This is the first in a multi-part series exploring the Republican Study Committee’s proposal for replacing ObamaCare.
Last week, the Republican Study Committee introduced a comprehensive health bill that addresses a fundamental question facing the movement to defund/repeal ObamaCare: What would you replace it with? The bill (H.R. 3121) is titled the American Health Care Reform Act of 2013 (AHCRA), and it’s loaded with solid proposals to move us from the current government-driven ObamaCare model to a market-based, consumer-driven health care framework.
Many of the concepts detailed in AHCRA have been discussed in broad generalities by Republicans for years. Now we have specific policy proposals in actual legislative form, and the good news is that there’s a lot to like. At it’s core, AHCRA is a tax reform bill that revolves around its featured legislative proposal - the Standard Deduction for Health Insurance.
It Starts With One Thing
AHCRA Section 101:
TITLE I—REPEAL OF OBAMACARE
(a) PPACA- Effective as of the enactment of the Patient Protection and Affordable Care Act (Public Law 111-148), such Act is repealed, and the provisions of law amended or repealed by such Act are restored or revived as if such Act had not been enacted.
Current Tax Law Currently Strongly Favors Employer-Sponsored Coverage
There are a number of reasons why more than half (56%) of people in the U.S. under age 65 are covered under an employer-sponsored health plan, and only 5.7% are covered under an individual health insurance policy. First and foremost is the tax incentives for businesses and workers to structure health coverage as an employee benefit.
For example, take a worker covered under an employer-sponsored group health plan. The average annual health premium for family coverage in 2013 is $16,351. Of that staggering amount, an average of $11,786 is paid by the employer, with the balance paid by the employee.
Section 106 of the Internal Revenue Code provides that this $11,786 employer-paid amount is excluded from the employee’s gross income for purposes of both income and payroll taxes. Of course, that’s a huge tax savings to the employee who doesn’t have to pay any taxes on the income he receives in the form of health benefits. But it’s also a strong incentive for the employer to offer health benefits instead of taxable cash compensation to avoid the employer share of the payroll taxes. Plus, the employer can deduct as a business expense the cost of the benefits under Section 162 in the same manner as cash compensation.
How about the remaining $4,565 portion of the premium paid by the employee? Most employers allow their workers to pay this amount on a pre-tax basis through a Section 125 Cafeteria Plan. As with the employer-paid amount, this means that the employee pays no income or payroll taxes on the amount he contributes to the premium by salary reduction, and the employer is off the hook for its share of the payroll taxes for that amount.
In other words, the current tax structure strongly encourages employers to provide and employees to receive income in the form of health benefits rather than cash.
Do you purchase an individual health insurance policy that is not tied to an employer? If so, the current Internal Revenue Code does you no favors. Section 213 allows you to deduct medical costs on an individual basis only to the extent they exceed 10% of your adjusted gross income. Thanks to PPACA Section 9013, that’s up from the previous mark of 7.5%. Plus, the deduction is available only if you’re one of the 33% of American taxpayers who itemize deductions.
In other words, unless you have horrendous medical expenses, you’re likely paying most or all of the freight for individual coverage with after-tax dollars - the complete opposite of the tax advantages for employer-sponsored coverage. (Think of this as one of the stealth tax increases that will result from ObamaCare’s push to move you from tax-free employer-sponsored coverage to after-tax individual coverage on the exchange.)
AHCRA Levels the Tax Playing Field for Employer and Individual Coverage
AHCRA’s proposed standard deduction for health insurance (SDHI) would radically alter the status quo by providing the same tax advantages for purchasing coverage individually as through an employer. The basic premise is actually pretty simple: Individuals get a $7,500 SDHI, Families get a $20,000 SDHI. As long as you maintain employer-sponsored or individual health coverage for the entire year, you get the full SDHI.
There are also a number of important subtleties to the SDHI proposal that give it such promise:
— The SDHI amount remains the same regardless of the cost of your coverage. This means that a family of four who purchases coverage for $16,000 will still receive a deduction of $20,000. Thus, the SDHI both encourages Americans to maintain coverage by tying it to eligibility for the SDHI (but without resorting to the iron-fisted individual mandate), and it encourages careful price shopping because you will still receive the balance of the SDHI even if you spend less. (Note that the SDHI is not a refundable tax credit in the manner of the ObamaCare exchange subsidies. As I’ve addressed previously, refundable premium tax credits are the only true forms of spending through the tax code, and they’re better viewed as an entitlement than a tax provision. AHCRA provides that its deduction will not exceed a taxpayer’s earned income.)
— AHCRA is intended to be revenue neutral because the SDHI replaces the provision under Section 106 that excludes employer payments toward health coverage from an employee’s income. This effectively eliminates the current tax predicament that makes employer-sponsored coverage the only rational choice when available. (Note that AHCRA still permits employers to deduct their benefit costs as a business expense.) Have no fear about the additional taxable income you would receive from including the cost of benefits in your wages. The SDHI will apply to reduce your gross income, resulting in a tax cut for most Americans.
— The SDHI is a standard deduction. That means it’s available to all American taxpayers, not just the 33% who itemize their deductions. AHCRA is also clear that the SDHI is available regardless of whether the taxpayer itemizes or not. This is a crucial point. It’s also probably unprecedented under our current Internal Revenue Code. Kudos to the RSC for thinking outside the box with this creative solution.
— The SDHI is also an above-the-line deduction. This means it is subtracted from your gross income before your adjusted gross income is calculated through various other deductions and credits. This borrows from an important precedent established by the standard-bearer for consumer-driven health care: The health savings account (HSA). HSA contributions are an above-the-line deduction that allow you receive the same tax advantages regardless of whether the contribution is made through an employer payroll or individually, and regardless of whether you take the standard deduction or itemize.
— The SDHI also applies to reduce your payroll tax liability. This ensures that even Americans with no federal income tax liability will benefit from the deduction.
AHCRA proposes a number of important reforms to re-introduce market forces back into the health insurance industry. Its standard deduction for health insurance is the key innovation that drives the bill. The SDHI has the potential to create a true consumer-driven individual market for insurance in a manner that is completely opposite from ObamaCare’s government-driven model.
As the RSC puts it, there is a better way than the one-size-fits-all approach of ObamaCare. AHCRA’s tax reform proposals are the most important contribution to date toward establishing that replacement narrative.