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Short Takes

Q: The President's Advisory Panel on Federal Tax Reform has proposed that taxpayers could deduct a standard amount off their tax filings for health insurance purchases. Would that help reduce the number of uninsured Americans?

The current tax code provides a generous subsidy for health insurance, amounting to $188.5 billion in 2004. The subsidy goes to people who have health insurance through work, but does not extend such subsidies to those who do not work. To economists, the design of this subsidy results in inefficiencies and distortions in the marketplace. For example, people who purchase health insurance via the workplace can buy it with untaxed or "before tax" dollars, making the coverage less expensive for them and encouraging them to buy more than they otherwise would. Other taxpayers don't have the same generous subsidy.

More people buying health insurance means health insurance costs less than it would if only the sickest people bought health insurance. This is good, and the tax code should encourage people to buy health insurance. But when people pay prices that do not reflect how much something costs, resources are not used wisely. Under the current tax code, this happens, which is akin to nails on a chalkboard for economists.

The President's Panel seeks to remedy this. In late 2005, the panel proposed allowing all taxpayers to deduct a certain amount of expense for health insurance from their taxable income, regardless of work status. This would reduce the distortion in current policy that offers favorable tax treatment only to those who are employed or self-employed. Keep in mind that those who purchase health insurance outside the workplace would still miss out on the benefits of pooling available to those who purchase group coverage.

The Panel's bigger proposal would limit how large a break the tax code gives to buying health insurance. The panel proposed that the current exclusion be limited to $11,500 for families and $5,000 for single individuals in 2006, and indexed for inflation in future years. Today, there is no limit.

The Panel wants to preserve the tax subsidy for the purchase of health insurance, and make it more equitable. Yet, it would moderate the incentive to buy too much coverage by setting a maximum dollar amount of health insurance that could be bought with before tax dollars. People could buy health plans that cost more than this maximum, but the cost above the cap would have to be purchased with after tax dollars. To most economists, this makes sense. Rather than having some have no opportunity to benefit from a tax subsidy and others an unlimited subsidy, everyone would face the same limit.

Bottom Line: Yes. Those who do not have access to tax-favored coverage now would gain it, and this should increase coverage.

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Funded by The Robert Wood Johnson Foundation, ERIU is a five-year program shedding new light on the causes and consequences of lack of coverage, and the crucial role that health insurance plays in shaping the U.S. labor market.