TABLE OF CONTENTS

EXECUTIVE SUMMARY
INTRODUCTION
HEALTH BENEFITS TAX EXPENDITURES IN 2000

CURRENT SYSTEM
TAX EXPENDITURES
DISTRIBUTION BY INCOME

PROVIDING TAX SUBSIDIES FOR INDIVIDUALLY PURCHASED NON-GROUP COVERAGE
TAX DEDUCTION FOR NON-GROUP PREMIUMS

TAX CREDIT FOR NON-GROUP INSURANCE PREMIUMS
THE TAX DEDUCTION AND THE TAX CREDIT COMPARED
PLACING LIMITS ON THE TAX-EXEMPT AMOUNT OF EMPLOYEE BENEFITS

LOW-INCOME TAX CREDIT PROPOSALS

TAX CREDIT FOR WORKERS WITHOUT ACCESS TO EMPLOYER COVERAGE
TAX CREDIT FOR ALL WORKERS
TAX CREDIT FOR WORKERS AND NON-WORKERS
VARYING THE SIZE OF THE TAX CREDIT AMOUNTS
IMPLEMENTATION ISSUES

FLAT-DOLLAR TAX CREDIT PROPOSAL

COVERAGE AND COST IMPACTS OF FLAT-DOLLAR TAX CREDIT
CREDIT/EXEMPTION ALTERNATIVE
IMPLEMENTATION ISSUES
IMPACT ON HEALTH EXPENDITURES

THE HERITAGE FOUNDATION PLAN

PROGRAM DESIGN
ASSUMPTIONS
COST AND COVERAGE IMPACTS
DISTRIBUTIONAL IMPACTS
IMPACT ON TOTAL HEALTH SPENDING
ADEQUACY OF INSURANCE MARKET REFORMS

CONCLUSIONS
TECHNICAL APPENDIX: ESTIMATING THE IMPACT OF TAX CREDITS ON INSURANCE COVERAGE

The various federal tax exemptions and deductions for health insurance premiums and health services provide Americans with about $125.6 billion in tax subsidies per year. These subsidies derive primarily from the fact that most spending for employer-sponsored health benefits is not counted as taxable income to the individual in computing either income tax or Social Security tax, even though these benefits are compensation to the employee. This tax-exempt treatment of health benefits has encouraged the development of employer-sponsored plans, which now provide coverage to about 158 million workers and their dependents. These tax subsidies derive from the following:

• Employer contributions for health benefits are not taxable to the individual;
• Employee contributions for health benefits in firms with a Section 125 plan (i.e., a "cafeteria plan") are tax-exempt;
• Out-of-pocket expenditures for health services can be paid in pre-tax income in firms with tax-exempt reimbursement accounts; and
• Expenditures for health insurance and health services in excess of 7.5 percent of adjusted gross income (AGI) are tax-deductible.

We estimate that tax expenditures under the federal income tax (i.e. ñ the amount not collected in taxes due to the above exclusions) will be $84.9 billion in 2000 (Figure ES - 1). This includes tax expenditures resulting from the health benefits exclusions, including the exclusion for employer contributions and employee contributions in Section 125 plans ($74.5 billion); the exclusion for reimbursement accounts ($5.6 billion); and the deduction for out-of-pocket spending over 7.5 percent of AGI ($4.8 billion). The exclusion of health benefits from Social Security and Medicare HI taxes will account for tax expenditures of $31.9 billion and $8.8 billion, respectively. The average tax subsidy for families with a family head under age 65 will be $1,155 in 2000 (Figure ES - 2).

The structure of the tax exemption raises important equity issues. Employer-provided health benefits are tax-exempt to the worker while individuals who must purchase coverage in the individual market receive no subsidy. Moreover, the value of the tax exemption is greatest among higher-income individuals who are more likely to be insured and who are in higher tax brackets (i.e., the tax expenditure is equal to the cost of coverage that is tax-exempt multiplied by the familyís marginal tax rate). For example, the average tax subsidy per family varies from just $79 for families with incomes of less than $15,000 to $2,638 for families with incomes in excess of $100,000 per year (Figure ES - 2).

In fact, 68.7 percent of federal health benefits tax subsidies under the current tax system are going to families with incomes of $50,000 or more, even though this group accounts for only 36 percent of the population. Redirecting some of these subsidies to lower-income groups could help many of the uninsured obtain coverage. With 43.4 million uninsured persons in the United States, many of whom are in relatively low-income groups, it is important for policy makers to question whether it is appropriate for the majority of health benefits tax subsidies to go to the highest-income groups.

Figure ES - 1
Federal Tax Expenditures for Health Benefits in 2000 (in billions)

Figure ES - 2
Average Federal Health Benefits Tax Expenditure by Income Level in 2000 ^a/

Concern over these issues has led to a series of proposals that are designed to provide a more equitable distribution of tax subsidies across families and assist uninsured persons in obtaining health insurance. These reforms range from incremental changes that extend a tax deduction to persons with non-group coverage to sweeping reforms that replace the current tax exemption for health benefits with a refundable tax credit to all privately insured persons. Some proposals are also specifically designed to encourage individuals to moderate their use of health services.

One proposal is to extend a health insurance tax deduction or credit to persons who purchase non-group coverage in the individual market. We estimate that a tax deduction for purchases of non-group coverage would induce about 3.9 million uninsured persons to purchase coverage at a cost to the federal government of $6.3 billion (Table ES - 1). However, because the value of the tax deduction is greatest for persons at high income levels, about 61 percent of these newly insured persons would be in families with incomes of $50,000 or more, with little change in coverage for lower-income groups.

Table ES - 1
Summary of Cost and Coverage Impacts Under Alternative Changes in Subsidies for Health in 2000

By comparison, we estimate that a refundable tax credit for purchasers of non-group coverage ($500 for single coverage and $1,000 for family coverage) would result in roughly the same number of persons taking the coverage (4.0 million) at a cost of $5.0 billion. But the tax credit would tend to increase coverage among lower-income groups because the credit amount for these groups would be substantially greater than the value of the deduction among persons with lower incomes. In fact, 61 percent of the persons who would become covered as a result of the tax credit would have incomes of less than $50,000 per year. Thus, the design of the tax subsidy can make a substantial difference in the types of population groups that would take coverage.

Another approach is to create a targeted tax credit for lower-income families. One proposal would provide a 30 percent health insurance tax credit for workers who do not have access to employer coverage and who have incomes below $35,000 for single individuals and $50,000 for families. There would be about 12.2 million uninsured workers and dependents who would be eligible for such a credit. However, only about 1.5 million uninsured persons would be induced to obtain coverage by the credit, at a cost of $3.3 billion. The reason for this low level of participation is that the credit covers only 30 percent of the premium, leaving the individuals to pay the remaining 70 percent, which many lower-income families would still find unaffordable.

The impact of such a 30% tax credit could be increased by extending it to non-workers with individual coverage, or by increasing the percentage of the premium covered by the credit. For example, the 30 percent credit could be extended to all low-income persons rather than just low-income worker families. The number of uninsured who would take coverage under this variation would be 4.5 million persons, at a cost of $11.3 billion.

Some proposals would eliminate the income tax exclusion for health benefits (i.e., the Social Security tax exemption would remain) and replace it with a flat-dollar tax credit. One proposal establishes a tax credit of $800 for single individuals and $1,600 for married couples, with an additional $400 per child up to a maximum of $2,400 per family. The cost of such a tax credit ($117.1 billion) would be partly offset by the amount of taxes collected as a result of eliminating the income tax exclusion for employer-provided benefits ($68.5 billion), reducing the net federal cost of this proposal to $48.6 billion. We estimate that 9.8 million uninsured persons would take coverage as a result of such a flat-dollar tax credit. However, many higher-income persons would find that the credit is lower than the tax subsidy they received under current law and we estimate that some (5.2 million) would actually drop their current coverage. Thus, this flat-dollar tax credit would result in a net increase in coverage of 4.6 million persons (i.e., 9.8 ñ 5.2).

To prevent any drop in coverage, some flat-dollar tax credit proposals include a provision where tax filers can choose between the tax credit or the existing tax exclusion to ensure that all families do at least as well as they would under current tax policy. This provision would increase the net federal cost of the flat-dollar tax credit proposal from $48.6 billion to $53.2 billion, but would reduce the number of uninsured by 9.8 million persons.

The Heritage Foundation plan is the most sweeping reform plan we examined. The Heritage plan achieves universal coverage by requiring all persons to purchase at least a high-deductible insurance package specified in the plan. Employers who now provide coverage are required to cash-out their health benefit by increasing wages by the amount of the cost of the coverage that they have been providing. Individuals would then use this income to purchase insurance in the individual market. The plan would provide a refundable tax credit for insurance premiums and out-of-pocket payments for health services, which would cover a percentage of these costs. The percentage of costs covered would vary by the level of health spending as a percentage of income. The tax credit would cost about $171.4 billion in 2000, which would be partly offset by $116.1 billion in increased tax paymentsñboth income and FICA taxesñon the increase in wages resulting from the cash-out of employee health benefits and the elimination of the health expense deduction. Thus, the net federal cost of the program would be $55.3 billion (i.e., $171.4 ñ$116.1).

The Heritage plan is unique in that individuals are given the cash that their employerís are now spending for health benefits, which they can use to purchase the coverage of their choosing. This creates a financial incentive for individuals to enroll in less expensive managed care health plans or high-deductible plans so that they can retain as much of the cash-out as possible for other uses. We estimate that the resulting moderation in health services utilization would reduce health spending by about $20.3 billion. However, these savings would be more than offset by an increase in utilization for newly insured persons ($37.8 billion) and an increase in insurance administrative costs ($3.9 billion), for a net increase in national health spending of $21.4 billion in 2000.

Overall, our analysis shows that refundable tax credits would tend to shift federal tax subsidies from higher-income groups to lower-income groups. This would enable many uninsured individuals to purchase coverage, resulting in a decline in the number of uninsured. However, unless there is a mandate for individuals to have coverage, there still would be 30 million or more persons without health insurance under the tax credit proposals that Congress is now considering. This is because many individuals would find that the cost of insurance is greater than they feel that they can afford, even with the credit.

While the impact of tax credits on coverage would be limited (with the exception of the Heritage plan), the emerging debate over tax credits provides an opportunity to rethink the role of tax policy in insurance coverage. Historically, the tax-exempt status of health benefits has played an important role in encouraging employers to provide health benefits. However, it is important to critically evaluate the equity of the existing system and its role in encouraging employers to offer comprehensive coverage that in turn encourages increased use of health services. Well-designed changes in tax policy could lead to an expansion in coverage together with improved equity and

greater emphasis on efficient health care delivery.

The current tax code will provide about $125.6 billion in tax subsidies for the purchase of health insurance and health services in 2000. These subsidies derive primarily from the fact that most spending for employer-sponsored health benefits is exempt from taxation under both the income tax and Social Security tax, even though these benefits are compensation to the employee. This tax-exempt treatment of health benefits has encouraged the development of employer-sponsored plans, which now provide coverage to about 158 million workers and dependents.

Under current tax law, health insurance premiums are largely tax exempt if the insurance is provided through an employer, but generally are not deductible when an individual purchases it directly. The share of the premium paid by the employer is not counted as income to the employee under the federal income and Social Security payroll taxes, and the employeeís share of the premium can be tax-exempt in firms with Section 125 flexible spending plans. Out-of-pocket health expenditures in excess of 7.5 percent of adjusted gross income (AGI) are tax deductible for all individuals. Also, many employees have access to a reimbursement account under their employerís flexible spending plan through which out-of-pocket health expenditures may be paid in pre-tax dollars.

While the current tax treatment of health benefits has encouraged employers to offer coverage, it has been criticized as inequitable and a major contributor to health care cost inflation. A major source of inequity in the current system is that it provides substantial tax benefits to persons with employer-sponsored coverage while persons who must purchase coverage in the individual market receive no tax subsidy. Also, the value of the health benefits tax exemption is greatest among higher-income workers, who are more likely to have coverage and face higher tax rates (i.e., the value of the exemption is equal to the cost of exempt benefits multiplied by the taxpayerís marginal tax rate). In addition, critics of the current system argue that the tax subsidy for health benefits tends to encourage increased use of health services by artificially lowering the net cost of health insurance to the individual. This encourages individuals to enroll in relatively comprehensive health plans that can encourage individuals to use more services.

Another criticism of the employer benefits tax exclusion is that it tends to lock workers into the coverage offered by their employer. Workers must take the coverage offered by their employer in order to take advantage of the tax exemption. Workers who prefer some other form of coverage cannot apply the tax exemption to the cost of purchasing an alternative health plan in the individual market. This tends to lock workers into the coverage decisions made by employers concerning managed care, covered services, and the physician network. This can be particularly restrictive for workers in firms that offer only one coverage option, which make up about 44 percent of all workers.

It also has been argued that employees would be better off if the value of health benefits were cashed-out as wages so that they could purchase health insurance policies that best meet their needs. In particular, this would provide individuals with the option of purchasing a lower-cost health plan and using the unspent portion of the cash-out for other uses. This approach provides a powerful cash incentive for individuals to enroll in plans that control costs through managed care or higher deductibles and co-payments that encourage individuals to moderate their use of health services. Enrollment in these types of plans could slow health care cost growth.

Concern over these issues has led to several proposals to reform the current tax treatment of employer-sponsored health benefits. These proposals range from relatively modest reforms, such as extending a tax deduction or tax credit to persons with non-group coverage, to sweeping reforms that would replace the existing tax exclusion with a tax credit for purchases of health insurance. To varying degrees all of these proposals are designed to increase insurance coverage by providing tax subsidies to individuals who are not receiving subsidies under current law.

Other proposals have emerged that would use tax credits to expand coverage among lower-income persons. For example, one proposal would provide a refundable 30 percent tax credit for purchases of health insurance for lower income families. The credit would be available only to workers with incomes below $35,000 ($50,000 for families) who do not have access to employer coverage (excluding Medicare and Medicaid recipients). However, this credit could be made generally available to all persons with incomes below these levels, including non-workers and workers who have access to employer coverage (credit for employee contribution only). Making these subsidies available to persons who have access to employer coverage could have a significant impact on coverage because, as discussed below, there are about 10.2 million uninsured workers and dependents who have declined the coverage that is available to them through employment.

Some proposals would create a flat-dollar tax credit that would replace the current exemption for employer-provided coverage. These proposals would effectively shift tax subsidies away from higher-income groups to lower-income groups. For instance, one proposal creates a refundable flat-dollar tax credit of $800 for single coverage or $1,600 for couples, plus $400 per child up to a maximum of $2,400. This credit would be substantially greater than the tax subsidy now going to lower income persons under the current tax exemption for employer-sponsored coverage. However, the credit would be less than the value of the exemption for some higher-income tax filers, which could result in some of these individuals dropping coverage. Moreover, the flat-dollar credit effectively places a limit on the subsidies a family receives, which will encourage some persons to enroll in more cost-effective health plans.

To eliminate the reduction in tax subsidies that would occur for some taxpayers under a flat-dollar tax credit, the National Association of Health Underwriters (NAHU) has developed a similar flat-dollar tax credit program where individuals can choose between the credit and the existing exclusion. This would result in a general increase in the subsidies available to lower-income tax filers while ensuring that no family will see a net reduction in tax subsidies under the plan.

The Heritage Foundation has developed a proposal to reform the tax treatment of health benefits that would cover all Americans while changing the tax subsidy in a way that encourages more efficient use of the health care system. The Heritage plan would eliminate the current tax exemption for health benefits and replace it with a refundable tax credit for premium and health care expenses for all persons, including workers and non-workers (Medicare and Medicaid beneficiaries would not be eligible for the credit). Employers would be required to cash-out their health benefits in the form of wages that would be subject to federal income and Social Security (i.e., FICA) taxes. All individuals would be required to purchase coverage, which would generally be provided through the individual market. The plan establishes a minimum standard benefits package with high deductibles that all insurers must offer, but permits individuals to purchase more comprehensive coverage if they wish. The insurance market would also be reformed to ensure guaranteed issue of coverage regardless of health status, with rates that vary only with age, sex and geography. This approach is designed to encourage individuals to enroll in efficient managed care plans and/or high-deductible plans that encourage moderation of the use of health services.

In this study we estimate the amount of tax subsidies provided under the current system and estimate the impact of proposed changes in the tax treatment of health benefits on federal costs and coverage. We then analyze the impact of the individual health benefits tax reform proposals. A discussion of the data and methods used to develop these estimates is presented in Appendix A. Our analysis is presented in the following sections:

• Health Benefits Tax Expenditures in 1998;
• Providing Tax Subsidies for Individually Purchased Non-Group Coverage;
• Low-Income Tax Credit Proposals;
• Flat-Dollar Tax Credit Proposal; and
• The Heritage Foundation Plan.

These various tax preferences for health benefits have effectively subsidized the purchase of employer-based insurance, which has encouraged employers to offer coverage. However, it is also widely believed that this tax subsidy has led some employers to provide relatively comprehensive insurance coverage with broad benefits and low deductibles and co-payments that encourage greater consumption of health care services than otherwise would be the case. Moreover, these tax preferences result in substantial reductions in tax revenues that tend to favor higher-income groups who are most likely to have employer-sponsored coverage. The amount of the tax revenues forgone by the government because of these tax preferences is called the "tax expenditure" for health benefits.

In this section, we present estimates of the magnitude of the "tax expenditure" resulting from the special tax treatment of health insurance premiums and of health care expenditures under the current tax system.

1. Current System

The current income tax system favors health spending and spending for health insurance in several ways. The portion of the health insurance premium paid by the employer is a business expense for the employer and tax-free in-kind income for the employee. Self-employed taxpayers may deduct a portion of their health insurance premium (40 percent in 1997, increasing to 60 percent in 1999). In addition, all taxpayers may deduct out-of-pocket health care expenditures in excess of 7.5 percent of AGI.

Even payments by workers for premiums and family health-related out-of-pocket expenses can be tax exempt if they obtain their coverage through an employer with a Section 125 health plan. Section 125 of the Internal Revenue Act permits employers to establish flexible spending accounts where a portion of the employeeís earnings can be used to purchase selected benefits offered through the employer ranging from employee contributions for health benefits to day care, where the amount contributed is exempt from taxation. Thus, for workers in Section 125 plans, sometimes known as "cafeteria plans," the entire cost of health benefits is exempt from taxation. Department of Labor data indicate that about 50 percent of workers in small firms and 75 percent of workers in medium and large firms are paying their employee contributions for health benefits through these tax-exempt Section 125 contributions. In addition, many employers offer a flexible spending account where an employer can contribute up to $3,000 in tax-exempt income to pay for out-of-pocket health-related costs.

Other federal and state taxes also favor health spending. For example, social security payroll taxes are computed as a percentage of wages and salaries excluding other employee income in the form of health benefits and other non-taxable in-kind benefits. Also, income tax programs around the country exclude health benefits from taxable income and many provide some form of deduction for medical expenses. These tax systems add to the income tax incentive to take compensation in the form of non-taxable benefits such as health care.

There are several effects of this favorable tax treatment. First, it creates what some have called a "tax expenditure." A "tax expenditure" represents the lost or forgone tax revenue due to tax-favored treatment of the item. For example, there is an implicit "tax expenditure" if the employer pays $1,000 per year for the employeeís health insurance. If the employee were in the 15 percent marginal federal tax bracket, the employee would have paid $150 in federal income taxes on this $1,000 if it had been included as income for tax purposes. If the employee pays an additional $500 for the health insurance through a pre-tax deduction from paychecks, the "tax expenditure" rises to $225.

Second, critics of the current system argue that the favorable tax treatment of health benefits induces the employee to purchase more health insurance than he or she would have in the absence of favorable treatment. This is because the tax exclusion has effectively made health insurance relatively less expensive than other goods and services, which may cause employees to purchase more of it. This will come in the form of policies that cover a greater variety of services and have lower deductibles and co-insurance rates. This, in turn, makes the consumption of health care services less expensive for the employee, which can result in greater utilization. In a similar manner, the ability to deduct health care expenditures from taxes or, equivalently, purchase health services with pre-tax income, also lowers the price of health care services relative to other goods and services and encourages consumption.

Third, it is a generally accepted proposition in economics that labor market (supply and demand conditions) determines the dollar cost of the total compensation package (cash wages and benefits) that the employer will offer. The favorable tax treatment of health benefits and deferred compensation in the form of pensions goes far to explain the mix of taxable wages and benefits in the total compensation package. Indeed, if health benefits were taxable as income, we would expect that, over time, the employer would reduce if not eliminate health benefits in the compensation package. Also, wages in the labor market would be bid up over time so that wages would increase by about the cost of the health benefit to the employer.

2. Tax Expenditures

Using the Health Benefits Simulation Model (HBSM) described above, we estimate that total spending for employer-sponsored coverage will be $355.9 billion in 2000. Of this, the employer will pay about $296.8 billion (83.4 percent), with the employees and retirees paying $59.1 billion (16.6 percent). All of the employer contribution for health benefits is exempt from taxation as income to employees and retirees. In addition, the employee and retiree contributions are made in pre-tax dollars in cases where the employee contribution is paid through a Section 125 cafeteria plan.

We estimate a total tax expenditure for the federal government and the states of $140.9 billion in 2000. Of this, $125.6 billion (89.1 percent) will be attributed to the federal government and $15.3 billion will be for tax expenditures under state income tax programs (Figure 1). In our analysis, federal tax expenditures include the revenues forgone due to various deductions and exemptions under the income tax and forgone revenues from the Social Security and Medicare Hospital Insurance (HI) payroll taxes. We estimate that federal income tax expenditures will be $84.9 billion in 2000. This includes the tax expenditures resulting from the health benefits exclusion, including the exclusion for employer contributions and employee contributions to Section 125 plans ($74.5 billion); the exclusion for reimbursement accounts ($5.6 billion); and the deduction for out-of-pocket spending ($4.8 billion). The exclusion of health benefits from the Social Security and Medicare HI taxes will account for tax expenditures of $31.9 billion and $8.8 billion, respectively.

Figure 1
Tax Expenditures for Health Benefits in 2000 (in billions)



Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

These estimates of the health benefits tax exclusion are crucial to the various tax credit proposals because they provide the primary source of funding for these tax credits. For example, under the various tax credit proposals, individuals would purchase coverage on their own in the insurance market and employer coverage would be eliminated. Because of competitive pressures in the labor market, wages and other forms of compensation such as pensions would be bid up to match total employee compensation levels prior to adopting the tax credit program. If all of the employer contributions for health benefits were converted to wages, the increase in federal tax revenues would be roughly equal to the estimated tax expenditure amount ($125.6 billion). However, if a large portion of what was spent on benefits were shifted to non-taxable forms of compensation such as pensions, the actual revenue increase would be less than the estimated tax expenditure amount. For this reason, some of the tax credit proposals contain provisions requiring employers to convert the full value of the benefits to wages.

Our estimates of the federal tax expenditures for health benefits and expenditures in 2000 ($125.6 billion) is higher than the Treasury Departmentís estimate of $86.4 billion, primarily because we include the Social Security and HI payroll tax expenditure while Treasury does not. The Treasury Departmentís estimate of the federal tax expenditure ($86.4 billion)ñwhich includes the health expense deduction and the exemptions for health benefits and reimbursement accountsñis actually quite close to the corresponding estimates in our analysis ($84.9 billion). Thus, the major difference between our estimate and the Treasury Departmentís is that we include $40.7 billion in tax expenditures attributed to the Social Security and HI payroll taxes.

The tax expenditure estimate is very sensitive to the assumptions used in estimating the value of the health benefit for individuals. For example, in this analysis, we assume that the value of the benefit to the individual is equal to the average premium cost per worker in the employer plan regardless of the age or sex of the individual (calculated separately for single individuals and families). However, the tax expenditure estimate would be substantially greater than we have estimated if the value of the benefit to each individual were actuarially adjusted by age. This is because costs are generally higher among older workers, who also tend to have higher incomes and a higher marginal tax rate. Thus, the amount of revenues collected under a tax credit program could be increased by requiring employers to convert health benefits to wages on an age-adjusted basis.

3. Distribution by Income

The tax expenditure for health benefits is heavily skewed toward high-income groups. We estimate that the average tax expenditure per family (including all families) will be $1,155 in 2000 (Figure 2). However, the average tax expenditure will be $2,638 for families with incomes in excess of $100,000 per year. By comparison, the average tax expenditure for families with incomes of less than $15,000 per year will be only $79 per family in 2000.

This reflects the fact that families with relatively higher incomes are in higher tax brackets and face a higher marginal tax rate, resulting in a large tax expenditure. It also reflects the fact that higher-income workers are more likely to have employer-sponsored coverage.

Figure 2
Average Federal Health Benefits Tax Expenditure by Income Level in 2000 ^a/

a/ Estimates for families with a family head under age 65.

Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

We estimate that about 23.6 percent of all federal tax expenditures in 2000 will be attributed to families with incomes of $100,000 or more per year even though this group will account for only 10 percent of the population (Figure 3). In fact, 68.7 percent of tax expenditures will be for families with incomes of $50,000 or more per year, who will make up only about 36 percent of the population. Only 31.3 percent of all tax expenditures will go to families with incomes below $50,000, even though this group will make up 64 percent of all families in the United States.

Families headed by a married individual on average will receive over twice as much tax benefit as families headed by single individuals. We estimate that the average tax expenditure in 2000 will be $1,585 in married-couple families compared with an average of $719 per single-head family (Figure 4). This reflects the fact that a disproportionate share of single individuals will be uninsured. It also reflects the fact that married-couple families tend to have a larger average family size than single-head families and therefore tend to have more family coverage policies, which are more costly. However, these estimates reflect our assumption that the value of the health benefit to an individual will vary by whether the worker has a single or a family policy. These numbers would change substantially if a uniform benefit value for all workers in firms had been used.

Figure 3
Distribution of Federal Health Benefits Tax Expenditures by Family Income in 2000 (in billions)

Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

Figure 4
Average Federal Health Benefits Tax Expenditures by Marital Status and Age in 2000

Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

The average tax expenditure amount varies with the age of the family head. We estimate that the average tax expenditure for families with a family head under the age of 25 will be $846 in 2000, compared with an average of $1,630 per family in families headed by a person aged 45 to 54 (Figure 4). This reflects the fact that younger individuals are more likely to be uninsured and are disproportionately single, resulting in less family coverage. It also reflects the fact that older workers tend to have relatively higher incomes where the marginal tax rates are higher. The average tax expenditure starts to fall among families with a head aged 55 to 64 as workers begin to retire. The average tax expenditure is estimated to be $396 per family with a head aged 65 and older even though these individuals are generally eligible for Medicare. This reflects the tax expenditure for retiree coverage and the tax expenditure for families with a head over age 65 who has a working spouse with employer coverage.

PROVIDING TAX SUBSIDIES FOR INDIVIDUALLY PURCHASED NON-GROUP COVERAGE

One of the greatest criticisms of the existing tax treatment of health benefits is that employer health benefits expenditures for workers are tax-exempt while persons who must purchase coverage in the individual insurance market receive no tax subsidy. In 2000, we estimate that there will be about 209.8 million persons without Medicare or Medicaid coverage. Of these 209.8 million persons, 158.1 million would be workers and dependents covered under an employer plan, all of whom would benefit from the tax exclusion for employer-provided health benefits. This would leave 51.7 million persons (i.e., 209.8 ñ 158.1) in families who would receive no tax subsidy for the purchase of insurance, including 8.3 million persons who would purchase individual non-group insurance and 43.4 million uninsured persons.

This inequity in the tax treatment of health benefits could be addressed by permitting individuals who do not have employer-sponsored coverage to deduct the full amount of the cost of individually purchased health insurance in determining their income tax. This deduction would be available only to individuals who purchase insurance in the individual market (excluding persons with Medigap coverage), including both workers whose employer does not provide health benefits and non-workers. Also, the availability of this deduction would encourage uninsured individuals to purchase non-group coverage by lowering the after-tax cost of insurance to the individual.

This approach would result in roughly the same federal income tax subsidies at a given income level for persons with and without employer-based coverage. However, the deduction would expand upon another perceived inequity in the current system. Under the current system, the value of the tax exemption generally increases with income. The reason for this is that the value of the deduction to the individual is greatest at higher income levels where marginal tax rates are highest (the value of the tax deduction is equal to the exempt amount of health benefits costs multiplied by the marginal tax rate, which increases with income). Thus, a tax deduction for non-group coverage would favor primarily higher-income persons while providing relatively little tax benefit to lower-income persons. Moreover, the tax benefit under the deduction can not be larger than the amount of taxes paid, which means that very low-income persons with little or no tax liability would receive little or no assistance under the deduction.

An alternative approach is to provide a flat-dollar tax credit to all tax filers purchasing non-group coverage regardless of their incomes. The tax credit would be $500 for single individuals and $1,000 for families. It would be refundable so that the credit amount could exceed a tax filerís tax liability for the year. This ensures that all persons purchasing non-group insurance will have access to substantial tax subsidies regardless of their incomes. Moreover, because subsidies for low-income persons under the tax credit are greater than they would be under the tax deduction, lower-income persons are more likely to respond to the credit by purchasing coverage for themselves and their families.

In this section, we estimate the impact of the tax deduction for persons purchasing individual non-group coverage on federal revenues and the number of persons with health insurance coverage. We then estimate the cost and coverage impacts of a bill that, instead of creating a tax deduction, provides a tax credit for tax filers purchasing non-group insurance in the individual market. This is the same group targeted under the tax deduction proposal. We then compare the costs and characteristics of uninsured persons who are induced to purchase coverage under these two proposals. In addition, we examine ways of funding these new tax subsidies by limiting the amount of premium contributions that are exempt from taxation for persons covered under employer plans.

TAX DEDUCTION FOR NON-GROUP PREMIUMS

As discussed above, the tax deduction would be available for the full amount of premiums paid for individually purchased non-group coverage. The tax credit would be available to tax filers for non-group premiums paid in months in which they were not covered by an employer plan, Medicare, or Medicaid. Excluding Medicare recipients effectively ensures that the deduction is not available for premiums paid for Medicare supplemental coverage (i.e., Medigap policies). Under the tax deduction model, premium payments for non-group coverage would no longer be counted in determining the deduction for health expenses in excess of 7.5 percent of AGI because these already will have been deducted.

In this scenario, we assumed that the deduction would take the form of an offset in calculating AGI rather than an itemized deduction. This means that the full amount of premium payments for non-group coverage is subtracted from income for all tax filers, including those who do not itemize deductions. This ensures that all eligible tax filers would benefit from the deduction even if they do not have enough deductions to itemize. Conceptually, this is the approach that is most comparable to the employee benefits exclusion, which effectively excludes the exempt amount of health benefits from AGI. Thus, the income tax deduction for non-group coverage would effectively mimic the effect of the exclusion for employer benefits under the current system.

About 51.7 million persons would be eligible for the tax deduction in 2000, including 8.3 million persons who would already be purchasing non-group coverage and about 43.4 million persons who would be uninsured. We assume that all of those persons who would be purchasing non-group coverage would take the deduction. We also estimate that about 3.9 million uninsured persons will be induced to purchase coverage as a result of the reduction in the net after-tax cost of coverage resulting from the deduction (Table 1). As discussed above, this estimate is based upon a prior Lewin Group study indicating that a 1.0 percent reduction in the net cost of insurance to the worker results in roughly a 0.2 percent increase in the percentage of workers and dependents with coverage.

Table 1
The Impact of a Health Insurance Deduction for Persons Without Employer-Sponsored Insurance on Coverage and Federal Costs in 2000 ^a/

a/ Estimates assume that persons who are not covered under an employer-sponsored plan are permitted to deduct from AGI the amount of their non-Medigap premium payments for individually purchased non-group coverage.

b/ Equals the tax revenue loss ($6.3 billion) divided by the number of newly insured persons (3.9 million).

Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

The tax deduction would result in a loss of tax revenues of about $6.3 billion in 2000. Of this $6.3 billion in tax subsidies, about $2.7 billion would go to the newly insured persons while the remaining $3.6 billion would be attributed to persons who are already purchasing insurance. The average annual federal cost per newly insured person would be $1,599.

1. Tax Credit for Non-Group Insurance Premiums

Another way of providing tax subsidies to persons purchasing coverage in the individual market is to provide a tax credit for the purchase of non-group coverage. To illustrate, we examined a tax credit that would be $500 for single individuals and $1,000 for family coverage. The credit would be available only to persons who are not obtaining coverage through an employer, which is the same population that would be eligible under the tax deduction scenario discussed above. As under the tax deduction option, the tax credit would not be available to Medicare or Medicaid recipients. This credit is designed to address the inequities resulting from the fact that employer contributions for health benefits are tax - exempt while persons who must purchase non-group insurance on their own in the individual market receive no tax benefit.

As under the tax deduction proposal, about 51.7 million Americans would be in families that are potentially eligible for this tax credit in 2000 (Table 2), including 8.3 million persons with non-group coverage and about 43.4 million uninsured persons. We estimate that 12.3 million of those who would be eligible will take the credit. We assume that all of the 8.3 million persons who would be purchasing non-group coverage will apply for and receive the credit. In addition, we estimate that about 4.0 million uninsured persons would be induced to obtain insurance with the help of the tax credit. The federal cost of the tax credit would be $5.0 billion in 2000. Of this $5.0 billion, $3.3 billion (62.9 percent) would go to persons who are currently insured, and $1.7 billion would go to persons who are induced to purchase coverage as a result of the tax credit. The average federal cost of the credit per newly insured person would be $1,247, which reflects the fact that two-thirds of tax credit dollars would go to persons who are already insured.

2. The Tax Deduction and the Tax Credit Compared

In the aggregate, the tax deduction and the tax credit proposals analyzed here would have similar impacts. Both proposal provide tax subsidies for the purchase of non-group insurance (excluding Medigap). The tax credit would reduce the number of uninsured by about 4.0 million persons, while the tax deduction would reduce the uninsured by 3.9 million persons (Table 3). However, the tax deduction proposal would be about 26.0 percent more costly ($6.3 billion) than the tax credit ($5.0 billion). Consequently, the average federal cost per newly insured persons would be $1,599 under the tax deduction proposal, compared with $1,247 under the tax credit.

Table 2
The Impact of a Health Insurance Tax Credit for Persons Without Employer-Sponsored Insurance on Coverage and Federal Costs in 2000 ^a/

	Persons in Families Eligible for Tax Credit (1,000s)	Persons in Families Who Take Tax Credit (1,000s)	Percentage Taking Credit	Reduction in Uninsured (1,000s)	Tax Credit Payments (millions)	Cost Per Recipient	Cost Per Newly Insured Person
Currently Purchasing Non-Group Coverage	8,281	8,281	100.0%	- -	$3,318	$401	- -
Uninsured	43,450	3,999	9.2%	3,999	$1,667	$417	- -
TOTAL	51,731	12,280	23.7%	3,999	$4,985	$406	$1,247 b/

a/ The tax credit is equal to $500 for single individuals and $1,000 for families.

b/ Equals total tax revenue loss ($5.0 billion) divided by the number of newly insured persons (4.0 million).

Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

Table 3
Comparison of the Deduction for Non-Group Coverage with a Tax Credit for Non-Group Coverage in 2000

	Tax Deduction for Non-Group Coverage a/	Tax Credit for Non-Group Coverage b/
Persons in Families Potentially Eligible for Benefit c/ (in thousands)	51,731	51,731
Number of Newly Insured Persons (in thousands)	3,927	3,999
Federal Costs (in millions)	$6,279	$4,985
Cost per Newly Insured Person	$1,599	$1,247

a/ Estimates assume that persons who are not covered under an employer-sponsored plan are permitted to deduct from AGI the amount of their non-Medigap premium payments for individually purchased non-group coverage.

b/ The tax credit is equal to $500 for single individuals and $1,000 for families.

c/ Includes persons currently purchasing non-group coverage and persons who are currently uninsured.

Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

While the impact of these two policy alternatives on coverage is quite similar, they have vastly different impacts across income groups. As discussed above, the value of the tax deduction will be greatest for persons in higher-income groups where marginal tax rates are greatest. In fact, lower-income groups will see little or no subsidy under the deduction. Consequently, most of the tax subsidy and the increase in coverage will be concentrated among higher-income groups. By contrast, the tax subsidy provided under the tax credit is uniform for each tax filer (except to the extent that it varies for single individuals and families) regardless of income level. Thus, the distribution of tax subsidies and increases in insurance coverage will tend to be distributed more evenly across income groups than under the tax deduction.

This difference in the distribution of tax subsidies across income groups under the deduction and the credit is evident from the distribution of newly insured persons by income under these two proposals. Under the tax deduction proposal, we estimate that 61.1 percent of newly insured persons would have family incomes of $50,000 or more (Figure 5). Only about 5.3 percent of newly insured persons would have incomes below $15,000. By comparison, under the tax credit proposal, only about 39 percent of newly insured persons would have incomes of $50,000 or more. About 16.1 percent of newly insured persons will be in families with income of less than $15,000. The tax credit is able to increase coverage at a lower total cost because the credit amounts are greater among lower-income groupsñwhich include a disproportionate share of the uninsuredñthan under the deduction.

Figure 5
Distribution of Newly Insured Persons by Income Under the Tax Deduction for Non-Group Coverage and Tax Credit for Non-Group Coverage in 2000
(in thousands)



a/ Estimates assume that persons who are not covered under an employer-sponsored plan are permitted to deduct from AGI the amount of their non-Medigap premium payments for individually purchased non-group coverage.

b/ The tax credit is equal to $500 for single individuals and $1,000 for families.

Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

3. Placing Limits on the Tax-Exempt Amount of Employee Benefits

Tax subsidies could be restructured to encourage individuals to moderate their use of health services. As discussed above, tax subsidies such as the employer health benefits exemption artificially reduce the price of health benefits to the consumer, thus causing individuals to consume more of it. By artificially reducing the price of insurance, individuals have had greater tendency to enroll in comprehensive health plans with relatively small deductibles and co-payments. The comprehensive nature of these plans in turn causes individuals to use more health services because the plan pays nearly all of the cost. This results in increased use of health services, which contributes to the health care cost inflation.

One approach to dealing with this problem is to place limits on the amount of health benefits expenditures that are exempt from taxation. For example, the total amount of the tax exemption for family insurance coverage could be set at $400 per month. Under this approach, total value of health benefits costs that is exempt from taxationñincluding the employer share and employee share in Section 125 plansñwould be limited, not to exceed the $400 amount. Thus, any health benefits expenditure in excess of that amount would be counted as taxable income to the employee.

Limits on the exemption for health benefits would provide an incentive for individuals to enroll in more efficient health plans with premiums that are within these tax-exemption limits. They might also cause some individuals to enroll in plans with higher co-payments, which typically results in lower levels of utilization. This would at least moderate the inflationary pressures created by the exemption. Moreover, these would provide a source of revenues that could be used to fund tax credits or other programs intended to increase insurance coverage.

For illustrative purposes, we estimated the amount of tax revenues that would be collected under alternative limits on the tax-exempt amount of contribution for employer-sponsored health benefits. We estimate that if the limit on tax-exempt contributions for health benefits were set at the median monthly premium amountñwhich we estimate to be $181 for single coverage and $429 for family coverageñincome tax revenues would increase by about $12.1 billion in 2000 (Table 4). This includes taxes on the increase in taxable income resulting from the exemption limit ($12.4 billion) minus an increase in revenue loss for the health expense deduction ($321 million). The health expenditure deduction increases because the amount paid for benefits in excess of the limitation will be countable in calculating the amount of health spending in excess of 7.5 percent of AGI.

The amount of revenues resulting from this exemption limitation declines as the limitation amounts increase. Setting the exemption limitation at the 75th percentile of premiums ($220 for single coverage and $522 for family coverage) would result in a net increase in revenues of $6.4 billion in 2000. Under an exemption limit equal to the 95th percentile ranking of premiums ($347 for individual coverage and $731 for family coverage), the net increase in revenues would be only $1.8 billion.

The impact of these exemptions on health expenditures is difficult to predict. The effective net increase in health insurance costs to the worker is likely to encourage some individuals to join managed care plans or enroll in plans with fewer benefits and higher co-payments. It is also possible that some individuals may respond by terminating coverage. However, this is likely to be rare because the exemption limits are most likely to affect relatively highly compensated workers with comprehensive benefit plans who are substantially less likely to respond to a given price increase by dropping coverage than are less highly compensated workers.

Table 4
Tax Revenues Under Alternative Limitations on Tax-Exempt Contributions for Health Benefits Under Alternative Limits in 2000

	Monthly Tax-Exempt Benefit Limits a/		Income Tax on Amounts Over Limits b/ (in millions)			Health Expense Deduction Revenue Loss c/ (in millions)		Net Federal Income Tax Revenues d/ (in millions)
Basis of Exemption Limitation Amount	Individual Coverage	Family Coverage
Median Premium	$181	$429		$12,401	$321		$12,080
75th Percentile Premium	$220	$522		$6,514	$158		$6,356
90th Percentile Premium	$269	$654		$3,206	$91		$3,115
95th Percentile Premium	$347	$731		$1,855	$62		$1,793

a/ Monthly tax-exempt benefit amounts were estimated based on the percentile ranking of policy holders in employer-sponsored health plansí monthly premium amount including the employer and employee contributions for health benefits, using the Health Benefits Simulation Model (HBSM).

b/ Assumes that the amount of tax-exempt contribution (including employer share and employee share in Section 125 plans) in excess of limits are taxable to the individual as regular income.

c/ The amount of individual health benefits contributions in excess of these limits would be countable for purposes of calculating the tax deduction for health expenditures in excess of 7.5 percent of AGI resulting in an increase in the revenue loss attributed to this deduction.

d/ Includes revenues on expenditures in excess of the tax-exempt limits minus the increased revenue loss under the health expense deduction.

Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

Low-Income Tax Credit Proposals

Several members of Congress are reportedly considering legislation that would provide a refundable tax credit for the health insurance premium payments by workers for themselves and their dependents. For example, one proposal calls for a tax credit that would be equal to 30 percent of premium payments and would be available to persons with incomes below specified levels. Such a program would provide subsidies to lower income workers and their dependents for the purchase of insurance, which would help reduce the number of uninsured. It also relieves tax inequities arising from the fact that workers with employer-sponsored coverage benefit from the health benefits exclusion while workers in firms that do not offer employer-sponsored benefits receive no tax benefits for the insurance that they can obtain only in the individual market.

In this analysis, we estimate the impact of a 30 percent tax credit for health insurance premium payments for persons who are not already receiving tax subsidies through the benefits exclusion. The amounts subject to the credit do not include Medicare Part-B premiums and premiums for a Medicare supplemental policy (i.e., Medigap), which effectively excludes Medicare beneficiaries from eligibility. The credit would be equal to 30 percent of the cost of insurance for working taxpayers who do not have access to an employer-sponsored plan. The tax credit would be refundable, which means that the tax credit amount can exceed the amount paid in taxes. We assume that the amount of the credit is phased out for taxpayers above specified income thresholds as follows:

• The credit would be equal to 30 percent of allowable insurance payments for single individuals with AGI below $25,000. The credit would be phased out for single persons with AGI between $25,000 and $35,000.
• Married couples with AGI below $40,000 would receive the full 30 percent credit, while the credit is phased out for those with AGI between $40,000 and $50,000.

While the low-income tax credits that have been proposed limit eligibility to workers without access to employer coverage, they could be extended to two other groups as well. First, the tax credit could be provided for the employee contribution for employer-sponsored coverage (except in cases where the workerís contribution is already tax exempt through a Section 125 program). This would assist those who have declined employer coverage for themselves or their dependents (estimated to be 10.2 million) in taking the coverage that is available to them through employment. Second, the tax credit could be made available for insurance purchases for non-workers who currently receive no tax benefits for purchasing insurance. Our analysis is presented in the following sections:

• Tax Credit for Workers Without Access to Employer Coverage;
• Tax Credit for All Workers;
• Tax Credit for Workers and Non-Workers;
• Varying the Size of the Tax Credit Amounts; and
• Implementation Issues.

1. Tax Credit for Workers Without Access to Employer Coverage

In this tax credit scenario, we assume that the tax credit would be available to workers who do not have access to employer coverage. This includes employees in firms that do not offer coverage and workers in insuring firms who do not meet the employer planís eligibility rules (e.g., part-time or temporary, etc.). However, the tax credit would not be available either to persons who have taken employer coverage or to the estimated 10.2 million persons who have declined the employer coverage that is available to them. As discussed above, we assume that eligibility would be limited to single individuals with incomes below $35,000 and married couples with incomes below $50,000.

There are about 15.0 million workers and dependents who meet these eligibility criteria in 2000, of whom about 2.8 million would be purchasing non-group insurance and about 12.2 million would be uninsured (Table 5). We estimate that of the 15.0 million persons eligible for the tax credit, about 4.4 million would actually take it. We assume that all of the 2.8 million eligible persons who would be purchasing insurance would take the credit. We also estimate that of the 12.2 million uninsured who would be eligible, about 1.5 million would use the credit to purchase non-group coverage. This represents a reduction in the number of uninsured persons in the United States (estimated to be 43.4 million persons in 2000) of 1.5 million persons (3.5 percent). As discussed above, our estimates of the number of persons who would take the credit are based on a prior Lewin Group study indicating that a 1.0 percent reduction in the net cost of insurance to the worker results in roughly a 0.2 percent increase in the percentage of workers and dependents with coverage.

Our estimate of the reduction in the number of uninsured persons is perhaps less than might have been hoped for. The coverage response is relatively small because the credit will cover no more than 30 percent of the cost of insurance, leaving the individual to pay the remaining 70 percent. Most of the uninsured who are eligible have relatively low incomes and would find it difficult to afford even 70 percent of the cost of the insurance. For example, a family policy that sells for $4,500 in todayís market would be equal to about 21 percent of income for families with annual incomes of $15,000, even after allowing for the 30 percent credit.

We estimate that the federal cost of the tax credit would be about $3.3 billion in 2000. Of this amount, about $2.0 billion would go toward the credits for eligible persons who are currently purchasing insurance and $1.3 billion would be for the credits provided to newly insured persons. The average credit amount would be about $746 per person (including workers and dependents). The overall cost of the program per newly insured person would be $2,121 in 2000.

2. Tax Credit for All Workers

The tax credit scenario discussed above assumed that workers with access to employer coverage would not be eligible for the tax credit. However, the credit could be extended to cover employee contributions for employer-sponsored health coverage as well. This would enable persons to receive a 30 percent credit for the amount that they contribute for employer-sponsored coverage. This would reduce the cost of insurance for persons who currently decline employer coverage, resulting in increased enrollment. However, we assume in this scenario that the credit would not


Table 5
The Impact of a 30 Percent Tax Credit for Workers Without Access to Employer Coverage in 2000 ^{a/, b/}

	Number of Persons Eligible for Credit c/ (in thousands)	Number of Persons Who Take Credit d/ (in thousands)	Percentage Taking Credit	Reduction in the Number Uninsured (in thousands)	Federal Cost of Tax Credit (in millions)	Credit Cost per Recipient	Cost per Newly Insured Person
Persons in Families with Workers Whose Employer Does Not Offer Coverage
Persons in Working Families Currently Purchasing Non-Group Coverage	2,839	2,839	100.0%	- -	$1,983	$698	- -
Persons in Working Families Eligible to Purchase Non-Group Insurance with the Credit	12,209	1,541	12.6%	1,541	$1,286	$835	- -
TOTAL	15,048	4,380	29.1%	1,541	$3,269	$746	$2,121 e/

a/ Includes persons in families with a worker with incomes below $25,000 ($50,000 for married couples). Excludes workers and dependents covered under a Section 125 employer plan and Medicare and Medicaid recipients.

b/ Estimates apply to refundable tax credit equal to 30 percent of insurance costs for eligible tax filers. Tax filers with income below $25,000 ($40,000 for married couples) receive the full 30 percent credit. The tax credit is phased out on a sliding scale with income between $25,000 and $35,000 for single individuals and between $40,000 and $50,000 for married tax filers.

c/ Includes persons who are not eligible to participate in an employer health plan with incomes below $35,000 for single individuals and $50,000 for married couples. Includes workers and dependents.

d/ Includes all eligible for the credit who are currently purchasing non-group insurance and all uninsured persons who are induced to purchase non-group insurance as a result of the tax credit. Includes workers and dependents.

e/ Equals the total tax revenue loss ($3.3 billion) divided by the number of newly insured persons (1.5 million).

Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

be allowed for tax-exempt contributions made by employees through Section 125 plans since they are already receiving a substantial tax benefit on their contributions.

This change in the tax credit could help slow the decline in the percentage of workers who take employer coverage when offered. Recent studies indicate that the percentage of persons who accept employer coverage when offered declined from 88.3 percent in 1987 to 80.1 percent by 1996, even though a greater percentage of workers are being offered coverage (Figure 6). In fact, the 1996 Medical Expenditures Panel Survey (MEPS) data indicate that there are about 10.2 million uninsured persons who have declined the employer coverage that is available to them. This includes 3.4 million uninsured workers who have declined employer coverage, 2.8 million uninsured dependents of these workers, and 4.0 million uninsured dependents of a covered worker who has declined the family coverage option.

Figure 6
Percentage of Workers Offered Employer Coverage and Percentage Accepting Coverage When Offered, 1987 and 1996



a/ Includes workers whose own employer offers coverage and workers with access to coverage as a dependent spouse.

Source: Cooper, Philip, and Barbara Steinberg-Schone, , "More Offers, Fewer Takers for Employment-Based Health Insurance: 1987 and 1996," Health Affairs, 1997, 16(6), 142-149.

The recent increases in the number of persons declining coverage appears to be attributed to a rapid increase in the percentage of the premium that workers are required to pay. For example, the KPMG annual employer survey data indicate that the percentage of the premium paid by the worker for single coverage increased from 13.0 percent in 1991 to 22.0 percent by 1996. During the same period, the percentage of the premium paid by the worker for family coverage increased from 23.0 percent to 31.2 percent.

A tax credit for workers with access to employer coverage would partially offset the employee contribution amount, resulting in more persons taking employer coverage when available. This is because individuals would be able to combine their employer contribution with the credit amount to purchase insurance. This effectively reduces the cost of insurance for uninsured persons who have declined employer coverage for themselves and/or their dependents. We estimate that in 2000 there would be 6.1 million uninsured persons in families with incomes that fall below the income eligibility levels who have declined coverage offered by an employer. We estimate that under this scenario, about 1.8 million of these uninsured persons would take the coverage offered by their employer (Table 6). In addition, as discussed in the above section, we also estimate that another 1.5 million persons who would not have access to employer coverage would be induced to take non-group coverage. We estimate an overall increase in employer spending for employee health benefits of $2.6 billion in 2000 because of this this effect. This would bring the total reduction in the number of uninsured under this scenario to 3.4 million persons.

The federal cost of this tax credit model would be $8.3 billion. This includes $3.3 billion in tax credits for workers without access to employer coverage plus $5.0 billion in tax credits for eligible workers with access to employer coverage. The $5.0 billion in credits for eligible persons with access to employer coverage would include costs for persons who are induced to take employer coverage and tax payments for eligible persons who would already have employer coverage. We estimate that in 2000 there would be about 22.2 million persons in families who will be contributing to the cost of employer-sponsored coverage in non-Section-125 plans whose income falls below the income eligibility thresholds. These individuals would receive $4.6 billion in tax credits. In addition, we estimate that there would be about 1.8 million workers and dependents in families that purchase non-group coverage who would be induced to take the credit at a cost of $428 million.

3. Tax Credit for Workers and Non-Workers

The 30 percent tax credit could be made generally available to both worker and non-worker families with incomes below the income eligibility thresholds. For example, the credit could be made available to all non-worker families under the same income eligibility levels that apply to workers (i.e., single individuals with incomes below $35,000 and married couples with incomes below $50,000). We estimate that about 1.1 million uninsured persons in non-worker families would be induced to purchase non-group coverage with the help of the credit in 2000 (Table 7). Another 3.2 million people in non-worker families who would be purchasing non-group coverage also would receive the credit. Total tax credit payments for non-workers would be $3.0 billion in 2000.

Table 6
Impact of a 30 Percent Tax Credit for Workers in 2000 ^{a/, b/}

	Number of Eligible Persons (in thousands)	Number of Persons Who Take Credit (in thousands)	Percentage Taking Credit	Reduction in Uninsured (in thousands)	Tax Credit Amount (in millions)	Increase in Employer Costs (in millions)	Credit Cost per Recipient	Cost per Newly Covered Person
Workers and Dependents With Access to Employer Coverage
Currently Covered by Employer c/	22,163	22,163	100.0%	- -	$4,617	- -	$208	- -
Uninsured Who Currently Decline Employer Coverage d/	6,075	1,823	30.0%	1,823	$428	$2,588	$235	- -
Total	28,238	23,986	84.9%	1,823	$5,045	$2,588	$210	$2,767
Workers and Dependents Without Access to Employer Coverage f/
Currently Purchase Non-Group Coverage e/	2,839	2,839	100.0%	- -	$1,983	- -	$698	- -
Currently Uninsured	12,209	1,541	12.6%	1,541	$1,286	- -	$835	- -
Total	15,048	4,380	29.1%	1,541	$3,269	- -	$746	$2,121
Total for All Groups
Total All Eligible Groups	43,286	28,366	65.5%	3,364	$8,314	$2,588	$293	$2,471 g/

a/ Includes persons in families with a worker with incomes below $35,000 ($50,000 for married couples). Excludes workers and dependents under a Section 125 employer plan and Medicare and Medicaid recipients.

b/ Estimates apply to refundable tax credit equal to 30 percent of insurance costs for eligible tax filers. Tax filers with incomes below $25,000 ($40,000 for married couples) receive the full 30 percent credit. The tax credit is phased out on a sliding scale with income between $25,000 and $35,000 for single individuals and between $40,000 and $50,000 for married tax filers.

c/ Includes persons currently covered by a non-Section-125 employer plan.

d/ Includes uninsured persons in families who decline employer coverage when offered. Also includes uninsured dependents of families where the worker takes self-only coverage but declines family coverage.

e/ Includes workers and dependents not eligible for coverage from an employer who purchase non-group coverage.

f/ Coverage and cost data for workers and dependents without access to employer coverage were estimated in Table 5 above.

g/ Equals the total tax revenue loss ($8.2 billion) divided by the number of newly insured persons (1.5 million).

Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

Table 7
Impact of a 30 Percent Tax Credit for Workers and Non-Workers in 2000 ^{a/, b/}

	Number of Eligible Persons (in thousands)	Number of Persons Who Take Credit (in thousands)	Percentage Taking Credit	Reduction in Uninsured (in thousands)	Tax Credit Amount (in millions)	Increase in Employer Costs (in millions)	Credit Cost per Recipient	Cost per Newly Covered Person
Workers and Dependents With Access to Employer Coverage f/
Currently Covered by Employer c/	22,163	22,163	100.0%	- -	$4,617	- -	$208	- -
Uninsured Who Currently Decline Employer Coverage d/	6,075	1,823	30.0%	1,823	$428	$2,588	$235	- -
Total	28,238	23,986	84.9%	1,823	$5,045	$2,588	$210	$2,767
Workers and Dependents Without Access to Employer Coverage g/
Currently Purchase Non-Group Coverage e/	2,839	2,839	100.0%	- -	$1,983	- -	$698	- -
Currently Uninsured	12,209	1,541	12.6%	1,541	$1,286	- -	$835	- -
Total	15,048	4,380	29.1%	1,541	$3,269	- -	$746	$2,121
Non-Workers
Currently Purchase Non-Group Coverage e/	3,246	3,246	100.0%	- -	$1,951	- -	$601	- -
Currently Uninsured	12,848	1,092	8.5%	1,092	$1,009	- -	$924	- -
Total	16,094	4,338	26.9%	1,092	$2,960	- -	$682	$2,711
Total for All Eligibility Groups
Total	59,380	32,704	55.1%	4,456	$11,274	$2,588	$345	$2,530 h/

a/ Includes persons in families with a worker with income below $35,000 ($50,000 for married couples). Excludes workers and dependents under a Section 125 employer plan and Medicare and Medicaid recipients.

b/ Estimates apply to refundable tax credit equal to 30 percent of insurance costs for eligible tax filers. Tax filers with incomes below $25,000 ($40,000 for married couples) receive the full 30 percent credit. The tax credit is phased out on a sliding scale with income between $25,000 and $35,000 for single individuals and between $40,000 and $50,000 for married tax filers.

c/ Includes persons currently covered by a non-Section-125 employer plan.

d/ Includes uninsured persons in families who decline employer coverage when offered. Also includes uninsured dependents of families where the worker takes self-only coverage but declines family coverage.

e/ Includes workers and dependents who are not eligible for coverage from an employer who purchase non-group coverage.

f/ Coverage and cost data for workers and dependents with access to employer coverage were estimated in Table 6 above.

g/ Coverage and cost data for workers and dependents without access to employer coverage were estimated in Table 5 above.

h/ Equals the total tax revenue loss ($11.3 billion) divided by the number of newly insured persons (4.5 million).

Source: Lewin Group estimates using the Health Benefits Simulation Model (HBSM).

Overall, this tax credit program would reduce the number of uninsured by 4.5 million persons in 2000. This includes 3.4 million uninsured persons in worker families who are induced to take coverage (as discussed above) and the 1.1 million uninsured persons in non-worker families that are induced to purchase coverage. This represents a 10.2 percent reduction in the number of uninsured reported by the Bureau of the Census (43.4 million). The total cost of this tax credit program for workers and non-workers would be $11.3 billion in 2000.

Although this tax credit scenario would help many uninsured individuals purchase insurance, most of the tax credit dollars would go to persons who are already insured. Overall, we estimate that about 32.7 million individuals would be in families who would receive the tax credit, of whom only about 4.5 million (13.6 percent) would be newly insured. Of the total federal tax credit amount of $11.3 billion, only about $2.7 billion (24.2 percent) would go to previously uninsured persons, with the remaining $8.6 billion going to persons who are already insured. Because of the large portion of tax dollars going to persons who are already insured, the cost of the tax credit per newly insured person would be about $2,530 in 2000. Table 8 presents our projection of tax credit expenditures under this scenario for 2000 through 2005.

Table 8
Federal Cost of a 30 Percent Tax Credit for Workers and Non-Workers:
2000 - 2005 ^a/ (in millions)

Year	Persons in Working Families with Employer Coverage Offered b/	Persons in Working Families Not Offered Employer Coverage who buy Non-Group Coverage	Persons in Non-Working Families with Non-Group Coverage	Total Tax Credit Cost
2000	$5,045	$3,269	$2,960	$11,274
2001	$5,307	$3,438	$3,113	$11,858
2002	$5,616	$3,640	$3,295	$12,551
2003	$5,939	$3,847	$3,484	$13,270
2004	$6,28