Ed Gillespie, the Republican candidate for the U.S. Senate from Virginia has proposed a substantive plan to reform U.S. health care. The Washington Post called it “the most sensible GOP alternative.” An economic consulting firm estimates the plan, which was developed by the 2017 Project, would reduce the federal deficit by $1.13 trillion over 10 years.
There is significant overlap between the 2017 Project’s proposal and the NCPA’s: They both rely on individual tax credits for individually-purchased insurance as a building block for a new, consumer-driven health system.
The 2017 Project’s proposal would give adults under 35 years of age a tax credit of $1,200 a year; those between 35-49 years would get $2,100; and those 50 or older would get $3,000. Those with children would get an additional $900 per child. Those who can buy health insurance for a lower premium can deposit the leftover tax credit in a Health Savings Account.
However, these tax credits would only be available to employees of firms with fewer than 50 full-time equivalent employees. Those in larger firms, who remain in the employer-based market, would retain non-taxable health benefits, up to a limit. However, the tax exclusion would be capped at the 75th percentile of annual premiums. The value of benefits above this cap would be taxable to the employee. (In 2014, the average premium for single coverage in employer-based benefits is estimated to be $6,223. Let’s say that the 75th percentile is $4,667. So, if a person has coverage worth $6,000, $1,333 of that would be taxable.)
The NCPA’s proposed reform, on the other hand, gives everyone a tax credit and includes all employer-based health benefits in taxable income. The 2017 Project’s alternative is more politically palatable because it does not appear to threaten employer-based benefits. (In fact, the NCPA’s alternative does not prevent employers from offering benefits either.) Like the NCPA’s reform, it restores medical underwriting.
The 2017 Project’s proposal has two unintended consequences which will need to be addressed before it can be implemented.
First, an individual’s preference for a tax credit or the current exclusion of employer-based benefits from taxable income is not based on whether he works at a firm with fewer than 50 employees but on his household income. For example, take a single 30-year-old with a taxable income of $50,000 and a combined federal and state marginal income tax rate of 15 percent. (To keep this very simple, we will ignore payroll taxes.) If his health benefits are worth $8,000, and he can buy a policy in the individual market for $8,000, he will be indifferent as to whether he gets employer-based benefits.
Why? If he can wrangle a raise of $8,000 by telling his employer that he doesn’t need $8,000 worth of health benefits, his taxable income will go up by $8,000. He will owe 15 percent of that raise, which is $1,200, in taxes. And he will get that back in a tax credit.
However, things get complicated pretty fast: Some people in that situation will be able to buy individual health insurance that suits their needs for less than $8,000. However, some will not and will prefer employer-based coverage. If they are working in a firm of fewer than 50 employees, this will create tension between the employees, employer and group health insurer (which will see healthy people leaving the group plan and sicker ones remaining).
If working in a company of 50 or more employees, those who could buy lower-priced health insurance individually will wonder why they are being discriminated against versus those who work in small businesses.
Also, if the 30-year-old has a 30-year-old colleague who has $75,000 in taxable income and a combined marginal income tax rate of 25 percent, the value of the tax exclusion of $8,000 in health benefits is worth $2,000. Because the exclusion is worth $800 more than the tax credit, he will resist losing employer-based coverage unless he can buy individual coverage for $7,200, a 10 percent reduction from the group premium. He will be unhappy if the small business employing him drops benefits because most employees prefer the tax credit. For a large business, the lower paid employees would prefer a tax credit in the individual market, but they are not able to claim it.
The complexities of employees’, employers’ and insurers’ decisions in such an environment are staggering. Perhaps this may not be as big a question in 2017 as it is now. By then, Obamacare will have already chewed through many workers’ employer-based benefits. Nevertheless, it is unlikely that this plan will allow politicians to campaign with a promise that “if you like your health plan, you can keep your health plan.”
Second, the 2017 Project’s proposal re-introduces medical underwriting in a deregulated market. However, it allows people to avoid this by maintaining continuous coverage. The plan appears to extend this beyond the pre-Obamacare status quo ante by forbidding all health insurers (not just the one which covered the employee at his previous employer) from underwriting the former employee who seeks individual insurance.
This would introduce adverse selection far greater than existed in the pre-Obamacare market, because every person working at a small business with fewer than 50 employees would be free to churn in and out of the individual market as he saw fit. In the example cited above, the healthy 30-year-old who could get underwritten insurance for less than $8,000 would buy a new policy, while the unhealthy 30-year-old would seek to maintain group coverage or take advantage of the continuous-coverage provisions to avoid being underwritten.
The 2017 Project’s proposal does not have any risk adjustment, or even open enrollment, to mitigate this. So, health insurers will design their plans to attract the healthy and spurn the sick. Abundant evidence indicates that Obamacare already motivates insurers to do this, despite risk adjustment that has been described as a taxpayer-funded “bailout” of health insurers.
The NCPA has proposed overcoming this problem with health-status insurance, also called “insurance against becoming uninsurable.” Alternatively, risk adjustment similar to that already used in Medicare Advantage would significantly (but not perfectly) mitigate the adverse selection.
Ed Gillespie is on the right track with his proposed health reform. If elected to the U.S. Senate, he and his colleagues will have two years to put the finishing touches on a compelling reform proposal for 2016.