I recently started building products focused on healthcare affordability in the US. As I was ramping up on a new space, the biggest question that sparked my curiosity was: how did we get here? This question is the inspiration for this weekly series chronicling the decisions, accidents, and breakthroughs that built the US healthcare system.
By 1954, employer-sponsored health insurance had been growing for over a decade. But it was built on uncertain legal ground — a patchwork of wartime exemptions, IRS rulings, and informal practice. One adverse ruling could have unraveled the whole thing.
Then Congress passed sweeping tax reform bill with one buried provision.
Section 106 of the Internal Revenue Code of 1954 was simple and deliberate: employer contributions to employee health plans were excluded from the employee’s taxable income entirely. Employers kept their deduction. Employees paid no tax on the benefit. Both sides of the transaction now had a powerful financial incentive to prefer health coverage over cash compensation.
In practice, a $500 raise cost an employee income tax on top. A $500 health plan was worth the full $500 — and the employer could deduct it too. Across every HR department, compensation managers ran the same calculation and reached the same conclusion. This wasn’t a healthcare decision, it was just math.
What made Section 106 particularly consequential was what it didn’t include: a cap. Unlike the tax treatment of life insurance, the health insurance exclusion had no ceiling. The bigger the health plan, the bigger the tax benefit. As healthcare costs rose over the following decades, the incentive to expand coverage rather than question costs grew right alongside them.
Every strength overused has a corresponding dark side. Similarly, a feature of the tax code designed to encourage coverage quietly became a structural barrier to cost scrutiny.
Interestingly, the Internal Revenue Code of 1954 passed on August 16th. Section 106 was a few sentences out of a 1,000 page bill with little debate about its implications for healthcare. It was a tax policy decision that permanently embedded a particular model of healthcare financing into the structure of American life.
Today that tax exclusion has an estimated $500 billion annual impact — making it one of the largest tax expenditures in the entire federal budget. Roughly 160 million Americans still get their coverage through this system.
A Quick Timeline to put it all in context
To put this in context, here is how the pieces came together across twelve years:
1942: FDR’s Stabilization Act freezes wages. Benefits are exempt. Employers begin competing on health coverage for the first time.
1942–1945: Henry Kaiser and Sidney Garfield scale prepaid healthcare to 200,000 shipyard workers in Richmond, California. Voluntary enrollment reaches 92.2%.
1943: The IRS rules that employer contributions to group health plans are not taxable to employees. Coverage begins growing rapidly.
1945: Kaiser opens his health plan to the public. Membership collapses from 200,000 to 11,000 as the shipyards close. The model survives.
1953: A new IRS ruling creates uncertainty, declaring some employer contributions taxable. The legal foundation of the entire employer-sponsored system wobbles.
1954: Section 106 resolves the ambiguity permanently. Employer contributions are tax-exempt, full stop.
By 1960, nearly 70% of Americans had health insurance. This was a fascinating 20 year period where a wartime workaround, scaled by an industrialist, and cemented by a tax code became the foundation of American healthcare.
The question nobody had fully answered yet: what about the other 30%? That comes next.
A Learning a Day 