Health Care Reform: Tax Deduction or Tax Credit?

March 22, 2011

The tax code needs to be reformed such that the tax benefit for having a health plan goes to the individual and not his employer.  What has never been well settled is whether this tax benefit should be a tax deduction or a tax credit, says John R. Graham, director of health studies at the Pacific Research Institute. 

  • Because of the progressive income tax regime, higher-income earners will value the deduction more than lower-income workers; this will lead to higher-income households overconsuming health goods and services at a higher rate than lower-income households.
  • Moreover, people who earn less than a certain threshold of income will not be able to enjoy the deduction, which implies that they will continue to be dependent on Medicaid and other taxpayer-funded programs.
  • This perpetuates the fragmentation of health insurance.

While tax credits are likely to be expensive, they have a key advantage, especially if the individual can "bank" any unspent tax credit for future use.  They do not reduce marginal prices of health goods and services, so individuals have less of an incentive to over-consume than under the status quo or a tax deduction. 

There are multiple arguments whether tax deductions or tax credits are a better way to reform health insurance, but there is no doubt that individual ownership is necessary for coverage that is portable from job to job and state to state, and where nobody is denied coverage due to a pre-existing condition, says Graham.

Source: John R. Graham, "Replacing Employer-Monopoly Health Benefits: Tax Deduction or Tax Credit?" Pacific Research Institute, March 2011.

 

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