No Runny Eggs

In case you missed the State of the Union speech, one of the few major policy initiatives announced was a massive rewrite of the federal tax code designed to bring more people into the health insurance cabal. I haven’t quite decided whether President Bush was channeling FDR or the head of Aurora Health Care when he made the announcements that he would seek to make all health insurance expenditures taxable income and then give a standard $7,500 (for individuals)/$15,000 (for families) deduction for those that purchase or have their employer purchase health insurance. What I do know is that this has the potential to be more destructive than Bush’s previous meddling in health care, the grafting of prescription drugs onto Medicare.

First, let’s take a look at the current mess that is the tax code as it relates to health insurance. After a bit of research (thanks to the National Coalition on Health Care and National Association of the Self-Employed), I believe I have it down. First off, the portion of health insurance costs paid for by a “C”-corporation is a deductable business expense for the employer and tax-exempt in-kind income for the employee (which means that neither income, the employee’s portion of FICA, nor the employer’s portion of FICA taxes are paid). This was instituted under Franklin Delano Roosevelt as a way to get around his wage controls in World War II.

Next, those employees of “C”-corporations that participate in Section 125 health plans similarily have that portion of the health insurance costs declared tax-exempt (again, neither income nor either portion of FICA taxes are paid). I don’t know exactly when this came about, but apparently most employees have this as an option.

Thirdly, the self-employed (sole-proprietors, partnerships, and “S”-corporations), at least those not eligible to get in on a spouse’s or parent’s health insurance plan, get to deduct the cost of the health insurance from their income tax, but not the self-employment tax (the same as both the employee and employer portions of FICA). This is a more-recent change, starting off with a portion deductable from income taxes in the 1980s and slowly rising to 100% deductable a few years ago.

Those “C”-corporation employees unlucky enough to be paying health insurance costs out of their pocket outside of Section 125 plans, and those self-employed who don’t take advantage of a spouse’s health plan, use after-tax dollars, where both income and FICA taxes (both employee and employer) are paid.

Now, let’s jump to Bush’s proposal. It’s a Rube Goldberg attempt to get everybody into the health insurance cabal. First, it removes the unlimited tax breaks for health insurance costs on employees and self-employed individuals (leaving the deduction for “C”-corporations alone) and treats it as taxable income. Then, it gives every individual tax filer who buys or has bought for him/her health insurance a $7,500 deduction on both income and payroll tax (it’s unclear whether that applies only to the employee’s portion or both that and the employer’s portion), with a joint/head of household filer getting a $15,000 deduction.

Problem #1 – In order to make this appear “revenue-neutral”, the employer’s portion of FICA (and the “employer’s” half of the self-employment tax) would have to be collected on that first $7,500/$15,000. Guess what that is, kids? A tax increase on every employer who provides health insurance, and any tax increase on the employers gets passed along to the employees and the consumers. That could take the form of reduced pay, reduced health benefits, reduced jobs or higher prices, or any combination of the four. Worse, at least from the perspective of the Party In Government, if most of the plans above the limit dropped down to the limit, there is no hope of “revenue-neutrality”. What happens when gubmint runs short of cash? If you said, “They raise taxes,” give yourself a gold star. If you said, “They’ll cut spending,” smack yourself in the forehead.

Problem #2 – Since that first $7,500/$15,000 is taxable income, and without a redefinition of “taxable income”, it would be added to the Social Security obligations, where is the FICA money going to come from? It definitely isn’t coming from the employee (and half isn’t coming from the self-employed). Elsewhere in the State of the Union speech, President Bush pointed out the impending collapse of the three programs dependent on FICA (Social Security, Medicare and Medicaid) without offering up any plan (side note – where’s the ‘Rat plan for this time bomb?). Increasing those obligations without any thought to how to pay for said obligations is a recipe for a faster disaster.

Problem #3 – This does not address the underlying causes of escalating health care costs – the lack of a free market where the consumer has an incentive to hold down the costs and out-of-control malpractice litigation/insurance costs. It might drive down the costs of insurance at the very high end, as the Rolls-Royce health benefits (usually enjoyed by gubmint employees) are scaled back to avoid the adverse tax consequences. It won’t have any effect on the costs of those plans that are underneath the limits, and not many people who currently have employer-provided health insurance where the total cost is underneath the limits will have the savvy to seek out cheaper plans to get the “free money” from the feds. Indeed, by adding more people to the no-cost-incentive scheme, it will drive costs even higher.

Problem #4 – By making the employer’s portion of health insurance as well as the Section 125 portion taxable, this probably opens that up to state taxation. My money says that ‘Rat-infested states, such as Wisconsin, will seek to capture all of that money, including the portion the feds don’t.

Problem #5 – This would adjust using the Consumer Price Index. Last I checked, health insurance costs have gone up much faster than the CPI since who-knows-when. Simply putting a cap on the tax benefits won’t stop that, at least not without stripping the plans of essentially all coverage.

So, what’s the solution? Short of changing the dominant American mindset of wanting to live forever, preferably on somebody else’s dime, there is none.