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Why The Bush Health Insurance Plan Matters

Posted on February 12, 2007 by Martin A. Sullivan
Document originally published in Tax Notes

on February 12, 2007.




Like a Hollywood movie that hits the video shelves in a matter of weeks, President Bush's plan to expand health insurance coverage is fading fast from public view. But there is a good chance it will develop a small loyal following. For those few thousand individuals who make their living studying, lobbying, and legislating domestic policy, the president's proposal to reshuffle $160 billion in tax benefits for health insurance is unique and thought-provoking. It breaks new ground not only in healthcare, but also in income tax and Social Security reform. Sure, it's far from perfect, but parts of it are startling. Love it or hate it, the White House plan challenges the status quo and puts the prestige of the presidency behind some bold new ideas.

Part I. Healthcare Reform



The president is proposing to add the value of employer-provided health insurance to wages for income and payroll tax purposes. In return, all workers would receive a flat deduction -- $7,500 for individuals, $15,000 for families -- from income and payroll taxes if they purchase health insurance, either on their own or through their employer.

The proposal arrives at a propitious time. Healthcare reform has returned to the forefront of American politics. A dozen years after the failed full frontal assault by the Clintons, reformers have finally recovered from their shell shock.

The states are leading the way.

In Massachusetts a program that provides near-universal healthcare was signed into law in April 2006 by Republican Mitt Romney, then governor. Under the plan, individuals are required to have health insurance the same way drivers are required to have auto insurance. For the lowest-income individuals, Medicaid has been expanded. For middle-income individuals, the program provides subsidies for purchasing private insurance. For upper-income individuals who don't buy insurance, there are tax penalties of up to half the cost of an insurance policy. Employers are required to provide health insurance for workers or pay a tax penalty of about $300 per employee. And the new Commonwealth Health Insurance Connector provides a marketplace in which small businesses and individuals can purchase insurance from a wide range of providers in a manner similar to the menu of options available to federal government employees.

Compared with Massachusetts, California is a much bigger state, has proportionately more uninsured citizens, and has fewer funds available to address its healthcare shortfalls. Nevertheless, this January, Republican Gov. Arnold Schwarzenegger proposed a Massachusetts-style plan for California. To cover the cost of subsidies and expanded government programs, noninsuring employers would be required to pay fees equal to 4 percent of payroll -- a far heftier burden than the flat per-employee charge in Massachusetts. Also, physicians would be required to contribute 2 percent -- and hospitals 4 percent -- of their gross revenue to help fund the program.

California and Massachusetts are not the only states moving toward universal healthcare. Vermont and Maine have already enacted laws -- albeit not as comprehensive as the Massachusetts plan -- intended to minimize the number of uninsured. And many more states, including Connecticut, Iowa, and Pennsylvania, are giving serious consideration to a plan like the one in Massachusetts.

Back in Washington, there has also been a lot of action on healthcare reform, but it's not on Capitol Hill. On January 18 a superalliance of political heavyweights announced a sweeping two-part proposal to expand health insurance coverage. The Health Coverage Coalition for the Uninsured (HCCU) is a diverse group of medical providers, insurers, pharmaceutical companies, and healthcare advocates from across the political spectrum. Among its members are the American Medical Association, AARP, the U.S. Chamber of Commerce, and Kaiser Permamente.

The first phase of the HCCU plan focuses on children. It would streamline enrollment in existing Medicaid and state programs for the six million children who are eligible for those programs but are not enrolled. For middle-income families with incomes up to $60,000, refundable tax credits that decline in value as income rises would be available for the purchase of children's health insurance.

The second phase of the program would expand Medicaid to adults in families with incomes below the poverty level (approximately $20,000). And the sliding-scale tax credit would be expanded to adults for families with incomes up to $60,000.

The most noteworthy feature of the coalition's plan is that much of the political legwork -- the negotiating, the estimating, the vetting -- has been done completely outside the formal legislative process. That should make Congress's job a lot easier, but, like suggesting that a chef serve a frozen meal, it may be a little difficult for the egos on Capitol Hill to accept.

It is into this preheated environment that Bush floated his plan in late January.

The knee-jerk response from most Democrats on Capitol Hill was to sneer and deride the plan as a threat to employer-provided health insurance. But since then, cooler heads -- and not all of them from the president's network of conservative supporters -- have not been so dismissive. The consensus among policy analysts goes something like this: The president's plan is innovative, he deserves credit for giving healthcare a more prominent role on the presidential agenda, and if the plan is flawed, it is not fatally so. In short, Bush's plan should be a welcome addition to a debate that is picking up steam. With some adjustments, it could nicely complement the plans both the states and the HCCU are moving.

What modifications could be made to Bush's proposal? The suggestions fall into two categories.

First, although the president proposes to cap tax benefits for "gold-plated" employer-provided health insurance, the benefits are still heavily skewed in favor of the rich. To give families in low tax brackets the same benefits as those in high tax brackets, the president's proposed flat deduction could be converted to a tax credit. To give families that don't pay income taxes the same benefit as those who do, the credit could be made refundable. And to target tax benefits even further to those most in need of assistance, the credit could be adjusted so that lower-income families get more generous credits (as under the HCCU plan).

Second, although the president's plan levels the playing field for employer-provided and self-purchased insurance, any migration out of the employer-provided market is dangerous because of the threat of higher premiums and reduced access for the chronically ill. The president could help reduce those problems by requiring insurance plans that qualify for the new deduction to provide renewable coverage to broad segments of the public and by making insurance pools -- like the Commonwealth Connector in Massachusetts -- available to individuals purchasing health insurance on their own. (The president has also proposed an "Affordable Choices Initiative" that would provide no new funding but would allow states to reallocate existing federal money to help poor and hard-to- insure individuals afford private insurance.)


Part II. Income Tax Reform



Deductions, exclusions, and credits are the bane of the income tax, but politicians and interest groups doggedly cling to them. If by some miracle the preferences could be eliminated and replaced with an enhanced standard deduction, personal exemption, or child credit, the tax system would get a much needed upgrade. It would be more economically efficient. It would treat households in similar situations more fairly. And it would redistribute the burden of the income tax away from lower-income families.

The president's proposal to eliminate the largest tax expenditure and replace it with a generous standard deduction would be a colossal step toward fundamental tax reform. To get some perspective on how momentous a change that is, imagine that Bush proposed an equivalent reform of the mortgage interest deduction. For example, suppose he proposed replacing the mortgage interest deduction with a flat $10,000 deduction for anybody who owns a home. That would simplify the law, remove many unhealthy incentives, and make the tax code a lot fairer.

The President's Advisory Panel on Federal Tax Reform did, in fact, propose a leveling of the mortgage interest tax break. Under the panel's reformed income tax, the mortgage interest deduction would be replaced with a tax credit equal to 15 percent of mortgage interest paid, with a limitation based on the average regional price of housing.

It is rare to get such bold tax reform proposals from any leading politician, much less the president of the United States. Even those who take issue with the proposal as healthcare reform should acknowledge and appreciate its role as tax reform.


Part III. Social Security Tax Reform



The effect Bush's plan would have on Social Security has gone almost entirely unnoticed. The plan, if enacted, would create the first deduction ever allowed from the federal payroll tax base. That alone is big news. It is particularly interesting that a conservative president has proposed a standard deduction conditioned on having health insurance. It is a relatively small step from the president's idea to a truly universal standard deduction for the federal payroll tax, which is the dream of many liberals who would like to make the tax system more progressive.

For many taxpayers, Bush's plan would constitute a significant payroll tax cut, while for some others there would be a payroll tax increase. That is illustrated in the table above. Workers with employer-provided insurance that costs less than $15,000 would get a payroll tax cut. Those with more expensive plans would see their payroll taxes rise. The largest tax reductions would go to the formerly uninsured workers who purchase insurance under the president's plan. Comparing the left side of the table with the right side, we can also see that the effects would be much greater in percentage terms for low-wage workers than for high-wage workers. But that is not the end of the story. Because Social Security retirement benefits are tied to payroll contributions, any tax cuts translate to benefit cuts. The benefit cuts would be largest for low- income families who had low-cost or no health insurance before the change in law. So a surprising and unfortunate side effect of Bush's plan is that it would reduce Social Security benefits for those it was most intended to help.

 Social Security Taxes: Current Law vs. President's Plan
 --------------------------------------------------------------------
                                     
Family, Single-Earner,
                                         Wages = $30,000

                                     --------------------------------
     
Types of Employer Insurance: A = low cost B = expensive
             C = equal to standard deduction D = none

 --------------------------------------------------------------------
                             
A          B          C         D
 --------------------------------------------------------------------
 
Current Law

 Wage Income                  $30,000    $30,000    $30,000    $30,000

 Employer-Provided             10,000     19,000     15,000         --
 Insurance

 Taxable Compensation          30,000     30,000     30,000     30,000

 Social Security Tax            3,720      3,720      3,720      3,720
 at 12.4%

 
President's Plan

 Wage Income                   30,000     30,000     30,000     30,000

 Employer-Provided Insurance   10,000     19,000     15,000         --

 Standard Deduction            15,000     15,000     15,000     15,000

 Taxable Compensation          25,000     34,000     30,000     15,000

 Social Security Tax            3,100      4,216      3,720      1,860
 at 12.4%

 Change in Social Security Tax   (620)       496         --     (1,860)

 % Change in Social Security     -17%        13%         0%        -50%
 Tax

 --------------------------------------------------------------------
                       
[Table Continued]
 --------------------------------------------------------------------
                                     
Family, Single-Earner,
                                         Wages = $75,000

                                     --------------------------------
     
Types of Employer Insurance: A = low cost B = expensive
             C = equal to standard deduction D = none

 --------------------------------------------------------------------
                             
A          B          C         D
 --------------------------------------------------------------------
 
Current Law

 Wage Income                  $75,000    $75,000    $75,000    $75,000

 Employer-Provided             10,000     19,000     15,000         --
 Insurance

 Taxable Compensation          75,000     75,000     75,000     75,000

 Social Security Tax            9,300      9,300      9,300      9,300
 at 12.4%

 
President's Plan

 Wage Income                   75,000     75,000     75,000     75,000

 Employer-Provided Insurance   10,000     19,000     15,000         --

 Standard Deduction            15,000     15,000     15,000     15,000

 Taxable Compensation          70,000     79,000     75,000     60,000

 Social Security Tax            8,680      9,796      9,300      7,440
 at 12.4%

 Change in Social Security       (620)       496         --     (1,860)
 Tax

 % Change in Social Security      -7%         5%         0%       -20%
 Tax
 ---------------------------------------------------------------------
 
Notes:

 * Compensation subject to federal payroll tax under the president's
 plan is wages plus health insurance premiums paid by an employer
 minus the new standard deduction (assuming the worker has health
 insurance).

 * Several categories of workers would have no change in Social
 Security tax: those with wages above the Social Security tax cap
 ($97,500 in 2007), and those without private health insurance before
 or after the change in law, including those insured under Medicaid,
 Medicare, or a state insurance program.

 * According to the National Coalition on Health Care, the annual
 premium that a health insurer charges an employer for a health plan
 covering a family of four averaged $11,500 in 2006. "Facts on Health
 Care Costs,"
available at
 http://www.nchc.org/facts/2007%20updates/cost.pdf.



Not Ready for Prime Time



There's no doubt that people who don't get health insurance at their job deserve a tax break if they purchase insurance on their own. There's no doubt that eliminating targeted tax benefits and replacing them with more neutral tax relief like a bigger standard deduction streamlines the tax system. Liberals may want to add a standard deduction to the payroll tax, and conservatives may want to reduce Social Security benefits. The president's healthcare proposal stirs up all those issues.

That's a lot of red meat for policy geeks. But that's as far it goes. Democrats control the agenda, and they are perfectly content to let the plan fade away