The President's Tax Fix for Health Insurance - Improved Tax Policy

President Bush has mentioned providing a tax deduction for health insurance. His 2009 budget proposal has more of the details:

1. Employees would be required to include in income the amount their employer pays to provide health care coverage for them. This amount would be reported on the employee's W-2 so they wuold know how much it is.
2. Employees (and others) could deduct what they spend on health insurance (or what their employer spends on them and they have to report as income). The deduction is limited to $15,000 ($7,500 for single coverage) and appears to be allowed as a deduction even if the individual does not itemize their deductions. It is also called a "standard deduction" and it appears you get that much even if you don't spend that much on your "qualified coverage."

Basically, the rationale is that this change should bring the insured - the patient, back into the health care COST decisions. Today, most employees with employer-provided health benefits probably cannot tell you how much their employer pays and how much they pay. They are also likely not aware that the government is giving them a tax break by not requiring them to pay income or payroll taxes on the benefit they get when their employer pays for their health insurance. And, most states match the tax break. It is very generous.

For example, Gina's employer provides her health insurance coverage and it costs the employer $10,000 each year. Gina contributes $3,000 towards the coverage which comes out of her payroll deductions. The total cost of the coverage is $13,000. The employer gets to deduct $10,000 on its tax return and Gina does NOT have to report the $10,000 benefit on her tax return (it is an "exclusion"). It is a great recruitment and pay strategy. An employee is much better off earning $10,000 less in taxable pay and instead having their employer use that money to buy them health insurance.

Because Gina isn't involved in much of the health insurance decision, she doesn't negotiate whether she is getting a good deal (as someone may likely do in getting car insurance). Also, the health plan may be quite generous and Gina just pays $10 every time she visits a doctor and doesn't know (or care) what the doctor is charging the insurance plan. Gina has no incentive to even ask about costs or whether all of the medical procedures she gets are crucial because it costs her so little.

All of this leads to increased medical care and health insurance costs for everyone.

Also, the current system provides a greater benefit to higher income individuals because they are in a higher tax rate. For example, if Gina has a marginal tax rate of 30%, the tax break saves her $3,000 in taxes each year. If she were instead in a 10% tax bracket, her savings would be $1,000.

Another rationale for the President's proposal is that employees with employer-provided health care get a better tax break then people who have to purchase their own insurance. While the tax law does include a medical deduction, it is only for those who itemize deductions and you can only deduct the excess of medical expenses over 7.5% of your adjusted gross income.

Back to Gina - President Bush is proposing that she include the $10,000 in her taxable income, but she would also get a deduction of $15,000 (apparently whether or not she itemizes her deductions). If her employer were instead paying over $15,000 for her health coverage, Gina would be limited to a $15,000 deduction.

It is not clear why the proposal allows a $15,000 deduction ($7,500 if single) even if the employer and employee are not paying that much for coverage.

More information on the health insurance tax proposal can be found at pages 19 - 22, and 92 of Treasury's explanation of the budget's revenue proposals.

There are specific rules on the type of coverage and several other details (as typical for special tax rules).

Some questions:

1. Treasury's explanation notes that this proposal would result in a revenue loss of $23 billion in 2009 and later years, but a revenue increase for 2009 - 2018. Is that a mistake? How was this all deterimined?
2. How would this change affect health care and spending decisions of employees, employers and those without employer-provided health insurance?
3. How would this proposal workwith other proposed and needed health care changes?
4. Would a tax credit be better? The income inclusion and deduction should offset, but if an individual's income inclusion from employer-provided health insurance is less than $15,000, they get a tax break (deduction is greater than the income hit) that is worth more to individuals in higher tax brackets while the credit is worth the same to everyone. Similarly for someone who buys their own health insurance - the credit would be more fair. And the credit should be refundable so that individuals who owe tax less than the credit would get it refunded (which would help them pay for the insurance).

Tax policy considerations - the proposal will bring transparency and greater fairness to the tax rules on health insurance taxability and deductions.

Other policy considerations - the proposal may also help control health care costs if it does lead patients to be more involved in spending and treatment decisions.

What do you think?