Health subsidies, prevention and welfare

People value healthy ageing but may underinvest in health‐improving preventive care. This arises when they ignore the beneficial effects of healthy ageing on public health expenditures and hence on the tax burden of future generations. This health externality justifies public intervention. 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 the health externality and the size of health care costs, and negatively on the discount factor. The subsidy rate should therefore be high when prevention is cost‐effective and when the population is careless about the future. Moreover, the welfare‐maximizing subsidy rate is lower than the health‐maximizing rate but higher than the capital‐maximizing rate. This underlines the trade‐off for a policy maker between health and economy.