The Economic Effects of the President's Proposal for a Standard Deduction for Health Insurance

Health care costs continue to rise rapidly in the United States, claiming an increasing share of economic resources. One factor contributing to this rise is the favorable tax treatment for employer–sponsored health insurance, whereby employees pay neither income nor payroll taxes on health care that is provided through their employers. This tax treatment, which amounts to a $300–$400 billion per year subsidy for health insurance, has led to greater reliance on employer–sponsored insurance and lower deductible plans. Moreover, individuals who purchase insurance on their own often receive no tax subsidy. This paper discusses a health tax proposal included in President Bush's FY 2009 Budget that would reduce or eliminate these tax biases through a new standard deduction for health insurance (SDHI). The SDHI would be available to all individuals purchasing qualifying insurance and improve incentives by breaking the link between how much an individual pays for insurance and the value of the tax subsidy. The SDHI would increase the number of individuals with health insurance by roughly six to nine million and reorient the tax subsidy more towards lower–income individuals. The paper also considers alternatives to the SDHI proposal, principally a flat refundable health insurance tax credit.