A Displaced Plan

January 24, 2002 • Commentary

This year’s installment of Washington’s chronically superficial health‐​care debate resumes later this month. With the return of Congress, the “new” idea will be refundable health tax credits for displaced workers. But the latest version of this concept, passed in an economic stimulus bill last month by the Republican‐​controlled House, represents bad tax policy, bad welfare policy, and bad health policy. Standard operating procedure on Capitol Hill. The politics of this health care issue are fairly simple. After the September 11 terrorist attacks pushed the economy into a deeper recession, both major political parties sought to express their compassion for workers who lost their jobs and found their health‐​insurance coverage in jeopardy. They also hoped to score some points that might advance their respective health‐​policy agendas.

Democrats opened with a legislative push to 1) expand government‐​run Medicaid assistance to displaced workers who lost access to employer‐​sponsored health plans and 2) provide even more lavish new subsidies to other laid‐​off wage earners who chose to continue their coverage under their past employer’s plan (so‐​called COBRA continuation coverage). This two‐​step strategy first hoped to convince voters that only greater federal spending and federal control for health insurance coverage could keep the ranks of the uninsured from swelling further. Second, if neither politically controlled universal health coverage nor a greatly expanded Medicaid program could be achieved, at least the employer‐​sponsored health‐​insurance system could be propped up further to serve as a platform for new mandates, hidden cross subsidies, and future scapegoating. Employer group plans keep most workers locked up in a narrow range of insurance arrangements and deterred from wandering off our overregulated “private/​public” health insurance reservation. They serve as second‐​best host organisms for political parasites.

The not‐​even‐​too‐​clever‐​by‐​half response from congressional Republicans was to let voters know that they “cared” too, but in a manner that limited budgetary costs and headed off any direct expansion of the troubled Medicaid program. Last month, House Republicans and the Bush administration placed their political bets on refundable tax credit assistance to many (but not all) displaced workers and their families. Eligible workers could obtain an advance income‐​tax credit (or an end‐​of‐​year credit) for 60% of their monthly premium payments for private health insurance.

At best, this proposal temporarily blocked an explicit expansion of Medicaid assistance to temporarily unemployed workers. It might open up some new private health insurance choices for them beyond the expensive COBRA coverage available from most of their former employers. Current COBRA benefits allow workers who leave jobs to retain group coverage for at least 18 months, but they must pay the full price for it without any tax benefits. Only about 20% of all eligible workers actually pick up this option. Employers complain that those who do exercise COBRA rights tend to run up larger insurance claims. Their costs exceed the maximum premiums allowed by more than 50%. Workers leaving jobs at companies that never offered health insurance or employed fewer than 20 people have no rights to any federal COBRA benefits at all.

But the Republican health care strategery misses the big picture for reform, while surrendering principles and just handing out more money


It fails to provide new health care choices and tax parity to employed workers who don’t participate, or do not want to remain, in their current employer’s health plan. The Republican game plan begins and ends with targeted handouts, instead of broad, individual‐​empowerment reforms.

Even on the compassion front, only idle workers who are eligible to receive unemployment benefits would qualify for the Bush administration’s refundable tax credits. In some states, that figure may be as low as one‐​third of all unemployed workers.

If the real policy goal is neutrality for government tax treatment of health insurance, the solution is to exclude the cost of health insurance purchases from a worker’s income that is subject to income and payroll taxes. Instead, Republicans have cobbled together an uneven policy mix: A tax exclusion (i.e., deductibility based on one’s marginal tax rate) for the many employees of firms providing group insurance, and a tax credit for other purchasers of individual insurance policies that is fixed at a single rate (60%) that is higher than any taxpayer’s marginal rate, but capped in total amount.

Even if the policy goal is to provide more of the current tax subsidy to lower‐​income workers, the real complaint should be with the progressive marginal tax rate structure of the current IRS code. Until we move to a flat tax (the permanent solution), the value of any income tax deductions will always be greater for taxpayers in higher income brackets.

Most refundable tax‐​credit proposals (including those of the Bush administration and House Republicans) are designed to award tax “cuts” to individuals who pay little, or no, federal taxes. Yet it was less than a year ago that Republicans had to fight off political claims that the administration’s tax‐​cut package was “unfair” because it provided most of its benefits to those who paid the largest share of federal income taxes. Duh. Endorsing a new round of income redistribution and federal spending via the tax code (in the name of “health care”) is contradictory and counterproductive.

Another long‐​range danger of targeting health insurance subsidies to low‐​income workers through refundable tax credits is that they are likely to be financed, under budgetary pay‐​as‐​you‐​go norms, by reducing the current health insurance tax benefits available to higher income Americans. In effect, this means increasing the latter’s marginal income‐​tax rates. Soak the rich, to subsidize the poor, for budget neutrality?

Refundable tax credits endorse expansion of current taxpayer‐​financed “entitlements” to health insurance coverage. They reinforce the mistaken view that health insurance is a “merit” for everyone and that necessary access to health care cannot be adequately financed without even greater subsidies from taxpayers for insurance coverage. As the income‐​redistribution auction proceeds, additional political conditions on how these new tax subsidies for health insurance are to be spent will follow inevitably.

With federal welfare‐​reform law up for review and reauthorization later this year, it’s puzzling that many lawmakers — who salute the benefits gained from limiting the magnitude and duration of cash assistance to low‐​income beneficiaries on the welfare rolls — nevertheless appear poised to dole out a new round of permanent “welfare” checks to the working poor, hidden beneath a refundable health tax‐​credit label. Apparently, the stigma of welfare still can be applied to outright income support, but not other welfare payments routed through the tax code. Could it be because the primary beneficiaries of the latter really are health‐​care providers and health insurers looking to get paid more regularly by lower income customers?

Do greater tax subsidies to purchase more health insurance necessarily improve one’s health? Interestingly enough, even though the self‐​employed receive less‐​generous tax advantages for health‐​insurance purchases than other workers and they are less likely than wage earners to be covered by health insurance, this relative lack of insurance doesn’t affect their health. Craig Perry and Harvey Rosen concluded in a recent study for the National Bureau of Economic Research that “for virtually every subjective and objective measure of health status, the self‐​employed and wage earners are statistically indistinguishable from each other.”

In fact, simply passing out a new set of transfer payments via inefficient political filters won’t substantially improve the health status of lower‐​income Americans. Recent research suggests that 1) improving the quality of education that individuals receive, 2) cushioning vulnerable workers against sudden economic shocks, and 3) expanding individual control of one’s health‐​care decisions will yield much greater returns. The real health policy reforms needed for dynamic change include:

  • Broad tax parity for all health‐​insurance purchasers who pay taxes
  • Greater deregulation of health insurance alternatives
  • Expansion of defined contribution plans
  • Multiyear rollovers of flexible spending‐​account balances
  • Facilitation of voluntary group‐​purchasing arrangements outside the workplace
  • A surgical tummy tuck for the health safety net

Instead, health‐​policy experts like Stuart Butler of the Heritage Foundation tell us that refundable tax credits are the ideal Left‐​Right compromise, because “liberals can vote for tax cuts and call them subsidies, while conservatives can vote for subsidies and call them tax cuts.” A reality check indicates that someone’s getting fooled in this political trade. Recent history suggests it’s not the political patrons of the welfare state.

Before we point the tax‐​policy gun in a new direction, let’s first make sure it’s not aimed at our own feet.

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