Federal Government Will Forgo $188.5 Billion In Tax Revenue
Through Favorable Treatment Of Health Care Benefits

Health Affairs Article Says Tax Policies Favor High-Income Families,
But Cautions That Changing System Could Leave More Uninsured

BETHESDA, MD — Exemptions for employer-provided health coverage and other favorable tax treatment will result in $188.5 billion in forgone federal tax revenue this year, with high-income families collecting a disproportionate share of the benefit, according to a new analysis posted today on the Health Affairs Web site.

John Sheils, vice president of the Lewin Group, and Randall Haught, a Lewin senior scientist, analyze federal health spending data to determine the revenue effects of federal tax policies allowing businesses and individuals to deduct health insurance and health care costs from their income for purposes of calculating annual income taxes.

They find that the benefits of the tax deductions—sometimes called “tax expenditures”—go disproportionately to higher-income households because those households are more likely to have employer coverage and are in higher tax brackets.

Families with incomes of $100,000 or more receive 26.7 percent of health-related income tax expenditures, even though they represent 14 percent of the population. Meanwhile, families with incomes of less than $50,000 receive 28.7 percent of the tax expenditures, even though they represent 57.5 percent of families.

The authors say that their results raise questions about equity in the U.S. health care system.

“Because 43.6 million Americans, most of whom are in relatively low income groups, are uninsured, it is important to ask whether it is appropriate that 26.7 percent of the health benefits tax expenditures go to the 14 percent of the population with the highest incomes,” Sheils says. “Moreover, these tax expenditures should be reevaluated in terms of their tendency to encourage overuse of the health care system.”

But the authors caution against proposals to immediately replace the current system with a refundable tax credit for individuals.

“Eliminating the relative tax advantages of employer coverage could cause some employers to stop offering coverage, assuming their workers will purchase their own nongroup coverage with the help of the tax credit,” Sheils says. “Without a mandate for all to offer coverage, this could result in a partially offsetting increase in the number of uninsured people, as the convenience and economy of employer-group coverage disappears.

“Also, nongroup insurance, which is difficult to obtain in many areas, is much more costly to administer than group coverage, so overall costs would increase,” Sheils says. “These problems must be addressed before these types of tax credit models can be a viable alternative.”

Sheils and Haught estimate about $575.5 billion in spending for employer-sponsored coverage, 77 percent of which was paid for by employers. Because the employers’ contributions are exempt from taxation, and some of the employees’ contributions are made with money that hasn’t been subject to income tax withholding, the federal government will forgo $101 billion in tax revenue through its treatment of employer-sponsored coverage.
Some other tax expenditures:

• Deduction for self-employed taxpayers who purchase insurance coverage ($4.6 billion)
• Deduction for out-of-pocket spending above 7.5 percent of adjusted gross income ($7.4 billion)
• Social Security and Medicare trust fund payroll taxes ($52.2 billion and $14.2 billion, respectively)

An accompanying article compares of out-of-pocket health care spending by lower-income uninsured people with their expected spending if they bought nongroup, or individual, insurance. The study shows that nearly all would spend more—often much more—even with a tax credit to help offset the cost of coverage.

More than 43 million Americans lack health insurance, and roughly half are candidates for tax credits because they lack access to employer coverage and have low or moderate incomes. The results of the study—authored by James D. Reschovsky, senior researcher with the Center for Studying Health System Change, and HSC senior fellow Jack Hadley—suggest that sizable reductions in the number of lower-income uninsured Americans would require much more generous tax credits for nongroup coverage than current proposals include.

For example, under the Bush administration’s tax credit proposal, families buying nongroup coverage would receive $1,000 per adult and $500 per child, up to a maximum of $3,000 for families with incomes up to $25,000, while families earning $60,000 or more would be ineligible.

“For most lower-income people, spending for health care and health insurance competes directly with spending for food and shelter,” Reschovsky says. “Future health care needs are often uncertain and can be delayed, while food and housing needs are both certain and immediate, leaving families with a stark trade-off. The results of the study strongly suggest that few would take advantage of tax credits unless the credits are much more generous.”

The study used data from HSC’s Community Tracking Study Household Survey, a nationally representative sample of approximately 60,000 people. Information from both the 1998-99 and 2000-01 surveys was combined to create a sample of 8,071 lower-income uninsured people—representing 22 million Americans—who lack access to employer-sponsored insurance. Income thresholds were set at $55,000 for individuals and $65,000 for families, and children in families with incomes below 200 percent of poverty were excluded because the State Children’s Health Insurance Program would likely cover them.

The Sheils-Haught article can be read at content.healthaffairs.org/cgi/content/abstract/hlthaff.w4.106.

The Reschovsky article can be read at content.healthaffairs.org/cgi/content/abstract/hlthaff.w4.113.

Health Affairs, published by Project HOPE, is a bimonthly multidisciplinary journal devoted to publishing the leading edge in health policy thought and research.

©2004 Project HOPE–The People-to-People Health Foundation, Inc.