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Stupid government getting away with it

So Rudd will now deny those he sees as wealthy a subsidy on their private health insurance but will honour his income tax cut proposals for these same people.  Both moves are foolish but he will get away with them both because of populist confusions.

The subsidy on private health insurance is a corrective that offsets the inadequate levels of demand for private health insurance that stem from the fact that we have a free public health system.  Those seeking free public health treatment derive benefits from facing a less crowded market because some are induced to take private cover.

The subsidy was essentially an attempt to correct a pricing distortion that inevitably accompanies public provision of anything for free. For the same reason private education should be subsidised.

Rudd’s policy is to eliminate the distortion for those he classifies as high-income. They will pay more for private health cover while those on lower incomes will pay less.  The move has redistributive intent but that necessarily creates inefficiency here because different prices are being set for the same services.  Why pick on health in particular that you wish to price high for the wealthy? Why not luxury cars or dinners at Flower Drum?

If one wishes to attack the income of the rich then rescind the promised tax cuts not make one item in their menu of consumption choices more expensive.  I think there are some arguments for doing just this given that the profligate extravagance of the Labor Party ignoramuses to deal with the GFC at the expense of the taxpayer have created such a need.

As I have argued before use income taxes to deal with distributional issues not excises and – in this case – corrective educational subsidies.

11 comments to Stupid government getting away with it

  • ennui

    Amongst other things, your link in the final paragraph seems faulty!

  • Uncle Milton

    On the contrary, Harry, you of all people should be supporting the idea of cutting people’s taxes and cutting the subsidies they get for buying particular things.

    Your analytical error is to assume that the subsidy for private health insurance just offsets some distortion elsewhere and that the price of the insurance is equal to the marginal social costs of its provision. On the contrary, the subsidy (like nearly all subsidies) is the cause of the distortion. Removing it is an efficiency-enhancing policy. The equity aspect is a bonus, but inessential to judging the merits of the policy.

    The rich can put their tax cuts towards paying their health insurance, or, if they prefer, they can spend their tax cuts on something else. This is a textbook Pareto improvement in their welfare, one that I am sure you have taught to thousands of students.

    (And, please, don’t come back with a second best argument that the distortion in the price of private health insurance is justified because of Medicare. Second best arguments are the last refuge of the economic scoundrel. They can be use to justify anything and everything, and often are.)

  • hc

    I don’t see that at all. An excess demand for health services is created by the fact that they are provided free in the public system. Health services are not a public good. The subsidy corrects that externality. It is a ‘first-best’ not a ‘second-best’ argument.

    The proposal as it stands is redistributive because it gives a higher benefit to those on low income.

    My argument is that such redistributions are better effected by income taxes rather than distorting the relative prices of goods. You might be concerned that the wealthy earn too much income relative to those who are poorer – OK then tax them. Don’t distort their consumption decisions between their health spending and their decisions about sending their kids to private schools.

  • Uncle Milton

    Harry, even on your assumptions, it is a second best argument. The first best solution would be to remove the distortion in public health prices. The second best solution is to create an offsetting distortion to private health prices. But your basic premise is flawed. Private health competes only in part with public health. Doctors’ visits aren’t covered by private health and dentists etc aren’t covered by public health. The only overlap is hospitals. But they aren’t really free, because you can’t walk in and demand a free operation. Because of waiting lists, you still pay – in time, not dollars. This is why the rich won’t be dropping their private health cover. They won’t want to wait in the public system.

  • hc

    I think that a public health scheme is a given. Subsidies to health insurance do provide an offsetting distortion. Hospital cover is the important area covered by health insurance and its costs are both monetary and in waiting time. You are saying that the wealthy will ignore the monetary costs and focus only on the time costs when deciding whether to insure.

    Treasury forecast 485,000 would leave private health insurance as a consequence of the threshold going from $50,000 to $100,000 while John Deeble forecast 750,000 plus a 5% increase in the Medicare levy (here). I don’t think these authors accept your hypothesis of inelasticity with respect to insurance cost.

  • conrad


    maybe you haven’t noticed it, but they are also going to increase the tax you have to pay if you don’t have insurance. Thus, whilst the increase of the threshold may have been silly, I can’t see how this change makes much difference. It’s basically stick, stick, stick and no carrot since it makes no sense not to have insurance for everyone that has to pay extra tax — you simply end up paying more — they could take away all of the subsidy for many groups, and there is not much these groups could do (except try to avoid tax, but that’s another story). Of course, even those that won’t pay the tax may want to pay anyway in case they think they will earn more in the future and because of the way premiums go up for the uninsured that want insurance later.

  • Uncle Milton

    485000 was based on a policy of abolishing the subsidy altogether not just for high income earners. So it will be a lot less than that. But 485000 gives a good indication of the elasticity. This represents maybe 10% of people with private health insurance. The subsidy cuts the cost by about 1/3. So the elasticity is about 0.3 – pretty small by any standards.

    I can tell you for sure that I won’t be dropping my private cover!

  • […] (sorry Harry Clarke) seem to be arguing that the mooted changes to health insurance — notably, means testing of […]

  • hc

    Conrad, Joshua Gans makes the same point at Core Economics.

  • hc

    I think Joshua Gans and Conrad are right. Essentially the rise in the tax surcharge for non-insuring high income earners offsets the effect of the reduced private health insurance subsidy.

    It does however make for a hellishly complex reform – tax cuts, reduced subsidies and tax surcharges for non-insurers comprise the package.

    A simpler reform – address the distortion of the public health system with a uniform subsidy and address income distribution issues via the income tax system.

  • Sinclair Davidson

    address income distribution issues via the income tax system

    Why not do that via the welfare system?

    Alternativily means test medicare and have the private system pick up everybody else. So make the private system the default and the public system piggy back of that, rather than the current public default and the private system piggy backing. The obvious way would be to have health insurance organised aolong the same lines as super.

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