Funding employer-based insurance: regressive taxation and premium exclusions

In the US, health insurance is linked to employment. The tax code treats health insurance premiums preferentially for employers, but not individuals. We show that this regressive policy reduces talent mis-allocation in two ways: (i) The larger tax benefit to those with higher health risk and managerial talent, conditional on being entrepreneurs, alters the incentive to be an entrepreneur. (ii) This enlarges the tax base, which reduces the effective tax rate, and increases wage and capital income. Our general equilibrium model with heterogeneous agents shows that the subsidy can increase welfare, with a maximum gain of 0.46% in consumption equivalent variation.