Health Insurance and the American Tax System

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 The President's Proposed Standard Deduction for Health Insurance - An Evaluation

Over 45 million Americans under the age of 65 - the overwhelming majority of them in working families - do not have health insurance. Most working-age Americans who have health insurance get it at work, and tax subsidies for employment-based health insurance cost over $200 billion annually in lost income and payroll tax revenues-the largest single tax expenditure in the federal budget. However, some analysts are concerned that the open-ended subsidy may do more harm than good, by inflating the price of health care and pricing many out of the market, especially those with low incomes or chronic health conditions. As the baby boomers begin to retire, rising health care costs also threaten to bury the nation in debt. Thus, how we address the challenges of rising health care costs and declining coverage will determine what kind of society we live in and our fiscal health in the 21st century.

President Bush tackled the issue in his 2007 State of the Union address with a proposal to make major changes to the tax treatment of health insurance. His plan would count health insurance premiums paid by employers as taxable income but allow a $15,000 deduction ($7,500 for single taxpayers) on both the federal income tax and on payroll taxes for people who obtain qualifying health insurance coverage. The plan would also eliminate most other tax preferences for health care expenditures and encourage states to redirect existing funds to help low-income families obtain health insurance coverage. By severing the link between work and insurance, the plan would give everyone the same tax incentives to obtain insurance coverage and help to limit spending on health care. But preliminary TPC analysis concludes that significant changes to the plan would be needed to make it fair and to prevent the possible erosion of health insurance coverage for many families.

Other options exist to addess these problems in a constructive way. Some have proposed redesigning the tax subsidy so that it is more useful for low-income households or harnesses market forces to expand coverage without undermining the employer-based system. (An Urban Institute First Tuesday forum in 2006 addressed these and other issues.)

Further Reading

Distributional Analysis of the Proposed Standard Deduction for Health Insurance.   The proposed standard deduction for health insurance will provide most taxpayers with an immediate tax cut, while others will experience a tax increase. Over time, many more taxpayers will see their taxes rise as premiums grow faster than the value of the standard deduction. These tables from the Tax Policy Center's Microsimulation Model show the distribution of the tax change under the proposal in 2009 and 2017, as well as the distribution of subsidies for health insurance under current law and under proposed law. Separate tables present results for income taxes alone, income and medicare taxes, and income and payroll taxes.  (February 7, 2007)

The President's Health Insurance Proposal - A First Look  The paper describes the basic features of the President's plan and evaluates the extent to which it would meet its stated goals of expanding health insurance coverage and restraining healthcare spending. The basic approach would improve the market for health insurance, but inadequate attention was paid to problems in the nongroup market or those facing households with low incomes. In consequence, the plan could actually reduce overall insurance coverage. The paper suggests a variety of ways in which the proposal could be improved so more people would be covered, including those with low incomes or in poor health.   (January 23, 2007)

Can We Buy Our Way to Health Reform?   No issue has stumped policymakers more than how to provide healthcare to its citizens in an efficient and fair manner. Healthcare costs spiral out of control, usurping other vital government functions. Those rising costs also lead to increased numbers of uninsured, as employers and employees both decide to avoid costs simply by neglecting health insurance altogether. In simply throwing more money into the system, they add to, rather than subtract from, the fundamental problem that someone, somewhere, somehow has to decide what health spending is worthwhile and what is not.  (June 12, 2006)

Taking a Checkup on the Nation's Health Care Tax Policy: a Prognosis: Statement of Leonard E. Burman before the United States Senate Committee on Finance. In this testimony before the Senate Finance Committee, Len Burman summarizes the latest data on who has health insurance and who doesn't, outlines the various tax subsidies that exist for health insurance, examines how those subsidies affect the market for health insurance and employment, and briefly comments on some reform options.  (March 8, 2006)

New Healthcare Tax Proposals: Costly and Counterproductive. The Budget for Fiscal Year 2007 contains a package of new tax incentives for individuals and employees who are covered by high deductible health insurance policies and contribute to Health Savings Accounts (HSAs). The new proposals would make the tax system more complex, less fair, and add to our budget woes, especially over the long run. The proposals would reduce revenues by $156 billion over ten years. Perhaps most problematic, they are likely to exacerbate the problems in the health care market.  (February 13, 2006)

Tax Credits for Health Insurance. Over 40 million Americans under age 65--the overwhelming majority of them in working families--lack health insurance. The public ultimately shoulders the burden of paying for the medical treatment of those lacking insurance, either through higher taxes or higher health care costs. Expanding health coverage through the tax system may not be the most efficient path, but tax subsidies appear the only game in town for expanding the federal role in the provision of health insurance. This policy brief examines implications of major expansions in tax credits for health insurance, starting with the President's refundable tax credit proposal.  (June 23, 2005)

Tax Incentives for Health Insurance.  This paper examines the data on health insurance coverage and discusses trends in coverage. It considers the problems in the health insurance market and their implications on the nature and scope of government intervention. It uses the Urban Institute's Transfer Income Model (TRIM) to show who gains from the current tax exclusion, and examines the mismatch between current subsidy schemes and the problems in the health insurance market that an ideal subsidy might mitigate. Using TRIM, we simulate the effects of illustrative tax subsidy proposals on the distribution of tax benefits and discuss the effectiveness of those proposals at addressing health insurance market failures.  (May 16, 2003)

Tax Subsidies for Private Health Insurance: Who Currently Benefits and What Are the Implications for New Policies?  Policymakers are considering a variety of new tax credit proposals to expand health insurance coverage. Understanding how current tax subsidies work and their role in supporting employer-sponsored insurance (ESI) is important when designing such policies. This brief presents essential information about the structure and distribution of existing tax subsidies for ESI and the implications for new policy options.  (May 1, 2003)

Congress Spends More to Increase Number of Uninsured   This column argues that by continunig to allow the exclusion from taxation for employees (and some self-employed) for the cost of health insurance if purchased through an employer, Congress is spending money to increase the number of uninsured. The provision amounts to an estimated $150 billion over the next five years as much as $1 trillion more within the next quarter century.  (May 1, 2003)

First, Do No Harm: Designing Tax Incentives for Health Insurance.  A bipartisan consensus favors public policy initiatives to expand health insurance coverage. This paper summarizes new CPS data on health insurance coverage for the nonelderly and discusses the issues involved in subsidizing health insurance. We outline a tax credit option designed to diminish many health insurance market flaws. A simple model illustrates that the Administration's recent proposal for tax credits for nongroup insurance alone is equivalent to a general insurance tax credit (our preferred option) with a tax on ESI. Thus, it runs the risk of doing harm - undermining the insurance that currently covers most nonelderly Americans.  (May 21, 2001)

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