Taxing Health Insurance Plans

By Marc Seltzer; originally published on October 13, 2009, at care2.com

When is a tax a good idea?

NEVER!  (Say it cause it feels good.  Then get real and move on.)

One important proposal for lowering costs in health care is taxing higher-value health insurance plans.  The principle here is that currently the U.S. government is subsidizing high-level insurance plans purchased by employers.  Health insurance premiums are not taxable, while employers do have to pay tax, such as payroll/social security tax, on income paid to employees.  The employers thus provide additional compensation to their employees without paying full price.  This deduction encourages over-spending by employer and employee.  By comparison, individuals who purchase insurance cannot deduct their premiums or costs of health care from their income.

The thinking goes something like this:  An employer deciding to purchase insurance looks at an $8,000 plan and a $10,000 plan.  It realizes that the $10,000 is a deal because of the subsidy, and it knows its employees will value the plan and consider it as part of the reason to work there.  The employee then has incentive to use medical benefits more than on the lesser plan because the higher-cost plan has lower deductibles, coverage of alternative care and lower co-pays.

There is nothing wrong with an individual choosing to pay more for health insurance and then making use of more in benefits.  But if the U.S. government is subsidizing the plans, then the incentives are distorted.  When conservatives talk about what is wrong with taxation and government, their best argument is that government does not efficiently allocate resources because it distorts the market to redistribute wealth in wasteful ways.  This is a prime example.

If progressives want the government to distort the market in health care, it would make sense to provide help to those who can’t afford care, or to provide subsidies to promote certain types of care such as free annual physicals that could be valuable in improving health or lowering costs, through prevention for the public as a whole.  But there is no reason that the government should redistribute wealth to encourage high-end employer-provided insurance and use of such plans to the fullest.

The result of the system in place today is that working individuals with expensive plans are encouraged to get any and all recommended medical care.  Some procedures are covered 100%.  Some 90%, 80%, 75%. What’s the right formula, where people correctly balance the need for health care against the cost?

Take away the subsidy and find out.

In my own experience, I broke my leg badly, while covered by a great insurance plan.  Surgery was recommended and the $30,000 bill turned into only $1,500 in out-of-pocket expenses.  This is exactly what insurance is designed to protect against and it worked well for me.  This involved emergency hospitalization, which, though expensive, is often well covered by all types of plans.  However, in rehabilitation, I sought chiropractic, acupuncture and physical therapy and remember that my out-of-pocket expenses were remarkably low or non-existent.  My firm offered this plan to compete for employees in the marketplace, but the tax code also underwrote my plan.  Remember, under current law, the more an employer spends on health care plans, the more money it avoids paying tax on.

Current proposals are structured to tax plans on the part of the premiums that go above $8,000 per year and family plans on the premiums above $21,000 (For example, $10,000 in premiums for an individual would be taxed on the $2,000 above the exemption at a rate of 40% for a tax of $800.)  The tax would affect employers and individuals who purchase insurance equally and would likely have several impacts:

1.   It would lower the number of high-end plans, as employers and individuals sought to avoid the tax.  In that case, affected employees, who previously would have received higher-value insurance packages underwritten by the government subsidy, would have lower-value insurance with somewhat higher co-payments.  Shifting some additional burden to the insured in this way would lower national spending on health care, yet continue individual choices on where to spend and where to save.

2.   It would raise an estimated $200 billion dollars from tax revenue on plans that were higher end.  Thus, employers and individuals who continued to purchase high-value plans would pay a new tax on those plans.  This revenue would go to underwrite the efforts to subsidize insurance to those who cannot afford it.  $200 billion represents about 1/4 of the cost estimated to subsidize insurance over the period of ten years.

3.   For people at or below the limits, there would be little change in premium or co-payment prices.  Theoretically, the lower use of medical resources would lower the price of health care in the overall marketplace.  This would likely be countered by the increased use of medical services by individuals who will gain coverage through the new legislation.  However, if the new legislation did not contain this tax provision, prices would continue to rise from increased demand as more people with insurance sought health care services.

There are a number of different ways that health care costs can be lowered and different options for how to bring more people into the insurance marketplace.  The current proposal is but one piece of reform.  Taxing of high-cost health plans is bound to be controversial because Americans are allergic to all tax hikes.  However, this proposal removes a tax loophole that encourages overuse, or at least subsidized use, of the health care system.  Even without the use of the revenue to provide subsidies for those who cannot afford health care, this tax makes sense.

N.Y. Times has an excellent story with political background including issues for unions whose members have received high-level benefits in lieu of compensation.  A detailed Huffington Post piece discusses how the tax may impact middle class Americans and a Commentary blog suggests it will change the health care we have now, against Obama’s promises.  Be that as it may, a loop-hole is a loop-hole, and it creates distortion and waste among executives and union employees alike.

Senator Olympia Snowe, (R)-Maine, who announced today that she is supporting the Democrats’ Senate Finance Committee bill (the Baucus bill) being sent to the full Senate today, supports taxing insurance plans, although she aims to ensure that middle and lower income members of the public and those above age 55 do not bear the burden of the tax.

We all want an efficient government that does not encourage waste of resources.  Calling or writing your congressional representative to demand a tax on excess health care premium plans is the same as demanding the end of an egregious tax loophole.  Remember, the point of health care reform is to insure more Americans and strengthen the financial foundation of the nation.

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