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Center for American Progress

Credit Check: Tax Policy’s Role in Health Reform

Credit Check: Tax Policy’s Role in Health Reform

The bottom line is that tax credits should be carefully crafted so that they help, not undermine, efforts to cover the uninsured.

Tax Credits Can Help or Hurt the Uninsured Problem

By Jeanne Lambrew

Health plans across the political spectrum contain nothing in common—almost. What they do have in common is that most include tax credits to make health insurance more affordable. Tax credits—rather than providing tax-subsidized lower premiums—lower taxes for people who purchase insurance. This approach is politically appealing because tax “spending” doesn’t show up on the federal budget as a new public program. Yet poorly designed tax credits could actually increase rather than decrease the number of uninsured by causing more high-risk people to lose group coverage than the number of low-risk people who gain individual-market coverage.

Experience with tax credits is limited and cautionary. It suggests several tests to be conducted prior to implementation to determine a credit’s effectiveness at reducing the number of uninsured.

First is the credit’s adequacy: Is it large enough to make premiums affordable for the uninsured? The credit amount must cover a sufficiently high percentage of the premium. It should be greater for those with low income or higher-than-average health costs. Since only about half of the uninsured pay taxes, it should also be refundable.

Second, the credit must be effective in its use: Is it directing the largest portion of the uninsured population to the best source of insurance? Tax credits would most likely work if they were targeted toward people most likely to be uninsured and buttress existing sources of coverage. But if the credits are biased toward individual market coverage or health savings accounts, they may undermine existing employer coverage, which could cause older, sicker workers to lose coverage while younger, healthier workers gain it.

Unfortunately, most conservative proposals don’t meet these two qualifications. Senator Tom Coburn (R-OK), for example, has proposed tax credits of $2,000 for individuals and $5,000 for families (S. 1019). These credits are refundable, but their fixed dollar amounts may be insufficient for people with high health care costs or a low income. The bill’s tax credit also funds a deregulated individual insurance market and removes incentives for employer-based coverage. The bill will likely help some low-risk uninsured, but other already-insured people could lose their coverage—and they may not find an affordable alternative.

The bottom line is that tax credits should be carefully crafted so that they help, not undermine, efforts to cover the uninsured.

Jeanne Lambrew is a Senior Fellow at the Center for American Progress and an associate professor of public affairs at the Lyndon B. Johnson School of Public Affairs at the University of Texas.

For additional reading:

L.J. Blumberg, “Health Insurance Tax Credits: Potential for Expanding Coverage,” Urban Institute, August 1, 2001.

L.E. Burman and J. Gruber, “Tax Credits for Health Insurance,” Urban Institute,
June 7, 2005.

S. Dorn, “Health Coverage Tax Credits: A Small Program Offering Large Policy Lessons,” Urban Institute, February 5, 2008.

M. Pauly and B. Herring, “Expanding Coverage via Tax Credits: Trade-Offs and Outcomes,” Health Affairs, 20 (1) (2001): 9-26.

J. Reschovsky and J. Hadley, “The Effect of Tax Credits for Nongroup Insurance on Health Spending by the Uninsured,” Health Affairs Web Exclusive, February 25, 2004.


Check List: Effectively Expanding Health Coverage Through Tax Credits

 Fully refundable and advanced when needed
 Sliding-scale value tied to insurance-premium affordability
 Linked to accessible, affordable coverage options
 Fair, needs-based eligibility
 Simplified enrollment/administration


Putting Tax Credits to Work

Tax credits can potentially reduce the number of uninsured by providing individuals and families with subsidies to use toward health insurance. Conservatives and progressives promote the use of credits, but the scale, scope, and potential effect of their tax credit proposals vary widely.

To understand the key differences between tax credit proposals, it is important to first visualize how credits work and how they differ from other tax subsidies. A tax credit is known as a dollar-for-dollar reduction because the full amount of the credit is directly reduced from one’s tax liability, or the total amount owed to the Internal Revenue Service. Conversely, a tax deduction is treated as an expense that reduces one’s taxable income and therefore reduces one’s tax liability by lowering the base, or taxable income, to which the tax rate is applied.

The simple example below illustrates the difference between tax credits and deductions. For this example, we assume that a family has a gross income of $50,000, a flat tax rate of 20 percent, and that both the tax deduction and credit are $5,000.

Most proposed tax credits are “fully refundable,” meaning that if an individual or family’s tax liability were lower than the amount of their credit, they would receive a refund of the difference. For example, if Joe Healthcare qualified for a $5,000 tax credit, and his tax liability was only $2,000, he would still receive the full benefit of the credit because the government would refund him the difference of $3,000.

Most progressive health care proposals use tax credits to provide financial assistance to low-income individuals and families who otherwise could not afford health insurance. Under some plans, qualifying individuals and families who purchase health insurance plans—whether through their employers or through a new purchasing pool—would receive a tax credit that offsets insurance premiums so that payments do not exceed a certain percent of income. This provides lower-income households larger tax credits, in dollar terms, compared to higher-income households since the uninsured tend to have low income.

Conservative plans typically include a health insurance tax credit for every insured person with no qualifying restrictions. Sen. Coburn, for example, proposes credits of $2,000 to individuals and $5,000 to families, regardless of income. This is known as a “flat” tax credit because low- and high-income households would receive the same dollar amount.

Coburn proposes to use this credit to replace the current system that allows people who are insured through their employers to exclude their employers’ contributions from their taxable income. The government provided approximately $200 billion in subsidies for employer-sponsored health coverage in 2007. In promoting flat tax credits, advocates strive to eliminate the tax bias toward employer-sponsored health insurance and reduce the cost of individual insurance. Insuring the uninsured is also a goal, but less emphasized than tax fairness.

For additional reading:

What Would a Good Health Care Tax Credit Look Like?” Families USA, January 17, 2007.

F. Goldberg, L. Batchelder and P. Orszag, “Reforming Tax Incentives into Uniform Refundable Tax Credits,” The Brookings Institution, August 2006.

C. Williams, “Tax Subsidies for Private Health Insurance: Who Currently Benefits and What are the Implications for New Policies?” The Robert Wood Johnson Foundation, May 2003.


Graph: A Flat Tax Credit Means Higher Premiums for Most Families



Point-Counterpoint: Flat Tax Credits May Not be Effective at Reducing the Number of Uninsured



The Bottom Line

All Americans should receive the same tax break, regardless of circumstance.

Flat tax credits do not take into account the great variation in insurance plan costs.

Flat credits don’t exhibit vertical equity; they are not adjusted according to a person’s level of need.

Low-income individuals will continue to spend a much higher percentage of their overall incomes on health insurance.

While credits may cover the cost of insurance for the young and healthy, they are unlikely to offset the high cost of coverage for older and sicker Americans and those living in high-cost communities.

A tax credit provided for individual-market coverage will help uninsured not covered by employers. 

More people could become uninsured if employers discontinue coverage.

One analysis of the president’s original tax credit proposal suggested that voluntary enrollment in individual-market plans would not offset the number of Americans who would become uninsured due to loss of employer coverage or a rise in employer premiums resulting from deterioration of the group market.

Models and experience show the projected effect of a credit on the uninsured is uncertain at best. Tax credits may therefore be more effective if used as part of a broader strategy to reduce the rates of uninsured.

Flat credits will encourage consumers to choose the best value plans, driving costs down. 

Credits alone are not going to reduce health insurance costs.

The benefits of competition among insurance companies will have to be weighed against:

The higher administrative cost of insurance in the individual market.

A decline of employer involvement, which helps with pooling risks and easing enrollment and payment.


In the News

Will tax incentives effectively eradicate the gaps in health care insurance coverage? Can they be rolled out on a state-by-state basis? Alabama Governor Bob Riley thinks so. He proposes offering tax credits to small businesses to assist them in providing group insurance to their employees. Read more.

Health insurance companies are stepping in to put their own health reform proposals on the policy agenda. Find out how one major provider proposes to use tax credits to reduce the number of uninsured. Read more.

State health reform is back in the news, as New Jersey aims to follow the lead of states like Massachusetts and Vermont in insuring all residents.  Can it succeed? Read more.

High-deductible health plans have been advanced by President Bush and conservatives, and now insure 12.5 million Americans. However, a new survey has found that, among these plan enrollees, satisfaction is lower and missed care is higher than among those in traditional health plans – with no apparent reduction in the uninsured. Read more.


The Last Word

“You just can’t give people a tax credit and say, ‘Go out to the unregulated, unstructured individual market and good luck.’”
Rick Curtis, health care consultant.

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