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Why Limiting Health Flexible Spending Accounts Makes Sense

Health reform (the Affordable Care Act, or ACA) includes a number of spending reductions and tax increases designed to ensure that expanding health coverage does not drive up the deficit.  Opponents, however, are trying to undercut the law by proposing to repeal many of these financing provisions.

We’ve recently written about the ACA’s excise tax on medical devices and will weigh in soon about its fee on health insurance providers.  In congressional testimony this week, I explained why the ACA’s limits on using health flexible spending accounts (FSAs) to pay for over-the-counter medications make sense both as tax policy and as health policy.

From 2003 through 2010, people could use FSAs and other tax-advantaged accounts to buy over-the-counter drugs and other products, such as pain relievers, cough syrup, herbal remedies, and sunscreen.   Thus, accountholders received a tax subsidy for these purchases.

Under the ACA, starting in 2011, people can use FSAs and other accounts to buy over-the-counter items only with a doctor’s prescription.

There are several reasons to limit the purchase of over-the-counter health products with tax-favored accounts.

  • Only a minority of workers benefit from the tax break.  Just one worker in seven has an FSA, and an even smaller fraction of workers is enrolled in other tax-favored accounts that can be used for health-related spending.
  • People with high incomes benefit disproportionately from the tax break. That’s because they are in higher tax brackets, tend to consume more health care, and can afford to deposit larger amounts in their accounts.  Middle- and lower-income people benefit much less, if at all.
  • Administrative and compliance costs are relatively high. Employers typically pay vendors to manage the accounts, and accountholders must spend hours complying with onerous recordkeeping requirements.
  • Tax-advantaged accounts encourage the overconsumption of health care.  Before the ACA restriction, people could use these accounts to buy nearly any health care item or service, regardless of whether it was medically necessary, cost effective, or of meaningful health value.
  • Over-the-counter medicines and other items constitute routine personal expenses, which are generally not considered deserving of a tax subsidy.

At the hearing, Rep. Tom Reed (R-NY) asked me if I thought that the money allocated to my FSA is “my money” that I should be free to use as I choose.  I replied that what’s at issue is not my money but a tax subsidy.  “I do not have a God-given right,” I said, “to a tax subsidy for buying cold medication.”