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Summary:
How tax policy affects health insurance and health care spending is a perennial subject of discussion in Washington. The issue is prompted by the size of the tax subsidies, particularly the exclusion for employer-paid insurance; by their effect on the cost and allocation of health care resources; and by interest in comprehensive tax and health care reform. President Bush has proposed taxing the insurance that workers receive from employers and providing a new standard deduction regardless of whether coverage was obtained through employment or in the individual or small group markets. He also has said that he is open to discussing a tax credit. Current law contains significant tax benefits for health insurance and expenses: (1) Employer-paid coverage is excluded from the determination of income and employment taxes. More than 60% of the noninstitutionalized population under age 65 is insured through employment-based plans; on average, large employers pay about 80% of the cost, though some pay all and others none. The exclusion also applies to cafeteria plans. (2) Self-employed taxpayers may deduct 100% of their health insurance, even if they do not itemize deductions. (3) Taxpayers who itemize may deduct insurance payments and other unreimbursed medical expenses to the extent they exceed 7.5% of adjusted gross income. While not widely used, this deduction benefits those who purchase individual market policies or who have catastrophic costs. (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) Four tax-advantaged accounts are available to help taxpayers pay their health care expenses: Flexible Spending Accounts, Health Reimbursement Accounts, Health Savings Accounts, and Medical Savings Accounts. (6) Coverage under Medicare, Medicaid, SCHIP, and military and veterans health care programs is not considered taxable income. (7) With exceptions, benefits received from private or public insurance are not taxable. By lowering the after-tax cost of insurance, these tax benefits generally help extend coverage to more people; they also lead some people to obtain more coverage than they otherwise would. 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 employment-based insurance in the United States. In addition, the tax benefits increase the demand for health care by enabling insured people to obtain services at discounted prices; this in turn contributes to rising health care costs. Because many people would likely obtain insurance without tax benefits, they can be an inefficient use of public dollars. When insurance is viewed as a form of personal consumption, the tax benefits appear inequitable because taxpayers' savings depend on marginal tax rates. When viewed as spreading catastrophic economic risk over multiple years, however, basing those savings on marginal rates might be justified as the proper treatment for losses under a progressive tax system. This report will be updated for legislative activity and other developments.
