Employment-Based Health Insurance, Uncertain Medical Expenses, and Aggregate Labor Supply∗

Using a general equilibrium life cycle model with endogenous labor supply and idiosyncratic risks in both income and medical expenses, we argue that employmentbased health insurance is an important reason why Americans work much more than Europeans. In contrast to Europeans, who get universal health insurance from the government, most working-age Americans get health insurance through their employers. Since medical expenses are large and volatile, and there is no good alternative available in the private market, health insurance from employers can be highly valuable to risk-averse individuals (much more than its actuarially fair cost), thus providing them with extra incentive to work. Our quantitative results suggest that different health insurance systems and uncertain medical expenses can account for more than half of the difference in aggregate hours that Americans and Europeans work. Furthermore, our model is also consistent with several other relevant empirical observations: (1) the differences in employment rate and in the shares of full-time/part-time workers, and (2) the labor supply difference by age. When our model is extended to include the main existing explanation, the taxation hypothesis, the extended model can account for a major portion of the difference in aggregate labor supply between the U.S. and Europe.