The foundation of the president’s plan rests on a tax deduction—$7,500 for individuals and $15,000 for families—for people who either purchase health insurance on the open market or receive it through their employer, the White House announced Monday, January 22. The president first spoke of his new tax plan during his weekly radio address Saturday, January 20.

Tax law has long favored corporations over individuals when it comes to purchasing health insurance. Individuals looking to purchase health insurance must do so with income that has already been taxed. Employers, meanwhile, can pay for health insurance with money that is not considered part of an employee’s wages and therefore not subject to payroll taxes.

The president’s plan would change that. Health insurance costs would be included as part of taxable compensation, from which the full deductible would be applied. This means employers and employees whose health plans come under the deductible would receive a tax break on the difference between the deductible and the cost of the insurance plan; those whose plans cost more than the deductible would have that portion added to their total taxable compensation, increasing payroll taxes for employer and employee alike. The employee would have the added burden of paying income tax on the increased compensation.

For example, if an employee earns $50,000  and has an individual health plan that costs $10,000, total compensation would equal $60,000. The $7,500 deductible would be applied to that total, meaning the employee and employer would face a payroll tax on $52,500. Likewise, if the health plan costs $5,000, that same employee would see his or her taxable compensation lowered to $47,500.

The Bush administration, which says 80 percent of employer-provided health insurance costs less than the deductibles, is calculating that such a tax structure would encourage employers and employees alike to purchase less expensive plans.

The White House hopes such a tax structure would encourage employers to offer health insurance with lower premiums, such as high-deductible plans with health savings accounts. (In December, Bush increased the maximum amount that can be contributed to those accounts.) The tax incentive to purchase less expensive health insurance is intended to bring down costs for employers, offer a tax saving for individuals and encourage those without insurance to purchase it.

“Our challenge is clear: We must address these rising costs, so that more Americans can afford basic health insurance,” Bush said in his radio address. “And we need to do it without creating a new federal entitlement program or raising taxes.”

Health policy analysts have offered differing visions on how such a policy would play out.

“This is the end of employer-based coverage as we know it,” says Paul Fronstin, director for health research at the Employee Benefits Research Institute. “Employers looking for an excuse to get out of it. If they’re tired of providing the benefit, this gives them an excuse.”

Fronstin says he fears employers would prefer to give employees a wage increase equal to the deductible and then let individuals purchase health insurance in the indivdual market.

“The tax benefit is the same whether you get it from your employer or buy it on your own,” he says of the Bush proposal.

The result, he predicts, is that if given the option to take the money and purchase insurance on their own, healthy individuals would find affordable coverage in the individual market (or forgo it altogether). Meanwhile, sicker employees would purchase through their employer at higher rates. Fronstin calls this the “death spiral,” but others think that is unlikely to happen.

More likely, says Paul Ginsburg, the president of the Center for Studying Health System Change, employers will retain coverage.

“The incentive to provide coverage is still there,” he says, because the tax deduction could lower the amount of income subject to the 7.5 percent payroll tax employers and employees each pay. Employers would simply offer more low-cost alternatives or eliminate high-cost coverage altogether. This would encourage high or medium deductibles or more restricted networks.

“There are lots of different ways to lower the premium,” Ginsburg says. “This would remove the undesirable incentive to make plans more elaborate.”

How employees react to the tax incentive remains to be seen, says Paul Dennett, vice president for health care policy at the American Benefits Council.

“The real question employers will be keenly interested in is, ‘Will my employees respond by shifting to lower-cost coverage to eliminate tax exposure or will they want to continue to have higher-cost heath benefits and look to employer for higher wages?’

“Generally, people tend to highly value health insurance coverage, but in the past that’s because there’s been no tax consequence,” Dennett says.

The idea to set a limit on how much of health care costs can be tax free has been around since the Nixon administration and was reintroduced, with overwhelming opposition from unions and businesses, in 1986 by President Reagan. Bush’s proposal offers something new—not simply a limit, but a deductible and in essence a tax break as well.

Massachusetts and California have already begun to tackle the issue in substantive ways. 

The president has said he prefers to make tax changes and to help fund state initiatives rather than broaden government health care programs. But whether he gets to do either will depend largely on the Democrat-controlled Congress.

“At this point in his presidency, when he has ignored the issue in the first six years, to put out a proposal that doesn’t excite conservatives and looks like a half a loaf to Democrats is not likely to cause consensus,” says health care author-consultant Michael Millenson, who added that the proposal would be taken more seriously if it were part of a larger reform package to tackle skyrocketing health care costs and the high number of uninsured. “Whether or not it’s a good idea, he doesn’t have the political capital to do anything about it.”

—Jeremy Smerd