Tax Incentives for Health Insurance

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TPC Discussion Paper No. 12

Note: This report is available in its entirety in the Portable Document Format (PDF).
Please also see TPC companion paper Tax Subsidies for Private Health Insurance

The Urban-Brookings Tax Policy Center

The Tax Policy Center (TPC) aims to clarify and analyze the nation's tax policy choices by providing timely and accessible facts, analyses, and commentary to policymakers, journalists, citizens and researchers. TPC's nationally recognized experts in tax, budget and social policy carry out an integrated program of research and communication on four overarching issues: fair, simple and efficient taxation; long-term implications of tax policy choices; social policy in the tax code; and state tax issues.

A joint venture of the Urban Institute and the Brookings Institution, the TPC receives support from a generous consortium of funders, including the Annie E. Casey Foundation, Charles Stewart Mott Foundation, Cummings Foundation, Ford Foundation, George Gund Foundation, and Lumina Foundation for Education.

Views expressed do not necessarily reflect those of the Urban Institute, the Brookings Institution, their boards of trustees, or their funders.

INTRODUCTION

President Bush has proposed a refundable tax credit in an effort to help the 16.5 percent of nonelderly Americans who lack health insurance coverage. His goal of expanding access to insurance enjoys bipartisan support. Members of both parties have advanced proposals including health insurance tax credits or deductions.

A government commitment to expanding coverage is a positive development. Approximately 41 million nonelderly Americans—the overwhelming majority of them in working families—are uninsured. They are less likely to obtain important preventive screenings while healthy, and they receive lower quality care when they get sick. Furthermore, the public ultimately shoulders the burden of paying for the medical treatment of those lacking insurance, either through higher taxes or higher health care costs.

The government is already involved in the health insurance market. By treating health insurance as a tax-free fringe benefit, the federal government provides a subsidy worth over $100 billion per year for employer-sponsored health insurance (ESI). The subsidy has worked in one sense: ESI covers more than two-thirds of workers and their families. However, the subsidy is very poorly targeted. The value of a tax exclusion grows with income and is worth little or nothing to those with low incomes. But high-income people would be the most likely to have insurance even if they were not subsidized.

The challenge for policymakers seeking to expand coverage is to build on the strengths of the employment-based health insurance market while providing coverage to those outside that system. This is not as easy as it might seem. Many reform proposals would offer new tax credits or deductions for insurance purchased outside of work. Although that seems justifiable on equity grounds, it threatens to undermine employment-based health insurance because it reduces the value of ESI.

This paper examines the data on health insurance coverage and discusses trends in coverage. It considers the problems in the health insurance market and their implications on the nature and scope of government intervention. It uses the Urban Institute's Transfer Income Model (TRIM) to show who gains from the current tax exclusion, and examines the mismatch between current subsidy schemes and the problems in the health insurance market that an ideal subsidy might mitigate. It also discusses how some reform schemes match up with the health insurance market failures described earlier. Finally, using TRIM, we simulate the effects of illustrative tax subsidy proposals.

Note: This report is available in its entirety in the Portable Document Format (PDF).

About the Authors

Leonard E. Burman is a senior fellow at the Urban Institute and codirector of the Tax Policy Center. Cori E. Uccello is a consultant in the Urban Institute's Income and Benefits Policy Center. Laura L. Wheaton is a senior research associate in the Urban Institute's Income and Benefits Policy Center. Deborah Kobes is a research assistant at the Urban Institute and Tax Policy Center.

Acknowledgments

We are grateful to Joe Antos, Linda Bilheimer, Linda Blumberg, Sonia Conly, Judy Feder, Gillian Hunter, Len Nichols, Eric Toder, and Sheila Zedlewski for very helpful comments on an earlier draft. Support from the Robert Wood Johnson Foundation is gratefully acknowledged. Any errors or opinions are the authors' and should not be taken to represent the views of the funders, officers, trustees, or staff of any of the institutions with which they are affiliated.

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