Tax Benefits for Health Insurance and Expenses: Overview of Current Law and Legislation

Tax Benefits for Health Insurance and Expenses:
Overview of Current Law and Legislation
Updated April 28, 2008
Bob Lyke
Specialist in Social Legislation
Domestic Social Policy Division
Julie M. Whittaker
Specialist in Income Security
Domestic Social Policy Division

Tax Benefits for Health Insurance and Expenses:
Overview of Current Law and Legislation
How tax policy affects health insurance and health care spending is a perennial
subject of discussion in Washington. The issue is prompted by the size of the tax
benefits, particularly the exclusion for employer-paid insurance; by their effect on
the cost and allocation of health care resources; and by interest in comprehensive tax
and health care reform. President Bush has proposed taxing the insurance that
workers receive from employers and providing a new standard deduction for health
insurance regardless of whether coverage is obtained through employment or in the
individual or small group markets. Tax code changes also figure prominently in
many comprehensive health care reform proposals.
Current law contains significant tax benefits for health insurance and expenses:
(1) Employer-paid coverage is excluded from the determination of both income and
employment taxes. This exclusion also applies to health benefits in cafeteria plans.
(2) Self-employed taxpayers may deduct 100% of their health insurance, even if they
do not itemize deductions. (3) Taxpayers who itemize may deduct insurance
payments and other unreimbursed medical expenses to the extent they exceed 7.5%
of adjusted gross income. While not widely used, this deduction benefits those who
purchase individual market policies or who have catastrophic costs. (4) Some
workers eligible for Trade Adjustment Assistance or receiving a pension paid by the
Pension Benefit Guarantee Corporation can receive an advanceable, refundable tax
credit (the health coverage tax credit, HCTC) to purchase certain types of insurance.
(5) Four tax-advantaged accounts are available to help taxpayers pay their health care
expenses: Flexible Spending Accounts, Health Reimbursement Accounts, Health
Savings Accounts, and Medical Savings Accounts. (6) Voluntary Employees’
Beneficiary Association (VEBA) plans, often called VEBAs, are vehicles for
prefunding retiree health benefits on a tax-advantaged basis for certain groups of
workers, particularly unionized workers. (7) Coverage under Medicare, Medicaid,
SCHIP, and military and veterans health care programs is not considered taxable
income. (8) With exceptions, benefits received from private or public insurance are
not taxable.
By lowering the after-tax cost of insurance, these tax benefits generally help
extend coverage to more people; they also lead some people to obtain more coverage
than they otherwise would. The incentives influence how coverage is acquired: the
uncapped exclusion for employer-paid insurance, which can benefit nearly all
workers and is easy to administer, is partly responsible for the predominance of
employment-based insurance in the United States. In addition, the tax benefits
increase the demand for health care by enabling insured people to obtain services at
discounted prices; this in turn contributes to rising health care costs. Because many
people would likely obtain insurance without tax benefits, they can be an inefficient
use of public dollars. When insurance is viewed as a form of personal consumption,
the tax benefits appear inequitable because taxpayers’ savings depend on marginal
tax rates. When viewed as spreading catastrophic economic risk over multiple years,
however, basing those savings on marginal rates might be justified as the proper
treatment for losses under a progressive tax system.

Most Recent Developments..........................................1
Tax Benefits in Current Law.........................................1
Employer-Paid Insurance........................................2
Unreimbursed Medical Expenses.................................3
Individual Market Policies...................................3
Self-Employed Individuals..................................4
Cafeteria Plans................................................4
Premium Conversion.......................................5
Flexible Spending Accounts.....................................6
Health Reimbursement Accounts.................................7
Health Savings Accounts........................................7
Medical Savings Accounts.......................................8
Health Coverage Tax Credit.....................................9
Military Health Care..........................................10
Veterans Health Care..........................................10
Medicare ...................................................10
Medicaid ...................................................12
SCHIP .....................................................12
VEBAs .....................................................12
Some Consequences of the Tax Benefits...............................13
Increases in Coverage.........................................13
The Source of Insurance Coverage...............................14
Increases in Health Care Use and Cost............................14
Equity ......................................................15
Current Proposals.................................................16
The President’s Proposal.......................................16
JCT and CBO Estimates for the FY2008 Proposal...............17
Some Observations.......................................18
Exclusion for Employer-Paid Insurance...........................18
Expanded Tax Deduction.......................................18
Self-Employed Deduction......................................19
Premium Conversion..........................................19
Flexible Spending Accounts....................................20
Health Savings Accounts.......................................21
Health Coverage Tax Credit....................................22
Refundable Individual Tax Credit................................23
Nonrefundable Tax Credit......................................24
Employer Tax Credit..........................................24
Tax Penalties................................................25
Some Other Tax Measures......................................26
For Additional Reading............................................26
Appendix .......................................................27

Tax Benefits for Health Insurance
and Expenses: Overview of
Current Law and Legislation
Most Recent Developments
On April 15, 2008, the House approved the Taxpayer Assistance and
Simplification Act of 2008 (H.R. 5719). Among other things, the legislation would
require that amounts paid or distributed for qualified medical expenses out of a
Health Savings Account after December 31, 2010, be substantiated in a manner
similar to the substantiation required for flexible spending accounts.
Tax Benefits in Current Law
Current law provides significant tax benefits for health insurance and expenses.
The tax subsidies (mostly federal income tax exclusions and deductions) are widely
available, though not everyone can take advantage of them. They reward some
people more than others, raising questions of equity. They influence the amount and
type of coverage that people obtain, which affects their ability to choose doctors and
other providers. In addition, the tax benefits affect the distribution and cost of health
This section of the report summarizes the current tax treatment of the principal
ways that people obtain health insurance and pay their health care expenses. It
describes general rules but does not discuss all limitations, qualifications, or
exceptions. To understand possible effects on tax liability, readers may want to refer
to the Appendix for an outline of the federal income tax formula. For example,
exclusions are omitted from gross income, whereas deductions are subtracted from
gross income in order to arrive at taxable income. Section number references are to
the Internal Revenue Code of 1986, as amended.
This section also includes Joint Committee on Taxation (JCT) estimates of tax
expenditures, where available. Tax expenditures measure the difference in tax
liabilities for individuals and corporations due to provisions that are exceptions to a
normative comprehensive income tax. Tax expenditures are not the same as revenue
losses to the government, the measurement of which reflects assumed behavioral
responses, timing considerations, and changes in employment tax receipts.1

1 All JCT estimates are from Estimates of Federal Tax Expenditures for Fiscal Years 2006-
2010, JCS-2-06 (April 25, 2006). Current estimates the JCT makes may be somewhat

Most of the tax rules discussed here have also been adopted by states that have
income taxes.
Employer-Paid Insurance
More than 60% of the noninstitutionalized population under age 65 is insured
under an employment-based plan. In the average plan, employers pay about 84% of
the cost of single coverage and 73% of the cost of family coverage, though some pay
all and others pay none.2
Health insurance paid by employers generally is excluded from employees’
gross income in determining their income tax liability; it also is not considered for
either the employee’s or the employer’s share of employment taxes (i.e., Social
Security, Medicare, and unemployment taxes).3 The income and employment tax
exclusions apply to both single and family coverage, which includes the employee’s
spouse and dependents. Premiums paid by employees may be subject to a premium
conversion arrangement under a cafeteria plan or counted towards the itemized
medical expense deduction (both of which are discussed below).
Insurance benefits paid from employment-based plans are excluded from gross
income if they are reimbursements for medical expenses or payments for permanent
physical injuries. Benefits not meeting these tests are taxable in proportion to the
share of the insurance costs paid by the employer that were previously excluded from
gross income. 4 Benefits are also taxable to the extent that taxpayers received a tax
benefit from deducting expenses in a prior year (e.g., if taxpayers claimed a
deduction for medical expenditures in 2006 and then received an insurance
reimbursement for them in 2007). In addition, benefits received by highly
compensated employees under discriminatory self-insured plans are partly taxable.
A self-insured plan is one in which the employer assumes the risk for a health care
plan and does not shift it to a third party.5
Employers may deduct their insurance payments as a business expense. The
deduction is not a tax benefit but a calculation necessary for the proper measurement
of the net income that is subject to taxation. Revenue loss attributable to this
deduction is not considered a tax expenditure.

1 (...continued)
different. The JCT report discusses how tax expenditures are defined (pp. 2-3) and
measured (pp. 26-27). Tax expenditures should not be added together since they do not take
account of interaction effects among provisions.
2 CRS Report 96-891, Health Insurance Coverage: Characteristics of the Insured and
Uninsured Populations in 2005, by Chris L. Peterson, and Employer Health Benefits: 2006
Summary of Findings, by the Kaiser Family Foundation and the Health Research and
Educational Trust. Much of the employers’ cost for this insurance is probably passed on to
employees through reductions in wages and other forms of compensation.
3 Sections 106 and 3121, respectively.
4 Sections 104 and 105.
5 About 70% of these employers purchase stop-loss insurance to cover major liabilities.

The Joint Committee on Taxation (JCT) estimated that the FY2007 tax
expenditure attributable to the exclusion for employer payments for health insurance
and health care (for self-insured plans) will be $99.7 billion. The estimate does not
include the effect of the exclusion on employment taxes.6
Unreimbursed Medical Expenses
Taxpayers who itemize their deductions may deduct unreimbursed medical
expenses that exceed 7.5% of adjusted gross income (AGI).7 Medical expenses
include health insurance premiums paid by the taxpayer, principally premiums for
individual market policies and the employee’s share of premiums for employment-
based coverage (aside from those subject to a premium conversion arrangement).
More generally, medical expenses include amounts paid for the “diagnosis, cure,
mitigation, treatment, or prevention of disease, or for the purpose of affecting any
structure or function of the body.”8 They also include certain transportation and
lodging expenditures, qualified long-term care costs, and long-term care insurance
premiums that do not exceed certain amounts.
The deduction is intended to help only people with catastrophic expenses, so by
design it is not widely used. For most taxpayers, the standard deduction is larger than
the sum of their itemized deductions; moreover, most do not have unreimbursed
expenses that exceed 7.5% AGI. In 2003, just under 34% of all individual income
tax returns had itemized deductions; of these returns, less than 20% (about 6.7% of
all returns) claimed a medical expense deduction.9
The JCT estimated that the FY2007 tax expenditure attributable to the medical
expense deduction (including long-term care expenses) will be about $8.2 billion.
Individual Market Policies. About 6% of the noninstitutionalized
population under age 65 is insured through private individual market policies. Likely
purchasers include early retirees, young adults, employees without access to
employment-based insurance, and the self-employed. All of these people can claim
the medical expense deduction just described, provided they qualify (i.e., they must
itemize and then can deduct only unreimbursed expenses that exceed 7.5% AGI).
Many self-employed taxpayers can claim a more generous deduction described

6 The JCT estimate includes payments of premiums through cafeteria plans. The FY2007
tax expenditure estimate from the Administration is considerably higher, $146.8 billion.
Analytical Perspectives, Budget of the United States Government, Fiscal Year 2007, p. 289.
The difference is attributable to several factors, the most important of which is the JCT
assumption that without the exclusion the itemized deduction for medical care would be
7 Section 213. If the taxpayer is subject to the Alternative Minimum Tax (AMT), this is
limited to expenses that exceed 10% of AGI. Section 56(b)1)(B).
8 Section 213(d)(1)(A).
9 Michael Parisi and Scott Hollenbeck, “Individual Income Tax Returns, 2003,” Statistics
of Income Bulletin, vol. 25 no. 2 (fall 2005), U.S. Internal Revenue Service, table 3.

Premiums for certain types of individual market insurance are not deductible,
including policies for loss of life, limb, and sight; policies that pay guaranteed
amounts each week for a stated number of weeks for hospitalization; policies to
provide payment for loss of earnings; and the part of car insurance that provides
medical coverage for persons injured in or by the policyholder’s car.
Benefits paid under accident and health insurance policies purchased by
individuals are excluded from gross income, even if they exceed medical expenses.
Self-Employed Individuals. Self-employed individuals include sole
proprietors (single owners of unincorporated businesses), general partners, limited
partners who receive guaranteed payments, and individuals who receive wages from10
S-corporations in which they are more than 2% shareholders.
Self-employed taxpayers may deduct payments for health insurance in
determining their AGI (i.e., as an “above-the-line” deduction).11 The “above-the-
line” deduction for the self-employed is not restricted to itemizers or subject to a
floor, as is the medical expense deduction described above. Currently, 100% of the
insurance cost may be taken into consideration. However, the deduction cannot
exceed the net profit and any other earned income from the business under which the
plan is established, less deductions taken for certain retirement plans and for one-half
the self-employment tax. It is not available for any month in which the taxpayer or
the taxpayer’s spouse is eligible to participate in a subsidized employment-based
health plan (i.e., one in which the employer pays part of the cost). These restrictions
prevent taxpayers with little net income from their business (which is not uncommon
for a new business) from deducting much if any of their insurance payments. The
portion not deductible under these rules may be treated as an itemized medical
expense deduction.
Self-employed individuals may not deduct their health insurance costs in
determining the employment taxes they pay (the self-employment tax).
In 2003, about 3.8 million tax returns (about 2.9% of all returns) claimed the
self-employed health insurance deduction. For FY2007, the JCT estimated that the
tax expenditure attributable to the deduction (including the self-employed deduction
for long-term care insurance) will be $4.2 billion.
Cafeteria Plans
Cafeteria plans are employer-established benefit plans under which employees
may choose between receiving cash (typically additional take-home pay) and certain
normally nontaxable benefits (such as employer-paid health insurance) without being
taxed on the value of the benefits if they select the latter. A general rule of taxation

10 Corporations may elect S-corporation status if they meet a number of Internal Revenue
Code requirements. Among other things, they cannot have more than 100 shareholders or
more than one class of stock. S-corporations are tax-reporting rather than tax-paying
entities, in contrast to C-corporations, which are subject to the corporate income tax.
11 Section 162(l).

is that taxpayers given these options will be taxed on whichever they choose because
they are deemed to be in constructive receipt of the cash. The cafeteria plan
provisions of the Code provide an express exception to this rule when the plan meets
various reporting and nondiscrimination requirements.12 Nontaxable benefits
received under a cafeteria plan are exempt from both income and employment taxes.
Cafeteria plans may be simple or complex. Simple plans might allow
employees to choose between cash and one nontaxable benefit, such as additional
health insurance. Complex plans might give employees a “pot of money” to allocate
among health insurance and reimbursement accounts, dependent care assistance,
group term life insurance, commuter benefits, and cash as they see fit.
Premium Conversion. Under a cafeteria plan option known as premium
conversion, employees may elect to reduce their taxable wages in exchange for
having their share of health insurance premiums paid on a pretax basis. The
arrangement reduces both income and employment taxes. Federal employees who
participate in the Federal Employees Health Benefits Program (FEHBP) have been
able to elect this option since October 2000. Private sector and state or local
government employees may also elect premium conversion if their employers permit.
In general, premium conversion is not available to retirees. The barrier is not
the cafeteria plan rules but an Internal Revenue Service (IRS) determination that
distributions from qualified retirement plans are always subject to taxes, aside from
several minor exceptions.13 The IRS ruling precludes former employees from
recasting pension payments as pretax income, as active workers can recast their
wages. However, employer payments for retiree health insurance are excluded from
taxes, just as they are for active workers. For many retirees, the employer pays much
of the premium.
The Pension Protection Act of 2006 (P.L. 109-280) allows certain retired public
safety officers to pay up to $3,000 of qualified health insurance premiums from their
pensions on a pretax basis. The premiums do not have to be for a plan sponsored by
the former employer; however, the exclusion does not apply to premiums paid by the
retiree and then reimbursed with pension distributions.
For FY2007, the JCT estimated that the tax expenditure attributable to cafeteria
plans will be $30.6 billion. The estimate includes the tax expenditures attributable
to dependent care flexible spending accounts.14

12 Section 125. “Cash” in this context includes any taxable benefit.
13 Rev. Rul. 2003-62.
14 The JCT estimate for health insurance received through cafeteria plans is also included
in the exclusion for employer-paid insurance (discussed above).

Flexible Spending Accounts
Flexible spending accounts (FSAs) are employer-established benefit plans that
reimburse employees for specified expenses as they are incurred.15 Accounts may be
used for dependent care or for medical and dental expenses, though there must be
separate accounts for these two purposes. FSAs and cafeteria plans are closely
related, but not all cafeteria plans have FSAs and not all FSAs are part of cafeteria
plans. FSA reimbursements funded through salary reduction agreements (the most
common arrangement) are exempt from income and employment taxes under
cafeteria plan provisions because employees have a choice between cash (their
regular salary) and a nontaxable benefit. In contrast, FSA reimbursements funded
by nonelective employer contributions are exempt from taxation directly under
provisions applying to employer-paid dependent care or health insurance.16
Health care FSAs must exhibit some of the risk-shifting and risk-distribution
characteristics of insurance. Among other things, participants must elect a specific
benefit amount prior to the start of a plan year; this election cannot be revoked except
for changes in family status. The full benefit amount (less any benefits paid) must
be made available throughout the entire year, even if employees spread their
contributions throughout the year. Amounts unused at the end of the year must be
forfeited to the employer (the “use it or lose it” rule), though employers may allow
a 2½-month grace period.17 FSAs cannot be used to purchase insurance; however,
they can be combined with premium conversion arrangements under cafeteria plans
to achieve the same tax effect.
In 2004, about 20% of private-sector establishments offered a health care FSA
to their workers.18 They are more common in larger firms: 61.5% of establishments
with 50 or more workers offered them, but only 6.5% of smaller establishments.
Similarly, more employees had access to an FSA if they worked in larger firms: 68%
of workers did in firms with 50 or more workers, but only 11% did in smaller firms.
Overall, 52% of private-sector employees could establish a health care FSA.
Most people with access to an FSA do not use them. A 2006 survey by Mercer
Human Resources Consulting showed that an average of 36% of eligible employees
participated in health care FSAs offered by employers with 10 or more employees.
The average amount contributed was $1,208.

15 Some FSAs are linked to employers’ health insurance plans so provider payments can be
made directly from the accounts. These arrangements avoid the need for employees to pay
first and then seek reimbursement.
16 For additional information, see CRS Report RL32656, Health Care Flexible Spending
Accounts, by Bob Lyke.
17 The Tax Relief and Health Care Act of 2006 (P.L. 109-432) allows individuals to make
limited, one-time rollovers from balances in their health care FSAs to Health Savings
Accounts. See IRS Notice 2007-22 for details.
18 Data in this paragraph are from the 2004 Medical Expenditure Panel Survey.

Federal employees have had the opportunity to use FSAs since July 2003. In

2005, there were 157,991 federal health care FSAs.

Health Reimbursement Accounts
Health Reimbursement Accounts (HRAs) are employer-established
arrangements to reimburse employees for medical and dental expenses not covered
by insurance or otherwise reimbursable. As with FSAs, reimbursements are not
subject to either income or employment taxes. In contrast, however, contributions
cannot be made through salary reduction agreements; only employers may contribute.
Employers need not actually fund HRAs until employees draw on them; the accounts
may be simply notional. Also unlike FSAs, reimbursements can be limited to
amounts previously contributed. Unused balances may be carried over indefinitely,
though employers may limit the aggregate carryovers.
HRAs are governed by the Code provisions discussed above for the exclusion
of benefits paid from employment-based plans and various IRS guidance.19
Health Savings Accounts
Health Savings Accounts (HSAs) are one way that people can pay on a tax-
advantaged basis for unreimbursed medical expenses (deductibles, copayments, and
services not covered by insurance).20 Eligible individuals can establish and fund
accounts when they have a qualifying high deductible health plan and no other health
plan, with some exceptions. The high deductible plan may be through an employer-
provided option or purchased individually. For 2008, the deductible for self-only
coverage must be at least $1,100 with an annual out-of-pocket limit not exceeding
$5,600; the deductible for family coverage must be at least $2,200 with an annual
out-of-pocket limit not exceeding $11,200.
The annual HSA contribution limit in 2008 for individuals with self-only
coverage is $2,900; for family coverage, it is $5,800. Individuals who are at least 55
years of age but not yet enrolled in Medicare may contribute an additional $900.21
Contributions may be made by employers, individuals, or both.
HSA contributions are deductible as an above-the line deduction if made by
individuals, and they are exempt from both income and employment taxes if made
by employers. Contributions may be made through salary reduction agreements, in
which case they are treated as if made by employers. Withdrawals are not taxed if
used for qualified medical expenses; however, they are taxable and usually subject

19 Section 105, Rev. Rul. 2002-41, and IRS Notice 2002-45.
20 For an overview of HSAs and three other types of tax-advantaged accounts (Flexible
Spending Accounts, Health Reimbursement Accounts, and Medical Savings Accounts) see
CRS Report RS21573, Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side
Comparison, by Bob Lyke and Chris L. Peterson.
21 Section 223. For more information, see CRS Report RL33257, Health Savings Accounts:
Overview of Rules for 2007, by Bob Lyke.

to a penalty if used for other expenses or to purchase health insurance, with some
exceptions. Account earnings are tax-exempt. Unused balances may accumulate
without limit.
In January 2007, there were about 4.5 million people covered by qualifying high
deductible insurance plans; the number includes both policyholders and their family
members. The number of people covered by HSAs is likely smaller because it is not
necessary to establish an account along with the insurance. Moreover, some accounts
may not be funded. Nonetheless, the number of HSAs appears to be growing
rapidly. 22
For FY2007, the JCT estimated that the tax expenditure attributable to HSAs
will be about $300 million.
Medical Savings Accounts
Medical Savings Accounts (MSAs) are an older, more-restrictive version of
HSAs. Begun as a demonstration program in 1997, they are limited to people who
either are self-employed or are employees covered by a high deductible insurance
plan established by a small employer (50 or fewer employees). Like HSAs, annual
contributions are limited and can be made only when account owners have qualifying
high deductible insurance, though the specific rules are different. Unlike HSAs,
contributions can be made by individuals or employers, not both, and they cannot
occur through salary-reduction agreements. The official name of MSAs is now
Archer MSAs.23
MSA contributions are deductible (as an above-the-line deduction) if made by
individuals, and they are exempt from both income and employment taxes if made
by employers. Withdrawals are not taxed if used for qualified medical expenses
under rules similar to those for HSAs. Account earnings are tax-exempt. Unused
balances may accumulate without limit.
The legislative upper limit on the number of MSAs is 750,000 (not counting
accounts of owners who previously were uninsured, among others), though there
never has been close to that many established. For tax year 2003, the IRS estimated
that there were fewer than 80,000 accounts in total. Many of these have probably
now been rolled into HSAs.
MSAs should be distinguished from Medicare MSAs, which are discussed
below under “Medicare.”

22 January 2007 Census Shows 4.5 Million People Covered by HSA/High Deductible Health
Plans. America’s Health Insurance Plans (AHIP) Center for Policy and Research (April
2007). (The Census was an AHIP Survey.) Also see CRS Report RS22417, Data on
Enrollment, Premiums, and Cost-Sharing in HSA-Qualified Health Plans, by Chris L.
23 Section 220.

Health Coverage Tax Credit
Three groups of taxpayers are potentially eligible for the health coverage tax
credit (HCTC):
!individuals receiving a Trade Readjustment Assistance allowance,
including those eligible for but not yet receiving the allowance
because they have not yet exhausted their state unemployment
!individuals receiving an Alternative Trade Adjustment Assistance
allowance; and
!individuals aged 55 and older receiving a Pension Benefit Guaranty
Corporation pension payment, including those who received a lump
sum payment after August 5, 2002.
Recipients cannot be enrolled in certain other health insurance, including
Medicaid or employment-based insurance for which the employer pays at least half
the cost, nor can they be entitled to Medicare.24
The HCTC equals 65% of the premiums the taxpayer pays for qualifying
insurance for themselves and for their family. Up to 10 types of coverage are
specified in the statute, though most require state action to become effective. The
credit is payable in advance to insurers, allowing workers to benefit before they file
their tax returns. It is also refundable: workers can receive the full credit even if they
have no regular tax liability.
The Internal Revenue Services reports that approximately 28,000 taxpayers
claimed the HCTC in tax year 2005. The average monthly premium for this group
was $600, for an average credit of $429. Approximately 17,000 family members
were covered under these plans; in total, 45,000 persons received some type of health
insurance subsidized by the HCTC.25
For FY2007, the JCT estimated that the tax expenditure attributable to the
HCTC will be about $200 million.

24 For additional information of the eligibility rules, see CRS Report RL32620, Health
Coverage Tax Credit Authorized by the Trade Act, by Julie Stone and Bob Lyke.
25 David R. Williams, Director of Electronic Tax Administration and Refundable Credits,
Internal Revenue Service, Testimony Before the House Committee on Ways and Means,
June 14, 2007, [].

Military Health Care
The U.S. Department of Defense (DOD) provides health care to active duty
military personnel, military retirees, and their dependents. In general, active duty
personnel receive care without cost (aside from small per diem charges), while the
others may have deductibles, copayments, and premiums depending on where they
are served and the particular insurance plan they are in. Military insurance plans
currently are called Tricare plans. Nearly 9 million people are eligible for services
and coverage by these arrangements.26
Coverage under military health care programs and the benefits they provide are
not considered taxable.27
For FY2007, the JCT estimated that the tax expenditure attributable to medical
care and Tricare insurance for military dependents, retirees, and dependents of
retirees will be approximately $2.0 billion.
Veterans Health Care
The U.S. Department of Veterans Affairs provides health care directly to
veterans through hospitals, nursing homes, residential rehabilitation treatment
centers, and community-based outpatient clinics. In some cases, it pays for care
provided by independent doctors and other health care professionals. Veterans health
care is not an entitlement (unlike Medicare Part A, for example), and eligibility for
services is prioritized according to several factors, including the severity of
disabilities, whether disabilities occurred during or after military service, certain
military events (e.g., having been a prisoner of war), the period of service, and means28
testing. Just over 5 million veterans receive services.
Coverage under veterans health care programs and the benefits they provide are
not considered taxable.29
Medicare is a national health insurance program for people aged 65 and older
or who meet certain disability tests. Nearly 42 million people are covered by one or

26 For more information, see CRS Report RL33537, Military Medical Care: Questions and
Answers, by Richard A. Best, Jr.
27 Section 134. The exemption of certain combat zone compensation under Section 112
might also apply, as might employer-provided health care and coverage under Sections 105
and 106.
28 For additional information, see CRS Report RL33409, Veterans’ Medical Care: FY2007
Appropriations, both by Sidath Viranga Panangala.
29 Section 134 of the Internal Revenue Code and 38 USC § 5301.

more of its parts. Coverage under Medicare and the benefits it pays for qualifying
expenses are not considered taxable.30
Medicare Part A (insurance for hospitalization, skilled nursing facilities, post-
hospitalization home health, and hospice care) is financed largely by employment
taxes that workers and their employers both pay, currently 1.45% of covered wages.
Individuals cannot take these tax payments into account for the itemized deduction
for medical expenses.31 However, employers may deduct what they pay as a business
Workers and their spouses become entitled to Part A once the workers have paid
employment taxes on covered wages for certain periods of time. They pay no
additional premium to be enrolled. People aged 65 and older who are not entitled to
Part A may voluntarily enroll by paying a monthly premium. This premium may be
taken into account for the itemized deduction for medical expenses, as may the
deductibles and copayments associated with Part A.
Medicare Part B (insurance for doctors’ fees, hospital outpatient services, most
home health, and other medical services) is financed by general tax revenues and
monthly premiums paid by those who enroll. Usually the premiums are withheld
from Social Security benefits. These premiums may be taken into account for the
itemized deduction for medical expenses, as may the deductibles and copayments
associated with Part B.32
Medicare Part D (insurance for prescription drugs) is also financed by general
tax revenues and monthly premiums paid by those who enroll. Deductibles and
copayments associated with Medicare Part D may be taken into account for the
itemized deduction for medical care, as may the Part D premiums themselves.33
Medicare Part C authorizes a number of alternative Medicare health plans, now
called Medicare Advantage plans. Participants must be enrolled in both Medicare
Part A and Part B. Some of these plans may charge an additional premium, which
can be taken into account for the itemized deduction for medical expenses. In 2007,
for the first time there are Medicare Medical Savings Account plans offered under
Part C. The tax treatment of these plans is similar to that of Health Savings
Accounts; contributions and account earnings are exempt from taxes, as are
withdrawals used to pay medical expenses.34 However, other specifications differ
depending on the plan. Contributions to Medicare MSA plans are made by the

30 Rev. Rul. 70-341. The ruling states that benefits received under Part A are not legally
distinguishable from certain Social Security benefits and thus are excluded from taxation
as disbursements made to further a social welfare function of the government. In contrast,
benefits received under Part B are excluded from taxation as medical insurance proceeds
under Section 104.
31 Rev. Rul. 66-216.
32 Rev. Rul 66-216.
33 IRS Publication 502, Medical and Dental Expenses, p. 9.
34 Section 138.

Centers for Medicare and Medicaid Services (CMS) of the U.S. Department of
Health and Human Services.
For FY2007, the JCT estimated that the tax expenditure attributable to the
exclusion of Medicare Part A benefits will be $20.7 billion. The tax expenditures
attributable to Part B and Part D were estimated to be $14.2 billion and $6.2 billion,
respect i v el y. 35
Medicaid is a form of health insurance for the elderly, people who have
disabilities, pregnant women, families with dependent children, and children who
have low income and few assets. It also pays for long-term care for people meeting
similar needs tests. As each state designs and administers its own program, there is
variation within broad federal guidelines with respect to who is served, benefits and
delivery systems, and cost-sharing and other patient requirements. Medicaid waivers
allow states even more flexibility for certain populations. Nearly 63 million people
are covered by Medicaid each year.36
Coverage under Medicaid and the benefits it pays for qualifying expenses are
not considered taxable.37
The State Children’s Health Insurance Program (SCHIP) provides health
insurance to children in families without coverage and with income above Medicaid
eligibility levels. Some states expand their Medicaid programs to cover these
children, whereas others have separate programs or a combination of both. SCHIP
waivers allow states to cover adults as well. More than 6 million children are
covered by SCHIP, as are about 650,000 adults.
As with Medicaid, coverage under SCHIP and the benefits it pays for qualifying
expenses are not considered taxable.
Voluntary Employees’ Beneficiary Association (VEBA) plans provide life
insurance, medical, disability, accident and other welfare benefits to employee38
members and their dependents. Most are organized as trusts to be legally separate

35 JCS-2-06.
36 For an overview, see CRS Report RL33202, Medicaid: A Primer, by Elicia J. Herz.
37 There apparently is no statutory provision or revenue ruling that Medicaid coverage and
benefits are exempt from taxation. The question would not often arise because Medicaid
usually is for individuals and families with low income.
38 Sections 501(a) and 501(c)(9). For a comprehensive summary of the tax treatment of
VEBAs, see Tax Expenditures: Compendium of Background Material on Individual

from employers, which is important if the latter become bankrupt. Provided certain
conditions are met, the investment earnings of VEBAs are exempt from taxation, as
are the benefits paid out if the benefit would normally be exempt. For example,
VEBA medical benefits would be tax exempt, but severance pay would not be.
VEBAs can be funded by employers or employees. Employer contributions are
tax deductible as a business expense, but the deductions generally are limited to the
sum of qualified direct costs (amounts employers could have deducted for the
employee benefit for the year if they followed cash basis accounting) and additions
to qualified asset accounts (reserves for unpaid claims, some administrative costs,
and certain post-retirement benefits), minus VEBA after-tax net income. Reserves
for retiree health benefits normally must be funded over the working lives of covered
individuals on a level basis, using actuarial assumptions incorporating current, but
not projected, medical costs. These limitations reduce the utility of VEBAs for
retiree health plans, but they do not apply to collectively-bargained plans or to
multiple employer welfare arrangements (MEWAs) of ten or more employers.39
According to the 2005 Mercer National Survey of Employer-Sponsored Plans,
9% of employers with 500 or more employees use VEBAs for prefunding retiree
health benefits. VEBAs are more common in heavy manufacturing, communication,
transportation, and utility industries.
Some Consequences of the Tax Benefits
Increases in Coverage
By lowering the after-tax cost of insurance, some of the tax benefits described
above help extend coverage to more people. This is, of course, the intention:
Congress has long been concerned about whether people have access to health care.
The public subsidy implicit in the incentives (the foregone tax revenue) usually is
justified on grounds that people would otherwise under-insure; that is, they would
delay purchasing coverage in the hope that they will not become ill or have an
accident. Uninsured people are an indication of what economists call market failure;
they impose spill-over costs on society in the form of public health risks and
uncompensated charity care. If insurance were purchased only by people who most
need health care, its cost would become prohibitive for others.
Tax benefits also lead some people to obtain more coverage than they might
otherwise choose. They purchase insurance that covers more than hospitalization and
other catastrophic expenses, such as routine doctor visits, prescription drugs, and
dental care. They obtain coverage with smaller deductibles and copayments than are
necessary. However, many people are risk-averse with respect to health care, so the

38 (...continued)
Provisions, U.S. Senate Committee on the Budget, December 2006 (S. Prt. 109-0720, p.


39 Sections 419 and 419A.

tax benefits are only one factor influencing the amount of insurance purchased.
Some people contend that comprehensive coverage and lower cost-sharing lead to
better preventive care and possibly long-term savings for certain medical conditions.
Tax benefits associated with Heath Savings Accounts are an attempt to
encourage people to purchase less coverage by having higher deductibles. In this
respect, they appear to differ from the tax benefits usually associated with health
insurance. However, the accounts themselves might be viewed as a form of
insurance, particularly as they grow in size, so it is not clear what their impact will
be in reducing overall coverage.
The Source of Insurance Coverage
Tax benefits influence the way in which insurance coverage is acquired. The
uncapped exclusion for employer-paid insurance, which can benefit nearly all
workers and is easy to administer, is partly responsible for the predominance of
employment-based insurance in the United States. In contrast, restrictions on the
itemized deduction allowed for individual private market insurance may be one
reason this insurance covers only about 6% of the noninstitutionalized population
under age 65.
Employment-based insurance carries both advantages and disadvantages for the
typical worker. The principal advantage is that coverage is based on larger and often
more stable risk pools; this generally lowers the cost for people who need more care.
Usually, employee premiums do not vary by age or risk. Although young and healthy
workers sometimes pay more than they would for identical individual market
coverage, they are protected from cost increases as they get older or need additional
care. However, plans chosen by employers may not meet individual workers’ needs,
particularly if there is only one available health plan, and changing jobs may require
both new insurance and doctors.
Increases in Health Care Use and Cost
Tax benefits increase the demand for health care by enabling insured people to
obtain services at discounted prices. This induced demand can be beneficial to the
extent that it reflects needed health care (that which society deems everyone should
have) that financial constraints otherwise would have prevented. It can be wasteful
to the extent it results in less essential or ineffective care. In any case, increasing use
of health care contributes to rising health care costs.
Whether insurance coverage could be encouraged without increasing the cost
of health care has long been a matter of debate. Comprehensive reforms that might
accomplish this goal include capping the exclusion for employer-paid insurance and
replacing both the exclusion and the deduction with a limited tax credit. But
substantial changes along these lines could be difficult to implement and might create
serious inequities. Consumer-driven health care (most commonly associated with
high deductible insurance plans coupled with Health Reimbursement Accounts and
Health Savings Accounts) is a recent attempt to help people obtain coverage without
driving up costs as much. The Congressional Budget Office analyzed this approach

in a December 2006 publication, Consumer-Directed Health Plans: Potential Effects
on Health Care and Spending Outcomes.
Many people probably would obtain some health insurance even without the tax
benefits. The cost of subsidizing people for what they would otherwise do is an
inefficient use of public dollars. One important goal of the tax incentives is for
insurance to be purchased only to the extent it results in better health care for society
as a whole. But how the incentives could be revised to accomplish this goal is a
difficult question given the different ways insurance is provided, the various ways it
is regulated, and the voluntary nature of decisions to purchase it.
Questions might be raised about the distribution of the tax incentives. Because
as a practical matter they are not available to everyone, problems of horizontal equity
arise.40 Workers without employment-based insurance generally cannot benefit from
them, nor can many early retirees (people under 65, the age of Medicare eligibility).
Even if these individuals itemize their deductions, they may deduct health insurance
premiums only to the extent that they (and other health care expenditures) exceed

7.5% of AGI. In contrast, the exclusion for employer-paid insurance is unlimited.

Even if everyone could benefit from the tax incentives, there would be questions
of vertical equity.41 Tax savings from the exclusions and deductions described above
generally are determined by taxpayers’ marginal tax rate. Thus, taxpayers in the 15%
tax bracket would save $600 in income taxes from a $4,000 exclusion (i.e., $4,000
x 0.15) for an employer-paid premium, whereas taxpayers in the 35% bracket would
save $1,400 (i.e., $4,000 x 0.35). If health insurance is considered a form of personal
consumption like food or clothing, this pattern of benefits would strike many people
as unfair. It is unlikely that a government grant program would be designed in this
manner. However, to the extent that health insurance is considered a way of
spreading an individual’s catastrophic economic risk over multiple years, basing tax
savings on marginal tax rates might be justified. Under a progressive income tax
system, economic losses ought to be deducted at applicable marginal rates, just as
economic gains are taxed at those rates.
Assessing the equity of tax incentives for health insurance is complicated by
uncertainty as to who pays for employer subsidies. In the long run, the cost of these
subsidies presumably is passed on to the workers in the form of reductions to wages
and other benefits. But whether these reductions are shared equally by all workers
is unclear given differences in their preferences for insurance, their attachment to
particular employers, and broader labor market forces.

40 Horizontal equity is a tax principle which in the case of an income tax holds that people
who have essentially equal economic income should be treated the same.
41 Vertical equity is a tax principle which in the case of an income tax holds that people who
have higher economic income should have higher tax liabilities.

Current Proposals
This section focuses on bills that have received committee or floor action or that
otherwise are the subject of discussion. It identifies other relevant bills but does not
attempt to cite them all. In a typical Congress, tax measures pertaining to health
insurance and expenses have numbered in the hundreds, not all of which are easily
tracked. In addition, not all bills are available in the Legislative Information System
(LIS) as of the date of this report.
A list of all bills on a particular topic (e.g., tax credits for health insurance) is
available to congressional staff through the LIS. The Advanced Search link in the
middle of the screen enables users to search for terms such as “‘Internal Revenue
Code’ AND ‘health insurance’ AND ‘credit.’” Often it is helpful to restrict searches
to terms that are likely to be in close proximity to each other in the bills. For
example, the previous search might be modified to “‘Internal Revenue Code’ AND
‘health insurance’ adj/7 ‘credit’.” Whatever the search terms, it is not unusual to
miss relevant bills and turn up others that are irrelevant. For assistance, call the CRS
inquiry number at 7-5700.
In considering bills on a particular topic, it is important to take account of
whether the legislation would make other changes to health care financing (e.g., by
authorizing the sale of insurance across state lines) or to the tax system (e.g., by
changing the definition of dependents or reducing tax rates). The effect of one
provision could differ substantially depending on the scope of these other changes.
Some changes might occur through legislation that ostensibly has little to do
with a particular topic. For example, a tax credit for health insurance could increase
the number of health savings accounts by enabling currently uninsured people to
purchase qualifying high deductible insurance. Similarly, capping the exclusion for
employer-paid insurance could increase the number of people who claim the medical
expense deduction because they would have more unreimbursed expenses.
The President’s Proposal
The President’s FY2009 budget proposes replacing several long-standing tax
benefits for health insurance and medical expenses with new standard deductions for
health insurance. The new deductions, $7,500 for self-only coverage or $15,000 for
family coverage, would be the same regardless of the cost of the insurance or whether
it was obtained in the individual and small group markets or through the employer.42

42 For information about the proposal, see Department of the Treasury, General
Explanations of the Administration’s Fiscal Year 2009 Revenue Proposals, February 2008,

With some minor exceptions, the proposal is similar to what was proposed in
the FY2008 budget. It would terminate these existing tax benefits:
!the exclusion for employer paid health insurance;
!the exclusion for employer paid health care;
!the exclusion for flexible spending accounts (FSAs) and health
reimbursement accounts (HRAs);
!the exclusion for premium conversion arrangements;
!the health insurance deduction available to self-employed taxpayers;
!the itemized deduction for medical expenses, except after 2013 for
those who are not eligible for the new standard deduction.
The proposal would also affect employment taxes (i.e., Social Security and
Medicare taxes). However, employers would be allowed to exclude a pro-rated
portion of these taxes, and prior to 2013 employees could claim a refund of employer
payments when they file their own returns. These rules are different from the
FY2008 proposal.
The proposal would not affect the exclusion for employer contributions to
Health Savings Accounts, nor the deduction individuals may take for their own HSA
Employers would be required to report the value of health insurance coverage
to their employees on their annual W-2 forms; the amounts would be subject to
regular withholding rules. Businesses would continue to deduct employer-paid health
insurance as a business expense, just as they do other taxable forms of compensation.
JCT and CBO Estimates for the FY2008 Proposal. The Joint
Committee on Taxation (JCT) estimated that repealing the provisions of existing law
and providing the new standard health insurance deduction would reduce net revenue
by $22.8 billion from FY2009 to FY2012. (The President proposed that the changes
would be effective for tax years beginning after December 31, 2008.) However, for
the FY2009-FY2017 period, there would be an estimated net revenue increase of43
$333.6 billion.
The Congressional Budget Office (CBO) estimated that under current law there
would be about 51 million people (both adults and children) without health insurance
on any given day in 2010. If the President’s proposal were enacted and individuals
and firms had fully adjusted to the new policy, CBO estimated that the number of44
uninsured would decline by about 6.8 million.

43 Joint Committee on Taxation, Description of Revenue Provisions Contained in the
President’s Fiscal Year 2008 Budget Proposal (JCS-2-07), p. 301. According to the JCT,
the projected increase in net revenue is largely attributable to JCT assumptions regarding
the growth of health insurance costs relative to the growth in the consumer price index.
44 Congressional Budget Office, An Analysis of the President’s Budgetary Proposals for
Fiscal Year 2008, p. 62. CBO cautions that estimated effects on coverage are highly

Some Observations. The President’s proposal would increase tax equity for
those who purchase health insurance outside of employer plans. In particular, the
proposed standard deduction would allow individuals who buy coverage with their
own funds to receive tax savings comparable to those who have the same amount of
employer-paid insurance. The proposal would also increase the transparency of
employee compensation by showing workers on their W-2 statements the nominal
amounts employers were paying for their insurance.
However, the proposed standard deduction may unfairly limit tax savings for
individuals who live where health care is expensive or who receive health insurance
from an employer with an older, less healthy risk pool. The more favorable tax
treatment of individual health insurance might spur some employers to drop coverage
if the healthiest and youngest workers opt for individual insurance. The proposal
would decrease the incentives for employers to build and maintain large risk pools,
pushing some workers into the uncertain individual market.
The CBO estimates cited above show that the proposal might reduce the number
of uninsured by about 13%, a not insubstantial amount. However, many analysts
argue that larger reductions could be achieved by replacing the proposed standard
deduction with a refundable tax credit.
Exclusion for Employer-Paid Insurance
The President’s proposal to terminate the exclusion for employer-paid health
insurance is discussed above.
S. 334 (Wyden), S. 1019 (Coburn), S. 1783 (Enzi), and S. 1875 (DeMint) would
terminate the exclusion for employer-paid health insurance, with several exceptions
as part of each of their respective comprehensive health care reform plans. H.R. 914
(Ryan) would limit the exclusion to $5,000 for self-only coverage and $11,500 for
family coverage.
Bills introduced by Representative Cooper (H.R. 666 and H.R. 847) would
require the amount that employers pay for health insurance be included on
employees’ W-2 statements. This would inform employees about how much of their
compensation (at least in nominal terms) is received through that benefit.
Expanded Tax Deduction
The President’s proposal for new standard deductions for health insurance is
discussed above.
S. 334 (Wyden) would also establish standard above-the-line deductions for
health insurance. The deduction amounts would vary according to family status. It
would not be available to people with incomes below the poverty line (who would
receive other subsidies for their insurance), and it would phase out starting at

44 (...continued)

incomes of $62,500 ($125,000 for a joint return). The provision is part of his
comprehensive health care reform plan.45
S. 1783 (Enzi) would establish standard above-the-line deductions for health
insurance. These would be paired with refundable tax credits for those people with
lower incomes. The provision is part of his comprehensive health care reform plan.
In recent Congresses, there have been a number of proposals allowing an above-
the-line deduction for what taxpayers actually paid for their health insurance and
sometimes other medical expenses. In the 110th Congress, H.R. 227 (Sterns) would
allow this deduction for health insurance and unreimbursed prescription drug costs.
H.R. 1110 (Tom Davis) and S. 773 (Warner) would allow this deduction for Tricare
supplemental premiums or enrollment fees. H.R. 2626 (Price) would allow the costs
of qualified health insurance to be deducted from income as part of his
comprehensive health care proposal. H.R. 2302 (King) would allow deductions for
premiums purchased on the individual market for high deductible plans associated
with HSAs. H.R. 3516 (McHugh), H.R. 3975 (Chabot), and S. 2835 (DeMint) would
allow the deduction of health insurance costs.
H.R. 636 (Bachman) would remove the AGI floor from the itemized deduction
for health insurance and unreimbursed medical care costs.
Self-Employed Deduction
The President’s FY2008 budget proposal to replace the tax exclusion for
employer-paid coverage with a new standard deduction for health insurance would
also terminate the tax deduction for self-employed taxpayers.
Self-employed individuals may not deduct their health insurance costs in
determining the employment taxes they pay (the self-employment tax). In contrast,
employer-paid health insurance is excluded from employment taxes of both
employees and the employer. Some people consider this treatment inequitable.
H.R. 3660 (Kind) and S. 2239 (Bingaman) would allow self-employed taxpayers
to subtract their health insurance costs in determining their self-employment taxes.
H.R. 2626 (Price) would limit the amount of self-employed tax payer’s health
care deduction as part of his comprehensive health care proposal.
Premium Conversion
H.R. 1110 (Tom Davis) and S. 773 (Warner) would allow retired military and
civilian federal workers to pay their federal health insurance premiums (Tricare andth
FEHBP, respectively) on a pretax basis. The bills are similar to the 109 Congress
measure (H.R. 994; Tom Davis), which was ordered to be reported by the House

45 In S. 1111, Wyden offers a standard health care deduction that is linked to the taxpayer’s
poverty level. This provision is part of a comprehensive tax reform plan.

Committee on Government Reform on June 16, 2005, but was never approved by the
House Ways and Means Committee.
Paying FEHBP premiums on a pretax basis is currently available to federal
workers, and it would appear equitable to allow federal retirees the same option,
particularly since retirees generally have less income than workers. However, it
would not seem equitable to allow this tax treatment for federal retirees but not
retirees with private sector or state and local governmental coverage. Including the
latter groups would substantially increase the cost of the legislation.
President Bush’s FY2008 budget proposal to replace the tax exclusion for
employer-paid coverage with a new standard deduction for health insurance would
terminate premium conversion arrangements.
Flexible Spending Accounts
President Bush’s FY2008 budget proposal to replace the tax exclusion for
employer-paid coverage with a new standard deduction for health insurance would
also terminate tax-advantaged Flexible Spending Accounts. The accounts could
continue without the tax advantage (i.e., employees could divert part of their taxable
wages into an account to be used for health care expenses), but it is not obvious who
would want these arrangements.
Under current IRS rules, FSA balances not used by the end of the year generally
are forfeited to the employer, though the employer may allow a 2½-month grace
period.46 One rationale for this requirement is that cafeteria plans, under which most
health care FSAs are funded, cannot include deferred compensation aside from one
express exception.
H.R. 298 (McCarthy) would allow a carryover of health care FSA funds, as
would S. 555 (Snowe), H.R. 3306 (Royce), and H.R. 3947 (Larson). S. 555 would
make other changes to FSAs as well, including allowing rollovers to qualified
retirement accounts, setting a statutory limit on the amount that can be contributed
to the accounts, limiting reimbursements to account balances, and permitting more
modifications to the accounts within a plan year. H.R. 3363 (Pomeroy) would allow
long-term care insurance to be offered under cafeteria plans and FSAs.
The principal argument for allowing rollovers is that taxpayers might be more
willing to participate in FSAs if unused balances at the end of the year were not lost.
Allowing carryovers or rollovers might also discourage participants from spending
remaining balances carelessly, just to use them up.
However, FSAs provide tax benefits for the first dollars of health care spending,
which is just the opposite of the restriction limiting the medical expense deduction
to catastrophic expenses (i.e., those exceeding 7.5% of AGI). FSAs also conflict

46 The Tax Relief and Health Care Act of 2006 (P.L. 109-432) allows individuals to make
limited, one-time rollovers from termination balances in their health care FSAs to Health
Savings Accounts.

with the rationale for high deductible insurance, which is not to provide third-party
assistance for expenditures that are customary and routine. Some argue that
expansion of FSAs may inhibit the spread of health savings accounts. Allowing
unused balances to be carried over or rolled over would also increase revenue losses
associated with FSAs.
Health Savings Accounts
On April 15, 2008, the House approved the Taxpayer Assistance and
Simplification Act of 2008 (H.R. 5719). Among other things, the legislation would
require that amounts paid or distributed for qualified medical expenses out of a
Health Savings Account after December 31, 2010, be substantiated in a manner
similar to the substantiation required for flexible spending accounts. Supporters of
the HSA provision argue that it is needed to ensure accountability for withdrawals.
Opponents claim that the provision would unreasonably increase administrative costs
and inhibit the use of debit cards, which are both popular and convenient. The
Administration opposes the provision.
The President’s FY2009 budget includes several measures that would make
them more attractive. These include
!allowing health plans with 50% coinsurance to qualify as high
deductible health plans,
!allowing any medical expense incurred on or after the first day of
HSA eligibility to be considered a qualified expense, even if
incurred before the HSA is established,
!allowing larger contributions from employers for chronically ill
!allowing family coverage to include coverage where each individual
can receive benefits once they have reached the minimum deductible
for an individual,
!allowing both spouses who are eligible individuals to contribute the
catch-up contribution to a single HSA owned by one spouse, and
!allowing contributions to HSAs to be made by individuals covered
by an FSA or HRA, but offset the maximum allowable HSA
contribution by the level of FSA or HRA coverage.
In the 110th Congress, S. 46 (Ensign) and S. 2835 (DeMint) would allow HSA
funds to be used (as a qualified distribution) to pay the premiums of individual
market high deductible health plans. H.R. 3234 (Cantor) would allow HSA funds to
be used to pay the premiums for most health insurance plans. H.R. 991 (Campbell)
and H.R. 3234 would allow individuals eligible for veterans health benefits to
contribute to HSAs.
S. 1019 (Coburn), H.R. 3234 (Cantor), and H.R. 3343 (Paul) would increase
HSA contribution limits and would make other modifications that would make the
accounts more attractive and effective.
H.R. 749 (Blackburn) and would allow people entitled to Medicare to instead
receive a voucher to purchase high deductible insurance and contribute to HSAs. S.

173 (Inhofe) would establish a new Medicare Health Savings Account option. H.R.

2302 (King) would allow deductions for premiums purchased on the individual
market for high deductible plans associated with HSAs. H.R. 2948 (Walberg) would
repeal the general prohibition against the purchase of health insurance from a health
savings account.
S. 2743 (Casey) would authorize new tax-exempt accounts for individuals with
disabilities; contributions from family members would be deductible up to $2,000
each year. Medical care would be one type of qualified expense for which an account
could be used.
Health Coverage Tax Credit
The HCTC is restricted to taxpayers who receive Trade Readjustment
Assistance (or would once their state unemployment benefits end), Alternative Trade
Adjustment Assistance, or a pension paid by the Pension Benefit Guaranty
Corporation. Currently, only manufacturing workers are eligible for Trade
Adjustment Assistance and Alternative Trade Adjustment Assistance. The Trade
Adjustment Assistance Reform Act of 2002 (P.L. 107-210) reauthorized the TAA
and ATAA programs through FY2007. P.L. 110-89 (Herger, H.R. 3375) extended
the program through CY2007.
The President’s FY2008 budget includes a proposal that would allow state
qualified plans to impose a pre-existing condition exclusion for a period of up to 12
months, provided the plan reduces the restriction period by the length of the eligible
individual’s creditable coverage as of the date of application for the state qualified
The FY2008 budget also proposes allowing the spouse of an HCTC-eligible
individual to claim the credit when the HCTC-eligible individual becomes entitled
to Medicare. The spouse would have to be at least 55 years of age.
H.R. 3920 (Rangel) would extend potential TAA eligibility (and thus HCTC
eligibility) to service and public sector workers and increase the credit rate from 65%
to 85%, among other things. It would also terminate the credit after December 31,
2009, except for those who have been previously eligible. The comparable Senate
bill (S. 1848), which is under consideration by the Committee on Finance, is similar
in most respects, though it would not terminate the credit.
Several 110th Congress bills would extend eligibility to different classes of
workers under certain circumstances, thus allowing them to get the tax credit; these
bills include S. 1848 (Baucus), H.R. 910 (English), H.R. 3801 (Smith) which would
extend the program to service and public agency workers; and H.R. 1729 (Hayes) and
S. 1652 (Dole), which would include presumptive eligibility of textile and apparel
S. 1739 (Rockefeller) and S. 1848 would allow family members to continue
eligibility for the credit after the person through whom they had coverage became
entitled to Medicare. S. 1739 would also have continued their eligibility in other

The narrow eligibility requirements are one reason why not many people use the
HCTC. The requirements appear unfair with respect to people who are in similar
circumstances, such as service workers whose jobs have been shifted overseas or lost
due to foreign trade. Although the bills remove this inequity for the groups
mentioned above, they are a small fraction of the many who now are ineligible.
Some 110th Congress bills (S. 1652, S. 1739, H.R. 1729, H.R. 910, S. 1848,
H.R. 3920, and H.R. 3801) would also increase the credit rate and expanded
insurance options. These steps would likely help cash-strapped families that now
cannot afford to pay the remaining 35% of the insurance cost or that cannot find
qualifying insurance. However, some might question whether additional subsidies
should be provided to narrowly targeted groups while others get nothing.
Refundable Individual Tax Credit
In recent years, there has been much discussion of a refundable income tax
credit for health insurance. Refundability allows taxpayers to receive the full amount
of a credit even if it exceeds their regular tax liability.47 The HCTC (described
above) is one example of a refundable tax credit. Unlike that credit, however, most
of the recent proposals would not be restricted to narrow eligibility groups.
An individual tax credit for health insurance could be claimed through the
normal tax-filing process. Taxpayers would include the credit when they file their
tax returns (normally by April 15 of the following year) and then use it either to
offset additional amounts they owe or to obtain a larger refund. It would also be
possible for taxpayers to adjust their withholding in order to benefit from the credit
earlier, but experience with the earned income tax credit suggests few would do so.
Most proposals would allow taxpayers to claim a refundable health insurance tax
credit in advance based on their prior year’s income. In this case, the insurer would
be reimbursed for the credit directly from the U.S. Treasury Department. Advance
payments now occur for some who receive the HCTC.
In the 110th Congress, H.R. 914 (Ryan), H.R. 2626 (Price), H.R. 2351 (Kaptur),
H.R. 5784 (Granger), S. 158 (Collins), S. 397 (Martinez), S. 1019 (Coburn), S. 1783
(Enzi), S. 1875 (DeMint) S. 1886 (Burr), H.R. 3343 (Paul), and H.R. 3515 (McHugh)
would all authorize a refundable individual income tax credit for health insurance.
H.R. 2737 (Boswell) would allow the credit for taxpayers who previously were
uninsured. H.R. 5348 (Langevin) would allow a credit as part of his comprehensive
health care reform proposal, which also would include a general premium subsidy for
certain coverage.
S. 95 (Kerry), H.R. 1111 (Waxman), H.R. 2147 (Emanuel), S. 2193 (Martinez),
and H.R. 3888 (Musgrave) would authorize a refundable tax credit for health
insurance coverage for children. In all bills, the credit is part of a more

47 It is also possible to place limits on refundability. For example, the credit might be
limited to the taxpayer’s regular tax liability plus payments for Social Security taxes. A
credit might be refundable for purposes of the regular income tax but not the alternative
minimum tax.

comprehensive children’s health insurance proposal. H.R. 2357 (Stark) and S. 2522
(Rockefeller) would authorize a refundable credit for catastrophic cost-sharing
expenses under their proposed comprehensive Medikids program.
H.R. 343 (Emerson) would authorize a refundable tax credit for Medicare Part
B premiums for military retirees.
A refundable tax credit for health insurance could be attractive. If it were
generally available, a credit could aid taxpayers who do not have access to
employment-based insurance but cannot claim the medical expense deduction. A
credit could provide all taxpayers with the same dollar reduction in final tax liability,
avoiding vertical equity problems associated with exclusions and deductions. A
credit could also provide lower-income taxpayers with sufficient resources to
purchase insurance, likely reducing the number of the uninsured.
The effects of tax credits, however, can vary widely depending on the
legislation. One important question is whether a credit would supplement or replace
existing tax benefits, particularly the exclusion for employer-paid insurance. If the
credit replaced the exclusion, it probably would have to be made available to people
with high as well as low income. A generous individual credit may lead employers
to drop coverage (or to not start it in the first place), possibly increasing the number
of the uninsured. A credit that is not generous would not enable lower-income
families to purchase insurance. Advance payments would be essential for many
families but might not work well on a large scale.
The most difficult questions about tax credits have to do with health policy. If
a credit were generous enough to provide meaningful help to lower income people,
it is likely that the legislation would have to specify what is qualifying insurance.
Otherwise, there would be no assurance that public funds would be used efficiently
and effectively. Defining qualifying insurance would involve decisions about
minimum benefits, deductible and copayment limits, guaranteed issue and pre-
existing condition exclusions, and other contentious issues.
Nonrefundable Tax Credit
H.R. 194 (Paul) would authorize a nonrefundable tax credit for 80% of the
unreimbursed prescription drug costs paid by individuals who have obtained the
Social Security retirement age.
Employer Tax Credit
Under current law, employers may deduct the expenses they incur for
employees’ health insurance and health care and the contributions they make to their
tax-advantaged health care savings accounts. Depending on the employer’s marginal
tax rate, a tax credit might result in greater tax savings, thereby providing an
additional incentive to start and maintain health insurance plans. Tax credits could
also be useful for government and nonprofit employers that are not subject to income
taxes; the credits would offset some of the employment taxes they pay.

Compared with the individual tax credits discussed above, an employer credit
could be targeted to industries or localities that have greater need. They can be
linked to employer contributions. An employer credit might not require advance
payments, though if necessary these probably would be easier to provide than in the
case of individual taxpayers. On the other hand, employer credits cannot be
accurately varied by employee income (because employers know only what they pay
workers, not their total income) and they would not be effective if employers do not
want to provide health insurance.
A number of health insurance employer tax credit bills were introduced in the

110th Congress. Many were aimed at small employers, among them S. 99 (Kerry), S.

158 (Collins), S. 2795 (Durbin), and H.R. 1802 (Hooley). H.R. 2737 (Boswell)

would authorize a tax credit for small business health expenses for previously
uninsured workers.
H.R. 5907 (Gerlach) would authorize a tax credit equal to one percent of taxable
income for employers designated as “Eagle Employers,” i.e., employers whose
compensation policies meet certain standards, including paying at least 60 percent
of each employee’s health care premiums.
Tax Penalties
Under current law, there are no tax penalties for individuals and families that do
not have health insurance coverage. Proposals requiring coverage of everyone often
include a tax penalty in order to encourage compliance. For example, in the
Massachusetts health care reform plan, people who do not have insurance and are not
exempt from the mandate will lose their state income tax personal exemption. Late
enrollers will also face an additional premium-based penalty that will be collected
through the state tax system.
S. 99 (Kerry) and H.R. 1111 (Waxman) would limit the dependent exemption
that could be claimed with respect to a child to the same percentage that represents
the proportion of the year that the child was covered by qualified health insurance.
(These bills would also authorize a refundable tax credit for the purchase of
children’s coverage and expand both SCHIP and Medicaid.)
The comprehensive health care reform bill of Senator Wyden (S. 334) would
also establish penalties for individuals who fail to purchase coverage, with some
exceptions, but the penalties are not tax penalties.
S. 1899 (Cardin) would create new low-cost health insurance plans for the states
for all individuals with incomes below 400% of the poverty level. It would require
all individuals to be covered by qualified health coverage. It would also impose an
excise tax for any individual who failed to have qualified health coverage.

Some Other Tax Measures
H.R. 15 (Dingell) would establish a national health insurance system with
payments made from a National Health Care Trust Fund. The source of revenue for
the fund would be a value added tax (a general sales tax on most goods and services).
H.R. 1200 (McDermott) would establish a new national health care system. It
would be financed by specific increases in the individual income tax, payroll taxes,
and excise taxes on tobacco products.
H.R. 1378 (Goode) would allow individuals to designate portions of their
income tax refunds to a federal trust fund to provide catastrophic health coverage to
uninsured individuals.
H.R. 2034 (Dingell) would create a comprehensive Medicare for all program
that would be financed by employment taxes and taxes on employers.
H.R. 3000 (Lee) would establish a comprehensive system financed by an
additional income tax levy on individuals and corporations. It would also modify or
repeal a number of existing tax provisions relating to health insurance.
H.R. 4864 (Paul) would waive the employee portion of Social Security taxes on
employees who have been diagnosed as having cancer or a terminal disease.
For Additional Reading
Feldman, Roger and Bryan Dowd. A New Estimate of the Welfare Loss of Excess
Health Insurance. American Economic Review. vol. 81 (March 1991), pp. 297-


Gruber, Jonathan. Tax Policy for Health Insurance. NBER Working Paper 10977
National Bureau of Economic Research. December 2004. 35 p.
Hubbard, R. Glenn, John F. Cogan, and Daniel P. Kessler. Healthy, Wealthy, and
Wise: Five Steps to a Better Health Care System. AEI Press/ The Hoover
Institution. November 2005.
Kaplow, Louis. The Income Tax as Insurance: The Casualty Loss and Medical
Expense Deductions and the Exclusion of Medical Insurance Premiums.
California Law Review, vol. 79 (1991), pp. 1485-1510.
Kahn, Charles N. and Ronald F. Pollack. Building a Consensus for Expanding
Health Coverage. Health Affairs, vol. 20 (January/February 2001), pp. 40-48.
Smart, Michael and Mark Stabile. Tax Credits and the Use of Medical Care. NBER
Working Paper 9855. National Bureau of Economic Research. July 2003.

35 p.

Pauly, Mark. Taxation, Health Insurance, and Market Failure in the Medical
Economy. Journal of Economic Literature, vol. 24 (1986), pp. 629-675.
Pauly, Mark and Bradley Herring. Expanding Coverage via Tax Credits: Trade-Offs
and Outcomes. Health Affairs, vol. 20 (January/February, 2001), pp. 9-26.
The President’s Advisory Panel on Federal Tax Reform. Simple, Fair, and Pro-
Growth: Proposals to Fix America’s Tax System. November 2005.
Sheils, John and Randall Haught. The Cost of Tax-Exempt Health Benefits in 2004.
Health Affairs, Web exclusive (January - June 2004), pp. W106-W112.
U.S. Congressional Budget Office. Consumer-Directed Health Plans: Potential
Effects on Health Care Spending and Outcomes. December 2006.
—— The Tax Treatment of Employment-Based Health Insurance. March 1994.
The general formula for calculating federal income taxes appears below. The
list omits some steps, such as prepayments (from withholding and estimated
payments) and the alternative minimum tax.

1.Gross income (everything counted for tax purposes)

2.Minus deductions (or adjustments) for determining adjusted gross income
(AGI) — “above the line deductions”
3.Equals AGI
4.Minus greater of standard or itemized deductions
5.Minus personal and dependency exemptions
6.Equals taxable income
7.Times tax rate

8.Equals tax on taxable income (i.e., “regular tax liability”)

9.Minus credits

10.Equals final tax liability