NCPA Health Care - Tax Treatment of the Uninsured and Low-Income Families

Tax Treatment of the Uninsured and Low-Income Families

TAX TREATMENT OF THE UNINSURED AND LOW-INCOME FAMILIES

Excerpted From: State Briefing Book on Health Care

September 23, 1994

All too often, help from the federal government goes to those who need it least. Both tax and spending policies are designed to undermine a reasonable social safety net.

Regressive Tax Subsidies for People With Health Insurance. This year the federal government will "spend" about $84 billion in tax subsidies for health insurance and state and local governments will spend another $10 billion. These subsidies will be distributed in a highly regressive way for two reasons. First, the ability to exclude employer-provided health insurance from taxable wages is more valuable to employees in higher tax brackets. Second, by restricting this tax subsidy to employer-provided insurance, the law favors people who work for larger firms. The result is a system that favors high-income over low-income families.
"This year government will 'spend' about $94 billion in tax subsidies for employer-provided health insurance."

As Figure I shows:

Families in the bottom fifth of the income distribution get an average benefit of $270 a year from federal tax subsidies for health insurance.

Families in the highest fifth of the income distribution get an average annual benefit of $1,560.

Thus the tax law benefits high-income families six times more than it benefits low-income families.

Tax Penalties for the Uninsured.
A common fallacy is that people who lack health insurance are getting a free ride at the expense of the rest of us. When the uninsured get sick, it is argued, they usually get medical care. And when they can't pay for it, the rest of us pay through cost shifting or higher taxes. What this argument overlooks is that the uninsured pay higher taxes precisely because they do not get tax subsidies. The problem is that the extra taxes go to Washington while the free care is delivered locally. A reasonable reform would be to require the federal government to return the extra taxes to the providers that deliver uncompensated care. [See below on a play-or-pay plan.]

Regressive Spending Programs.
This year the federal government will spend about $313 billion on health care. How much goes to low-income families who need help? Surprisingly little. Only one out of every four dollars spent by the federal government goes to a poor family that qualifies for benefits under a means-tested program. The bulk goes to middle- and upper-middle-income families, even though the taxes used to pay for these benefits often come from low-income workers. For example, take the $161 billion the federal government spends on Medicare. Under the program:

The lowest-income workers pay 2.9 percent of their income to support Medicare.

Yet the primary beneficiaries of Medicare " the elderly " have higher after-tax incomes and considerably more assets than the nonelderly.
For the most part, federal health dollars benefit the nonpoor. In the process, they force up prices for the poor.

"High-income families get about six times as much help from government as low-income families."

Federal Policy Needed to Insure the Uninsured: A Play-or-Pay Plan That Works

The problem with the existing system is not that the uninsured are denied health care. Uninsured patients are routinely treated at our nation's hospitals. Nor is the problem that the uninsured are getting a free ride at everyone else's expense. Precisely because they do not receive the average tax subsidy enjoyed by those who have employer-provided insurance, the uninsured pay higher taxes - perhaps as much as the amount of free hospital care they consume each year.

Instead, there are two other problems. First, the tax subsidy for health insurance is arbitrary and regressive. The system arbitrarily excludes people who purchase health insurance on their own and most of the benefits go to higher-income families. Second, under the current system most of the additional taxes paid by the uninsured go to Washington rather than to the local hospitals that provide the free care. How can we solve these problems?
Refundable Tax Credits.
Part of the solution is to offer everyone a tax subsidy for the purchase of health insurance, with higher subsidies for lower-income families. For individual purchases of health insurance, a tax credit would be entered on individual income tax returns. The cost of employer-provided insurance would be included in the gross wages of employees, and tax credits would be entered on their tax returns. For those with very low incomes, there would be refundable tax credits - with government directly subsidizing a portion of the health insurance premium.
Access to Health Care.
Even faced with a generous subsidy, some people would opt to be uninsured. If they did so, they would pay higher taxes. These additional taxes would be sent back to local communities to cover the cost of their health care. Existing laws generally require hospitals to provide emergency care to patients, regardless of ability to pay. With the new source of funds proposed here, we could liberalize access to health care for uninsured, indigent patients. But "free" care is unlikely to be perceived as being as desirable as "purchased" care and may involve considerable health care rationing.

Under this proposal, no one would be required to purchase health insurance. Those who chose not to do so would be forced to rely on charity care if they could not pay their medical bills. Thus people would have incentives to purchase health insurance - to protect their own assets, to acquire the quality of health care they want and to be free to exercise choice in the medical marketplace.
Strengthening the Social Safety Net.
Funds for indigent health care could go to local health care agencies (LHCAs), which would be responsible for providing uncompensated health care. Those not covered by private health insurance and or a federal program would be self-insured for the amount of their personal assets. Once an individual's assets were depleted, the remaining costs would be paid by an LHCA - just as Medicaid currently assumes financial responsibility for private-pay nursing home patients.

HERITAGE BACKGROUNDER: EXPANDING TAX BREAKS FOR HEALTH INSURANCE (SUMMARY) (TEXT)

Today's tax-favored treatment of employer-purchased health coverage distorts the market for health insurance by limiting tax relief to employer-purchased coverage, say analysts.

Since employment-based health coverage is not taxed as income, workers receive a substantial income tax benefit, and an additional 7.65 percent relief from personal payroll taxes.

Almost 80 percent of the uninsured are workers or dependents of a working head of household, but if an employer does not provide health benefits, or does so for employees but not for their dependents, workers must purchase coverage with aftertax dollars.

Allowing those individuals to deduct health care costs from their annual income taxes or providing refundable health care tax credits to low-income workers are two ways to level the playing field between employers and individual consumers.

Moreover, expanding tax breaks for health insurance would give individuals the incentive to own and control their own health care policies, make coverage truly portable, and force health plans to be accountable to health care consumers, not employers.

For example, take a low-income couple with two children that earned $30,000 in 1997 (see figure). With no deductions, the family's income tax liability was $1,879. If they had been allowed to deduct the premium costs for a $3,000 health plan, their tax burden would have been $1,429, a savings of $450. If they had a tax credit worth 50 percent of the value of their health plan premiums, their tax burden would have been reduced by $1,500 for the year, and the family would have owed just $379 in taxes.

Analysts say proposals to broaden health insurance tax breaks offer families what they really want in health reform: control and ownership of their health coverage.

Source: Carrie J. Gavora, "Back to the Drawing Board: Why Tax Reform is the Key to Health Care Reform," Backgrounder No. 1189, June 8, 1998, Heritage Foundation, 214 Massachusetts Avenue, N.E., Washington, D.C. 20002, (202) 546-4400.

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