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Congress Expands High-Income Tax Shelters, Drops Children’s Health Care from Final "Tax Extenders" Bill

CBPP Statement: December 7, 2006 - For Immediate Release

Revise December 8, 2006


In closed-door negotiations on the "tax extenders" package, bipartisan House and Senate negotiators added an expansion of Health Savings Accounts (HSAs) that would make these accounts more lucrative as tax shelters for high-income individuals. At the same time, they declined to include a modest provision to close part of the shortfall in federal funding for the State Children's Health Insurance Program (SCHIP), a decision that puts health coverage for up to 600,000 low-income children at risk.

Expanding HSAs. Under current law, anyone who enrolls in a high-deductible health plan may establish an HSA. Individuals may not only make tax-deductible contributions to HSAs and have the earnings on these funds grow tax-free, but also may withdraw funds tax-free from the accounts, as long as the funds are used to pay for out-of-pocket medical costs. This treatment, under which both contributions and withdrawals are tax advantaged, is without precedent in the tax code. As a result, many analysts have warned that HSAs are likely to be used extensively as tax shelters by high-income individuals. A recent GAO study shows HSAs are indeed being used disproportionately by high-income individuals and indicates many of these people are likely using HSAs as tax shelters.

The HSA provision in the "tax extenders" bill would allow people to put much more money into their HSAs each year than they would need to cover the deductible in their health plan. All HSA participants would be allowed to contribute up to $5,450 each year to their HSA (for family coverage), irrespective of the deductible required under their plan. Currently, HSA contributions are limited to the lesser of $5,450 or the deductible, so only participants with deductibles of at least $5,450 can contribute up to that amount. Plan deductibles are generally lower than that.

The new provision, which was not passed by either the House or the Senate, would encourage increased use of HSAs as tax shelters -- especially by high-income individuals, the ones who can best afford to substantially increase their HSA contributions.

Ignoring SCHIP. SCHIP, which covers more than 4 million low-income children (most of whom would otherwise be uninsured), is jointly financed by states and the federal government. Both the Congressional Research Service and the Centers for Medicare and Medicaid Services project that in 2007, states will face substantial shortfalls in federal SCHIP funding that will prevent them from maintaining their current programs. If Congress does not provide the funds needed to close these shortfalls, an estimated 17 states will have to scale back their SCHIP programs, such as by limiting eligibility, capping enrollment, or eliminating benefits (unless they substantially increase their own funding for SCHIP). The $921 million in shortfalls projected for 2007 is equivalent to the cost of covering 630,000 children under SCHIP.

It has been known all year that states faced significant SCHIP shortfalls for 2007. The Administration included a proposal in its budget to address these shortfalls, and various bills to fully resolve the problem were introduced in Congress. The most recent proposal, which would have addressed only a portion of the shortfall, was introduced during negotiations over the "tax extenders" package but then dropped -- though Congress found the time to expand HSA-related tax shelters for high-income households in that same package.

While some may have cited the cost of the SCHIP provision as a reason not to address the SCHIP shortfalls in the bill, the final measure -- with its ten-year cost of close to $50 billion -- showed little in the way of cost restraint. The "tax extenders" package has been touted as urgent because it includes extensions of tax provisions that expired at the end of 2005 or will expire at the end of 2006. Yet Congress also found room in the measure to extend a variety of energy-related tax provisions that do not expire this year and to provide several new special-interest tax breaks. It seems clear that the decision to exclude SCHIP reflected congressional priorities rather than cost constraints.