In his State of the Union address, President Bush proposed a
bold approach to neutralize the long distorted tax treatment of
health insurance between those with employer-based coverage and
those without it. Some skeptics have voiced concern that this would
erode the existing employer-based system. But these are not new
concerns and apply to many approaches to helping the uninsured.
Moreover, the concerns can be addressed by amendments to the basic
Bush approach. Rather than dismiss the proposal and ignore its
worthy objectives, policymakers should seize the opportunity for a
fresh conversation about coverage and fix the disparity in the tax
Today, individuals who obtain health care coverage through their
place of work receive an unlimited tax break by excluding the value
of this benefit from their taxable income. This policy perpetuates
the growing cost of health care by encouraging workers to take more
generous (and expensive) health care benefits in lieu of taxable
income. However, individuals purchasing or wishing to purchase
coverage on their own do not receive such a tax break and must use
after-tax dollars to do so.
Unlike today's system, the President's health care proposal
would give every American tax relief for their health insurance.
The President's plan would provide a $15,000 standard deduction for
families and a $7,500 deduction for individuals. This deduction
would replace the current, open-ended tax exclusion that
exclusively favors employer-based coverage.
Employer-Sponsored Coverage Does Not
Work for Everyone
Today's workforce is very different than during World War II
when the health care tax exclusion came to be. It is no longer the
standard for individuals to have the same employer throughout their
career until retirement. The workforce is more mobile, and each
time an individual changes employers, he or she changes health
insurance or risks losing it altogether.
There are a variety of reasons why an individual may not have
employer-sponsored coverage, according to analysis by the Employee
Benefit Research Institute. First, not all employers offer
coverage. About 54 percent of uninsured workers are not covered by
their employer's plan because their employer does not offer
Second, not all workers qualify for employer coverage. About 19
percent of uninsured workers were ineligible for their employer's
Finally, not all workers can afford their employer's coverage.
Fully 64 percent of uninsured workers who chose not to participate
in an employer plan cited cost as the reason.
These issues are even more pronounced for workers in smaller
firms and lower-income workers. A study by researchers at the
Commonwealth Fund found that, among workers earning less than $10
per hour, 53 percent did not have health care coverage through
their employer; among workers with incomes below the federal
poverty level, 74 percent did not have employer coverage.
The "Risk" of Adverse Selection
Although the employer-based system falls short for many workers,
it still provides coverage to the majority of Americans. So
whenever a proposal is made to provide help for families who lack
adequate or any insurance, some worry that the effect will be to
weaken the employer-based system. This concern applies to proposals
to allow working families to acquire public coverage, such as
Medicaid, or private coverage, such as under the President's
The concern raised about the President's plan is that it might
induce some younger, healthier workers to exit the employment-based
system, leaving employers with only older and costlier workers-a
pattern known as "adverse selection." This could drive up employer
group insurance costs and, so, may cause some employers to drop
coverage. Thus, leveling the tax-subsidy playing field for workers
with employer-sponsored coverage and other private coverage
options, such as coverage in the individual market, may cause some
employers to discontinue health care coverage for their workers
While these may be reasonable concerns, and should be
recognized, there are other reasons why an employer-based system
would continue, and there are steps that can be taken to amend the
basic Bush plan to avoid adverse selection.
Employer-Based Coverage Would Continue.
For at least three strong reasons, employer-based coverage would
continue under the President's proposal to change the tax treatment
of health care coverage:
- Employers do not provide coverage as an act of generosity. In a
tight labor market, employers must compete for workers based on
overall compensation, not just wages. Thus, even though the tax
treatment would be level, an employer's offer of coverage would
remain a key competitive advantage.
- Employers are natural pooling agents and, so, help to reduce
the overall cost of health insurance. The larger the employer pool,
the more negotiating power the employer has to strike better deals
for its workers with insurers. Moreover, many employers have
participation-rate requirements to ensure that their pools reflect
a balance of their workforces. So employers have a strong incentive
to make their plans attractive to younger workers.
- Workers' basic familiarity with employer-sponsored coverage
will continue to be an advantage for employers. Purchasing health
insurance can be complicated. Workers may feel more comfortable
having a trusted employer assist them and facilitate these
transactions, as with retirement savings.
Addressing Adverse Selection
Despite the natural advantages employers have as sponsors of
insurance, giving assistance to families without such coverage
still raises the legitimate concern of adverse selection-younger,
healthier workers leaving employer-based group plans because they
can find cheaper individual insurance elsewhere. But steps can be
taken to avoid this potential problem, while still offering
tax-break assistance to families without employer-based
- Link the individual deduction to access to
employer-sponsored coverage. While this would not be ideal,
workers with access to employer-based coverage could be required to
enroll in their employer plan in order to receive the deduction.
Younger, healthier employees with coverage today would have no
incentive to leave their employers' plan because they would not be
eligible for a deduction for non-employment based coverage.
Families without access to employer-sponsored coverage, however,
would be eligible for the individual deduction.
- Create a marketplace that combines employer-sponsored and
individual coverage. The employer-based system need not be in
competition with the individual market; there are ways to blend the
two markets together. The Massachusetts Connector and other state
"health insurance exchange" proposals, for example, preserve the
benefits of employer-sponsored coverage but also facilitate
individual choice and ownership of personal, portable policies. In
fact, these approaches could entice more employers to participate
in facilitating coverage for their workers and so to create
personal, portable coverage for workers and their families.
- Adopt policies to improve overall insurance market access,
stability, and affordability. With or without the proposed tax
changes, if the employer-based system continues to decline, the
troubles with the individual market will need to be addressed.
States are exploring insurance reforms and introducing policies
such as high-risk pools and risk adjustment. These mechanisms are
important tools to accomplish stability in health care coverage.
The President's proposal recognizes that change is needed to
properly accommodate the growing individual market, and state
insurance initiatives should develop in parallel to the tax
fairness measure in the President's proposal.
The President's plan would alleviate the disparities of the tax
code by giving all workers, regardless of job or job status, the
same health care tax benefits. Even with this change, the
employer-based system will continue to be of value to its workers.
To the extent that adverse selection becomes a problem, however,
there are tools that could be used to address it within the context
of the President's plan. Policymakers thus should not shun the
President's proposal because it shakes up the status quo, which has
resulted in millions of uninsured Americans. Instead they should
find ways to build on its fundamental principle of tax equity for
Owcharenko is Senior Policy Analyst for Health Care in the
Center for Health Policy Studies, at The Heritage Foundation.