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Health Care: How does the employer-sponsored insurance exclusion affect coverage?

The exclusion of employer-sponsored insurance (ESI) from taxable income tends to increase coverage rates because it lowers the cost of insurance for most people, spurring demand. Its effects are uneven, however, and alternative policies that focus subsidies more broadly and on those less likely to get insurance on their own could have greater impact at the same cost. Because the cost reduction increases with the individual’s marginal tax rate, the ESI exclusion gives smaller benefits to lower-income workers than to those with higher incomes, who are already more likely to obtain insurance coverage. In contrast, a refundable tax credit available to everyone would provide the same subsidy for all insured workers as well as nonworkers, and thus would not exacerbate already unequal coverage rates. Shifting to such a policy could increase coverage without raising costs.

  • About 83 percent of all workers are offered health insurance by their employers, and roughly two-thirds of those workers accept the offer (see table).
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  • Workers facing the lowest marginal tax rates are much less likely to be offered insurance coverage than those facing higher rates. Only about 70 percent of workers with marginal tax rates of 10 percent or lower receive such offers, compared with more than 85 percent of those with tax rates above 10 percent.
  • Take-up rates for single workers first rise and then fall as the marginal tax rate rises. About one-fifth of all single workers with the lowest tax rates receive and accept an offer of ESI, rising to about five-sixths of those with tax rates around 28 percent. But only about two-thirds of those facing the top marginal rate are offered and accept coverage. In contrast, about three-fifths of married and head-of-household workers across all but the two lowest tax categories in the table do so.
  • Married or head-of-household workers are much more likely than their single counterparts to get health insurance by virtue of being dependents of other workers, although those who face lower tax rates are less than half as likely to do so as those facing higher rates. More than half of married and head-of-household workers who face marginal tax rates above 10 percent and who do not get insurance from their own employers receive coverage as dependents.
  • Many factors besides cost affect whether people obtain health insurance coverage. Low-income individuals, especially younger ones, may face lower health risk and thus perceive less need for coverage. They may choose to spend their scarce resources on other goods and thus have lower willingness to pay for insurance. They may also find it easier than others to satisfy income and asset eligibility requirements for public coverage in the event of a serious health condition. These factors make it difficult to know whether low-income individuals would elect to purchase health insurance even if they faced the same price as higher-income individuals.
  • Many proposals to expand health insurance coverage focus on increasing tax incentives to obtain health insurance. Yet a 2004 study examined a range of tax policies designed to increase coverage and found that every one was much less efficient at increasing coverage than expansions of public insurance. The study did find, however, that policies tightly targeted to the lowest income earners were much more efficient at increasing coverage than those that are also available to households higher in the income distribution.
 
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