Universal Coverage:
How Do We Pay for It?

by Edie Rasell, M.D., Ph.D.

Physicians for National Health newsletter, September 1998

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 charges.

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 the program.

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 they insure.

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 health care.

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 out-of-pocket.

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 care system.

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 system.

Conclusion

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.

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