A Blueprint for Tax Reform and Health Reform : Before the Senate Committee on Finance

A Blueprint for Tax Reform and Health ReformLeonard E. Burman

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

In this testimony Burman outlines a plan for tax reform that would maintain progressivity, raise enough revenues to finance the government, and dovetail with plans to provide universal access to health insurance. It would combine a value-added tax (VAT) dedicated to pay for a new universal health insurance voucher with a vastly simplified and much flatter income tax. With a new financing source for health care, income tax rates could be cut sharply—the top rates could be cut to 25 percent or less. The health care voucher would also offset the inherent regressivity of a VAT. And, under the simplified system, most Americans would not have to file income tax returns.

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Chairman Baucus, Ranking Member Grassley, and members of the committee: Thank you for inviting me to testify on tax reform.

It is a great honor to speak to you on this topic. The last great tax reform effort lured me to Washington away from academia to work for the Treasury Department in 1985. I remember when Chairman Packwood rescued reform from the abyss with his “27-percent solution”—a top rate so low it caught the public’s attention and sustained momentum for what became the Tax Reform Act of 1986. The creativity and bipartisanship of this committee were key elements in the success of the 1986 Act.

In the mid-1980s, the tax system desperately needed fixing. Tax shelters were rampant, with investment decisions often motivated solely by the tax savings they could produce, rather than their underlying economics, which were often dubious. The public had lost confidence in the fairness of the tax system.

If anything, the need for tax reform is even greater now for at least four reasons. First, under current law most of the tax cuts enacted since 2000 are set to expire at the end of 2010 and the code will revert to that of 2000. In theory, this will trigger what tax cut advocates are already calling the largest tax increase in history, but extending the tax cuts seems fiscally reckless. Second, the baby boomers are beginning to retire and the costs of providing their Social Security and medical care will strain available federal revenues. Third, under current law, the reach of the individual alternative minimum tax (AMT), a pointlessly complicated and unfair element of the current code, is scheduled to mushroom, hitting 32 million taxpayers by 2010, up from 4 million in 2007. Were that to happen the middle class would scream in protest, but making up for the hundreds of billions of dollars in revenue that the AMT is projected to produce will be a huge challenge. Finally, there is growing public dissatisfaction with our federal tax system which is complex, riddled with loopholes, and widely perceived to be unfair. It is hard to see how these challenges can be tackled without a major tax reform.

Although tax reform is always a long shot, there are reasons for optimism. Politicians in both parties—and even current presidential candidates—understand that the current situation is unsustainable. A new president who had campaigned on a platform of working in a bipartisan way to advance objectives that matter to both parties may be willing to stake political capital on advancing tax reform. And the fact that both sides acknowledge that this is a “change election” bodes well for the next president’s willingness to take political risks.

(End of excerpt. The entire testimony is available in PDF format.)

The views expressed are those of the author and should not be attributed to the Urban Institute, its trustees, or its funders.

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Tax Code and Health Insurance Coverage : Before the House Committee on the Budget

Tax Code and Health Insurance CoverageLeonard E. Burman

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

In this testimony Burman argues that there are limitations to using tax credits to expand health insurance coverage. A program of health insurance tax credits combined with reforms of the market for nongroup health insurance could significantly expand coverage, but at a very high cost. The testimony summarizes the current tax treatment of health insurance, the effects of tax subsidies on coverage and health care costs, and discusses ways that tax credits might affect health coverage. Burman offers recommendations and adds that the most cost-effective approach to expanding health insurance coverage may not be a tax subsidy at all, but an expansion of an existing public program, such as Medicaid, S-CHIP, or Medicare.

The text below is Leonard Burman's oral testimony.
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Chairman Spratt, Ranking Member Ryan, and members of the committee: Thank you for inviting me to discuss the role of the tax system in expanding access to health insurance. This hearing is extremely timely. About 47 million Americans under age 65, including 9 million children, lack health insurance. They are less likely to get important preventive screenings while healthy, and they receive lower-quality care when sick. And, the public ultimately shoulders the burden of paying for the medical treatment of those lacking insurance, through higher taxes or higher health care costs.

The recent debate over the State Children’s Health Insurance Program (S-CHIP) has focused on the best way to cover uninsured children, and many, including the president, have suggested that the tax system is the answer. I’d like to focus on the potential and limitations of using tax credits to expand coverage, as that is the only feasible way to use the tax system to help lower-income households obtain health insurance. Mr. Ryan has cosponsored a bill, H.R. 914, to provide a refundable credit up to $4,000 per year to help lower-income households purchase insurance in the individual nongroup market, similar to an earlier proposal from President Bush.

In considering such options, it is best to keep in mind Hippocrates’ dictum: “Do no harm.” A carefully designed program of health insurance tax credits combined with effective reforms of the market for nongroup health insurance could significantly expand health insurance coverage, although potentially at very high cost per newly insured person. And proposals to subsidize nongroup insurance alone with no meaningful provisions to fix the inherent failings in the nongroup health-insurance market would cause millions of Americans to lose their health insurance coverage. Those who suffer from chronic health conditions or have low incomes would be most vulnerable.

My testimony briefly summarizes the current tax treatment of health insurance, the effects of tax subsidies on coverage and health care costs, discusses ways that tax credits might affect health care coverage, and concludes with some recommendations.

The text above is Leonard Burman's oral testimony.
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The views expressed are those of the author and should not be attributed to the Urban Institute, its trustees, or its funders.

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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

Leonard E. Burman

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

Note: This testimony is available in its entirety in the Portable Document Format (PDF).

The text below is a portion of the complete document.

Chairman Grassley, Ranking Member Baucus, and Members of the Committee:

Thank you for inviting me to share my views on the state of tax policy with respect to health care in the United States.

This hearing is extremely timely. Over 45 million Americans under age 65—the overwhelming majority of them in working families—lack health insurance. They are less likely to obtain important preventive screenings while healthy, and they receive lower-quality care when sick.1 And, the public ultimately shoulders the burden of paying for the medical treatment of those lacking insurance, through either higher taxes or higher health care costs.

The tax system has played an important role in the evolution of the market for health care, and tax reform will inevitably be a part of the solution to the market's problems. Tax subsidies for health insurance and health care will reduce federal income and payroll tax revenues by over $200 billion in fiscal year 2007. Almost all of that revenue loss is attributable to the exclusion from income and payroll taxes of employer contributions to employer-sponsored health insurance. Thus, it is no surprise that most Americans under age 65 get their insurance at work. What may be surprising, however, is that even with such huge subsidies, more and more people are becoming uninsured, especially the young, those with low incomes, and those who work for small firms.

Some observers have suggested that the tax subsidies are a significant part of the problem. The subsidies encourage people to get insurance at work, stifling the individual nongroup market, and they encourage employers to provide overly generous insurance since the cost is subsidized. What's more, the subsidy is upside down—aiding most the high-income families that would probably purchase insurance under any scenario, and providing little aid to those of modest means.

Some, such as former Council of Economic Advisers chairman R. Glenn Hubbard and colleagues, have suggested that the best option would be to eliminate the employer exclusion altogether and let the market come up with cost-effective ways to supply health insurance to the public. But, in an unfettered free market, health insurance is likely to be too expensive for four reasons. First, the very act of having insurance increases utilization. People spend more when someone else is writing the check, but this causes insurance to be more expensive than it might be (a phenomenon known as moral hazard). Second, insurance is most attractive to people who expect to benefit most from it—such as those with chronic conditions and people who plan to have children. Because insurers can only imperfectly match premiums to expected utilization, they have to assume that purchasers have higher costs than the population average. That means that healthy people get a relatively bad deal from insurance—unless they can align themselves with a large group. (This feature of insurance is called adverse selection.) Third, the existence of free—even if inadequate—emergency health care for those with low incomes serves as a deterrent for purchasing health insurance, both because the free care provides a safety net and because uncompensated care raises the cost of care for those with insurance. Finally, healthy people—especially in the non-group market—can only imperfectly insure against the costs of developing chronic illnesses, because premiums for non-group health insurance increase over time for sick people.

Subsidizing individuals who get insurance at work mitigates some of these problems and exacerbates others. On the one hand, encouraging individuals to get insurance at work reduces the problem of adverse selection, because people choose employment for reasons unrelated to health status, and also offers those who work for large firms a kind of renewable insurance. But this pooling works less well for small employers whose costs may be heavily influenced by the poor health status of one or several employees. On the other hand, the tax subsidies encourage over-use of medical services because people don't face the true costs of insurance. And, as noted, the current tax subsidies are poorly targeted. The value of a tax exclusion grows with income and is worth little or nothing to those with low incomes, even though they are most likely to be deterred by the cost of insurance.

On balance, despite its failings, the current employer-based system supplies health insurance coverage to almost 70 percent of American workers under age 65. Reform should build upon that coverage base instead of eroding it. Simplistic market-based solutions, though appealing, are likely to come up short. Market reforms that ignore adverse selection, for example, or the fact that a growing fraction of Americans simply cannot afford to pay for health care and meet other basic needs are bound to fail. The best option is to retarget existing subsidies, guarantee that low-income people can afford adequate insurance and that affordable health insurance exists either at work or in a reformed nongroup market, without encouraging excessive spending. And the best option might be one that works outside the tax system.

In the rest of my testimony, I summarize the latest data on who has health insurance and who doesn't, outline the various tax subsidies that exist for health insurance, examine how those subsidies affect the market for health insurance and employment, and briefly comment on some reform options.

Notes from this section

1 Hadley (2003) estimates that mortality declines by 4.5 to 7.0 percent for people when they gain health insurance.

Note: This testimony is available in its entirety in the Portable Document Format (PDF).

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