Phasing out Employee-Sponsored Health Insurance

By William Hegelmeyer

Problem Statement

There is no challenging problem in public policy quite like healthcare due to how extensively it impacts human life, as well as the complexity of the systems that exist to support it.  Health policy in the United Statesis often considered enormously complex, and for good reason.  Our system is arguably the most multi-faceted in the developed world.  There are dozens of insurers, multiple tiers of insurance, markets and policies that vary by region, and an ever-growing list of regulations, subsidies, and tax credits.  Despite the number of players, public and private, in the insurance industry, almost 49% of the population gets insurance through the same place: their employers.  Employee-sponsored health insurance (ESHI) is deeply embedded in our culture, especially for working families, but it’s worth asking how it got to be that way, especially as our nation grapples with health costs higher than any other developed country (Commonwealth Fund). 


The concept of health insurance itself is fairly modern.  Until the mid-20th century, most people spent very little on healthcare because most of the products and services we see today that improve health outcomes hadn’t been invented yet.  In 1940, only 9% of people had health insurance (Carroll NYT), compared to roughly 90% of Americans who are insured today, in which roughly an equivalent amount of people are without insurance (Tolbert et al. KFF).  In 1950, however, the insured rate jumped to 50%.   

This change can be attributed to the effects of  World War II, when a labor shortage created the potential for an upward spiral in wages, which could have significantly increased inflation.  To prevent this, FDR put in place a wage freeze (Krugman 112), in which businesses would have to seek government approval to give their employees a raise.  To circumvent this policy, businesses began to offer health insurance.  After the war, many other developed countries, most notably Canada and Britain, adopted the centralized models of government-provided health care that they have retained today. The United States almost followed suit when  Harry Truman pushed for a national health insurance system during his presidency, though this  failed due to opposition from businesses and some unions (Markel PBS).  In the 1960s, we went on to adopt Medicare and Medicaid, but these were for specific subsets of the population.  For individuals and families of working age, ESHI crystallized, largely due to a huge subsidy given by the government: tax-exempt status.  In 1947, the IRS decided not to tax health insurance (Carroll NYT), even though it augments a family’s ability to consume just like normal income.  

What history reveals is that despite the central role that ESHI plays in how Americans today get coverage, its adoption of that role was by no means pre-determined.   Put another way, ESHI is not so much a staple of the American health system as simply another feature.  


The widespread adoption of employer-sponsored health insurance has produced market inefficiency and inequitable healthcare outcomes for Americans. Its removal is something that we as a society must seriously consider as health costs continue to rise.

The primary issue with ESHI, and what has caused it to draw criticism from many public finance economists, is its inefficiency (NBER).  ESHI provides tax-exempt status to what is essentially income, reducing the pool of taxable income and in turn lowering tax revenues.  The Tax Policy Center estimates that the subsidies given for ESHI cost the government $178bn dollars per year (Tax Policy Center). The second efficiency-based issue created by ESHI is job lock, which is when employees choose to remain in their jobs simply due to the health benefits.  This is an observed economic phenomenon that has been shown to sharply reduce mobility in the labor market (Madrian 1994).  Put another way, some Americans decided against pursuing new job opportunities because of the risk of losing healthcare for themselves and their families..  The final efficiency snag is the way in which it groups recipients of healthcare.  Theory suggests that the impediments to health insurance, adverse selection and moral hazard, are best overcome in large groups, reducing overall risk.  This was the rationale behind President Obama’s individual mandate, which is seen in every healthcare model in the developed world.  ESHI is purchased at the company level, so the size of the group being insured varies significantly across firms.  Due to variation in firm size, and varying commitment from employers to provide quality insurance to their employees, ESHI likely fails to manage risk as effectively as larger health insurance systems.  This inefficiency becomes less surprising when we consider how randomly ESHI became prominent in the first place.  It was a response by businesses to tight regulations, not an intricately crafted policy doctrine, and with wage freezes far removed from our own reality, it’s unclear what problem the existence of ESHI is currently solving.  Not only is it inefficient, but it can also be shown to be inequitable, with benefits that accrue largely to those at the upper end of the income distribution.

ESHI creates a preferred type of income, one immune from taxation, and does so in a highly regressive manner that is harmful to equity.   More prestigious professions will often receive higher quality health insurance, so those with more lucrative jobs not only benefit from a higher salary, but a higher tax break from the government.  Their higher income also puts them in a higher tax bracket, which means that artificially reducing their taxable income, even if by the same amount, benefits wealthier individuals more than poorer ones in absolute terms.  In short, the rich not only get a bigger tax reduction, but one that will help them more than lower-income citizens, some of whom may not benefit from this tax break whatsoever.

In public finance, the framework within which policy is analyzed is the equity-efficiency trade-off (Gruber Public Finance 8).  A common goal for a society is to assist those in poverty, which is typically done through redistribution, but this must be counterbalanced by the possibility that such redistribution may reduce the incentives to create wealth in our society. Policies like taxation, particularly progressive taxation, may redistribute wealth, but they cause changes in behavior that lead to suboptimal outcomes.  This phenomenon is called deadweight loss, and it results in there being less to distribute.  In addition to political considerations, it is the balancing of these tradeoffs that makes a policymaker’s job difficult.   ESHI, however, is  both inefficient and inequitable, and with healthcare costs rising at the rate they are, we can’t afford either.  

Recommendation 1: End ACA expansion of employer obligations and address the preferential status given to ESHI in our tax code

As far as the actual mechanics of eliminating ESHI, it would be a good starting point to eliminate the ACA provision that requires businesses of more than 50 employees to buy their employees health insurance.  This will be a boon to smaller businesses who were struggling with providing insurance to all of their employees.  Then, at some point, we must fix the problem ESHI creates in our tax code, and stop giving it tax-exempt status.  This would likely have a much larger effect than repealing the mandate, and therefore a much more potentially disorienting one for employees, which is where increasing the generosity and eligibility range of Marketplace tax subsidies could alleviate suffering.  A less radical and more equitable intermediate step would be to cap the income at which families receive the deduction.  A similar policy was a feature of Hillary Clinton’s 2008 health plan and a set of recommendations given by a tax reform panel commissioned by the Bush Administration (Gruber NTJ 16).  

Recommendation 2: Public Diplomacy

What must be kept in mind when we talk about a program as well-entrenched as ESHI is that people fear the unknown.  Making changes to something as central to people’s lives as healthcare cannot be done hastily, no matter how well-intentioned or well-supported they may be.  The Affordable Care Act is evidence of this.  The fact that some had to change health insurance plans cost Obama a significant amount of political capital, especially after he infamously promised that,  “if you like your plan, you can keep it”.  To minimize the creative destruction involved in the shift away from ESHI, start with having the conversation about the issues it causes with constituents through town halls.  Run ads, both digital and televised, to begin to challenge the necessity of ESHI in the minds of the constituents.  To help with the transition, temporarily increase the range of incomes that receive a tax credit through purchasing a Marketplace plan.  A public option as suggested by Joe Biden and his team may smooth this transition further, although this would create partisanship in what was previously an ideology-free analysis of the issues and set of solutions.  A possible inroad is that these ideas are bipartisan in nature.  The specific policy recommendations provided in the previous paragraph were considered by Democrats and Republicans alike in the early 2000s (Gruber NTJ 16).   Phasing out ESHI creates choice, decreases government involvement, and improves both equity and efficiency in our healthcare system.  As of now, there is no party that this proposal would be more naturally aligned with, so I urge any policymaker who puts these ideas forth to do so while engaging with the opposite party, whichever it may be.


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“Employer-Sponsored Health Insurance and Health Reform.” NBER, 2 June 2009,

“How Does the Tax Exclusion for Employer-Sponsored Health Insurance Work?” Tax Policy Center, 

Gruber, Jon. “The Tax Exclusion for Employee-Based Health Insurance.” National Tax Journal, June 2011, pp. 511–530. 

Gruber, Jonathan. Public Finance and Public Policy. Worth Publishers, 2019. 

Krugman, Paul R. The Conscience of a Liberal: Reclaiming America from the Right. Penguin Books, 2009. 

Madrian, B. C. “Employment-Based Health Insurance and Job Mobility: Is There Evidence of Job-Lock?” The Quarterly Journal of Economics, vol. 109, no. 1, 1994, pp. 27–54., doi:10.2307/2118427. 

Markel, Dr. Howard. “69 Years Ago, a President Pitches His Idea for National Health Care.” PBS, Public Broadcasting Service, 19 Nov. 2014,

Tolbert and Orgera. “Key Facts about the Uninsured Population.” KFF, KFF, 12 Nov. 2020,

“U.S. Health Care from a Global Perspective, 2019: Higher Spending, Worse Outcomes?” U.S. Health Care from a Global Perspective, 2019 | Commonwealth Fund, The Commonwealth Fund, 30 Jan. 2020, 

“What’s Wrong with Employer Sponsored Health Insurance.” Niskanen Center, 15 Feb. 2021,