How McCain’s Health Reforms Would Raise Marginal Tax Rates
A recent TPC< analysis looked at the effect of both candidates' plans on marginal tax rates–the tax paid on an additional $1 of income. Spurred by a comment from Greg Mankiw, we also reported an alternative analysis that tilted the numbers more in Senator McCain's favor. That prompted a complaint from Obama advisors pointing out that TPC's analysis failed to consider how the McCain health plan could boost marginal effective tax rates.
Senator McCain's health care proposal would replace the existing tax exclusion for employer-sponsored health insurance (ESI) premiums with a refundable tax credit of $2,500 for individuals and $5,000 for those families who obtain qualifying health insurance. A Tax Policy Center (TPC<) analysis concludes that this plan would be much more progressive than the current system and would slightly reduce the number of people without insurance, but would also cost about $1.3 trillion over 10 years.
Two factors cause marginal rates to increase.
First, the proposal would raise the cost of purchasing more health insurance. Workers choosing to work more may want to spend some of their added compensation to buy additional coverage. For instance, they may demand more comprehensive plans from their employers. Under the current system, workers receive these extra benefits tax-free. McCain would require that added premiums come out of after-tax pay, effectively raising the marginal tax rate on labor.
Second, adding ESI premiums to taxable compensation will push some taxpayers into higher tax brackets, further raising the marginal cost of additional work. For example, a single taxpayer with taxable income of $75,000 and $7,000 in ESI premiums is in the 25 percent bracket. McCain's plan would raise her taxable income to $82,000 and push her into the 28 percent bracket.
McCain's plan might also change workers' employment decisions. Since he would reward taxpayers for obtaining health coverage, regardless of whether they get it through an employer, some workers may switch from a position that offers health benefits to one that doesn't, or they might switch from full-time to part-time if they do not need to work 40 hours to get tax-subsidized health insurance. Some might elect to not work at all.
There is no formal estimate of the effect of the plan on marginal tax rates but a Congressional Budget Office analysis of a somewhat different plan suggests that a plan like McCain's could raise marginal tax rates by perhaps 1.5 to 2 percentage points above the estimated 31 percent current rate.
In a sense, these effects are by design – one of the strengths of McCain's proposal is that it reduces the incentives for taxpayers to buy overly comprehensive insurance. The downside is that he raises the after-tax price of purchasing additional insurance. We may have to raise the cost of coverage to limit the increase in health costs, but we should not ignore the accompanying impact on labor supply.
I'm a man with coverage for pap-smears and gynecology visits, and 20% discounts to specific gyms and a lot of other nonsense. It would be great if the market could provide us with no-frills coverage that is tailored to the individual. It could conceivably drive costs down. Seeing as how I go to the dr's office about never, I would wind up with a large portion of tax credit stored in an HSA account annually to pay for all my visits and medications should I ever need them. If the HSA was depleted in a given year I would have met the deductible and insurance will cover everything else. How can you dislike this plan?
“reduces the incentives for taxpayers to buy overly comprehensive insurance.”
What kind of nonsense is that? Who could possibly be over insured? When you have 40% of Americans with no insurance and 80% of insured Americans are underinsured, only one major illness or accident away from bankruptcy.
Your logic overlooks the savings to the employer – if they used to pay 9200 of the cost and now pay 4200, that's 5000 available to paid as wages. In your conclusion, you assume the employer pockets the difference. Of course that would increase corporate taxes.
Doesn't the McCain tax plan directly raise taxes on employees even after the $5000 “tax credit”?
On the average, employer paid health care costs about $12600 and the employee pays about $3400 of that currently.
Under the McCain plan the employee would continue to pay the $3400, would get taxed about $1500 and get a $5000 “tax credit”. However, the $5000 wouldn't go to the employee, it would go directly to the insurance company to partially offset the insurance cost. It is more properly described as an insurance subsidy than a tax credit.
The net result is that of the $12600 cost, $3400 would be paid by the employee, $5000 by the subsidy, and $4200 by the employer.
Presumably the employee wouldn't be taxed on the subsidy, but would be taxed on the $4200 employer contribution, something like $600 in addition to the $3400 contribution.
In the end, assuming the employer kept offering the health insurance, the employee would go from paying $3400 now to $4000 under the McCain plan due to the $600 tax increase.