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Health policy 2007-2008: Coming revolution?

By Rob Smith, Ceridian manager of Government Relations

This is the first of a two-part article examining proposals at the federal and state levels to address rising health insurance costs.

Since the federal government enacted legislation in the 1950s that made job-based health insurance tax deductible for companies and tax free for workers, Americans' health coverage has been largely tied to their place of work. This relationship worked well for a time -- businesses used health benefits to attract quality employees and workers purchased coverage at a far cheaper cost than on the individual market. But now, over five decades later, it's starting to erode.

Over the past seven years, health costs have almost doubled, which has led many businesses to drop or reduce their employee health plans. From 2000 to 2004, nearly four million Americans lost their employer-provided health insurance, and these numbers are sure to rise as premiums are predicted to increase to nearly $20,000 per employee by 2010. On average, employers cover roughly 80 percent of their employees' health insurance costs, which places this expense as "the single largest cost pressure that employers face," according to John Castellani, president of the Business Roundtable, an association that represents 165 of the largest companies in the United States.

Taxes take their toll
Strangely, these pressures on employers and workers run almost directly counter to the federal tax treatment of health benefits. More and more workers are buying coverage in the individual health market and businesses strain under mounting costs, but, in contrast to the tax benefits workers receive with employer-based plans, people who want to purchase health insurance on the individual market receive almost no tax advantages.

What's more, the current system can also provide disproportionate benefits to wealthier employees who "use the subsidy to buy all-inclusive health plans, which in turn causes them to throw money at health services; health inflation goes up, making insurance too expensive for poor families," says Stephen Mallaby, a columnist with the Washington Post. Indeed, of the $208 billion dollar tax subsidy the federal government provided to employer-based health plans in 2006, nearly a quarter went to workers who make over $150,000 a year.

The president's plan
In his State of the Union Address on January 21, President Bush proposed a revolutionary new tax plan that aims to achieve a more "level playing field" in the tax treatment of employer-employee group coverage and those who purchase coverage on the individual market.

The president's plan would remove the current unlimited tax exclusion on all employer-provided health benefits and replace it with a standard deduction of $7,500 for single coverage or $15,000 for family coverage for all workers who have health insurance, regardless of whether they have group employer insurance or an individual plan. This deduction would apply to federal income and payroll taxes, and tax payers could claim the full tax benefit even if their health policy is worth less than the limit. However, employees would be required to pay taxes on health benefits that exceed the limits. The plan would also eliminate flexible spending accounts and health reimbursement accounts.

According to Bush Administration estimates, about 80 percent of the 175 million workers who receive employer-provided health coverage would see their tax liability decrease. The remaining 20 percent -- those with more generous health policies -- would pay more in taxes than they do under the current system.

Although it is in its early stages and no legislation has been introduced in Congress to amend the tax treatment of health benefits, the buzz the president's plan has created among policy makers and the benefits community has been deafening.

What might happen under the plan
The majority of health-related measures over the last several decades have been aimed at expanding coverage for specific populations or making administrative changes within the health system (Medicare prescription drug plan, Medicaid S-CHIP program, HIPAA, etc.). While these efforts are certainly important, the government has made little progress toward ensuring that everyone who wants to purchase health insurance can afford to do so.

The president's plan would take two important steps to achieving this goal.

First, the glaring contrast between the tax treatment of group and non-group plans greatly distorts the health insurance market and makes coverage, on average, 50 percent more expensive for people who try to purchase health insurance on the individual market after tax. By removing this bias and bringing tax advantages to the individual market, the plan would allow millions of Americans who are self-employed, who have lost their employer-sponsored coverage or whose place of work doesn't sponsor a health plan, to purchase a health insurance policy at a more affordable price.

Second, the $7,500 and $15,000 standard deductions would put pressure on employers to seek coverage that would come in under the cap. Likewise, there would be increased competition for insurers to design similar coverage for non-group policies. Currently, the market for individual health insurance is extremely hostile. Not only is this coverage very expensive, it can be difficult to find an insurer who is willing to issue a health insurance policy to one person. But if the Bush plan is successful, insurers would have more incentive to provide readily available and reasonably priced individual policies as millions of people enter the market to take advantage of the tax deduction.

These cost pressures are also likely to contribute to a rise in high deductible plans and HSA consumer-directed health plans. As a whole, since the deductible on these plans is significantly higher than with traditional plans, they are somewhat insulated from sharp annual premium increases that could drive their values over the standard deduction limits. Growth in this market would also present tremendous business opportunities for companies that provide health decision support services, which are a key but, as of yet, underdeveloped component of the consumer-directed health model. "Legislative changes are only the first step in solving our nations' health care issues; information that is applicable to consumer choice will be key," says Ingrid Lindberg, vice president of Product Management for Ceridian Benefits Services.

"I often liken the changes in health care to the changes that defined benefits underwent with the passing of ERISA. The move from managed care to consumer directed plans is so similar to the transition that the financial sector went through as defined benefits started to be replaced with defined contribution plans. What we learned with the DB to DC conversion though, was that it simply isn't enough to change the legislation and give consumers transparency into their options. We learned that we must package the information in such a way that it is applicable to the consumer. The advent of retirement savings calculators and "lifestyle" funds are a testament to those learnings. We now must take those same principles and apply it to the consumers in the health care market," states Lindberg.

Looking ahead
A number of arguments can be made for and against the plan, and Congress, for its part, has remained relatively quiet.

The Democrats, who currently control both the House and Senate, historically have favored expanding medical coverage through a federal single-payer program similar to Medicare, or expanding the existing Medicare program to include individuals who do not have health insurance. Given the enormous cost burden these proposals would place on our Treasury and the fact that the Medicare fund is already steadily weakening, it is unlikely that Congress would be able to undertake such measures in the near future. However, the tax code provides numerous workable, cost-neutral opportunities to remove some of the gross inequity that plagues the health insurance market.

While most people probably wouldn't relish having their employer-provided health plans count as taxable income, it doesn't make sense to maintain a regressive tax system that inexplicably favors people who have employer-based health coverage over those who don't.

Trends in health insurance enrollment over the past 10 years clearly show that the current employer-provided health care system is eroding at an increasingly rapid pace. As more people are forced into a difficult individual insurance market, the cry for help will grow louder and louder. We can't afford to add to the ranks of the 47 million people without health insurance. The Bush plan provides an opening for a serious national conversation on health insurance equity and what realistic steps our nation can take to amend a fractured health system that is badly in need of repair.

Congress would be wise to give Bush's health care standard deduction plan the consideration it is due. It may not be a perfect solution -- it would do little to address actual health care expenses and provides minimal assistance to lower-income individuals who don't pay any income tax anyway. But it is a fresh approach to a problem that our nation desperately needs to solve, and tax adjustments could be combined with other proposals to achieve broader reform.

The 2008 presidential elections are fast approaching, and candidates will need a proposal for providing health care coverage for the uninsured. Regardless of whether Congress acts on Bush's plan, don't be surprised to see the eventual Democratic and Republican nominees supporting a plan that incorporates his ideas -- and the trend toward consumer-directed health care accelerated.