Excerpted From: State Briefing Book on Health Care
September 23, 1994
W6
Tax Treatment of Small Business
Under current employee benefits law, employers have few opportunities to institute sound cost-containment practices without substantial income tax penalties, and employees have few opportunities to purchase less costly health insurance or policies tailored to individual and family needs.
How Federal Policy Affects Small Business.
Suppose a small firm is considering purchasing an individual health insurance policy for each employee in order to take advantage of the favorable treatment of health insurance under the tax law. As Table I shows, this firm will immediately confront four problems.
First, the cost of the policy will vary with the age of the employee. (A 60-year-old male, for example, is about three times more expensive to insure than a 25-year-old male.) The obvious solution is to pay the premiums for the policies and reduce each worker's salary by the premium amount. Second, not all employees may want health insurance (e.g., some may be covered by another policy). The obvious solution is to give health insurance only to those employees who want it, reducing the salary of each by the amount of the premium. Third, some employees may have preexisting illnesses, and the insurer may want to insert exclusions and riders into their policies. The obvious solution is to get each employee the best possible deal. And fourth, employees may have different preferences about the content of their policies. Some may want to trade off a higher deductible for a lower premium. Others may want coverage for different types of illnesses and medical services (e.g., infertility coverage). The obvious answer is to let each employee choose a policy best suited to the employee's needs and preferences."Many cost containment techniques are penalized by the tax law."
Despite the fact that these solutions seem obvious and that every employee may gain from them, they are generally unavailable. In general, the federal tax law forbids employees from choosing between wages and health insurance and insists that all employees be offered the same coverage on the same terms. The result is that the employer must turn to a more expensive group policy with a package of benefits that no single employee may want.
How Federal Policy Contributes to Rising Costs
. One consequence of the barriers described above is that employers are forced to adopt a health care plan in which benefits are individualized, but costs are collectivized. Although large employers have a few more options, they too are forced into a system that has two devastating defects.
First, under the current system there is no direct relationship between health insurance premium costs and individual employee wages. In many cases, employees do not know what the premiums are. In those cases where they do (e.g., where they are asked to pay part of the premium), each is charged the same premium - regardless of age, sex, place of work, type of work or any other factor that affects real premium costs. The upshot is that the individual employee sees no relationship between the cost of employer-provided health insurance and personal take-home pay. Small wonder that employees of large companies demand lavish health care benefits.
Second, under conventional employer health plans there is no relationship between wasteful, imprudent health care purchases and salary. Under most policies, it is as though the employee has a company credit card to take to the hospital equivalent of a shopping mall. The employee will find many interesting things to buy, all chargeable to the employer. Under this system, employees have no personal incentives to be careful, prudent buyers of health care.
How Federal Policy Causes More People To Be Uninsured.
In the face of constraints imposed by federal policy, employers are trying to hold down health care costs by taking actions that have very negative social consequences. Unable to adopt a sensible approach to employee health insurance, many large firms are asking employees to pay (with aftertax dollars) a larger share of the premium. Often employers pay most of the premium for the employee but ask employees to pay a much larger share for their dependents. These practices result in some employees' opting not to buy into an employer's group health insurance plan. More frequently, employees choose coverage for themselves but drop coverage for their dependents. Three million people who lack health insurance are dependents of employees who are themselves insured."Employees see no relationship between the cost of employer-provided health insurance and personal take-home pay."
Because employee benefits law prevents smaller firms from adopting a sensible approach to employee health insurance, many are responding to rising health insurance premiums by canceling their group policies. Often, employers give bonuses or raises to pass along their corporate savings and encourage employees to buy individual health insurance policies (with aftertax dollars). Many, of course, do not.
Needed Changes in Federal Policies. Most proposed state health care reforms operate either through employers or through government. As a result, they fail to consider all of the other options. This is not so strange when we consider that employee benefits and tax payments are both tax deductible, whereas every other method of paying for health care is not. Thus the federal tax system has greatly constrained the types of reforms state governments can realistically consider.
To help solve problems for individuals, employers and state legislators health insurance benefits should be made personal and portable, with each employee free to choose an individual policy and keep it in spite of job changes. Health insurance benefits should be included in the gross wages of employees, who could claim deductions or tax credits for premiums on their personal tax returns - directly gaining from prudent choices and bearing the direct costs of wasteful ones. [See the sidebar on federal policies and employer-based insurance.]
"Health insurance benefits should be personal and portable."
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