Revised March 5, 2003

by Edwin Park

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As part of its fiscal year 2004 budget, the Administration has proposed a deduction for the purchase of long-term care insurance.[1]  This proposal would provide little or no assistance to most low- and middle-income families, and thus is unlikely to be very effective in helping more people secure long-term care coverage.  Instead, it would primarily serve as another tax-cut benefit disproportionately geared toward high-income individuals.

The Administration’s fiscal year 2004 budget also includes a second tax cut related to long-term care.  The Administration proposes to allow families caring for a family member with long-term care needs to claim an additional personal exemption.  This proposal, as well, would be of greatest benefit to higher-income individuals, since the value of the additional personal exemption — like the value of the proposed long-term care deduction — would vary depending on a taxpayer’s tax bracket.  This proposal, too, ultimately would provide the largest subsidies to those in the highest tax brackets, much less assistance to most middle-income families, and no assistance to low-income working families that do not owe enough to earn income tax.

As a result, the Administration’s long-term care proposals would have perverse effects.  These proposals would consume a substantial amount of federal budget resources to provide new subsidies for long-term care to the very Americans who need such subsidies least, while doing little to address the large long-term care costs that millions of Americans face.  A much better way to help defray a portion of long-term care costs through the tax code would be to institute a refundable tax credit for long-term care expenses.  Such a credit would assist households in caring for a family member living in their homes.  Unlike with a deduction, the value of a refundable tax credit would not vary with an individual’s tax bracket.


Deduction for the Purchase of Long-Term Care Insurance

This proposal would provide a deduction for the purchase of long-term care insurance, primarily in the individual insurance market.  This deduction could be taken both for the premium costs that tax filers paid to purchase policies in the individual market, as well as for the employee’s share of premium costs for long-term care insurance offered through an employer if the employee pays at least 50 percent of the cost.  The deduction would start to be available in tax year 2004 and be phased in over four years.  Starting in 2007, taxpayers could deduct 100 percent of the cost of long-term care insurance premiums, up to certain dollar limits.  Both those who itemize deductions and those who do not could take this deduction.

The cost of the proposal is $22.6 billion over 10 years, according to the Joint Committee on Taxation.  This cost is held down because of the slow phase-in.  The Joint Committee on Taxation estimates that the proposal would cost $16.6 billion in the second five years of the ten-year period, when it would be in full effect.  This is nearly triple the proposal’s cost in the first five years.

While the proposal is intended to help more people secure long-term care insurance, the deduction is actually a subsidy, delivered through the tax system, that is targeted to those with higher incomes who least assistance and does little or nothing to help those who cannot currently afford long-term care insurance.  This is because the proposed deduction would offer little or no assistance to low- and middle-income families.  Most low- and middle-income families either do not earn enough to owe income tax (in which case they would receive no benefit from the deduction) or are in the 10 percent or 15 percent income tax brackets.  Only the top 30 percent of tax filers is in brackets higher than the 15 percent bracket.

The proposal also appears not to include the insurance market reforms necessary to make long-term care insurance accessible and affordable.  In the absence of significant reforms, large numbers of individuals would be shut of the market for individual long-term care policies.  This is because companies selling long-term care insurance can generally vary the premiums they charge, based on age and medical history, and can deny coverage entirely.  According to a study by the Commonwealth Fund, up to 23 percent of applicants for long-term care insurance at age 65 are rejected outright.[2]

A more equitable and effective tax-based alternative would be a refundable tax credit to help subsidize a family’s long-term care expenses.  Unlike a deduction, the value of a tax credit does not vary by tax brackets.  A refundable tax credit for individuals who care for family members with long-term care needs could provide the full tax credit subsidy to taxpayers who most need help in covering these costs, rather than shutting out those most in need and providing a subsidy that grows as a taxpayer’s income rises.

Over time, states also could take advantage of the increased flexibility that federal regulations issued last year have given states to expand Medicaid coverage to elderly and disabled individuals who are incurring catastrophic long-term care costs.  Under these regulations, states can reduce substantially the size of the “medically needy” spenddown amount — the amount of out-of-pocket costs for long-term care expenses that individuals must incur before they qualify for Medicaid coverage.  This would have the effect of making it easier for elderly and disabled people with substantial long-term care costs to qualify for Medicaid.

Additional Personal Exemption for Caregivers

The Administration also proposes to permit taxpayers who care for family members with long-term care needs to claim an additional personal exemption on their tax returns.   The dependent family member would have to live in the taxpayer’s household and be a spouse, ancestor, or spouse of an ancestor.  As determined by a physician, the dependent also would have to need assistance with at least two Activities of Daily Living (ADLs), such as eating or toileting.  The proposal would be effective starting in tax year 2004 and cost $3.4 billion over 10 years.

This provision, as well, is poorly designed to respond to the needs of families that need assistance in covering long-term care costs.

As noted above, a far more equitable tax-based approach to the difficult problem of financing long-term care costs would be to establish a refundable tax credit (rather than a deduction or an additional exemption) to subsidize long-term care expenses that low- and middle-income families incur, coupled with insurance market reforms. 

Expansion of Flexible Spending Accounts

The budget also includes provisions related to flexible spending arrangements (FSAs).  FSAs for medical care are accounts into which employees can deposit a portion of their wages and from which they may pay for out-of-pocket health care costs.  Funds deposited into these accounts do not count as wages or income for the employee for tax purposes.  An employee may not carry over any funds left in an FSA at the end of the year.

The first Administration proposal in this area would permit amounts of up to $500 in a medical care FSA to be carried forward from one year to the next.  Under the second proposal, employees could transfer up to $500 in funds that remain in their FSA accounts at the end of the year to their retirement plans or to Medical Savings Accounts.  Both proposals would be effective starting in tax year 2004.  Their combined cost would be $8.7 billion over 10 years.

The Center on Budget and Policy Priorities is grateful to the
Nathan Cummings Foundation for its support of this report.

End Notes:

[1] U.S. Department of Treasury, General Explanations of the Administration’s Fiscal Year 2004 Revenue Proposals, February 3, 2003.

[2] Mark Merlis, Financing Long-Term Care in the Twenty-First Century: The Public and Private Roles, Commonwealth Fund, September 1999.

[3] As with the general personal exemption, the additional exemption would phase out by two percentage points for each $2,500 ($1,250 if married taxpayers file separately) by which adjusted gross income exceeds certain income thresholds based on filing status.  For tax year 2003, the thresholds are $139,500 for single filers, $209,250 for joint filers, $174,400 for heads of households, and $104,625 for married taxpayers filing separately.  The thresholds are indexed for inflation.  However, the tax changes enacted in 2001 eliminate the phaseout between 2006 and 2010.  By 2010, high-income taxpayers will receive the full personal exemption and under this proposal, they also would receive the full additional exemption.

[4] See Edwin Park, Administration’s Proposed Tax Credit for the Purchase of Health Insurance Could Weaken Employer-Based Health Insurance, Center on Budget and Policy Priorities, Revised March 5, 2003 and Edwin Park, Administration MSA Expansions Could Drive Up the Price of Health Insurance Premiums and Increase the Number of Uninsured, Center on Budget and Policy Priorities (forthcoming).