Problem: Under the current system, the ability to exclude employer-provided health insurance from taxable income is more valuable to people in higher tax brackets.

Solution: If it is socially desirable to encourage families to purchase health insurance for large medical bills through the income tax system, then all families should receive the same encouragement, regardless of income level.

Discussion: Since the value of the tax subsidy rises with income, it is hardly surprising that the lower a family's income, the less likely the family is to have health insurance. About 92 percent of all people who lack health insurance have an annual income less than $25,000. [13] Table 2 shows the value of employer-provided health insurance relative to the payment of a dollar of wages. As the table shows: [14]

  • For a low-income worker who is paying no income tax, federal tax law makes a dollar of health insurance benefits equivalent to $1.18 in wages.

  • For a worker who is in the 28 percent bracket and paying the Social Security (FICA) tax, however, a dollar of health insurance benefits is equivalent to $1.76 in wages.

If an employer gave the higher-paid worker $1.76 in wages, the worker's take-home pay would only be $1.00 after taxes are paid. On the other hand, if the $1.76 is spent on health insurance premiums, the worker gets the full value of the benefit.

In order to give all people the same economic incentives to purchase health insurance, premiums paid by employers should be included in the gross wages of their employees, and all taxpayers should receive a tax credit equal to a percent (say, 30 percent) of the premium. [15] This would make the tax subsidy for health insurance the same for all taxpayers, regardless of income and regardless of whether the policies are purchased individually or by employers. For individuals who pay no federal income tax, the tax credit could be made refundable. This proposal would also have other advantages discussed below.

TABLE 2

VALUE OF A DOLLAR OF EMPLOYER-PROVIDED HEALTH INSURANCE

(Relative to Taxable Wages)

Federal Tax Category

No State and Local Income Tax

State and Local Income Tax

FICA Tax Only

$1.18

$1.241

FICA Tax Plus 15 percent income Tax

1.44

1.562

FICA Tax Plus 28 percent Income Tax

1.76

1.972

1State and local income tax rate equals 4 percent.

2State and local income tax rate equals 6 percent.


Note: Table shows the amount of taxable wages that are equivalent to a dollar spent on an employee benefit.