The Right Way to Replace Obamacare’s Subsidy

On the eve of the New Hampshire primary, nine candidates for the Republican presidential nomination remain. All are staunch critics of Obamacare.

But they differ on what they’d put in its place. One point of tension? How to replace Obamacare’s overly complicated subsidy system.

The GOP roughly falls into two camps — those who would prefer to allow Americans to deduct a portion of the cost of health insurance from their income taxes, just as businesses can, and those who would grant individuals age-based refundable tax credits to help cover the cost of coverage.

Those in the latter camp have the better argument. Such credits represent the most effective way to make health insurance affordable and accessible to the greatest number of Americans.

Universally available individual tax credits would help rid the U.S. healthcare system of one of its biggest problems — the inequity between those who get health insurance through work and those who must purchase it on their own.

Employers can book the cost of health insurance for their workers as a business expense. So health coverage is effectively tax-free compensation for employees, even though their wages are deflated as a result. In contrast, those who buy insurance on their own — or pay health bills out of pocket — must do so with after-tax dollars.

As a result, a total of 160 million people get coverage through work.

Because a dollar of untaxed health insurance is “worth” more than a dollar of taxed wages, individuals and firms understandably seek out overly generous health plans. That generosity shields people from the true cost of their care — and encourages them to consume more of it than if they were paying for it themselves.

The result? Inflated overall health spending.

Obamacare addressed this distortion — but poorly. The law created a scheme of subsidies dependent on three separate variables: a person’s income, the federal poverty level, and the cost of the second-cheapest mid-level “Silver” plan available on Obamacare’s exchanges in a person’s location.

Since these three numbers vary from year to year, a person’s subsidy can change markedly. If the benchmark Silver plan drops in price one year, so does the subsidy. That change can leave people stuck with huge increases in their net premiums.

Likewise, someone who gets a small bump in salary can see his subsidy shrink dramatically as the subsidy rate drops. This means that some people could turn down a promotion if it means their income would rise too much.

At tax time, a person who receives a subsidy must reconcile his actual income with his original estimate. If his income is higher, he must refund the government part of his subsidy out of his own pocket — even though the original subsidy went straight to the insurance company from whom he purchased coverage.

Age-based refundable tax credits are a more straightforward way to help people pay for insurance.

As I’ve noted in my new book, The Way Out of Obamacare, these credits should be set at the following levels: $1,200 for those aged 18 to 35, $2,100 for those 35 to 50, and $3,000 for anyone over 50. Families should also receive $900 for each child covered.

According to Dr. Jeffrey Anderson of the Hudson Institute, such credits would cover most — if not all — of the premium for a basic pre-Obamacare insurance plan in most states. Anderson’s analysis is based on a report from the U.S. Government Accountability Office. The agency found that individual insurance plans were surprisingly inexpensive prior to Obamacare’s tsunami of mandates and regulations.

This credit isn’t a new entitlement program. It merely puts employer-provided insurance and the individual market on equal footing. Since no one would stand for eliminating the employer tax exclusion outright, extending it to the individual market makes perfect political sense.

Some Republicans have proposed simply making the cost of an individual policy 100 percent tax-deductible. But such a change would do little to expand access to insurance. A little less than half of all Americans pay no income tax already. Making the cost of health insurance tax-deductible would do little to help them pay for policies.

A tax deduction for health insurance also benefits the wealthy disproportionately more than the poor. That’s not a winning political sales pitch for Obamacare’s critics.

Other Republican plans agree on the value of a refundable credit but would pay it to insurance companies. They would also base the credit on both income and age.

That’s a mistake for two reasons.

First, means-testing new health insurance tax credits is little different from the Obamacare status quo. It would also be pointless. Most wealthy people wouldn’t claim the credit anyway, as they’re likely to already have coverage through work.

Second, giving the credit to insurers would not tamp down health spending as much as handing it to individuals would. If consumers were directly responsible for spending their credits, they’d be more likely to shop around for the best deal on insurance — or to save any excess credit in a tax-advantaged Health Savings Account.

Age-based refundable tax credits will help Americans purchase health insurance fairly and efficiently. They should be at the center of a single GOP replacement plan for Obamacare.

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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