The Washington Post editorializes today:
Unlike wages, health coverage is not subject to income or payroll taxes. This exclusion is the single largest subsidy in the tax code; it is projected to reduce federal tax revenue (both income and payroll taxes) by more than $200 billion next year. This arrangement is not only costly, it is also unfair. Because higher-paid workers are taxed at higher rates, they enjoy a larger benefit from not having to pay taxes on the health insurance they receive. Furthermore, the exclusion is counterproductive: tax-free health benefits encourage employers to provide more compensation in the form of health insurance and encourage insured individuals to use more health care than they would if they had to pay with after-tax dollars. The result is higher health-care costs.
We couldn’t agree more. Heritage fellows Greg D’Angelo and Robert E. Moffit wrote in March:
If there is one area in health policy where there is a powerful consensus among serious analysts, conservative and liberal alike, it is the need to change the existing tax treatment of health insurance. President Ronald Reagan first proposed a change to the tax law governing health insurance in 1983, but Congress never acted on the proposal. Six years later, analysts at The Heritage Foundation unveiled a national health reform proposal grounded in comprehensive tax reform. Now, the idea could—depending on its details—potentially serve as the basis of a bipartisan compromise on health reform in the coming months.
The current tax treatment of health insurance is a byproduct of wage and price controls imposed by the Roosevelt Administration during the World War II era. The federal tax code currently excludes, without limit, the value of employer-sponsored health insurance from an individual’s income for the purposes of both income and payroll taxes. This tax exclusion for employer-sponsored insurance is a huge, but hidden, tax subsidy. The Joint Committee on Taxation estimated that value of the tax exclusion in 2007 was $246.1 billion in foregone income and payroll taxes.
The tax treatment of health insurance also has the perverse effect of increasing health care spending and driving up costs by essentially lowering the effective price of employer-sponsored health insurance. The exclusion does encourage individuals to obtain insurance. But it also encourages many individuals to have more generous insurance than they typically need, because the higher the cost of the insurance and the higher the person’s income, the bigger the tax benefit for the individual
The best way to change the current tax treatment would be to replace the existing tax exclusion with a more equitable and efficient system of individual tax relief, leveling the playing field for robust competition among insurers and creating a level of consumer choice that is routine in every other sector of the American economy.
Short of that, Congress could limit or cap the exclusion, perhaps only for income tax purposes, while simultaneously using the new revenue to provide health care tax credits for taxpaying households.