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Summary:
The second session of the 108th Congress is considering a number of new or expanded tax benefits for health insurance. President Bush has proposed that individuals who make contributions to the new health savings accounts (HSAs) authorized by the Medicare prescription drug legislation (P.L. 108-173) be allowed to deduct the cost of their health insurance. He has also proposed, as in prior years, a refundable tax credit to help lower income families purchase insurance. Proponents of these and other measures generally argue that new tax benefits are needed to reduce the number of uninsured and to address efficiency and equity problems; opponents claim they would primarily benefit higher income taxpayers (in the case of the deduction) and do little for most without coverage. Current law contains significant tax benefits for health insurance. (1) Most important is the exclusion of employer-paid coverage from the determination of income and employment taxes. Two-thirds of the noninstitutionalized population under age 65 are insured through employment-based plans; on average, large employers pay about 80% of its cost, though some pay all and others none. The exclusion also applies to health insurance provided through cafeteria plans. (2) Selfemployed taxpayers may deduct 100% of their health insurance, even if they do not itemize deductions. (3) Taxpayers who do itemize may deduct insurance payments to the extent they and other unreimbursed medical expenses exceed 7.5% of adjusted gross income. While not widely used, this deduction benefits some who purchase individual market policies and others who pay for employment-based insurance with after-tax dollars. (4) Some workers eligible for Trade Adjustment Assistance or receiving a pension paid by the Pension Benefit Guarantee Corporation can receive an advanceable, refundable tax credit (the health coverage tax credit, HCTC) to purchase certain types of insurance. (5) Coverage under Medicare and Medicaid is not considered taxable income. (6) With some exceptions, benefits received from private or public insurance are not taxable. By lowering the after-tax cost of insurance, these tax benefits help extend coverage to more people; they also lead insured people to obtain more coverage than otherwise. The incentives influence how coverage is acquired: the uncapped exclusion for employer-paid insurance, which can benefit nearly all workers and is easy to administer, is partly responsible for the predominance of employmentbased insurance in the United States. Employment-based insurance has both advantages and disadvantages for the typical worker. The tax benefits also increase the demand for health care by enabling insured people to obtain services at discounted prices. This is one reason health care prices have risen more rapidly than general inflation. Moreover, since many people would likely obtain some insurance without the tax benefits, they can be an inefficient use of public dollars. They also raise questions of equity, largely because the tax savings they generate depend upon the taxpayer's marginal tax rate. When viewed as a form of personal consumption, giving tax incentives for health insurance provides more benefits to higher income families who may not need them. Comprehensive reforms (e.g., capping the employer exclusion or replacing it with deductions and credits) might address these concerns, though they could be difficult to implement and may cause inequities of their own.
