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Baucus Intrigued by Changing Tax Code to Cover Uninsured

By John Reichard, CQ HealthBeat Editor

July 31, 2008 -- One thing seemed perfectly clear at a Senate Finance Committee hearing Thursday—Chairman Max Baucus sees tax code changes as a rich vein of revenue to fund coverage of the uninsured in any health system overhaul plan he unveils in the next Congress. But Baucus was less clear on how to navigate the political hazards involved.

At issue was what the Montana Democrat called "tax subsidies for health benefits"—the fact that health insurance premiums paid by employers aren't counted as taxable income to employees. That "exclusion," Baucus noted, has been called after Medicare and Medicaid "the third largest government entitlement for health care."

Because the government doesn't tax employer-paid premiums as income, the feds forego upwards of $200 billion a year in revenue. But if the government capped that exclusion—in other words, taxed some part of the premiums paid—it could raise money to cover the uninsured. A growing number of Democrats and Republicans are drawn to the idea.

Economists at Thursday's hearing charted a path to overhauling the health care system based on changing the exclusion. The numbers they tossed around as potential revenues that could be raised are clearly dazzling to lawmakers, but the accompanying health system changes that would be needed are perhaps equally daunting.

Massachusetts Institute of Technology professor Jonathan Gruber estimated that there are $250 billion a year in foregone tax revenues from excluding employer expenditures on health insurance from taxation. But this subsidy is flawed, he said. Because higher income families have higher tax brackets, they save more than low-income families when employer payments for health insurance aren't counted as taxable income.

Gruber testified that "about three-quarters of these dollars go to the top half of the income distribution."

Another problem is that "this tax subsidy makes health insurance, which is bought with tax-sheltered dollars artificially cheap relative to other goods bought with taxed dollars, leading to over-insurance for most Americans." The $250 billion a year "is an enormous sum of money which could be more effectively deployed elsewhere, especially through alternative approaches to increasing insurance coverage."

It would be administratively simple to remove the subsidy—"employers would report their spending on insurance as taxable wages on W-2 forms, and the government would raise the resulting revenues," Gruber said.

But "many employers currently only offer health insurance because of this 'tax bribe', and ending the exclusion would lead to a large erosion of employer-sponsored insurance."

Gruber said that if an employer dropped coverage, a large body of economic evidence shows that the employee could expect to see that money in the form of higher wages. But the erosion of employer-sponsored insurance is worrisome because "sick and older individuals are treated much more fairly in employer groups than they will be in today's non-group insurance market."

Under employer-sponsored insurance, "all individuals pay the same for insurance regardless of their health or age. But in most states those who are sick or older must pay much more for their non-group insurance, and in many cases it is simply unavailable. So as employer-sponsored insurance falls we could end up with a large new set of uninsured who cannot afford, or cannot obtain at any price, non-group insurance."

Gruber offered four approaches to lessening this problem. "The first is to remove the exclusion either slowly or partially. For example, President Bush's 2005 tax policy panel suggested capping the exclusion, only subjecting insurance premiums above the national average to taxation. Alternatively, all individuals could be taxed on a portion of their employer-sponsored insurance premiums.

Another approach is to reform the insurance market so that companies couldn't charge the sick much more for their insurance. "Of course, this reform cannot happen in a vacuum, as forced community rating on insurers would lead to higher prices for all."

"This leads to my third suggestion, a mandate on individuals to buy health insurance. As we have shown in my home state of Massachusetts, such a mandate can lead to low prices for non-group insurance side-by-side with regulations that keep prices the same for the sick and the healthy." Analysts note that such a mandate means that insurers can offset the cost of sicker patients they insure with the premium dollars of younger and healthier enrollees.

Remarkably, Gruber said, the law in Massachusetts to create nearly universal coverage has increased the number of residents with employer-sponsored coverage despite fears that employers would drop coverage because of subsidies provided to lower-income residents to buy benefits. He speculated that employees in firms without coverage are telling their employers that they are now required to have insurance and so are putting pressure on them to provide it.

Another approach, he said, would be to move from subsidizing individuals to buy coverage to subsidizing firms because when companies offer it "the vast majority of employees will enroll."

Edward D. Kleinbard, chief of staff of the Joint Committee on Taxation, and Katherine Baicker, a health economics professor at Harvard, also noted problems with the current subsidy, pointing out that it creates inefficiency in the health care system by making the insured insensitive to the costs of care because of the problem of overinsurance. The tax subsidy gives a large number of Americans overly generous coverage, witnesses said.

Baicker said that "a not insubstantial share [of U.S. health care] is devoted to intensive, expensive care with questionable health benefits."

But Kleinbard also noted the advantages of the group health plans offered by employers, saying they help spread costs associated with sicker enrollees. He added that they have "superior negotiating power" with insurers than individuals do and can achieve administrative savings.

Baucus wondered how the federal government could trim more generous coverage in a way that is politically palatable.

"There is a lot of virtue to a long transition period" in lowering the amount of employer-paid premiums that could escape taxation, Kleinbard replied.

Baucus emphasized that he many more questions he wants to ask about changing the exclusion in future hearings. Ending the employer role in providing health care "might be too much change," he said.

At the same time, "all of us recognize that our system is unsustainable. We cannot continue on our current path. But we must strike a balance. We need to fix what's broken, without breaking what's working."

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