The Efficiency Costs of Tax-Financed Health Improvements

The fraction of gross domestic product (GDP) devoted to health care in the United States is the highest in the world and rising rapidly. Recent economic studies have highlighted the growing value of health improvements, but less attention has been paid to the efficiency costs of tax-financed spending to pay for such improvements. In a new study, Katherine Baicker and Jonathan Skinner use a life cycle model of labour supply, saving and longevity improvement to measure the balanced-budget impact of continued growth in the Medicare and Medicaid programs.

  • The model predicts that top marginal tax rates could rise to 70 per cent by 2060, depending on the progressivity of future tax changes.
  • The deadweight loss of the tax system is greater when the financing is more progressive.
  • If the share of taxes paid by high-income taxpayers remains the same, the efficiency cost of raising the revenue needed to finance the additional health spending is $1.48 per dollar of revenue collected, and GDP declines (relative to trend) by 11 per cent.
  • A proportional payroll tax has a lower efficiency cost (41 cents per dollar of revenue averaged over all tax hikes, a 5 per cent drop in GDP) but more than doubles the share of the tax burden borne by lower income taxpayers.

    Source: Katherine Baicker, Jonathan S. Skinner, Health Care Spending Growth and the Future of U.S. Tax Rates, National Bureau of Economic Research, February 2011.

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    First published by the National Center for Policy Analysis, United States

    FMF Policy Bulletin/ 1 March 2011
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