President Bush will set out in the State of the Union address a new health proposal that once again uses tax policy to encourage movement from employer-based health insurance system to one in which individuals buy health insurance on their own. Yet, the administration’s plan does little to insure the uninsured, help the low income, or aid the less healthy.
The stated intent of the proposal is to equalize the individual and employer-based health insurance markets and create tax incentives for people to buy cheaper, less comprehensive plans so that consumers spend their health dollars more wisely. The current tax exclusion allows premiums from employer-based plans to be exempt from individual income tax and payroll taxes, which include Social Security and Medicare taxes. The Bush plan works like this: If workers purchase health insurance either through their employer or the individual market, a fixed amount is deducted from taxable income. The proposed tax deduction is $7,500 for individual plans and $15,000 for family plans. Thus, if you buy a single plan for $3,000, then you receive an additional tax deduction on the $4,500 you did not spend on health premiums.
Over time, this proposal will significantly erode the employer market. This is not particularly surprising as this administration has presided over a period of declining access to employer provided health insurance and has pushed and passed policies, such as Health Savings Accounts (HSAs), to advantage the individual market. However, it makes more sense to encourage the employer market because it produces larger risk pools, and keeps insurance more affordable for those who get sick and really need it. Employers provide a way to group people according to non-health characteristics, which makes them viable as insurance pools. A flat subsidy that encourages the purchase of the “leanest” (least comprehensive) insurance plan possible potentially siphons off the younger, healthier people into the individual market and destabilizes employer risk pools. The flat exclusion will likely affect few people in the beginning, but as health costs rise faster than the exclusion amount, it will cause further employer erosion in years to come.
Some people may be enticed by the new exclusion in the individual market to become insured. However, in the long-run, the erosion in the employer market may leave some of the neediest uninsurable in the individual market. Low-earners will not see many benefits from this plan for a simple reason—you need to make enough earnings for the tax exclusion to become valuable. If, for example, you spend much of the year uninsured because of unemployment, you almost surely will not have enough earnings to make any tax exclusion valuable. This problem could be fixed by making the flat exclusion a “refundable” tax credit, like the Earned Income Tax Credit (EITC), which delivers benefits regardless of one’s tax liability. Furthermore, cash-constrained workers cannot get the money now when they need to purchase the insurance. And, it is hard to imagine how the administration plans to handle the complex and costly nightmare of returning payroll taxes to all those non-filers.
Another problem with the Bush proposal is that it will create incentives to buy cheaper, less comprehensive insurance. Restrictions on the required coverage appear to be only minimal, giving individual insurance purchasers further inducement to buy high deductible health plans, particularly plans that qualify HSAs. All data suggest that these plans are unpopular. In fact, the proposal creates such a large incentive to buy less expensive policies that one wonders why the administration has chosen to continue the HSA preference for high deductible health plans.
The flat exclusion is supposed to tax ‘Cadillac’ health plans, allegedly because mostly high-income people have such extravagant health insurance. However, there is little evidence that the regressivity of current policy is due to a correlation between earnings and Cadillac health plans, rather, it stems from the simple fact that any tax exclusion necessarily provides benefits to those with high incomes (and hence high marginal tax rates). There is indeed little evidence to suggest that only high earners consume costly plans, and there are good reasons to think that they do not. Smaller firms employing one less-healthy employee or primarily older employees pay higher premiums. Even blue-collar workers who have successfully bargained for benefits often pay higher premiums. What is billed as progressive may not necessarily be so.
Many have decried the overall size of the tax expenditure resulting from current policy—the employer-exclusion is the single largest tax subsidy in the federal budget, more than double the size of the mortgage interest deduction. Moreover, the Bush proposal will increase the size of this expenditure, at least in the short-run. Support for this plan cannot be based on grounds of reducing the budget deficit.
More than anything, the health policies introduced by the Bush administration this week (and throughout the administration) are about shifting risk onto the individual. As the employer market erodes, more individuals must seek insurance on their own if they want any kind of health security. The individual market puts the onus on the individual to find and purchase health insurance, and there is no guarantee that the insurance they buy today will be available to them next year. Those unlucky enough to be unhealthy today or to get sick tomorrow will find it very difficult to find affordable insurance in the private market. At least the employer market promotes shared risk (or risk pooling) among individuals and families in firms and provides protection from financial loss when illness strikes. Risk pooling offers a way for individuals to share that risk. This year, your co-worker might need more health care and the next year, it might be you or your child that needs it.
To be clear, the current policy of exempting employer-based health insurance premiums from taxation is an expensive policy, benefiting only those with ties to the workplace. However, it does promote some measure of risk-pooling, which helps insurance markets function. Attacking this pooling without having a more comprehensive system in place to offer affordable, high-quality health insurance for those left without a pool is not a progressive endeavor.