Health Reform Through Tax Credits

health-care-costs(A version of this Health Alert was published by RealClearPolicy.)

Lost in the blur of the presidential campaign, the evidence indicates the Republican Obamacare replacement plan will include refundable tax credits. In its purest form, this means each person with employer-sponsored benefits, an individual health plan, or dependent on a welfare program like Medicaid or the Children’s Health Insurance Plan (CHIP) will start with a clean slate and a fixed sum of taxpayer-funded money to choose health care of his choice. The Republican proposal will not likely go that far, but it will go a long way to introducing fairness in the tax treatment of health benefits, which is currently broken.

Today, working-age people dependent on government funding for health coverage are subject to a trap that hinders them from seeking higher incomes. Whether on Medicaid, the joint state-federal welfare program for low-income people, or receiving coverage through an Obamacare exchange with premiums discounted by tax credits paid to insurers, these people are subject to clawbacks which dramatically increase their health spending if they get a raise. In many cases, their take-home pay is reduced.

Take the example of a nationally representative family of four, whose household income increases by just one dollar from $31,720 to $31,721. In an Obamacare exchange, I estimate the household is initially liable to pay $958 for the most common Obamacare plan. For an increase of one dollar of income, the household net annual premium increases by $320 (from $638 to $958), resulting in a net loss of $319. What an incentive to turn away from higher paying work!

On the other hand, people who get employer-based benefits exclude the value of those benefits from their taxable income. Because the U.S. has a highly progressive income tax regime, this exclusion is worth far more to high-income households than middle-income ones.

A universal tax credit would eliminate this tax discrimination. To be sure, the leading Republican presidential contender, Donald Trump, does not have a tax credit in his plan. However Mr. Trump’s plan needs a lot of work, to put it mildly. Senator Ted Cruz and Governor John Kasich, the other two Republican presidential contenders, appear open to reforming the tax treatment of health benefits, but are not wedded to one way of doing it. This means, if a Republican president is elected, the initiative for post-Obamacare health reform will fall to the Congress.

In February, Speaker Paul Ryan selected four Committee Chairman to a Health Care Reform Task Force. Budget Committee Chairman Tom Price (R-GA) id one of the four, and he has already proposed his own Obamacare replacement plan. If elected, a Republican president would likely look to Dr. Price’s plan for the design of a tax credit.

Price’s bill offers a universal tax credit, adjusted by age, to every American who chooses to buy individual health insurance: $1,200 for those aged 18 through 34, $2,100 for those 35 through 49, $3,000 for those 50 through 54, and $900 per child. Price would allow people to decline employer-based benefits and claim their tax credit in the individual market.

Some conservative critics of tax credits for health insurance point out that tax credits must be paid for. This is one reason Republican politicians who support tax credits have failed to get them more generally accepted by Republican fiscal hawks. They have failed to emphasize that a universal tax credit would replace, not supplement, current federal spending. First, Medicaid funding would be used to fund the tax credit. According to the Congressional Budget Office, federal spending on Medicaid and the Children’s Health Insurance Plan (CHIP) will amount to $394 billion this year.

Another source of funding is the current exclusion of employer-based health benefits from taxable income. This exclusion will cost $144 billion of tax revenue this year. There is an important difference between this so-called “tax expenditure” and actual spending on Medicaid and other welfare programs. Excluding benefits from taxable income does not impose a direct cost on other taxpayers.  Nevertheless, if the government eliminated this exclusion and substituted a tax credit, it would eliminate the exclusion’s bias favoring high-income households and leave many households more after-tax dollars.

Using this revenue, plus current tax credits funding insurers in Obamacare exchanges, would result in $594 billion in universal tax credits for 232 million people on Medicaid,  CHIP, employer-based benefits, and individual plans (either on or off Obamacare exchanges). That averages over $2,500 per person.

Although the actual amount would likely be adjusted by age, as in Dr. Price’s bill, that is a big enough amount of money to overcome political resistance to a universal tax credit for health coverage, which would be much simpler and vastly superior to the status quo.

Comments (13)

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  1. Brad says:

    John, good stuff. curious what calculator you used to get the subsidy info in 3rd paragraph? $31,720 is 130.539% of 2016 FPL ($24,300 for family of 4), which puts that family in the category of not paying more than 2% of the MAGI for health insurance. They would have to make more than $32,319/yr (in non-Medicaid expanded states) to increase to the next level of MAGI requirement which is 3-4%. The point is right on, but I think the numbers are off for 2016.

    • Thank you. I may well have been using 2015 figures. I thank you for agreeing that the points stands up nevertheless.

      Plus, of course, any such reform would not happen until 2017 at the very earliest. So, we should not get too wrapped up in the decimal points.

  2. Jimbino says:

    I am curious about the effect of individual healthcare tax credits. Married folks enjoy lower tax brackets than two singles with the same combined income. Why should they then enjoy healthcare tax credits as individuals rather than a reduced tax credit based on their being married? It seems that the plan described will result in singles’ being royally screwed both coming and going.

    • You make a good point. Generally, when we advocate tax credits, we accept the personal income tax system otherwise stays the same. If we were to make big changes to personal income taxes, e.g. flat tax, it would lead us to change how we propose tax credits.

      Dr. Price’s reform does not yet consider individuals versus married filing jointly. I’ll send him that feedback for the next iteration.

  3. Ron Greiner says:

    Good stuff John. Tom Price has the best plan and his amounts would let healthy people get health insurance with 100% of the cost paid for by the tax credits. So the healthy will be sucked out of the existing employer plans which leaves them with who? Finally, the end of employer-based health insurance.

    Get ready to sell your United Health Care stock.

    Employers will switch to making HSA deposits for employees.

  4. The Big Ham says:

    Hillary Fiction will not like this. That would leave way to much money in the private sector. 👍

  5. PJohnson says:

    Man, there has to be an easier way. The entire article was a convoluted miasma of government tweaking. And another testimony of what’s wrong in DC.

  6. James R. Chaillet, Jr., MD says:

    Thank you for explaining the tax credit approach. I would hope that any Republican approach to Health Care Reform would include reversing the trend of more and more mandated benefits. There will not be heavy pressure on prices until more patients or consumers have to make decisions about the value of medical services. (and audience please spare me the argument that people can’t make rational decisions when faced with a medical emergency – most health care dollars are not spent on emergency care.)

  7. Bob Hertz says:

    First an academic point:

    The exclusion of employer paid benefits from taxes may have a larger impact than $144 billion…..
    see the attached:

    • Office of Management and Budget. Table 14-1. ESTIMATES OF TOTAL INCOME TAX EXPENDITURES FOR FISCAL YEARS 2015-2025. In 2016, total federal revenue losses related to tax benefits related to employer-provided health plans will amount to $350 billion.
    o Line item 126 lists federal income tax revenue losses related to the exclusion of employer contributions for medical insurance premiums and medical care. Footnote 11 provides the corresponding revenue losses related to FICA payroll taxes. In 2016, income tax losses were $210.980 billion, while payroll tax losses were $131.380 billion. Total=$342.3 billion.

    Now for a how-does-it-work question……..

    Joe Smith age 40 works for the state of Massachusetts and has a Cadillac plan that costs $25,000 a year for family coverage.

    For simplicity let’s say that the employer pays the entire premium.

    In comes the Price plan.

    If the employer maintains the plan, does Joe bring $25,000 into his income taxes? That will cost him a lot of dough. Paying taxes at his highest marginal rate in a state like Mass., this will cost him at least $8,000.

    Does he bring the $25,000 into income, but then he and his wife can take $2,100 each as a credit, and take $900 times two for his two kids?

    Then it is not so bad and the pitchforks will not be out for the Congress that passed this.

    • Yes, in fact, the tax credit would be worth far more than the exclusion for people below a certain income cut off. It should be a political winner.

  8. Bob Hertz says:

    But by not disagreeing with me, you imply that the tax credit system could be a loser for persons with generous employer-paid coverage and medium to high incomes.

    John, that is millions of people, and more to the point, that is millions of well-paid employees who are going to vote.

    Just look at the 2010 and 2014 elections. The lower income persons who benefit from the ACA were very sporadic voters. Whereas upper income persons who are paying higher taxes for the ACA are very regular voters.

    • Ron Greiner says:

      Bob, the credit is worth more to low wage workers because they don’t pay income tax. That doesn’t mean that high wage workers would vote against tax credits.

      I would think the high wage earners would prefer their employers making tax-free HSA deposits instead of spending that cash to the employer-based health insurance companies. It’s time to let high wage earners choose their insurance on their children instead of an employer who is more concerned with the bottom line.
      than the health of their employees dependents.

    • Yes, you have a good point.