Obama Targets Wrong Tax for Health Reform

Health reform is going to be expensive. President Barack Obama's budget includes a $634-billion reserve fund for health reform, and that's just a down payment. The president hasn't revealed how he would spend this money. But he has explained how he would raise it.

Obama plans to generate half of that $634 billion by limiting income-tax deductions for affluent taxpayers. If he has to raise taxes like this to pay for health reform, he's targeted the wrong part of the tax code. Obama should instead admit that John McCain was right--we need to fix the inefficient tax treatment of employer-sponsored health insurance.

If your employer pays for part of your health insurance premium, that amount is currently excluded from your taxable income. But if you have to pay the whole premium yourself, you don't get that tax break. That means a worker who buys his own insurance must pay 30 percent more for his policy, thanks to higher income and payroll taxes.

Unrestrained demand for health care has driven prices up. Between 2000 and 2007, the average worker's insurance premiums grew twice as fast as wages.

As a result, most Americans get insurance through their employers. In 2007, approximately 70 percent of the insured--177 million people--had policies through work. The tax subsidy totaled $246 billion in that year alone. That makes the tax exclusion for employer-sponsored insurance the third-largest federal health care subsidy in this country, behind Medicare and Medicaid.

Employer-sponsored insurance certainly works well for those lucky enough to have generous benefit packages. But it's also responsible for many of the problems plaguing the U.S. health care system.

First, the tax exclusion increases the cost of insurance. The exclusion encourages employers to offer "gold-plated" insurance policies that cover medical services that may not be worth the money. That fuels overconsumption of health care, as patients don't perceive the full cost of the services they consume.

Unrestrained demand for health care has driven prices up. Between 2000 and 2007, the average worker's insurance premiums grew twice as fast as wages.

Second, the tax exclusion ties insurance to employment, which limits job opportunities and squeezes wages. Money that employers could have used for pay raises instead covers skyrocketing health insurance premiums. Between 2000 and 2007, premiums for employer-sponsored insurance jumped 98 percent--four times faster than wages. Moreover, workers think twice before seeking a better job if that means the possible loss of their health insurance.

Finally, the tax exclusion for employer-sponsored insurance is unfair. We give a larger tax subsidy to people with higher incomes, even though they are more able to pay for insurance. And we don't give the tax subsidy to everyone who needs it. Workers at businesses that don't offer insurance, the self-employed, and the unemployed all have to pay for policies with after-tax dollars. These people face higher premiums for individual insurance burdened by state mandates and regulations that drive up the cost of a policy. Most people in employer-sponsored plans don't have to bear such additional expenses.

Obama could simultaneously lower health costs and extend coverage to millions of uninsured Americans by reforming the tax treatment of health insurance.

Granting everyone a standard tax deduction or a refundable tax credit for the purchase of insurance would level the playing field and ensure that all Americans--rich and poor, employed and unemployed--could get help buying health insurance that best meets their needs.

Such a reform would inject competition into the private insurance market by empowering consumers to spend their health care dollars as they wish--not as instructed by their employer or the government.

The first step is to cap the value of benefits that are tax-free, preferably at a high level. The capped amount could be reduced gradually, which would give employers and insurers time to adjust the terms of their coverage to promote efficient providers and high-value health services. Gold-plated insurance would not be regulated out of existence, but people who wanted such coverage would have to pay for it without help from the average taxpayer.

Obama is right to target the tax code in his health reform plans. But limiting deductions for the wealthy won't do anything to correct the perverse tax incentives that drive up health care costs and put health insurance out of reach for millions of Americans.

Joseph Antos is the Wilson H. Taylor Scholar in Health Care and Retirement Policy at AEI.

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