Thank you Mr. Chairman for the opportunity to testify before the
Committee on this important subject. My name is Stuart Butler. I am
Vice President for Domestic and Economic Policy Studies at The
Heritage Foundation. My testimony represents my personal views on
the issue of health care reform, and should not be construed as
representing any official position of The Heritage Foundation
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
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
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
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,
1) Eligibility ideally should include those with
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
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
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
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
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
- 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
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
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
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.
Stuart M. Butler, Ph.D., is Vice
President for Domestic and Economic Policy Studies at The Heritage