Statement of Jeff Lemieux, Senior Economist, Progressive Policy Institute

Testimony Before the House Committee on Ways and Means

Hearing on Health Care Tax Credits to Decrease the Number of Uninsured

February 13, 2002

Thank you, Mr. Chairman, Representative Rangel, and committee members, for inviting me to testify on using tax credits to increase the number of Americans with health insurance.  My name is Jeff Lemieux, and I am the senior economist for the Progressive Policy Institute (PPI).  Prior to this position I worked for the Bipartisan Medicare Commission, the Congressional Budget Office, the Health Care Financing Administration (HCFA), and an economic forecasting firm then known as DRI/McGraw-Hill. 

Universal health coverage is a national imperative.  It can be achieved in a series of responsible, practical stages, and the PPI has long argued that tax credits should be a cornerstone of that effort.  The first step is to help the newly unemployed maintain their health insurance.  By preventing those with insurance from losing it when they lose their jobs, we can at least prevent the number of uninsured from rising. 

The second step is to reduce the number of uninsured Americans by making certain that all have good choices of health insurance at reasonable group rates, that they can exercise those choices in the most convenient and secure setting possible (usually their place of employment), and that financial assistance (based on tax credits) is provided to help those with low incomes.

After a few general comments, my remarks focus on two specific proposals:  the temporary tax credits targeted to displaced workers receiving unemployment insurance that the House passed in December as part of the debate on economic “stimulus,” and the proposal for permanent means-tested tax credits for individual health insurance that was included in the President’s budget.

By tax credits for health insurance, I am referring to tax credits that are both refundable—that is, fully paid even to those whose incomes are so low that no income tax liability is owed—and available “in advance,” when the insurance is purchased.  Otherwise, low-income workers most at risk of being uninsured would be unable to take advantage of the credits.  Both the House-passed proposal for displaced workers and the Administration’s tax credits for individual coverage pass those tests. 

Two of the greatest strengths of the U.S. economy are our work ethic and the flexibility of our labor markets.  Now more than ever, Americans move into and out of the workforce and particular jobs, sometimes working part-time and sometimes overtime, sometimes working for large or small firms or several firms at once.  Freelance and independent work is common. 

Labor market flexibility is both economically efficient and socially helpful.  It allows us to tailor our skills and work styles closely to our social and family needs.  However, we need to do much more to adapt benefits like health insurance to the realities of the modern workplace.  Specifically, we should strengthen the bond between work and health insurance, and ensure all Americans have a fair chance to obtain good coverage, no matter how or where they work.

The foundation of health coverage in the U.S. is subsidized group health insurance, arranged through employers.  Past pushes for universal coverage have failed primarily because of uncertainty about the fate of work-based health coverage, which people value very highly.

The main reasons for the success of employment-based health insurance are the subsidies and the group insurance pools.  Subsidies provided by employers make health insurance desirable even for the young and healthy, and group pooling makes coverage fair and affordable, even for those who are older and more likely to need extensive health care services.  Getting health coverage through employers is also convenient and reassuring.  Employers handle the paperwork and payroll deduction of premiums, and can help resolve disputes with health plans.

The one major problem with employment-based coverage is choice:  Too few workers have a wide choice of health plans.  Employers may switch health plans abruptly, severing employees’ relationships with health providers.  And workers routinely have to switch health plans when they change employers.

On the other hand, the market for individual health insurance is small, fragile, and problematic.  Although availability varies from state to state, individual coverage can be hard to get or even unaffordable, especially for people with health problems—precisely those who most need health coverage.  Fear that only persons with hidden illnesses will apply for coverage causes insurers offering individual coverage to “load” premiums with extra amounts to hedge against unseen risks.

In sum, the market for employment-based coverage is robust, but often lacks choices, which can thwart continuity of health care.  The market for individual coverage is weak and unpredictable—in ways that also reduce choice and continuity.

Ideally, public policy should help employers offer a wide menu of health insurance choices.  That would allow workers to stick with a plan they like, even if they switch jobs.  Since more and more workers are self-employed, we must also improve individual coverage.  That market needs the best features of employer coverage:  It should be more predictable, affordable, fairly priced, and available to all. 

The best policy would be a combination of tax credits and new group purchasing arrangements.  That would help inject choice into the market for employer coverage, and would bring choice, subsidies, and group coverage to people who can’t get work-based coverage. 

Ideally, tax credits shouldn’t favor employer or individual health coverage.  The current tax law favors employment-based coverage, but the Administration’s proposal of permanent tax credits only for individual coverage is an overreaction, favoring individual coverage, especially for lower-income workers.  The right policy is a balance.  Tax credits should be available in both markets, so that both markets are strengthened.

Temporary Tax Credits for Transitional Health Coverage

The House-passed bill would give a 60 percent, uncapped tax credit for either COBRA continuing health coverage or individual coverage.  In general, displaced workers receiving unemployment benefits would be eligible for up to 12 months.

The PPI has argued that tax credits for COBRA coverage would be beneficial not only to displaced workers, but also to employers.  Under COBRA, most workers who are laid off are allowed to remain in their employer-based health plan for up to 18 months, provided they pay the full premium (their share plus the employer share) and a small administrative fee.  The problem is, the full premium for employment-based coverage averages about $200 per month for self-only coverage or around $600 per month for family coverage. 

Since COBRA coverage is very expensive, many laid-off workers choose to remain uninsured, gambling that they won’t get sick before they find another job.  However, workers who already have a chronic health condition generally accept COBRA coverage, despite the high cost.  Otherwise they would have no protection against high medical bills they know they will face.

In the jargon of health insurance, employers offering COBRA coverage experience “adverse selection,” that is, healthier-than-average ex-workers decline the continuing coverage, and sicker-than-average workers accept.  Even though the workers who accept coverage pay the full premium, their costs are actually higher than average, which drives up the premium for the employer’s whole group.  Although only a small fraction of ex-employees accept the coverage—approximately 25 percent—it still drives up employers’ health costs.

Based on past estimates from the Congressional Budget Office, over half of laid-off workers would accept COBRA coverage with a 60 percent subsidy.  In my opinion, that would certainly reduce adverse selection by drawing younger and healthier workers into COBRA pools.  It could even reduce employers’ overall costs because the reduction in costs associated with adverse selection could be enough to offset the additional cost of increased participation. 

However, there is one way to be sure:  raise the subsidy rate from 60 percent to 75 percent or more.  As the subsidy increases, it is reasonable to assume that each subsequent person enticed to purchase coverage is a little healthier than those who would have purchased at a lower subsidy.  At a 75 percent subsidy, most unemployed workers could afford to stay on COBRA, adverse selection would probably be very small, and employers’ overall costs would be more likely to decline. 

The House-passed proposal also allows the tax credits to be used for individual coverage.  That is important, because firms with fewer than 20 employees are not required to offer COBRA coverage, and workers laid-off from those firms would not be able to continue their employer-based coverage in any event.  The bill also allows workers eligible for COBRA to use the tax credit for individual coverage instead.

Allowing workers eligible for COBRA to use the credit for individual coverage doesn’t change the relative price of health insurance they face.  Previously, a laid-off worker could choose COBRA or individual coverage with no subsidy.  With a percentage subsidy of any amount, the relative price doesn’t change.  Economists would say that the substitution effect in that case is zero—because the price of COBRA didn’t change with respect to the price of individual insurance, there is no reason for people to change their decision between the two. 

However, there also could be a so-called income effect.  That is, the presence of a subsidy gives the worker a higher net income after purchasing health insurance—that effect can also impact purchasing decisions.  In this case, I think it is reasonable to assume laid-off workers would be very concerned about holding on to their familiar employer-based health coverage.  Although any income effect in this case would probably be faint, I believe it would work in the direction of people choosing COBRA coverage.

In sum, under current law a laid-off worker eligible for COBRA faces a choice of COBRA or individual coverage with no subsidy.  Most go uninsured.  With a subsidy of 75 percent or more, most would choose insurance.  Those who would have purchased COBRA without any subsidy would almost certainly choose COBRA over individual coverage if equal percentage subsidies were offered.  Those who would have purchased individual coverage would probably stick with that too, although some may switch to COBRA if subsidies were offered.

We don’t know whether COBRA-eligible workers who otherwise would have been uninsured would choose COBRA or individual coverage after a tax credit was offered.  Some would probably choose individual coverage.  Therefore, the improvement in adverse selection in the COBRA market would not be as great if subsidies were also available for individual coverage—as in the House-passed bill—compared with proposals that would restrict the subsidy to COBRA coverage alone.

Permanent Tax Credits for Individual Coverage

The Administration proposes to give low-income people who can’t get health coverage at work a refundable tax credit of up to 90 percent of their premium up to limits of $1,000 per covered adult and $500 per child, up to two children.  Therefore, the maximum credit would be $3,000 for a two-adult, two-child family.  The proposal would allow the tax credits to be used for individual coverage, or coverage obtained through a purchasing group or high-risk pool.

These tax credits would be available in full for single people with annual earnings of $15,000 or less, or families with earnings of $25,000 or less.  The credits would phase down to zero for individuals with annual incomes of $30,000, one-adult families with incomes of $40,000, or two-adult families with incomes of $60,000 a year. 

The proposal would use a novel procedure to make the credits available in advance:  People would prove their eligibility based on their previous year’s tax data.  Individuals would present their earlier tax forms to an insurance company or purchasing group to demonstrate eligibility; then the credit would be deducted from their premium.  That is an unwieldy procedure—it requires insurance companies or purchasing groups to adjudicate eligibility based on personal tax returns.  However, workers would not be obliged to “reconcile” the tax credits they received in that manner on their end-of-year tax forms in order to calculate their tax credits with greater precision and up-to-date income data.

The biggest flaw in the Administration’s proposal is that it does not allow people who could get health coverage at work to receive tax credits, even if their incomes are very low.  That is unfair, since low-income people who can’t afford coverage at work (or who struggle to afford work-based coverage) would get nothing.  They would have an incentive to switch to other (often higher paying) jobs that don’t offer coverage. 

In general, businesses that don’t offer employee benefits like health insurance can afford to grant higher wages instead.  When they decide to hire or retain a worker, businesses focus on the cost of the total compensation package, not the split between cash wages and non-wage benefits.  Of course, individual workers may not always be able to trade benefits for wages, because they may not have a wide choice of jobs with different mixes of compensation available to them at any one time.  But in the overall economy and over a sufficient period of time, the choice of health benefits versus higher wages is very real.

Under the Administration’s proposal, low-income workers would have a particularly strong incentive to take higher wages instead of employment-based health benefits, and then use the tax credit to purchase individual coverage.  To save their employees the hassle of switching into no-benefit jobs to take advantage of that incentive (and to retain valued employees), some small businesses would just stop offering coverage in the first place.  That would reverse the recent trend toward more small employers offering coverage to their employees.

Second, because its tax credits would cover up to 90 percent of a premium, the Administration’s proposal could spawn the development of inferior insurance plans for low-income people.  For example, the Administration’s plan would give an individual purchasing a $1,000 policy a tax credit of $900 (90 percent of $1,000).  Similarly, someone purchasing a really cheap $500 policy would get a tax credit of $450 (90 percent of $500).  The Administration’s tax credit would pay 90 percent for premiums costing up to roughly $1,110 (the maximum $1,000 credit is approximately 90 percent of $1,110).  The problem is:  any coverage valued at $1,110 or less is probably pretty meager coverage.  (For example, the average premium for self-only coverage purchased through employers is about $2,400.)  Low-rate insurance would be better than nothing, but it might not really solve the core problem:  getting everyone access to high-quality medical care.

One simple way to improve the Administration’s proposal may seem counterintuitive:  reduce the maximum percentage of a health insurance premium the tax credit could cover from 90 percent to 50 percent across the board.  That would give people incentives to purchase full coverage—for example, a person wishing to obtain the full $1,000 credit would have to purchase health insurance worth $2,000, which is closer to the value of mainstream coverage.  Those wishing to purchase cheaper, less generous coverage could still do so, but they wouldn’t get the maximum $1,000 credit, and the credit couldn’t cover more than half of the premium in any case.  Because young and healthy workers could not get the full credit for cheap, barebones coverage outside the workplace, they would have a stronger incentive to stick with employer-based coverage (and their employers would have a much weaker incentive to drop coverage on their behalf).

On the downside, fixing the Administration’s tax credit so that it could cover at most 50 percent of the premium would reduce the number of very young or healthy people who would be induced to purchase insurance.  It would give them an incentive to purchase more expensive coverage with a richer set of benefits than might otherwise be available. 

However, we should not try to get health insurance to young, healthy people by discouraging employer-based coverage or encouraging low-rate benefits.  The better path toward universal coverage is to make mainstream group coverage affordable and easily available at every workplace (whether or not the employer helps pay for coverage) and in every state. 

Therefore, a second way to improve the Administration’s proposal would be to allow low-income workers to use the credits toward the purchase of employer-based coverage.  Since employer-paid health premiums are already excluded from employees’ incomes, the caps on tax credits for employer-subsidized coverage should be lower than those for individual coverage.  That would keep the tax treatment of employer coverage and individual coverage roughly equal, and thereby eliminate incentives tilted toward one form of coverage.

Finally, the tax credits should be administered—at least as an option—through the workplace.  All employees, on their first day on the job and each year thereafter, should receive an enrollment form for health insurance.  At the very least, that enrollment form should contain a menu of options.  States should take on the role of ensuring that options for reasonably priced group coverage were available, ideally through purchasing groups.  A special version of the Federal Employees Health Benefits program could be used as a backup, if states didn’t ensure a choice of coverage was available.

Employers who sponsor coverage would deduct premiums from employees’ paychecks, as they do now.  In addition, they would add back to an employee’s pay the tax credit for which the employee was eligible, up to the amount of the employee’s share of the premium.  In effect, companies would give tax credits to their employees as they purchased coverage, right on their paychecks.  The government would pay employers back contemporaneously, through bookkeeping adjustments in the amounts withheld and sent to the federal government for employees’ tax payments. 

Employers who do not sponsor coverage would nevertheless give their employees enrollment forms for at least one menu of health plans.  (Those employers could provide options from other insurance companies or groups, but at the very least would supply a form for a menu of health plans put together by the state.)  Like firms that sponsor coverage, they would handle payroll deduction of premiums, forwarding those payments to the purchasing group.  They would also add back to employees’ paychecks the tax credits for which the employees were eligible.  Again, the company would be reimbursed for the tax credits via its business tax arrangements.

How would employers know whether or not an employee was eligible for a tax credit?  The employee’s hourly wage could be used as a guideline.  A schedule of hourly wages could be drawn up to match the Administration’s annual earnings limits.

Tax credits provided on employees’ paychecks should probably also be reconciled on their end-of-year tax returns.  At the end of the year, the company would show the amount added to workers’ pay from the tax credit on their W-2 forms.  Then workers would file for the tax credit on their tax returns; that would be the final determination of exactly how much they would receive.  The IRS could add a worksheet on the W-4 form so that employees with multiple jobs or a spouse who works could figure an appropriate amount to add to their pay.

Reconciling tax credits advanced through the workplace or health insurers could reduce the number of people willing to take them in the first place, if they feared having to pay the money back at the end of the year.  But it would also allow workers whose employers paid 100 percent of the premium for health insurance (and received less in wages as a result) to share in the credit.  That is the only truly fair way to distribute tax credits, and it would ensure there were no incentives for employers to reduce the share of health premiums they pay.

Conclusion

While the latest economic indicators signal improvement, I believe for several reasons that the economic recovery is likely to be weak, and unemployment will keep rising for some time.  Meanwhile, after a long period of slow growth, health insurance premiums are increasing rapidly.  The combination of a slow economic growth and rising health premiums will cause the number of the uninsured to rise, perhaps significantly.

The PPI strongly supports the effort to make refundable tax credits an integral part of a renewed drive toward universal health coverage.  I encourage committee members to increase the subsidy level of the temporary tax credit for displaced workers from 60 percent to 75 percent or more, to better ensure that few workers would lose health coverage and that employers’ health costs would be reduced.  The Administration’s proposal for permanent credits for individual health insurance should be expanded to include employment-based coverage, and should also be made available through payroll deduction at the workplace.  In any event, the percentage of the premium for those tax credits should be reduced from a high of 90 percent to a flat 50 percent to encourage comprehensive coverage.