(A version of this Health Alert was published by RealClearPolicy.)
Lost in the blur of the presidential campaign, the evidence indicates the Republican Obamacare replacement plan will include refundable tax credits. In its purest form, this means each person with employer-sponsored benefits, an individual health plan, or dependent on a welfare program like Medicaid or the Children’s Health Insurance Plan (CHIP) will start with a clean slate and a fixed sum of taxpayer-funded money to choose health care of his choice. The Republican proposal will not likely go that far, but it will go a long way to introducing fairness in the tax treatment of health benefits, which is currently broken.
Today, working-age people dependent on government funding for health coverage are subject to a trap that hinders them from seeking higher incomes. Whether on Medicaid, the joint state-federal welfare program for low-income people, or receiving coverage through an Obamacare exchange with premiums discounted by tax credits paid to insurers, these people are subject to clawbacks which dramatically increase their health spending if they get a raise. In many cases, their take-home pay is reduced.
Take the example of a nationally representative family of four, whose household income increases by just one dollar from $31,720 to $31,721. In an Obamacare exchange, I estimate the household is initially liable to pay $958 for the most common Obamacare plan. For an increase of one dollar of income, the household net annual premium increases by $320 (from $638 to $958), resulting in a net loss of $319. What an incentive to turn away from higher paying work!
On the other hand, people who get employer-based benefits exclude the value of those benefits from their taxable income. Because the U.S. has a highly progressive income tax regime, this exclusion is worth far more to high-income households than middle-income ones.
A universal tax credit would eliminate this tax discrimination. To be sure, the leading Republican presidential contender, Donald Trump, does not have a tax credit in his plan. However Mr. Trump’s plan needs a lot of work, to put it mildly. Senator Ted Cruz and Governor John Kasich, the other two Republican presidential contenders, appear open to reforming the tax treatment of health benefits, but are not wedded to one way of doing it. This means, if a Republican president is elected, the initiative for post-Obamacare health reform will fall to the Congress.
In February, Speaker Paul Ryan selected four Committee Chairman to a Health Care Reform Task Force. Budget Committee Chairman Tom Price (R-GA) id one of the four, and he has already proposed his own Obamacare replacement plan. If elected, a Republican president would likely look to Dr. Price’s plan for the design of a tax credit.
Price’s bill offers a universal tax credit, adjusted by age, to every American who chooses to buy individual health insurance: $1,200 for those aged 18 through 34, $2,100 for those 35 through 49, $3,000 for those 50 through 54, and $900 per child. Price would allow people to decline employer-based benefits and claim their tax credit in the individual market.
Some conservative critics of tax credits for health insurance point out that tax credits must be paid for. This is one reason Republican politicians who support tax credits have failed to get them more generally accepted by Republican fiscal hawks. They have failed to emphasize that a universal tax credit would replace, not supplement, current federal spending. First, Medicaid funding would be used to fund the tax credit. According to the Congressional Budget Office, federal spending on Medicaid and the Children’s Health Insurance Plan (CHIP) will amount to $394 billion this year.
Another source of funding is the current exclusion of employer-based health benefits from taxable income. This exclusion will cost $144 billion of tax revenue this year. There is an important difference between this so-called “tax expenditure” and actual spending on Medicaid and other welfare programs. Excluding benefits from taxable income does not impose a direct cost on other taxpayers. Nevertheless, if the government eliminated this exclusion and substituted a tax credit, it would eliminate the exclusion’s bias favoring high-income households and leave many households more after-tax dollars.
Using this revenue, plus current tax credits funding insurers in Obamacare exchanges, would result in $594 billion in universal tax credits for 232 million people on Medicaid, CHIP, employer-based benefits, and individual plans (either on or off Obamacare exchanges). That averages over $2,500 per person.
Although the actual amount would likely be adjusted by age, as in Dr. Price’s bill, that is a big enough amount of money to overcome political resistance to a universal tax credit for health coverage, which would be much simpler and vastly superior to the status quo.