Health subsidies, prevention and welfare

Health subsidies involve public budgetary costs. However, they generate a positive externality by encouraging participation in health-improving initiatives, which help reduce future health care costs. We build an overlapping generations model with a government subsidizing investment in health by the young generation and paying the health care costs of the old generation. We find that the welfare-maximizing subsidy rate depends positively on health externality and the size of health care costs, and negatively on the discount factor. The subsidy rate should therefore be high when prevention more effective at cost saving and when the population is myopic about the future. Moreover, the welfare-maximizing subsidy rate is lower than the health-maximizing rate but higher than the capital-maximizing rate.