After spending hundreds of millions of dollars in the last campaign election accusing John McCain of wanting to tax the health insurance benefits of ordinary Americans President Obama now says he is open to the very same idea and it seems likely that Congressional Democrats will themselves opt to tax health insurance benefits as part of overall health reform. Is this a complete flip flop? Yes.
And other than Kimberley Strassels Wall Street Journal editorial last Friday the media is giving the President a free pass.
But can the Democrats claim that Republicans have endorsed the same idea?
If they are intellectually honest I think not. What McCain proposed and what health economists have been advocating for years is different.
The idea which is also the center-piece of a Republican plan by Senators Tom Coburn (OK) and Richard Burr (NC) and Representatives Paul Ryan (WI) and Devin Nunes (CA) was proposed more than a decade ago in an article by Mark Pauly and me. It would replace a current tax subsidy with a different and better tax regime one that would have made about 80 to 90 of taxpayers better off.
In fact to ease the transition we should probably give people a choice of tax regimes for several years.
By contrast Obama and the Democrats in Congress are going to tax some peoples health insurance for the express purpose of collecting funds to subsidize insurance for others.
Under this approach half the population is going to be made worse off so that the other half can be made better off.
The case for a change of tax regimes is very strong. Consider these alternatives for family insurance. The first case describes the current system of excluding health insurance benefits from income and payroll taxes:
Case I: Employer paid premium $15000 Tax bracket (including payroll taxes) 40 Tax subsidy $6000
Now consider treating health insurance just like taxable wages but giving people a tax break on their personal tax return:
Case II: Employer paid premium: $15000 Tax on the benefit $6000 Lump sum tax credit $6000
On the surface the outcome appears to be the same. The family has the same amount of health insurance and the same after-tax income in both cases. But on closer inspection Case II is much better.
In Case I the only way the family can get a $6000 tax subsidy is by spending $15000 on health insurance (technically the employer pays it rather than paying taxable wages). If for example the employer/employee spent only $10000 on health insurance the tax subsidy would be only $4000. In Case II by contrast the tax subsidy is concentrated on the core insurance that we want everyone to have and all extra insurance is paid with after-tax dollars. The first $6000 of insurance gets a dollar-for-dollar tax credit. After that every dollar spent on insurance is a dollar that could have been spent on other goods and services. Suppose again that the employer/employee spent only $10000. In this case the tax subsidy remains the same and the family will have $5000 to spend in other ways. The fixed sum tax credit therefore is far more valuable than the current tax exclusion system. It will allow people to make more economical choices and keep every dollar they save. Note: Good incentives may also be created by the Congressional health plan. But dont count on it. Congresss goal is not to create good incentives. To the contrary the bill is likely to be replete with perverse incentives of all sorts. The goal is to collect money from some to pay for the health insurance of others. They are likely to pursue that goal in ways that make economic incentives worse not better.
