Tax Benefits for Health Insurance and Expenses: Overview of Current Law and Legislation

Publication Date: July 2007

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Banking and finance; Health

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Abstract:

How tax policy affects health insurance and health care spending is a subject of increasing discussion in Washington. The issue is prompted both by the size of the tax subsidies, particularly the exclusion for employer-paid insurance, and by growing interest in comprehensive tax and health care reform. At the moment, however, attention is focused on narrower goals, such as improving health savings accounts and allowing carryovers of unused balances in flexible spending accounts.

Current law contains significant tax benefits for health insurance and expenses: (1) Employer-paid coverage is excluded from the determination of income and employment taxes. More than 60% of the noninstitutionalized population under age 65 is insured through employment-based plans; on average, large employers pay about 80% of their cost, though some pay all and others none. The exclusion also applies to health insurance provided through cafeteria plans. (2) Self-employed taxpayers may deduct 100% of their health insurance, even if they do not itemize deductions. (3) Taxpayers who itemize may deduct insurance payments and other unreimbursed medical expenses to the extent they exceed 7.5% of adjusted gross income. While not widely used, this deduction benefits those who purchase individual market policies or who have catastrophic costs. (4) Some workers eligible for Trade Adjustment Assistance or receiving a pension paid by the Pension Benefit Guarantee Corporation can receive an advanceable, refundable tax credit (the health coverage tax credit, HCTC) to purchase certain types of insurance. (5) Four tax-advantaged accounts are available to help taxpayers pay their health care expenses: Flexible Spending Accounts, Health Reimbursement Accounts, Health Savings Accounts, and Medical Savings Accounts. (6) Coverage under Medicare, Medicaid, SCHIP, and military and veterans health care programs is not considered taxable income. (7) With exceptions, benefits received from private or public insurance are not taxable.

By lowering the after-tax cost of insurance, some of these tax benefits help extend coverage to more people; they also lead some people to obtain more coverage than they would otherwise. The incentives also influence how coverage is acquired: the uncapped exclusion for employer-paid insurance, which can benefit nearly all workers and is easy to administer, is partly responsible for the predominance of employment-based insurance in the United States. In addition, the tax benefits increase the demand for health care by enabling insured people to obtain services at discounted prices; this in turn contributes to rising health care costs. Because many people would likely obtain insurance without tax benefits, they can be an inefficient use of public dollars. When insurance is viewed as a form of personal consumption, the tax benefits appear inequitable because taxpayers' savings depend on marginal tax rates. When viewed as spreading catastrophic economic risk over multiple years, however, basing those savings on marginal rates might be justified as the proper treatment for losses under a progressive tax system. This report replaces CRS Issue Brief IB98037, Tax Benefits for Health Insurance and Expenses: Current Legislation, and it will be updated as warranted by legislative activities and other developments.