The health insurance tax reform President Bush plans to announce in tonight’s State of the Union address is the most radical and yet simplest proposal to emerge in decades.
To understand why, readers need a little background.
During World War II, the country imposed wage and price controls to limit inflation during wartime shortages. Employers started offering health insurance as a way to attract good employees in a tight labor market. The question arose whether those benefits would be considered taxable income. In October 1943, the IRS announced that employer-provided health insurance benefits would not be considered income for tax purposes—that is known as a “tax exclusion” because the money spent on health insurance is excluded from income.
In the economic boom after World War II, more and more employers began offering health insurance as a benefit. The result is that the U.S. now has an employer-based health insurance system where between 85 and 90 percent of those with private health insurance (i.e., those not part of Medicare or Medicaid), get their coverage through an employer plan.
While employer-based health insurance has both pluses and minuses—for employees, employers and health care providers—it also creates some huge disparities. Employees who work for an employer who provides health insurance get a significant tax break. The average cost of a family policy is about $11,500 a year. If an employer is paying all of the premium, that represents a sizeable amount of untaxed income. [Note: economists see that as income because it is part of the total compensation package.] It’s a good deal if you can get it.
The self-employed get a 100 percent deduction for their health insurance premiums—though that is a fairly recent addition to the tax code.
However, employees who work for employers who do not provide health insurance—often small employers and companies engaged in the service sector where profit margins are thin—get no tax break for insurance. If they buy a policy, they have to do it with after-tax dollars. And these tend to be lower-income workers, and therefore the ones who can least afford paying for coverage out of their own pockets.
Economists have long grumbled about these disparities. To address the problem, Nobel Prize-winning economist Milton Friedman argued that all health insurance tax breaks should be eliminated. That would make health insurance similar to just about every other kind of insurance—auto, life, homeowner’s policies, etc.—none of which receives a tax break.
The alternative to eliminating the tax break for health insurance is to give everyone the same tax break. That is what President Bush has chosen to do.