Stop Subsidizing Health Insurance For The Wealthy

August 31, 2009|By John O. Fox

It's the elephant in the room that the health reform committees haven't decided whether to take on. Yet Congress must address the dysfunctional federal tax subsidy for health insurance if it is serious about eliminating excessive health insurance and health care costs, extending health care coverage to most of the 46 million uninsured Americans, and paying for it in a fair and sensible way.

What should be a slam dunk, at least for Democrats, has been resisted so far by President Barack Obama, the Democratic congressional leadership, and even leaders of the American labor movement.

Ask yourself this: If you wanted Congress to fashion tax subsidies for health insurance to promote universal health care at the least cost to the American taxpayer, would you recommend (A) giving the largest subsidies to the highest-income earners and the lowest subsidies to the lowest-income earners, or (B) allocating subsidies in ratio to need?

Choice (A), in fact, represents the status quo, an upside down program that undermines effective health care financing. Here's the rule: Health insurance premiums, no matter how large, are excluded from tax if acquired at work. Inevitably, the greatest tax savings belong to the highest-income workers, who acquire the most expensive plans and avoid tax at the highest marginal tax brackets - a tax break flawed in four fundamental ways.

First, it makes no sense as social policy to help people most who need it least, as occurs through the existing tax exclusion. Second, it prevents Congress from collecting much of the revenue needed to pay for universal health care. Third, it contributes greatly to the excessive cost of health insurance by encouraging the purchase of the most expensive policies. And fourth, it drives up health care costs because, when an insured person has few out-of-pocket costs, he is encouraged to maximize his use of health care and he has little incentive to shop for less-expensive providers.

Commentators refer to these luxurious policies as "Cadillac" plans, because their large premiums - say, $20,000-$25,000 for a family - include few deductibles and co-pays and deliver a vast menu of care. Recently, however, we learned about a plan that dwarfs all others: a true Rolls Royce. Goldman Sachs pays $40,543 in annual health insurance premiums - all tax free - for each of its elite 400 or so managers. Each manager would have paid the top 35 percent federal income tax rate on the premiums if they had been taxable. So here's the math: This tax break saves each of the "Lucky 400" more than $14,000 (35 percent of $40,543) annually in federal income taxes. That's the cost of most basic family policies.

In other words, Congress covers the entire cost of a basic family policy for our richest executives, saving the Lucky 400, collectively, an astonishing $5.6 million just this year, while scratching its head over ways to help insure the 46 million uninsured Americans. How can anyone argue that this tax policy makes sense?

At a minimum, Congress should limit the tax exclusion to the cost of a basic policy, which alone would yield hundreds of billions of dollars of additional tax revenue over the next 10 years. Most of that revenue would come from households that earn more than $100,000 and could afford the additional tax if they continued to acquire Cadillac plans. But this sensible reform poses a political problem for President Obama in light of his promise not to raise the taxes of married couples with incomes under $250,000 and others with incomes under $200,000.

Indeed, preserving any exclusion for health insurance still would provide high-income workers with the greatest tax savings; the exclusion spares them from tax at the highest marginal tax rates.

For Congress to award subsidies based on need, it would replace the exclusion with a tax credit, a proposal made by none other than Arizona Republican Sen. John McCain during the presidential campaign. Credits offset tax liabilities dollar for dollar. The largest credits - equivalent to government grants - would be available to low- and moderate-income households, with the amounts gradually reduced as household incomes rise. The IRS would send checks for the amount of the credit (called "refundable credits") to the millions of households that don't earn enough to owe income taxes but need the assistance most.

And just think: If Congress proceeds in any of these ways, we could thank Goldman Sachs for its contribution to the cause of health care reform.

John O. Fox, a visiting professor at Mount Holyoke College, teaches U.S. tax policy. He is the author of "If Americans Really Understood the Income Tax."

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