RALEIGH – The National Center for Policy Analysis in Dallas has its finger on a problem affecting many families in North Carolina and elsewhere – and proposes some easy yet excellent ways to address it and reduce health-care inflation at the same time.
For me, however, the problem is a purely theoretical one. It involves the perverse “use it or lose it” incentive in managing a flexible spending account (FSA). These are accounts, typically set up by employers, into which employees can opt to steer a set amount of their income, pre-tax, to pay for out-of-pocket medical expenses and certain other spending. FSAs allow individuals spending cash to get the same favorable tax treatment – exemption not only from income tax but also payroll tax – afforded to recipients of health insurance used for the same purpose.
Equal tax treatment of cash and non-wage benefits accomplishes three important goals simultaneously. First, it reduces the tax burden a bit, which is welcome given that a good portion of our federal tax relief since 2001 has been offset by state and local tax hikes. Second, it promotes fairness: there’s no good reason why those with access to generous employer-based benefits, often disproportionately wealthier, should enjoy a lower effective tax burden than those without such access.
Third, and most importantly, FSAs and other cash-based health arrangements encourage patients to consume care wisely. A major driving force behind medical inflation is the problem of third-party payment. Most people naturally pay more attention to what they are buying, and at what price, when they are paying cash rather than swiping an insurance card.
Unfortunately, FSAs as currently structured don’t advance this third goal as much as they could. The reason is that any unspent money in an FSA reverts to the employer at the end of the year. This obviously creates a planning problem for many individuals and families trying to take maximum advantage of the tax benefits of an FSA without losing any money at the end of the term. Indeed, the result sometimes is the reverse of a solution to third-party payment, as people scurry around to spend down their accounts with services they don’t truly need so as to beat the deadline.
In an ideal world, careful planning would obviate the need to do this. But for many, it’s hard to get it right.
So why is this purely a theoretical problem for me? Because estimating medical expenses in my household isn’t particularly hard. For me, the estimate doesn’t go much beyond a regular order of one-day disposable contact lenses. Other than that, I’m essentially anti-med. I feel it is my solemn civic duty, through irresponsible avoidance of any and all medical checkups, to counterbalance the very large (and also largely predictable) expenses related to my wife’s diabetes.
Still, I would love to see happen what NCPA researchers have been advocating for years: fix the “use it or lose it” problem with FSAs by allowing at least some unspent deposits to roll over into the next year. It would mean less guesswork, fewer last-minute spend-downs, more sensible health consumption. Sure, some sticks-in-the-mud complain that allowing roll-overs would be a roundabout way for people to expand their tax-free savings.
I’m still waiting for an argument against the idea.
Hood is president of the John Locke Foundation and publisher of Carolina Journal.