Moral Hazard in Health Insurance: Liquidity or Distortion?

I exploit the timing of the Earned Income Tax Credit, a large transfer to low-income working families, in order to estimate the effect of cash liquidity on the demand for medical care for children. I use the estimate to decompose moral hazard into a welfare increasing “liquidity effect” and a welfare decreasing “substitution effect.” Empirical estimates of the liquidity effect are large for the uninsured. Uninsured children are much more likely to seek care in months following EITC receipt as compared to other months of the year. The likelihood of visiting a primary care doctor or the dentist increases, but there is no effect on the propensity to seek care at the emergency room. There is little to no effect on children who are publicly or privately insured. I then use the new empirical estimate to evaluate the net change to social welfare resulting from an expansion of public health insurance for children through the State Children’s Health Insurance Program. The “liquidity effect” of health insurance is large relative to the “substitution effect” resulting in a sizable net increase to social welfare that is larger than other estimates in the literature that use different methods.