Heritage’s Robert Moffit and Nina Owcharenko have a new paper examining Sen. John McCain’s proposals for reforming health care, and in that paper they explain why McCain’s proposed $5,000 tax credit for individuals to buy health insurance is the right reform for fixing a deeply flawed health care system. The proposal, which replaces the current unlimited exclusion for employer-provided insurance with an individual credit that is available to all, would end the bias in the tax code toward employer-provided insurance. Ending that bias, say Moffit and Owcharenko, would have a number of important benefits, including:
1. Creating greater equity in the tax code. Because the current exclusion is unlimited, the tax benefit increases as the health plan becomes more expensive. That tends to benefit higher-income workers more than lower-income workers. It also encourages firms to choose more expensive plans that suit the needs of their senior employees over the preferences of their lower-income workers who might not be able to afford the gold-plated plan.
2. Encouraging the search for value in health care. As noted, the unlimited exclusion for employer-provided insurance encourages firms to purchase more expensive health care plans than individual would otherwise choose to purchase on their own without the tax preferment. Replacing the unlimited exclusion with a limited tax credit, reduces this distortionary impact.
3. Ending “job lock.” When health care is tied to the job, workers can face a difficult transition when they want to change jobs. They may not be able to replace their old coverage so easily, or their new plan may not allow them to continue seeing their preferred physician. With an individual tax credit, however, workers can choose the coverage that is suitable for them and retain that coverage whereever they work.
Moffit and Owcharenko also note:
Some critics claim that this transition from a tax exclusion to a tax credit—financing the credit by making health benefits taxable compensation like wages—would amount to a tax increase. … This is incorrect. In fact, the proposed taxation of health benefits is simply a mechanism for transitioning from one tax break (the exclusion) to another (the credit). Under almost any scenario, the credit is a far more equitable and transparent tax policy.
Tax experts, regardless of philosophical persuasion, point out that the vast majority of Americans would be net winners with such a transition. Economist Len Burman, a tax policy specialist at the Urban Institute and Brookings Institution’s Tax Policy Center, estimates that “[f]amilies at all income levels would pay lower taxes, at least on average.… On average, is about a $1,200 tax cut in 2009.” …
A recent analysis by Republican congressional staff looked at the impact of transitioning from the exclusion to a credit on middle-class families. Assuming that the average annual value of employer-based family group coverage is roughly $12,000 and that those benefits were subject to income tax liability, a middle-class family in the 25 percent tax bracket would have a tax liability of $3,000 on those benefits. However, that family would be automatically eligible for a $5,000 health care tax credit, thus securing a $2,000 tax savings. A family in the 28 percent tax bracket would have a tax liability on the same health benefits package of $3,360, but the $5,000 credit would yield a tax savings of $1,640.