Tax Credits for Health Insurance

Brief #11 from the series Tax Policy Issues and Options

The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders.

Note: This report is available in its entirety in the Portable Document Format (PDF).
This paper is also available as a Discussion Paper (44 pgs.)

Health insurance provided by employers is a tax-free fringe benefit that costs the government over $140 billion annually. Subsidizing employer-sponsored insurance (or ESI) has worked in one sense: ESI now covers almost two-thirds of workers and their families. However, the subsidy is poorly targeted. The value of the tax exclusion grows with income and is worth little or nothing to those with low incomes, even though they are most likely to be deterred by the cost of insurance.

Numerous proposals would provide additional tax subsides for health insurance. Most notably, for the past four years President Bush has proposed a refundable tax credit for the purchase of health insurance by lower-income individuals not covered by ESI or a public insurance program such as Medicare or Medicaid. Although critics have complained the subsidy is far too small to substantially expand coverage among those who most need help, it would represent a major new expenditure on behalf of the poor.

Expanding health coverage through the tax system may not be the most efficient path, but tax subsidies appear the only game in town for expanding the federal role in the provision of health insurance. This brief examines the implications of major expansions in tax credits, starting with the president's refundable tax credit proposal. A microsimulation model is used to examine the effects of the proposals on health insurance coverage. At least in the short run, the president's proposal would modestly increase the number of people with health insurance. However, many people currently covered by health insurance at work would lose that coverage and would not be covered by alternative insurance. Still, many currently uninsured people would gain coverage and many low-income people would see their insurance costs lowered by the president's proposed subsidy.

This brief also details the impact of other, more generous tax subsidies. The basic model is a tax credit, designed to mimic a voucher, equal to the difference between the cost of insurance and 10 percent of a household's income. This plan, unlike the president's proposal, assumes that affordable health insurance would be available to individuals through something similar to the Federal Employees Health Benefits Plan (FEHBP), a successful program that gives all federal workers and retirees access to a range of health insurance plans.

We examine the effect of policies that would allow the credit only for individual non-group coverage (as in the president's plan), only for ESI, and for insurance acquired in either market. Each option would reduce the number of uninsured by far more than the president's proposal, but at greater cost. The non-group-only credit would also cause millions of people to become newly uninsured, although two people would gain insurance for every one who loses it. The other two policies would not cause significant numbers of people to lose insurance, but their costs would be commensurately greater. All reform options are much more progressive than the current tax subsidy.

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

Usage and reprints: Most publications may be downloaded free of charge from the web site and may be used and copies made for research, academic, policy or other non-commercial purposes. Proper attribution is required. Posting UI research papers on other websites is permitted subject to prior approval from the Urban Institute—contact [email protected].

If you are unable to access or print the PDF document please contact us or call the Publications Office at (202) 261-5687.

Disclaimer: The nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders. Copyright of the written materials contained within the Urban Institute website is owned or controlled by the Urban Institute.