Maryland’s recent enactment, over Governor Ehrlich’s veto, of a law mandating that Wal-Mart spend at least 8% of its payroll on employee health care underscores anew the absurdity of an employer-centric health care system. The premise of Maryland’s new unfunded mandate, the leading edge in a national movement, is that U.S. employers are not spending enough on health care. This premise is dangerous and wrong, because the root of the health care crisis is precisely the opposite – employers are already paying too much.

The third-party payment system, in which health care consumers don’t pay directly for their care – employers and taxpayers pick up the tab – makes controlling costs difficult to impossible. Real health care reform must shift costs back from third parties to consumers, not just shuffle the balance between employers and taxpayers.

Employer-provided health insurance is an historical quirk, a byproduct of World War II wage controls. It endures because of misguided tax policy. When an employer pays for health care, it is tax-subsidized, because the employer can deduct the expense, but the employee does not have to declare it as income. If an employee buys his or her own health care, it is usually with after-tax dollars. This tax preference, which would be limited only modestly by the proposed Mack-Breaux reforms, has created an irrational structure in the health care sector.

The structure, in which providers and consumers make decisions while employers and taxpayers pick up the tab, creates a wedge. In the absence of effective cost constraints, the market focuses on the best possible care, even at astronomical costs. Instead, the industry should be focused on developing new treatments that consumers can afford. Unless the system is reoriented to consumers and markets, government will end up having to set prices, and then when price controls fail, the government will end up having to ration health care directly.

To drive affordable innovation and provide effective care, the market must set prices and allocate health care. The solution lies in transforming a tax-subsidized, employer-financed and third-party provided system of prepaid health care into consumer-financed health insurance in which health care is provided directly to consumers by providers who are paid directly by consumers. The government’s role should be to provide a safety net through voucher-based assistance to low-income Americans to ensure they can afford to participate in the market.

Congress should consider ways to shift the tax subsidy for health care from employers to individuals. One simple way to accomplish this would be to end deductibility of health care expenses for employers while creating an unlimited, tax-deductible medical savings account for individuals. Medical savings accounts, combined with federal subsidization for low-income Americans, could create universal health care coverage in a way that empowers individual consumers and creates incentives for cost containment and affordable innovation.

Health care looks like it’s heading inevitably toward crisis, with over 40 million Americans already uninsured and state and federal health care programs facing trillions of dollars in unfunded liabilities. Fortunately, if we can eliminate the huge structural inefficiencies, quality care will become and remain affordable. Workers already pay a large share of their income, implicitly and highly inefficiently, to purchase health care.

Federal and state legislators need to reject the illusory Maryland solution of dumping the third party payment burden from taxpayers to employers and open their imaginations to real, structural reform. Giving consumers explicit control of their health care dollars would give the industry the incentives it needs to solve the problem.

Mr. Factor is chairman of the Free Enterprise Fund.