Re: Taxing health insurance benefits to pay for reform

In comments, B wonders whether or not President Obama will end up supporting a tax on health insurance as part of the Senate health care bill, primarily because Obama lambasted McCain's health care plan during the campaign for including pretty much the same tax.  As I've said before, there are significant differences in the overall packages and what they'll do for working- and middle-class families and, as they say, therein lies the rub.  From October of 2008, Harvard University's Jeff Liebman on the effect of McCain's plan to tax health insurance:

Here's how the McCain plan works. Every family receives a refundable tax credit of $5000 that can be used only to purchase health insurance. Individuals receive $2500. McCain's advisers say the cost of this tax credit is $3.6 trillion dollars over ten years. They also say that their plan is revenue neutral because they introduce a new tax on employer-based health insurance that the Joint Committee on Taxation scores as raising $3.6 trillion over 10 years.

Currently, employee compensation in the form of employer-provided health insurance is exempt from both the personal income tax and FICA payroll taxes. Most employee payments for employer-based health insurance are also tax preferred. McCain's plan would eliminate these and other health-related tax expenditures.

The fact that the plan is revenue neutral means that the tax savings for families receiving tax cuts are exactly balanced by the tax increases for families whose taxes go up. But because the tax cuts are front loaded, after just a few years most American families will see their tax bills go up under the McCain plan.

What does this mean for a typical family? In 2009 the average premium for a family health insurance policy will cost about $13,600. With McCain's new tax on employer-provided health benefits, families in the 25 percent federal income tax bracket (which starts at taxable income of $65,100) will pay additional income tax of $3400, additional payroll tax of $1040, and will have their earnings cut by $1040 as their employers pass on the increase in the employer portion of the FICA tax. So the total tax on health insurance will be $5480, $480 more than the value of the new health insurance tax credit.

Because the McCain tax credit would be indexed only to inflation while the cost of health insurance has been rising at around 7 percent a year, the net tax increase will rise rapidly over time. By 2012 this typical family would receive a tax credit from the McCain plan of about $5337. But with premiums rising in that year to over $16,600, the new McCain health insurance tax would reach $6699 - for a net tax increase of $1362. By 2016, the tax credit would be $5823, while the new tax would be $8782 - a net tax increase of almost $3000.

Families in lower tax brackets will initially receive a tax cut from the McCain plan, but after a few years, they too will pay higher taxes. And millions of families with better than average health insurance plans or living in states with higher than average health care costs will see their taxes go up under the McCain plan by substantially more than is illustrated in the example above. In effect, the McCain plan punishes families with good health care by raising their taxes the most.