An Analysis of the Effect of Tax Policy on Health Insurance Purchases by Risk Group

There is an extensive body of literature dealing with the welfare loss associated with generous levels of health insurance as a function of the tax subsidy. The theoretical discussion in this study considers the effect of the tax subsidy on pooling within plans, and suggests the hypotheses that the tax subsidy will have a disproportionately positive effect on the likelihood that a high‐risk worker will be eligible for and participate in employment‐based coverage, while the effect of the tax subsidy on plan generosity will be greatest for low‐risk employees. If coverage of high‐risk individuals enhances social welfare, this result may offset, at least in part, the welfare loss associated with generous plans. Data from the 1987 National Medical Expenditure Survey are used to test these hypotheses. The results provide evidence that the subsidy works to expand risk pools in the employment‐based health insurance market.