Health Care Financing over the Life Cycle, Universal Medical Vouchers and Welfare

In this paper we develop a general equilibrium overlapping generations (OLG) model with health shocks to study the life-cycle behaviors of health care spending and financing. We show that a calibrated version of our model is able to match the life-cycle trend of insurance take up ratios and average medical expenditure from the Medical Expenditure Panel Survey (MEPS) data in 2004/05. We then apply our model to analyze macroeconomic implications of a counter factual health care reform in the U.S., using a system of universal health insurance vouchers. Our results suggest that health insurance vouchers are able to extend insurance coverage to the entire population but they also increase aggregate spending on health. More importantly, we find that the positive insurance effect (efficient risk pooling) dominates the negative incentive effect (tax distortions and moral hazard) which results in significant welfare gains for all generations when a payroll tax is used to finance the voucher program. In addition, our results suggest that the choice of tax financing instrument and accounting for general equilibrium price adjustments are critical in determining the performance of the voucher program. JEL: H51, I18, I38, E6, E21, E62