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Would the McCain Health Plan Raise Taxes?

By John Reichard, CQ HealthBeat Editor

October 14, 2008 -- It's one of the Obama campaign ads that infuriates Republicans the most: a warning that middle-class families will pay higher taxes under the McCain health overhaul plan—the largest middle-class tax increase in history," one Obama ad asserts.

But Obama's ads largely ignore the impact of the tax credits McCain would provide Americans for the premiums they pay toward their health insurance. When those are taken into account, Americans in every tax bracket get a tax break on the average cost of a family plan, according to defenders of the McCain plan (the amount of that tax break—the sum by which the tax credit exceeded any tax increase—would be deposited into a tax-deferred savings account designed to be used only to pay health care expenses).

Tax analysts with the Urban Institute and Brookings Institution agree. Only after a decade or more would the value of the tax credits provided by the McCain plan fall behind the added tax liability Americans face under the McCain plan, these analysts say.

So while it's true the McCain plan would increase taxes, it would only do so after a decade or more, according to their analysis.

But the story isn't that simple. There's a $1.3 trillion shortfall in the 10-year cost of funding the McCain plan, according to the Urban Institute-Brookings Tax Policy Center. Making up for that shortfall any time soon would likely require tax hikes, spending cuts in other federal programs such as Medicare or Medicaid, or adding to the federal deficit—or some combination of the three.

The same also could be said of the Obama plan. While according to the center it covers many more of the uninsured, it has a bigger shortfall than the McCain plan—$1.6 trillion over 10 years. So paying for that plan also would likely require big tax hikes, spending cuts in other federal programs, adding to the federal deficit, or some combination of the three.

Into the Weeds
McCain is calling for a $5,000 tax credit to help families cover premium costs, whether they stick with employer-based coverage or try to buy coverage on their own on the non-group, or "individual" market. Individuals would get a $2,500 tax credit for those uses.

Obama says that's only part of the story:

"On health care, John McCain promises a tax credit," an Obama ad states. "But here's what he won't tell you. McCain would impose a new tax on health benefits, taxing your health care for the first time ever. It's a multi-trillion dollar tax hike—the largest middle-class tax increase in history. You won't find one word about it on his Web site. But the McCain tax could cost your family thousands. Can you afford it?"

Obama is lying, McCain's Web site says: "John McCain is not going to raise taxes on middle-class families."

It's true that the McCain plan would make employer-paid premiums taxable for the first time. In filing their tax returns, workers would have to count the value of those premiums in figuring out their taxable income. That's because McCain would end—in part—the "exclusion."

The term refers to excluding from taxable income employer-paid health insurance premiums. There are two types of possible exclusions—one is excluding employer-paid premiums from income taxes, and the other is excluding them from payroll taxes.

The McCain plan would keep the exclusion as far as payroll taxes are concerned. So, if an employer paid $12,000 in premiums for family coverage, that money wouldn't be counted in calculating payroll taxes, and payroll taxes paid by the family would not go up. But the exclusion would end as far as income taxes go. So the family would have to add the $12,000 to its tally of taxable income in filing its income tax return.

That doesn't mean the family's income taxes would go up, however. How much of a tax hike results from an increase in taxable income depends on one's tax bracket and the degree to which tax credits are available to offset the tax hike.

One of the Senate's leading tax writers made that point in floor remarks delivered Sept. 30.

Under the McCain plan, "this family would pay income taxes on the $12,000 policy," said Sen. Charles E. Grassley, R-Iowa, the top Republican on the Senate Finance Committee. "Let's assume that this family was in the 25 percent tax bracket. This family would pay $3,000 in additional income taxes.

"This new tax liability, however, would be offset by the $5,000 tax credit for family health insurance. As a result, $2,000 would be left over. This means that the family would receive a $2,000 tax cut." The tax cut would be even greater if the family had less expensive employer-sponsored coverage, Grassley noted.

Even if the family were in the highest tax bracket—35 percent—it would have lower taxes, Grassley noted. In that example, it would pay $4,200 in added taxes. But the $5,000 credit means it would have a tax cut of $800. And at the other end of the income scale the tax savings would be far greater.

Thus if the family were in the 10 percent tax bracket, it would pay $1,200 in added taxes, but that would be offset by the $5,000 tax credit, meaning it would get a $3,800 tax cut (which would be deposited into a tax deferred account for payment of health care expenses).

The cost of coverage would have to be very high for the increased tax liability to exceed the tax credit.

A family in the 10 percent tax bracket would have to have a policy in excess of $50,000 policy in order to see a tax increase after taking into account the $5,000 credit, according to a Senate aide familiar with the McCain plan. A family in the 35 percent bracket would have to have a policy in excess of $14,285. But defenders of the McCain plan say this would be an upper-income family, and the McCain exclusion policy aims to discourage workers from getting very expensive coverage because it contributes to increased health care spending.

So Where's the Revenue?
But if so many Americans get a tax break from the McCain plan, where does the revenue come from to fund all of the tax credits?

Supporters of the McCain plan say that while its true people in all tax brackets receiving an average family plan would get a tax cut, people in the highest tax brackets continuing to get expensive coverage would pay higher taxes. So that would pay some of the revenue to fund the tax credits, although the McCain campaign estimates that fewer than five percent of Americans with employer-based coverage would pay higher taxes.

What about the rest? The Tax Policy Center, after all, estimates a $1.3 trillion shortfall in funding for the McCain plan over 10 years.

McCain senior policy adviser Douglas Holtz-Eakin has taken exception to reports that McCain would cut Medicare and Medicaid to fund his health overhaul plan. Holtz-Eakin says that improved methods of detecting and preventing fraud would generate savings. He has also suggested that better preventive care and improved methods of treatment for chronic diseases would create savings that could fund the overhaul plan, as well as improvements in information technology and savings from selling insurance across state lines. And the campaign also says it is likely that some people on Medicaid or whose children are enrolled in the State Children's Health Insurance Program would get coverage using the McCain tax credit, thereby taking them off the public rolls.

But those sources of savings are highly speculative and are unlikely to come close to quickly plugging the revenue gap in the McCain plan, judging from previous research on the impact of preventive care, disease management, and improved fraud detection, on health care outlays.

An Obama Adviser Responds
Until recently, the McCain campaign has indicated that the tax code changes sought by McCain would cover the full cost of the tax credits.

In her Oct. 2 vice-presidential debate with Democratic Sen. Joseph R. Biden Jr. of Delaware, Alaska's Republican Gov. Sarah Palin said the McCain tax credit is "budget neutral. That doesn't cost the government anything," she said.

The Obama campaign says that isn't the case, however.

"There's a little bit of a confusion about what McCain intends to do," an Obama adviser said. "Initially, he said his plan was revenue-neutral. And of course with the Tax Policy Center saying it cost $1.3 trillion dollars, the way you do that was you had the payroll tax in there and that roughly made it revenue-neutral. And so for a while they were kind of telling people that health insurance would be subject to the payroll tax as well. If you do that then for the typical middle-income person then you're going to end up raising their taxes."

Obama's ads have assumed that the McCain plan would be budget neutral, and thus assumed the exclusion for payroll taxes would end—leaving millions more Americans paying higher taxes, he said. Since the payroll-related exclusion doesn't end under the plan, McCain has to find other ways to pay for his plans, such as Medicare and Medicaid cuts, the adviser said.

Holtz-Eakin says however of the tax code changes that "we view this as part of a broad reform that has a lot of components" and that would be budget-neutral overall. He acknowledged that putting into place system changes that produce savings "won't happen overnight," but said that producing those savings is imperative.

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