Our Unhealthy Tax Code

If progressives want to cure what ails the health care system, they first have to put the tax code on the examination table.

Not only would President Bush’s proposals have limited upside in controlling health spending; they, as designed, could even end up increasing health spending, thanks to all the new tax incentives that encourage greater health spending by people already enrolled in HSAs. Perhaps more alarming, healthier individuals would opt into high-deductible plans and the individual market, driving up costs for everyone left in the old system. The Bush plan also would undermine the one pooling mechanism that works tolerably well, the employer-sponsored system, without providing any replacement pooling mechanism. As a result, despite spending $15 billion annually, the plan would do little to reduce the number of uninsured and could even end up swelling their ranks. By creating a new tax deduction for individuals purchasing insurance on their own, the President’s proposal would eliminate the added tax incentive to purchase insurance through an employer. MIT economist Jonathan Gruber estimates that nine million people will be dropped from, or choose to leave, their employer-sponsored coverage as a result of this change. This more than offsets the number of people who would get insurance under the plan, raising the total number of uninsured by approximately 600,000. In addition, many of the people who would lose their health insurance are sicker than average, while the people who gain health insurance are healthier.

And, ironically, President Bush’s proposal–one lauded by free-market conservatives–actually restricts consumer choice. All of the tax breaks are reserved for purchasers of one type of government-approved health insurance, with specific limits on deductibles, out-of-pocket payments, and other aspects of the plan. Even Bush’s own Council of Economic Advisers acknowledges in the 2006 Economic Report of the President that this one-size-fits-all design may be inappropriate in some cases, like lower-income families who will forgo needed care.

A Progressive Way Forward Over the past several months, progressive politicians and allied groups have united in their opposition to the President’s HSA plan. But few have followed their criticism to its logical conclusion: addressing our unhealthy tax system. The bottom line is that we should spend less subsidizing more expensive insurance and more health care for higher-income people and spend more to help moderate-income families obtain the health insurance they lack.

How can this be done? For one, Congress could cap the amount of health insurance that is tax-deductible and use the savings to expand coverage, say by limiting the deductibility of employer-premium contributions to a certain amount, such as $7,500 for a family policy. Alternatively, it might be more politically feasible to phase the policy in over time by initially setting a higher threshold but not fully indexing it for the growth of premiums for a period of time. In addition, the value of deductibility could be limited for higher-income individuals, either by capping the deduction at 25 percent of the health premium or phasing it down for high earners. Any combination of these approaches could save a sizeable chunk of the current $200 billion subsidy.

Those savings, in turn, could be used to expand coverage in a variety of ways, such as by guaranteeing Medicaid to all Americans below the poverty level (or an even higher threshold), by providing progressive tax credits to strengthen the weakest link in the employer-sponsored system (coverage by small businesses) or by funding subsidies for new mechanisms to make insurance affordable for all Americans, such as allowing them to buy into a plan like the Federal Employees Health Benefit Plan (FEHBP), the same health plan available to members of Congress.

In such a scenario, there is little risk of undermining the employer-sponsored health system, because the proposal would retain the current structure of tax subsidies for employer-sponsored insurance. Moreover, employers who are currently considering dropping their coverage are probably paying lower shares of their employee premiums and thus would not be affected by lower caps. It is also unlikely that a generous employer who contributes $10,000 toward annual premiums would drop coverage altogether just because the employee’s tax benefit is trimmed. Finally, capping tax benefits could lead some companies to pay workers more in wages and less in insurance coverage, which would reduce overuse of the health system and make the system cheaper for everyone. Unlike HSAs, however, the progressive alternative is not contingent upon a specific government-approved form of cost-sharing; instead, individuals and firms are free to shape cost-sharing as they deem best, adapting them to individual tastes and the best evidence of medical effectiveness.

This approach would buy the health care system some time, but would not cure it. To do that, policymakers should consider scrapping the deductibility of health insurance entirely and replacing it with a progressive tax credit. Individuals could count the value of their health insurance as part of their income when calculating their taxes, but they would get a new progressive tax credit instead of a deduction. The tax credit would be the reverse of the current system, more like $4,000 going to the cleaner and $1,000 to the investment banker. The tax credits would go to anyone with health insurance, but would not provide additional subsidies for more generous insurance. This could create the basis for a simpler, fairer system of universal health insurance. Although health benefits might be slightly less generous, higher out-of-pocket costs would be offset by higher wages.

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