Section of Taxation Publications
  VOL. 60
NO. 2

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Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.

Michael P. Spiro*

* Attorney, Flaster/Greenberg, P.C., Cherry Hill, New Jersey; Brandeis University, B.A., 2001; University of Pennsylvania, J.D., 2004; Temple University, LL.M. (Taxation), 2007


A. Background: The Theory of Consumer Driven Health Care

It has been reported that the United States spends an aggregate of $1.7 trillion per year on health care, which represents 15% of total economic output. With the aging and retirement of the baby boomer generation, the cost of retiree health care is projected to increase drastically in the coming years. According to a 2006 estimate, the average couple retiring in 2006 will require $200,000 in order to cover out-of-pocket medical expenses over the course of a 20 year retirement. The massive costs associated with health care have led to many governmental attempts at reform and, in recent years, these reforms have focused on transitioning the provision of health care to a more consumer-driven approach.

The rationale behind consumer-driven health care is that the economic inefficiencies caused by an employer-based system have both contributed to the spiraling cost of health care and prevented individuals from taking responsibility for containing the cost of their own health care needs. In short, the health care market has been a victim of what is known in the insurance field as moral hazard, which occurs “when insurance coverage increases the likelihood of incurring a covered expense or increasing the size of the covered expense.” Through significant tax advantages, Congress has incentivized employers to create generous employee health benefits. The promulgation of these generous benefits has caused both patients and providers to ignore economic reality in making health care decisions. Since modern health insurance tends to cover almost all medical expenses, Americans have an economic incentive to maximize their consumption of health care. Moreover, “with increased demand and price insensitivity on the part of health care consumers, medical care providers can raise their fees.” The result of this moral hazard has been twofold: (1) it has engendered sky rocketing health care costs, and (2) it has prevented individuals from accumulating savings for their future health care needs in retirement, causing an increased reliance on the Medicaid system to supplement insufficient retiree savings.

Consumer driven health plans (CDHPs) seek to reduce this moral hazard by placing more responsibility for health care budgeting in the hands of consumers. CDHPs generally allow consumers to combine high deductible insurance plans with tax advantaged savings plans for health care expenses, thus creating a consumer-based market for normal health care costs while preserving catastrophic health care coverage. By placing more responsibility for cost-monitoring and saving in the hands of individuals, Congress hopes to both reduce health care costs on the macroeconomic level and encourage individuals to save money for their future health care needs in retirement.

B. The Rise of Health Savings Accounts

Two of Congress’s most aggressive moves towards CDHPs have been the passage of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (Medicare Act), which added new section 223 to the 1986 Code, and the passage of the Tax Relief and Health Care Act of 2006 (TRHCA), which modified certain provisions of section 223. Section 223 introduced a new form of tax advantaged savings vehicle for health care costs: the Health Saving Account (HSA). HSAs are tax-free accounts established by individuals, which, when combined with a High Deductible Health Plan (HDHP), allow the individual to save pre-tax dollars in a private account and have such savings accrue earnings on a tax-free basis. To the extent that amounts saved in an HSA are used to pay for “qualified medical expenses,” withdrawals from an HSA are also tax-free. The allowance of HSAs has created a new form of CDHP that has been widely discussed (if not widely used as of yet). The purpose of this article is to examine the utility of HSAs in providing for future retiree health care needs.

C. Policy Analysis of HSAs

In evaluating tax policy, it is important to note that the Code generally has two policy objectives: (1) to generate revenue for the government, and (2) to motivate taxpayer behavior for social or economic purposes, or both. Congress routinely uses the Code to promote certain behaviors and to discourage others; examples abound. The Code has been used to encourage home ownership (via the home mortgage interest deduction in section 163(h)(3)), saving for retirement (via the tax deferral for personal retirement savings provided by sections 401 and 408, among others), employer-provided health insurance (via sections 105, 106, and 125), and small business ownership (via the single-tier tax benefits of Subchapter S). Thus, any tax policy analysis must answer the following questions: (1) what is the revenue impact of the policy, and (2) does the policy succeed in achieving the desired behavior?

Accordingly, the remainder of this Article is divided into six parts. Part II examines the rules and regulations governing HSAs, with an eye towards the rules that impact the health care of retirees; Part III explores the potential revenue impact of HSAs in their current form; Part IV considers whether HSAs effectively encourage retiree health care savings; Part V examines whether, upon reaching retirement, HSAs are an effective means of providing for retiree health care; Part VI provides certain policy recommendations for the improvement of HSAs; and Part VII concludes. This Article will argue that while consumer-driven health care in the form of HSAs has the potential to provide for future retiree health care savings, elements of the tax treatment of HSAs limit their utility in adequately achieving this ultimate goal.


Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


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