Tax subsidies for private health insurance: Who benefits and at what cost?

Tax subsidies for private health insurance: Who benefits and at what cost?Leonard E. Burman, Sarah Goodell, Surachai Khitatrakun

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Reprinted with permission of the Robert Wood Johnson Foundation.

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Policymakers are considering modifications to the tax treatment of employer-sponsored insurance (ESI) as a way to raise revenue to help pay for health reform and provide incentives to reduce health care costs. Understanding how current subsidies work is important to assessing health reform proposals. This brief presents essential information about the structure and distribution of existing tax subsidies for ESI and the implications for policy options.

How does the federal government subsidize private health insurance?

The tax exclusion for employer contributions to ESI is the largest subsidy for private insurance. When employers purchase or provide insurance for employees, the employer contribution to the premium is excluded from income and payroll taxes.

Employees' contributions to ESI also are excluded from taxes if the premiums are paid through a flexible savings account (FSA). Once established by employers, workers can use FSAs to set aside a portion of their income to pay for health insurance and other expected medical expenses.

Employer contributions to Health Savings Accounts (HSAs) are excluded from income and payroll taxes. Employers pair HSAs with a high deductible health insurance plan and withdrawals are tax-free if used to pay for health care. Employee contributions to HSAs are excluded from income, but not payroll, tax.

People who purchase insurance outside of their employment do not enjoy all of the same tax advantages. They can deduct medical expenses, including premiums, only if the expenses exceed 7.5 percent of their adjusted gross income. However, most people never reach that threshold. Insurance purchased by self-employed individuals and contributions to HSAs are excluded from income, but not payroll, tax.

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