Is Taxing One Item Because It's in a Subsidized Category a Good Idea?
By David Henderson
Co-blogger Scott Sumner advocates keeping a tax on medical devices. His reason:
the medical devices tax was far smaller than the subsidy on medical devices, which is enormous. (Subsidies include Medicare, Medicaid, tax deductibility of insurance, etc.)
But normally when people advocate a tax to offset a subsidy, it’s because the subsidy is on the item taxed. As Scott admits in the above, medical devices per se are not subsidized. Instead, medical care for the poor and near-poor is subsidized through Medicaid; medical care for the elderly is subsidized through Medicare; medical care for employees is implicitly subsidized by the tax code.
So a way to offset the subsidy, if the first-best solution of eliminating or reducing the subsidy is, for some reason, off the table, is to tax the thing being subsidized.
The problem is that to single out medical devices does not clearly reduce the deadweight loss that Scott would like to reduce. If, say, 70%, of expenditures on medical care were on medical devices, probably singling them out for a tax would make sense. But I’m guessing that medical devices account for under 10% of expenditures on medical care. Taxing just medical devices will cause the price of them to rise relative to the prices of other inputs: doctors, nurses, hospital rooms, drugs, etc. So the tax would cause a distortion in inputs used: fewer medical devices used and more of the other inputs.
Actually, this post overlaps with a comment made on Scott’s post by Jim Glass.