A Sick Policy on Health Insurance
Tax breaks for buying health insurance save buckets of taxes for executives who acquire deluxe policies, provide spoonfuls of savings for low and moderate-income workers, and excessively drive up the cost of health insurance and health care in general.
Question 5. Ask the Candidate:
Should tax breaks for acquiring health insurance do more to help ordinary workers become insured, and should the tax breaks be limited to the cost of a basic policy?
Health insurance premiums, which have been rising at double-digit rates and are likely to continue to do so, pose enormous problems for most us. About 47 million Americans under age 65, the great majority of whom are members of working families, have no health insurance. Rank-and-file employees with basic health insurance through their work struggle to keep their coverage at a time when their employers insist that they pay an increasing share of the costs.
On the other hand, managers (a term used here to include all highly-compensated employees) might select top-of-the-line (let's call them "deluxe") policies that offer the most extensive coverage and smallest co-payments, and their employers often foot most, if not all, of the bill.
Any thoughtful lawmaker recognizes the benefits of a healthy society. Aside from wishing fellow citizens well, lawmakers know that healthy children are more likely to have better school attendance and be better students, and healthy adults are more likely to work productively and be able to support themselves and their families and not become a burden on government.
We can easily understand, therefore, why Congress might adopt a tax break that encourages workers to acquire health insurance. Congress would have a hard time explaining, however, why it has designed the tax break so badly. For 2007, the income tax savings for workers amounted to about $107 billion. From 2007 through 2011, the savings are estimated to be about $645 billion.[1] Yet the largest savings are for the most highly paid workers, who could acquire a policy without the government's assistance, and the least savings are for low-income workers. The tax break also excessively drives up the price of health insurance and health care generally.[2] We can't afford a mistake of this magnitude.
Primo Subsidies for Primo Premiums
In general, if your employer pays for your personal expenses (e.g., food and housing), the payments count as wages and are added to your W-2 form. One exception is for health insurance premiums acquired at work. Whether the employer actually pays the premium, or deducts money from your wages and makes the payment on your behalf, the money involved is exempt from income and payroll taxes.
About two-thirds of workers and their families obtain their insurance at work, but the people who are helped most by the exclusion, as in the case of all exclusions, are people who otherwise would be taxed at the highest marginal tax brackets. For example, each $1 excluded saves 35 cents for someone who, without the exclusion, would pay the top 35% tax rate on it. For the roughly 45% of households whose top tax bracket is only 10% or 15%, each $1 excluded saves only 10 cents or 15 cents. And, as Congress knows, the exclusion has no value for the roughly 30% of households whose taxable income is so low they wouldn't pay a tax on the premium even if it counted as income.
In other words, 75% of all households benefit little or not at all from the exclusion of health insurance acquired at work; the remaining 25% benefit a lot.[3]
Moreover, an employer often pays for family policies for married managers, including deluxe policies, but pays only for the cost of a single basic policy for other married workers, who have to come up with the difference if they want a family policy. No wonder this tax break produces such upside-down subsidies.
You may recall that in the Introduction, we discussed the lopsided tax savings for Mr. CEO vs. Ms. Secretary that resulted from the tax exclusion for disability income insurance premiums acquired at work. That's exactly what happens with the exclusion for health insurance premiums.
Let's say Mr. CEO and Ms. Secretary are each married with young children, and that ABC, Inc. pays $8,000 for a basic health insurance policy for each. The $8,000 is excluded from their respective tax returns. Mr. CEO, who earns $500,000, saves $2,800 in income taxes, because without the exclusion, he would have been taxed on the $8,000 at the highest 35% tax bracket (35% x $8,000 = $2,800). Ms. Secretary, who earns $30,000, saves only $1,200 at her 15% tax bracket.
And if ABC buys the deluxe $16,000 policy for Mr. CEO (with low deductibles and small co-insurance), while buying the basic policy for Ms. Secretary, his income tax savings are jacked up to $5,600 (35% x $16,000).
You get the picture. The federal government has paid for 35% of Mr. CEO's policy and only 15% of Ms. Secretary's policy. And the difference is even greater if ABC buys Mr. CEO a fancier policy than it buys Ms. Secretary. Guess which one of them could afford health insurance without the tax break?
Congress also knows that (i) higher-income workers are much more likely to be covered by an employer-based health insurance policy than are lower-income workers, (ii) full-time, full-year workers are much more likely to be covered than are part-time or part-year workers, and (iii) workers at large firms are much more likely to be covered than are workers at small firms.
As experts from the nonpartisan Tax Policy Center have written, "Putting all...factors together, the picture is of a tax subsidy that overwhelmingly favors middle- and upper-income households."[4]
Here's something else to think about: Economists tell us that the unlimited exclusion for health insurance premiums paid at work induces many workers to acquire more insurance than they would otherwise. That may or may not be in a worker's best interest. The increased demand for health insurance, however, drives up the cost of premiums, particularly because the insurance companies know that the government is footing part of the bill; and the effect is magnified as the policies get fancier and the premiums more expensive. Furthermore, deluxe policies, by providing full or nearly full insurance coverage for even the most minor medical problems, especially drive up health costs because they minimize the incentives of the insured and physicians to worry about costs.
What Congress Should Do
Congress could reduce health care costs overall and solve coverage problems if it adopted universal health care. (Universal health care should be accompanied by an emphasis on preventive care and by controls on unneeded procedures, medical errors, hospital infections, and other wasteful aspects of our nation's health care system.) The most straight-forward and efficient way to achieve universal health care, but the most politically difficult, would be to cover everyone, regardless of employment or means, through tax revenues. Short of that, Congress should revise the tax laws in three major ways to make them more fair and efficient.
Limit Exclusion to a Basic Policy. Congress should limit the exclusion to health insurance premiums for a basic policy-adjusted for the size of the household. What is "basic" will need defining, but these are challenges that commonly arise in the tax laws. I'm hardly the first person to suggest this. In fact, as far back as 1984, the Treasury Department made this exact recommendation--and went on to specify the maximum monthly amount. It happened to be Ronald Reagan's Treasury Department.[5]
Deny Exclusion for Policies Favoring Managers. Congress should deny the exclusion to highly-compensated workers if other workers for the same employer are not entitled to insurance comparable to theirs. Congress is no stranger to this idea. It already has adopted these rules when employees themselves pay for their health insurance pursuant to an employer's cafeteria plan.
Cafeteria plans allow employees to have various personal expenses paid, such as for health and disability income insurance and for child care, by having their employers subtract the necessary amounts from their salary. All payments allowed by the cafeteria plan are tax free except for highly-compensated employees if the program improperly discriminates in their favor. In the case of health insurance premiums, the tax exclusion for highly-compensated workers is eliminated altogether unless comparable percentages of other workers acquire the policies and the policies for highly-compensated workers are comparable to policies for other participants. (Employers can encourage rank-and-file workers to participate by contributing to the cost of the premium.) Typically, when rank-and-file workers choose to participate, they acquire only a basic health insurance plan because that's all they can afford.
Why Congress has imposed such reasonable limitations for cafeteria plans but not for the typical employer-paid premium is unclear. What is clear is that the tax savings from limiting the exclusion to a basic policy can be enormous. The Congressional Budget Office recently estimated that limiting the exclusion for employer-based health insurance to $910 per month for family coverage and $340 a month for individual coverage would increase revenues from income and payroll taxes by $290 billion from 2008 through 2012 and by $999 billion from 2008 through 2017.[6]
Tax Credit for Individual Purchasers. Congress should create a tax credit available to everyone who acquires insurance outside of work. (While beyond the scope of this book, Congress must make sure that all households have access to competitive premium rates nationwide.) Under current law, these households rarely receive any tax break for paying health insurance premiums personally, because they rarely itemize their deductions, and the deduction even then is limited to health care spending in excess of 7.5% of their income.[7]
The credit should be refundable (as defined in Question One) to make sure that it helps people who don't owe income taxes; it should be targeted primarily at taxpayers with moderate incomes or less; and it should be large enough to make the insurance affordable, covering the full cost for households who cannot afford any insurance. Depending upon the size of the credit and the number of people who use it, the additional costs to the government would be offset, at least in good part, by the revenue generated from limiting the tax exclusion for health insurance premiums to premiums for a basic policy.[8]
In order that people not have to wait until the end of the year to know the size of their credit, the credit should be based on a taxpayer's income for the prior year. Rules also would have to be developed to assure that the credit is in fact used to acquire insurance. For example, the credit could be assigned directly to the insurance company, or it might be assigned to an employer who will use it to acquire the insurance for its employees.[9]
A final note. Some experts argue that these changes would have the effect of reducing, rather than increasing, the number of insured because some employers would stop contributing to the costs of their employees' health insurance if the tax exclusion did not apply to deluxe policies. That debate is too extensive to be addressed here, except for two observations.[10] First, I believe that relatively few employers would discontinue their programs because (i) middle- and upper-income employees would still benefit from considerable income tax and administrative advantages if their insurance is acquired at work, and (ii) the premiums paid by the employer for basic policies would continue to avoid payroll taxes, at a considerable savings to employers and employees. Second, many currently uninsured households would become insured through the proposed credit.
What we should expect from every candidate, however, is agreement that any tax subsidy for health insurance should focus on maximizing the number of insured at the minimum cost to the government. Let's find out if they agree.
[1] Joint Committee on Taxation, Estimates of Federal Tax Expenditures for Fiscal Years 2007-2011, JCS-33-07. Washington, D.C.: GPO, 2007, 33. A minor portion of these savings includes the tax savings from having uninsured health costs paid, tax-free, through health plans at work, a controversial topic not addressed here.
[2] Statement of Leonard E. Burman, United States Senate Committee on Finance, March 8, 2006. Mr. Burman is a Senior Fellow at the Urban Institute and director of the Tax Policy Center of Washington, D.C.
[3] The tax break for acquiring health insurance discriminates most severely against people who acquire their insurance outside of their job. They receive no tax relief at all unless they itemize, as few low-and moderate-income workers do, and even households that itemize may deduct only health costs, including the cost of their premiums, that exceed 7.5% of their income.
[4] Leonard Burman, Bowen Garrett, and Surachai Khitatrakun, "The Tax Code, Health Insurance Coverage, and Utilization," a paper for presentation at a meeting at the Brookings Institution, Washington, D.C., February 29, 2008.
[5] Department of the Treasury. Tax Reform for Fairness, Simplicity, and Economic Growth: The Treasury Department Report to the President, Vol. II, November 1984, 17.
[6] Congressional Budget Office. Budget Options. Washington, D.C.: Government Printing Office, February 2007, 279. CBO's premium figures do not adjust for cost-of-living adjustments, which presumably would be included in any legislation. Their figures include eliminating the exclusion for health cost reimbursements through a cafeteria plan, flexible savings accounts (FSAs), and health savings accounts (HSAs] but the great bulk of the tax savings comes from limiting the exclusion for health insurance premiums. CBO notes that the additional Social Security taxes that would be paid because a portion of premiums previously exempt would count as wages also would permit additional Social Security benefits over the long run.
[7] For a similar conclusion, see The President's Advisory Panel on Federal Tax Reform, "Simple, Fair, & Pro-Growth: Proposals to Fix America's Tax System, November 2005, 81.
[8] It probably has occurred to you that Congress could eliminate the tax exclusion for health insurance premiums altogether and provide every household with a credit (refundable, where needed) toward health insurance costs, whether the insurance is acquired at work or outside of work. Although the exclusion is costly, its elimination altogether at this time would likely have too many adverse effects on the coverage of workers who currently acquire their insurance through work.
[9] For an evaluation of President Bush's proposed revision of tax subsidies for health insurance, see Len Burman, Jason Furman, Roberton Williams, "The President's Health Insurance Proposal-A First Look," Tax Policy Center, January 23, 2007.
[10] For a discussion of this issue, see citation in endnote 3; see also Leonard E. Burman and Jonathan Gruber, "Tax Credits for Health Insurance," Discussion Paper No. 19, The Urban Institute, Washington, D.C. 2005. See also John F. Cogan, John F., R. Glenn Hubbard, and Daniel P. Kessler. Healthy, Wealthy, and Wise: Five Steps to a Better Health Care System. Washington, D.C.: American Enterprise Institute Press, 2005.