A Proposal to Finance Long-Term Care Services through Medicare with an Income Tax Surcharge

A Proposal to Finance Long-Term Care Services through Medicare with an Income Tax SurchargeRichard W. Johnson, Leonard E. Burman

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We propose a new system of financing long-term care services in the United States. Our plan expands Medicare to cover comprehensive long-term care services, including home care and custodial nursing home care. Beneficiaries would share in the cost of services through deductibles and copayments, but the program would include stop loss coverage and special protections for low-income adults. By providing long-term care insurance that actually protects the assets of older adults, our proposal would eliminate the disincentive to save inherent in the means-tested Medicaid system. Our plan would also remove the bias in the current system for institutional care, enabling more persons with disabilities to remain at home where most prefer to live. We propose to finance this expansion of Medicare benefits with a surcharge on federal income taxes. Unlike the regressive payroll tax that finances Medicare’s hospitalization coverage, the surcharge we propose would not increase tax burdens for low-income individuals or families. All of the revenue generated by the tax would be dedicated to a special Medicare trust fund that would finance future long-term care services.

The financing of long-term care services for elderly adults is a critical public policy issue. As baby boomers age, the number of older Americans will soar over the next few decades. Between 2000 and 2040, the population aged 65 and older will almost double, to 77.2 million, while the population aged 85 and older will more than triple, to 14.3 million (U.S. Census Bureau 2000). Despite recent improvements in health at older ages (Manton and Gu 2001; Freedman et al. 2004), many elderly Americans will continue to need assistance with basic personal care. The Congressional Budget Office (1999, 2004) estimates that the number of Americans aged 65 and older with long-term care needs will increase from 8.8 million in 2000 to at least 12.1 million in 2040.

The family has traditionally been an important provider of care to the frail elderly. Most older persons with disabilities live in the community, not in nursing homes (Feder, Komisar, and Niefeld 2000), and receive care from spouses and adult children (Johnson and Wiener 2006). The availability of informal care is a critical factor in enabling frail elders to live independently in the community (LoSasso and Johnson 2002). However, it is unlikely that family caregivers alone can meet the expected rise in long-term care needs. Women are much more likely than men to provide care to their parents (Mui 1995), but many are being forced to reduce the amount of time they devote to caregiving activities as more and more women enter the labor force. And declining fertility rates may limit the number of adult children who will be available to provide care to their parents in the future. As a result, an increasing number of older adults may rely on paid helpers in the next few decades, either at home or in institutions, to meet their long-term care needs.

Despite the growing importance of formal long-term care services in the United States, there are significant problems with the way in which they are now financed. Most nursing home costs are paid by the public sector today. Although this is clearly a boon for frail elderly Americans, the availability of public funds for long-term care services discourages individuals from preparing for their own long-term care needs when they are young and healthy. Medicaid eligibility rules impose a nearly 100 percent tax on income and assets for nursing home residents. This implicit tax may be an important factor behind the alarmingly low savings rate for middle-class Americans. The current system also favors institutional care over home- and community-based services, which are not as heavily subsidized as nursing home services.

Private insurance is available for long-term care expenses, but coverage rates are very low. Adults may be reluctant to purchase long-term care policies because Medicaid will pay for expenses that exceed their financial resources. Other problems with the private market for long-term care insurance include benefits that often turn out to be inadequate to cover future expenses, high load factors, large year-to-year premium increases and resultant high nonrenewal rates, and serious adverse selection problems.

To remedy the problems with the current system, we propose expanding Medicare to cover comprehensive long-term care services, including home care and custodial nursing home care. Beneficiaries would share in the cost of services through deductibles and copayments, but the program would include stop loss coverage and special protections for low-income adults. By providing long-term care insurance that actually protects the assets of older adults, our proposal would eliminate the disincentive to save inherent in the means-tested Medicaid system. Our plan would also remove the bias in the current system in favor of institutional care, enabling more persons with disabilities to remain at home where most prefer to live. We propose to finance this expansion of Medicare benefits with a surcharge on federal income taxes. Unlike the regressive payroll tax that finances Medicare’s hospitalization coverage, the surcharge we propose would not increase tax burdens for low-income individuals or families. All of the revenue generated by the tax would be dedicated to a special Medicare trust fund that would finance future long-term care services.

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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.

Note: This report is available in its entirety in PDF Format.

The text below is a summary of the complete document.

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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The President's Health Care Proposal Misses the Point

Linda J. Blumberg, John Holahan

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.

How much in the way of kudos does President Bush deserve over his latest health care proposal? Some have decried the quick negative response of the democrats to the president's proposal. Is the criticism fair?

The president's proposal would replace the current open-ended tax exemption for employer-sponsored health insurance with a flat standard deduction for buying at least catastrophic coverage through an employer or a private individual policy.

Economists dislike the current tax subsidy, which increases with higher employer contributions and is greatest for those with the highest incomes. It's a subsidy for the purchase of overly generous insurance plans that encourage the overuse of medical services, driving up spending. And it mainly goes toward the purchase of coverage for those who are most likely to buy it no matter what—high-income people—while giving little help to those who need it the most, people with low incomes.

The president's proposal would set annual limits for the level of spending subsidized, which is good. But this new proposal does nothing to address the second complaint—that the subsidy is upside down to begin with.

So should we give the president half credit? No. The first problem has waned over time relative to the second. When economists first recognized the perverse incentives associated with excluding employer premiums from taxation, most health insurance was based on fee-for-service, and premiums were not nearly as high (even adjusted for inflation).

With annual premium growth far outpacing earnings and inflation, workers and employers no longer seek such generous coverage; they trim benefits and increase cost-sharing to keep premiums affordable. Meanwhile, the number of uninsured Americans climbs, and most among their ranks would receive little to nothing from the president's proposal.

The president's proposal would also end the difference between the tax treatment that employer-based insurance gets compared with individually purchased coverage.  Economists love leveling the playing field, but in the case of health insurance, removing this advantage over policies individuals purchase on the open market will prompt some employers to stop offering insurance.

Young and healthy workers may save money by buying insurance on their own, and that market would be happy to serve them. But in most states, the insurers will pull up the welcome mat for older and less healthy workers. For these more vulnerable workers, the options aren't pretty: insurance could be impossible to come by at any price in most states, premiums could be substantially higher, or care for an individual's particular health conditions could be excluded from coverage. Nothing in the president's proposal guarantees that these currently insured individuals would have affordable, accessible, and adequate insurance post-reform.

The president's approaches to reform have consistently emphasized moving individuals into coverage with higher deductibles and lower benefits—intending to rein in systemwide spending by making individuals feel the financial bite when using services. If premiums go down because people use less care, the thinking goes, more people can afford coverage and the number of uninsured will fall. But this ignores a key fact at the heart of why our system is so costly. 

Most health care spending is on a small percentage of individuals with very high medical costs. That means to dramatically cut costs, we'd have to reduce spending in the range well above even the higher deductibles the president would like to see. These costs are attributable to people with chronic and other serious conditions and are largely driven by the use of advanced medical technologies. The president's assumption that overly insured individuals are the problem behind premium growth and the number of uninsured is just plain wrong.

One component of the president's plan holds some promise, however. It would allow states to redirect government funds currently going to hospitals and use them to expand coverage for the poor, if states act. These provisions could help shore up the availability of care for low-income people, particularly if combined with a progressive tax credit instead of the proposed standard deduction. 

Without a tax credit, however, the federal funds available to states are not sufficient to meet their needs. Even then, the availability of what is being offered is completely dependent on states' ability and willingness to enact serious reforms. In states that do not, this plan offers little to those who need it most—those with the greatest medical needs and the low-income. 

Linda J. Blumberg is a principal research associate in the Urban Institute's Health Policy Center, which is directed by John Holahan. The views expressed are those of the authors and should not be attributed to the Urban Institute, its sponsors, staff, or trustees.

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