October 31, 2005

October 31, 2005 | Commentary on Health Care

Tax-Cut Rx for Health Care

Want to know whether President Bush's Tax Panel has hit a home run when it releases its report on Nov. 1? A key test will be the way it handles the federal tax treatment of health insurance, which sorely needs some strong medicine if it is to reduce the ranks of the uninsured any time soon.

The current arrangement, which has remained largely unchanged since World War II, works like this: You can get unlimited tax relief for the purchase of health insurance if you get that insurance through your job.

Your health insurance is part of your compensation, just like wages, but the IRS excludes the value of this part of your compensation from your taxable income in its annual calculation of your federal income taxes and your Social Security taxes. This special federal tax break on health insurance is called a tax exclusion. Employers, meanwhile, get to deduct this tax break as a business expense, just like wages. It's a win for employers. It's also a win for workers lucky enough to have job-based health insurance.

It's big money, too: Federal tax breaks for health insurance were worth $189 billion in 2004. Throw in state tax breaks and the total tax benefit climbs to about $210 billion. And the biggest tax breaks go to those in the highest tax brackets: families with annual incomes of $100,000 or more averaged almost $2,800 in tax breaks, while those making between $15,000 and $20,000 got tax breaks averaging only about $300. Those without employer coverage typically got zilch for any health insurance they bought themselves.

This tax policy, plus federal and state law and regulation, largely ties access to health insurance to one's place of work. When most Americans stayed at the same job for all or most of their working lives, this didn't seem to be much of a problem.

But times have changed. Today, we have a highly mobile workforce. According to the U.S. Department of Labor, the average American will have had 10 jobs by the time he or she reaches 38 years of age. Access to health insurance coverage for many Americans, therefore, is also constantly changing. And those with steady employment and job-based health coverage often feel trapped in their jobs -- unable to move because they might lose their insurance coverage.

What an anomaly. If you change jobs, you don't automatically lose your auto insurance, your life insurance or your homeowner's insurance. But you lose your health insurance. The company owns the policy and you don't, so you can't take it with you. Sure, you can buy health insurance outside of your place of work, but unless you're classified as "self employed," you normally have to pay for the coverage with after tax dollars, which could add as much as 40 percent to the premium price. This explains the strong correlation between job status and access to insurance -- and why the uninsured are often low-income workers without job-based coverage or folks who are between jobs.

We need wholesale reform of this inequitable and inefficient tax break.

The best option would be to replace the current tax breaks for health insurance -- in particular, the tax exclusion of employee health benefits -- with a universal health-care tax credit system. This would give every American basic tax relief for health insurance they buy themselves, not just health plans from employers. This change would also focus help where it's needed the most. Today, we do the opposite.

But will the president's Tax Panel swing for the fences -- or bunt? Early news reports indicate that it may simply cap the value of health benefits that could be excluded from taxation. That would be a start. But the question will be what to do with the new revenues. With households now paying roughly 40 percent of their income in taxes of all kinds, any new revenues should go directly back to the citizens in the form of the proposed tax credit.

If we're to get serious about reducing the number of America's uninsured, tax reform is a key part of the solution. And when we expand health-care coverage, we will reduce the taxpayers' big bills for uncompensated care. Everyone wins. Talk about a healthy solution.

Robert Moffit is director of the director of the Center for Health Policy Studies at the Heritage Foundation.

About the Author

Robert E. Moffit, Ph.D. Senior Fellow
Center for Health Policy Studies

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