Financing Universal Healthcare Part I: Tax funded or Social Health Insurance

Posted on November 22, 2008


Implementation of a Universal Healthcare system can be thought of as an exercise in managing 3 interlinked challenges:

  1. Funding: How to raise adequate and equitable – those with means subsidise those without – funding?
  2. Pooling: How to ensure efficient and equitable risk pooling – ensure that the more risky are not left out and the less risky don’t opt out?
  3. Purchasing: How to transfer the collected funds efficiently – with low leakages and low overheads – to the service providers?

In this article I am focusing on the first of these three challenges i.e. funding.

Societies choose to finance a UHC through either a tax funded system or a mandatory social health insurance (SHI) system. In a tax funded system, the government collects money from all tax payers and uses this money to deliver/buy healthcare services. In the SHI system, the government mandates certain minimum contribution by employers and employees to one or more insurance schemes. The administrators of these schemes use the premia money to deliver/buy services. A few countries adopt a middle path where the financing is a combination of tax funded and social health insurance. In the discussion below I have attempted to compare the two financing systems and their relative advantages and disadvantages.

Tax Funded


  1. Coverage for all: Given ability to raise adequate taxes, governments can easily extend coverage to all its citizens.
  2. Minimal incremental administrative overhead: Governments have an existing infrastructure for tax collection and hence there is minimal to no incremental overhead costs of collecting additional tax to fund the UHC.


  1. Dependency on number of tax payers: The direct tax regimes of most countries aim to be progressive by making the wealthier pay more tax on their incomes. However if the number of those that pay direct taxes is a small percentage of the population , it leads to an untenable situation of a small minority requiring to support a large majority. This would introduce distortions like under reporting of income to save on the tax burden or high overhead costs to ensure compliance. On the other hand, even though a large percentage of the population pays indirect taxes, it is difficult to establish equitable financing participation as indirect taxes which are normally levied on consumption.
  2. Volatility in fund allocation: Governments need to balance its priorities across a number of social and administrative requirements. It is a justified fear that over a period, either through inertia, financial challenges or changing political priorities, the fund allocation quantum to healthcare may turn volatile and even reduce.
  3. Inequity in receipts of benefits: Medical facilities are usually unequally distributed with rural and remote areas lacking in infrastrucutre and facilities. This means population in these areas are at a disadvantage while accessing medical services when compared to their urban peers.

Social Health Insurance


  1. Avoiding the “least common denominator” effect: Unlike the tax funded system, the SHI does not suffer from the tyranny of the “least common denominator” effect. SHI schemes have greater flexibility in responding to its members’ needs for benefit packages and service providers that are relevant to their needs and situations which may be different from the wider population. Usually demanding members are willing to pay additional contribution for a differentiated benefit packages and service providers.
  2. Predictability in funding: Funds collected under the SHI system are for a defined purpose and there are no competing requirements for these funds. This makes the financing predictable and allows SHI schemes greater advantage when negotiating for long term contracts with service providers.


  1. Requires a large organized sector: The SHI system requires only voluntary participation of those that are unemployed or are self employed. It is, therefore, much more difficult to ensure total or even extensive coverage of the population. In a developing economy people employed in the organised sector usually represent a small percentage of the population and the problem of limited coverage is only exacerbated.
  2. “Tax” on employment: The SHI system imposes an additional financial burden on both employees and employers. This may shift the employment curve leftwards with both employers reducing their labour requirements or preferring an informal hiring of employees and employees resorting to under reporting of salaries or preferring payment in kind rather than cash.
  3. Duplicated infrastructure and overheads: Each SHI scheme essentially duplicates the infrastructure and overheads required to managing itself. This channels a greater portion of the overall funds to non-productive expenses.