Michigan Universal Health Care Access Network

Home Page Politics 2000 News/Comment Publications Organization Links

Universal Coverage: How Do We Pay for It?

by Edie Rasell

Economic Policy Institute
1660 L St., NW, Suite 1200
Washington, DC 20036

While universal coverage has been the goal of health care reformers for many years, the specifics of how to equitably finance such a system are less well understood. This paper outlines one way to finance universal coverage which preserves much of the current financing system and replaces inequitable financial flows with revenue from more progressive sources.

The financing system described here is designed to function within a health care system that provides universal coverage for all medically-necessary services for either all or part of the population. [1] The health care system would also have the following components: a global budget with budget enforcement mechanisms, capital budgeting and planning, a single payer, and cost containment. In addition, the link between employment and health insurance coverage would be severed. [2]

How much will it cost?

Before deciding how to fund a new system, it is necessary to know how much it will cost. In particular, one needs to know whether the new system will cost more than the old. This is especially important since the universal plan described here will differ from the current system in ways that have large cost implications. First, the currently uninsured and underinsured will gain full insurance coverage, increasing their access to and use of services. Second, reductions in cost sharing could lead to increased utilization by the already insured. Third, administrative costs will fall due to the single payer. Fourth, new cost containment features will provide better constraints on cost growth in the years after the plan is implemented.

There have been only a few studies examining how national expenditures would change if a universal, single payer system were instituted. However there is general agreement in their findings. The General Accounting Office (1991) estimated that a shift to single payer, universal system could occur with essentially no change in total expenditures. The Congressional Budget Office (1993) estimated that S.491 (Senator Paul Wellstone's American Health Security Act) would raise national expenditures above baseline (the level of spending that would have occurred if no changes in the system had been made) by 4.8% in the first year after implementation. [3] However, in subsequent years, improved cost containment and the slower growth in spending associated with the new system would reduce the gap between expenditures in the new system and the baseline. By year five (and in subsequent years), the new system would cost less than baseline. [4]

These studies show that a universal system that provided health insurance coverage for everyone could probably be instituted with essentially no increase in expenditures over what the nation would otherwise be paying. Or, if an increase did occur, it could be financed with short-term adjustments that could be phased out in a few years. Moreover, improved cost containment would slow the rate of future expenditure growth compared with what would be expected under the current system.

In the model presented in this paper, it is assumed that in the first year after implementing a universal, single payer plan, total national health expenditures are unchanged from baseline. If expenditures were higher than baseline in the first few years, then additional revenues above those described here would be needed. However, these higher costs would be more than offset by savings which would accrue within the first decade of the program.

Principles which shape the financing system

How to finance universal coverage is more a political and ethical question than an economic one. The following principles shape the financing system described here.

  1. Progressive financing - people with higher incomes pay more, as a share of income, than people with lower incomes.
  2. No financial penalty for being ill or using services; no cost sharing.
  3. Minimized administrative expense.
  4. Stringent cost containment in a manner consistent with these principles.
  5. Minimized transition costs. The new financing system should be built on the current one where that is possible and compatible with the other goals of financing.

New Ways to Fund a Health Care System

In thinking about ways to fund health care, it is necessary to examine funding separately from services received. Under a new system, consumers would continue to seek and receive health care services possibly from the same providers they had used in the old system. However, the current payers (private health insurance, Medicare, Medicaid, etc.) would no longer be paying the bills. To evaluate funding equity, it is necessary to look behind these payers to examine the sources of their funds, for example, personal income taxes and firms' purchases of insurance premiums. The equity of these more fundamental funding sources is what needs to be evaluated.

In general, progressive income taxes are the most equitable way to pay for health care since costs are borne in relation to income with higher-income people paying a greater share of income than lower-income people. Premiums should be avoided since, even under a community-rated system, the cost is the same to everyone, regardless of income. Cost-sharing and out-of-pocket expenditures should not be used since these expenses fall disproportionately on people who use the most services (the less healthy members of the community) and the costs are not assessed in relation to income.

The Current Financing System

In 1995 (the last year for which data are available), federal, state, and local governments were the largest purchasers of health care services, responsible for 44% of the national total: 33 % by the federal government and 11% by states and localities. (If the public sector in its role as employer purchasing health insurance for employees is also included - an additional 6% of all health care spending - then government accounts for fully half of all national health expenditures.) Employers' spending for health care (primarily for insurance for employees) was approximately 28% of all health expenditures. Households accounted for 26% of the total. Non-patient revenues, for example, charitable donations and net revenues from sales in hospital gift shops, were 3% of funds. See Table 1. The sources of the money spent by each of these payers is now examined to determine whether the funding stream should be eliminated and/or how it should be changed in a new system.

Households: Households' purchases of and contributions toward health insurance premiums constitute 7% of all money flowing into the health care system. Since purchasing premiums is an inequitable way to fund health care, this funding stream would need to be replaced in a new system.

Households' out-of-pocket expenditures account for 19% of all health care dollars. Table 2 shows the services currently purchased out of pocket. Some of these services are not medically necessary and would not be covered under the new system, for example, cosmetic surgery and nonprescription drugs. But all medically-indicated services would be covered under the publicly-financed system.

Data are not available that would allow us to calculate the exact share of out-of-pocket spending that should be paid for through the new system. However, it is possible to roughly estimate the medically-necessary component as 80% of current out-of-pocket spending, or about 15% (19% x .80) of all health expenditures. [5] Some 4% of national health expenditures would continue to be financed out of pocket.

Businesses: In their purchases of health care for employees, businesses currently are responsible for 28% of all health care spending. There are a number of reasons why reforms are needed in the way businesses pay for health care. First, although employers often pay some or all the cost of employee health insurance and health care, wages are reduced to offset at least part of this expense. So employees actually bear most or all of the cost of premiums. But premiums paid by workers are an inequitable way to fund health care. To end the reliance on premiums requires a change in the way employers pay for health care. Second, some of the cost of employee health care may be borne by firms, not workers, resulting in lower profits for the firm or higher prices for the firm's products. This places a firm that is "doing the right thing" at a competitive disadvantage compared with a firm that did not provide health coverage. To level the playing field among firms and remove the incentives to avoid providing employee health insurance, all employers must share in the responsibility for health insurance coverage.

Although wages are reduced to offset the cost of the insurance policies, if employers were suddenly relieved of the responsibility for employee health insurance coverage and dropped their health insurance policies - for example, because a universal health care system funded entirely through taxes on employees were instituted - it is unlikely that all the savings would be returned to employees as higher wages. Some of the savings would likely be retained by the employers, So, the employees would pay higher taxes to support the tax-financed health care system, but would not have the additional income to be able to afford this. At the same time, employers would receive windfall profits. This squeeze on workers must be avoided while ensuring that money currently spent by employers for health care continues to flow into the system.

A more equitable way for employers to pay for health care would be through a payroll tax that raised the same amount of money as they were paying under the current system. [6] Employers currently pay about $307 billion for health care while wages and salaries total about $4.500 billion. Therefore, a payroll tax of slightly less than 7% would also raise $300 billion. Some employers that currently pay a large amount of money for employees' health care would see their costs fall. (These savings should be passed on to workers as wage increases.) Other employers that currently spend little for health care would see their costs rise. Workers, who ultimately pay these taxes through lower wages, would face costs that were proportional to (that is, 7% of) their earnings. This system would also level the playing field among employers and remove the competitive advantage currently enjoyed by those who provide no health care coverage to employees. Since this payroll tax could be collected as part of the existing payroll tax system, it would be quite simple and inexpensive to administer.

Federal Government: As with other premiums, Medicare Part B premiums (2% of all health expenditures) should be eliminated. These revenues would need to be replaced. Current Medicare payroll taxes, paid by both employers and employees on all wages and salaries, would continue to flow unchanged into the system although the Medicare program would no longer exist in its current form. Other federal payments (for Medicaid, the balance of the Medicare system, and other federal health programs) are paid out of general revenues raised through personal and corporate income taxes, excise taxes, and other taxes and fees. Under the new system these revenue streams would continue to provide the same level of resources for health care.

State Government: These funds, in the same amount as under the current system, would continue to flow into the new health care system.

Non-patient revenues: These funds would continue to come into the new health care system.

Replacements for Inequitable Funding

In 1998, the U. S. is expected to spend $1,138 billion for health care (CBO 1998). Since the new, universal system will cost the same as the old, we can determine the amount of money that must be replaced as inequitable funding sources are phased out. Three funding streams have been identified that would need to be replaced.

  • Households' purchases of private health insurance premiums, 7% of health care spending or $80 billion in 1998;
  • 80% of household out-of-pocket spending, 15% of spending or $171 billion in 1998;
  • Expenditures on Medicare Part B premiums, 2% of spending or $23 billion in 1998.

In 1998, the total amount that would need to be replaced is $274 billion. Of all the money currently paying for health care, fully 76% would continue to be raised as is currently done with changes within the employer funding stream, as well. Since total expenditures would be unchanged, the changes in financing simply shift costs among payers, However, if a higher level of cost sharing were retained, or if more money were raised from employers, it would be possible to fund a universal system with a smaller increase in taxes.

The most equitable way to replace this money is through the federal personal income tax. In 1998, the average, middle-income household will have an income of about $37,290 and pay about $2,088 (5.6 % of income) in federal personal income taxes. (If this number seems small, it is because it omits payroll taxes; nearly three-quarters of households pay more in payroll taxes than federal income taxes.) To fully replace the needed health care funding would require this family to pay an additional 2% of income in federal personal income taxes, or $731, raising their total to $2,819. The increase for families with incomes below this level would be less than 2% of income, and the increase would be larger for upper-income families. Table 3 shows the necessary tax increase for households in five different income categories. Because a system exists to collect personal income taxes, the administrative costs of this change are trivial. In exchange for the tax increase, no American (or American employer) would have to buy health insurance or face any out-of-pocket charges. Everyone would have access to all needed health care services and their insurance could never be lost or taken away. We would also gain a much more efficient system.


A publicly-funded, universal health care system is possible. (The public sector currently pays for 44% of all health care, or fully 50% when the public sector's role as employer providing health insurance for employees is also included.) In a new system, the total amount spent on health care would not change. However, to improve equity, new funding sources would be needed for 24% of health expenditures. These replacement funds would be raised through the federal personal income tax, an equitable and affordable way to pay for health care. In exchange for the tax increase, premiums and out-of-pocket spending would be eliminated. For the typical, middle-income household, taxes would rise by $731. For fully 60% of households, the increase would average less than $1,000. For another 20%, the increase would average about $1,600. Only the 20% of households with the highest income would face a larger tax increase. Costs would be distributed from the sick to the healthy, from low- and middle-income households to those with higher incomes, and from business currently providing health care benefits to those that do not. Even more important, greater efficiency and improved cost containment would become possible, leading to sizable savings in the future. The impediment to fundamental reform in health care financing is not economic, but political. Political will, not economic expertise, is what will bring about this important change.