More on McCain’s Health Care Tax Credit

September 17, 2008

The Angry Bear blog has brought to my attention two points on McCain's health care tax plan in response to my earlier post about Joe Klein's ignorance of a credit versus exclusion. Joe Klein's misunderstanding still holds given his direct comparison of the credit amount to the average health insurance plan and saying it's thereby a tax hike, but Tom Bozzo at AB does make two good points:

(1) If states piggyback off the federal definition of income that would be expanded under McCain's health care plan, state income tax bills could go up. This would raise revenues for state governments without having to take voter wrath over "raising taxes." This problem, however, is one that faces almost all fundamental tax reforms.

(2) For those employees whose employer drops them from coverage, any wage substitution for employer-provided health insurance would mean that those additional wages would be subject to payroll taxes, even though McCain is not going to subject employer-provided health insurance to payroll taxes.

The second point is most noteworthy. In the short-term, McCain's health care credit would still be more than sufficient for most families as most aren't going to have their coverage kicked off by an employer, and of those that are kicked off, most won't have a tax hike even after the higher payroll taxes. (Also, if payroll taxes go up, what about Social Security benefits later in life?) So let's take a look at a relatively static example.

A family makes $100,000 (60,000/40,000 split) and is in the 25 percent tax bracket. The husband's employer provides the health insurance and it is valued at $12,000. Now the employer terminates health insurance and they go out onto the private market to purchase a $12,000 policy. Since we assume the entire burden of the payroll tax is borne by the worker, employer cost of compensation remains the same. The total compensation is $72,000, yet it's all in wage form, and thereby subject to $1,836 in extra payroll taxes. (Note: if total compensation was the same, why would employers drop coverage?)

The family's overall tax cut from McCain's plan is thereby $164. But even after getting thrown into the private sector, assuming the price is the same as the value of employer-provided health insurance, this family still gets a tax cut. If we assume that the family lives in a typical state that piggybacks off the state income tax, it would turn into a tax hike. (However, the family would get more government services from the higher state revenue.)

But Bozzo does acknowledge a wage compensating differential would take place. If it didn't and the employer pocketed the difference, which has been implied by Sen. Biden, the family would definitely be worse off from McCain's tax cut plan, assuming the tax cut induced the employer to get rid of health insurance.

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