CRS OUTLINES TAX OPTIONS FOR HEALTH CARE REFORM.

                       UPDATED AUGUST 11, 1993

Bills providing for changes in Federal tax law to promote financial access to insurance coverage and medical services or to contain health care costs are likely to be among those receiving serious consideration by the 103rd Congress as it begins its work on health care reform. A program of tax credits and deductions was the cornerstone of President Bush's health care reform plan and tax-based measures are likely to be part of President Clinton's reform proposal, expected to be sent to Congress later this year.

Under current law, the Federal Government provides incentives to employers to furnish health insurance by treating the cost of insurance as a deductible business expense and by excluding employer- provided benefits from taxable employee income. In addition, individuals may deduct medical expenses, including health insurance premiums, to the extent to which those expenses exceed 7.5% of adjusted gross income. Low-income families may also receive a tax credit for part of the costs of purchasing coverage for children. In 1993, the reduction in Federal revenues resulting from the individual medical expense deduction and the exclusion of employer-provided benefits from employees' taxable income will total close to $50 billion.

Proposals to modify the current tax treatment of health insurance have arisen in the context of the broader debate over how to provide health coverage to the uninsured (35.4 million in 1991) while controlling the growth in national health spending, projected to reach $940 billion, or 14% of gross domestic product, in 1993. Tax system changes may serve either of these two broad objectives. On the one hand, enhancement of existing deductions and credits could encourage individuals to purchase coverage or employers to provide it to their workers. On the other hand, limits on the favorable tax treatment already provided for health coverage could encourage restraint in personal health spending. While the two goals appear to be in conflict, many proposals embody both approaches, using savings from limiting tax benefits for some individuals in order to expand tax benefits for others.

This approach is found, for example, in plans developed by the Heritage Foundation, Mark Pauly of the American Enterprise Institute (AEI), and several 102nd and 103rd Congress bills. Some proposals view changes in the tax system as a way of restructuring incentives for health care consumers and providers. This approach is a central component of some of the "managed competition" plans now under discussion, such as the "Jackson Hole" and Conservative Democratic Forum plans. Changing consumer incentives is also important to proponents of medical savings accounts (MSAs), but with a different insurance market resulting than that envisioned under managed competition.

Tax initiatives have been incorporated in legislation passed by the 103rd Congress. The conference agreement for the Omnibus Budget Reconciliation Act of 1993 (H.R. 2264, P.L. 103-66) extends the 25% deduction for self-employed businesses through Dec. 31, 1993; it also eliminates what many say was an unworkable health insurance component of the Earned Income Tax Credit. Many bills are pending that use tax system approaches to increase access to health insurance or contain health care costs.

MOST RECENT DEVELOPMENTS

THE CONFERENCE AGREEMENT FOR THE OMNIBUS BUDGET RECONCILIATION ACT OF 1993, H.R. 2264, INCLUDES AN EXTENSION OF THE 25% HEALTH INSURANCE DEDUCTION FOR THE SELF-EMPLOYED (WHICH EXPIRED JUNE 30, 1992) THROUGH DEC. 31, 1993, AND A REPEAL OF THE HEALTH INSURANCE COMPONENT OF THE EARNED INCOME TAX CREDIT (EITC). PRESIDENT CLINTON SIGNED H.R. 2264 INTO LAW ON AUG. 10, 1993 (P.L. 103-66). ON A SEPARATE TRACK, BILLS HAVE BEEN INTRODUCED TO INCREASE THE SELF- EMPLOYED DEDUCTION TO 100% AND MAKE IT PERMANENT. OTHER TAX-BASED PROPOSALS TO INCREASE ACCESS TO HEALTH INSURANCE OR CONTAIN HEALTH CARE COSTS HAVE ALSO BEEN INTRODUCED.

BACKGROUND AND ANALYSIS

Numerous bills have been introduced in the 103rd Congress providing for changes in Federal tax law to promote financial access to insurance coverage and medical services or to contain health care costs. Some bills provide for incentives through credits and deductions. Others use tax penalties, such as limits on current-law credits or deductions, for failure to comply with certain requirements, such as providing health insurance benefits in excess of some specified limit. Still others, such as medical savings account proposals, allow individuals to set aside pre-tax earnings in special accounts to be used to pay for medical expenses. Many of these measures are stand-alone approaches to health care reform; others are part of broader initiatives.

President Bush's proposal to expand access to health insurance used refundable tax credits (combined with an expanded deduction for higher income persons) to encourage individuals to purchase insurance. The health care reform plan advanced by President Clinton during the 1992 campaign would provide tax credits and deductions to help offset the cost to small businesses of providing health insurance to their employees. So far, it looks like these measures will be in the plan President Clinton sends to Congress later this year.

Two tax-based health care initiatives were incorporated in bills passed by the l02nd Congress but vetoed by President Bush. One would have extended the 25% deduction for self-employed businesses. The second would have allowed withdrawals from individual retirement accounts (IRAs) to pay for qualified medical expenses without incurring a tax penalty. In the 103rd Congress, the conference agreement for the Omnibus Budget Reconciliation Act of 1993 (OBRA of 1993, H.R. 2264, P.L. 103-66) extends the 25% deduction for the self- employed through Dec. 31, 1993. Other tax-based approaches to expanding coverage and controlling health care costs are likely to be among those seriously considered by the 103rd Congress.

CURRENT FEDERAL TAX LAWS

Under current law, the Federal Government provides incentives to employers to furnish health insurance by treating the cost of insurance as a deductible business expense and by excluding employer- provided benefits from taxable employee income. In addition, individuals may deduct medical expenses, including health insurance premiums, to the extent to which those expenses exceed 7.5% of adjusted gross income. Low-income families may also receive a tax credit for part of the costs of purchasing coverage for children.

EMPLOYER EXCLUSION. The Internal Revenue Code excludes from taxable income of workers all contributions made by employers on their behalf to health and accident plans. (Employer-provided health insurance would otherwise be treated as an alternative to wages and salaries and thus treated as taxable income.) Contributions are also excluded from the wage base for determining Social Security taxes.

EMPLOYER BUSINESS EXPENSE DEDUCTION AND SELF-EMPLOYED DEDUCTION. Employers may deduct as an ordinary business expense 100% of the contributions made on behalf of their employees for health benefits. The self-employed whose businesses are not incorporated may deduct as a business expense the full cost of coverage for employees, but not for themselves and their families. Instead, the self-employed were, until June 30, 1992, provided a separate deduction on their tax returns, limited to 25% of the amounts paid for health insurance for themselves, their spouses, and their dependents when calculating their adjusted gross income for the taxable year. The deduction was not allowed if the self-employed person was also eligible to participate in any subsidized health plan of another employer or the employer of his/her spouse. The amounts deductible did not reduce the income base for computation of the self-employed individual's Social Security tax.

The 25% deduction for the self-employed was added to the Code by the Tax Reform Act of 1986 (P.L. 99-514) and was originally scheduled to apply only to tax years ending on or before Dec. 31, 1989. The deduction was repeatedly extended, but was allowed to expire in 1992 when President Bush vetoed a bill, H.R. 4210, which included a one- year extension. On May 27, the House passed OBRA of 1993, H.R. 2264, which included an extension from June 30, 1992 through Dec. 31, 1993. The Senate also included this 18-month extension in its version of OBRA 93, passed on June 24, 1993. The 18-month extension was preserved in the conference agreement, passed by the House on Aug. 5, and the Senate on Aug. 6, and signed into law (P.L. 103-66) by President Clinton on Aug. 10, 1993.

HEALTH INSURANCE TAX CREDIT. The Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508) created a small tax credit for low-income persons buying coverage for children. This tax credit is a supplement to the earned income tax credit (EITC), a "refundable" credit for families with children whose incomes are below $22,370 in 1992. If the EITC for a family is greater than the family's tax liability, the excess is payable to the family. Those who are eligible may also elect to receive advance payments over the course of the year, instead of waiting for a refund in the following year. The supplemental health insurance credit is available for families eligible for the EITC who buy coverage that includes qualifying children. The maximum credit is $451 for families with earned incomes below $11,840 in 1992; the credit is reduced as families approach the $22,370 income limit. Because the credit first became available only in 1991, there are not yet any estimates of the number of families taking advantage of it. Reportedly, however, its complexity has discouraged its use; also problems have arisen with respect to the marketing of policies that do not qualify for the credit. President Clinton proposed that the Health Insurance Tax Credit be terminated, with the savings applied to an expanded and reformed EITC program. This policy was adopted in the House- and Senate-passed versions of OBRA of 1993 (H.R. 2264), as well as the conference agreement (P.L. 103-66).

MEDICAL EXPENSE DEDUCTION. Individuals who itemize deductions on their Federal income tax returns have been able to deduct nonreimbursed medical expenses (including insurance premiums) above a specified floor since 1942. From 1954 through 1982, the floor for the medical expense deduction was 3% of the taxpayer's adjusted gross income (AGI). A separate floor of 1% of AGI applied to nonreimbursed expenditures for medicine and drugs. Under the Tax Equity and Fiscal Responsibility Act of 1982 (P.L. 97-248), the overall floor was increased to 5% of AGI, and was applied to the total of all eligible medical expenses, prescription drugs and insulin. The separate floor for medicine and drug expenses was eliminated. In addition, nonprescription drugs were made ineligible for the deduction. Under the Tax Reform Act of 1986 (P.L. 99-514), the floor for the medical expense deduction was increased to 7.5% of AGI, beginning in 1987. The deductions can be taken for medical care of the taxpayer and of the taxpayer's spouse and dependents. Thus, current law permits taxpayers to deduct the costs of health care that are, in effect, catastrophic as measured against family income.

FEDERAL TAX EXPENDITURES. The reductions in Federal revenues resulting from favorable treatment of certain types of private spending are often referred to as "tax expenditures;" the term reflects an assumption that the tax provisions achieve indirectly objectives that might also have been achieved through direct expenditure programs. Federal tax expenditures for the medical expense deduction and the exclusion of employer-provided benefits from employees' taxable income are projected by the Joint Committee on Taxation to total $49.5 billion in 1993. (This figure excludes lost Social Security payroll taxes, because higher collections now would mean higher benefit payments later.) The low-income health insurance tax credit will cost $0.7 billion. The self-employed health insurance deduction, if it had been extended at the 25% level, would have cost another $200 million. No estimates are available for the general employer business expense deduction for the costs of employee health benefits. Federal health-related deductions and exclusions may also affect the revenues of those State and local governments that impose an income tax and that follow the Federal system.

TAX SYSTEM OPTIONS FOR HEALTH CARE REFORM

Proposals to modify the current tax treatment of health insurance have arisen in the context of the broader debate over how to provide health coverage to the uninsured (35.4 million in 1991) while controlling the growth in national health spending, projected to reach $940 billion, or 14% of gross domestic product, in 1993. Tax system changes may serve either of these two broad objectives. On the one hand, enhancement of existing deductions and credits could encourage individuals to purchase coverage or employers to provide it to their workers. On the other hand, limits on the favorable tax treatment already provided for health coverage could encourage restraint in personal health spending. While the two goals appear to be in conflict, many proposals embody both approaches, using savings from limiting tax benefits for some individuals in order to expand tax benefits for others. Some of these proposals view changes in the tax system as a way of restructuring incentives for health care consumers and providers. This approach is a central component of some of the "managed competition" plans now under discussion. It also underlies the design of plans that would establish MSAs.

MEASURES TO ENCOURAGE INSURANCE COVERAGE

Numerous proposals would create new Federal or State tax subsidies, or modify existing ones, to help individuals with the cost of health insurance (including, in some cases, the employee contribution required in most group health plans) or to encourage employers to provide coverage to their workers. Whether targeted at individuals or employers, tax incentive proposals rest on the assumption that assistance with the purchase of private insurance is preferable to direct public provision of health care coverage.

Proponents of this view believe that health care reform should build on the existing system of private coverage. They argue that a competitive private market is more likely than a government-operated system to promote efficiency and maintain quality. Those favoring public programs point out, however, that private insurance has high administrative costs (an average of 16.5% above medical benefits paid in 1990, compared to 2.1% for Medicare and 5.3% for Medicaid). Private insurers have expenses, such as marketing costs, that public programs do not incur, and must also build reserves and/or produce a profit for stockholders. These costs may be partially offset if private insurers are better able to control health care utilization or negotiate lower prices for medical services.

The goals met by tax subsidies could also be achieved through direct public grants to individuals or businesses to assist with the purchase of health coverage. The tax system provides a relatively simple way to transfer money to individuals and families. Tax subsidies could be administered using existing tax filing and refund procedures; they would not require the creation of new administrative agencies or procedures. However, new procedures would be required if, as in some tax credit proposals, assistance would also be provided on a means-tested basis to low-income persons who do not currently file tax returns.

INDIVIDUALS

Tax incentives for the individual purchase of health insurance could take either of two forms: an expanded deduction (which reduces the amount of income subject to tax) or a credit (which directly reduces the amount of tax paid).

The current medical expense deduction provides assistance only to taxpayers who itemize deductions on their returns instead of taking the standard deduction. Except for homeowners, most low-income and some middle-income taxpayers derive no benefit from the deduction, because their other potential deductions are insufficient to raise the total to an amount greater than the standard deduction. One proposal would be to allow direct deduction of medical expenses by taxpayers who do not itemize. However, the benefits for lower- income families would still be limited. For those in the lowest tax bracket, the deduction would subsidize no more than 15% of their premium costs, and it would provide no assistance to families whose incomes are so low that they have no income tax liability.

For this reason, most tax incentive bills use a tax credit instead of a tax deduction (exceptions include H.R. 144 and H.R. 403). To ensure that assistance would be available to lower-income families, most proposals call for a refundable credit: if the amount of the allowable credit exceeds an individual's tax liability, the difference is payable to the individual.

A refundable tax credit for low-income taxpayers (combined with an expanded deduction for higher-income persons) was the centerpiece of the health care proposal advanced by President Bush in February 1992. President Bush's plan would have provided a maximum credit of $1,250 for individuals and $3,750 for families with incomes below the minimum subject to Federal income tax; the maximum credit would have declined as family income rose. Families eligible for the maximum credit could have received a voucher to purchase coverage over the course of the year, instead of waiting until the end of the year to claim a refund. Each State would have been required to ensure that at least some basic plan would be available within the State at a price no greater than the maximum credit amount. The Bush Administration projected the total cost of the proposal to the Federal Government at $35 billion in 1997 dollars. Although this component of the Bush proposal was never submitted to Congress, H.R. 5335 closely resembled it. Refundable tax credits were included in a number of other 102nd Congress bills. They are also in H.R. 196 and S. 28, S. 631, and S. 728 introduced in the 103rd Congress.

Proposals similar to the Bush Administration plan may well receive further consideration in the 103rd Congress, and the issues raised by the plan remain of continuing interest in considering any tax credit approach toward expanding access to coverage. The first issue is that of adequacy: are the credits sufficient to encourage many individuals to purchase basic coverage? The Administration contended that market reforms and other cost containment proposals included in the plan would reduce the cost of insurance; critics of the plan argued that those assumptions were unrealistic and that larger subsidies were needed. They noted that the credit amounts phased down very rapidly with increasing income. It was not certain that low-income families receiving only a partial credit would be able or willing to make the additional expenditure needed to buy coverage. These concerns could be addressed by increasing the amount of the credits, but the cost to the Federal Treasury would also be increased. There is also a question of how much the credit amount should be allowed to grow in future years. If the credit keeps pace with growth in medical care spending, there may be no incentive for insurers or providers to improve efficiency; if the credit falls too far behind that growth, the value of the benefits it can purchase may decline from year to year.

A second question raised by tax credit plans is that of equity. Because health insurance costs vary by geography and by characteristics of the purchaser (such as age and sex), a fixed national credit amount might not allow all individuals to purchase comparable coverage. There may also be problems in targeting tax credits to avoid replacing existing public and private expenditures. Under the Bush Administration proposal, for example, some employers would have had incentives to reduce their contributions to premiums for low-income employees, because the employees could use credits to pay more towards their coverage. In addition, many poor individuals eligible for the maximum credit might have been shifted from Medicaid (with joint State/Federal funding) to a private plan purchased with the credit (solely Federal funding).

Finally, as was noted above, much of the amount distributed to individuals in the form of a credit would go to cover private insurers' administrative costs. For individually purchased coverage, these costs can be over 40% of benefits (compared to about 5% for the largest employer groups). The cost of a tax credit approach may therefore depend on whether the proposal includes some method for aggregating consumers into larger purchasing groups.

EMPLOYERS

Tax credits and deductions could also be used to influence employers' decisions regarding the purchase of health insurance. Such decisions can also be influenced through the use of tax penalties.

THE SELF-EMPLOYED TAX DEDUCTION. The likelihood of receiving health insurance from an employer is highly associated with a firm's size and organizational structure. Coverage rates decrease as firm size decreases; coverage is least likely for firms with fewer than 10 employees where the owner is self-employed. Many believe that health insurance coverage rates are lower for self-employed businesses because the owner of the firm is limited to a 25% personal income tax deduction for the costs of buying insurance for himself and his family.

While many bills were introduced in the 102nd Congress to extend the 25% deduction and/or increase it to 100%, in the end Congress voted to extend the 25% deduction for another year as part of the Revenue Act of 1992 (H.R. 11). H.R. 11 bill was vetoed by President Bush for reasons having nothing to do with this provision. President Clinton indicated support for full deductibility during the 1992 campaign.

In the 103rd Congress, efforts are being renewed to restore the 25% deduction and/or to increase the deduction to 100%. (One bill, H.R. 577, would increase the deduction to 50%.) Some bills phase in an increase in the deduction over several years; others provide for immediate full deductibility. Many proposals to increase [or] restore the tax deduction are freestanding: they are solely intended to treat the deductibility of health care costs for self-employed businesses. (See "Legislation" below.) Some are included in broader reform proposals. Under the conference agreement for OBRA of 1993 (H.R. 2264, P.L. 103-66), the 25% deduction has been extended from June 30, 1992 to Dec. 31, 1993.

Proponents of full deductibility for self-employed firms argue that it would equalize the treatment of employer-sponsored health insurance. They say it is unfair that a self-employed person whose gross income includes most of the value of employer-paid health insurance has less after tax income than an employee with the same wages, other fringe benefits and expenses, but whose income does not include the value of any employer-paid health insurance. Opponents might respond that in the case of the self-employed, the employee is also an owner, and can therefore decide on how they will be compensated. Giving the self-employed a larger deduction for health benefits might encourage such owners to substitute tax-free health insurance for taxable wages. Also, providing the 100% deduction could encourage the purchase of richer ("Cadillac") insurance plans, thus driving up utilization of medical services and fueling inflation of health care costs. While this problem could be eased by limiting full deductibility to those plans that include but do not exceed some specified set of benefits, enforcing such limits could be problematic.

Proponents of full deductibility also argue that the 100% deduction would increase the incentive for self-employed businesses to buy insurance for their workers. The National Federation of Independent Businesses estimates, for example, that uninsured workers would decline by 25 to 50% as a result of increasing the deduction to 100%. Others are skeptical that this tax change would produce such a significant reduction in uninsured workers and their dependents. While over 20% of uninsured workers and their families are linked to self-employed firms, full deductibility might not induce large numbers of self-employed businesses to buy insurance for their employees. Many self-employed firms are unprofitable and have no tax liability to offset by a deduction that is not refundable. Also, changing the self-employed deduction only affects the taxable amount of income of the self-employed proprietor; it does not alter the tax treatment of premiums paid for employees' coverage. Because the after-tax costs for health insurance decline as the number of employees rise, full deductibility would most heavily benefit those firms where the proprietor is the only employee, and least benefit those with more than a few employees. Raising the deduction to 100% also raises budget issues. CBO estimates that the cost of extending the 25% deduction effective July 1, 1992 through Dec. 31, 1993 is $566 billion in FY1994. In March 1992, the Congressional Joint Committee on Taxation estimated that the cost of increasing the deduction to 100% is $1.7 billion for FY1994 and $1.2 billion for FY1995.

TAX CREDITS FOR SMALL BUSINESSES. Some proposals would provide tax credits to employers to offset some of the cost of providing health insurance to their employees and their employees' families. (See 102nd Congress bills H.R. 5536, S. 1227, S. 1936 and S. 2114. The Clinton health reform proposal is expected to include tax credits for small businesses.) Credits can be more effective than deductions in changing behavior because the amount of the credit does not necessarily depend on a firm having a tax liability. Eligible firms -- even those with no profits on which to pay taxes -- could still receive a credit to offset some portion of their employee health benefit costs. Tax credits can stand alone or be used in conjunction with other approaches to expanding coverage, such as pay-or-play proposals, private insurance market reform, or a combination of tax credits and deductions for individuals and businesses.

Different tax credit designs are possible, depending on the objective. Most are intended to ease the burden of providing health benefits on smaller employers, often defined as firms with 100 or fewer employees. Some bills draw the line at 50 employees, some at 25. The credit can be made available to all such small employers, only those newly providing health insurance, or those meeting specific requirements, such as those participating in a small employer purchasing group. If the credit were available to all small employers, private dollars now spent for coverage would be replaced by public dollars. If the credit were limited to currently uninsured firms, the public subsidy resulting from the tax credit would be more directly targeted on reducing the number of uninsured workers and their families. However, firms not receiving the credits because they already provided coverage could argue that they would be treated unfairly and could be placed at a competitive disadvantage. Some bills, such as S. 1227 in the 102nd Congress, further limit the availability of the tax credit to only those small firms for whom the cost of providing health insurance represents a significant financial obligation, measured either as a specified percentage of payroll or profits or some combination of both.

The design of the tax credit may also reflect other objectives such as encouraging the purchase of various types of insurance benefits and/or encouraging the containment of health care costs. Some proposals limit the tax credit for the purchase of qualified plans, meaning a specified benefit package, specified cost-sharing in the form of deductibles and coinsurance, a package that includes managed care elements, and/or some other feature that may be desired because of its effects on the cost or quality of care. Some proposals make the credit available on an ongoing basis. Others phase it out as other elements of the proposal take effect.

The effects of tax credits on coverage rates are unclear. Under a voluntary program in which the credits are used as an incentive for employers to buy coverage, much depends on the size of the subsidy provided through the tax credit, the cost of insurance, awareness of the credit, and other factors such as whether changes are made to the private insurance market to make insurance more available. State and local experiments using direct small employer subsidies such as tax credits to encourage the purchase of health insurance have produced only modest increases in coverage. Under a compulsory program, such as an employer mandate or play-or-pay requirement, the tax credits could offset some of the cost of providing coverage, thereby reducing adverse effects of the mandate on eligible employers and their employees.

OPTIONS TO CONTAIN COSTS AND/OR FINANCE EXPANDED COVERAGE

TAXING EMPLOYER-PAID HEALTH INSURANCE. As noted above, when an employer pays part or all of the health insurance benefits or premium for an employee, the employee is not taxed on the employer's contribution. Instead, the contribution is wholly excluded from the employee's statement of wages and salary. The tax-free status of employer-paid health benefits has been credited with encouraging the growth of health plans offered through the work place, so that today, about 65% of the nonaged population is covered by employer-sponsored health insurance.

Some lawmakers and health policy experts have proposed the elimination of the exclusion (see S. 3348 from the 102nd Congress and "Heritage Foundation" below). Another possibility is to place a limit on the amount of contributions that can be excluded from an employee's taxable income (see, for example, H.R. 834 and S. 325 from the 103rd Congress). The limit is often referred to as a "tax cap."

Some advocates of eliminating or limiting the exclusion focus on the potential revenue gains, while others focus on the implications for health policy, contending that the current exclusion stimulates medical care inflation by encouraging excess insurance coverage. Opponents of changing the treatment of employer contributions argue that the loss in foregone revenues to the Federal Treasury ($46.4 billion in 1993) is far outweighed by the value of the benefits to employees.

There are at least two ways of limiting the tax exclusion for health benefits. One is to set a fixed dollar limit on employer contributions and tax any contribution in excess of that limit. Another option is to define a minimum standard benefit package and tax contributions to a plan whose benefits exceeded that standard. Either option could be applied to all taxpayers or limited to higher- income taxpayers. However implemented, a tax cap would theoretically change the way employees assessed the value of insurance coverage. The current exclusion has meant that each additional dollar of health benefits is worth more than a dollar of wages. As a result, workers negotiating a total compensation package may opt for more insurance than they would purchase if they had to use after-tax dollars. A tax cap might shift the balance back towards wages.

From a revenue standpoint, it would make no difference whether employees chose to continue receiving health benefits in excess of the tax cap or chose to convert the excess into wages. The Treasury would gain either way (but would not gain if workers shifted their health insurance dollars to some other form of tax-free compensation). From a health policy standpoint, however, the choice between wages and benefits is an important one. Would employees reduce their insurance coverage in response to a tax cap, and would any such reductions change the way they used medical services? Precisely because the current system has been in place for so long, there is little empirical evidence about how much coverage people would buy in the absence of a tax subsidy, or how they might change their coverage if pressured to reduce it. The effects of a tax cap on the medical care system are, then, less predictable than the effects on revenues.

LIMITING EMPLOYERS' DEDUCTIONS FOR MEDICAL INSURANCE. Another option would be to eliminate or cap the amount an employer is allowed to deduct as a business expense for providing employee health benefits. For example, in the 102nd Congress, H.R. 3892 would have denied the deduction to an employer's group health plan that discriminates against adopted children. H.R. 2264 would have denied the deduction for self-insured health plans that discriminate against services performed by chiropractors. S. 2346 and H.R. 5174 would have denied the deduction in the case of employer plans that do not meet specific benefit qualifications. S. 3348 would have limited the deduction to an overall per employee dollar amount. H.R. 191, H.R. 1976, and S. 631 in the 103rd Congress would deny the deduction for providing coverage in excess of a defined minimum benefit package. The effectiveness of reducing or eliminating the deductibility of premium contributions in influencing employers' decisions regarding health benefits would vary with the value of the deduction as well as other factors, such as the employer's need to provide comprehensive benefits to attract and retain employees.

MEDICAL SAVINGS ACCOUNTS (MSAs). A different cost containment approach is captured in bills providing for medical spending accounts (MSAs). (See, for example, 103rd Congress bills: H.R. 101, H.R. 150, H.R. 192, and S. 1105.) The MSA approach is based on the assumption that spending on health care is out of control because consumers are shielded from the costs of care by their health insurance plans, the direct costs of which are fully or partially paid by employers. (Indirectly, employees may be paying through foregone wage increases.) To sensitize consumers to the costs of care, they must be placed in the position of paying directly for that care.

Under most MSA proposals, employers would be allowed to pay the amounts they currently spend on employee health benefits directly to their employees. This amount would not be included as taxable wages to the employee, and would be deductible by the employer as a normal business expense. Employees would then set up their own MSAs and buy their own insurance policies. Workers and their families could use their MSAs to pay for all routine medical services; any unused funds could remain in the account, collecting interest (usually tax-free), and withdrawn later to pay for medical expenses. Funds withdrawn for other purposes would be treated as taxable income (much like early withdrawals for individual retirement accounts). Insurance policies would only cover catastrophic medical expenses, defined as expenses in excess of a specified threshold. Some MSA proposals would also provide federal subsidies to those in need to assist them in buying the catastrophic insurance.

In addition to containing costs, proponents of the MSA approach say that it would make insurance more portable than today's employer- sponsored health plans, because employees could, in effect, take their accounts with them. Moreover, employers would no longer have to bear the administrative burdens of setting up health plans, negotiating with insurers, and/or paying claims. Their principal role would be a financial one: to make contributions to employees' MSAs. Also, MSAs could provide greater benefit flexibility than typical employer-sponsored health plans. Employees would not be limited to one or a few insurance plans offered by an employer. They would instead have the entire market of insurers and their catastrophic plans from which to choose.

Opponents of MSAs say that their cost containment potential is greatly overstated. They argue that the consumer has relatively little influence over the intensity and volume of medical services. It is, instead, the physician who makes the most critical buying decisions. Also, they say, it is not clear whether many consumers are willing to buy the economy model of medical care. They might prefer the more expensive physician or hospital, making an assumption that cost and quality are linked. Another problem is that under the MSA approach, individuals do not have the bargaining power to obtain the kinds of discounted rates that are negotiated by large employers and insurers with providers. Some critics also argue that MSAs are incompatible with managed care arrangements, such as health maintenance organizations (HMOs), and thus go against effective cost containment. HMOs, for example, try to control costs by managing care from the time the patient enters the health care system. By the time catastrophic coverage is needed -- the point at which insurance is triggered under the MSA approach -- it is too late in the episode of care to manage.

Opponents also question other claims made by MSA advocates. They say that while the MSA itself might be portable, the source of financing would still be employer-dependent, and thus unpredictable. Some employers might not contribute; others might make inadequate contributions. Another concern is that the MSA approach moves people out of group insurance into the more expensive and less reliable individual insurance market to buy catastrophic policies. This could cause significant disruptions in coverage. Finally, opponents argue that because the MSA approach only shifts current employer dollars from one system to another, it appears to do nothing to expand access to coverage for America's 35 million uninsured, and could lead to increased numbers of uninsured if the solvency of MSA accounts were dependent upon the continuity of employer contributions.

TAX INCENTIVES AND COMPETITIVE APPROACHES TO UNIVERSAL COVERAGE

Numerous proposals have been advanced that combine limits on the favorable tax treatment of employer-provided coverage with subsidies (whether or not tax-based) for the purchase of individual coverage. Several bills in the 102nd Congress adopted this approach, including H.R. 5936 (Representative Cooper, the Conservative Democratic Forum or CDF proposal), H.R. 5989 (Representative McEwen), and S. 3348 (Senator Hatch). It is also incorporated in S. 223 (Senator Cohen), introduced in the 103rd Congress. Similar proposals have been developed by trade associations, academics, and others. Among the more widely discussed are the Jackson Hole plan (by Alain Enthoven, Paul Ellwood, and Lynn Etheredge), a plan by Mark Pauly and his colleagues (sometimes referred to as the American Enterprise Institute or AEI proposal), and the Heritage Foundation plan.

All these proposals assume that the existing tax treatment of employer-provided health insurance creates inequity in the government subsidization of health care costs (because the tax benefits increase with income) and fuels health care inflation by shielding individuals from the costs of their medical care purchasing decisions. By shifting some or all Federal assistance (whether tax or non-tax) away from employer-based plans and towards individuals, they seek to ensure that every American has basic health coverage, regardless of employment status. (They may also address "job lock," workers' reluctance to change jobs because of a fear of losing health benefits.) However, the major focus of the competition proposals is on cost containment: they seek to encourage individuals to be cost- conscious in their choice of health insurance and/or in their use of medical services by giving them a more direct financial stake in those decisions. All the plans assume that, if consumers are given a financial stake in their health care purchasing decisions, the market will respond: health care providers and/or insurers will compete on the basis of price and quality.

Proposals to restructure financial incentives and promote competition have been debated for many years. For example, Ellwood and Enthoven each advanced early versions of their current proposal in the 1970s. Several basic concerns have been raised about the competitive approach in the past. First, individual consumers may not have sufficient information or sophistication to compare the relative quality of different health plans; even price comparisons may be complicated if different insurers offer different benefit packages. Second, insurers may be able to compete, not on the basis of quality or efficiency, but on the basis of their ability to attract low-cost enrollees and screen out those presenting higher risks (by rejecting some individuals, imposing waiting periods for coverage of preexisting conditions, or charging high-risk enrollees prohibitive premiums). Third, as was noted earlier, administrative costs for individual coverage are much higher than for group coverage, and may offset any expected savings from competition.

Each of the proposals attempts to address some or all of these concerns. All the plans call for a uniform minimum benefit package, to facilitate comparison among competing insurers. All except the Heritage and Pauly proposals would regulate insurance underwriting practices, to limit the ability of insurers to screen out high-risk applicants. (Pauly suggests, in lieu of regulation, that higher-risk individuals might be given more tax assistance to meet the higher premiums they would have to pay.) The Jackson Hole and CDF plans go further, proposing the development of structured systems for what they term "managed competition." (See CRS Issue Brief 93008, Health Care Reform: Managed Competition, by Mark Merlis.)

Under managed competition, employers or other purchasers of health insurance would be grouped together in cooperative buying arrangements known as health insurance purchasing corporations or cooperatives (HIPCs). Individuals participating in the arrangement would have a choice among different health care plans and would be given a financial incentive to select the least costly plan. Plans would have uniform benefits, so that in theory any price differences would reflect relative efficiency. Proponents of this approach assume that the less costly plans would resemble health maintenance organizations (HMOs), which provide care through a restricted network of affiliated providers. Consumers wishing to select a less restrictive and more costly plan would have to pay the added costs from their own funds, without tax assistance. (It should be noted that not all managed competition plans involve tax system changes. Senator Bingaman's proposal (S. 3300 in the 102nd Congress) and President Clinton's campaign proposal used other means to encourage the choice of efficient plans.)

Critics of this approach argue that the evidence of savings from managed care is limited and that systems offering multiple choices of plans may be subject to "biased selection." All the young and healthy people may wind up in HMOs or other restrictive plans, while the older and sicker enrollees stay with the conventional plan and continue to incur high costs. Proponents of managed competition suggest adjusting premium rates to correct for this problem; however, it is not yet certain that adequate methods are available. (For a full discussion of the cost-saving potential of managed care, see CRS Report 90-64, Controlling Health Care Costs.)

The following is a brief summary of the major tax-based plans advanced to date.

HERITAGE FOUNDATION PLAN. Under the Heritage plan, the existing tax exclusion for employer contributions for health insurance would be phased out and replaced with refundable tax credits, the amount of which would be tied to a family's income, insurance premiums, and other health care expenses. Credits could be used both for insurance premiums and for payment of out-of-pocket expenses. Lower-income families with high medical expenses would be most favored by the credits; high-income families with low medical expenses would be least favored. All Americans would be required to enroll in a health insurance plan containing Federally prescribed benefits, including coverage for catastrophic expenses, hospital and physician services, and routine preventive care. Plan deductibles and coinsurance could not exceed 10% of a family's income and would be offset by the tax credits. Medicare would be continued for the elderly and disabled, Medicaid for eligible low-income persons.

PAULY PLAN. The Pauly (or AEI) plan also repeals the tax exclusion of employer-provided health benefits and provides income- based tax credits to assist individuals in purchasing plans providing minimum federally specified benefits. There are at least four major differences between this and the Heritage plan. First, employers would be required to perform some administrative functions to facilitate employees' purchase of coverage. Second, tax credits could be used only to subsidize premiums and not to pay for medical services. Third, cost-sharing requirements under the minimum benefit package would be inversely related to enrollees' income. Finally, the amount of tax credits might be adjusted to reflect the level of health risk presented by each individual, in order to reduce the incentives for insurers to exclude potentially costly applicants.

H.R. 5989/S. 3348 (102nd CONGRESS). The McEwen-Hatch proposal resembles the Heritage plan: it phases out the employer exclusion and provides a tax credit that can be used both for purchase of a basic health plan and for direct payment of medical expenses. However, the size of the credit is not related to income, and the maximum amount is limited to 80% of the first $275 in premiums per person, 18% of remaining premiums, and 18% of health care costs not covered by health insurance. The bill includes stronger measures than the Heritage and Pauly proposals to ensure that coverage will be available to individuals receiving the credit. States would be required to establish programs to provide coverage (with income- related premiums) for the uninsured; the bill also includes regulation of underwriting and rating practices of small group insurers.

JACKSON HOLE PLAN. The Jackson Hole proposal would limit the employer exclusion to the cost of the lowest-priced plan available through the HIPC in the area (whether or not the employer's plan was actually purchased through the cooperative). Employers would be required to contribute towards coverage of their full-time workers and dependents; any difference between the employer's contribution and the total premium for the lowest-priced plan would be deductible for the individual. Non-tax system government subsidies would be available to help persons without employer coverage purchase a HIPC plan.

H.R. 5936 (102nd Congress). The CDF proposal is based on the Jackson Hole plan, but differs from it in at least two key features. First, employers would not be required to contribute towards employee coverage. Second, instead of limiting the exclusion of employer contributions from employees' taxable income, the plan imposes a tax penalty on an employer whose contributions exceed the cost of the lowest-price HIPC plan.

LEGISLATION

This summary does not include bills that solely treat the health insurance tax deduction for the self-employed. These are: H.R. 162 (Grandy); H.R. 264 (McCandless); H.R. 577 (Bereuter); H.R. 679 (Holden); H.R. 815 (Barrett); H.R. 836 (Hutchinson); H.R. 912 (Peterson); H.R. 1695 (Carr); H.R. 2336 (Lambert); H.R. 2497 (Frank); S. 339 (Baucus); S. 360 (Dorgan); S. 381 (Daschle); S. 571/S. 572 (Durenberger).

Please note that many of the following bills include more than tax system changes.

P.L. 103-66, H.R. 2264

Omnibus Budget Reconciliation Act of 1993. Section 14131 repeals the health insurance component of the Earned Income Tax Credit, effective for taxable years beginning after Dec. 31, 1993. Section 14173 extends the self-employed deduction effective July 1, 1992 through Dec. 31, 1993. Introduced May 25, 1993; referred to Committee on the Budget. Passed House May 27, 1993. (See H.Rept. 103-111.) Incorporates the Ways and Means reconciliation provisions, H.R. 2141 and its earlier version, H.R. 1960. Section 8131 of the Senate amendment repeals the health insurance component of the Earned Income Tax Credit, effective for taxable years beginning after Dec. 31, 1993, and Section 8175 extends the self-employed deduction effective July 1, 1992 through Dec. 31, 1993. Passed Senate June 24, 1993. (See S.Rept. 103-36.) Conference report (H.Rept. 103-213) passed House Aug. 5 and Senate Aug. 6, 1993 (see Sections 13174 and 13131). Signed by the President on Aug. 10, 1993.

H.R. 30 (Grandy)

Universal Health Benefits Empowerment and Partnership Act of 1993. Provides for phase-in of 100% deductibility for self-employed. Introduced Jan. 5, 1993; referred to Committees on Education and Labor, Energy and Commerce, and Ways and Means.

H.R. 101 (Michel)

Action Now Health Care Reform Act of 1993. Provides for phase-in to 100% deduction for self-employed and allows tax-free employer contributions to MSAs. Introduced Jan. 5, 1993; referred to Committees on Ways and Means, Energy and Commerce, Judiciary, and Education and Labor.

H.R. 144 (Cox)

Provides for full deductibility for individuals of unreimbursed medical expenses. Introduced Jan. 5, 1993; referred to Committees on Ways and Means, Judiciary, and Energy and Commerce.

H.R. 150 (Hastert)

Health Care Choice and Access Improvement Act of 1993. Allows a tax deduction for contributions to MSAs and for premiums for a catastrophic health insurance policy; expands the self-employed deduction to 100% and makes permanent. Introduced Jan. 5, 1993; referred to Committees on Ways and Means, Energy and Commerce, and Judiciary.

H.R. 191 (Gekas)

American Consumers Health Care Reform Act of 1993. Taxes employer health benefits in excess of a minimum package and provides 100% deduction for self-employed for costs of that package. Introduced Jan. 5, 1993; referred to Committees on Ways and Means, Energy and Commerce, Education and Labor, Judiciary, and Rules.

H.R. 192 (Gunderson)

Farm and Rural Medical Equity Reform Act of 1993. Allows a tax deduction for contributions to MSAs and for premiums for a catastrophic health insurance policy. Provides for 100% self-employed deduction. Introduced Jan. 5, 1993; referred to Committees on Ways and Means and Energy and Commerce.

H.R. 196 (Houghton)

Health Equity and Access Improvement Act of 1993. Creates refundable health insurance tax credit, makes insurance fully deductible for individuals; restores 25% self-employed deduction. Introduced Jan. 5, 1993; referred to Committees on Ways and Means, Energy and Commerce, and Judiciary.

H.R. 200 (Stark)

Health Care Cost Containment and Reform Act of 1993. Restores 25% self-employed deduction effective July 1, 1992 and increases to 100%, effective for taxable years after Dec. 31, 1993. Introduced Jan. 5, 1993; referred to Committees on Ways and Means, Energy and Commerce, and Education and Labor.

H.R. 403 (Solomon)

Permits tax deduction for up to $3,000 in health insurance premiums without regard to current requirement that medical expenses are deductible only when they exceed 7.5% of adjusted gross income. Introduced Jan. 5, 1993; referred to Committee on Ways and Means.

H.R. 1965 (Regula)

Universal Coordinated Care Act of 1992. Includes IRA-like accounts for long-term and catastrophic care. Introduced May 4, 1993; referred to Committees on Ways and Means and Energy and Commerce.

H.R. 1976 (Thomas of WY)

Comprehensive Health and Rural Equity Act of 1993. Limits employer deduction and employee inclusion for benefits beyond a specified minimum. Introduced May 5, 1993; referred to Committees on Ways and Means, Energy and Commerce, Judiciary, and Education and Labor.

H.R. 2089 (Brown of CA)

Health Insurance Purchasing Cooperatives Act. Includes full deductibility for unincorporated firms that buy insurance through a HIPC. Introduced May 12, 1993; referred to Committees on Energy and Commerce, Ways and Means, and Judiciary.

H.R. 2210 (Collins of MI)

Mammography Access Tax Credit Act of 1993. Provides employers a credit against income tax for the cost of providing mammography screening for employees. Introduced May 20, 1993; referred to Committee on Ways and Means.

H.R. 2228 (Petri)

Repeals the health insurance component of the Earned Income Tax Credit. Introduced May 20, 1993; referred to Committee on Ways and Means.

H.R. 2367 (Baker of LA)

Restores self-employed deduction, and provides incentives for certain medical practitioners to practice in rural areas. Also provide for the creation of medical savings accounts. Introduced June 10, 1993; referred to Committees on Ways and Means, Energy and Commerce, and Judiciary.

H.R. 2368 (Bilirakis)

Provides a deduction for the expenses of providing care for certain elderly individuals. Introduced June 10, 1993; referred to Committee on Ways and Means.

H.R. 2597 (Machtley)

Allows a tax credit to small employers for the cost of implementing health promotion and disease prevention programs for their employees. Introduced July 1, 1993; referred to Committee on Ways and Means.

S. 18 (Specter)

Comprehensive Health Care Act of 1993. Includes 100% deduction for self-employed, effective for taxable years after June 30, 1992. Introduced Jan. 21, 1993; referred to Committee on Finance.

S. 28 (McCain)

Children's Health Care Improvement Act of 1993. Establishes refundable tax credit for health insurance expenses of children in families below 200% of poverty; the credit may be used only for school-based insurance programs established by States and localities. Introduced Jan. 21, 1993; referred to Committee on Finance.

S.223 (Cohen)

Comprehensive Health Care Act of 1991. Taxes employer health plan contributions in excess of lowest-priced Accountable Health Plan (AHP) in the area. Provides refundable tax credit for individuals purchasing AHP coverage. Increases self-employed deduction. Introduced Jan. 27, 1993; referred to Committee on Finance.

S. 325 (Kassebaum)/H.R. 834 (Glickman)

Provides for 100% deduction for self-employed; disallows employer exclusion, business deduction, and nonreimbursed individual medical expenses deduction for premiums paid for plans that are not BasicCare health plans. Allows an individual to deduct unreimbursed premiums paid for a BasicCare health plan, regardless of whether the taxpayer meets the 7.5% AGI threshold. Introduced Feb. 4, 1993; S. 325 referred to Committee on Finance; H.R. 834 referred to Committees on Energy and Commerce, Ways and Means, Judiciary, Education and Labor, and Rules.

S. 631 (Specter)

Comprehensive Access and Affordability Health Care Act of 1993. Includes refundable tax credit for accountable health plan costs scaled to income for persons without employer provided insurance and a refundable tax credit for the purchase of health insurance for low- income children. Limits the employer business deduction for employee health expenses to the amount of the lowest cost accountable health plan in the region; provides for full deductibility for self employed; and provides to individuals without employer provided health insurance a medical expense deduction equal to 100% of lowest- cost accountable health plan. Introduced Mar. 23, 1993; referred to Committee on Finance.

S. 728 (McConnell)

Comprehensive American Health Care Act. Provides tax credits for the purchase of health insurance to individuals with incomes below $40,000 per year. Introduced Apr. 1, 1993; referred to Committee on Finance.

S. 1105 (Coats)

Individual Medical Savings Accounts Act of 1993. Amends the IRC to provide for the establishment of medical savings accounts to assist in the payment of medical and long-term care expenses and to allow rollovers of such accounts into IRAs. Introduced June 15, 1993; referred to Committee on Finance.

FOR ADDITIONAL READING

Butler, Stuart M. A Tax Reform Strategy to Deal with the Uninsured. Journal of the American Medical Association. May 15, 1991, v. 265, no. 19, p. 2541-2544.

Pauly, Mark V., et al. Responsible National Health Insurance. Washington. The AEI Press. 1992.

___ Health Care Reform: Managed Competition, by Mark Merlis. [Washington] Regularly updated. CRS Issue Brief 93008

___ Taxation of Employer-Provided Health Benefits, [by] Beth Fuchs and Mark Merlis. [Washington] Oct. 2, 1990. CRS Report 90-507 EPW.