Easy Fix to Help Federal and State Budgets (and Health Care)

I have written about this topic before - policymakers lament trying to find dollars to help get more people health care, yet millions of workers reap overly generous tax benefits when their employer pays all or part of their health care coverage. These generous tax benefits represent dollars from the federal and state budgets that could be used for other purposes. And, the problem is even worse because having so many insured employees not directly involved in how much their health care coverage costs tends to make them get too much health care at times, which drives up costs for everyone.

Here are prior posts:

• Health Care Spending versus Extending 2001/2003 Tax Cuts - Tough Issues
• Tax Reform and Health Care Reform

On 7/31/08, the Senate Finance Committee held a hearing on Health Benefits in the Tax Code: The Right Incentives.

Each of the three witnesses commented on the exclusion for employer-provided health insurance. Joint Committee on Taxation Chief of Staff Edward Kleinbard noted:

"the current system of providing a generous tax subsidy for employer provided health care with no or little subsidy in the case of insurance purchased outside of the employer market distorts taxpayer and market behavior. The existence of the subsidy reduces the price of the consumption of health care, leading to overconsumption of health care relative to other goods and services for those taxpayers with qualifying plans, and very expensive health care for taxpayers in the individual market. Unlike most tax expenditures, the large subsidy associated with employer-provided health care is subject to few statutory limitations."

The exclusion, measured as a tax expenditure, is one of the largest in the income tax system. It is also an exclusion from Social Security and Medicare taxes. Kleinbard's testimony noted the cost of this tax break for 2007 as:

• Income taxes $145.3 billion
• FICA $100.1 billion

That's a lot of money!

Most, if not all states also follow the federal exclusion.

The exclusion is an even better deal than a tax deduction because the employee has not spent anything to get the break (ok - except for foregone wages). For example:

Jamie's employer pays $10,000 for Jamie's health insurance coverage. If the employer did not provide this benefit, the employer would liekly increase Jamie's salary by $10,000. Under our tax system, having the mployer pay for Jamie's insruance is a much better deal than getting $10K more of salaty. The $10K is not taxable to Jamie, although the employer deducts it on their tax return. Also, no FICA or Medicare tax is owed by either party on the $10K. If Jamie's marginal tax rate is 25%, Jamie save $2,500 of taxes. BUT, if Jamie had to include the $10K in income, Jamie would still have a good deal - getting $10K of insurance benefit for $2,500.

The federal government should cut back on this exclusion and better target it so more relief is given to low-income taxpayers. For example, depending on one's income level, an increasing percentage of the health insurance benefit would be included in income.

This would give the federal government funds to help move health care towards universal coverage. It would help states with their revenue problems.

AND - it would bring greater equity to the tax system. Today, it is more likely that higher income workers have health insurance from their employers. When individuals have to buy insurance on their own, there is not tax break.

Also, cutting back on this tax break would mean that employers would have to include the amount of the benefit on the employee's W-2. That would be good because today, most employees probably can't tell you how much the benefit is. This change would also be a good start in moving towards the bigger health care solutions that are needed.

What do you think?