After decades of debate, there is broad bipartisan agreement that action must be taken to address the problem of the uninsured. There is also a growing recognition that although the traditional employment-based health insurance has in many respects been very successful in achieving good insurance coverage for million of Americans, for many workers that system does not assure stable, continuous coverage. For example:

• There are very high rates of uninsurance among the employees of small firms. According to a recent survey by the Kaiser Foundation, 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 offered insurance. One reason for this is that employers trying to offer coverage to very small groups tend to face high administrative costs. 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.
   
• The tax laws effectively force workers to accept coverage from their employers. The current tax system excludes from taxable income (federal and state income tax, and payroll taxes) all compensation provided in the form of employer-sponsored insurance. The lack of virtually any practical tax relief or similar assistance for the vast majority of workers without such coverage helps explain the high uninsurance rate among employees of smaller firms and those between jobs. The absence of such assistance has also discouraged the growth of insurance offered through large organization with which workers may have along term affiliation, such as their union or their church.

Spurred by these general concerns and by the more immediate issue of families without insurance due to the economic slowdown and the direct effects of September 11th, Congress has three broad approaches before it. Namely:

Approach 1: Expand government programs to include millions more working families. It has always been the goal of some politicians and organizations to achieve a national single payer health system, and this would be a step towards it. But besides the chronic problems besetting Medicaid as well as national systems in Canada, Britain and elsewhere, there is strong resistance to this approach among Americans, as well as within Congress and the Administration.

Approach 2: Link any assistance to families remaining with their former employer's plan. Some proposals, such as that offered recently by the Senate Democratic leadership, would provide assistance to laid-off workers, but only if they continued to purchase coverage under COBRA. This, of course, does nothing for workers without a plan offered by their current or former employer. Moreover, in many cases laid-off workers cannot afford, or do not want, plans offered through their former employer - an employer in many cases who has abandoned them and may be in dire financial straits. Under this approach a former Enron worker - who has just lost his or her job and pension - would be told they could get help for insurance but only if they used it to buy coverage through the bankrupt firm that had thrown them onto the street.

Approach 3: Offer a refundable tax credit for those for whom employer-sponsored insurance is not a viable or sensible option. A number of proposals, including one from the Administration, one passed by the House, and plans offered in both chambers by a remarkably bipartisan group of members, would provide a refundable tax credit for the purchase of insurance. These approaches make far more sense. They would allow a parallel "third way" system to develop alongside employer-sponsored and government-sponsored coverage for those Americans who want private insurance but also want the stability and control that comes with a plan chosen by the family and organized through an organization they trust - much as members of Congress are able to do through the FEHBP.
As important as the technical merits, a tax credit approach is also the most practicable option today precisely because it commands wide support in Congress and the Administration, and so can be achieved. To be sure, design issues need to be addressed and choices made. A refundable tax credit for health insurance can - and should be - enacted by Congress and signed into law by President Bush.

Key Design Issues for a Tax Credit Program

There are several desirable elements for an effective tax credit, especially for laid-off workers and for low-income, uninsured populations

1) Eligibility ideally should include those with employer-sponsored coverage.

Ideally some level of credit should be available regardless of job status - i.e. available to the working uninsured and insured, and to unemployed workers. With a properly designed credit, this eligibility criterion would eliminate any bias against employer-sponsored coverage by providing the equivalent level of help to those with or without that option. I suggest the committee examine Senate legislation offered by Senator Jeffords and others (the REACH Act, S 590). This contains a lower credit for employees with employer-sponsored plans. When combined with the exclusion, this lower credit is designed to provide a level of subsidy for the out-of-pocket costs of insured employees that is equivalent o the full credit available for the uninsured.

2) The credit should be refundable and advanceable.

To be meaningful to lower-income families, refundability is necessary. So is a credit, rather than a deduction, is needed in order that families with low marginal tax rates receive adequate help. A credit also should designed to be available "up front" instead of requiring the family to wait until the end of the year. This can be achieved simply enough through the tax withholding system for employed, taxpaying individuals - in the same way that other tax benefits, such as the mortgage deduction or child care credit, are "advanced." In addition, if the credit can be "assigned" to a health plan in return for a lower premium (much like federal employees receive their government subsidy in the FEHBP), that would make a simple alternative method available for workers who do not file a tax return or do not wish to use the withholding system. Assignment can be organized easily for a fixed or percentage credit with no income phase out. Income adjusted credits pose small complications but can be reconciled through the tax system.

An unemployed person with an assigned credit similarly would face a reduced premium. Alternatively, a tax credit for unemployed workers could be paid through the unemployment insurance system. This would require a funds transfer between the Treasury and the Department of Labor, with the money then distributed to state unemployment offices (similar to the supplemental benefit programs delivered in this way since 1958). The state unemployment offices could take on responsibility for remitting premium payments to insurers. Unemployment offices would be required to inform the unemployed individuals about the tax credit and to provide necessary participation forms. Unemployment offices, which are already responsible for verifying unemployment, would be required to verify worker eligibility for the credit.

3) Different forms of credit will have different impacts.

There are several forms of tax credits, each of which have subtly different effects. One is a fixed dollar credit, as proposed by the President and others, such as Senator Jeffords, Representative Armey, and in 1999 legislation by Representative Stark. This is simpler, making calculation of the after-credit premium cost easy for the insurer and recipient. Assignment of the credit would also be easy. For a given budgeted amount, moreover, the fixed credit does concentrate the assistance to those most financially needy. On the other hand, individuals with greater health care costs would face 100 per cent of additional out-of-pocket costs if they needed elaborate coverage.

Another approach is a percentage credit, such as that included in the House stimulus package and in legislation offered in the past by several lawmakers, including Representative McDermott. This approach would be more expensive if it also included a minimum at least equal to the fixed credit, but it would help families with higher health care costs by reducing the marginal after-tax premium cost. In addition, by making it more affordable for younger, healthier individuals to purchase more comprehensive plans, it would reduce adverse selection concerns. Recent unpublished research by Emory University professor Ken Thorpe suggests that there would be very little adverse selection at all with a credit equivalent to the FEHBP subsidy (approximately 75 per cent).

4) Employers may be the best location through which most families get coverage, even though 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). Employers thus facilitate the tax system, but they do not in any sense design or "sponsor" the tax code. They could more appropriately be considered a clearinghouse for tax payments.

The place of employment would also is likewise particularly convenient and efficient for handling health insurance payments. With individual tax credits available, employers who do not currently sponsor insurance could still carry out the critical clearinghouse role for plan choices, tax adjustments, and premium payments. 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, very small employers could play a very important role in facilitating coverage without having to organize coverage.

5) Avoid minimum benefits requirements.

Some argue that any tax credit should be conditioned on the eligible family purchasing a health plan with a federally determined comprehensive benefits package. This would be a mistake. A federally mandated comprehensive plan would be very expensive, putting it out of reach for many families, and yet in many cases still would not included certain benefits required by some families (this has, after all, been a constant feature of Medicare). A comprehensive federal benefits package (which would be the ceiling as well as the floor for most lower-income families) would also invite provider lobbying to include often-marginal benefits. This pattern, seen at the state level, could make insurance prohibitive to lower-income families, as the experience of state mandates has demonstrated.

If Congress unwisely insists on a benefits package, it should be for a minimum package, primarily catastrophic insurance protection, and not comprehensive coverage. It should also be in the form of broad areas of coverage, such as hospitalization and major medical, similar to the requirements for plans in the FEHBP or the California Public Employees' Retirement System (CalPERS), rather than a precisely defined set of specific benefits, such as Medicare fee-for-service.

6) Washington should work with states to make new forms of groups and intermediaries available as vehicles for insurance.

The individual market does not have to be the only choice for coverage. Indeed, with a tax credit reducing the obstacles to new forms of group emerging, it is likely that other purchasing options - in some cases similar in structure to employer-based coverage - would begin to emerge. This development can be hastened through government action.

Four types of groups are particularly attractive additions to traditional employer-sponsored coverage.

• Affinity groups. Several common institutions in American communities are well placed to serve this function for insurance and as intermediaries negotiating with insurers on behalf of families. For example, unions as "friendly societies," have had a long history of involvement in health care. In addition, many religious denominations also have a long history of providing insurance services for their congregations. For lower-income African Americans and others, churches are a far more stable institution in the community than local public health and small employers, and one that has the long-term social welfare of families firmly in mind. These groups acting as insurers themselves, any more than the Mailhandlers union does in the FEHBP, but instead as buying agents that reach agreements with insurance plans that actually shoulder the risk.
   
• Associations. Various employment-related associations have arisen to group people together to obtain insurance without the employer directly sponsoring coverage. These include health purchasing cooperatives and coalitions and multiple-employer welfare arrangements (MEWAs), and they also face strict restrictions at the state level that affect their insurance arrangement and benefits. There have been proposals in recent years to create new kinds of associations that would be free from many state restrictions, particularly state benefit mandates.
   
• The Federal Employee Health Benefits Program (FEHBP). While technically an employer-based system, the FEHBP actually serves the equivalent of a small country (with nearly 10 million covered individuals) and offers a broad choice of plans. While a federal worker's immediate employer does not sponsor plans, the place of employment is still the "entry point" for selecting plans. FEHBP plans are regulated at the federal level, through a combination of general statutory and administrative regulation supplemented by a process of negotiations between the Office and Personnel Management, on behalf of the federal government, and plans wishing to market through the FEHBP. There have been several proposals to open up the FEHBP to non-federal workers under various conditions, typically using a separate insurance pool. On a small scale, this model could be implemented by states using their state employee plans.
   
• 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, principally because the tax code provides no tax benefits to families buying health insurance from a corporate plan that is not their employer

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 has offered 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.

The federal government should work with the states to foster new forms of purchasing arrangements, in addition to the high-risk pools and other vehicles already being for high-risk individuals. To do this, Congress could enact legislation to permit a range of new kinds of groups, such as opening the FEHBP system to groups of the uninsured in each state, and new forms of purchasing groups. The federal government could then enter into discussions with each state to create a federal-state package of new forms of group insurance, selected from a "menu" of the federal options combined with state measures.

Problems with Other Approaches

Some alternative proposals before Congress would do not adequately provide targeted assistance for the low-income, uninsured populations. Among them:

• Medicaid/SCHIP expansion. Extending Medicaid eligibility for the uninsured population raises a number of concerns. For one thing it segregates the uninsured population further from the rest of society with private coverage. Over 85 percent of the uninsured are in working homes. It makes little sense to require these families to seek coverage from a welfare program rather than to help them afford coverage they prefer. Moreover, if the family income rises and they become ineligible for Medicaid, there would be another break in coverage. And further, states are already facing severe budget shortfalls. Some 37 states overspent their Medicaid budgets in FY 2001, and this year Medicaid is already over budget in 23 states according to a survey of state budget officers. States are looking to keep health costs down, not burden themselves financially by expanding eligibility.
   
• COBRA-only subsidies. Subsidizing only COBRA coverage, through direct subsidies or a tax credit, raises several problems. First, many unemployed workers, especially low-income workers, do not qualify for COBRA. Some 42 million unemployed workers are ineligible for COBRA and 60 percent of low-income families do not qualify. Second, it would give many families only the "choice" of a still-unaffordable comprehensive plan when their economic conditions would make only a leaner plan affordable even with a subsidy. And third there is the "Enron problem." It makes little sense to condition a subsidy on remaining in coverage organized by the former employer who fired the worker and has no other connection to the family, and who may also be facing severe financial problems that could lead to coverage cutbacks.
   
• Subsiding the employer. Some proposals see to expand coverage by subsiding employers who offer coverage. But this would be like pushing on a string. Credits or other subsidies for employers do not make small firms turn into 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 it likely lead to a choice of plans. A subsidy would also not deal with the "hassle factor" that causes so many small-business owners to compete for workers by giving them cash instead of complex benefits.

Two Common Criticisms

Critics of tax credits raise a number of arguments, two of which are widely heard:

Argument 1: The proposed credit is not sufficient to afford coverage and so the take-up rate would be low.

To be sure, a large tax credit would make insurance affordable to more families than a small credit would, just a public program with a large budget would cover more people than one with a small budget. If Congress were to raise the budget devoted to a tax credit program it would certainly be more effective. But there are good reasons to believe that the Administration and Hill proposals for credits would have a significant impact on the uninsured.

First, the individual market may not be as inaccessible as perceived. An E-Healthinsurance survey shows that there are quite affordable coverage options available in most states, especially those who do not impose a high level of mandated benefits.

Second, a federal tax credit should be considered a foundation upon which other financing bricks are added. Put other way, a $3,000 federal credit puts the family $3,000 closer to obtaining affordable coverage. Under current law, and with waivers from the federal government, state governments can provide families with SCHIP and other funds to subsidize the purchase of private coverage. The federal government should combine a tax credit program with an aggressive waiver initiative designed to complement the federal credits. In addition, if workers could join large pools utilizing a credit, many small employers in a competitive labor market would have the incentive to make contributions on behalf of their employee's coverage as well, especially those employers who do not offer coverage because of the administrative cost.

Third, the take-up rate of coverage is likely to be greater than some estimates, even at the credit levels now under discussion. A recent study by Pauly and Herring, for instance, estimates that a fixed tax credit equal to 50 percent of the cost of a standard plan would lead to a 48 percent reduction in the number of uninsured. Determining the take-up rate is difficult - as it is with, say, expansions of Medicaid. Two contributing factors are illustrative. If alternative government programs (and emergency room care) is inexpensive to families, this has the effect of "crowding out" tax credit-subsided coverage, leading to lower take-up rates. But if these alternatives are less available or more costly the take-up rate would be much higher. The ease of obtaining the subsidy and signing up for coverage is also a significant influence. With assignment and automatic enrolment at the place of work, take-up rates likely would be quite high. Evidence from pension plans indicates that an automatic enrollment system for health insurance could have dramatic effects on sign-up rates.

Argument 2: A credit would "crowd out" traditional employer-sponsored plans.

Some critics maintain that providing a tax subsidy to the uninsured is inefficient because many employers currently providing insurance would drop their employees' coverage.

The simplest response to this charge is that it applies, of course, to any proposal to help the uninsured, including expansions of public programs. Indeed, there have been a number of studies of "crowd out" in Medicaid and other programs, and these indicate a significant substitution effect. Cutler and Gruber, for instance, found a range of crowd out effects for Medicaid expansions in the late 1980s and early 1990s, depending on exactly what was measured. The decline in private coverage, as a share of the persons who enrolled in Medicaid directly as a result of the expansions was as much as 50 percent. A new study of state-based expansions of coverage, by Kronick and Gilmer, indicate a variety of crowd-out effects depending on the design of the program. Oregon and Washington, for example, reduced uninsurance with very little crowding out of private insurance, while in Tennessee almost half of the increase in publicly covered individuals resulted from a decline in private coverage. In Minnesota almost all the enrollment in the new public plan "was accompanied by a decline in the number of privately insured persons and virtually no change in that of uninsured persons."

The answer is not to do nothing, of course, but to recognize that tax credits are no different from other approaches in having some substitution effects. In some cases substitution is actually desirable. It is beneficial, for instance, if it means workers using a tax credit can obtain permanent coverage through a large non-employer group, rather than using the tax exclusion to obtain impermanent coverage through a small employer that does not meet their needs is very costly. Steps should be explored to reduce unwelcome crowding out, however. The smaller credit available in the Jeffords REACH act for individuals with employer-sponsored coverage likely would reduce crowding out, for instance. In addition, it would be wise to include a prohibition against workers dropping out of an employer-sponsored pool and claiming the credit - not just to discourage crowding out but to prevent the employer's risk pool being undermined.

In conclusion, it is vital that Congress seizes the opportunity before it to make a real downpayment on helping the uninsured through a mechanism that has strong support in each chamber and in the White House. A tax credit for insurance not provided through the place of employment is a sensible step that Congress could take this year, while it also take steps to improve the availability of group coverage throughout the states. Taking this step would be consistent with the objective shared by both conservatives and liberals of achieving a health system in which a family's access to health care and coverage, and the help they get to afford care, does not depend on where they work.

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