Tax Subsidies for Private Health Insurance: Who Currently Benefits and What Are the Implications for New Policies?

Federal tax subsidies for employer-sponsored insurance (ESI) provide over $100 billion in tax benefits annually.HOW DOES THE FEDERAL GOVERNMENT SUBSIDIZE PRIVATE HEALTH INSURANCE?EThe largest subsidy is the tax exemption for employer contributions to ESI.When employers purchase or provide insurance for their employees, their contributions to the premiumare exempt from income and payroll taxes.EEmployees’ contributions to ESI are also tax-exempt if workers useflexible spending accounts (FSAs).Once established by employers,workers can use these tax-exempt accounts to set aside a portion oftheir income to pay for health insurance and expected medicalexpenses. EPeople who buy insurance outside of work do not have the sametax advantages. They can deduct medical expenses, including premiums, that exceed 7.5 percent of their adjusted gross income. However, many people never reach that threshold. Special rulesapply to self-employed people, who can deduct a portion of theirhealth insurance costs without meeting the threshold. This year,these costs become fully deductible.ALL TOGETHER, HOW MUCH ARE THESE SUBSIDIES WORTH?EThe tax exemption for ESI provided more than $100 billion inincome and payroll tax subsidies in 2002. EOther tax subsidies for health insurance, primarily for the self-employed and others purchasing nongroup coverage, amounted to about $7 billion dollars—less than 10 percent of the value of the ESI subsidy.THESYNTHESIS PROJECTNEW INSIGHTS FROM RESEARCH RESULTS*Definitions of “small” firms vary from study to study and are noted in figures.1INTRODUCTIONPolicy-makers are considering a variety of new tax credit proposalsto expand health insurance coverage.Understanding how current tax subsidies work and their role in supporting employer-sponsoredinsurance (ESI) is important whendesigning such policies.This brief presents essential informa-tion about the structure and distri-bution of existing tax subsidies forESI and the implications for new policy options.Tax subsidiesfor privatehealth insurance:who currentlybenefits andwhat are theimplications fornew policies?POLICY PRIMER NO.1MAY 2003author: Claudia Williams; based on a report by Len Burman, Cori Uccello, Laura Wheaton and Deborah Kobes.Also see the report on this topicavailable at www.taxpolicycenter.orgThis policy primer is available atwww.policysynthesis.org FIGURE 1.Percentage of nonelderly work-ers covered by different sources of healthinsurance, by poverty level, 2001100806040200ESIPrivatePublicUninsuredNongroup2THE SYNTHESIS PROJECT, POLICY PRIMER NO. 1Higher-income workers benefit the mostfrom the current tax subsidies.WHO BENEFITS FROM THE CURRENT TAX EXCLUSIONS?EHigher-income workers benefit the most from current tax subsidiesbecause: •They are in higher tax brackets so the tax exclusion is worth more to them.•They are more likely to have ESI coverage(FIGURE 1).•Their employers pay a higher share of their premiums, on average (FIGURE 2).•They typically have more comprehensive health coverage. ELower-income workers who have ESI receive only a small benefitfrom current subsidies.EWorkers do not benefit from current subsidies if their firms do notoffer coverage or if they are ineligible for coverage that is offered.Low-income workers are more likely to be in these situations.EPeople who purchase private nongroup coverage do not receivethe ESI exemption, and receive little benefit from other tax subsi-dies.Lower-income workers are slightly more likely to have this typeof coverage (FIGURE 1). DISCUSSIONHigher-income workers benefit farmore from the current ESI tax sub-sidy than lower-income workers. First of all, they are in higher taxbrackets. A worker in the 28 percenttax bracket saves 28 percent of thepremium cost, while a worker in the15 percent bracket saves only 15percent. They also are more likely to have ESI.Almost 90 percent of workers withincome three times the poverty levelor higher have ESI, compared to lessthan one-third of workers withincome below the poverty level.In addition, employers of higher-income workers pay a larger percent-age of the premium on average,translating into a larger tax exemp-tion for those employees. Finally, higher-income workers tendto have more coverage—multiplepolicies, richer benefits, and familyrather than individual coverage—increasing premiums and the valueof the tax exemption.Lower-income workers benefit onlyslightly from the income tax exemp-tion and the Medicare payroll taxexemption. They benefit in the shortrun from the Social Security payrolltax exemption, but it hurts them inthe long run by reducing their retire-ment income.FIGURE 2. Percentage of ESI premium paidby employer, by family income, 1998100806040200Under $20.0K–$40.0K–$75.0K–$200.0K$20.0K$39.9K$74.9K$199.9K or more 6874767879305173885544158314937197Familyincome as a percent of poverty levelBelow 100100 - 199200 - 299300 and overWorker Health CoverageEmployer Share of Premium The ESI subsidy is upside down. WHAT IS THE VALUE OF TH