The United States is the only country in the developed world where health coverage is tied to employment. And while this arrangement seemingly works out great for both the employed (and covered) and the employees who offer health insurance as a benefit, the most basic flaw of such a system is it's effect on everyone else. So how did it get this way?
Even though the government played a role in the emergence of employee based healthcare, the reality is: it wasn't a carefully designed (or well thought-out) system at all. In fact, it was a combination of market forces, limited government intervention, and the rule of unintended consequences.
WWII wage and price controls
As the health insurance market began to emerge, the U.S. entered WWII which sent a large part of the working population off to fight in the war. With labor scarce, employers sought ways to recruit and replace the missing workers. Because those drafted were restricted in their pay while they were off risking their lives, restrictions on wage increases and prices for domestic products back home were put in place. So employers looked for other “fringe benefits” to offer the scarce workforce to fill the empty spots. One such benefit was health insurance.
Without knowing it, this policy in effect, kick-started the trend of employers offering health coverage as a part of a compensation package. A trend that would only be further reinforced by future government policies.
Other contributing factors in the 40's
With the growing trend of group health insurance benefits from employers, 2 major rulings contributed to its reinforcement:
First, in 1945 the War Labor Board ruled that employers could not modify or cancel group insurance plans during the contract period.
Then, in 1949, the National Labor Relations Board ruled in a dispute between the Inland Steel Co. and the United Steelworkers Union that the term "wages" included pension and insurance benefits. Therefore, when negotiating for wages, the union was allowed to negotiate benefit packages on behalf of workers as well. This ruling, affirmed later by the U.S. Supreme Court, further reinforced the employment-based system.
Source: http://eh.net/encyclopedia/article/thomasson.insurance.health.us
Tax policy
What solidified the employee based healthcare system we have today was the emerging tax advantages for both employers and employees of health insurance as a benefit. First of all, employers do not have to pay any payroll taxes on their contribution to the premiums as they would a salary. And even though in most circumstances employees still had to pay income tax on the benefits, in 1954, the IRS made it an exemption passing the tax benefits to employees as well. This move further increased the demand for health insurance among employment groups to record levels. (this was seen as a good thing)
Why the employment based system is flawed
The most glaring problem with health coverage being tied to employment is its effect on the unemployed. As if loss of income isn't bad enough, to compound it with loss of health insurance can be financially devastating. But it's not just the potential out-of-pocket health care costs that are the problem. Purchasing individual health insurance on the private market tends to carry more expensive premiums (beyond the lack of tax benefits) for less coverage. And even temporary loss of coverage can lead to being denied insurance or charged outrageous premiums for “pre-existing conditions”. COBRA and HIPAA attempted to reconcile this problem, to a degree, by allowing extensions and portability of health insurance benefits. Certain portions of the Affordable Healthcare Act will also do the same.
The lack of a grounded private/individual market for health coverage also means insurance is out of reach for a large portion of the employed (who aren't offered coverage through their employer). According to a 2007 study, less than 60% of employers at small firms under 200 employees (but more than three) in the US provide employee health insurance. And according to the US Census Bureau, only 9% of Americans are covered under health insurance purchased directly.
Another fundamental flaw with this system is the lack of price controls on premiums based on usage. Because a majority of the costs of coverage (typically around 80%) is paid for by the employer, employees have little incentive to control the cost of premiums (that are based largely on usage). As a result, this has contributed to the rising costs of health care premiums overall. And now companies who are trying to stay competitive on a global marketplace have started to reduce (or cut) such benefits in order to limit costs.
Why we're stuck with it
A transition from the current system of employee based healthcare to any viable alternative would be a logistical nightmare. That's why politicians continue to design policies that embrace employee sponsored health insurance as the major method for coverage. The signing of the Affordable Care Act is just the latest installment of such policies backed by the U.S. government. In 2014, employers with over 50 employees will pay a $2000 fine for every full-time employee without health coverage. And even though the bill will also attempt to level the playing field for individual marketplace (even mandating coverage for all), it's clear that the system of health insurance being tied to employment isn't going away any time soon.
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