Health Care Reform and the Tax Code

Many problems with health insurance markets in the United States are associated with aspects of the tax code.

  • A large tax preference for employer-based insurance often results in discontinuities in insurance coverage during job transitions and periods of unemployment.
  • The preferential treatment of employer-based insurance reduces competition and adversely impacts insurance outcomes in state exchange markets.
  • The reliance on tax preferences for employer-based insurance favors workers at large profitable firms over workers at small less profitable firms.
  • Tax rules prevent low-income workers at firms with an offer of affordable health insurance from claiming the premium tax credit for purchase of health insurance on state exchanges even when the state exchange plan is superior to the employer-based insurance.
  • Middle-income people without offers of employer-based insurance are not eligible for the premium tax credit used to purchase state exchange insurance.
  • Tax incentives favoring the use of high-deductible health plans impose hardships on low-income and middle-income households, create an incentive for some people to forego necessary treatments or prescription drugs and create a tradeoff between saving for retirement and saving for health care.
  • The 2017 Tax Reconciliation bill zeroed out fines for the individual mandate, increasing incentives for people to forego health insurance or underinsure and led to a court case challenging the constitutionality of the entire ACA.

The purpose of this memo is to propose and evaluate tax policy changes, which would reduce imperfections in health insurance markets.

Modify tax preferences for employer subsidies of health insurance to promote the increased use of ACA state exchanges:

The ACA maintained long standing tax preferences provided to employer-based insurance and included rules favoring employer-based coverage over state exchange coverage.  Employer payments for health insurance premiums are deductible to the employer and untaxed to the employee.  Currently, around 11 million Americans obtain health insurance from state exchanges compared to around 157 million who obtain health insurance from their employer.

The continued dominance of employer-based health insurance has resulted in several problems including — discontinuities in insurance coverage during periods of job transitions or during unemployment and a lack of competition and choice in state exchange markets.  A merger of employer-based and state exchange insurance markets by having employers subsidize health insurance purchases for their employees in state exchange markets would benefit participants in both markets.

Employer contributions to state-exchange health insurance would facilitate continuous coverage during job transitions.  A person switching jobs with state exchange insurance would keep the same health insurance plan and would not have to meet a new deductible in order to receive benefits.

A single health insurance market separate from the employer facilitates lower cost continuous coverage for the unemployed.  COBRA allows unemployed people to maintain their current employer-based health insurance; however, the worker is responsible for the entire cost of the health insurance plan plus a 2 percent administration fee.  COBRA is unaffordable to many unemployed workers.  By contrast, unemployed people with state exchange health insurance who experience a reduction in income and a loss of their employer subsidy might automatically become eligible for a premium tax credit that covers part of the cost of state exchange health insurance.

The possibility of keeping an employer-based health insurance plan through COBRA payments is often not possible in a bankruptcy situation.   Employers experiencing a Chapter 11 bankruptcy often eliminate coverage or reduce subsidies.   Chapter 7 bankruptcy generally results in the termination of all employer-based health insurance including COBRA.  By contrast, state exchange health insurance is unaffected by corporate bankruptcy.

The increased ability for the unemployed to retain continuous affordable health insurance coverage would greatly benefit the current economy.  A recent study by the Economic Policy Institute found that around 9.2 million people have lost their health insurance due to the COVID pandemic.

The creation of large statewide health insurance markets serving both people with employer-based subsidy and people with state exchange health insurance will expand health insurance choices for many households.

Currently, most people with an offer of employer-based health insurance will not qualify for premium tax credits on state exchanges and the employer health plan is often insufficient or not affordable for lower-income households. The creation of a single health insurance market allows workers to use employer subsides and also claim the premium tax credit if the worker’s income was low and the employer subsidy was insufficient to cover the entire health insurance premium.

Many employers, especially small firms, only offer a single insurance option.   The proposal presented here would allow all people access to any insurance plan offered on state exchanges.

The plan increases competition and offerings of health plans on state exchanges.  A report by the Kaiser Family Foundation found in 2020 two state exchanges were served by only one insurance company and another fourteen state exchanges had two insurance companies offering products.  Research has revealed that health insurance plans offered on state exchanges often lack access to top hospitals or specialists.  The larger single market would result in more competition, which should improve insurance plan quality and reduce premiums.

Most people who forego health insurance are both healthy and lack subsidies for insurance premiums.  The decision of healthy people to forego health insurance until they become sick increases insurance premiums.   The larger state exchange health insurance market including people with employer subsidies will have a smaller share of people who forego health insurance coverage.

The creation of a larger insurance market where a larger share of people automatically purchase health insurance due to generous employer subsidies will reduce the need for an individual mandate because the small share of people foregoing health insurance will have a relatively small impact on insurance premiums.

Modify the tax code to promote additional employer contributions for small firms and firms with low-income workers:

The current tax code treats employer payments on employee health insurance premiums as a tax-deductible business expense.   The value of this deduction is larger for more profitable companies than less profitable companies.   The current tax code also exempts insurance premiums from taxable income of households creating a benefit that is more valuable to taxpayers with high marginal tax rates.

The expansion of and modification of the small business tax credit could promote additional contributions for employer-based health insurance on state exchanges targeting small firms with low-income households.

The modified program would be available for firms subsidizing insurance for employees on state exchanges rather than firms providing employer-based insurance.   The modified program would be open to all firms where more than half of the employees had a salary less than a certain threshold rather than the average salary of all employees.

The proposal to expand tax benefits associated with health insurance subsidies for smaller firms with low income workers is similar in structure and spirit to a a new Biden 401(k) tax proposal which expands tax breaks for contributions to 401(k) contributions to low-income households.

Make several modifications to rules governing health savings accounts and high-deductible health plans to make these plans less burdensome to low-income households and people with expensive health conditions:

 Health savings accounts coupled with high-deductible health plans passed as part of the 2003 Medicare law are growing in popularity.  The use of high-deductible health plans reduces insurance premiums.   The use of health savings accounts creates pre-tax savings for health expenses.  However, current health savings accounts and high deductible health plans create several problems for low-income and middle-income people including increased out-of-pocket expenses, reduced adherence to prescription drug regimens and a tradeoff between saving for retirement and saving for health care.

Four policy changes, which could mitigate problems associated with increased use of health savings accounts and high deductible plans, are proposed and discussed below.

The first two proposals attempt to mitigate financial hardship imposed on households from increased cost sharing.

  • A tax credit for contributions to health savings account would be established for households with income below a particular threshold.Higher income households would continue to make untaxed contributions to health savings account.   This provision would encourage use of less expensive health plans by lower income households and reduce disparities occurring because of the difference in the value of tax subsidy stemming from differences in marginal tax rates.
  • Rules governing contributions to health savings accounts would be modified to allow contributions to health insurance plans with higher coinsurance rate plans even if their plan had a relatively low deductible.The current laws governing health savings accounts only allow contributions from people with a high deductible health plan even though health plans with a relatively low deductible and high coinsurance rate allow for substantial cost sharing and can provide better outcomes to households than a high deductible plan.

Many low-deductible health plans pay most costs for prescription drugs even prior to the deductible being met.  However, many of the new high-deductible health plans do not pay for any prescription drug treatments prior to the deductible.  The more onerous rules on prescription drug payments by high-deductible health plan have created an incentive for many people to forego or cut short necessary prescriptions.  This incentive is especially large for people with diseases like diabetes where the patient does not have immediate symptoms.  The failure to control chronic health problems can lead to bad health consequences and more expensive health services in the long or medium term.  For example, the failure by diabetics to control blood sugar can lead to kidney problems, eye problems, amputation and heart issues.

Two additional proposals are presented to address potential problems associated with reduced use of prescription medicines stemming from increased use of high-deductible health plans.

  • Regulations governing prescription benefit formulas for high-deductible plans should be modified to require partial payment by insurance firms on prescription drugs for the treatment of chronic diseases prior to the deductible being met. Current law allows high-deductible health plan to make payments for some preventive treatments prior to the deductible being met.It should be possible for Health and Human Services to mandate coverage for some prescriptions treating chronic diseases as a preventive method under current regulations.
  • Congress could establish a fund to directly pay part of the cost of necessary health prescriptions for low-income and middle-income households.The funds for this effort could be obtained through an excess profit tax on pharmaceutical companies.

Both approaches have advantages and disadvantages.  The adoption of a regulation requiring greater insurance payments for prescription drugs would increase insurance premiums.   The creation of a new fund subsidizing insurance payments for prescription drugs would not increase premiums but would have to be enacted through new legislation.

All four of the proposals presented here could make cost sharing between insurance firms and household more palatable to low-income households.  Any proposal that shifts households to a plan that imposes more cost sharing could reduce premiums and tax expenditures for premium subsidies.

Note also, that a new tax credit associated with health savings accounts requires households have a particular form of insurance coverage would also reduce the number of households forgoing health insurance.

Modify the premium tax credit to include some assistance for middle-income households and eliminate the:

The current ACA premium tax credit does not provide any assistance to people with income over 400 percent of the federal poverty line, around $50,000 for a person seeking an individual only health plan.  This abrupt cutoff of benefits creates two problems.

  • People with household income under 400 percent of the federal poverty line often forego health insurance or underinsure.
  • Many people claim an advanced tax credit to pay for their health insurance prior to knowing their actual annual income.People who earn more than 400 percent of the federal poverty line lose access to the entire tax credit and often owe substantial tax payments to the Treasury.

The most effective way to fix both of these problems is to modify the premium tax credit and guarantee a minimum tax subsidy (perhaps $1,000 for an individual and $2,000 for a family).

The minimum tax credit could be given either to all people without access to an employer-based insurance plan or all people in the population.   The former approach would be less expensive to taxpayers but some small firms could decide to forego employer-based subsidies so their employees could claim the premium tax credit.   The later approach by having firms and taxpayers share the cost of premiums would reduce cost to employers.

The proposal presented contrasts sharply with Vice President Biden’s proposal to extend the premium tax credit past 400 percent of the federal poverty line and increase the generosity of the tax credit.  Vice President Biden’s plan does not provide any assistance to many middle-income households. For example, based on calculations obtained from the Kaiser Family Foundation Health Insurance Marketplace Calculator a 30 year old person making $60,000 per year seeking an individual-only health plan would pay $409 per month and receive no support from the premium tax credit. (Figures presented here are based on average U.S. insurance premiums.)

Reduce standard or itemized deductions for people who choose a public health insurance plan over a private health insurance plan:

People who are uninsured and healthy tend to forego health insurance and immediately seek coverage if they become ill or injured.  In order to deter this behavior, the ACA included a financial penalty in the form of a tax fine for people without health coverage.   The individual mandate was resented and opposed by many individuals.  The 2017 tax reconciliation bill zeroed out fines for the individual mandate.  The repeal of fines led to litigation, brought by some state attorney generals, claiming that the entire ACA without the individual mandate was unconstitutional.   The fifth circuit federal appeals court agreed that the ACA is unconstitutional without the individual mandate and this court case is now heading to the Supreme Court.

It is difficult to predict with certainty the outcome of any Supreme Court case.    The court upheld the law in a 5-4 decision in a previous case.   The new more conservative court is more likely to repeal the law.

A 2017 tax reconciliation bill modified the individual mandate and led to the current challenge.  Depending on the outcome of the 2020 election, a 2021 tax reconciliation bill could either restore fines for the individual mandate or create some other financial incentives designed to assure that people maintain continuous health insurance coverage.

One way to create incentives for people to maintain continuous health insurance coverage and to address legal concerns about the constitutionality of the entire ACA is to create a new financial penalty for people choosing to forego health insurance coverage.  The financial incentive could be implemented in the form of the loss of some standard or itemized deduction for people who do not have health insurance and need not be as large as the original fines for violating the individual mandate.

Concluding Remarks on Tax Policy and Health Insurance:

The tax proposals presented here expand the size of state exchange markets, reduce the number of people who forego health insurance coverage, improve the quality of health insurance coverage, and obviate the need for an onerous individual mandate.  The passage of these tax reforms would address legal concerns stemming from the litigation following the passage of the 2017 tax reconciliation bill.



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