Illustration of the President’s Health Care Tax Initiative

January 25, 2007

Download Fiscal Fact No. 75

Fiscal Fact No. 75

Now that more details of the President’s health care proposal have emerged, we can look more closely at how different groups of Americans will be impacted. As discussed in Tax Foundation Fiscal Fact No. 74, “President to Propose Large Tax Deduction to Spur Health Insurance Purchases,” 53 percent of uninsured Americans have no federal income tax liability. Therefore, the President was forced to allow the deduction for purchasing health insurance to reduce payroll tax liability; this is the only way to let the 53 percent with no income tax liability benefit, at least in the short run, from the deduction.

Following is an illustration of how the new Bush health care plan proposed during the State of the Union Address would affect four types of families.

First, we present a family of four with two children that earns $80,000 per year in wage and salary income and receives $10,000 in employer-provided health insurance. Next, we show that same family, but we assume it receives $20,000 in employer-provided health insurance. Third, we show the impact on a low-income family with a single mother of two children who earns $25,000 in wage and salary income and currently has no health insurance. Finally, we show a single person living by himself earning $50,000 and currently uninsured. We assume all families currently take the standard deduction and receive the child tax credit (if applicable), and no other credits. Also, we calculate the Earned Income Tax Credit (EITC) and the additional child tax credit for the low-income single mother.

Table 1: Family of Four Earning $80,000 in Wage and Salary Income and Receiving $10,000 in Employer-Provided Health Insurance

Current Law

Bush Health Care Proposal

Wage and Salary Income

$80,000

$80,000

Health Insurance

$10,000

$10,000

AGI

$80,000

$90,000

Standard Deduction (regular)

$10,700

$10,700

Standard Health Deduction

$0

$15,000

Exemptions

$13,600

$13,600

Taxable Income

$55,700

$50,700

Income Tax Before Credits

$7,572.50

$6,822.50

Child Tax Credit

$2,000

$2,000

Income Tax After Credits

$5,572.50

$4,822.50

Payroll Tax Base

$80,000

$75,000

Payroll Tax (Employee)

$6,000

$5,625

Payroll Tax (Employer)

$6,000

$5,625

Total Payroll Tax

$12,000

$11,250

Total Income and Payroll Tax

$17,572.50

$16,072.50

Total Tax Savings

$1,500

Marginal cost of an additional dollar of health insurance (through employer); moved from wage/salary

Take-home pay (outside health insurance) falls by 70 cents for each additional dollar of health insurance (assuming overall compensation stays constant)

Take-home pay (outside health insurance) falls by $1 for each additional dollar of health insurance (assuming overall compensation stays constant)

Table 2: Family of Four Earning $80,000 in Wage and Salary Income and Receiving $20,000 in Employer-Provided Health Insurance

Current Law

Bush Health Care Proposal

Wage and Salary Income

$80,000

$80,000

Health Insurance

$20,000

$20,000

AGI

$80,000

$100,000

Standard Deduction (regular)

$10,700

$10,700

Standard Health Deduction

$0

$15,000

Exemptions

$13,600

$13,600

Taxable Income

$55,700

$60,700

Income Tax Before Credits

$7,572.50

$8,322.50

Credits

$2,000

$2,000

Income Tax After Credits

$5,572.50

$6,322.50

Payroll Tax Base

$80,000

$85,000

Payroll Tax (Employee)

$6,000

$6,375

Payroll Tax (Employer)

$6,000

$6,375

Total Payroll Tax

$12,000

$12,750

Total Income and Payroll Tax

$17,572.50

$19,072.50

Total Tax Loss

$1,500

Marginal cost of an additional dollar of health insurance (through employer); moved from wage/salary

Take-home pay (outside health insurance) falls by 70 cents for each additional dollar of health insurance (assuming overall compensation stays constant)

Take-home pay (outside health insurance) falls by $1 for each additional dollar of health insurance (assuming overall compensation stays constant)

Table 3: Single Mother with Two Children (Head of Household), Earning $25,000 in Wage and Salary Income, Uninsured but Purchasing Health Insurance

Current Law

Bush Health Care Proposal

Wage and Salary Income

$25,000

$25,000

Health Insurance

$0

$0

AGI

$25,000

$25,000

Standard Deduction (regular)

$7,850

$7,850

Standard Health Deduction

$0

$15,000

Exemptions

$9,900

$9,900

Taxable Income

$7,250

$0

Income Tax Before Credits

$725

$0

Child Tax Credit

$2,000
(only partly used)

$2,000
(not used)

Income Tax After Credits

$0

$0

Refundable EITC (estimate)

$2,475

$2,475

Additional Child Tax Credit

$1,300

$1,300

Payroll Tax Base

$25,000

$10,000

Payroll Tax (Employee)

$1,875

$750

Payroll Tax (Employer)

$1,875

$750

Total Payroll Tax

$3,750

$1,500

Total Income and Payroll Tax (after refundable credits)

-$25

-$2,275

Total Tax Savings

$2,250

Marginal cost of an additional dollar of health insurance (purchased on own assuming $1 has already spent)

First dollar: $1

Next dollar: $1

First dollar: – $2,249

Next dollar: $1

Note: The price of the health insurance she purchases on her own is irrelevant. Even if she purchases a very cheap plan, she still gets to take the full $15,000 deduction. She could even purchase a plan that is cheaper than the amount she saves from the tax change. We assume no changes to her EITC or additional child tax credit amount as a result of the policy change. Such technicalities should be known at a later date.

Table 4: Single Man with No Children, $50,000 in Wage and Salary Income, Uninsured but Purchasing Health Insurance

Current Law

Bush Health Care Proposal

Wage and Salary Income

$50,000

$50,000

Health Insurance

$0

$0

AGI

$50,000

$50,000

Standard Deduction (regular)

$5350

$5,350

Standard Health Deduction

$0

$7,500

Exemptions

$3,400

$3,400

Taxable Income

$41,250

$33,750

Income Tax Before Credits

$6,736.25

$4,861.25

Credits

$0

$0

Income Tax After Credits

$6,736.25

$4,861.25

Payroll Tax Base

$50,000

$42,500

Payroll Tax (Employee)

$3,750

$3,187.50

Payroll Tax (Employer)

$3,750

$3,187.50

Total Payroll Tax

$7,500

$6,375

Total Income and Payroll Tax

$14,236.25

$11,236.25

Total Tax Savings

$3,000

Marginal cost of an additional dollar of health insurance (purchased on own)

First dollar: $1

Next dollar: $1

First dollar: – $2,999

Next dollar: $1

Note: He is currently uninsured, but now purchases health insurance as a result of this plan. The price of the health insurance he purchases on his own is irrelevant. Even if he purchases a very cheap plan, he still gets to take the full $15,000 deduction. He could even purchase a plan that is cheaper than the amount he saves from the tax change.

Overall, this health care tax reform plan has its share of both good and bad tax policy. It has been common these past several decades to promote social goals through the income tax code, and this is another example. However, such tax code manipulations do have limits, and the President’s plan has bumped up against one of them: so many people pay no income taxes that deductions no longer have any value to them.

Therefore, to reach a significant fraction of the uninsured, it was necessary to reduce their Social Security and Medicare taxes. A few commentators have begun to wonder whether these lower payroll taxes will translate into lower Social Security benefits after retirement. Tax payments are still linked to benefits by law through a complex formula, and a calculation of how such potential reductions would compare to the benefit people receive from the new health insurance deduction is not possible until more detailed analysis from government agencies is available.


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