Orange County Register, November 13, 2005

Next year, about one-third of employers in the United States will offer health savings accounts, according to a survey by Buck Consultants. Health savings accounts have existed for less than two years and are a significant innovation in consumer-directed health care. With a health savings account, the patient, not an insurance company or government bureaucracy, controls money spent on ordinary health care. This change is certain to bring better value and more satisfied patients.

California lawmakers seem incapable of recognizing this. They have levied a tax against health savings accounts. This will punish those who want to take responsibility for their own health care.

If you have health insurance with a high deductible, you or your employer can deposit that amount into a health savings account to pay for health expenses below the deductible.

The federal government and almost every state encourage this by allowing you or your employer to fund health savings accounts with pretax income, similar to an IRA. The account can be used to pay for qualifying medical expenses, and the account holder never has to pay income tax on that money. Funds left over at the end of the year accrue tax-free to help build a retirement nest egg. Better still, when employees move to a new job, they take the health savings account with them.

The tax treatment is important because the federal and state governments treat health insurance as a nontaxable benefit for employees. Those who buy health insurance on their own generally spend after-tax income. The government should make these two methods equal before taxes, but lacks the political will. Instead, the government attempts to level the playing field by giving health savings accounts the same tax treatment as other employer-sponsored health insurance.

Under this type of plan, patients are motivated to demand value in health care, which saves money for them and their employers. They are not just for young, healthy people. Around 29 percent of health savings-account investors earn less than $50,000 a year, and approximately 40 percent were previously uninsured. The majority is families, about half over age 40, and about one-fifth over 50. Between 2004 and 2005, premiums dropped 15 percent for health savings account-eligible health-insurance plans.

Employers are getting so excited about these plans that many are depositing bonuses of $500 or more into employees' health savings accounts. Wal-Mart recently announced that it will offer plans eligible for health savings accounts. The rules are flexible enough that Wal-Mart can allow workers up to three free visits to the doctor before they have to start paying the deductible. In this case, the high deductible does not deter patients from seeing the doctor because of cost, but makes them more price-sensitive when they do have to pay for health goods and services.

Smart governments are boosting health savings account-eligible accounts by offering them to state employees. Florida Gov. Jeb Bush recently made that move. The small city of Hurricane, W.Va., saved almost $300,000 in health costs over the last three years since implementing this type of account. These savings come despite the fact that the city, not the workers, deposits funds into the savings accounts. Unfortunately, Californians will not be able to fully benefit from this valuable reform.

Gov. Arnold Schwarzenegger recently signed a bill that will bring much of California's tax code into conformity with the federal tax code, with the remarkable exception of health savings accounts. Our legislators have stalled an important improvement in individual health ownership. This oversight is inexcusable.

California's taxation of health savings-account contributions is especially insulting because California has the second-highest personal income-tax rates in the nation, after Vermont. Worse, not only do contributions remain taxable, the earnings within the account will be taxed annually.

Consider the excess tax burden on a California family of four earning about $50,000. This family makes a health savings-account contribution of $5,000 and has $2,000 of medical expenses annually. Taxing the contribution means the family will immediately lose $372 to the tax man.

Things get worse from there. If the remaining savings of $3,000 earn interest at a relatively meager 2 percent, the loss goes up next year to $379, and then to $395 in the third year, assuming the contributions are unchanged. If the rate of return is higher, then the tax penalty also becomes more painful.

What do California legislators propose as an alternative? Single-payer, government monopoly health care is the flavor of the month in Sacramento, but it is a nonstarter. The lengthy queues for diagnosis and surgery, misuse of capital, and complete lack of patient control make it anathema to people who value their liberty and good health care.

Another alternative is mandated employer-provided health insurance. Last year, Californians defeated Proposition 72, which would have created a government-run system that mandated employers to cover 80 percent of their employees' health coverage. This was simply a punitive tax on those employers unable to offer health insurance. The result would have been more unemployment and more workers joining the underground economy.

(Even voluntarily offered, employer sponsored health care has serious drawback. If employers bought automobile insurance or fire and theft insurance, many of the same problems would arise. Costs would increase, while quality and choice would suffer. That is why employers pay wages, to allow employees to buy what they want from other companies, rather than providing goods and services directly.)

Health savings accounts and health savings account-eligible health insurance, even if provided through the workplace, have already shown that they reduce costs, increase choice, and even bring previously uninsured people on board. Indeed, as the benefits of consumer-directed health care become increasingly apparent, the United States and other state governments will introduce even more reforms that put patients in charge of health resources.

The reform train has left the station, and California lags behind. If legislators want to catch up, they need to change the tax code to reward, not punish, those willing to take more responsibility for their own health spending.

John R. Graham is is director of health-care studies at the San Francisco-based Pacific Research Institute. He can be reached at jgraham@pacificresearch.org.