A number of legislative proposals on Capitol Hill
would provide uninsured workers with a tax credit to help them
purchase health insurance. The most recent was
introduced on March 14 by Senators John Breaux (D-LA) and James
Jeffords (R-VT). President George W.
Bush has proposed a similar tax credit.
Such
proposals for individual tax credits have prompted some to argue
that a better way to increase the rate of insurance would be to
subsidize employers, perhaps through special targeted tax credits
directed to employers to induce them to provide affordable coverage
to the uninsured. Supporters of this view maintain that
employment-sponsored health plans are popular and practical, and
that subsidizing employers rather than families would therefore be
a better way to cover uninsured families.
This
view, however, fails to recognize the inherent limitation of
traditional employer-sponsored insurance. While it usually does
make sense for large, sophisticated employers to sponsor
insurance--in other words, to arrange coverage--it is
administratively costly and inefficient for small employers to try
to sponsor health plans. Small firms also can rarely offer plan
choices to their employees and tailor coverage to worker needs.
Subsidizing these small employers would not overcome these
drawbacks.
What
is needed is a variant of employment-based coverage for certain
groups of workers, especially employees of small firms among whom
the rate of uninsurance is particularly high. Crafting such a
variant requires lawmakers to recognize that:
-
Providing tax credits to employers rather
than families would not solve the uninsurance problem.
-
Automatic enrollment could be used to
boost coverage.
-
Although the place of work may be the best
location through which most families can get coverage, employers
are not necessarily the best sponsors of coverage.
-
Individual tax credits could make large
corporate health plans available to non-employees.
-
Tax credits can easily be made available
to families when payments are due.
-
Credits would make it possible for plans
to be offered through churches, unions, and other associations, as
well as through the Federal Employees Health Benefits Program
(FEHBP).
- Congress can protect traditional
employer-sponsored coverage.
Introducing individual tax credits would
allow the employment-based system to evolve in a way that would
better meet the needs of working families. Individual tax credits
would allow traditional employer-sponsored insurance to continue
for most workers and would even make it available to additional
families. But a system of credits for families also would encourage
the simultaneous development of a slightly different system,
primarily for uninsured workers in small firms.
WHY EMPLOYER-SPONSORED INSURANCE IS
POPULAR AND OFTEN MAKES SENSE
Popularity of Employer-Sponsored
Insurance. Surveys indicate that working Americans generally
prefer employer-based health coverage to other ways of acquiring
health insurance. There are several reasons for the popularity of
employer-sponsored coverage.
-
Employees often view benefits as somehow
free because the employer "pays for" coverage. Workers who
receive health insurance from their employer often think of it as a
free or subsidized benefit that adds to their total compensation.
Faced with a choice between having the employer pay for coverage
(even if it is less than ideal) or having to pay for it themselves,
workers understandably prefer that the employer pay. But this
vision of employer-sponsored coverage rests on an illusion.
Employers are not charities, and as economists point out, health
care and other fringe benefits are really substitutes for cash
compensation and therefore are substantially paid for by the
employee. Thus, part of the
attraction of employer-sponsored coverage is based on a
misunderstanding by workers about who is really paying for
insurance.
-
Employment-based coverage is the only way
for most families to obtain a very large tax benefit for insurance
costs. When part of a worker's compensation is provided in the
form of health insurance, the value of that compensation is exempt
from all income and payroll taxes. The total value of this
so-called tax exclusion is about $125 billion each year in federal
and state income taxes, and payroll taxes. For an insured
family with an annual income of over $100,000, the average value of
the tax benefit is well over $2,000. For lower-income but insured
families, it is a small fraction of that amount because their
marginal tax rate is lower. And if an uninsured person were to buy
coverage for himself and his family, he normally would receive no
tax benefits at all. It is therefore not surprising that Americans
prefer a way of providing coverage that gives them a tax break--and
for some, a very large break.
- Employment-based insurance is very
convenient. When an employer provides coverage, it is normally
very easy for an employee to take part in the plan. Premiums are
paid directly by the employer, and the worker does not have to
apply for a tax exclusion; the W-2 form, indicating the worker's
income for tax purposes, simply makes no mention of the value of
the employer's contribution to his health insurance. Moreover, if
the worker has to pay something toward the cost of his plan, this
is usually done in the form of a convenient payroll deduction
during each pay period.
Technical Benefits
Besides these preferences expressed by
workers, there are technical reasons why it usually makes good
sense for large companies to sponsor health insurance.
-
Pooling. A company with a large work
force obviously also has a large pool for insurance purposes.
Hence, a large number of individuals can be grouped together and
insured as a group for a standard premium, despite possibly wide
variations in medical risks among employees. Large companies also
have the economies of scale and sophistication to provide insurance
at a low administrative cost per employee.
-
Advantages for bargaining and
administration. Larger companies also can bargain very
effectively with insurers and providers, and so are able to deliver
cost-effective coverage that is often tailored specifically for
their work force.
- Choice. Because of the size of their
insurance pool and their sophistication, large companies can
arrange a choice of health plans, making it more likely that
workers will be reasonably satisfied with their coverage.
OBSTACLES TO SMALL EMPLOYERS OFFERING
INSURANCE
While these advantages of
employer-sponsored coverage certainly apply to workers in many
firms, they are less likely to apply to certain specific categories
of workers, especially those employed in small firms. Among the reasons
for this are the following:
-
Small firms by definition are small
insurance pools. A retail store with a handful of employees is a
dismal pool for insurance purposes. Hiring a new employee with a
disability, for example, or the diagnosis of a chronic heart
problem in an older worker can mean a huge change in insurance
costs for the employer. States and the federal government recognize
this and are exploring various ways to group small firms together
to form larger insurance pools. But the need for these efforts only
underscores the fact that the place of employment is not a
particularly good basis for the pooling of these insurance risks
for employees of small firms.
-
Small firms face relatively high
administrative costs, and many small-business owners do not wish to
organize insurance. Because they lack the economies of scale and
the
management resources of larger firms, small businesses tend to face
high costs when administering plans. According to data collected by
the Congressional Budget Office, overhead costs for providing
insurance can be over 30 percent of premium costs for firms with
fewer than 10 employees, compared with about 12 percent for firms
with more than 500 employees. Moreover, many
small-business owners have little desire to engage in the demanding
task of trying to organize health insurance that meets the often
varied needs of their employees.
- Small firms can rarely offer a choice of
plans. If a small employer provides coverage, it tends to be a
single "one-size-fits-all" plan. Small companies rarely offer a
choice of plans. While 81 percent of workers with insurance in
firms of 5,000 or more employees had a choice of at least three
plans in 2000, only 2 percent of covered workers in companies with
fewer than 25 employees had a similar choice of at least three
plans. Meanwhile, 95 percent of covered workers in the smaller
companies had only one plan available to them.
The Result: High Rates of Uninsurance in
Small Firms
These obstacles to employment-based
coverage in the small-business sector help to explain the high
level of uninsurance among families with workers in that sector.
According to a recent
survey by the Kaiser Foundation, 74 percent of the uninsured are in
families with at least one full-time worker, and while 99 percent
of large firms offer insurance, only 55 of firms with fewer than 10
employees do so. Among low-wage workers (defined as those who
earned less than $7 an hour in 1996), 45 percent are not even
offered insurance.
WHY A TAX CREDIT FOR EMPLOYERS IS NOT THE
ANSWER
The
limitations of small firms as sponsors of insurance reveal the
weakness of proposals that would subsidize to cover the uninsured.
Credits or other subsidies for employers do not make small firms
good risk pools. Even though a subsidy would help to offset the
high administrative costs borne by small employers, it would not
make administration more efficient or sophisticated. Nor would a
subsidy deal with the "hassle factor" that causes so many
small-business owners to compete for workers by giving cash instead
of complex benefits.
Tax
credits for employers--in contrast to tax credits for
employees--are also very difficult to target efficiently. If the
government wishes to help lower-income families to afford
insurance, it can use eligibility criteria based on family income;
but if it tries to do this by means of a credit for employers,
there is the problem of assuring that the subsidy supports coverage
only for those who really need assistance. Simply providing a
subsidy to all small businesses would not do this, since the
taxpayer would end up subsidizing the coverage of many well-paid
lawyers, doctors, computer engineers, and others who work for small
firms. Yet trying to limit subsidies to the costs of covering
lower-income households would require employers to determine the
household income of their employees, which would be a burden and
also would raise issues of privacy and potential fraud.
The Folly of the Common Ground
Proposal. The targeting problems associated with a tax credit
for employers can be seen in the "Common Ground" proposal, an
approach to dealing with uninsurance recently advanced by a group
of organizations headed by Families USA and the Health Insurance
Association of America (HIAA). In trying to restrict the credit
only to expanded coverage for lower-income households, the credit
calculation becomes very complex for business owners and fraught
with potential legal problems. According to the authors of the
plan:
The
credit would be available to those employers that pay a larger
share of the premium (than what is offered to other workers in the
company) for workers with family incomes between 133 and 200
percent of poverty. For example, if a business currently pays 70
percent of the premiums for all workers and decides to pay all or
part of the remaining premium for low-income workers, that business
would receive a tax credit for that additional amount. The employer
tax credit would be available only to companies that make
contributions to their health plans commensurate with the
contribution levels of other similarly situated employers.
One
of the most significant problems with this mechanism, quite
separate from its complexity and paperwork burden, is the
difficulty of assessing family income. To be sure, the employer has
a record of the worker's income, but a low worker's income does not
necessarily mean a low household income. For instance, the worker
may be a second earner who earns substantially less than his or her
spouse. Basing the credit only on the worker's income thus could
mean subsidizing coverage for middle-income or even upper-income
households.
Basing the credit on total family income,
however, means that each potentially eligible family would have to
provide its employer with complete income information--a
significant invasion of privacy. Moreover, the financial incentive
for both employer and worker to understate household income in
order to establish eligibility would invite fraud and therefore
would require careful audits by the government. If such an audit
discovered that an employer had claimed a credit inappropriately,
it would be difficult to know whether the employer had committed
fraud or had simply been supplied erroneous income information by
the worker. This legal jeopardy would discourage many employers
from claiming the credit.
DESIGNING AN ALTERNATIVE FOR THE
UNINSURED
The
inherent problems that characterize employment based coverage have
induced a number of analysts and lawmakers to suggest providing tax
credits directly to individuals to help uninsured families pay for
coverage, either sponsored by their employer or obtained from
another source. Some proposals
would provide a credit of a specific amount; others, a credit based
on some proportion of the premium's cost to the family. Most would
restrict the credit to households below a certain income and
typically would make the credit refundable, meaning that if the
eligible credit exceeded the taxes otherwise paid by the family,
the household would receive a direct payment from the
government.
The
central features of these proposals are that the tax credit would
go to the family, not the employer, and would not be confined to
traditional employer-sponsored coverage. Thus, the responsibility
for demonstrating eligibility also would rest with the family, not
the employer.
As
Congress considers health care tax credits for families, it is
important for lawmakers to keep certain things in mind.
- The place of work may be the best location
through which most families can get coverage, but employers are not
necessarily the best sponsors of coverage.
Most
people in America pay their taxes through a place of work. This is
a very convenient system under which employers withhold income and
Social Security taxes and send the money to the government. In
addition, employees typically adjust their withholdings to take
advantage of any tax breaks for which they may be eligible (for
example, the mortgage interest deduction). In a sense, this means
that employers actually operate the basic income tax system; but
they do not in any sense design the tax code for their employees or
"sponsor" the tax system. They could more appropriately be
considered a clearinghouse for tax payments.
The
place of employment is likewise particularly convenient and
efficient for handling health insurance payments. Workers with
employer-sponsored health insurance benefits typically sign up for
the firm's plan when they take a job and arrange for a payroll
deduction to cover premium costs for them or their family. With
individual tax credits available, employers currently sponsoring
insurance could continue to do so, but workers eligible for the
credit (in most proposals, low-income employees) could use the
credit to help pay for their share of the premium. This would make
traditional employer-sponsored coverage more affordable for many
workers.
Individual tax credits also mean that an
employer who is reluctant to sponsor coverage could still carry out
the critical clearinghouse role for plan choices, tax adjustments,
and premium payments. Such employers would no longer be required to
organize or sponsor a plan for their employees to obtain tax relief
for the cost of coverage--or financial contributions made by the
employer.
In
other words, smaller employers could handle the mechanical aspects
of arranging for payroll deductions and premium payments (similar
to their role in the tax collection system) without having to
sponsor a plan. With individual credits, eligible employees could
join any plan available in their area, not just one sponsored by
their employer, and still obtain tax benefits. Thus, the employer
could play a very important role in facilitating coverage without
having to organize coverage. Moreover, with the credit not
restricted to employer-sponsored coverage, eligible workers could
enjoy a wide choice of plans.
- Tax credits can easily be made available
to families when payments are due.
It
is sometimes said that individual credits would not work for
low-income workers because they could not wait until the end of the
year for the credit. It is also argued that many workers who today
do not make enough to file a tax return would have to start filing
a return just to obtain these credits. Both arguments are
spurious.
Delivering the credit through the
withholding system. The simplest way to deliver the subsidy to
workers would be through an adjustment in tax withholdings, much as
deductions (such as mortgage interest) or credits (such as the
child care credit) are typically handled today with the employer
remitting tax payments to the government that are net of the
credits. This means that workers would receive the tax benefit in
increments throughout the year when they receive their
paychecks.
Employers also could institute a system of
payroll deductions for health premiums, perhaps through the
existing rules for flexible benefit plans, so that money would be
available when premiums were due. Employers could pay premiums
directly from these accounts on behalf of employees. In this way,
the credit-premium transaction would be relatively simple for both
employer and employee.
An alternative: assigning the credit to
a health plan. Another option would be to permit families to
assign the value of their credit to their insurance plan in return
for a lower premium. With assignment, the employee signs a document
allowing the insurer to claim the credit on his behalf, and the
insurer agrees to reduce premiums by the same amount. Insurers
normally would obtain the credit through an adjustment in their tax
payments to the government. Thus, rather than deal with the
withholding system, a family would have only to establish its
eligibility for a fixed or simple percentage credit.
This
alternative would be particularly attractive to those lower-income
families that do not even file tax returns, and would also be
another way to deal with the concern that the tax subsidy might not
be available when premiums are due. The process would mirror the
premium payment system in the Federal Employees Health Benefits
Program, under which Members of Congress and other federal
employees are quoted premiums net of the government
contribution.
- Automatic enrollment could be used to
boost coverage.
Whether or not they sponsored insurance,
employers could institute an automatic enrollment and payment
system to make health insurance premium payments and obtain
health-related tax benefits. This means that employees would
automatically be enrolled in a health plan unless they explicitly
declined to do so, perhaps by signing a document indicating that
they understood the possible consequences of not enrolling in a
plan. Alternatively, a state could establish a default bare-bones
health plan in conjunction with a private insurer, to which anyone
not otherwise choosing a plan would be assigned.
In
addition, as noted earlier, employers could establish a payroll
deduction and premium payment system for employees, structured much
like the flexible spending plans operated voluntarily by many
employers. The employer could then make a payment to the insurer on
behalf of the employee--or, more likely, a payroll company would
handle the entire transaction for a small firm. Employers would not
have to sponsor the insurance themselves for such a system to
operate; the key is to provide a tax benefit to the employee even
though the employer is not the plan sponsor. The proposed tax
credit measures would do this.
Evidence from pension plans indicates that
an automatic enrollment system for health insurance could have
dramatic effects on sign-up rates. This payment system is also very
similar to the way in which the FEHBP enables a federal worker who
may work in a small workplace, such as the local office of a Member
of Congress, to choose from possibly dozens of plans.
- Individual tax credits could make large
corporate health plans available to non-employees.
Tax
credits to individuals would remove the current tax barrier to
large corporations' marketing their health plans widely to
non-employees. This could mean major and attractive new options,
especially for the uninsured and for the workers employed by very
small firms.
It
is quite common for large firms to take products developed
initially as an internal service to the firm and market them to
external customers. For example, General Motors formed the General
Motors Acceptance Corporation (GMAC) out of its huge automobile
loan service and markets a broad range of financial services to
non-employees. It is even possible for people with no connection to
General Motors to finance their house with a mortgage from GM.
But
this does not happen with health insurance. The main reason: While
the tax system does not deny the mortgage interest deduction to
someone obtaining a mortgage from a car company, it does not
normally give tax relief to individuals or non-employment groups
signing up for health plans offered by another employer. The only
way such individuals could gain access to these large corporate
plans would be for the corporation to reach an agreement with the
individual's employer to manage the smaller firm's health
insurance. (Daimler-Chrysler is exploring such an arrangement with
its suppliers.)
An
individual tax credit would remove this obstacle, allowing families
to join any health plan while claiming the credit. This would
dramatically change the incentives in the current market, opening
up a potentially large new market for existing corporate plans and
an opportunity for many working families to obtain coverage under
these plans.
One
firm whose activities hint at what could happen in a more
liberalized environment is the John Deere Company. Intent on
improving the health care of its own employees while reducing
costs, the company several years ago created its own Health
Maintenance Organization (HMO). It then began to offer coverage to
other employers and purchased health operations to serve its new
market.
The
company, however, has not confined itself to offering its expertise
and facilities only to employer groups. Its for-profit health
division, John Deere Health Care, also offers coverage to
individuals as a Medicare HMO and provides managed care Medicaid
services in several states. The Deere Plan is also available to
some federal workers under the FEHBP. Out of more than 400,000
enrolled in Deere plans in the Midwest and Southeast, less than 20
percent are John Deere employees. The tax code, however, makes it
very uneconomic for Deere to offer coverage to groups of working
families (except federal workers) other than through their
employer.
With
a tax and regulatory system that was more conducive to
entrepreneurship by corporate health plans, one could imagine a
surge of new ventures by existing corporate plans, reminiscent of
similar patterns when restrictions on spin-off ventures in other
industries were removed.
- Credits would make it possible for plans
to be offered through churches, unions, and other associations, as
well as through the FEHBP.
Individual tax credits would also make it
much more practical and economic for families to obtain insurance
through large organizations with which they are affiliated rather
than being confined to employer-sponsored plans. By obtaining
insurance through large organizations, workers in small firms could
obtain many of the administrative economies of scale and large
insurance pools now normally available only to the employees of
large firms.
These organizations could offer insurance
plans alongside traditional employer-sponsored coverage. Typically,
they would not get into the business of insurance themselves, but
would act much as a buyers club does by negotiating an arrangement
with existing insurance companies. Organizations such as churches,
the American Association of Retired Persons (AARP), professional
and trade associations, farm bureaus, and credit unions could reach
agreements with health plans.
Some
organizations (for example, many farm bureaus) already offer plans,
but working families joining these plans typically are not eligible
for tax relief. Tax credits for health insurance would change that.
Many African-American church congregations have organized insurance
and other services for their members for years. Moreover, in many
inner-city communities, these churches are typically larger, more
stable, and more sophisticated--as well as more trusted--than the
typical employer, making them a natural avenue through which many
families armed with tax credits could obtain their health
insurance.
In
recent years, there have been proposals at the federal level that
would create new kinds of associations that would be freed from
many federal and state restrictions, particularly state benefit
mandates. The most important of these are Health Marts and
Association Health Plans. These reforms would make it easier for
organizations to offer coverage to individuals or groups.
The
Federal Employees Health Benefits Program offers federal workers
and their dependents and insurers (the equivalent of a small
country: nearly 10 million covered individuals) a wide choice of
plans.
The FEHBP is a generally successful system that operates in
parallel to the systems available to workers outside the federal
government, and there have been several proposals to open it to
non-federal workers under various conditions, typically using a
separate insurance pool.
To
make the FEHBP available to non-federal workers using tax credits,
federal law governing the FEHBP would be amended to permit a
separate insurance pool for non-federal employees. Plans currently
available in the FEHBP would be allowed to market to the new pool,
if they wished, and other plans could market exclusively to the new
pool provided they met the general requirements of the FEHBP.
Similarly, the "friendly society" role of
unions has a long history in this and other countries. In markets
where there are fewer tax and regulatory obstacles to
union-sponsored plans, they exist and indeed flourish. Several of
the leading FEHBP plans are organized by unions; the Mail Handlers,
for example, even offers associate membership to non-union members
who wish to gain access to the health plan. Indeed, the Mail
Handlers Benefit Plan, backed by CNA Insurance, has roughly 10
times as many enrollees as the union has regular union members.
These unions do not carry the insurance
risk themselves; instead, they organize a group and negotiate an
insurance package from an insurer for a fee. Many union-sponsored
plans also operate under the Taft-Hartley Act, where
union-sponsored plans are a rational way to provide coverage when
there is only a weak relationship between employer and worker.
Changing the federal rules governing such plans and making a tax
credit available for families to purchase insurance directly could
lead to an expansion of union-sponsored plans.
- Congress can protect traditional
employer-sponsored coverage.
While Americans want to help the
uninsured, they do not want to do so at the risk of losing what
they already have. For the more than 170 million Americans who rely
on job-based health insurance, as well as their companies and
insurers, this means that any reform to help the uninsured should
create a system that parallels what is already in place rather than
supplanting it.
Large, medium, and some small businesses
see their ability to offer health coverage as part of their
competitive advantage in gaining and keeping workers. Even though
the satisfaction level with job-based coverage is steadily eroding,
workers nevertheless have a level of security with the coverage
they already have and do not want it to be disrupted.
Concerns that actions to help the
uninsured could undermine the traditional employment-based system
are not unique to tax credits. Any program to help the uninsured,
including the expansion of government programs, poses competition
to parts of the employer-sponsored system. To reduce the possible
erosion of the existing employer-sponsored system, Congress could
restrict eligibility to those who are not offered insurance through
their place of work. It also--if employer-sponsored insurance is
available--would require that the credit be used to purchase a plan
offered by the employer.
The
response of some small employers doubtless would be to convert
health benefits into cash income or into a defined cash
contribution to a plan chosen by the employee, but this would be a
benign form of "unraveling" since employees would now have more
income and tax benefits with which to choose the plans they want.
This effect would also be offset as currently uninsured families in
other firms used their credit to buy into their employer's
plan.
CONCLUSION
Uninsurance among working families is
testament to the limitations of the employment-based health system,
especially in the small-business sector. Yet the tax system
discourages other insurance arrangements from serving the
uninsured.
Proposals for individual tax credits for
health coverage, such as those advanced by President Bush and
bipartisan groups of lawmakers on Capitol Hill, would help remove
this barrier to alternative insurance arrangements. With this
reform in place, new forms of coverage--including plans offered
through churches, large corporations, and the FEHBP--would become
available to working Americans. For this to occur, however,
Congress must recognize that an important distinction exists
between the place of employment as the convenient place to obtain
insurance and making tax relief to families contingent upon
employer sponsorship of their health insurance.
--Stuart M.
Butler, Ph.D., is Vice President for Domestic and Economic
Policy Studies at The Heritage Foundation.