FSAs encourage rather than reduce unnecessary healthcare spending

Here’s how healthcare management works in the Hiltzik household as 2011 starts to slip away:

We’ve ordered a year’s worth of disposable contact lenses for my son to supplement the year’s supply he already has. I’ve bugged my wife to buy new eyeglasses and sunglasses, although the two pair of designer frames she already has are functional, and plenty stylish too.

When the latest statement arrived from my dentist, I cursed my dental plan for paying 100% of his fee.

Whatever could explain this absurd behavior? Simple. Of the $1,800 I placed in my flexible healthcare spending account at the beginning of 2011, I still have $1,000 to spend. Whatever we don’t use by Dec. 31, we lose.

Like millions of other Americans, in the late fall of every year I face two annoying conundrums. Somehow I have to forecast my out-of-pocket healthcare costs for the coming 12 months, so I know how much to invest in my flexible account, and I have to root around for qualified medical expenses to rectify any overestimate from the year before.

The flexible spending account is a shining example of a government program conceived as a consumer benefit, then encrusted with so many peculiarities that it crosses the line into insanity. Enacted by Congress in the 1970s, the FSA law allows you to place a certain amount of money annually into an account for spending on healthcare items not covered by your insurance — your deductible, co-pays, drugs, medical equipment, chiropractic, etc.

A separate account for dependent care is also available. The money in either account is tax-exempt, so that spending is effectively subsidized by the percentage of your maximum combined state and federal tax rates.

The chief rationale of FSAs is to level the healthcare playing field between employees whose health plans cover almost all expenses and those whose coverage leaves them with bills to pay. Premiums for employer-sponsored plans are tax-exempt, so FSAs effectively extend the tax exemption to many out-of-pocket expenses.

But then the complications kick in. One is that it’s up to your employer to offer an FSA as part of a benefit package — it’s not available to the self-employed or those whose companies choose not to provide the option. Employers can limit the size of employees’ accounts — most opt for $2,500 to $5,000. You have to decide before the start of the year how much to put in the account, and you can’t change your mind later even though your allocation is subject to the use-it-or-lose-it rule: You forfeit anything you don’t spend by the end of the year. (Your employer keeps the excess.)

Except for people with large, predictable annual expenses such as from diabetes or other chronic conditions, out-of-pocket medical expenses are notoriously hard to predict. My experience is probably typical: Sometimes I spend down my account by midyear, sometimes I have to contrive hundreds of dollars in dubious end-of-year expenses.

Who benefits from this guesswork? Opticians, surely, because eyeglasses are among the few covered expenses incurred by almost every family and they don’t require an invasive or painful procedure. Compare them to the onerous option once chosen by Princeton University health economist Uwe Reinhardt. He says that he and his wife scheduled his-and-hers Christmas Eve colonoscopies to spend down their FSAs, which may help explain why he later damned FSAs as “a vexatious affront.”

Thanks to the implicit gamble faced by employees and the complicated record-keeping required of employers, these plans have never ranked high as employee benefits. Government and private surveys have found they were offered by only about half of all large employers and fewer small and medium-size companies, and only about 30% of their workers enrolled.

Even among those who do enroll, the benefit is hardly a working-class gift. Like any tax exemption, it’s highly regressive, disproportionately benefiting the wealthy. If your combined federal and state tax rates top out at 50%, then your effective cost for an FSA-covered $1,000 root canal is $500. If you’re a file clerk in the combined 10% bracket, it’s $900.

“That’s very peculiar social ethics,” Reinhardt told me. “Where in the Bible would you find justification for making healthcare cheaper for rich people?”

How did this Byzantine system come about? If these rules arose from aggressive lobbying by one interest group or another that might profit from the complexity, whether Wall Street or the insurance industry — choose your own villain — that would be understandable. (I said understandable, not rational.)

But that doesn’t seem to be the case. Instead, they seem to derive from congressional absent-mindedness, abetted by the Internal Revenue Service’s effort to fill in the gaps left by lawmakers by slotting FSAs into preexisting conditions within the tax code.

Burdened with the task of writing FSA regulations in the 1970s, the IRS concluded that to fit within the framework of tax-exempt benefits, the accounts couldn’t involve deferred compensation and they couldn’t be altered in the course of a year. By tax-law logic, which sometimes seems to come to us from Planet Zorg, that means the money has to be forfeited if unspent within a given calendar year.

The FSA law “wasn’t drafted with these [tax] regulations in mind,” observes Amy B. Monahan, a healthcare law expert at the University of Minnesota. The perverse consequence is that FSAs encourage, rather than reduce, unnecessary healthcare spending.

Congress has recently taken steps to pare FSAs back. Over-the-counter medicines, which could previously be bought with FSA funds, were taken off the list this year by the healthcare reform law of 2010 — except when they’re prescribed by a doctor. (Another homegrown healthcare absurdity: If our national goal is to control health spending, why force people to make a special trip to the doctor just to make their aspirin purchases FSA-eligible?) As of 2013, the maximum FSA account for anyone will be $2,500.

It would be gratifying if these changes were made because Congress had devoted careful thought to how to make FSAs better. But no, they were designed merely to raise tax revenue: Congress estimated that the $2,500 limit would translate into an additional $14.6 billion for the Treasury from 2010 through 2019.

There are ways to make FSAs more equitable and useful, though no one in government seems inclined to devote much time or effort to doing so. Reinhardt suggests that anyone with an FSA receive a flat 30% tax credit for the money in the account, and be allowed to roll it over for an extra year to eliminate the incentive to spend money pointlessly.

Helping Americans moderate the cost of healthcare via a fair and accessible public subsidy, so that they get the goods and services they need and don’t waste money on frills, is a perfectly sound idea. But FSAs miss the target from almost every angle, sucking up resources and time that could be better applied to some other program. As they’re currently fashioned, says health economist Timothy Jost of Washington & Lee University, “from the standpoint of health policy, they make no sense at all.”

Michael Hiltzik’s column appears Sundays and Wednesdays. His latest book is “The New Deal: A Modern History.” Reach him at mhiltzik@latimes.com, read past columns at latimes.com/hiltzik, check out facebook.com/hiltzik and follow @latimeshiltzik on Twitter.