Problem: Health insurance provided by an employer is excluded from the taxable wages of the employees, but insurance premiums paid by individuals are not tax deductible. This means that some people realize generous tax advantages from the purchase of health insurance, while others do not.

Solution: All Americans should receive the same tax treatment with respect to health insurance, regardless of employment and regardless of who purchases the health insurance policy – an individual, employer or self-employed person.

Discussion: Federal tax law has an enormous impact on the employee benefit plans of employers precisely because marginal tax rates are so high. Even a moderate wage-earner in the U.S. economy gets to keep less than 70 cents out of each additional dollar earned. The federal income tax rate for this worker is 15 percent and the combined (employer plus employee) Social Security tax rate is 15.3 percent. Thus, federal taxes take 30.3 cents out of each additional dollar of wages. If this employee faces a 6 percent state and local income tax, the marginal tax rate is 36.3 percent, leaving the employee with less than two-thirds of a dollar of wages in the form of take-home pay.

As Table 1 shows, workers in the 28 percent federal income tax bracket face a marginal tax rate of 43.3 percent – leaving them with less than 57 cents in take-home pay out of each additional dollar of earnings. If state and local income taxes apply, the situation is much worse. Indeed, millions of American workers take home less than 50 cents of each dollar of earnings.

TABLE 1

AFTER-TAX VALUE OF A DOLLAR OF MONEY WAGES

Federal Tax Category

No State and Local Income Tax

State and Local Income Tax

FICA Tax Only

85¢

81¢ 1

FICA Tax Plus 15 % Income Tax

70¢

64¢ 2

FICA Tax Plus 28 % Income Tax

57¢

51¢ 2

1State and local income tax rate equals 4 percent.

2State and local income tax rate equals 6 percent.

These high tax rates give employers and employees strong incentives to replace wages with nontaxable health insurance benefits. These incentives make the purchase of health insurance very attractive, even if it would not otherwise have been purchased. The total tax deduction for employer-provided health insurance is about $48.5 billion per year – roughly $485 for every American family. Yet most of the 37 million individuals who do not have health insurance (including about 17.5 million employees), [9] and about 10 percent of insured individuals who purchase health insurance on their own, have no opportunity to receive a tax subsidy. As a result some employees of large companies have lavish health insurance plans (all tax deductible) while other Americans have no tax-subsidized health insurance. In general:

  • The value of the right to exclude health insurance coverage from taxable .v ages ranges from about $1,200 per year in reduced taxes for an auto worker to about 5300 for a worker in retail trade. [10]

  • Self-employed individuals are allowed to deduct only 25 percent of their health insurance premiums, and even this right has an uncertain future. [11]

  • Unemployed people and employees of firms which do not provide health insurance receive no tax subsidy for the health insurance they purchase.

Not Surprisingly, people respond to these incentives. The more generous the tax subsidy, the more likely people are to have health insurance. [12] Those most likely to be uninsured are people who receive no tax subsidy.

Equity in taxation requires that all Americans receive the same tax encouragement to purchase health insurance, regardless of employment. Accordingly, the self-employed, the unemployed and employees who purchase health insurance on their own should be entitled to a tax deduction or tax credit that is just as generous as the tax treatment they would have received if their policies had been provided by an employer.