Revised April 22, 2003 


by Edwin Park

 Executive Summary

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As part of its fiscal year 2004 budget, the Administration has proposed to provide a refundable tax credit to individuals and families for the purchase of health insurance in the individual health insurance market.  This proposal is the chief component of a series of budget proposals related to the uninsured.

The tax credit would be available for the purchase of health insurance in the individual market for individuals and families who do not participate in employer-based coverage or public health insurance programs.  The credit would equal up to $1,000 for individuals and up to $3,000 for families with children, with the full credit being available to individuals with incomes of less than $15,000 per year and families with incomes below $25,000.  The tax credit would phase down as income rose above these levels and would phase out entirely when income reached $30,000 for individuals and $60,000 for a two-parent family of four.  According to the Joint Committee on Taxation, the proposal would cost $64 billion over 10 years (the Administration estimates the cost at $89 billion).  The proposal accounts for a large percentage of the new federal resources the Administration is proposing for the uninsured.

While the tax credit would result in some currently uninsured individuals gaining insurance, the proposal is highly controversial.  It poses substantial risks.  In particular, the tax credit could materially weaken the employer-based health system through which the vast majority of insured Americans obtain their health insurance coverage and could cause some currently insured people — particularly people who are older or are in poorer health — to lose insurance altogether or to have to pay exorbitant amounts to retain insurance.

This analysis examines the Administration’s tax credit proposal.  It considers how the credit would affect the two pillars of group health insurance in the United States — employer-based average and public coverage through programs such a Medicaid and SCHIP.  The analysis finds that the tax credit proposal would pose significant risks, including the following:

This phenomenon — known as “adverse selection” — could then induce additional younger, healthier workers to abandon employer-based coverage and use their tax credits instead, because the departure of the first wave of younger, healthier employees would have caused premiums for employer-based coverage to rise.  In this way, a vicious cycle could be set in motion.  The increase in premiums for employer-based coverage that ultimately could occur could induce many employers either to cease offering health insurance or to increase substantially the amounts their employees must pay for insurance.  The end result would likely be that many older and less healthy individuals would eventually lose their employer-based coverage and become uninsured or underinsured or have to pay exorbitant amounts for decent coverage.

Intensifying the risk that many firms might not offer coverage is the recent return of a high rate of inflation in health care costs, which are now rising at double-digit rates.  As a result, fewer firms, especially those of smaller size, are offering health insurance coverage to their employees.  Institution of the tax credit could provide a further incentive for some employers seeking to cut costs to drop or not to institute coverage for their workforce.

The Administration says its proposal responds to this concern by allowing tax-credit recipients to buy coverage through high-risk pools and private purchasing pools.  The success and scope of these mechanisms, however, has been quite limited.  Even with some federal and state funding, participation is often low, premium costs are substantial, and the health insurance benefits provided can be restricted to a fairly narrow range of services.  Moreover, policies available through high-risk pools often impose high deductibles and cost-sharing or exclude coverage of pre-existing conditions for a lengthy period of time.

The Administration’s proposal would permit states to allow certain individuals also to use their tax credits to buy into comprehensive public coverage.  It is uncertain, however, how many states would elect this option and open their Medicaid and SCHIP managed care plans to tax-credit recipients.  Because the people most in need of buys-in to public coverage tend to be sicker, high-risk individuals unable to obtain coverage in the individual market, adding these individuals to the current Medicaid and SCHIP managed care pools (which primarily enroll relatively healthy families and children) could increase Medicaid and SCHIP costs.

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