When asked about President Bush’s health-care proposal on ABC News after the State of the Union address, Senator Barack Obama responded that it did not do enough by way of controlling costs. Such is the confusion among many in Congress over what the president proposed and how it would work. In fact, the president’s proposal to restructure the tax-law treatment of employer-paid and individually purchased health-insurance coverage is the most significant cost-control proposal put before the Congress in many years, perhaps ever.
Today, when an employer pays health-insurance premiums for a worker, the entire payment is deductible by the employer and excluded from income and payroll taxes owed by the worker. Over many years, this open-ended subsidy has encouraged employers to give their workers more health insurance coverage in lieu of cash wages. The result has been a long-term trend toward expansive health-insurance plans, with relatively low deductibles and copayments, particularly for workers in large companies. With third-party payment the norm, workers and their doctors have become less sensitive to cost concerns, fueling an explosion in medical specialization, diagnostic capability, and treatment options. Over time, these new, expensive innovations — while highly valuable in the right setting — have become standard practice in many settings, driving costs higher for all who use the same health care provider network. Medical specialization has also left the system fragmented, making accountability difficult and productivity improvement nearly impossible.
Breaking the cost spiral requires changing these incentives, and the president’s proposal would do just that. Bush’s idea is to make all employer-paid premiums taxable income to the worker, just like cash wages. In return, all households with health-insurance coverage would get a new standard deduction, set at $7,500 for individuals and $15,000 for families. Importantly, these standard amounts would increase with general price inflation over time, not health care cost growth.
Replacing the open-ended subsidy for employer-based insurance with the standard deduction would dramatically change the financial incentives for most American households. Instead of an incentive for expensive, employer-paid insurance, there will be a strong incentive to get coverage that costs less than the standard amount. Insurers will respond to this incentive by offering plans with premiums below the standard deduction thresholds. For this to work, insurers will need to embark on an intensive effort to separate the “nice to have” from the medically essential, with more consumer cost-sharing to ensure appropriate price sensitivity.
It is particularly noteworthy that, under the Bush plan, workers would get the same standard deduction regardless of the premium they paid for coverage. Households will therefore have a strong incentive to seek out the lowest cost plan they can find with coverage adequate to their health-care needs. The more successful they are in lowering their health-insurance premiums, the more they would save in comparison to the standard deduction.
The plan would also significantly reduce the number of uninsured Americans. According to the latest U.S. Census Bureau estimates, there were 17 million people who were uninsured and lived in households with annual incomes exceeding $50,000 in 2005. With the standard deduction, a typical uninsured household — assuming they are in the 15-percent income-tax bracket — would save about $3,400 in income and payroll taxes if they secured health coverage for everyone in their family. This substantial tax savings should be enough to encourage large numbers of the uninsured to secure at least basic coverage to qualify for the deduction. As more low risk Americans move from uninsured to insured, premiums should come down for everyone.
Bush’s proposal would also substantially improve the portability and stability of private insurance. Today’s over-reliance on employer-based coverage means that workers must sign up for a new plan every time they switch jobs. At lower wage levels, with many part-time and seasonal workers, frequent job changes sometimes means short periods without coverage. A 2003 study showed that, over a four year period, there were 84.8 million people who went at least one month without insurance, but half of these spells lasted less than one year.
For these households, the Bush plan would be a real benefit. They could secure individually purchased insurance that would stay with them as they switch employers without losing any of the tax advantage that comes with employer-provided coverage today.
Some critics worry the proposal would mean the immediate end of employer-sponsored insurance. This concern is misplaced. Employers will still be able to offer plans with lower administrative costs and deeper provider discounts than smaller group plans can provide. For stability, most workers are likely to remain with what they have today.
But there is no doubt that the president’s approach would speed the trend toward individually-owned and purchased insurance. Here the administration proposal to provide funding for state innovation can be particularly helpful. Like Massachusetts, states could use these resources to establish arrangements similar to the federal employees’ health-benefit program, through which individuals, particularly employees of small businesses, could pick from among competing private insurers offering a group rate to all participants.
Congressional leaders have already made it clear that the president’s proposals will face an uphill battle over the next two years. They are undoubtedly uncomfortable with the Bush plan because it is a market-based reform which would make private insurance more affordable, undermining the argument for more public coverage and government regulation.
The initial, negative reaction of some congressional leaders to the Bush plan should not discourage advocates of market-based reform. The debate over the direction of the nation’s health-care system — toward more government control or a better functioning marketplace — has taken place over many years, and will continue well into the future. The president’s workable proposal vastly improves the chances that the nation will eventually select affordable private insurance over a completely government-run plan.
– James C. Capretta is a fellow at the Ethics and Public Policy Center and a policy and research consultant to health-industry clients.