A Taxing Question on HSAs

Health Savings Accounts, or HSAs, are tax-advantaged savings accounts that are paired with a high deductible health plan (HDHP).

The idea is to take on a HDHP and put enough money into a MSA, so as to have money to pay for both expected and unexpected health care expenses.

Contributions to HSAs can be done via pretax earnings, thereby saving or at worst delaying the tax that otherwise would be paid (if withdrawn for nonmedical use after age 65, the non-earnings part of the distribution would be taxable). Earnings on contributions accumulate taxfree, even if withdrawn for nonmedical use after age 65.

So here is the question. Suppose someone is in an HDHP and puts the maximum amount, $3100, into their account. At the end of the year, they see that they have incurred $1000 of health care expenses, and begin to prepare a withdrawal from the HSA to repay themselves.

But...those funds in the HSA are earning taxfree returns. Suppose the individual has maxed out on all other tax-advantaged investment opportunities, such as their IRA.

Then why take any funds out of the HSA? The person should really just eat the health care expenses out of regular savings or income. Leave that HSA alone and let it accumulate taxfree!

The question then is: One might have thought ex ante that, with the HSA, the marginal cost of health care expenses would be lower by the marginal tax rate, that is, if the marginal tax rate is 30%, then the real cost of health care expenses will only be 70 cents per dollar incurred. But if one is behaving optimally, it seems that one should just put the maximum contribution into the HSA and leave it there for retirement...or for general living expenses, health care included, if any kind of cash flow situation develops.

So the cost of health care seems to be dollar for dollar, at the margin, just like for any other consumption. The fact that the HSA is funded with pretax dollars is just a gift from the government in general; it is not a means for lowering the marginal cost of health care.

This is different from Medical Reimbursement Accounts, which are funded with pretax dollars but cannot roll from year to year and do not earn returns. With MRAs, the money has to be spent on health care, and they do lower the marginal cost to the consumer of health care only.

Is this right? Will consumers see this pricing difference and behave differently with HSAs than MRAs -- purchasing less health care? My bet is yes: Come the end of the year, and people start thinking about withdrawing from their HSA to pay for health care, some of them will realize they are better just leaving the money there. Others will have used their HSA on a pay-as-you-go basis, since they come with a debit card sometimes. These people will be foregoing a very nice way to save tax free for retirement. Of course, many people are not currently maximizing their opportunities to save taxfree for a variety of reasons.

Is this the market working?

Here is a very interesting WSJ article involving customer claims to their money from the failure of MFGlobal.

Recall the basic situation: customers who held funds in accounts at MFGlobal have not been fully paid, and the money as of yet has not been located. It appears that in the flurry of MFGlobal's plunge into bankruptcy, those sacrosanct customer funds were mis-appropriated...but nothing has been proved yet.

Now comes a couple banks, Barclay's and Royal Bank of Scotland, offering to pay US customers of MFGlobal 91 cents on the dollar in return for the customer's claim against MF. Not too bad...those customers as of now have received 72 cents on the dollar from the bankruptcy process.

Why would the banks do this? Well, they or the investors on the other side think that 91 cents is a good price for the claim.

I wonder if there is a chance that the owner of the claim could get more than 100% -- maybe due to penalties.

My colleague Randall Thomas and I once wrote a paper where we discussed the sale of claims arising from class action lawsuits to the highest bidder. The advantage here, as with the MFGlobal situation, is that you will get a concentration of economic incentives to litigate the case efficiently.

Fascinating how markets work.

Is this insider trading?

A while back, my colleague John R. Lott Jr. and I wrote two papers around the same general topic, on the effect that one firm has on another firm through competitive actions and the implications for stock market prices.

For instance, we discussed what might happen if Firm A were to announce a decision to entry into Firm B's market. Without perfectly competitive markets, it should be expected that Firm A's decision would cause Firm B's market value to fall.

Knowing this, would it be profitable/feasible/legal for Firm A to trade in the securities of Firm B before making their announcement?

We looked into the legal aspects of this and concluded that it did not appear illegal, so long as the announcement were not fraudulent. Legality at least on insider trading grounds hinges on the managers of Firm A not having a fiduciary responsibility to Firm B. Of course, Firm A might restrict its employees from such trading (not sure why they would, but they could). But Firm A could instruct its pension fund, for instance, to short Firm B before the entry announcement.

We had trouble finding current examples of such behavior. Too bad, or the article would have gotten into an even better journal.

But now we have this Reuters article about Starbucks and Green Mountain Coffee. Quoting from the article:

A heavy burst of bearish option action in Green Mountain Coffee Roasters Inc in the hours before Starbucks announced plans to launch a single-cup coffee and espresso brewer has raised eyebrows among some option market participants.

"The level of aggressiveness that traders early on Thursday came for Green Mountain March downside puts was very suspicious," said Alan Thompson, options market maker at Timber Hill, a division of Interactive Brokers Group. "It raised our eyebrows."

"We expect that the regulators will take a deeper look at both Starbucks and Green Mountain ahead of (Thursday) night's announcement," Najarian said.

The U.S. Securities and Exchange Commission, which looks into unusual stock and options activity, declined to comment.

Post on Certificates of Need in Hospital Industry

I wrote a post last week for US News & World Report on the issue of certificates of need for new hospitals. It is available here.

In New Hampshire, a new specialty hospital, Cancer Treatment Centers of America, wants to bypass the usual Certificate of Need process. That has raised interesting questions on the role of competition in health care.

If anyone wants to read an academic paper on the topic, a very recent one is

Cutler, David M., Robert S. Huckman, and Jonathan T. Kolstad. 2010. "Input Constraints and the Efficiency of Entry: Lessons from Cardiac Surgery." American Economic Journal: Economic Policy, 2(1): 51–76.