Thursday, February 11, 2010

Article 2 of Title I: Health Care Reform

In my February 8th EconoBlast post, I copied Title I: Health Care Reform, taken from Paul Ryan’s Roadmap for America’s Future. Today’s EconoBlast offers a critical analysis of Ryan’s second article of Title I for reforming health care. Future posts will consider additional articles of Title I.

Article 2: Ryan's Roadmap proposes to eliminate the federal tax code provision that allows payments made by companies for group health care insurance for their employees, to be excluded from taxable income of their employees.

Under current federal tax law, payments made by a company for employee health insurance are not counted as income paid to employees for federal or state income tax purposes. In 2007, had there been no such exclusion in the federal tax code, the IRS would have collected $246 billion in additional income taxes from workers. Clearly, the tax code provides an enormous tax advantage for workers whose companies sponsor a group health insurance plan.

Section 106(a) of the Internal Revenue Code established this particular tax preference in 1954. As you might imagine, the details and operational complications for this particular income tax exclusion are complicated and eye-glazing, just like the rest of the Internal Revenue Code.

Economists have criticized Section 106(a) of the tax code for several reasons. First, this tax preference (a.k.a., loophole) gives people an incentive to consume more health care than they otherwise would. Of course, the increased demand for health care caused by Section 106(a) is one of the chief factors driving the ever-rising cost of health care in America.

Others have criticized this tax exclusion because they see it as unfair. Higher-paid employees are more likely than lower-paid employees to work for companies that offer their employees a "company paid" health care insurance plan.

Of course, companies never really pay for their employees' health care insurance; they just remit insurance premiums to insurance companies instead of paying higher wages to their workers. Health care insurance companies really like that arrangement, and so do doctors and hospitals, as you might imagine.

Employees tend to think they are getting a freebie when they are not. Insurance companies, doctors, and other health care providers get more income than they otherwise would without Section 106(a) in place.

Others have criticized the Section 106(a) exclusion because it benefits higher-paid workers more than lower-paid workers, even within the same company that offers a health care "benefit." That's because higher-paid workers have a higher marginal tax rate than lower-paid workers, so the exclusion saves higher-income employees more in tax payments not made.

The Section 106(a) exclusion is a regressive provision of the tax code, benefiting higher-income workers more than lower-income workers. But that's nothing new for the tax code; the very same thing is true of payroll withholding taxes (a.k.a., withholding for social security, medicaid, and the like).

Still others have criticized the Section 106(a) exclusion because the code doesn't stipulate anything about the kind of health care insurance plan that is eligible for the exclusion. That means that so-called "Cadillac" plans that are typically enjoyed by very high income earners qualify for the exclusion, just like bare-bones plans offered by small companies. Some folks think that's unfair, too.

I support Ryan's call for eliminating the Section 106(a) exclusion, but I do so with the proviso that we also eliminate all the other tax preferences that are now included in the Internal Revenue Code. In fact, I propose that we eliminate the Internal Revenue Code entirely and replace it with HR 25/S 296, the Fair Tax.

Ryan is calling for removing the exclusion so that his proposal for giving individuals a tax credit (Article 1 of Title I) could become part of the tax code. As I stated here, I cannot support Ryan's proposed tax credit to consumers of health care insurance. Ryan's proposal does have merit, if it is compared to the current tax code only. But compared to eliminating the federal income tax altogether, Ryan's Article 2 of Title I losses its attractiveness.

Ryan's proposal for eliminating Section 106(a) simply substitutes one tax preference for another, all within an income tax code that is directly responsible for monumental inefficiency in our economy.

The federal income tax is also directly responsible for making possible an ever-expanding federal government. Yes, the federal government could expand even without the federal income tax. But it is also true that the Internal Revenue Code, as we have it today, makes it ridiculously simple.

To sum up, Ryan's proposal to eliminate Section 106(a) of the Internal Revenue Code would be better than doing nothing, but not better than getting health care divorced from tax collections altogether. Replacing the Internal Revenue Code with the Fair Tax would do just that, and at the same time, eliminate thousands of other tax preferences that distort our economy.

I repeat from an earlier post; the federal tax code should do one thing only. It should provide for funding activities of the federal government with the least distortion of choices people make through voluntary exchange. The federal tax code should not favor some to the disadvantage of others; it should not nudge people toward one choice instead of another; it should not enhance the revenue of a particular industry over others. Our current federal tax code does all these and more.

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