The President's Health Insurance Proposal - A First Look

Leonard E. Burman, Jason Furman, Roberton Williams

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.

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In his State of the Union address, President Bush will propose to replace most current tax exclusions and deductions for health insurance premiums and out-of-pocket costs with a new $15,000 standard deduction ($7,500 for single people) in the federal income tax-as well as an exemption from payroll taxes-for all taxpayers who obtain qualifying health insurance. The plan would eliminate the current bias in favor of health insurance obtained through employers, provide tax incentives for the purchase of health insurance in the private market, and reduce current tax incentives to over-spend on healthcare services. As designed, the proposal would be revenue neutral over ten years, after which it would generate a growing stream of revenue.

The innovative plan is a major step toward improving the efficiency of the market for health insurance. By severing the link between work and insurance, it would offer everyone the same tax incentives to obtain insurance coverage and limit spending on health care. Whether it would succeed in meeting its objectives in a fair way is less clear.

The new tax incentives will help some individuals to gain coverage. But they could also lead employers, particularly those in small firms, to discontinue health plans for their workers, some of whom would end up without insurance. Furthermore, by relying on tax deductions, the plan would continue to provide the largest benefits to high-income taxpayers and offer little or no financial incentive for low-income people who most need help paying for insurance. The plan would encourage states to shift existing funds to subsidize insurance for people with low incomes and chronic health conditions, but those funds could well be too small to be effective.

Changes to the President's proposal could improve its chances of success:

Replacing the deduction with a refundable credit or voucher would provide more assistance to low-income families, increasing coverage and improving progressivity. Requiring that qualifying insurance plans offer community-rated premiums would help to assure the availability of affordable coverage for people regardless of their health status. Providing additional funds for complementary programs like Medicaid and SCHIP would help to provide coverage for low-income families and children. Explicitly mandating individuals to purchase health insurance, in combination with adequate subsidies for those with low incomes, would increase coverage and reduce adverse selection. Eliminating tax subsidies for health savings accounts would remove a bias in favor of those accounts that would otherwise exist. Indexing the deduction to the health CPI or even the rate of change in overall health spending would maintain its value over time, albeit at the cost of lost revenue.

Despite its limitations, the President's plan marks an encouraging step in the right direction. With appropriate modifications, it could expand health insurance coverage and improve market efficiency.

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First, Do No Harm: Designing Tax Incentives for Health Insurance

Leonard E. Burman, Amelia Gruber

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.

This report is available in its entirety in the Portable Document Format (PDF), which many find convenient when printing.

INTRODUCTION

As part of his 2001 Budget, President Bush proposed a refundable tax credit in an effort to help the nearly 18 percent of nonelderly Americans who lack health insurance coverage. His goal of expanding access to insurance enjoys bipartisan support. Members of both parties have advanced proposals including health insurance tax credits or deductions.

A government commitment to expanding coverage is a positive development. More than 40 million nonelderly Americans—the overwhelming majority of them in working families—are uninsured. They are less likely to obtain important preventive screenings while healthy and receive lower quality care when they get sick. Furthermore, 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.

The President’s plan may help some of those who currently lack health insurance. But his proposed commitment of about eight billion dollars per year in tax subsidies, starting in 2005, may also trigger unintended consequences. The vast majority of working-age Americans currently obtains health insurance coverage through an employer. Yet, the Administration’s tax subsidy initiative would only be available to those without employer-sponsored insurance (ESI), effectively penalizing ESI recipients. Any policy undermining ESI might cause many workers, especially those at small firms, to lose their insurance coverage.

Our paper summarizes the latest descriptive data on health insurance coverage for the nonelderly, discusses the economic arguments for health insurance subsidies, and details the advantages and disadvantages of subsidizing ESI. We outline a private, market-based option that combines voluntary health insurance market reforms and public incentives for individuals to obtain either high quality nongroup insurance or ESI. We also develop a simple model illustrating how various subsidy schemes affect the status quo and demonstrate that the President’s proposal for non-ESI tax credits is equivalent to a nondiscriminatory subsidy scheme, financed partly by a tax on ESI. For that reason, it runs the risk of doing harm—that is, undermining the kind of insurance that currently covers most nonelderly Americans.

We are grateful to Cori Uccello for extensive advice and technical assistance, and to Linda Bilheimer, Linda Blumberg, Sonia Conly, Judy Feder, Gillian Hunter, and Eric Toder for very helpful comments on an earlier draft. Views expressed are solely those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

JEL Codes: H24, H31, I11

This report is available in its entirety in the Portable Document Format (PDF), which many find convenient when printing.

View the original article here