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Some Facts on McCain’s Health Care Tax Credit

4 min readBy: Gerald Prante

The Obama campaign and many in the leftist blogosphere are in the process of pulling a John McCain on taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy: don't tell the whole truth about your opponent's tax plan.

Today in a speech in Kansas City, Joe Biden said, "They want to tax your health-care benefits; I am not making this up."

While it's true that McCain's plan would tax the value of employer-provided health insurance (as it should be under a true income tax), Biden ignores the fact that McCain's plan also provides a refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit (EITC). that for most would exceed the tax increase induced by the taxation of employer-provided health insurance (over time, this value of this credit could erode, see below). In summary, for most, it's a tax cut. It is true that for some (mostly very large families and high-income families), taxes could go up. But for the vast majority of tax returns, tax liabilities would actually decrease over the next five-to-ten years.

A common misinterpretation among voters who Biden misleads will likely come from a misunderstanding of the difference between a credit and exclusion. The value of an exclusion equals the amount excluded multiplied by your marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. , which is why exclusions and deductions tend to disproportionately benefit higher income taxpayers who are in higher tax brackets. A refundable credit's value to the taxpayer is exactly the value of that credit. So a tax return in the 25 percent bracket would have to receive an exorbitant amount ($20,001) in health insurance income to actually have its tax bill go up in 2009.

Even a family earning $50,000 who had an expensive $15,000 health care plan would actually pay less tax under McCain's health tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. plan. Their income tax before credits would rise by $2,250. But they would get a $5,000 credit that would more than offset that higher tax before credits.

A family earning $100,000 who has a huge $20,000 health care plan (which is much more than the national average) would actually break even. If that family had a more reasonable $10,000 health care plan, it would receive a tax cut.

A family earning $200,000 who had a $15,000 health care plan (28% bracket) would even get a tax cut. If that family had the expensive $20,000 health care plan, it would face a tax hike of around only $600.

Note that these $15,000 and $20,000 figures cited are not normal. They are on the very high side. For most families, these assumed health care plan figures are in excess of what they receive, meaning that very few families would be getting a tax hike from McCain's plan over the next five-to-ten years.

For a single person, the credit is $2,500. The means if a single person had a health plan worth $5,000 (which is also above the national average) and he made $75,000 (still in 25% bracket most likely), he would get a tax cut. If that single person with a $5,000 health care plan made $150,000 (28% bracket most likely), he would even get a tax cut.

Now McCain's campaign hasn't talked much about this plan, probably because it costs a lot of money over the next ten years, thereby increasing the amount his plan adds to the debt. Why does it cost a lot of money? Because in that ten year window, it is a significant tax cut that the Tax Policy Center estimates would cost $1.3 trillion, not a tax hike as Biden suggests.

It's also odd that Biden would criticize this part of McCain's plan because relative to a current policy baseline, it is the most progressive part of McCain's tax plan. McCain's health care tax plan would make the tax code more progressive due to the fact that he would move from an exclusion to a refundable credit. However, in a fiscal incidence context, according to TPC, Obama's health care plan, much of which is done outside the tax system, is still more progressive than McCain's.

One downside to McCain's plan is that it does push some people into higher marginal tax brackets, which can have the effect of deterring labor (especially at the high end). This is a common critique made by supply-siders to raising tax rates.

Another downside: in the long-run (beyond ten-year window), it is likely that McCain's plan could result in a net tax hike because he calls for indexing the credit based upon CPI-U (as most tax provisions are indexed). And although this proposal is designed to try to limit the rapid rise in health care costs, it is likely that in the forseeable future, the increase in the price of health insurance would exceed CPI-U. (One of the issues not discussed much is the fact that price indeces ignore quality over time, which for health care is a big deal.) If McCain were to index it to a health care cost index to appease those concerned about the tax hikes, it would have two competing effects: lower taxes yet reduce the restraint on health care costs that he is trying to impose.