The welfare gain from replacing the health insurance tax exclusion with lump-sum tax credits
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The welfare gain from replacing the health insurance tax exclusion with lump-sum tax credits Liqun Liu · Andrew J. Rettenmaier · Thomas R. Saving
Received: 22 June 2010 / Accepted: 23 March 2011 / Published online: 3 April 2011 © Springer Science+Business Media, LLC 2011
Abstract This paper analyzes the welfare gain from replacing the tax exclusion of employer-provided health insurance with a lump-sum tax credit. It differs from earlier studies in that we look at the welfare cost of health insurance tax exclusion as coming directly from excessive health insurance rather than from overconsumption of medical care and that we account for the labor market effect of the tax exclusion on welfare. Both differences work to produce a smaller tax reform welfare gain. For a set of mid-range parameter values, the welfare gain is about 21% of current health insurance tax expenditures. In addition, government tax expenditures would fall by 38%, and health insurance spending would fall by 77% after the reform. Keywords
Health insurance · Tax exclusion · Subsidy · Welfare cost
JEL Classification
H24 · I18
1 Introduction Both employer and individual contributions to the purchase of employer-provided health insurance are excluded from an individual’s taxable income. This tax exclusion, essentially a health insurance price subsidy, resulted in a federal government revenue loss of more than
L. Liu · A. J. Rettenmaier (B) Private Enterprise Research Center, Texas A&M University, 4231 TAMU, College Station, 77843-4231 TX, USA e-mail: [email protected] L. Liu e-mail: [email protected] T. R. Saving Private Enterprise Research Center and Department of Economics, Texas A&M University, 4231 TAMU, College Station, 77843-4231 TX, USA e-mail: [email protected]
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$200 billion in 2009, a loss that is expected to grow over time.1 The tax subsidy is credited, or vilified depending on your point of view, for the market dominance of employer sponsored health insurance. At the same time, this tax exclusion has been criticized on several counts. It creates a distortion that favors consumption of health insurance over other consumption (including uninsured medical care). It is argued that the tax exclusion is unfair to low income workers because the subsidy is larger for higher marginal tax rate individuals. Finally, the exclusion discriminates against those self employed or who are employed by firms that do not have health insurance as a fringe benefit. It has been proposed that the current health insurance tax exclusion be replaced with fixed-amount tax credits. For example, Pauly and Goodman (1995) argued that tax credits, even if restricted to individuals with employment-based health insurance, would eliminate the favoritism the current system bestows on higher earners. Giving low income workers a sufficient, fixed-amount credit is even more relevant considering that it better serves the purpose of encouraging health insurance coverage for low income workers who pay little or no taxes. More importantly, they argued
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