 1998. In exchange for the tax increase,
no one would need to buy health insurance or face any out-of-pocket
The financing system described here is designed to function
within a health care system that provides universal coverage for
all medically-necessary services for either all or part of the
population.' The health care system would also include the following
cost containment components: a global budget with enforcement
mechanisms, capital planning and budgeting, a single payer, and
negotiated reimbursement rates. In addition, the link between
employment and health insurance coverage would be severed.
Money that pays for health care flows from a variety of sources,
including income and payroll taxes, purchases of premiums, and
out-of-pocket expenditures. Within each of these funding streams,
the share of income paid for health care varies by household.
When higher-income households pay a larger share of income than
lower-income households, (as in a graduated income tax), the funding
stream is progressive. When the reverse is true and lower-income
households pay a higher share of income than do upper-income ones,
then the funding sources is regressive. Progressive financing
is considered more equitable than regressive.
The following principles shape the financing system: progressive
sources of revenue; no financial penalty for being ill or using
services, that is, no cost sharing; and minimized transition costs-the
new financing system should build on the current one where possible.
How Much Will It Cost?
The new system would change the costs of health care in four
ways. First, the currently uninsured and underinsured will gain
full insurance coverage, increasing their access to and use of
services. Second, reductions in cost sharing could similarly lead
to increased utilization by the already insured. However, administrative
costs will fall due to the single payer. Fourth, new cost containment
features will provide a better constraint on cost growth in the
years after the plan is implemented.
There have been just a few estimates of how national expenditures
would change under a universal, single payer system. However,
they generally agree in their findings: the effect on spending
would be minimal and within a very few years, expenditures under
the new system would be lower than under the old. The General
Accounting Office (1991a) estimated that a shift to a single payer,
universal system could occur with essentially no change in total
expenditures. The Congressional Budget Office (1993) estimated
that S. 491 (Senator Paul Wellstone's American Health Security
Act) would raise national expenditures above baseline (the level
of spending that would have occurred if no changes in the system
had been made) by 4.8% in the first year after implementation.
However, in subsequent years, improved cost containment would
reduce the gap between expenditures in the new system and the
baseline. By year five (and in subsequent years), the new system
would cost less than baseline.
In the financing model presented in this paper, I assumed
that in the first year after implementing a universal, single-payer
plan, total national health expenditures would be unchanged from
baseline. If expenditures were higher than baseline in the first
few years, then additional revenues above those described here
would be needed. However, these higher costs would be more than
offset by savings that would accrue within the first decade of
New Ways to Fund a Health Care System
Under a new system, service delivery could continue more or
less unchanged. However, some health care payers (the people who
pay the bills-for example, private insurance companies, Medicare,
and Medicaid) and some of the funding sources would be eliminated
to increase the progressivity of financing. Ending regressive
financing would primarily impact private health insurance companies.
Insurance firms obtain their funds from premiums paid by the people
Even when people obtain health insurance through an employer
who pays some or all of the cost, wages are reduced to offset
this expense, so employees actually bear most or all of the cost
of their premiums. Since the price of a particular insurance policy
is the same regardless of a household's income, this means that
a low-income household (that has private insurance) pays a larger
share of its income for a premium than does an high-income household.
This regressive source of financing would need to be replaced.
Cost sharing and out-of-pocket spending should also be avoided
since these expenses fall disproportionately on people who use
the most services (the less healthy members of the community)
and the costs are not assessed in relation to income. As a rule,
progressive income taxes are the most equitable way to pay for
The Current Financing System
In 1995 (the last year for which these data are available),
federal, state, and local governments were the largest purchasers
of health care services, responsible for 44% of the national total:
33% by the federal government and 11% by states and localities.
(Including Workers Compensation spending and payments made by
the public sector in its role as an employer purchasing health
insurance for employees raises the total to 52%.) Employers' spending
for health care (primarily for insurance for employees) was approximately
28% of all health expenditures. Households accounted for 26% of
the total. Non-patient revenues, for example, charitable donations
and net revenues from sales in hospital gift shops, were 3% of
funds. The sources of this money are now examined to determine
whether the funding stream should be eliminated and/or changed
in a new system.
Households: Households' contributions to private health insurance
premiums, including employees' payroll deductions for health insurance
premiums, constitute 7% of all money flowing into the health care
system. Since premiums are regressive, this funding stream would
need to be replaced.
Households' out-of-pocket expenditures account for an additional
19% of all health care dollars. Table 2 shows the services currently
purchased out-of-pocket. A few of these services are not medically
necessary and would not be covered under the new system, for example,
cosmetic surgery and most non-prescription drugs. But all medically-indicated
services, approximately 80% of current out-of-pocket expenditures,
or 15% (19% x 0.80) of all health expenditures would be covered.'
Some 4% of national health expenditures would continue to be financed
Businesses: Businesses currently are responsible for 28% of
all health care spending. There are a number of reasons why reforms
are needed in the way businesses pay for health care. First, as
mentioned, although employers often pay some or all of the cost
of employee health insurance, wages are reduced to offset at least
part of this expense. So employees indirectly bear most of the
cost of premiums. Second, to the extent that some of the cost
of employee health care is ultimately borne by firms, profits
are lowered. This places a firm that is "doing the right
thing" by providing health insurance for its workers at a
competitive disadvantage compared with a firm that does not provide
health coverage. To level the playing field, all employers must
share in the responsibility for paying for health care.
A more equitable way for this money to be raised would be
through a payroll tax that brought in the same amount of money
as was paid for premiums under the current system. Since this
payroll tax could be collected as part of the existing payroll
tax system, it would be quite simple and inexpensive to administer.
Employers currently pay about $307 billion for health care while
wages and salaries total about $4,500 billion. Therefore, a payroll
tax on all employers of slightly less than 7% would also raise
about $300 billion. Some employers who currently pay a large amount
of money for employees' health care would see their costs fall.
(These savings should be passed on to workers as wage increases.)
Other employers that currently spend little for health care would
see their costs rise. Workers, who ultimately pay these taxes
through lower wages, would face costs equal to 7% of their earnings.
However, this 7% tax would fall evenly on all workers.
Federal Government: As with other premiums, Medicare Part
B premiums paid by those seniors choosing to participate in Medicare
coverage for doctors visits (2% of all health expenditures) should
be replaced. Current Medicare payroll taxes, 2.9% of all wages
and salaries, would continue to flow unchanged into the system
although the Medicare program would no longer exist as a separate
system. Other federal payments (for Medicaid, the balance of the
Medicare system, and other federal health programs) are paid out
of general revenues raised through personal and corporate income
taxes, excise taxes, and other taxes and fees. Under the new system,
these revenue streams would continue to provide the same level
of resources for health care.
State government: These funds, in the same amount as under
the current system, would continue to flow into the new health
Non-patient revenues: These funds would continue in the new
health care system.
Replacements for Regressive Funding
Three funding streams have been identified that would need
to be replaced:
* households' purchases of private health insurance premiums,
7% of total health care spending, or $80 billion in 1998;
* 80% of household out-of-pocket spending, 15% of total spending,
or $171 billion in 1998;
* expenditures on Medicare Part B premiums, 2% of spending,
or $23 billion in 1998.
In 1998, $274 billion in health care funding would need to
be replaced out of an estimated $1,138 billion spent for health
care (CBO 1998). Of all the money currently paying for health
care, fully 76% would continue to be raised as is currently done
with changes within the employer funding stream as described.
Since total expenditures would be unchanged, the changes in financing
simply shift costs among payers.
The scenario presented in this paper assumes that these funds
would be replaced with revenue from the federal personal income
tax, the most progressive source of funding. However, if funding
was reduced for other federal programs, for example, the military,
then the amount of replacement funding needed would be reduced.
In addition, if a higher level of cost sharing were retained or
if more money were raised from employers, it would be possible
to fund a universal system with a smaller increase in taxes.
In 1998, the average, middle-income household will have an
income of about $37,290 and pay about $2,088 (5.6% of income)
in federal personal income taxes. (If this number seems small,
it is because it omits payroll taxes; nearly three-quarters of
households pay more in payroll taxes than federal income taxes).
Fully replacing the needed health care funding would require this
average household to pay an additional 2% of income in federal
personal income taxes, or an additional $731, raising its total
to $2,819. The increase for households with incomes below this
level would be less than 2% of income, and the increase would
be larger for upper-income households. Table 3 shows the necessary
tax increase for households in five different income categories.
Because a system exists to collect personal income taxes, the
administrative costs of this change are trivial. In exchange for
the tax increase, no American would have to buy health insurance
or face any out-of-pocket charges. Everyone would have access
to all needed health care services and their insurance could never
be lost or taken away. We would also gain a much more efficient
A publicly-funded, universal health care system is possible.
However, to improve equity, new funding would be needed for the
24% of health expenditures that are currently paid by funds from
regressive sources. These replacement funds should be raised through
an increase in the federal personal income tax, the most progressive
way to fund health care. For an average, middle-income household,
taxes would rise by $731. In other words, for fully 60% of households,
the increase would be about $731 or less. For another 20%, the
increase would average about $1,600. Only the 20% of households
with the highest incomes would face a larger tax increase. In
exchange for the tax increase, premiums and out-of-pocket spending
would be eliminated. Costs would be redistributed from the sick
to the healthy, from low- and middle-income households to those
with higher-incomes, and from businesses currently providing health
care benefits to those that do not. Just as important, greater
efficiency and improved cost containment would become possible,
leading to sizable savings in the future. The impediment to fundamental
reform in health care financing is not economic, but political.