Tax panel: Overhaul health insurance treatment

Employees who buy their own health insurance should receive the same tax break for the cost of their premiums as those who receive coverage from their employer, according to the President's Advisory Panel on Federal Tax Reform. A second and more controversial recommendation is to put a cap, for the first time, on the tax exclusion allowed for health insurance.

These and other proposals for streamlining the nation's tax code are included in the group's final report issued on Nov. 1.

Under the current system, workers do not have to pay taxes on employer-provided health coverage, and the self-employed can deduct the cost of their premiums from their income taxes. But workers who buy their own health insurance must pay premiums out of their taxable income.

The panel, chaired by former Sens. Connie Mack, a Florida Republican, and John Breaux, a Louisiana Democrat, recommends that all taxpayers be allowed to purchase health insurance using pre-tax money. This would "level the playing field between workers who have access to employer-provided health insurance plans and those who do not." The proposal is one of a number of major changes to the federal tax system that are included in the panel's report, "Simple, Fair, and Pro-Growth: Proposals to Fix America's Tax System."

But the new tax deduction would offer little or no help to low-income workers trying to buy their own health insurance, said Len Burman, PhD, co-director of the Tax Policy Center. The center is a joint venture of the Urban Institute and the Brookings Institution, both of which study and issue reports on health and other issues. "Most workers who are uninsured have relatively low incomes, so a tax deduction is worth very little to them," Dr. Burman said. "The people who would benefit most are those in the top tax bracket, so it's an upside-down subsidy."

A refundable tax credit "would be worth significantly more" to low-income workers and their families, Dr. Burman said. Even those with incomes too low to owe taxes could receive the credit and use it to purchase health insurance, he said. Refundable tax credits are a cornerstone of the AMA's plan for reducing the ranks of the uninsured, and President Bush has proposed giving low-income individuals and families as much as $3,000 in tax credits to buy health insurance.

The AMA also supports the right of individuals who purchase their own health insurance to receive the same tax treatment as workers who receive employer-provided coverage.

Capping the tax exclusion

A more controversial recommendation is that Congress cap the amount of health insurance that workers can exclude from their taxable income.

Currently, the tax exclusion for employer-provided health coverage is unlimited, but the panel recommends capping that exclusion at $11,500 for families and $5,000 for single individuals. Those figures are the national averages projected to be spent on health insurance premiums in 2006. If a family or individual has health insurance that costs more, they would have to pay tax on the difference.

Limiting the tax exclusion would mean health insurance tax benefits are distributed more evenly, the report says. The change would make workers "more cognizant of the amount they spend on health insurance."

But the cap also could lead to employees pressuring their employers to sponsor less expensive policies to minimize workers' tax liability for health benefits, said Gary Claxton, vice president of the Kaiser Family Foundation and director of its Health Care Marketplace Project.

"For [workers] above the average [cost of a health policy], there would be pressure to somehow lower the benefit package to get within the caps," he said. That pressure would increase each year because the report recommends indexing the caps to overall inflation, which has been growing more slowly than premiums.

"So a health insurance policy that is at the caps would probably have to get progressively less generous over time, unless we quickly learned how to constrain health care cost growth, which is something we've really never done," Claxton said.

The proposal has received mixed reviews from employer groups. The National Small Business Assn. has applauded the idea, calling it "a crucial first step in the direction of bringing down health costs for the long-term." But the National Assn. of Manufacturers said the recommendation is "quite troubling."

The AMA advocates incremental steps toward financing the individual purchase of health insurance, including capping the tax exclusion for employer-provided insurance, an AMA spokesperson said.

But health insurers have concerns about the potential impact, said Larry Akey, a spokesman for the trade group America's Health Insurance Plans.

An AHIP-commissioned survey conducted in September found that more than nine out of 10 voters in three key presidential primary states -- Iowa, New Hampshire and South Carolina -- think the nation should "keep health care benefits tax free to make it easier for people to afford health insurance," rather than tax health benefits but lower overall tax rates. At least one in 10 respondents who currently receive health insurance from their employer said they are likely to drop coverage if they are taxed on their health benefits.

The tax reform panel also is recommending changes to tax-preferred savings accounts for health care. The group recommends replacing medical savings accounts, health savings accounts and flexible spending arrangements with one tax-free account that it says would be simpler and more efficient.

The plan is to create a new Save for Family Account that could be used not only for medical expenses but also for education expenses and new home costs. Contributions to the new accounts would be limited to $10,000 annually, while the annual limit for contributing pre-tax dollars to an HSA is $2,650 for individuals and $5,250 for families. The report also recommends providing low-income taxpayers with a refundable tax credit as a matching contribution to their account.

Eliminating HSAs would be regrettable, AHIP's Akey said. "At a time when HSAs are just starting to get established in the market, we wonder whether it makes sense to roll them up into one 'Save for Family' account." Also, employers and individuals seem to like having several options for health savings vehicles, he said.

The AMA has been a strong proponent of HSAs, which combine tax-free savings accounts with high-deductible health plans and allow more flexibility than MSAs. The Bush administration has not yet indicated if the president plans to take up any of the panel's recommendations.