Friday, February 2, 2007

Bush's health plan: a step in the right direction

In my previous posting I wrote about why introducing a new standard deduction in the income tax would do almost nothing to reduce the number of uninsured Americans. This week I will focus on what Bush’s reform will do for the 247 million of citizens who already have health insurance, whether obtained through the workplace (175 million) or purchased privately (72 million).

One of Bush’s propositions was to turn employer-provided health insurance into taxable income. A virtue of this proposal is that it would improve on the fairness of the fiscal system. Nowadays, if you have to pay for your own insurance, you receive an implicit “tax penalty” from the government. This is because the value of the insurance purchased by the employer on behalf of the employees is not considered taxable income.

Consider a four-person family (two adults and two dependents) with an annual income of $75,000, consisting entirely of salaries. Nowadays, if this family receives employer-provided health insurance worth $5,000, their tax bill amounts to $6,970. Consider another four-person family, with an income of $80,000. If they purchase a $5,000 health policy on their own they end up with $75,000 in disposable salaries, the same as the first family. Their tax bill, however, amounts to $7,720, $750 more. Under Bush’s proposal, both families would pay exactly the same.

The current situation looks even more unfair once you consider that most jobs without health insurance are in the lowest echelons of the salary distribution –jobs which are either part-time or temporary or hourly paid or requiring low skills, or all of the above. For the record, in 2005 the average family income for families who purchase their own insurance was $40,000; for families who get their insurance through the workplace, average income was $87,000.

Another result of Bush’s plan is that it would provide a tax cut to all families with health insurance costing less than $15,000 (for families) or $7,500 (for individuals), thanks to the standard deduction. In the example above, the family with employer-provided insurance would get a $1,500 tax benefit, whereas the family with private insurance would get $2,250.

This should be good news to taxpayers, although it is a second-order feature of Bush’s plan, really. Families with basic health insurance policies, costing well below $15,000, also tend to have the lowest incomes, and therefore lowest marginal tax rates, which leaves them with small tax savings. Besides, the tax cut would vanish in just a few years, because the cost of health insurance would rise, whereas the amount of the tax deduction most likely would not rise as fast, if at all.

One the flip side, the tax cut would mean lower revenues for the government and a subsidy for health insurance, which I really do not support. It is hard to justify why the government should pay for a service, health care, which is provided in the private sector under market competition and whose consumption (or lack of) does not generate any externalities. The fact that wealthier families would get bigger subsidies is even harder to justify.

The government’s responsibility should be limited to making sure that everyone is insured against catastrophic health problems and, perhaps, that all children receive basic health care. That would be best done by: (1) making catastrophic and basic child insurance mandatory and then giving health vouchers to those families who cannot afford it, and (2) making employer-provided insurance taxable, as proposed by Bush, but not granting any tax deduction for health insurance whatsoever.

Including employer-provided health insurance as part of regular income improves on the fairness of the federal income tax. In spite of its shortcomings, most notably the absence of a provision to make basic insurance mandatory, let us hope that Mr. Bush’s reform will be put into effect.

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