Legislative Alert
The State of the Union
President Bush's January 31st address to the nation was
billed as major vehicle for an outline of an ambitious health
policy agenda. The New York Times, The Washington Post,
and other national media outlets were reporting that Bush would
break new ground in his widely anticipated speech. In reality,
the President only devoted one single paragraph to health issues
in a speech that focused mostly on international relations, Iraq
and the war against terrorism, as well as Presidential
initiatives on energy, taxes, and homeland security.
As the President ascended the rostrum in the House of
Representatives, the White House did issue a more detailed
description of the President's health policy initiatives,
fleshing out details that were absent from the speech. Beyond
health savings account (HSA) and insurance provisions, President
Bush will be offering initiatives for price transparency and
quality information, medical information technology, chronic
conditions, and community health initiatives. The details will be
forthcoming with the submission of the President's budget.
Getting Incentives Right. In his address, the President
cited a series of incremental initiatives, including a plea for
greater equity in government policy for all American who purchase
medical insurance, additional changes to the HSA law that would
juice up and expand the HSA option, a greater reliance on
electronic medical records (which he said would reduce costs and
medical errors), and medical malpractice reform.
The President noted that in nearly 1,500 counties in the
United States, there are no practicing obstetrician/gynecolog-
ists, and pleaded with Congress to pass medical tort reform this
year. In the past ten years, the House of Representatives has
enacted medical malpractice reform seven times, and each time
the proposal was killed or died languishing in the Senate, where
Senate Democratic opposition is stiff and unyielding.
The heart of the President's health policy initiatives was
to be found in modifications of the existing federal tax
treatment of medical insurance. Today, Americans buying medical
insurance in the individual market, roughly about 8% of the total
of those who have coverage, are required by law to pay for that
coverage with after-tax dollars. This increases their costs, by
as much as 40% of the premium, compared to what they would get
through an employer group policy. Individual medical insurance
markets are burdened with other problems, including higher
administrative and marketing costs, as well as often excessive
state regulation of individual policies. For example, today there
are more than 1,800 state-mandated benefits and medical
procedures required by state legislatures. State legislators also
often impose guaranteed issue and community rating rules for
state regulated medical insurance, requiring insurers to cover
everybody and often at the same rate. These together help to
drive up costs.
Beyond individual purchase of medical insurance, all out-of-
pocket payment for medical services are made with after-tax
dollars, so that direct payment to physicians, for example,
suffers under a tax penalty that does not apply to payments made
through employer-based insurance. The tax code strongly favors
the existing third-party payment system, and economists have long
argued that there will never be a free market that is worthy of
the name without a change in the tax code.
But Getting the Tax Policy Wrong. In his address, the
President said: "We will strengthen Health Savings Accounts by
making sure that individuals and small business employees can buy
health insurance with the same advantages that people working for
big businesses now get." This would apply to individuals, the
self-employed, the unemployed, and early retirees, as well as
workers who don't or can't get their medical insurance through
the place of work.
This, on the surface, sounds like a good idea. Many of us
like HSAs, and many of us are enrolled in them. Current law
enables individuals to contribute up to $2,700 tax free, and
families up to $5,450. There are now more than 3 million HSA
policyholders, and their numbers are growing rapidly. The
tiresome Leftist predictions that HSAs would only benefit the
young and healthy, and that they would only appeal to upper-
income folks, has not been borne out by the empirical evidence.
They make medical insurance affordable for millions of Americans,
including those previously uninsured, and they are generating
high rates of personal satisfaction.
The President's proposal, however, creates a series of new
problems. Based on the more detailed White House description of
this initiative released at the time of the President's address,
it is clear that tax liberalization is confined to the purchase
of high-deductible/HSA plans. It would provide an income tax
credit to offset payroll taxes paid on premiums for the HSA
policies, and retirees purchasing a non-group plan would be able
to make the premium payments tax free from their HSA.
The President also proposed to eliminate taxes on all out-
of-pocket expenses, not just the deductibles, through expanded
HSA options. The proposal would also provide a tax credit for
payroll taxes paid on HSA contributions made by individuals. The
White House projects that these changes would dramatically
increase the attractiveness and the number of HSA plans.
Finally, while not specified in his speech to the nation,
the President proposes to assist low-income individuals and
families with a refundable tax credit for medical insurance.
According to the White House briefing paper, a family making
$25,000 or less per annum would be eligible for a $3,000
refundable tax credit (i.e., a government subsidy) to help
buy a private HSA plan, and could put up to $1,000 of the credit
into their account for routine medical expenses. Any funds
remaining, of course, can be rolled over to the next year tax-
free.
So, the President's proposal would not eliminate or
neutralize the enormous bias of the powerful federal tax code,
but would simply re-target it to favor HSAs and high-
deductible health plans. So the many distortions of the current
tax treatment of medical expenses would be complicated and
distorted even further.
A Better Policy. If one is serious about creating a
free market based on consumer choice, the government should not
rig the rules of the game to favor one option. Right now, the
government favors employer-based medical insurance, managed care,
and third-party as opposed to direct payment.
If expanded tax deductibility is to be the vehicle for
reform, the deductibility should be applied equally to
all insurance, whether purchased directly or through an
employer. This would introduce fairness and would allow for
innovations. Likewise, the President's proposal to provide tax
relief for the direct payment of medical services could decrease
costs by eliminating the bureaucratic claims-filing
apparatus. There is nothing sacred about passing payment
through a bank account labeled an HSA. If a person wants to pay a
doctor directly with any funds from any account and under any
conditions that he sees fit, that should be the business of the
patient and the doctor, and should not be penalized in any way by
government policy. If Congress decides to build upon President
Bush's proposals for expanded tax deductibility, it should do so
with a view toward establishing a real open market. That means
strict neutrality.
One more thing: Expansion of tax deductibility would create
greater fairness in the tax code and stimulate economic
efficiency in the delivery of medical services. But it would not,
of itself, significantly reduce the numbers of the uninsured nor
reduce medical expenditures.
If the objective is to control rising costs, it is not clear
how this will be achieved. Perhaps the increased competition
envisioned by the proposal will prove to be sufficient in
restraining cost growth. But, as economists generally recognize,
new tax breaks encourage more, not less, consumption.
The uninsured problem is more straightforward. Most of the
uninsured are in low-income working families, often employed in
small businesses, and would not benefit directly from expanded
tax deductibility. Hence, Bush proposes to target tax credits to
HSAs to encourage the enrollment of low-income Americans. This
does, however, limit the choices.
Promoting Portability in Coverage. In speaking of
medical insurance coverage, the President said, "We will do more
to make this coverage portable, so workers can switch jobs
without having to worry about losing their health insurance."
This is a key policy objective, around which there is a broad
consensus. Real portability is only possible, of course, if
you own and control your own medical insurance policy, just like
other insurance policies. It is not portable if it is owned
by your employer, or some other third-party payer. In the
accompanying White House briefing materials on the President's
proposal, it is clear, however, that the portability of
medical insurance coverage is once again restricted to high-
deductible/HSA plans: "Employers would have the ability to
offer workers a portable HSA insurance policy that the employees
would own, control and be able to take wherever they went. Their
premiums would be tax free and would not be increased based on
their health status at the time that they changed jobs, left the
labor force, or moved."
The language of the Bush "portability" proposal is curious,
because it specifies that employers would be the ones to offer
these portable plans. To which, one must ask: why
employers? In an open market, with equality of tax treatment,
(or, alternatively, a flat tax arrangement), there would be no
need for government bias for or against employer, or for or
against any particular type of plan. In a real market, medical
insurance, like other types of insurance, would be a product
tailored to a variety of wants and needs, which are infinitely
diverse.
Promoting Insurance Market Reform. Medical insurance
markets in the United States are a mess. They are distorted by
the federal tax code. They are further distorted by excessive and
costly state regulation. Millions of Americans are priced out of
existing coverage, or cannot get the affordable coverage that
they want or need.
While he did not mention it in the State of the Union
address, the White House staff has said that the President is
supporting the creation of Association Health Plans (AHPs). These
plans would enable small businesses to pool their resources in
associations in order to purchase medical insurance for their
workers. As embodied in House passed legislation in 2005, the AHP
concept is restricted to businesses. This is, in substance, also
the President's proposal. According to the White House language,
"AHPs let small businesses join together to purchase health
coverage, giving them the same advantages, administrative
efficiencies, and negotiating clout enjoyed by big businesses and
labor unions. By purchasing coverage for thousands of employees
at a time, association members can pay lower premiums for better
coverage."
Conservatives in Congress should recognize that AHPs do
not in themselves advance a new system based on individual
consumer choice and competition. If they think that this is a
problem, the good news is that the answer is simple: expand
consumer choice to include all kinds of association plans, not
just employment-based plans. Thus, individuals and families
should be able to join individual membership organizations as
well as business associations, as the President also suggests,
and employers could define contribution into these plans and
secure tax breaks for doing so. That way, the medical insurance
market would be opened up, and further diversified. Personal
freedom would be expanded.
Likewise, the President has also proposed that Americans
should be able to purchase medical insurance across state lines.
The proposal would, in effect, create an interstate commerce
in medical insurance. This is a good idea. It would allow the
creation of large national pools and long-term insurance
contracts, which could significantly reduce administrative costs,
and make coverage more affordable. It would also allow people to
purchase national health plans from organizations and
associations with which they have an affinity, including plans
offered by employees organizations, unions, and even faith-based
institutions. A resident in Orlando, Florida, could buy a health
plan domiciled in Seattle, Washington. National choice of
different health plans is, of course, routinely available to
federal employees and retirees in the Federal Employees Health
benefits Program (FEHBP). Rep. John Shadegg (R-AZ) has sponsored
the Health Care Choice Act (H.R. 2325) to accomplish this
objective for all Americans.
Robert Moffit is Director, the Center for Health Policy
Studies at the Heritage Foundation, Washington, D.C.
