Employee Cost-Sharing and the Welfare Effects of Flexible Spending Accounts

Abstract:     
In recent years, employees have been shouldering an increasing share of the costs of employee-provided health care. At the same time, more and more employers have been allowing employees to pay their out-of-pocket health care costs using pre-tax earnings, through tax-subsidized flexible spending accounts (FSAs). We use a cross-section of firm-level data from 1993 to show empirically that these FSAs can explain a significant fraction of the shift in health care costs to employees, and that this shift may be efficient, given the distortionary effects of the existing tax-subsidy to premiums. Correcting for selection effects, we find that FSAs are associated with insurance contracts with coinsurance rates that are about 7 percentage points higher, relative to a sample average coinsurance rate of 17 percent. Meanwhile, coinsurance rates net of the subsidy are approximately unchanged, providing evidence that FSAs are welfare-neutral.

Keywords: Health expenditure subsidies, moral hazard, Flexible Spending Accounts

JEL Classifications: D60, H21, I18

Working Paper Series