Commentary

McCain’s Mediocre Tax Credit

Until recently, John McCain’s health plan had two features that libertarians and conservatives found appealing. One is his proposal to deregulate health insurance by letting people buy insurance across state lines. The other was his proposed health-insurance tax credit, which would expand choice and competition by leveling the playing field between job-based insurance and coverage that consumers purchase themselves.

Or so we thought. The McCain camp now admits his tax credit would not level that playing field, leaving free-market advocates with even less reason to support an already mediocre proposal.

Congress grants a huge tax break to one particular type of health insurance: Workers pay neither income nor payroll taxes on the value of their employer-purchased health benefits. Workers who purchase coverage themselves (on the “individual” market) generally get no tax breaks.

Why is leveling the playing field important? Economists argue the “tax exclusion” for job-based coverage encourages excessive cost growth, traps workers in bad jobs, and leaves many without coverage when they need it most. It’s also unfair: after taxes, workers who buy on the individual market can pay twice as much for the same or less coverage.

A level playing field would end that inequity. It would also encourage more people to purchase coverage on the individual market, which provides greater choice and often greater financial security to seriously ill enrollees.

Many libertarians and conservatives are hostile to tax credits, yet most support McCain’s proposal. A big reason is that, contrary to Barack Obama’s claims, substituting tax credits for the current exclusion would effectively cut taxes for everyone, because all workers would gain more control over their earnings.

How? If employers no longer hold the keys to the tax break, workers would have the freedom to buy their own coverage and demand cash from their employers rather than health benefits. For workers with family coverage, that would shift an average of $9,000 of compensation from a form workers don’t control (health benefits) to a form they do control (wages). The labor market would force employers to fork that money over.

McCain led everyone to believe his tax credit would eliminate all tax preferences for job-based coverage.”

That shift would effectively cut taxes even for workers who see a nominal tax increase. Suppose a working mother’s health benefits cost $15,000 and her tax rate is 40 percent. Taxing her benefits costs her $6,000. After receiving McCain’s $5,000 credit, she would be among the very few who would pay more in taxes ($1,000).

If her employer gives her that $15,000 in wages instead of health benefits, however, then after taxes she would control $14,000 that she previously did not. Even if her employer continues providing health benefits, competing employers would offer her the $15,000 in cash, which likewise increases her control over her earnings, her health care, and her life.

Over 10 years, workers would control some $6.6 trillion dollars of their earnings that employers would otherwise control, which swamps the $3.6 trillion tax increase Obama claims is hidden in the McCain proposal.

McCain led everyone to believe his tax credit would eliminate all tax preferences for job-based coverage. Thanks to the tenacity of two left-wing think tanks, however, we now know that is not the case.

McCain’s advisors now admit he would preserve the payroll-tax exclusion. That means the tax code would continue to favor job-based coverage, drive health-insurance costs skyward, leave seriously ill patients with gaps in coverage, and deny workers control of that $6.6 trillion. For libertarians and conservatives, that eliminates most of the proposal’s value.

Worse, McCain may have set back the cause of tax reform. Rather than sell a level playing field as a tax cut for all workers, he let critics demagogue the idea by tying it to Medicare cuts. It’s hard to believe a campaign could so bungle an idea that had previously been endorsed by one of their opponent’s senior economic advisors.

Libertarians and conservatives will still find McCain’s health plan preferable to Obama’s, which has been rightly criticized as yet another step toward socialized medicine. We owe a debt, however, to the Tax Policy Center and the Center for American Progress, who forced McCain to admit he wasn’t promising us what we thought.

Michael F. Cannon is director of health policy studies at the libertarian Cato Institute and author of “Large Health Savings Accounts: A Step toward Tax Neutrality for Health Care”