[House Hearing, 110 Congress]
[From the U.S. Government Publishing Office]


 
               THE TAX CODE AND HEALTH INSURANCE COVERAGE

=======================================================================

                                HEARING

                               before the

                        COMMITTEE ON THE BUDGET
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED TENTH CONGRESS

                             FIRST SESSION

                               __________

            HEARING HELD IN WASHINGTON, DC, OCTOBER 18, 2007

                               __________

                           Serial No. 110-21

                               __________

           Printed for the use of the Committee on the Budget


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                        COMMITTEE ON THE BUDGET

             JOHN M. SPRATT, Jr., South Carolina, Chairman
ROSA L. DeLAURO, Connecticut,        PAUL RYAN, Wisconsin,
CHET EDWARDS, Texas                    Ranking Minority Member
JIM COOPER, Tennessee                J. GRESHAM BARRETT, South Carolina
THOMAS H. ALLEN, Maine               JO BONNER, Alabama
ALLYSON Y. SCHWARTZ, Pennsylvania    SCOTT GARRETT, New Jersey
MARCY KAPTUR, Ohio                   MARIO DIAZ-BALART, Florida
XAVIER BECERRA, California           JEB HENSARLING, Texas
LLOYD DOGGETT, Texas                 DANIEL E. LUNGREN, California
EARL BLUMENAUER, Oregon              MICHAEL K. SIMPSON, Idaho
MARION BERRY, Arkansas               PATRICK T. McHENRY, North Carolina
ALLEN BOYD, Florida                  CONNIE MACK, Florida
JAMES P. McGOVERN, Massachusetts     K. MICHAEL CONAWAY, Texas
ROBERT E. ANDREWS, New Jersey        JOHN CAMPBELL, California
ROBERT C. ``BOBBY'' SCOTT, Virginia  PATRICK J. TIBERI, Ohio
BOB ETHERIDGE, North Carolina        JON C. PORTER, Nevada
DARLENE HOOLEY, Oregon               RODNEY ALEXANDER, Louisiana
BRIAN BAIRD, Washington              ADRIAN SMITH, Nebraska
DENNIS MOORE, Kansas                 [Vacancy]
TIMOTHY H. BISHOP, New York
GWEN MOORE, Wisconsin
[Vacancy]

                           Professional Staff

            Thomas S. Kahn, Staff Director and Chief Counsel
           Patrick L. Knudsen, Acting Minority Chief of Staff


                            C O N T E N T S

                                                                   Page
Hearing held in Washington, DC, October 18, 2007.................     1

Statement of:
    Hon. John M. Spratt, Jr., Chairman, House Committee on the 
      Budget.....................................................     1
    Hon. Paul Ryan, ranking minority member, House Committee on 
      the Budget.................................................     2
    Hon. Adrian Smith, a Representative in Congress from the 
      State of Nebraska:
        Prepared statement of....................................     4
        Questions for the record.................................    61
    Grace-Marie Turner, president, Galen Institute...............     4
        Prepared statement of....................................     8
    Leonard E. Burman, director, Tax Policy Center, senior 
      fellow, the Urban Institute................................    13
        Prepared statement of....................................    19

Additional Materials:
    Hon. Lloyd Doggett, a Representative in Congress From the 
      State of Texas, article for the record:
        ``Can the President's Health Care Tax Proposal Serve as 
          an Effective Substitute for SCHIP Expansion?'' by Linda 
          J. Blumberg, the Urban Institute, October 2007.........    45


                            THE TAX CODE AND
                       HEALTH INSURANCE COVERAGE

                              ----------                              


                       THURSDAY, OCTOBER 18, 2007

                          House of Representatives,
                                   Committee on the Budget,
                                                    Washington, DC.
    The committee met, pursuant to call, at 10:02 a.m. in room 
210, Cannon House Office Building, Hon. John Spratt [chairman 
of the committee] presiding.
    Present: Representatives Spratt, Cooper, Schwartz, Becerra, 
Doggett, Berry, Boyd, McGovern, Hooley, Baird, Moore of Kansas, 
Moore of Wisconsin, Ryan, Bonner, Hensarling, Lungren, Conaway 
and Smith.
    Chairman Spratt. Good morning again and welcome to the 
Budget Committee's hearing on The Tax Code and Health Insurance 
Coverage. We have two excellent and provocative witnesses to 
testify before us today, Leonard Burman of the Urban Institute 
and Grace-Marie Turner of the Galen Institute.
    Let me say from the outset that this hearing has been 
requested by--suggested by, requested and sought by the ranking 
member, Mr. Ryan. I agreed to hold the hearing at his bequest 
but also because this is an extremely important issue for the 
country and not just for the budget and Federal government, but 
for the entire country.
    Our Tax Code plays a pivotal role in making health coverage 
accessible to millions of Americans. The tax treatment of 
health insurance has significant budget implications. For 
example, current law excludes employer contributions for health 
care from the employee's compensation for income and payroll 
tax purposes; and this tax expenditure has a substantial impact 
on the budget, up to $200 billion in foregone revenues.
    Employers are a vital source of coverage, however, for 7 
out of 10 American workers, especially important to workers 
with health problems who are unlikely to afford or find 
affordable coverage on the individual market. Employment-based 
coverage offers advantages over individually covered, no 
question about that, in terms of lower administrative costs, 
greater bargaining power with the insurance companies and 
medical providers and, to some extent, the ability to pool 
risk.
    At the same time, the number of Americans without health 
insurance has risen steadily since the year 2000 and currently 
stands at 47 million Americans, including 9 to 10 million 
children. People who are young, people who have low incomes, 
people who work for small firms are more likely to be uninsured 
because insurance is not available to them partly because of 
this and the employer-sponsored nature of our insurance system. 
The declining availability of employer-sponsored insurance has 
also been an important factor in the growth of the uninsured 
population.
    As we look for ways to improve health insurance coverage in 
our Nation, today's hearing will give us an opportunity to 
examine the question from the standpoint of tax subsidies for 
health care. We will want to explore, for example, questions 
such as whether the Tax Code should favor employer-provided 
insurance over individually purchased insurance and whether tax 
breaks should be structured to target more assistance for low-
income and moderate-income Americans. There may be changes to 
the tax treatment of health insurance that are worth exploring 
on the grounds of both efficiency and equity.
    But before we start tinkering with a system that is working 
well for lots of people, we had better be sure we do not make 
more problems than we solve. Indeed, we should keep in mind 
research from various outside institutes such as the Urban 
Institute, which shows that tax subsidies may not necessarily 
be the most effective and efficient way of expanding coverage.
    The SCHIP bill being considered today, on the other hand, 
has merits and aspects to it that warrant our appreciation as 
we look through the Tax Code and ask ourselves how we make 
evolutionary change so that we gradually step by step close the 
gap that now encompasses 47 million Americans who do not have 
health insurance.
    As I said, Mr. Ryan has sought this hearing; and we are 
pleased to accommodate him because this is an important 
subject. So let me turn to him for his statement before we turn 
to our witnesses.
    Mr. Ryan. Thank you, Mr. Chairman.
    First I want to thank you for honoring this request, number 
one; and, number two, you have been a very fair chairman on 
this committee and I thank you for that.
    I just got an e-mail from the floor which shows we are 
going to have votes between 10:20 and 10:30 and then another 
vote at 12:30, so we will have a nice gap in between there. But 
it is a 15-minute vote in about--so we ought to get to our 
testimony and come back for questions. Is that your intention?
    Chairman Spratt. I hope so. I was going to invite both 
witnesses, since we only have a panel of two this morning, to 
take their time in plowing their way through their testimonies.
    Mr. Ryan. So we ought to have another half hour?
    Chairman Spratt. I think so.
    Mr. Ryan. First, I don't think this hearing could have been 
better timed. Later today or in a couple of hours we are going 
to have another vote on the proposed SCHIP expansion that has 
been so vigorously debated over the past few months.
    To be clear, those of us who will vote to sustain the 
President's veto won't be doing so because we don't like 
children. It won't be simply because the bill is too expensive, 
and it won't be because we are somehow trying to punish people 
who are already in the program. We will vote this way because 
we have a fundamentally different vision of how best to reform 
health care for the entire country. Our vision for reform is 
based on personal ownership, individual control of health 
coverage for everyone. We also believe the reforms we make 
today need to be sustainable for the next generation.
    Unfortunately, the SCHIP vote we are about to have today 
will take us in exactly the opposite direction. It is an 
incremental step towards greater dependency on government and 
will further expand Federal health care entitlement spending 
that every Member of Congress knows today is unsustainable.
    If you could bring up chart one, please. As you can see 
from this chart, the SCHIP bill spends $35 billion over 5 years 
to remove 3.8 million people from the uninsured population, 
leaving 43 million still uninsured. In order to cover the rest 
of the uninsured population under this plan in this method, the 
Federal government would have to spend an additional $400 
billion over the same 5-year period. This adds at least $8 
trillion to the unfunded liability to the Federal government 
entitlement programs over the next 75 years. $8 trillion ought 
to be a familiar number. That is the number that people 
criticize Part D as adding. This adds that and then some.
    In short, the SCHIP bill, as currently designed, is going 
to lure and trap a whole lot of people into a promise that the 
Federal government, according to nearly every budget expert out 
there, simply cannot keep in the long run.
    We believe there is a better way. There is an alternative 
path that can fulfill the mission of health security without 
smothering the economy in expanding, unsustainable levels of 
dependency.
    Here are the fundamental components of the approach we 
envision. I will say it quickly so we can get to our witnesses.
    Reform needs to be comprehensive. To get anywhere in the 
industry, we have to start looking at the whole picture--health 
care, Medicare and the Tax Code--which is what we are doing 
today.
    It has got to provide security. Obviously, we want to 
ensure that everyone has access to coverage; and that includes 
low-income families, middle-income families, children and 
people with medical conditions who get branded as uninsurable.
    Third, it must enhance our economic competitiveness in this 
era of globalization. Health care reform has to ease, not add 
to the unsustainable upward pressure of medical costs; and it 
must do so without rationing services.
    Fourth--and this is the point of today's hearing--the 
critical role of ownership is essential. The principle of 
ownership has long been a central component of America's 
prosperity, and it should apply to health care as it does in 
other areas. After all, we wouldn't let someone else choose our 
cars, our refrigerators or what we are going to have for dinner 
tonight. And yet with something as vital and personal as health 
care coverage that is exactly what many Americans do. They 
effectively let employers or the government decide what kind of 
health coverage they should have.
    The problem is that our Tax Code creates an immense bias in 
favor of third-party ownership of health care. CBO estimates 
that this bias to personal income tax exclusion for employer-
provided health insurance consumes around $3.5 trillion over 10 
years. I don't think there is any argument to be made that this 
is a wise or remotely equitable way to distribute this money. 
Letting individuals own their own health care coverage would 
put them back in control of their health care. It would lead to 
vastly more choices of the kinds of coverage available, and it 
would relieve the insecurity that comes from having your health 
insurance tied to your job. Also, if done properly, it could 
mean that no matter what your income level you would not have 
to rely on the government dole and all the stigmas that come 
along with that to get health care coverage.
    We are not here to endorse any particular health tax 
benefit today. We are here to discuss how best to adjust the 
Tax Code so that all individuals can have access to health 
insurance that is affordable, that they can own and control for 
themselves.
    I thank you for holding this hearing, Mr. Chairman; and 
hopefully this is the beginning of a discussion that is two-
sided between two different visions of health care. Thank you.
    Chairman Spratt. Thank you, Mr. Ryan.
    Now let us turn to our two witnesses; and let me say 
further what I said earlier, namely, that we have your pre-
filed testimony. By unanimous consent, we will make it part of 
the record. But we invite you to plow through it at length to 
cover your analysis of the choices before us, because I think 
both of them are provocative pieces of work and a good analysis 
of the issues that are confronting us. So thank you for coming. 
Thank you for your testimony.
    Let me ask unanimous consent also that our members be 
allowed to submit an opening statement for the record at this 
point in the record. So ordered.
    [The prepared statement of Mr. Smith follows:]

 Prepared Statement of Hon. Adrian Smith, a Representative in Congress 
                       From the State of Nebraska

    Good Morning. I would like to thank Chairman Spratt for holding 
today's hearing on this issue of concern to Americans.
    Our goal in this committee today is to address access and 
affordability of health care while looking for solutions that promote 
both fiscal and individual responsibility. Throughout the nation people 
are concerned about having access to health care; in my home state of 
Nebraska 11.1 percent of people go without health insurance.
    Today this Congress is grappling with the issue of providing health 
insurance to needy children. We must not lose sight, however, of the 
need for public policy that will reduce the number of Americans who are 
uninsured while continuing to foster a system that provides consumers 
with choice and competition. Choice and competition in health care 
promotes efficiency and innovation that works to keep the costs of 
health care under control.
    I look forward to hearing the testimony of the witnesses today.
    Mr. Chairman, I thank you for your leadership in holding this 
hearing.

    Chairman Spratt. Ms. Turner, why don't we begin with you, 
if that is okay.

  STATEMENT OF GRACE-MARIE TURNER, PRESIDENT, GALEN INSTITUTE

    Ms. Turner. Thank you, Chairman Spratt. Thank you, Ranking 
Member Ryan and members of the committee.
    Can you hear okay? Is the microphone on? No, it doesn't 
seem to be. A little closer? There we go.
    Thank you, Mr. Chairman. Thank you, Mr. Ryan and members of 
the committee. I really appreciate your holding this hearing 
today to address the Tax Code and health insurance, and I 
particularly appreciate the opportunity to testify.
    I founded the Galen Institute 12 years ago because I felt 
it was really important to address this fundamental issue about 
what I believe is a driving force in the way our health sector 
is organized. While the favored tax treatment of employment-
based health insurance has provided a stable source of coverage 
for hundreds of millions of Americans over the last half 
century or more, it is also clear that it is leading to many of 
the problems that our health sector is facing today and I 
believe that really makes this issue well worth addressing.
    There are a number of provisions in the Internal Revenue 
Code that address health care and that I have described in my 
testimony. Economist John Shields, as you mentioned, Mr. 
Chairman, estimates that the favorable tax treatment of health 
insurance was worth, in 2004, $189 billion a year in savings to 
individuals and families. If you think about it, that makes it 
the third-largest health care program in the Federal government 
after Medicare and Medicaid, the way that we support 
employment-based health insurance. This is a sizeable 
investment by any measure, and it seems appropriate to ask if 
we are getting our money's worth.
    The biggest of these tax expenditures, as John Shields 
describes them, is the one that I would like to address today 
and that is the employee exclusion for job-based health 
insurance which the chairman first mentioned.
    Section 106 of the Internal Revenue Code gives employees a 
generous yet invisible tax preference for health insurance that 
they receive through the workplace. I will argue that employers 
should continue to be allowed to deduct the cost of health 
insurance as a legitimate business expense but that employees 
should not continue to receive an exemption for an unlimited 
amount of health insurance that they receive through the 
workplace. Further, I will argue that there are better ways to 
use the Tax Code to support health insurance to better align 
with our 21st century economy.
    The Federal tax policy that began in World War II in 
response to wage and price controls has grown over 65 years to 
really shape our private health sector. In my written 
testimony, I detailed the history and impact of this powerful 
law and explained how it works and how it distorts the health 
care marketplace.
    Briefly, if someone gets their health insurance at work, 
that part of their compensation package that they receive in 
the form of health coverage is not taxed. While that seems sort 
of like a small and invisible thing early on, over time it has 
grown to become the single-largest tax break allowed by Federal 
law. Today, that specific provision is worth $160 billion. By 
comparison, the popular mortgage interest deduction is worth 
about $88 billion to American taxpayers.
    It is unlikely we would have created a subsidy system like 
this deliberately. Our progressive income tax system works 
against workers who most need help in purchasing health 
insurance. An employee earning $10,000 to $20,000 a year gets 
about $292 a year in value from this tax break. Yet somebody 
that is making $100,000 a year gets $2,780 in value a year 
through--in tax forgiveness for the value of their health 
insurance policy, nearly 10 times more. So, clearly, the 
regressivity is not something that we would have designed into 
Federal law.
    In addition, with four in ten workers changing jobs every 
year, tying health insurance to the workplace is leaving 
millions of Americans behind. People lose their health 
insurance when they lose or change their jobs, and many work 
for employers who simply can't afford to offer health insurance 
coverage. These workers receive little or no tax benefit from 
this regressive, rich and yet hidden tax preference--most 
people don't even know they get it--for employment-based health 
insurance; and it is no surprise that these are the ones that 
are most likely to be uninsured.
    But the revision causes problems even for those who have 
job-based health insurance. Because the full cost of their 
health insurance is also invisible to them, they demand richer 
and richer benefits without realizing that this may be 
shrinking their take-home pay. If employees saw health 
insurance as the part of their compensation package that it is, 
they likely would make different decisions about how they are 
going to organize this part of their budget.
    Many Members of Congress on both sides of the aisle have 
offered proposals that would move public policy forward on 
rewriting the tax treatment of health insurance. Congressman 
Ryan, for example, is working on a proposal that would provide 
a universal tax credit for health insurance. President Bush has 
offered a proposal that would replace the current tax exclusion 
with a generous universal tax deduction with a credit for 
payroll taxes. Others have offered proposals for income-
adjusted refundable tax credits, and some are considering a 
combination of the tax deduction and a credit for those at the 
lower end of the income scale.
    Senator Hillary Clinton in her recent health proposal 
recommends capping the amount of income that higher-income 
individuals can exclude from taxes through health insurance.
    The most important thing I think here is that we are 
beginning to have a conversation over this important issue. 
Whatever we do to address the problems in our health sector, 
though, as the chairman indicated, we know from experience that 
trying to make too many changes too fast will create a backlash 
of opposition. Millions of people rely on the current system 
for their health insurance. Making any rapid change needs to be 
done very carefully and with clear attention to any transitions 
and to making sure that we are helping people, not hurting them 
with any changes in policy.
    Even though the tax exclusion for job-based health 
insurance contributes to many distortions in our health sector, 
the changes will need to be gradual and give employees and 
employers and individuals options and time to adjust. But with 
so many people, 47 million, left out of the current system, it 
is crucial that we begin to build a new system that does not 
tie health insurance so tightly to the workplace for everyone. 
That is just not working.
    The National Restaurant Association said, how are we going 
to do this when we have employees that may only work for us for 
3 days? So, clearly, individually owned, affordable health 
insurance is really crucial. Policy changes could allow us to 
move forward to a system that allows health insurance to be 
portable from job to job, that allows people to make their own 
decisions about the health insurance that suits them and their 
families and that makes the subsidies for health insurance 
fairer and more equitable.
    Consumers can make decisions for themselves about many, 
many purchases they make in the economy. Because of the 
paternalism of our health care system over the last 60 years, 
they really haven't been asked to make those questions. But new 
resources are becoming available, really facilitated by the 
Internet and the information economy.
    They are beginning to learn about which physicians and 
which hospitals are best at which procedures and treatments, 
what are the costs of certain treatments. Some new consumer-
directed kinds of account-based health plans allow people to 
make decisions, particularly about routine health care 
expenditures and how they can best allocate those resources.
    Policies that were suited to this paternalistic 
industrialized world are no longer suited to a much more mobile 
economy. An in-depth survey asking what women want is certainly 
just as relevant today as in the year 2000 when it was first 
conducted. The survey found that a large majority of women, 72 
percent, would like their health insurance to be independent of 
employment. This wasn't even one of the issues that those 
taking the survey had intended to ask about, but it came up so 
often in the early focus group testing before the poll that 
they felt they had to include it.
    I believe that we are at a turning point in our health 
sector and that the outcome of the 2008 Presidential elections 
will largely determine what path we will take. The question is 
this: Will we slide toward greater and greater government 
control over our health sector or will we move toward a 
properly functioning private market?
    We certainly need a lot of work in the private market for 
this to work to provide health insurance that gives people more 
choice and more control over their coverage. In poll after 
poll, people clearly stated a preference for private health 
insurance over government control of the health sector.
    If people are going to have the option for viable private 
insurance, we need to realign the financial incentives that 
support insurance. Addressing the tax treatment of health 
insurance is the first crucial step toward that goal. This 
would allow greater portability of coverage, as Mr. Ryan 
mentioned, and would minimize the risk that people would lose 
their health insurance when they lose or change their jobs.
    Do we need to--1 more minute, and then I am done.
    Chairman Spratt. We have 4 minutes. So why don't you take 
the last 3 minutes.
    Ms. Turner. I am almost done.
    This would enable greater visibility over the cost of 
health insurance and health care, providing an incentive for 
consumers to demand coverage that offers the best care.
    We don't have a properly functioning market in the health 
sector because consumers are not engaged in really bargaining 
for better value in their health insurance. Which doesn't mean 
they are going to be negotiating over whether they get an MRI 
or a CAT scan if they are wheeled into an emergency room after 
an accident, but they can decide what kind of insurance 
coverage they want if that were to happen.
    It would also facilitate competition among insurers who 
want to enroll millions of these uninsured people and give the 
insurance companies an incentive to compete on price and value.
    Consumers would have many more choices. And with health 
care representing one-sixth of our economy, it will certainly 
take a long time to make any changes. But the first step is for 
the government to encourage people to buy health insurance that 
would be able to create some kind of new allowances.
    Maybe it is targeted at the uninsured. Maybe it is a reform 
of the system. That is a hearing for another day. It could be 
direct subsidies to individuals, refundable credits, tax 
deductions or a combination. But incentives work and markets 
work.
    What we need to do is engage the power of consumers to 
transform our health sector to become more efficient, more 
responsive to consumer needs, more affordable. Making changes 
to tax policy will offer more options and I believe would be a 
giant leap to transform the health sector around a 21st century 
market economy that allows health insurance to be portable, 
that forces the markets to realign around consumers, to provide 
them options, that gives individuals ownership of that health 
insurance so that if they don't like the insurance they can 
change to another policy or they have contract rights to make 
sure that they can enforce that contract if the insurer is not 
abiding by the terms of the contract.
    Thank you for the opportunity, Mr. Chairman, to testify 
today; and I look forward to the opportunity to work with you 
and members of the committee and the Congress to continue to 
educate the public about this important issue. Thank you.
    Chairman Spratt. Thank you very much for your testimony.
    [The prepared statement of Grace-Marie Turner follows:]

  Prepared Statement of Grace-Marie Turner, President, Galen Institute

    Chairman Spratt, Ranking Member Ryan, and members of the committee, 
I sincerely thank you for calling this hearing today to address the 
crucial issue of the tax code and health insurance, and I particularly 
appreciate the opportunity to testify before you today.
    I founded the Galen Institute 12 years ago primarily because I 
wanted to highlight this issue and promote an informed debate over what 
I believe is a central driving policy in our health sector. While the 
favored tax treatment of health insurance has provided a stable source 
of health coverage for hundreds of millions of American workers over 
the last half century or more, it also is clear that it is leading to 
many of the problems that our health sector faces today. This issue is 
well worth addressing today.
    There are a number of provisions in the Internal Revenue Code that 
address health care. For example:
     That part of an employee's compensation package that he or 
she receives at work in the form of employer-sponsored health insurance 
is excluded from income and payroll taxes.
     Employers can deduct as a business expense the amount they 
pay for health insurance for their workers.
     Workers whose employers offer Section 125 cafeteria plans, 
called flexible spending accounts, can put aside a portion of their 
income on a pre-tax basis to pay for allowed expenses, including their 
share of health insurance premiums, copayments, and other allowed 
medical expenses. Any amount that is unspent at the end of the year 
reverts back to the employer.
     A 2002 IRS ruling interprets existing law to give 
companies the opportunity to make deposits to Health Reimbursement 
Arrangement spending accounts that are tax-free to their employees.
     The self-employed can deduct the cost of health insurance 
from their income.
     Individuals can deduct medical expenses on itemized 
returns if their expenses exceed 7.5% of their adjusted gross income.
     Individuals or workers who have high-deductible health 
insurance policies can put money aside in Health Savings Accounts on a 
tax-free basis to pay for medical expenses today or in the future. The 
HSA deposit is tax free, the inside buildup or interest is tax free, 
the money stays tax free as long as it is spent on allowed health 
expenses, and the HSA money rolls over from year to year.

                                THE COST

    Economist John Sheils estimates that the favorable tax treatment of 
these health expenses was worth $188.5 billion in federal tax savings 
to individuals and companies in 2004.\1\ The amount of these tax 
benefits grows each year without a vote by Congress. Sheils estimates 
that when federal and state tax benefits are combined, the total in 
2004 was $209.9 billion.
    This is a sizeable investment by any measure, and it seems 
appropriate to ask if we are getting our money's worth.
    The biggest ``tax expenditure,'' as Sheils describes it, and the 
one that I would like to address today, is the employee tax exclusion 
for job-based health insurance. Section 106 of the Internal Revenue 
Code gives employees a generous--yet invisible--tax preference for the 
health insurance that they receive through the workplace. I will argue 
that employers should continue to be allowed to deduct the cost of 
health insurance as a legitimate business expense, but that employees 
should not continue to receive tax exemption for an unlimited amount of 
health insurance because of the distorting effects this exclusion 
creates throughout the health sector. Further, I will argue that there 
are better ways to use the tax code to support health insurance that 
are more appropriate to a 21st century economy.

                 THE TAX EXCLUSION: HISTORY AND IMPACT

    It is worth noting that the tax exclusion for employment-based 
health insurance is the single largest tax break allowed by federal 
law, worth more than $160 billion.\2\ (By comparison, the popular home 
mortgage interest deduction is worth $88 billion to American 
taxpayers.) The tax exclusion for health insurance provides a huge 
incentive for employees to receive their health coverage through the 
workplace. And because of our progressive income tax system, the 
benefits are heavily skewed toward higher-income workers. According to 
Sheils, the average employee earning $100,000 a year or more shields 
$2,780 a year from taxes by getting health insurance through the 
workplace. But an employee earning $10,000 to $19,999 gets only $292 in 
value from this tax provision, nearly a 10-fold difference.
    It is not surprising that the majority of the uninsured are workers 
and their dependents in these lower-income categories. The deck is 
stacked against them: They are less likely to have jobs that provide 
health insurance, less likely to be able to afford their share of the 
premiums if their employers do offer insurance, and less likely to get 
much value from the tax exclusion since they are in lower tax brackets.
    I don't believe we would ever intentionally have created a system 
that would have this result. Rather, it evolved from a simple decision 
decades ago.

                            THE HISTORY \3\

    Early in the 20th century, the link between health insurance and 
the workplace began to be established in the United States. During and 
after World War II, however, employment-based health insurance became 
more widespread, and the link became stronger.
    Factories were pushed to meet wartime production schedules. 
Competition for good workers was intense but was hampered by wartime 
wage controls. Employers found they could compete for scarce workers 
and boost compensation without running afoul of these controls by 
offering health insurance as a benefit in lieu of cash wages. In 1943, 
federal officials ruled that employers' contributions to group health 
insurance would not violate wage controls and would not count as 
taxable income for employees.
    That ruling, later codified by Congress in 1954, in addition to 
rising tax rates on middle-class incomes and the rising demand for 
health insurance, all combined to create a strong incentive for health 
insurance to be obtained through employment-based groups.
    The generous tax preference accorded to job-based health insurance 
is a historical accident that has increased automatically over the 
decades without legislative authorization or appropriations. It has 
percolated through the economy for more than 60 years to become the 
foundation for a system that provides strong financial incentives for 
more than 177 million Americans to get their health insurance through 
their employers.\4\

                      HOW THE TAX PREFERENCE WORKS

    Employment-based health insurance is part of the compensation 
package many employers provide to their employees as a form of non-cash 
wage. Employers can take a tax deduction for the cost of this health 
coverage, as they do for most other forms of employee compensation. 
They write the check for the premiums, and some pay medical bills 
directly if they self-insure. Businesses deduct these costs from their 
earnings since they are part of the total compensation package paid to 
workers and must be deducted to measure net profits correctly.
    What makes health insurance different from cash wage or salary 
compensation, however, is that workers also do not pay taxes on that 
part of their compensation package they receive in the form of health 
benefits. That part of their pay is tax free.
    Section 106 of the Internal Revenue Code provides that the value of 
health benefits is not counted as part of the taxable income of 
employees--i.e., it is excluded from their taxable income as long as 
the employer writes the check for the coverage. However, workers may 
receive this tax-favored benefit only if health coverage is provided 
through an employer. Because it is excluded from their taxable income, 
the value of the health coverage, the tax benefit, and the costs in 
forgone cash wages are largely invisible to workers.

             HOW THIS DISTORTS THE HEALTH CARE MARKETPLACE

    The employee tax exclusion for job-based health insurance distorts 
the health care marketplace in a number of ways:
     It undermines cost consciousness by hiding the true cost 
of insurance and medical care from employees.
     Because the full cost of health insurance is not visible 
to employees, it artificially supports increased demand for covered 
medical services and more costly insurance. As a result, inefficient 
health care delivery often is subsidized at the expense of more 
efficient care and coverage.
     Cash wages are suppressed as health insurance costs rise.
     Many employees with job-based coverage have little choice 
and control over their health insurance and their access to medical 
services.
     The tax benefits are skewed to favor higher-income 
individuals and those who demand the most expensive health coverage and 
medical treatments.
     Those with equal incomes are taxed unequally.
     Millions of Americans who are unemployed or whose 
employers do not offer health insurance are discriminated against 
because they receive much less assistance, if any at all, when they 
purchase health insurance.
    With four in ten workers changing jobs in the U.S. every year,\5\ 
this provision which so generously subsidizes health insurance through 
the workplace is leaving millions of Americans behind. They lose their 
health insurance when they lose or change jobs, and many may work for 
employers who can't afford to offer coverage. These workers receive 
little or no benefit from this regressive, rich, and hidden tax 
preference for employment-based health insurance. It is no surprise 
that they are most likely to be uninsured.
    But the provision causes problems even for those who do have job-
based coverage. A key element of the problem relates to visibility. 
Deductions are visible, but exclusions are invisible. When straight tax 
deductions are taken, as employers do in deducting the cost of health 
insurance, the full cost of the expenditure is visible because they 
must first make the payment before taking the deduction. Because 
employers write the checks for health coverage, they do complain about 
the high costs of health care.
    On the other hand, employees who are demanding expensive health 
insurance seldom know the full cost of the policy--and the amount of 
compensation they are forgoing as a result--because its cost is 
excluded from their income. Few employees are aware that an average of 
$12,000 a year of their compensation package is going to fund their 
family health insurance policy.\6\ Employees may be receiving smaller 
pay raises as a result of the rising cost of health insurance, but this 
is a less visible consequence. If employees saw health insurance as a 
more visible part of their pay package, they would likely make 
different choices than they do today about that spending.
    So what should we do?
    Many members of Congress from both sides of the aisle have offered 
proposals that would move public policy forward regarding the tax 
treatment of health insurance. Rep. Ryan, for example, is working on a 
proposal that would provide a universal tax credit for health 
insurance. President Bush has offered a proposal to replace the current 
tax exclusion with a generous universal tax deduction. Others have 
offered proposals for income adjusted, refundable tax credits. And some 
are considering a combination of a tax deduction and credit. Senator 
Hillary Clinton in her recent health proposal recommends capping the 
amount of income that higher-income employees can exclude from taxes 
through health insurance.\7\
    The most important thing here is that we are having a conversation 
about this important issue.
    I facilitate a group called the Health Policy Consensus Group that 
is composed of the leading health policy experts from the market-
oriented think tanks. We have long advocated addressing the tax 
treatment of health insurance, and many of our members support 
refundable tax credits for health insurance.\8\
    President Bush's proposal earlier this year to allow a universal 
tax deduction brought a new idea to the table in allowing a generous 
deduction for health insurance combined with a credit against payroll 
taxes. Because all workers pay payroll taxes, this latter proposal 
would provide help to those at the lower end of the income scale who 
may not owe income taxes or are in a very low tax bracket.\9\
    Whatever we do to address problems in our health sector, we know 
from experience that trying to make too many changes too fast will 
create a backlash of opposition. Even though the tax exclusion for job-
based health insurance contributes to many of the distortions in our 
health sector, any changes will need do be gradual and give employees 
and employers options and time to adjust. But with so many people left 
out of the current system of tax subsidies for private insurance, it is 
crucial that we build a new system that does not tie health insurance 
so tightly to the workplace. Policy changes would allow us to move 
toward a system that allows health insurance to be portable from job-
to-job, that allows people to make their own decisions about the health 
insurance that suits them and their families, and that makes the 
subsidies for health insurance fairer and more equitable.

            THE COMING INFORMATION REVOLUTION IN HEALTH CARE

    For decades, our health sector has been organized around a 
paternalistic system in which government agencies or corporate human 
resources departments have been in charge of making decisions for 
people about their health benefits. This means that the vast majority 
of people have little experience or even confidence in making their own 
decisions involving health care and health insurance, and they have had 
little information that allows them to seek out the best value in their 
health spending.
    This is beginning to change: New resources are being offered to 
help consumers learn which physicians and hospitals are more highly 
rated for certain procedures. The Internet is facilitating a wider 
dissemination of information about everything from the cost of health 
procedures, availability of new medical treatments and medicines, and 
the options for individually-purchased health insurance. Health Savings 
Accounts and other consumer-centered health care financing arrangements 
are giving people new incentives to search for options and to seek 
value in their health spending.
    Demands from consumers for greater involvement in their health care 
decisions is taking root in every developed industrialized country. 
Policies that were suited to a paternalistic, industrialized world are 
no longer suited to today's health care economy. An in-depth survey 
asking ``what women want'' is certainly just as relevant today as it 
was in 2000 when it was conducted. The survey found that ``a large 
majority of women--72 percent--would like their health insurance to be 
independent of their employment. This was not even one of the issues 
the pollsters had intended to ask about, but it came up repeatedly in 
the focus groups that preceded the polling.'' \10\

                           TAX POLICY IS KEY

    I believe we are at a turning point in our health sector, and the 
outcome of the 2008 presidential election will largely determine which 
path we take. The question is this: Will we slide toward greater and 
greater government control over our health sector or will we move 
toward a properly functioning private market for health insurance that 
gives people choice and control over their coverage?
    In poll after poll, people clearly state a preference for private 
health insurance over government control of the health sector. If 
people are to have the option of viable private insurance, we need to 
realign the financial incentives that support that insurance. 
Addressing the tax treatment of health insurance is the first crucial 
step toward that goal.
    This would allow greater portability of coverage and would minimize 
the risk that people would lose their health insurance when they lose 
their jobs. It would enable greater visibility over the cost of 
insurance and health care, providing an incentive for consumers to 
demand coverage that offers the best value. It would facilitate 
competition among insurers to enroll millions of new people and would 
give them an incentive to compete on price and benefit structures. And 
this would mean consumers would have many more choices than they do 
today to find the coverage that best suits their needs and pocketbooks. 
In a world in which individuals have more control over their insurance, 
they would gain peace of mind by having coverage that they own and that 
can follow them as they move from job to job and even state to state.
    There will need to be new safeguards for consumers in this 
transformed world of health insurance, but that is the topic for 
another hearing. Many other 20th century health policies would need to 
be modernized in this process. For example, states need to do a much 
better job of allowing individuals more choice by inviting rather than 
suppressing competition in their health insurance markets. States would 
need to rethink whether the 1,900 coverage mandates on their collective 
books are helping or hindering access to affordable coverage. And state 
monopolies over health insurance could be broken by allowing consumers 
to purchase health insurance across state lines.
    In the process of this transformation, we do not want to make 
changes so fast that it disrupts the coverage that gives millions of 
people the security they want and need. If tax policy were relaxed to 
allow portability of the tax benefits associated with health insurance, 
some employers would opt to cash out the value of the health insurance 
they are providing to their workers so they can buy coverage through 
other sources. I believe that most companies would continue to offer or 
sponsor health coverage for their workers, just as they do today. But 
giving people more options in how they arrange the financing of their 
insurance would get our health care system moving toward 21st century 
coverage that is more portable, more flexible, and more affordable.

                     THE CRUCIAL ELEMENT IS CHOICE

    With health care representing one-sixth of our economy, it will 
take a long time to make these changes. But a first step by government 
to encourage people to buy health insurance would to create new 
allowances, whether through direct subsidies to individuals, refundable 
tax credits, tax deductions, or a combination, targeted directly to 
individuals to assist them in purchasing the health coverage of their 
choice.
    We do need to focus the debate between those who believe that the 
answer to the problems in the health sector lies in much more 
government involvement through expansion of public programs, and those 
who believe that the free market can and does have much more potential 
to get health insurance costs down and provide people with greater 
access to coverage and more choices.
    In our economy, incentives work and competition works. What we need 
to do is engage the power of consumers to transform our health sector 
to become more efficient, more responsive to consumer needs, and more 
affordable.
    We have seen that the tax treatment of health insurance is a 
powerful force in how the health sector is organized. Making changes to 
offer more options would be a giant leap to begin to transform our 
health sector in a way that provides millions of people currently left 
out of the system with new resources to get coverage; that provides 
millions of people who are worried they could lose their coverage at 
work with the security of knowing that they can own their policies; and 
that provides new incentives to put patients and doctors back in charge 
of medical decisions.
    Thank you for the opportunity to testify today, and I look forward 
to the opportunity to work with you to advance a more informed 
conversation about this very important issue.

                                ENDNOTES

    \1\ John Sheils and Randall Haught, ``The Cost of Tax-Exempt Health 
Benefits in 2004,'' Health Aff (Millwood), 2004 Jan-Jun;Suppl Web 
Exclusives:W4-106-12 at http://content.healthaffairs.org/cgi/content/
full/hlthaff.w4.106v1/DC1.
    \2\ Office and Management and Budget, ``Budget of the United States 
Government: Fiscal Year 2008,'' February 5, 2007, at http://
www.whitehouse.gov/omb/budget/fy2008/budget.html.
    \3\ Description is drawn from ``A Vision Statement for Consumer-
Driven Health Care Reform'' by the Health Policy Consensus Group. 
http://www.org/vision.asp
    \4\ U.S. Census Bureau, Current Population Survey, 2007 Annual 
Social and Economic Supplement, Table HI01. Health Insurance Coverage 
Status and Type of Coverage by Selected Characteristics: 2006, All 
Races at http://pubdb3.census.gov/macro/032007/health/h01--001.htm.
    \5\ ``Job openings and labor turnover: November 2006,'' Bureau of 
Labor Statistics, United States Department of Labor, January 10, 2007. 
http://www.bls.gov/news.release/archives/jolts--01102007.pdf
    \6\ The Kaiser Family Foundation and Health Research and 
Educational Trust, ``Employer Health Benefits 2007 Annual Survey,'' 
September 11, 2007, at http://www.kff.org/insurance/7672/.
    \7\ Hillary Clinton, ``American Health Choices Plan,'' September 
2007, at http://www.hillaryclinton.com/feature/healthcareplan/.
    \8\ ``Empowering Health Care Consumers Through Tax Reform,'' Grace-
Marie Arnett, Ed., University of Michigan Press, Ann Arbor, September 
1999, at http://www.galen.org/book.asp.
    \9\ White House Fact Sheet, ``Affordable, Accessible, And Flexible 
Health Coverage,'' January 2007, at http://www.whitehouse.gov/
stateoftheunion/2007/initiatives/healthcare.html.
    \10\ ``In America. Focus on women,'' Bob Herbert, The New York 
Times, September 28, 2000.

    Chairman Spratt. Now, if both of you will forebear, we will 
go vote and come back as quickly as we can. Thank you very 
much, and we will be back.
    The committee will stand in recess subject to the call of 
the Chair. [Recess.]
    Chairman Spratt. I call the committee back to order; and, 
Dr. Burman, the floor is yours.
    As I said before, you can summarize your testimony as you 
see fit. But you have got an excellent analytical narrative to 
go along with your testimony, And we would invite you to take 
some time to lay out the analysis you have put into your 
written testimony.

 STATEMENT OF LEONARD E. BURMAN, DIRECTOR, TAX POLICY CENTER, 
               SENIOR FELLOW, THE URBAN INSTITUTE

    Dr. Burman. Thank you very much, Mr. Chairman.
    It reminds me a little bit of the old saying, you should be 
careful what you wish for. Last night, when I was trying to cut 
my testimony down to a very short bite-sized bit, I said I wish 
I had more time. Now I am thinking what of the 20 pages of 
testimony do I want to add in. There are a few points I do want 
to add in. I hope you will forgive me if at times, it is not 
entirely polished.
    Chairman Spratt, Ranking Member Ryan and members of the 
committee, thank you for inviting me to discuss the role of the 
tax system and expanding access to health insurance.
    The hearing is extremely timely. About 47 million Americans 
under age 65, including 9 million children, lack health 
insurance. As you are acutely aware, Congress and the President 
are in the midst of a heated disagreement about how best to 
cover some of those kids; and, of course, the challenges facing 
adults who cannot attain health insurance are no less daunting.
    The current system is far from perfect. The tax subsidy for 
employer-sponsored insurance--if we could put up the slide with 
figure one on it. I was told that was possible.
    The current subsidy, basically, health insurance you get 
through your employer is excluded from your income. It is worth 
the most to you if you are in a high marginal tax bracket and 
worth little or nothing if you are in a low bracket. Thirty 
percent of Americans don't owe income taxes and are in the zero 
income tax bracket. So getting a reduction in their taxable 
income doesn't really help them at all.
    This chart which we did when we analyzed the President's 
proposal--so it is in 2009 levels--shows that current lost 
subsidy rates from employer-sponsored insurance--that is the 
blue line--and it goes from basically zero up to about 30 
percent for families with incomes between $100,000 and 
$200,000. Very high income levels will go up to the 35 percent 
top bracket.
    There is an additional benefit from saving Social Security 
taxes as well. But that is kind of a mixed blessing, especially 
if you are a low-income person and you pay less in for Social 
Security. You are also going to get less benefits when you 
retire. So that is not included.
    The red dash line shows the premium burden for health 
insurance, which is the after-tax cost of health insurance as a 
share of income; and what you can see is that for low-income 
people it is enormous. As Ms. Turner pointed out in her 
testimony, the average cost of employer-sponsored insurance is 
about $12,000 for family coverage. Somebody earning twice the 
poverty level, about $40,000 for a family of four, would be 
paying more than a quarter of their income for health 
insurance; and they get virtually no help from the tax system. 
So there certainly is room for improvement.
    I want to point out there are some advantages to tying 
health insurance to employment. For one thing, it is a natural 
way to pool health insurance risks. People choose where they 
work for reasons that are unrelated to their health status and 
that solves or at least mitigates one of the big problems in 
the health insurance market, especially for larger firms.
    It is also true that for larger firms administrative and 
marketing costs are much lower. The load factors that the 
overhead costs for insurance purchased in the individual 
nongroup market are something like 35 percent of premiums. One-
third of the premium dollars goes to pay the costs of marketing 
and underwriting, determining people's health status. Those 
costs can largely be saved in the employer setting.
    But employer-sponsored insurance is an imperfect pooling 
mechanism. In small firms, if somebody gets sick, premiums can 
go through the roof; and that is a big source of uncertainty 
for employers. I wouldn't want to be in the situation of a 
small employer who had a sick employee and had to tell her 
employees either that they are going to pay a lot more for 
their health insurance or that they were going to have to drop 
coverage.
    And the subsidies for employer-sponsored insurance amplify 
the advantages that large firms have over small firms. They 
have the really low costs of providing insurance where small 
firms have to pay much more for health insurance, and I think 
that is a problem.
    Also, there is this phenomenon called ``job lock''. The 
people who become ill stay working for their firms because they 
don't want to lose their health insurance, and that is clearly 
inefficient.
    But, for all of its imperfections, employer-sponsored 
insurance covers almost 70 percent of American workers.
    If we could see table one on the overhead. It shows some of 
the statistics about--well it may be better to look in the 
testimony.
    It covers almost 70 percent of American workers. It is 100 
million workers and their families that are covered by 
employer-based insurance. Even in small firms, more than 51 
percent of those workers get health insurance through 
employers. Full-time, full-year workers are much more likely to 
get insurance than part-time, part-year workers. But even part 
timers more often than not get health insurance.
    Similarly, it is clearly the fact that because the subsidy 
is worth a lot less for low-income people than for high income 
people they are less likely to get health insurance through 
their employer or through anybody else. But still 45 percent of 
workers with incomes below $20,000 get health insurance at 
work. Eighty-six percent of those with incomes over $40,000 get 
it.
    Well, the takeaway from that is that I think there are 
serious risks to just jettisoning the employer-based system, 
even if you think that in a perfect world there might be a 
better alternative. I am put to mind of something Winston 
Churchill said about democracy, which is that it is the worst 
system except for all those others that have been tried from 
time to time.
    The nongroup market, which is basically the alternative to 
providing insurance through employers, doesn't work very well; 
and some people would argue that the reason is because the tax 
subsidies keep people out of the nongroup market and because 
there are a lot of regulations in that market. But there are 
also some inherent market flaws that would have to be fixed 
before it would be safe to throw those 100 million workers or 
even a sizeable fraction of them into the nongroup market. And 
I want to talk a little bit about the economics because I think 
some people--I don't think Ms. Turner--but I think some people 
have oversimplified the challenges we face here.
    The basic idea behind putting people into an unregulated 
nongroup market is that, under some circumstances, markets are 
economically efficient, meaning you can't do better than the 
market at allocating resources, allocating goods and services. 
They drive down prices and get people what they want. But the 
under certain circumstances part is really important. For 
markets to work well, there are a number of assumptions that 
have to be met, and those assumptions and those circumstances 
are--virtually every one of them fails in the market for health 
insurance.
    Yesterday, it was announced that one of my favorite 
professors in grad school, Leo Hurwicz, won a Nobel prize in 
economics for his research on what you do when certain kinds of 
markets fail. You develop new kinds of mechanisms for getting 
markets to efficiently establish prices when they fail. Well, 
he didn't come up with any solution for the nongroup health 
insurance market, at least not that I know of.
    The problem with the nongroup health insurance market--
well, there are a number of them. The most important one in 
terms of the risks it creates for low-income people, especially 
for people with health problems, is something called adverse 
selection.
    By comparison, if you think about a market that is working, 
say--when I wrote my testimony, I was thinking about computers. 
Because I was writing it on a very inexpensive laptop computer 
that I had delivered to my house, and I thought how wonderful 
that you can take sand and a whole bunch of people working all 
over the world and I can get exactly what I wanted for a low 
price.
    When I buy a computer, the seller knows how much it will 
cost to supply it, and he offers it for cost plus a modest 
profit, and I buy it if it is worth at least that much to me. 
Competitive forces keep the computer's cost low, and I have 
lots of choices.
    Well, the health market is just like the computer market, 
except the seller doesn't actually know how much it will cost 
to supply the good. The individual, if they really value it, 
won't be able to buy it for a reasonable price. And even if you 
can get it for a reasonable price, say because you are healthy 
in the short run, over the long term the price can get very 
high if you really, really need insurance. That is a serious 
problem.
    The health insurance insurers have imperfect information 
about the health status of their customers. The people who 
choose to buy insurance tend to be those who value it the most, 
those that expect to have high health care costs. So an insurer 
who offered to all comers would have to charge very high 
premiums to account for the fact that they would get a sicker-
than-average pool, this adverse selection problem.
    The higher premiums actually discourage more healthy people 
from buying insurance. A lot of people would value it even if 
they are not sick. But when the premiums go up, it becomes a 
worse and worse deal for those who are healthy. That pushes up 
premiums even further. There is this wonderful term called a 
``death spiral'' that describes this process. And under certain 
circumstances the market for insurance can fall apart 
altogether.
    Now, it doesn't work out that way in the market for health 
insurance because the insurers are not passive. What they do is 
they try to get the healthiest people they can to buy their 
product. So there is selection on the other side. They can 
profit if they attract a healthier-than-average workforce and 
if they can deter those who have, say, preexisting conditions 
from buying insurance.
    But the consequence is that the nongroup health insurance 
market ironically only works for healthy people. If you are 
sick and you need insurance and you don't get it at work or 
through a public program, you are out of luck.
    Now, even if you buy affordable insurance when you are 
healthy, if you develop a chronic illness such as diabetes, 
your premiums tend to go up over time because you get put into 
a pool with other people who buy insurance at the same time. 
And basically there is underwriting at the start so the people 
in the pool are healthier than average to begin with. 
Eventually, some people get sick, premiums go up, the healthy 
people drop out to get a cheaper product somewhere else, and 
the premiums go up and up for the people who have no other 
alternative. That is a really serious problem.
    Now, I don't think those are insuperable problems, and I 
have recommendations about what you can do in the nongroup 
market. But it would be a serious risk to just throw people 
into the nongroup market without dealing with its inherent 
flaws.
    You could say, well, if you had a tax credit for nongroup 
health insurance, maybe you could cover some of the 47 million 
who are uninsured. But the problem is that if all you did was 
offer a tax credit for nongroup health insurance, a lot of 
employers would stop offering insurance for a couple of 
reasons. One is that one powerful incentive for employers to 
offer insurance now, especially small employers, is that it is 
the only way for the employer himself or herself to get the tax 
exclusion. You have to offer it through work. If you had a tax 
credit for nongroup insurance and you are healthy especially, 
you could get the tax benefits yourself without offering 
insurance to your employees.
    The other thing is, even if the employer wanted to offer 
insurance, they would find that the healthy employees would 
say, well, I can get a tax credit in a nongroup market. I don't 
have to pay much for the premium. Don't offer me health 
insurance. Give me higher wages.
    Virtually every model that looks at what would happen if 
you offered a nongroup tax credit finds that a lot of employers 
would stop offering insurance. A lot of people would pick up 
insurance in the nongroup market, but not all of them. The ones 
who are sick won't be able to find insurance they can afford. 
Low-income people typically can't afford insurance with the 
kinds of credits that have been talked about and proposals that 
have been made.
    So the negative message I guess is, without reforms to 
nongroup markets and substantial subsidies for low-income 
households, many people who are currently insured are likely to 
lose their coverage if tax credits were offered for nongroup 
insurance. Those who lose coverage would tend to be the most 
vulnerable, those with low incomes and serious health problems, 
while those who gain coverage would tend to be those who are 
healthy. In my view, that is a poor trade.
    There are other market failures in the health market; and I 
want to acknowledge right now that, you know, a lot of times 
when you hear the debate about this, it is like that on one 
side all they care about is adverse selection and on the other 
side all they care about is moral hazard. I think both problems 
are important.
    Another problem with the insurance market is that if you 
have unlimited insurance you really don't care about how much 
you pay for health care. As Ms. Turner pointed out, that with a 
big subsidy for health insurance you might not be that 
interested in shopping for a policy that could constrain costs 
effectively. That is a serious problem, too. If it pushes up--
that actually pushes up the price of health care. If people 
don't care about what they are paying for the health care 
because insurance is covering the cost, it pushes up the price. 
That actually raises premiums, which makes it harder for people 
to afford to pay for health insurance in the first place. So I 
think we have to deal with the problems of moral hazard as 
well.
    The President actually had a proposal which--one element of 
the proposal would have been a good way to deal with this 
problem of moral hazard. One of the problems with the current 
subsidy is that you get a larger subsidy the more you pay for 
health insurance. If you have a $20,000 health insurance 
policy, your income is reduced by $20,000. You only have to pay 
a fraction of that cost. The President's proposal said that you 
get a fixed deduction for having insurance, but if you get a 
more generous policy, you wouldn't get a bigger deduction; if 
you got a less generous policy, you wouldn't lose part of your 
deduction.
    Now, having a deduction for health insurance I think shares 
all the problems of the current system, and he also would allow 
this in the nongroup market, which would raise some other 
concerns. It retains the upside down subsidy. But if you turn 
that deduction into a tax credit and you dealt with the 
problems of adverse selection in a nongroup market, you 
conceivably could actually expand coverage and put some 
downward pressure on prices.
    So I have a few recommendations in my written testimony. I 
will try to go through them very quickly.
    One is, I think that replacing the ESI exclusion with a 
progressive, refundable tax credit would be a big improvement 
over current law. It would be a way to turn that upside down 
subsidy right. So a refundable tax credit would benefit people 
who don't have income tax liability. You could target the 
subsidy to the people who most need help and a subsidy that is 
available in the employer group would retain the advantages of 
ESI as a pool--employer-sponsored insurance as a pooling 
mechanism. It would encourage more healthy people to buy 
insurance as they tend to have lower incomes, but they would 
get a larger subsidy under this alternative, and that would 
tend to lower average premiums.
    If a credit is offered for nongroup insurance, the nongroup 
market must be reformed. One approach would be to set up a pool 
of insurers that promises to take all comers in exchange for 
being able to sell insurance that qualifies for the credit. 
Actually, most of you get insurance through such a pool. The 
Federal Employees Health Benefits Program contracts with a 
number of individual insurers who have an incentive to try to 
keep their premiums relatively low, and you choose the option 
you like the most, and you can get it irregardless of your 
health status. There is still the potential for adverse 
selection if the tax credit is small.
    One of the things that makes the FEHBP program work so well 
is that the government pays 70 percent of the cost. But if you 
had a credit that was large enough so low-income people could 
afford to buy in, you could get a lot of healthy people to buy 
insurance, and that would tend to keep the overall premiums 
low.
    Another improvement would be to require insurers who wish 
to sell nongroup insurance that qualifies for the tax credit to 
offer insurance that is fully renewable and portable. 
Individuals who maintain continuous coverage either through an 
employer-sponsored insurance or through qualifying nongroup 
insurance would be guaranteed that they could purchase 
insurance from any participating insurer at the lowest rates 
available.
    This would solve the problem that when you get sick your 
premiums start to go up. It would give you an incentive to buy 
insurance when you are healthy, because it would guarantee that 
you would get a low premium when you become ill and it would 
mesh well with the employer-based system which I think for a 
lot of workers would still be the best option.
    There are a number of issues that would need to be 
addressed if the tax credit is to help poor families gain 
insurance.
    First, the credit would need to be much larger than has so 
far been proposed. As I noted, the premium for employer-
sponsored insurance in 2007 for families is almost $12,000 or 
25 percent of the pretax income for a family of four. 
Experience with the health care tax credit that was enacted in, 
I think, 2003 to help workers who lost their jobs is that only 
11 percent of people took out that credit, and that was I think 
a 65 percent credit. That experience suggests that for low-
income people, for vulnerable people you might need to pay a 
much larger portion of the premium costs.
    I should note that if money is an issue, and particularly 
if it is difficult to cut back on the current employer 
exclusion for employer-sponsored insurance, the most cost-
effective approach might be to expand existing public programs. 
I understand there are political issues involved there. But the 
evidence is that, say, expanding coverage through SCHIP covers 
more new people than, say--I didn't say this very well. The 
SCHIP expansion that is being considered, according to CBO, it 
would cover something like two new people for every one person 
that already has insurance who would be getting coverage 
through SCHIP.
    Virtually all of the tax credit proposals that I have 
looked at--and John Gruber and I did some simulations to 
examine this--involved a lot of buying up the base. Most of the 
people who would get a tax credit already have insurance 
currently, and that adds to the cost of the program.
    The bottom line is that there are many ways to improve on 
the current system, But tax credits for insurance purchase in 
an unregulated private market would surely make things worse. 
It would be truly ironic if those who claim to favor market-
based solutions messed up the health insurance market so much 
that middle-class people and small employers demanded a 
government takeover of the whole system; and, in my view, I 
think that is a distinct possibility.
    With that said, a well-thought-out tax credit program that 
was integrated with the current employer-sponsored system could 
make things much better; and I applaud the chairman, ranking 
member and other members of this committee for taking on this 
very difficult and very important issue.
    Thank you.
    [The prepared statement of Leonard E. Burman follows:]

 Prepared Statement of Leonard E. Burman, Director, Tax Policy Center, 
                   Senior Fellow, the Urban Institute

    Chairman Spratt, Ranking Member Ryan, and members of the committee: 
Thank you for inviting me to discuss the role of the tax system in 
expanding access to health insurance. This hearing is extremely timely. 
About 47 million Americans under age 65, including 9 million children, 
lack health insurance. They are less likely to get important preventive 
screenings while healthy, and they receive lower-quality care when 
sick.\1\ And, the public ultimately shoulders the burden of paying for 
the medical treatment of those lacking insurance, through higher taxes 
or higher health care costs.
    The recent debate over the State Children's Health Insurance 
Program (S-CHIP) has focused on the best way to cover uninsured 
children, and many, including the president, have suggested that the 
tax system is the answer. I'd like to focus on the potential and 
limitations of using tax credits to expand coverage, as that is the 
only feasible way to use the tax system to help lower-income households 
obtain health insurance. Mr. Ryan has cosponsored a bill, H.R. 914, to 
provide a refundable credit up to $4,000 per year to help lower-income 
households purchase insurance in the individual nongroup market, 
similar to an earlier proposal from President Bush.
    In considering such options, it is best to keep in mind 
Hippocrates' dictum: ``Do no harm.'' A carefully designed program of 
health insurance tax credits combined with effective reforms of the 
market for nongroup health insurance could significantly expand health 
insurance coverage, although potentially at very high cost per newly 
insured person. And proposals to subsidize nongroup insurance alone 
with no meaningful provisions to fix the inherent failings in the 
nongroup health-insurance market would cause millions of Americans to 
lose their health insurance coverage. Those who suffer from chronic 
health conditions or have low incomes would be most vulnerable.
    My testimony briefly summarizes the current tax treatment of health 
insurance, the effects of tax subsidies on coverage and health care 
costs, discusses ways that tax credits might affect health care 
coverage, and concludes with some recommendations.

                   TAX SUBSIDIES FOR HEALTH INSURANCE

    Because the tax system heavily subsidizes employer-sponsored 
insurance (ESI), most nonelderly Americans get their health insurance 
at work. Employer contributions to employee health insurance are 
treated as nontaxable fringe benefits and are not considered part of 
total compensation for income or payroll tax purposes. The tax 
subsidies for ESI reduced income and payroll tax receipts by as much as 
$200 billion in fiscal year 2007.
    Section 125 of the Internal Revenue Code allows employers to set up 
so-called cafeteria plans for administering certain employee benefits. 
A cafeteria plan allows employees to choose to receive part of their 
compensation either as cash wages or as one or more nontaxable fringe 
benefits, including health insurance. Flexible spending accounts (FSAs) 
are similar to cafeteria plans. They allow employees to set aside a 
fixed dollar amount of annual compensation to pay for out-of-pocket 
expenses for medical and dental services, prescription drugs and 
eyeglasses, and the employee's share of the cost of employer-sponsored 
health insurance. An FSA is financed through regular salary reductions. 
Any amount unspent at the end of the year is forfeited to the 
employer.\2\ Employees pay no income or payroll taxes on the medical-
related benefits paid through a cafeteria plan or FSA. As a result, 
employees with access to such plans may pay for all or most of their 
medical costs with pretax dollars.
    Employers may purchase insurance for their employees or provide 
insurance themselves (i.e., self-insure--typically, in a plan managed 
by a third-party administrator). Section 105 of the Internal Revenue 
Code sets out nondiscrimination rules for benefits provided by self-
insured plans. These rules aim to prevent highly compensated managers 
from providing generous tax-free benefits for themselves that are not 
available to the rank-and-file workers.\3\ The Employee Retirement 
Income Security Act of 1974 (ERISA) exempts self-insured plans from 
state mandates and health insurance premium taxes that apply to third-
party insurers.
    The Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) 
amended ERISA to require employers with 20 or more employees who 
provide health insurance (whether self-insured or not) to allow 
participants and other beneficiaries (i.e., family members) to purchase 
continuing coverage for at least 18 months after it would otherwise 
cease for any reason, including termination, death, or divorce. 
Employers can charge covered employees their premium cost plus 2 
percent for continuation of coverage. Workers who become disabled may 
retain coverage beyond the 18-month period by paying a premium up to 
150 percent of the employer's average cost.
    The Trade Adjustment Assistance Reform Act of 2003 created a 65-
percent refundable tax credit for health insurance purchased by workers 
certified by the Department of Labor as having lost their jobs due to 
foreign competition. Workers covered by a pension taken over by the 
Pension Benefit Guaranty Corporation also qualify.
    Most individuals who purchase their own insurance directly, whether 
through COBRA or not, cannot deduct the cost. However, individuals may 
deduct the portion of premiums they pay for health insurance plus other 
medical expenses that exceed 7.5 percent of adjusted gross income 
(AGI).\4\ In addition, the self-employed may deduct their health 
insurance premiums from income tax (though not payroll tax) if they do 
not have access to ESI.
    The Health Insurance Portability and Accountability Act of 1996 
(HIPAA) established a four-year pilot program to make Medical Savings 
Accounts (MSAs) available to a limited number of people who are self-
employed or work for small firms. The Medicare Prescription Drug 
Improvement and Modernization Act of 2003 renamed MSAs Health Savings 
Accounts (HSAs) and made them available to workers regardless of firm 
size. The Tax Relief and Health Care Act of 2006 modified the rules on 
annual contributions that could be made to an HSA. To qualify, 
individuals must be under age 65 and covered by a high-deductible 
health insurance plan, either offered at work or purchased in the 
nongroup market. The deductible must be at least $1,100 for single 
coverage and $2,200 for family coverage. The out-of-pocket maximums are 
limited to $5,500 and $11,000 for single and family coverage, 
respectively. The individual may contribute up to $2,850 for single 
coverage and $5,650 for family coverage into the HSA, regardless of the 
deductible.\5\ Employer contributions to an employee's HSA up to those 
limits minus any employee contribution are excluded from taxable income 
for both income and payroll tax purposes--just as contributions to ESI 
are. Individuals' contributions to an HSA are deductible for income tax 
purposes.\6\ Individuals age 55 to 64 may make additional ``catch-up'' 
contributions of up to $800 in 2007.\7\ Balances in an HSA may be 
withdrawn to pay for qualifying medical expenses without penalty; 
nonmedical withdrawals are subject to income tax, and withdrawals made 
before age 65 are subject to an additional 10 percent penalty. Unspent 
balances in an HSA accumulate tax-free.
    These supplemental tax subsidies for health insurance are small 
compared with the exclusion for employment-based health insurance. They 
reduced income tax revenues by an estimated $13 billion in fiscal year 
2007. In contrast, the employer exclusion reduced income tax revenues 
by between $106 and $141 billion in the same year.\8\ Including payroll 
taxes, the total revenue loss could exceed $200 billion per year.\9\

         EFFECTS OF TAX SUBSIDIES ON HEALTH INSURANCE COVERAGE

    The tax subsidy for ESI has produced mixed results. Although it has 
undoubtedly allowed millions of Americans to get insurance, it is a 
flawed subsidy mechanism. On one hand, excluding employer contributions 
toward health insurance is administratively quite simple. Employers do 
not need to measure and allocate premiums to include in employees' 
income.
    On the other hand, the ESI exclusion is an upside-down subsidy. The 
largest subsidies go to high-income taxpayers who would be most likely 
to obtain insurance under almost any system. Those with low incomes get 
little or nothing. The subsidy for ESI depends on the marginal income 
tax rate, which increases with income. Taxpayers in the highest income 
tax bracket (35 percent) save 35 cents in income taxes for every dollar 
of earnings received in the form of health insurance. The roughly 30 
percent of low-income households in the zero tax bracket, in contrast, 
receive no income tax benefit. (They might save payroll taxes, but that 
is a mixed blessing since their reduced payroll contributions to Social 
Security produce a commensurate drop in retirement benefits.) The 
result is a system in which households that face the highest premium 
burden as a share of income receive the smallest subsidy rate (figure 
1).



    There are also advantages and disadvantages to tying health 
insurance to employment. The main advantage of subsidizing ESI is that 
employment is a natural way to pool health insurance risks since people 
choose employment for many reasons other than their expected use of 
health care. Employment pooling works best for large firms, but Pauly 
and Herring (1999) claim that even relatively small groups can 
effectively pool most risks. But Cutler (1994) found evidence of large 
year-to-year variation in average health expenditures in small groups, 
which creates a substantial risk of large premium increases in small 
firms.
    Another advantage with large groups is that administrative and 
marketing costs are lower (Monheit, Nichols, and Selden 1995). 
Collecting premiums as a part of payroll processing is less expensive 
than direct billing. Collecting insurance premiums, either explicitly 
or implicitly as a part of payroll processing, may also be an 
especially effective way to encourage participation because individuals 
like to break up large expenses into small, automatically collected 
pieces (Thaler 1992). Also, participation rates are higher if the 
choice workers face is framed in terms of opting out rather than opting 
into an insurance plan. Large groups also have bargaining power to 
lower costs when dealing with insurers and providers. And, to the 
extent that workers can count on long-term employment with an 
established firm, ESI may provide more protection against premium 
increases than does the individual market.
    But ESI has drawbacks as well. It is an imperfect pooling 
mechanism. In a small firm, if one person gets sick, average costs can 
jump. Also, ESI provides limited renewability at best. People can lose 
their jobs or employers can decide to drop coverage--for example, 
because of unacceptably large premium increases.\10\ Although no better 
mechanism for pooling or renewability currently exists in the 
individual market, such a mechanism might have arisen were it not for 
the large tax subsidy for ESI. For example, if professional 
associations, unions, or religious institutions were subsidized, they 
might also offer group health insurance policies to their members, much 
as they do with life insurance (Pauly and Herring 2001).
    Finally, the subsidy for ESI amplifies the advantage of large firms 
over small ones as payers for health insurance. To see why, imagine a 
world without a tax exclusion for ESI. Many large firms might still 
offer health insurance even without a tax subsidy because of their 
advantages in pooling and lower administrative costs. Few, if any, 
small firms would. Now, after a tax exclusion is introduced, taxes fall 
for employees of firms that offer health insurance, but not for 
employees of other firms. Firms that do not offer health insurance now 
would face pressure from their employees to offer this valuable tax-
free fringe benefit, and many would do so, but their compensation costs 
would increase relative to the large firms because, for a given package 
or benefits, health insurance is more expensive for small firms. The 
higher benefit costs place smaller firms at a competitive disadvantage. 
Effectively, the tax exclusion for ESI is a differential labor subsidy 
that is most valuable to large firms. It distorts the allocation of 
labor in favor of large firms and reduces production efficiency because 
workers who might be more productive at small firms are induced to 
shift to large firms by the tax subsidy.
    The subsidy for ESI also creates other inefficiencies. It gives 
employers an incentive to outsource low-income and younger workers (who 
would not value the insurance as much) and distorts workers' decisions 
about work and retirement (CBO 1994).
    For all its imperfections, however, ESI covers almost 70 percent of 
American workers (table 1). Not surprisingly, higher-income workers are 
much more likely to be covered by ESI than those with lower incomes. 
About 45 percent of workers with incomes under $20,000 were covered by 
ESI, compared with 86 percent of workers with incomes over $40,000. 
Full-time, full-year workers were much more likely to get ESI than 
part-time or part-year workers. And workers at large firms were much 
more likely to be covered by ESI than those working for small firms. 
Nonetheless, more than half of employees at small firms (fewer than 25 
employees) were covered by their own or their spouse's ESI. More than 
30 percent were covered by their own employer (not shown in table). 
This raises important concerns about policies that would cause more 
small employers to stop offering coverage.



    Although some analysts believe that a better mechanism would arise 
if there were no ESI, there is a risk that major tax changes could 
significantly reduce insurance coverage. Removing or reducing 
employers' incentives to sponsor health insurance would have mixed 
effects on coverage. While some young, healthy people might be induced 
to acquire coverage in the individual nongroup market under a different 
set of incentives, the loss of ESI could be particularly devastating to 
old and unhealthy workers who would face prohibitively high health 
insurance premiums in the private nongroup market in the vast majority 
of states.

               TAX CREDITS FOR NONGROUP HEALTH INSURANCE

    Although ESI and public programs cover most Americans, 47 million 
Americans lack health insurance. Subsidizing the purchase of private 
nongroup insurance for those who cannot obtain it at work seems a 
natural remedy, but it might actually do more harm than good.
    The appeal of tax credits for nongroup health insurance is obvious. 
It seems unfair to limit tax subsidies to those who get insurance at 
work. And most uninsured people do not have access to employment-based 
health insurance, so the only effective way to subsidize them would 
seem to be through the nongroup market, a public program such as S-CHIP 
or Medicaid, or new state- or federally subsidized purchasing pools.
    Health credit advocates also believe that moving more consumers 
into the nongroup market would unleash competitive forces that would 
constrain health care costs. Insurers, competing for business, would 
find new and innovative ways to limit health spending while providing a 
product that people value. Health care consumers, for their part, when 
faced with more responsibility for health care costs, would put 
pressure on providers to avoid unnecessary tests, therapies, and drugs.
    On its face, I'm very attracted to these arguments. As an 
economist, I live in awe of well-functioning markets. It is a marvel 
that a completely decentralized process whereby agents all over the 
world, acting completely in their own self-interests, could turn sand 
and other raw materials into just the perfect computer, delivered right 
to my door, ready for producing testimony.
    But economists also know that there are circumstances in which the 
magic of the marketplace breaks down. Almost every one of those 
circumstances applies in the markets for health care and health 
insurance. That doesn't mean that we shouldn't try to unleash market 
forces to control costs. It does mean, however, that an unregulated 
insurance market will fail to provide insurance for many millions of 
Americans, including those who are most vulnerable. If there is a role 
for government in any market, there is a role here.
    The Achilles' heel of the health insurance market is adverse 
selection. When I buy a computer, the seller knows how much it will 
cost to supply it. The seller offers it for cost plus a modest profit 
and I buy it if it is worth at least that much to me.
    For health insurance, the situation is completely different. Most 
people would like to have insurance if they can get it at a reasonable 
price because it protects them from a major financial risk. But, 
because of adverse selection, those who most value health insurance 
will have trouble finding affordable insurance in the nongroup market.
    Insurers have imperfect information about the health status of 
their customers. And the voluntary nature of health insurance 
complicates the market further. The people who choose to buy insurance 
will tend to be those who expect to have the highest health care costs. 
An insurer that offered insurance to all comers (something that most 
states do not require insurers to do) would have to charge higher 
premiums to account for the greater likelihood of attracting high-cost 
enrollees. The higher premiums, in turn, would dissuade additional 
healthy people from buying insurance. As the health status of the pool 
of covered people eroded, premiums would get higher and higher, making 
it even less attractive to relatively healthy people. In the extreme, 
this ``death spiral'' could cause the insurance market to self-destruct 
altogether (Rothschild and Stiglitz 1976).
    In fact, it doesn't work out this way because insurers are not 
passive in this process. They profit most if they can attract a 
healthier-than-average customer base. Newhouse (1996) documented how 
insurers exclude preexisting conditions and use other methods to 
attract the healthiest individuals. The consequence is that the 
nongroup health insurance market, ironically, only works for healthy 
people. If you are sick and need health insurance and you don't get it 
at work or through a public program, you are out of luck.
    One might think that purchasing insurance when healthy and 
maintaining continuous coverage would guarantee affordable insurance 
when the insured person becomes ill, but it doesn't work that way in 
practice, despite the guarantee of renewability. The problem is the way 
insurers set premiums in the nongroup market. Those who purchase a 
nongroup policy are included in a pool with other policyholders who 
purchase the same product at the same time. The original premium is low 
because underwriting guarantees that the original pool is healthier 
than average. Future premiums depend on the experience of people in the 
group. Eventually, some people in the group become ill and the premiums 
start to rise. Healthy people in the group discover that they can pay a 
lower premium if they buy into a new, healthier group. (Sometimes their 
own insurer will offer them a lower premium for a new policy.) As 
healthy people drop out of the group, premiums start to rise very fast 
for those who have no other alternative--like a person who has 
developed diabetes. The consequence is that those who get sick either 
end up paying very high premiums or find insurance unaffordable and 
drop coverage altogether (Hall 2000).
    I should note that insurers are not doing anything different from 
other businesses. They are simply seeking to maximize profits. Indeed, 
an insurer that decided to ``do the right thing'' and offer affordable 
insurance to people with serious health problems would go bankrupt. The 
premiums would not come close to covering the health care costs.
    When the market works, as in the market for my laptop computer, 
many producers compete to sell a product that will be most appealing to 
consumers. The people who value computers most can find exactly what 
they are looking for at a fair price.
    The private nongroup health insurance market does not, and cannot, 
produce this wonderful result. The decentralized system of firms trying 
to make a profit and consumers trying to get a good deal results in 
very little insurance being sold, and mostly to the people who need it 
least. Less than 6 percent of workers are covered by nongroup health 
insurance (table 1). More than three times as many (19 percent) are 
uninsured. People who most need health insurance often cannot find 
insurance they can afford.
    Also, administrative loads are higher; information for consumers is 
highly imperfect (widely varying benefit packages make price 
comparisons difficult, if not impossible; many buy policies without 
fully understanding what is covered or excluded), and many states allow 
insurers to use benefit exclusions to deny coverage on particular body 
parts and body systems related to preexisting medical conditions. Also, 
in the nongroup market, insurers view an individual looking for a 
comprehensive policy typical of those available in the group market as 
someone signaling an intent to use significant amounts of medical 
services. As a consequence, comprehensive policies are priced high to 
account for expected adverse selection, leaving policies with higher 
deductible and cost-sharing and more limited benefit packages as the 
only affordable options. But such policies are of little value to those 
with significant health care needs and to those with lower incomes, who 
often cannot afford the cost-sharing requirements.

  POORLY DESIGNED TAX CREDITS MAY UNDERMINE ESI AND REDUCE INSURANCE 
                                COVERAGE

    Of course, despite the nongroup market's flaws, covering several 
million more people in that market would seem to be a step in the right 
direction, even if most of the 47 million uninsured remain uncovered. 
The problem is that a poorly designed tax credit could cause millions 
of those with ESI to lose coverage and some of them, especially those 
in poor health or with low incomes, will not be able to afford coverage 
in the nongroup market.
    Subsidizing private nongroup insurance makes employment-based 
insurance relatively less attractive. Of special concern are proposals 
that only make the credit available in the nongroup market, such as 
President Bush's early tax credit proposals and H.R. 914. This could 
cause many employers to stop offering coverage, because their employees 
could only benefit from the credit if they don't get ESI. But even a 
neutral credit that applied equally to ESI and nongroup insurance would 
tend to undermine employer-based health insurance, especially at small 
firms, since it would eliminate the relative tax advantage for ESI.
    Due to higher administrative loads and higher year-to-year 
variability in group medical expenses, smaller employers often face 
higher health insurance premiums than do large employers--a major 
reason why they are least likely to offer coverage now. In addition, 
their employees tend to have lower incomes, making the value of a tax-
free fringe benefit low, and those employees cannot afford to sacrifice 
much in wages in exchange for insurance. If tax credits are available 
for nongroup insurance, business owners would no longer have to offer 
insurance to their employees to qualify for a tax break on their own 
health insurance. The owners could simply purchase insurance in the 
nongroup market. Healthy employees are also likely to prefer that their 
employers stop offering insurance under these circumstances, because 
they would be able to get a better deal in the nongroup market, where 
healthy people face very low premiums, and still qualify for a tax 
subsidy. In response to these new incentives, some employers who 
currently offer health insurance would ``cash out'' this benefit, 
boosting their workers' wages by what they spent on health insurance 
and telling those who want to retain coverage to buy it in the 
individual market using the new tax credit to offset part of the 
premium. Many firms, particularly larger ones, would still offer 
insurance because of the combination of convenience, administrative 
cost savings, and pooling afforded by large groups of people subject to 
relatively little adverse selection. But firms currently near the 
margin between retaining and dropping insurance would be likely to 
drop.
    The adverse effect on the employer-sponsored system raises concerns 
not just because of fragmented risk pools and adverse selection. Many 
individuals likely sign up for coverage because it is easy and almost 
automatic when administered through their employers. Put them in the 
individual market where search costs for an appropriate policy are 
relatively high, underwriting requires a medical exam, and payments are 
not automatically deducted from payroll, and many might make the short-
sighted choice to forgo insurance (and potentially impose costs on 
others who pay the cost of uncompensated care through higher premiums 
or taxes).
    The bottom line is that without reforms to the nongroup market and 
substantial subsidies for low-income households, many people currently 
insured would likely lose their coverage if tax credits are offered for 
nongroup insurance. Those who lose coverage would tend to be the most 
vulnerable--those with low incomes and serious health problems--while 
those who gain coverage will tend to be those who are healthy. In my 
view, that would be a poor trade.

            HEALTH INSURANCE SUBSIDIES AND HEALTH CARE COSTS

    Expanding coverage is not the only motivation of health market 
reformers. There is also an urgent need to rein in the growth of health 
care costs, which have been continually growing much faster than 
incomes. Indeed, health cost inflation and health insurance coverage 
are linked. Rising health care costs translate into higher health 
insurance premiums, which prices health insurance out of the reach of 
more and more workers.
    Insurance gives individuals an incentive to use too much health 
care because they have to pay only a fraction of the cost (the 
deductible and coinsurance). They will thus be willing to undergo 
medical procedures or take expensive prescription drugs even if they 
are of little value because the insured persons out-of-pocket cost is 
very low or even zero. To counteract this tendency, many insurers rely 
on managed care schemes that limit unnecessary medical expenditures.
    But how much of the cost of medical care is due to this moral 
hazard that arises from the low net-of-insurance price of insured care? 
Newhouse (1992) argues that the lion's share of growth of health 
expenditures stems from advances in medical technology, not moral 
hazard. He concludes that overzealous efforts to limit moral hazard 
could do more harm than good if they reduced the incentive for medical 
innovation.
    Nonetheless, the tax exclusion for ESI clearly creates an incentive 
to acquire overly generous health insurance coverage as it lowers the 
after-tax cost of health insurance by as much as 35 percent for 
taxpayers in the top income tax bracket (and even more when savings in 
payroll taxes and state income taxes are considered). At the discounted 
price, consumers may demand more comprehensive insurance with lower 
copayments and deductibles, and less aggressively managed care.
    Several policy responses have been put forward to offset this 
incentive to purchase overly generous care. The generous tax subsidies 
for HSAs are one such approach, intended to encourage the purchase of 
health insurance plans with high deductibles. However, the high-
deductible health plans (HDHPs) may not be the best way to control 
costs. For one thing, they encourage the risk segmentation of the 
market, as they are most attractive to healthier-than-average people, 
for whom the high deductibles are a good bet. If employers offer both 
HDHPs and traditional insurance, adverse selection will tend to make 
premiums for traditional insurance higher and higher over time.\11\
    But if HDHPs supplant insurance with lower deductibles, they could 
ultimately reduce coverage, especially for those with low incomes or 
chronically poor health. The $2,200 deductible for family coverage in 
2007, for example, would represent a significant financial risk for a 
low-income household. If that were its only insurance option, the 
family might opt to refuse health insurance coverage altogether. It 
would also represent a substantial hardship for someone with a chronic 
illness who knows that he or she will exceed the deductible every year.
    What's more, HDHPs might not even be a particularly effective means 
of controlling health care spending. Most health care spending is done 
by a small number of very sick people. Berk and Monheit (2001) reported 
that 70 percent of health care spending is attributable to only 10 
percent of individuals. Blumberg (2007b) calculated that 97 percent of 
health care costs are incurred by individuals who spend more than the 
deductibles in HDHPs. Once individuals reach the deductible, insurance 
pays all additional costs and they have no more incentive to economize 
than anyone else with insurance. As a result, HDHPs and HSAs are 
unlikely to have a substantial effect on overall medical spending.
    The president's proposed standard deduction for health insurance 
represented an innovative approach to balancing adverse selection and 
moral hazard. The proposal would provide a fixed subsidy solely for 
acquiring insurance that met minimum standards. More expensive 
insurance would not qualify for a larger subsidy. This approach would 
encourage individuals and families to get insurance while preserving a 
strong incentive to shop for a low-cost plan. The deduction is 
problematic since it retains the upside-down subsidy structure 
discussed above, but if the deduction were converted to a refundable 
credit and the individual nongroup market reformed as discussed below, 
this proposal could encourage consumers to get insurance without 
encouraging excessive consumption. What's more, if HSAs were 
eliminated, this option would remove the bias in favor of HDHPs over 
other possibly more effective means of controlling costs, such as 
managed care.

                            RECOMMENDATIONS

    Replacing the ESI exclusion with a progressive refundable tax 
credit would be an improvement over current tax law. Such a credit 
could turn the upside-down subsidy right side up. It could be designed 
to provide the largest subsidy to low-income households who most need 
help, even if they do not owe income taxes. That would encourage more 
low-income employees to take up employers' offers of insurance, and 
would encourage more employers--especially small firms--to offer 
insurance. Since young, healthy people are more likely to have 
relatively low incomes, a refundable credit would also encourage more 
healthy people to take up their employers' offers of insurance, 
lowering average premiums.
    It would also be a good idea, as the president proposed in his 
State of the Union address in January 2007, to make the subsidy amount 
depend only on having qualifying insurance, not on the amount of the 
insurance premium. This would encourage households to gain insurance 
coverage while retaining an incentive for cost-containment, whether 
through high deductibles, aggressively managed care, or some other 
means.
    A credit for nongroup insurance alone, as in H.R. 914 and the 
president's earlier tax credit proposals, would likely do more harm 
than good. It would cause some employers, especially small ones, to 
stop offering health insurance, and would likely cause many people with 
health problems or low incomes to lose their health insurance coverage.
    A credit for ESI and nongroup insurance could represent an 
improvement if the inherent problems in the nongroup market can be 
solved (Blumberg 2007a). There are several possible approaches to doing 
this. One would be to set up, either at the national level or within 
each state, a pool of insurers that promises to take all comers in 
exchange for being able to sell insurance that qualifies for the tax 
credit. An example of such an arrangement is the Federal Employees' 
Health Benefits Program, which includes a set of insurers that offer 
insurance that meets minimum actuarial standards and charges a 
community-rated premium in each market to any federal employee who 
chooses their product.\12\ There is still the potential that adverse 
selection would drive up premiums in the purchasing pool if the credit 
is small. However, if the credit is large enough, then even healthy 
people would want to buy into the publicly sponsored pool, which would 
help keep premiums affordable.
    Alternatively, or as a complement to state efforts, insurers who 
wished to sell nongroup insurance that qualifies for the tax credit 
could be required to offer insurance that is fully renewable and 
portable (Burman and Gruber 2001). Individuals who maintained 
continuous coverage through employer-sponsored insurance or qualifying 
insurance offered in the nongroup market would be guaranteed that they 
could purchase insurance from any participating insurer at the lowest 
rates available, even if their health status worsens. This option would 
give healthy people a strong incentive to purchase insurance, because 
they would be guaranteed that they could get affordable insurance when 
they got sick and they would qualify for a tax subsidy. This strong 
incentive for healthy people to participate would help keep premiums 
for qualifying insurance relatively low, as they are in large employer 
groups. Insurers might try to undermine the pooling arrangement by 
attempting to cherry-pick healthy individuals, but that might be 
deterred by federal or state regulation of qualifying insurance.
    Some issues would need to be addressed if a tax credit is to help 
many poor families gain insurance. First, the credit would need to be 
much larger than has so far been proposed. The premium for employer-
sponsored family coverage in 2007 averages almost $12,000. That is over 
25 percent of pretax income for a family of four earning 200 percent of 
the federal poverty level.\13\ It is likely that for such families, the 
credit would need to equal 75 percent or more of the premium to induce 
substantial participation. The Health Coverage Tax Credit, which covers 
displaced workers who lose their health insurance, covers 65 percent of 
premiums, and only 11 percent of qualifying individuals take the 
credit.\14\
    A second issue is getting the credit to workers when they need the 
money. Almost all tax credits are claimed after the end of the calendar 
year, when a household files its tax return.\15\ For a major expense, 
such as the cost of family health insurance coverage, a lower-income 
household would have great difficulty advancing the premium, even if it 
knows that most of the cost would be refunded at tax time. To deal with 
this problem, the HCTC is paid directly to health insurers. If the 
credit is available for both ESI and nongroup insurance (as I 
recommend), it should also be payable in advance to employers who 
sponsor health insurance.
    A further complication arises if the credit amount is based on 
income. Current annual income is difficult to predict in advance, 
especially for low-income families whose attachment to the labor force 
may be erratic. For that reason, President Bush's proposals have 
allowed households to elect to claim eligibility for an advance credit 
based on a prior year's income. This approach may still result in a 
mismatch between eligibility and subsidy levels for a family whose 
income is very volatile. When they have great need, for example, 
because of a job loss, they might not be eligible because prior year's 
income was too high. It also raises administrative issues for the IRS.
    Also, transferable tax credits may be very costly for the IRS to 
administer. Dorn (2007b) estimates that in FY 2007, only 66 percent of 
the cost of the HCTC went to pay for health care. The rest went to the 
IRS (21 percent) and the cost of health plan administration (13 
percent).
    Finally, if tax credits are an add-on to current subsidies rather 
than a replacement for the ESI exclusion (as President Bush's proposals 
were), they could prove to be a very costly way to expand coverage. 
Burman and Gruber (2005) estimated that a tax credit for both ESI and 
nongroup coverage could cost $6.50 for every dollar of new insurance 
purchased, largely because so much of the cost would go to buying up 
the base--that is, covering people who already have either ESI or 
nongroup insurance. And those estimates do not include administrative 
costs.
    The most cost-effective approach to expanding health insurance 
coverage may not be a tax subsidy at all, but expansion of an existing 
public program, such as Medicaid, S-CHIP, or Medicare. For example, CBO 
(2007) concluded that most of the children who gain insurance under S-
CHIP would otherwise be uninsured. In contrast, Burman and Gruber 
(2005) estimated that most of those who would qualify for tax credits 
(whether for ESI, nongroup, or both) would have had insurance even 
without the tax credit.

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                                 NOTES

    I am grateful to Linda Blumberg, Allison Cook, Stu Kantor, Jenny 
Kenney, Lek Khitatrakun, Edwin Park, and Bob Williams for helpful 
comments and advice and to Julianna Koch and Greg Leiserson for 
research assistance. All views expressed are my own and should not be 
attributed to the Tax Policy Center, the Urban Institute, its board, or 
its sponsors.

    \1\ Hadley (2003) estimates that mortality declines by 4.5 to 7.0 
percent for people when they gain health insurance.
    \2\ Treasury Notice 2005-86 allows employees a grace period of up 
to two and a half months beyond the end of the calendar year to submit 
charges for reimbursement under a health FSA if the employer permits.
    \3\ In contrast, no nondiscrimination rules apply to the provisions 
of commercially purchased health insurance. The Tax Reform Act of 1986 
included a new Section 89, which set out nondiscrimination rules for 
employee health and welfare benefits, but the new restrictions raised a 
firestorm of protest among business interests and others and were 
repealed in 1989.
    \4\ The threshold is 10 percent for taxpayers subject to the 
individual alternative minimum tax.
    \5\ All of the thresholds are indexed for inflation.
    \6\ If the individual contributions are made through a cafeteria 
plan, they are also excluded from income for payroll tax purposes.
    \7\ The catch-up contribution limit phases up to $1,000 by 2009. 
The concept of a catch-up contribution was implemented for individual 
retirement accounts and defined contribution plans in the Economic 
Growth and Taxpayer Relief and Reconciliation Act of 2001 based on the 
logic that women had to make additional contributions to catch up for 
the time spent out of the labor force. This is a dubious justification 
for a provision that mostly benefits men, and its application to HSAs 
is truly puzzling since their ostensible purpose is to offset unusually 
high medical expenses, not provide another retirement savings vehicle.
    \8\ The official government estimates are done for Congress by the 
Joint Committee of Taxation (JCT) and for the administration by 
Treasury's Office of Tax Analysis (OTA). Their estimates for the 
deduction for medical expenses and for health insurance premiums of the 
self-employed are similar, but their estimates for the exclusion from 
income tax of ESI diverge markedly. OTA estimates that the latter 
provision will reduce revenues by $141 billion in fiscal year 2007; JCT 
estimates a $106 billion revenue loss. The JCT estimates are smaller 
because they assume that, absent the tax exclusion, individuals who 
itemize deductions would be able to deduct the part of their health 
insurance premiums that, combined with other medical expenditures, 
exceeds 7.5 percent of AGI. OTA does not account for this offsetting 
deduction because it would logically require an increase in the tax 
expenditure estimate for the itemized deduction for health 
expenditures. Note that tax expenditure estimates differ from revenue 
estimates because, by convention, they do not take into account most 
behavioral responses or interactions with other tax expenditures. See 
Office of Management and Budget (2007) and JCT (2007).
    \9\ Payroll tax revenue losses are more than half of the income tax 
revenue cost. (See Burman et al. 2003). Thus, conservatively, the 
payroll tax expenditure would be at least $70 billion, based on 
Treasury numbers, or $53 billion, based on JCT's estimates. This yields 
a range of $159 to $211 billion or more for the combined revenue loss.
    \10\ HIPAA requires insurers to offer insurance to terminated 
employees who have exhausted their COBRA coverage, but insurers can and 
do charge much higher rates for HIPAA customers. For example, CareFirst 
(Blue Cross-Blue Shield) charges a markup of about 80 percent for HIPAA 
coverage in Virginia compared with otherwise identical underwritten 
policies (http://www.carefirst.com, October 8, 2006).
    \11\ To see why, consider the story of Blue Cross high option 
health insurance. For years, federal employees had a choice of ``high 
option'' Blue Cross health insurance and a standard option with a 
slightly lower deductible and a few other limitations. For the typical 
federal employee, the high option was worth a little more, and 
initially premiums were slightly higher. Young, healthy employees 
risked having to pay the higher deductible in exchange for the small 
premium difference. Older, sicker employees preferred the high option. 
But the premium difference grew larger over time as more healthy people 
shunned the high option. When last offered in 2001, the Blue Cross 
high-option family premium was $1,500 more than standard option. In 
2002, the high option was discontinued.
    \12\ The minimum actuarial standard is necessary to prevent 
insurers from cherry-picking--designing policies that are most 
attractive to healthier-than-average employees. The advent of high-
deductible plans that qualify for HSAs may have undermined this policy, 
although it is too early to tell.
    \13\ The average premium for family coverage offered through 
employers is an estimated $11,790 in 2007. The federal poverty level 
for a family of four in 2007 is $20,650.
    \14\ There are other issues with HCTC, as discussed in Dorn 
(2007a).
    \15\ The EITC allows advance payments through employers, but almost 
nobody takes advantage of this option (GAO 2007). The HCTC provides 
payments directly to health insurance providers, although there is a 
delay before payments begin (Dorn 2007a).

    Chairman Spratt. Thank you very much, both of you. Dr. 
Burman and Ms. Turner, I thank you very much for your excellent 
testimony.
    But, Dr. Burman, you leave us with sort of an elliptical 
paragraph there at the end. You say the most cost-effective 
approach to expanding health insurance coverage may not be a 
tax subsidy at all, after spending about six or seven pages 
discussing the tax credit, but expansion of an existing public 
program such as Medicare, Medicaid or SCHIP. I would like for 
you to elaborate on that.
    Before you do, let me just make a statement.
    Ms. Turner, you were talking about turning much more of 
this type of coverage over to consumers, individual consumers 
and the individual market and allowing them to amass their 
consumer influence and get something that they wanted, as 
opposed to having paternalistic employers provide it for them. 
Bear in mind that today 46 percent, according to MedPAC, of the 
health care paid for or provided in this country is paid for or 
provided by the Federal Government through Medicaid, Medicare, 
FEHB, Tricare Prime, Tricare for life, Veterans Administration 
and SCHIP; and I find it hard to believe that we would turn 
this battleship around and undo most of that coverage that is 
institutionally so rooted in everybody's expectations, that to 
change the system, we have got to change it incrementally, in 
my opinion.
    We have really got two choices. We will take a 
revolutionary leap to a completely different type of health 
care delivery and a completely different type of health care 
compensation or insurance or do we go step by step with 
incremental change. The early 1990s and the Clinton proposal 
convinced me we would find it very difficult to do anything 
revolutionary. It has got to be evolutionary.
    If we are going to have a market-based solution, then we, 
the Members of Congress, have to market it, first of all, to 
our constituents; and that is awfully hard to do. Most of them 
are satisfied to have the employee make the decision about 
their policy. They don't read their policy.
    I don't think there is a member sitting here in this room 
who can tell you that he or she has read his health insurance 
policy obtained under FEHB. We are generally familiar with the 
coverage. We know basically what the deductibles and copays 
are. We would probably find something excluded that we would 
think was there--hearing aids, eyeglasses, stuff like that--
that we might assume was there until we went and looked and 
found that it isn't.
    I am just saying it is going to be extraordinarily 
difficult to change anything; and to the extent, the more 
radical the change, the harder it will be, first of all, to 
sell to the population, I think.
    But, Dr. Burman, going back to my first question to you, 
you seem to be headed off in a different direction in that last 
paragraph of your testimony.
    Dr. Burman. And getting dangerously on the verge of a 
subject in which I am not an expert. But the problem with the 
tax credit approach is that almost all the proposals would 
involve a lot of buying up the base.
    Say we had just a tax credit for nongroup health insurance. 
Nongroup health insurance covers a lot of people already, and 
all of those people would qualify for a tax credit, and they 
wouldn't get additional coverage. The estimates that John 
Gruber and I did suggested that only a fraction of the people 
who would get the credit would actually be newly insured. By 
comparison, according to CBO, the SCHIP expansion, something 
like two-thirds of the people who would get SCHIP under the 
expansions are currently uninsured.
    There is crowd out in both public programs and in tax 
credits. But I think it is a little bit--it appears to be 
harder to target tax credits to the people who are currently 
uninsured than it is to target, say, something like the SCHIP 
expansion. That might not be true if we had a major expansion 
in public programs, if we decided we wanted to cover everybody 
with insurance up to 400 percent of poverty or 500 percent of 
poverty. Obviously, a lot of those people have insurance now. 
But for these small, incremental changes--you get 400 million 
people getting coverage at a relatively modest price, it would 
be hard to do that through a tax credit program.
    There have been proposals saying that you only get the 
credit if you don't currently have insurance, but there are two 
problems with that.
    One is, it seems unfair. People have been struggling to pay 
premiums themselves for all these years and they find out that 
the people who are going to get it are the ones who were opting 
out of the market. That just doesn't seem right.
    The other one is it can create some bad incentives. You 
can, say, drop your insurance for a year so you can qualify for 
a credit down the road.
    Similarly, there are some subsidies--you only get it if 
your employer doesn't provide insurance. That provides a very 
strong incentive for the employers to drop their coverage. 
Because, basically, by offering insurance at work, you are 
poisoning the well for all of your employees. If they wanted to 
get a credit in the nongroup market, you would have to drop it.
    So those are the kinds of concerns that I was worried 
about.
    Chairman Spratt. Ms. Turner?
    Ms. Turner. I think that Dr. Burman, who really describes 
that whatever we do is going to be complex, and I absolutely 
agree with him, Mr. Chairman, that whatever we do needs to make 
sure that we don't rock the boat for people who have stable 
coverage.
    But one of the concerns that many people have right now is 
even job-based coverage is starting to decline. You know, we 
see it fall below 60 percent in the latest Census Bureau 
numbers. And my concern is, if we don't do something to give 
people who are left out of the system and who may be left out 
of the system in this evolving economy other options, that we 
are going to continue to see that number of uninsured increase 
to the point that public programs may seem to be the only 
option. And that is certainly something that I think, 
considering the current budget deficit and the current budget 
debt, is just really--is very difficult to envision; and I 
would like to----
    You know, one of the things that I see that is particularly 
important in changes in the health sector is recognizing that 
there would be a different market response if the incentives 
were different. And it is not really just the current 
individual market, which, by the way, insures about 27 million 
people but also--it is not just the individual market as we 
know it now or the employment-based group market as we know it 
now, but I believe all kinds of new groups would evolve so that 
people could have the advantages of purchasing group health 
insurance through other kinds of groups that may be more stable 
forces in their life than their job--their church group, 
community, professional, labor trade associations--that gives 
them continuity of coverage. But allowing people to have the 
tax break follow them as a person rather than as an employee 
would allow them to find new kinds of efficient mechanisms to 
purchase health insurance rather than just the current 
individual market. So----
    Chairman Spratt. You have more confidence than I do in the 
ability of individuals to get into the complex insurance market 
and make comparative decisions about the type of coverage, the 
cost of coverage that he or she might want to get.
    When I was younger, I used to have a life insurance 
salesman come by my office almost every week trying to sell me 
whole life insurance; and in all the years that I was in 
private practice, in business, nobody ever tried to sell me an 
individual health insurance policy because I had group 
coverage. But nobody tried to sell me an individual policy even 
though--an umbrella policy.
    Ms. Turner. I also think that many of the problems that we 
see currently in the health insurance market could be addressed 
if people had greater continuity in their ownership of that 
health insurance policy.
    I was in Europe----
    Chairman Spratt. Are we talking about preexisting 
conditions or renewability?
    Ms. Turner. Yes, absolutely. But I think also if people had 
a policy that they owned and could keep with them for years--I 
was in Europe recently talking with a woman from Germany who 
had the same health plan, sickness fund for 40 years.
    Chairman Spratt. Are you saying that the company, once 
having to ensure this individual, regardless of his or her 
health, couldn't adjust upward the premium?
    Ms. Turner. I think we need to look at what the rules would 
be. If people have a contract that says if you stay with us for 
5 years or 10 years, we are going to cover you no matter what, 
and we are going to negotiate what that premium would be so 
that you have something that is affordable for you.
    But I believe that if people saw an incentive to have a 
longer-term relationship--nobody really wants to go renegotiate 
their health insurance policy every year, and I believe if they 
have that continuity that it would work on both sides. Not only 
would insurers have more of an incentive----
    Chairman Spratt. Realistically, whom do you know who has 
ever sat down individually and negotiated health insurance 
policies?
    Ms. Turner. That is why I think these new kinds of groups 
would help people to aggregate so they have some trusted agent 
that would help do that for them. The individual market may not 
work. It may work for a few people. But I think new kinds of 
groups and new kinds of mechanisms for people to be able to 
aggregate together to get a better deal, to have more longevity 
in their coverage would actually provide many new options than 
we see in today's market.
    Chairman Spratt. Thank you.
    Dr. Burman.
    Dr. Burman. I definitely think it is possible that if we 
had a different set of incentives that there would be 
institutions that would set up in the individual market that 
would solve some of the problems.
    But the inherent problem of adverse selection is really 
difficult. For example, if the church offered health insurance 
to people who would be most likely to want to sign on, it would 
be the people who have high health costs and the church doesn't 
have any way of requiring or even providing much of an 
inducement for all of their members to join in.
    One thing employers can do is say, well, I am going to pay 
70 percent of the premium; you can take it or not. But given 
that that money is already on the table, it is a very strong 
incentive for most people to buy into the plan. It is possible 
and almost--it is likely that the market would come up with 
some innovations that it hasn't if it got a lot larger, and 
certainly if more people were buying insurance in the nongroup 
market that by itself would help some with the adverse 
selection problem. But I think it would be a tremendous gamble 
to just assume that those institutions would arise and solve 
these seemingly very serious problems without some kinds of 
other restrictions.
    I was glad to hear Ms. Turner say that we need to change 
the way we deal with long-term contracts with insurers. I think 
a really fundamental problem is that when you buy term life 
insurance or whole life insurance that your insurer doesn't 
come back to you 10 years later and say, well, you have 
gotten--it looks like you are really healthy. You have started 
riding your bike. You are going to live forever. Therefore, I 
will cut your premium--or I guess it is the other way around. 
You started smoking, so I am going to raise your premium, or 
you developed heart problems.
    You have got to have some way that if you keep continuous 
coverage for health insurance you can get the lowest premium, 
and there needs to be a way to keep insurers from cherry-
picking. There is a very strong incentive for insurers to find 
ways to get the healthiest people to sign up and to discourage 
the people who are unhealthy from being in the pool. I mean, it 
is just--competitive pressures actually force them to do that. 
It is not because they are especially evil. It is just that if 
you decide to be the good guy and take sick people, you will go 
bankrupt.
    There is an example I heard of--it is probably apocryphal--
but there was somebody selling Medigap coverage for a really 
low price and all you had to do was walk up to the second story 
to get it. Insurers are very creative at finding ways to select 
the healthy risks.
    Mr. Ryan. Is that a true story?
    Okay. This is a great hearing. Let me just ask both of you 
these questions as I go on.
    When we have these conversations, we keep seeming to think 
that the market is the way it is and it is always going to be 
the way it is; and we need to challenge that conventional 
wisdom. You mentioned it is $12,000, on average, for a family 
to buy health insurance on the individual market, and that is 
just too much, and there is nothing we can do about it. I would 
like to challenge the fact that there probably is something we 
can do about it. So my questions go to, you know, how do we 
find that sustainable equilibrium, that sweet spot between 
moral hazard and adverse selection? Where is it so that you are 
not careening between the two?
    And the question is, basically, if you take a look at the 
underwriting guidelines of insurers today, their interests are 
directly opposed to the interests of their clients or their 
consumers. Where else is it good economic sense to get a pool 
together, to get a bunch of clients and then run it for 5 years 
and then just cancel the whole thing? So you made your spread 
and start over again and get rid of these clients. That is 
basically what they do. That is what the economics--that is 
good business practice.
    So how do we reform the market without having a government 
takeover of this market? But how do we reform this so that the 
underwriting guidelines and the interests underpinning those 
more clearly align with those of us as consumers? That is 
question number one.
    Question number two is, as you look at that and you model 
this, don't you agree with the premise that if we find a way to 
do that, whether it is reinsurance or, you know, connectors or 
good high-risk pools that work that address the moral hazard 
issue, isn't it axiomatic that the rest of the cost of 
insurance for everybody else will go down? If we find a good 
mechanism that gets people with two co-morbidities, the high-
risk people, insured at an affordable rate and we just 
subsidize that, which is probably the easiest, most rational 
way to do it, isn't it axiomatic that the average cost won't be 
$12,000 for a family plan for relatively healthy people, that 
it would go down?
    And the final question here, and I will actually have a 
follow-up with my time, I think, you know, if we don't address 
the root cause of health inflation, we are all in trouble. So 
we have got to--we have got a need in our economy--in our 
society that 16 percent of GDP is growing at two--in some years 
three--times the rate of ordinary inflation. More government 
programs doesn't address that. The same kind of tax policy we 
have doesn't address that. It is clearly that something that 
changes the market structure and incentives has to be done to 
address the root cause of health inflation.
    Because, as we see in this committee, we are in a 
completely unsustainable course with--and it is basically 
health care. If you take health care out of the equation with 
our entitlements, we really don't have a problem. But because 
of health care--and, more importantly, if you look at Peter 
Orszag studies and all of these other, health inflation is more 
than demographics, the problem we are facing with these 
entitlements. So if you could get into those, I would very much 
appreciate it.
    Dr. Burman. Those are great questions.
    The first was how you could reform the system to align 
incentives. One thing that is important to point out is that 
the current system doesn't actually work for insurers even, at 
least in the aggregate, because the adverse selection means 
that many fewer people have insurance than would have it if the 
market somehow could be made to work. Insurers would like to 
sell insurance to everybody who wants to buy it, but they are 
trying to figure out a way to do it and still make money.
    If you had a system where there were substantial subsidies, 
especially for low-income people so they could afford to buy 
it; if you had incentives for people to retain continuous 
coverage; if you were able to prevent the kind of 
cherrypicking, which is an incentive for every individual 
insurer but not an incentive of the whole market; so by setting 
up these purchasing pools or by requiring to take all comers so 
long as they have maintained continuous coverage, insurers 
could sell a lot more insurance.
    It would lower average premiums, because you would have 
more healthy people in the pool, and people, when they got 
sick, would still be served, either through employers or 
through reforms in the nongroup market.
    Mr. Ryan. When you say that, are you just suggesting, you 
know, just, sort of, mandates like guaranteed issue or 
community rating? Is that what you are suggesting when you say 
that? Or are there other----
    Dr. Burman. The problem with community rating, just by 
itself--I mean, there are sort of simplistic solutions that 
have been put forward on both sides. Community rating, by 
itself, creates--that actually leads to the death spiral, if 
you don't have other incentives. Because if the insurers have 
to take everybody and the people who want to buy insurance most 
are the ones who are sick, premiums are high, healthy people 
drop out, premiums get even higher.
    So it is a combination of--basically, my view, particularly 
if you are going to offer tax credits, tax credits ought to pay 
for something--something the market is not doing now--and not 
just provide a subsidy to people who are buying insurance in a 
dysfunctional market.
    And what I suggest, and I actually wrote a paper a while 
ago with a different Gruber, Amelia Gruber, who was my RA back 
in the late 1990s. It was called something like ``Health 
Insurance with a Purpose.'' Basically it said that the insurers 
would have to come up with a way to guarantee that you could 
continue to get insurance at the lowest premium from any 
provider, basically guaranteed issue, but the requirement on 
the other side was that you have to maintain continuous 
coverage.
    And, obviously, you are going to need to do things to take 
care of people who lose their jobs, who can't afford to pay for 
the premiums, people who fall upon hard times. But you don't 
want people basically saying, ``I am only going to buy 
insurance when I really need it,'' because that is just a 
recipe for disaster. And you don't want the insurers to be able 
to turn down everybody but the healthy people.
    Mr. Ryan. So guaranteed issued with the mandate, basically.
    Dr. Burman. Not quite. It is softer than a--obviously, a 
mandate would work, too. And if you wanted to make subsidies 
large enough so that actually everybody could afford to pay for 
health insurance, which means pretty big subsidies at the low 
end, that is a way you could get universal coverage in a 
decentralized system.
    What I am suggesting is something less radical than that, 
which is just that if you keep continuous coverage, either 
through an employer or by purchasing in the nongroup market, 
all insurers have to take you, and they have to take you at the 
lowest premium, and they can't raise your premiums over time if 
you get sick.
    You asked about what would happen if you covered high-risk 
people through some kind of high-risk pool. And it is certainly 
true that it would lower premiums in the rest of the market. I 
don't know that that, by itself, does anything to the overall 
problem of what we are spending on health care. It just means 
you are kind of segmenting the market into a high-risk pool 
that gets subsidized insurance through States or some other 
mechanism and then a relatively healthy pool, which might 
include employers as well as--right now, basically, we have a 
healthy pool anyway. So insurers are mostly covering people who 
are healthier than average. And this would just make that even, 
sort of--have that be an explicit policy. But I am not sure it 
would do anything about overall health spending. It would just 
change who was paying which parts of it.
    I think there also might be some problems in terms of risk 
adjustment, although I am not an expert on that, so I will 
defer to others on that issue.
    On the issue of health cost inflation, I think you are 
exactly right. If we don't deal with the problem of rising 
health-care costs, the Government is going to go bankrupt. And 
basically no one in this room will have a situation they like. 
We will have Government spending 30 to 40 percent GDP, mostly 
on health care for the elderly. There won't be any money left 
for other programs we care about, like roads, safety net for 
low-income people, and everything else. And we will need really 
high taxes, as well. Solving that problem is the biggest 
challenge you are facing, going forward.
    Peter Orszag, when he talks about it, has focused a lot on 
information, finding ways to automate processes in hospitals 
and among medical providers to reduce--you know, one big 
problem is there is a lot of just duplication of care. I heard 
stories about--my colleague, Howard Gleckman, followed some 
people around in a hospital, and really sick people, and 
discovered that a patient was getting prescribed the same MRI 
by two or three different doctors, because they didn't have any 
way of figuring out what other doctors had prescribed. Doctors 
prescribe medicines without even knowing what other medicines 
people are taking, which sometimes makes people even sicker. 
So, obviously, there is some potential there.
    I do think we do need to deal with the problem of moral 
hazard. And I like the idea behind the President's proposal of 
having the subsidy for health insurance depend on purchasing an 
adequate health policy but not have the subsidy be larger if 
you purchase a policy that is even more comprehensive and more 
expensive.
    That said, you need to pay attention to problems of adverse 
selection. One approach that has been put forward to control 
costs is health savings accounts and high deductibles. And it 
is certainly true that if you are paying your own money for 
medical care, rather than having the insurer reimburse it, you 
are going to pay more attention to the cost. But the problem is 
that, if people have a choice between high-deductible plans and 
other plans, the people who are going to like the high-
deductable plans are the ones who are healthy. It is a good bet 
for them. And maybe it is okay for everybody to be in high-
deductible plans, except, if you do that, you have to 
acknowledge the fact that a $2,200 deductible might be no 
problem for people in this room but it will be an insuperable 
barrier to somebody with relatively modest income. Again, you 
could end up having the most vulnerable people thrown out of 
the system because of this sort of selection process.
    Ms. Turner. In an attempt to be efficient with out time, I 
may have not made it clear that the $12,000 cost of a family 
policy is in the job-based market. And actually, when you look 
at the individual market, it is less than half that for a 
family policy. And one of the reasons is--one of the reasons--
is because people who are purchasing their own health insurance 
are more likely to choose to have a higher-deductible policy in 
order to be able to really have the policy cover them for major 
expenses.
    Then we get into a pricing issue. What about lower-income 
people who can't afford the higher deductible? Well, that is a 
pricing issue. That is a subsidy issue. And if we were to have 
a system in which the subsidies were risk-adjusted, if we 
provide additional subsidies, as Leonard said, for people at 
the lower end of the income scale to help them purchase that 
coverage, they can buy that lower-deductible policy because 
they have more resources to do that.
    So it is really a pricing issue that I think could be 
solved in order to be able to make this market work well even 
for people at the lower end of the income scale.
    And to your question about incentives, that is really it. 
Right now, insurance companies are selling to big employers, 
small employers. They talk about people as covered lives. They 
don't even talk about them as individuals, instead of as 
customers, instead of as consumers.
    And if we had a market in which consumers had more control 
over those resources, then I believe the market would have a 
much greater incentive than it does now to make those policies 
something that people want to buy; to make them be long-term 
contracts, long-term stable pricing of those contracts, to make 
sure that people know they have guaranteed coverage.
    And part of the problem is the market we have now, of the 
47 million, 45 percent or so are just moving through the 
employment-based market. They are likely to have health 
insurance again in 4 to 5 months. They are just--they have 
fallen off the cliff and getting coverage again. So we need to 
break this down and figure out who really needs subsidies, in 
addition to a tax credit, a refundable tax credit, or a tax 
deduction, however those subsidies are organized, in order to 
be able to help them get into the system.
    And you are absolutely right that the rising costs of 
health coverage are not only unsustainable for the Federal 
budget, but they are really unsustainable for businesses. We 
hear so much talk--look at General Motors, deciding that it is 
going to officially cash out the value of its health benefits 
to employees to their labor union so that they can begin to get 
some stability with those costs. And I think that is really an 
important issue.
    How do we give both individuals an incentive to shop for 
better value than they do in this current invisible market for 
health insurance, give employers an opportunity to know what 
their costs are going to be? And Mr. Cooper, I know, has 
proposed legislation that says employers need to tell employees 
what the value of your health insurance policy is, and then 
provide incentives for the market to do a better job than it is 
now of providing something that people actually want to buy.
    Mr. Ryan. I have so many other questions. But I want to----
    Chairman Spratt. We will come back around.
    Mr. Ryan. Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Cooper?
    Mr. Cooper. Thank you, Mr. Chairman.
    After decades of stalemate in health reform, I hope that at 
least on this issue we can have a truce or perhaps, with lower 
expectations, at least a temporary cease-fire.
    I appreciate Ms. Turner mentioning my bill--I was going to 
bring that up anyway, as you might expect--H.R. 847, which is a 
remarkably simple and hopefully bipartisan approach that would 
just require that, on the employer's W-2 form, they also list 
what the employer is sponsoring, in terms of the health 
benefit.
    Because this key piece of information is completely missing 
from anyone's paperwork. Now, nothing prevents an employer 
today from telling the employee what they are paying. But some 
folks don't believe their employer, especially with these 
astronomical health-care costs.
    Mr. Ryan. Will you yield just for a second?
    Mr. Cooper. I would be delighted to yield.
    Mr. Ryan. Would you put me on as a cosponsor? And now you 
can call it bipartisan.
    Mr. Cooper. Thank you. Good man. I am proud to have you, 
Paul.
    I think it is a particularly key issue, because this puts 
information at the fingertips of the worker right when they are 
doing their taxes, and they can see how much they paid in for 
Social Security and Medicare and 401(k) and things like that. 
It is my understanding that this change actually could be done 
administratively today, but the White House needs some 
encouragement in that direction. They liked the proposal, but 
they haven't been willing to go ahead and do it.
    But at least we, as members, could put this key piece of 
information in the marketplace. Because the most important 
point to me is this: The money that goes to pay for the health 
benefit is not the boss's money. It is really the worker's 
money. Most economists agree on this. It is foregone wage 
increases. And that is the tragedy, that the employee today is 
prevented, by a cumbersome bureaucratic system, by even seeing 
what he or she is being forced to pay for health coverage. That 
is a truly amazing situation, and we can cure that with this 
one simple, one-page bill.
    There are deeper questions I wanted to get into. I worry 
that we have underestimated the coming-together that has 
already occurred, the lessening of hostilities. It is amazing, 
the first President to mention fundamental tax change, that I 
have ever remembered, and what President Bush did in the State 
of the Union, that was a brave move, although probably a lot of 
people missed it.
    Second, to have Andy Stern of the SEIU join together with 
AT&T, Intel, Wal-Mart and others to recommend a shift away from 
the employer-based system is amazing. Ron Wyden's bill in the 
Senate is an amazing thing. Brian Baird, I know, is going to 
talk about that in a few minutes. That is a remarkable and 
fundamental reform that most of our presidential candidates 
can't talk about.
    The CED, the thinktank, just came out with a bold new 
report recently that is amazing and actually steps away from 
their prior thinking on this issue, by recommending that we 
move away from the employer-based system.
    So there are great signs of hope right now, even in the 
partisan atmosphere in Washington.
    I think the best way to preserve peace on this issue is to 
avoid misconceptions. And the way I see it is no one in either 
party wants to push people into the so-called individual market 
today, because that is full of so many problems. It has got to 
be reformed. So that is kind of a strawman that is sometimes 
put up. It is not all bad, but it has some real problems.
    Likewise, on the other side, another strawman is that a tax 
credit is just a delightful answer to these problems. As Len 
points out in his testimony on page 13, one type of tax credit 
would cost $6.50 for every dollar of new insurance purchased. I 
have seen some other studies from Len and Jon Gruber that 
indicate some of these credits are so inefficient you might be 
spending $15 or $18 for every dollar of new coverage. Surely, 
no one is for that.
    So hopefully we can get away from these straw figures and 
focus on the real thing, because I don't think any Democrat 
alive today would vote in favor of a tax subsidy system that is 
so horribly expensive and that favors employees of large 
companies who are the highest-paid. Now, we love high-paid 
people, but, you know, those are the folks that need the 
subsidy the least. And yet, as your graph pointed out, Len, 
they are getting most of the money. It is a crazy, upside-down 
system that our forebears may have ratified in 1954, the year I 
was born, but it should not be allowed to continue.
    So this is a very encouraging hearing. I appreciate the 
Chair holding it. These are fundamental but invisible issues, 
and they have got to be dealt with, because you can't have a 
$200 billion market distortion and have the system work.
    I am sorry for the statement more than a question.
    Ms. Turner. Mr. Cooper, you have really been a leader on 
this issue for as long as I have been following it. At least 15 
years, you have been trying to get attention. And thank you for 
coming back to Congress to continue this battle.
    I do think that the climate is much more fertile now to 
consider this issue, because we do see bipartisan support to 
say the current system is not working; we have got to do 
something different. And you have really provided wonderful 
leadership on this. Thank you.
    Chairman Spratt. Mr. Conaway?
    Mr. Conaway. Thank you, Mr. Chairman.
    And thank you all for being here.
    You need to start the clock. Being a CPA, I am a slave to 
the rules. Thank you, sir.
    Insurance is not a panacea; it is a risk-management tool. 
And when I hear both of you make comments about restricting 
growth in premiums because somebody got sicker, those costs 
still have to be paid for. I mean, insurance is not the--you 
know, whatever it is going to cost, the premiums, whether paid 
by the Federal Government or the employer or the individual, 
still have to cover the cost of the care, overhead and some 
profit, unless it is the Government, to the insurer. And to the 
extent you both make comments about not allowing that mechanism 
to happen, I question how that mechanically can work.
    The Chairman talked about revolutionary change. There is 
not enough pain in the system to support that right now. My 
little brother needs a knee replacement, and he has for 20 
years. And the trigger on that was when he got in so much pain 
that he was willing to do it, and he will have the surgery on 
November the 5th.
    Well, the analogy is there is not enough pain--there is 
plenty of pain in the payment system now, as you testified to, 
we all pontificate about. But, quite frankly, there is not 
enough pain in the system for us to be willing to give up all 
the things that we think work and go to a blank sheet of paper 
and start over.
    We all cling to things that are currently working in pieces 
and try to figure out the Band-Aids and the props and the other 
kinds of things that will continue to cobble along this current 
system that we knew. And whether it is the baby boomers not 
being able to find doctors to take them under Medicare or 
whether it is employers significantly dropping the number of 
people off of employer-sponsored plans, whatever those triggers 
or tipping points are going to be, we are headed for a spot 
where, one of the these days, the will of the people will say, 
``Mr. President, Congress, Senate, fix this problem.'' But I 
don't think we are there, at this point.
    Ms. Turner, you mentioned new groups that you want to see 
formed up. What are the barriers, Ms. Turner, that you see are 
in place to prevent that from happening right now?
    Ms. Turner. Well, the portability of the tax treatment of 
health insurance, really. Because, right now, you can only get 
this generous tax benefit worth--what was it--collectively $189 
billion if your employer writes the check for your insurance.
    So, in order to be able to have health insurance be 
portable and for people to have other group options than just 
the employer group, that insurance tax deduction or tax break, 
tax exclusion, tax credit, would need to be portable and follow 
the person as an individual rather than as an employee.
    Mr. Conaway. All right.
    Speaking of individuals and personal responsibility, we 
passed, maybe last term or this term, a law that allows 
employers to automatically sign up people in 401(k) plans, 
because participation levels are greater if you are 
automatically in and have to opt out.
    So, speak to us about the personal-responsibility elements 
of both of your proposals, in that people choose to make bad 
decisions. Particularly low-income people, if we were to say, 
``All right, you are going to get the extra 12,000 a year that 
the employer is paying for your health insurance,'' I am 
reticent to think that all of those people will automatically 
turn around and buy health insurance to cover their families, 
because they are living paycheck to paycheck as it is.
    So how do we avoid the paternal issue that you spoke of 
earlier, which I agree with? Do we have the coldness of heart 
to tell folks, ``Well, you know, we have now gone to a system 
where you are personally responsible for your health insurance; 
you chose not to get health insurance because you weren't sick 
at the time; you are now sick; you are going to have to die''? 
That doesn't seem to be an America that most of us would want 
to live in.
    Ms. Turner. No. And I think there are a lot of ways that 
you could address this in a new world.
    First of all, employers could easily make it contingent, 
that we are not going to cash out the value of your--the 
amount----
    Mr. Conaway. Well, that is a different--my colleague Mr. 
Cooper has left. If we just keeping adding additional mandates 
to employers, somebody has to comply with it.
    Ms. Turner. Well----
    Mr. Conaway. Somebody has to figure out how much the cost 
of--they both left--of putting that number on your W-2. You 
continue to make it more difficult for employers to do what 
they are doing by splitting it up.
    Ms. Turner. Well, but if individuals can't get the tax 
break, if they don't buy the insurance, then they are going to 
be--in fact, you could even make a credit assignable, so that 
that person is eligible for that credit. And if they don't buy 
health insurance, then they get bought in, you know, they 
become part of a pool of insurers. Then they rotate through 
that pool of insurers who agreed to participate in the pool.
    Mr. Conaway. Well, how does that insurer force the premium 
up? When you tell me that the sickest folks are going to be 
doing this, how do you make sure that you have insurers making 
a profit on that program?
    Ms. Turner. You know, I really think that people--people 
really want health insurance. Even young people want health 
insurance. They just don't want to pay $12,000 a year for it. 
So what you need is the incentive for the market to begin to 
provide more incentives to provide coverage that is affordable 
that people want to buy, and, if they are in those lower income 
categories, to be able to provide them with resources to help 
them purchase that coverage. And employers can be great 
facilitators for access to coverage, maybe not necessarily 
totally responsible like they are today.
    But I think that it is really a reformed market in which 
people have many more choices, new incentives to purchase 
coverage. That coverage is more affordable because consumers 
are really demanding better value in their health insurance, 
and they see the whole price of that coverage. That really is 
going to move us in a different direction than we currently 
are, toward more and more health insurance coverage that is 
more and more expensive, more and more invisible, more and more 
subsidies for people at the higher end of the income scale, and 
Government programs becoming ever more of a safety net for 
those people for whom that system is not working.
    Mr. Conaway. It is going to get ever more expensive. I 
mean, so far nothing that you have talked about has pulled the 
expense piece out of that mechanism.
    Ms. Turner. Well, when you look at the fact that a job-
based health insurance policy, which has gotten usually a lot 
richer and much lower deductibles, costs $12,000, but the 
policy that people are buying on their own in aggregate costs 
$4,000 to $5,000 on average----
    Mr. Conaway. They still have to cover the cost of care.
    Ms. Turner. But the insurance companies are selling those 
policies. They must be making----
    Mr. Conaway. Thank you, Mr. Chairman.
    Chairman Spratt. Mr. Doggett?
    Mr. Doggett. Thank you, Mr. Chairman.
    And I thank our witnesses.
    Ms. Turner, you used the term, in describing the way we 
deal with the employer-provided tax system now, that it is a 
tax expenditure. And I certainly agree with you. I think it is 
an expenditure just as real as if we wrote an appropriations 
bill and paid that money out.
    And your comment causes me to reflect on a recent hearing 
that this committee had with Peter Orszag and others on the 
importance of performance evaluation applying to tax 
expenditures also. I raised that issue with Mr. Ryan when we 
met with Secretary Paulson the other day.
    Given the fact that the current Treasury Department favors 
your perspective, to a significant degree anyway, I hope you 
will join us in encouraging the Treasury Department to begin a 
process of evaluating each of these tax expenditures. They 
could do it without our passing any legislation. We need that 
kind of evaluation just as we need careful performance 
evaluations of all of our appropriations, our direct 
appropriations.
    That is an area we agree on. I think I disagree with your 
conclusions.
    First, you mentioned in your testimony, Dr. Burman, about 
the difficulty of targeting tax credits to the uninsured. And 
it does seem to me that all of our tax credits, all of our tax 
expenditures, are rather blunt instruments to accomplish their 
purpose.
    To some extent, I think what we need is a cost-benefit 
analysis on these tax credits. If we are really concerned--and 
you have talked about the challenges that we have in providing 
health care to seniors through the current system. And we are 
talking about, on something like children's health insurance 
today, what is the most cost-effective way to reach the largest 
number of uninsured children today or uninsured adults on some 
other day?
    I just have great difficulty in seeing that the tax credits 
would be the most cost-effective way to cover children and that 
a direct Government program relying on private insurance, in 
many cases, for children's health insurance is a more cost-
efficient way for the taxpayer, for the Treasury to reach more 
of our children.
    Would you react to that, Dr. Burman?
    Dr. Burman. Based on the evidence that I have seen, that 
certainly seems to be right.
    And I completely agree with you that we should do tax 
expenditure analysis. One of the ironic things in the U.S. is 
that we actually invented the notion of tax expenditures. It 
was Stanley Surrey, who was a Treasury Assistant Secretary in 
the 1960s, who invented the whole notion. This has been 
embraced by countries all over the world.
    I went to Mauritius to talk to them about--this little 
island country in the Indian Ocean--to talk to them about 
evaluating their tax expenditures and comparing them to direct 
spending programs. Everywhere else they do that, and the tax 
subsidies and the direct spending programs are all on the 
table. In the United States, we pretend that there is this big 
difference.
    David Bradford, who is a Princeton professor, once said 
that he could run the military with tax credits, and it 
wouldn't look like a spending program anymore. It would be a 
dumb thing to do, but it would be a tax cut instead of new 
spending, so it would look like it was an improvement.
    The fact is you would have to raise taxes to pay for, not 
only the tax credits, but all the inefficiency that they 
created as well. So I completely agree.
    Mr. Doggett. You feel that using tax credits would not be a 
very effective, a very cost-efficient way of insuring more 
uninsured children?
    Dr. Burman. I can't think of a tax credit program that 
would be anywhere near as cheap as expanding SCHIP. I mean, you 
could reform the whole system, and you could certainly do 
better than we are with current subsidies, as Ms. Turner said, 
but for an incremental expansion, the President has said that 
he thinks tax incentives are the answer, but the tax subsidies 
that he proposed in his budget would only cover a tiny fraction 
of the cost of health insurance for these low-income children, 
according to an analysis my colleague Linda Blumberg did.
    Mr. Doggett. I think her presentation, which is in our 
written materials--and are you making that a part of our 
record, I suppose, Mr. Chairman, or should I ask unanimous 
consent to do that, the Blumberg study?
    Chairman Spratt. Sure.
    Mr. Doggett. I would ask unanimous consent----
    Chairman Spratt. You want to enter it in the record?
    Mr. Doggett. Yes. I think it is a valuable study, and it 
prompted my question.
    And then I would just close by saying, not on the tax 
credit issue, but on the question of the advantages of personal 
choice, which we are all for, when you apply that into the 
practicalities, as you said in one of your observations 
earlier, of having everyone dealing with insurance sales people 
on this issue, we have something of a demonstration project 
under way right now. It is called Medicare Advantage.
    And I just came from a hearing in our Health Subcommittee 
this week about the tremendous number of marketing abuses to 
our seniors under this attempt to privatize Medicare and let it 
wither on the vine, as our former Speaker said.
    And there are plenty of practical problems in turning over 
seniors, particularly poor seniors, to these private insurance 
companies. It has been very costly to the taxpayer. And, if 
anything, it is the demonstration project and the example that 
simply privatizing this entire area may not be the best way to 
go.
    Chairman Spratt. Do you have a copy of the Blumberg 
article?
    Mr. Doggett. I do. I believe it is here in our packet that 
each member has, but I will formally tender it to the committee 
for the record.
    Chairman Spratt. Without objection, it will be made part of 
the record.
    [The information follows:]

    
    
    
    Mr. Doggett. Thank you both.
    Chairman Spratt. Mr. Lungren?
    Mr. Lungren. Thank you very much, Mr. Chairman.
    I appreciate the witnesses here.
    I understand the seriousness with which you talk about, 
quote/unquote, ``tax expenditures.'' I just have a problem with 
the ease with which we talk about tax expenditures, because, 
philosophically, it presumes that all money someone earns, 
first claim on it is the Government, and if the Government 
decides to not take it from you, it is an expenditure by the 
Government. It seems to me that reverses the relationship of 
who is to serve whom.
    Now, I understand how you have to analyze this in terms of 
budgets and so forth. But I just would like to render at least 
my objection to the ease with which we use tax expenditures, 
which seems to presume that the Government has first call on 
the money, and if we in Government are nice enough to let you 
keep it, then we have expended something.
    I am also reminded in this debate of a townhall I had 
recently when someone in the back got up and said, 
``Congressman, we demand, or we deserve, or we should have the 
same health care that you have.'' And I said, ``Fine;'' I said, 
``I pay insurance, like everybody else does.'' ``Well, I am not 
saying that I ought to pay it,'' she said. And it reminded me 
of Frederic Bastiat's comment where he said, ``The state is the 
great fictitious entity by which everyone seeks to live at the 
expense of everyone else.''
    And what I am trying to figure out in this whole process 
is, how do we move toward health-care access to the American 
people in a way which makes transparent the costs involved, so 
that we can make some logical decisions with respect to this--
for any number of reasons, the first of which, the way the 
system works now, particularly Medicare and Medicaid, it is 
going to bankrupt us; we just can't keep going that way. But 
secondly, does that enhance or does that inhibit the ability 
for us to bring down the rate of increase of cost in medical 
care?
    And the reason I ask that is this: Recently, I went through 
a procedure dealing with veins in my legs. Now, 25 years ago, 
you would have done that by stripping it. They would have cut 
one end of your leg and cut the other end of the leg, put an 
instrument in there and actually pulled it out. It would have 
required hospitalization for any number of days. Now they have 
a system where they put a catheter in with a wire inside that 
has radio frequency, and they literally, through high-intensity 
heat, burn the inside of your vein, and it collapses in on 
itself. And the procedure takes 20 minutes. The actual use of 
radio frequency is about 7 minutes. No hospitalization. If it 
all goes well, you go home. You are able to work the next day.
    It is not the most comfortable thing, but the difference 
between that procedure 25 years ago and today, in terms of the 
cost of hospitalization, in terms of lost work, in terms of 
your ability to continue with other activities, is tremendous. 
Now, the procedure isn't cheap, but in terms of probably 
inflation-adjusted cost, it is cheaper than the procedure 25 
years ago.
    There is evidence of where the overall cost to the 
individual or society or whoever pays for it is less; the 
interruption or opportunity cost lost is less.
    Similarly, we now control things by use of medication, 
where, before, it probably would lead toward surgical 
intervention or, in some cases, even incapacitation from work.
    So, on the one hand, I see tremendous improvements in 
medical care that actually are expressed in economically 
beneficial ways. And, on the other hand, I see the continuing 
costs going up of the overall system that seems to outstrip 
this benefit.
    To what extent, if any, does the way that we operate our 
health-care system, with insurance primarily sponsored or 
subsidized by employers, cause the advantages that we see in 
medical advancements to be overcome by the way we operate?
    I know that is kind of a general question, but I am really 
confused by that as I continue to look at the evidence of 
improvement here.
    Is it because we have such inefficiencies in other parts of 
it that are unrelated to true care that we have it? Or is it 
just that the advances I talk about cost so much to get there 
that, even though maybe in an individual procedure it is more 
efficient, the overall system that had to create it overwhelms 
the costs of the system?
    Ms. Turner. I do think that that really shows that--why 
does the health sector not work like the rest of the economy, 
where we can figure out ways to get faster, better, cheaper by 
having these innovations be more widely adopted?
    And in the health sector, I do think that a huge part of it 
is the invisibility of the cost, the third-party payment 
system. When you ask a doctor or a hospital how much does an 
MRI cost or how much is this procedure going to cost, they 
don't know. So how can you have a true market when buyers and 
sellers don't have the vaguest idea whether or not it is more 
efficient to do these kind of services?
    But I do think that the private marketplace is absolutely 
going to encourage much more of that kind of innovation than a 
Government-run system in which the Government is expanding 
current programs under payment schedules and systems of A, B, C 
and D are covered. You need to make sure that you have got that 
vitality and that energy to continue to come up with 
innovations. And we see so much more of that in this country 
than you do in other countries that have Government-dominated 
health-care systems.
    So there are a million different things, including 
utilization of these new technologies, that are driving up 
costs. As people are able to get more and better medical 
procedures to address their health-care issues, then they want 
more of them, including new medicines.
    So, are we healthier as a result of increased use of 
technology? Not always. We have seen that in Florida, for 
example, with the Medicare program, that Florida residents in a 
couple of counties spend twice as much as someone living in 
Minnesota on medical care, and yet they are oftentimes less 
healthy.
    So if consumers are given an incentive to--and especially 
seniors in Florida, who seem to think of going to the doctor as 
more of a recreational activity, in many cases, you know, 
``Should we go to lunch today before or after your doctor's 
appointment?''--is that really the right kind of incentive? Or 
do people need to have more price visibility so that they can 
utilize those services more wisely?
    And I also think that if we have a system in which the 
Government is paying less and less and less, as it is now, for 
both doctors and hospitals and procedures, then it pushes up 
the prices of private insurance. So we have got to get to a 
system in which private insurance is not going up simply 
because doctors and hospitals have to recoup their costs 
someplace. And they are not even making ends meet oftentimes if 
they see Medicaid patients.
    We need to find a system in which the payments are more 
visible and there is more rationality in those pricing systems, 
and let this sector of our economy have more of the market 
forces that really direct and organize the rest of the economy. 
I think that is primarily what is absent in the third-party 
payment system, both on the public and the private side.
    Dr. Burman. May I make just a quick comment?
    There actually is some evidence specifically on the 
question that you asked about whether the medical innovation 
is, on balance, a good thing or a bad thing. There is a study 
by Harvard economist Joe Newhouse that looked at the 
relationship between insurance and medical innovation, the 
thing you benefited from. And he said that, on balance, he 
thought that it was a good thing, that the fact that people had 
insurance meant that there were a lot of cost-effective medical 
innovations that were created. Obviously, not all of them are.
    And the concern he raised, actually, was that if there was 
an overzealous effort to restrain moral hazard, try to really 
push down pressure on prices, that, in fact, a lot of cost-
effective innovations wouldn't be done because it would be 
harder for companies to invest in new technologies.
    Chairman Spratt. Mr. Baird?
    Mr. Baird. Thank you, Mr. Chairman.
    And I want to thank our witnesses.
    As I listen to many of the issues you raise and the 
concerns, I have to reflect that it seems to me that there is a 
bill proposed that solves most of them. And the Wyden-Bennett 
bill in the Senate, Baird-Emerson in the House, does it.
    And I will just list a few of them. When you speak about 
adverse selection, our bill specifically says insurance 
companies have to take in all takers, so the competition is 
based on quality of care and price control, not on cherry-
picking or adverse selection.
    Now, the issue Ms. Turner raised, and I think it is 
absolutely valid, about health care information, under my bill 
in the House, we would require that patients be given--we move 
toward a system where patients be given a priori information 
about costs, options and what percent they will share. So that 
if you want to have back surgery versus core-strengthening 
exercises, yet the empirical data suggests they are similar in 
outcome, then you pay for the back surgery, the bulk of that, 
over what it would cost you for core-strengthening exercises.
    So many of the things you address--and my friend Mr. 
Conaway said we are afraid in the Congress to start from 
scratch. Not Ron Wyden and me. We have started from scratch. We 
have not said, let's cobble together, you know, SCHIP and 
Medicaid, et cetera.
    We have said, clear it out, it is a simple bill; the model 
is that you have to buy your own health-care insurance because 
God didn't say your employer is responsible for your health; 
you are responsible for your health. The employers don't get 
the deductions; you don't have that price distortion. And you 
get large-group purchasing, so that the individual person is in 
the same boat as the person in the largest corporation. And if 
you change jobs, you are not locked into your job, because you 
have your own health policy. And there is an incentive for you 
to save your health costs because, over time, you can reap the 
benefits of that by choosing a policy that, by the way, under 
our bills, have incentives to save costs.
    So I am very happy to hear your testimony. I wish I could 
get more members of Congress to hear it and look seriously at 
our bill. I don't think we have to wait until the next 
messianic President on either side to solve the problem. We are 
Article I, we are the Legislative Branch, it is our 
responsibility.
    And, by the way, as I have looked at the plans on both 
sides, both the Republican presidential candidates and many of 
the Democratic presidential candidates, I don't see a one that 
I think is superior to the bill that we have put forward in the 
legislative branch. And so I hope some of my colleagues on both 
sides of the aisle--we have bipartisan sponsorship now, but I 
hope others will do it.
    One difference between Wyden's bill and my bill is we are 
calling for credits and Ron would go for a deduction. And I am 
just interested in your thoughts. I don't necessarily have a 
big dog in the fight one way or the other. I just want to know 
what your thoughts are about what would work best in that 
regard.
    And at the risk of even looking toward a third rail, I 
wonder if you might want to speculate on the feasibility of 
extending a system like this throughout the lifespan of a 
person. So, in other words, when they hit 65, they don't 
necessarily drop off my policy; I could carry my policy.
    And if there is a third part to the question, what are your 
thoughts about if there were a--one of the options that we 
could pick--you know, Mr. Lungren's constituent said, ``I want 
your plan.'' That is what prompted Ron to develop his, and I 
agree with it, except you are right: We have to pay for it. And 
it would be foolhardy not to pay it, because you don't value 
and conserve what you don't pay for.
    But what if one of the choices in the FEHB-type plan that 
Ron's bill and mine would offer were a Government-run plan? If 
you want to put your money on the back of the Government, you 
can do that. The Government would still bill you for it; it is 
not free. But you could purchase a Government-provided system.
    So those are three questions I would love your thoughts on.
    Ms. Turner. On the question on credits versus deductions, 
it is such a difficult question, because I think that 
deductions are much more like the tax exclusions that 160 
million people have benefited from through the employment-based 
system--invisibly, but it is much more like a deduction. So, 
you know, that could make an argument for the deduction for 
people who currently have coverage.
    But credits are much more valuable to people at the lower 
end of the income scale. So that a deduction, you know, for all 
of the reasons that we have discussed, is just not going to 
help people at the lower end of the income scale, unless you 
supplement it somehow. And it could be through refundable 
credits, but it could be through other kinds of payments. But, 
essentially, people just need more help if they are going to 
actually purchase----
    Mr. Baird. Yes, I should say, in our House bill, it is not 
a full credit for everything you pay. It is a limited amount, 
so that lower-income people would benefit proportionately more 
because they will hit that limit, presumably, sooner. And, 
also, those who buy more conservative policies would, as well.
    Dr. Burman. The current system is just extremely poorly 
targeted, and deductions just can't help low-income people. 
Thirty percent of people are in the zero tax bracket. They 
don't benefit if their taxable income is reduced. And, you 
know, they are the ones who most need help paying for health 
insurance.
    I actually think credit versus deduction is the easiest 
question.
    Ms. Turner. And regarding the carry-forward to Medicare, we 
were talking earlier about the State Children's Health 
Insurance Program. There is no reason that the SCHIP benefit 
couldn't be basically cashed out to allow people that may be 
eligible for health benefits through Wal-Mart but just can't 
afford to make their part of the premium coverage for their 
dependents couldn't use the value of that to be able to have 
family coverage through Wal-Mart.
    And I think that is sort of the same thing with the 
Medicare benefit. Why couldn't people have the value, the 
actuarial value, in a risk-adjusted, age-adjusted I am sure, 
mechanism, to let people have the opportunity to continue 
whatever coverage they have selected that provides stability, 
longevity?
    I think the whole question of stability is so important 
because, both on the individual side and on the--the insurer 
and on the physician side, that continuity is going to get us 
to a system where we have better incentives for chronic care 
management. Rather than just saying, ``How long do I have to 
cover this person before they get sick?'', you are thinking, 
``How can I keep this person healthy as long as possible?''
    And we need to realign all the incentives to make that 
happen. And longevity in the ownership of health insurance and 
the relationship with the company that provides your care, and 
therefore the financing that supports it, I think are all 
really critical elements.
    Dr. Burman. One thing I think is important about your plans 
is the idea of mandates and pooling at the insurer level.
    One thing that Ms. Turner said a few times that I actually 
will take issue with is that nongroup insurance is inexpensive. 
And it is true, the premiums for nongroup insurance in the 
current market are a lot lower than what they are for typical 
employer-based coverage. But there are two things. One is that 
there are huge load factors. Thirty five percent of the 
premium, by some estimates, is marketing costs and 
underwriting. And most of those costs are not incurred through 
large employer groups, and they wouldn't be incurred through a 
system where insurers had to take all comers and there was 
pooling on a large scale.
    The other thing is the adverse selection; the people who 
buy insurance in the nongroup market are healthier than 
average. The sick people can't get in, whereas they are in, at 
least the larger groups.
    The third thing is the kind of insurance sold in the 
nongroup market tends to have very, very high deductibles and 
copayments. Again, it works okay for people who are healthy, 
but, basically, the way the nongroup market works is----
    Mr. Baird. Mr. Burman, let me just interrupt for a second. 
I just would point out--I know that we have other questions, 
and I think we have a vote coming up--our bill obviates all of 
that.
    Dr. Burman. Yes.
    Ms. Turner. Right.
    Dr. Burman. I am agreeing.
    Mr. Baird. Yes. I think that is part of what the merit is. 
I think part of what is so impressive.
    Any thoughts, finally, about this issue of does it make 
sense to offer a Government-run program as one of the choices 
in addition to the private insurance market? Because in Ron's 
bill and mine, you can buy your policy from the private 
insurance market, but if the Government wanted to offer one and 
you believed in the Government, does that make sense?
    Ms. Turner. I believe in choice, so, absolutely.
    Dr. Burman. It seems like you could do a cost-benefit 
analysis to see what the cost of running that is versus 
contracting with private insurers.
    Chairman Spratt. Thank you, Mr. Baird.
    Gwen Moore, Mrs. Moore from Wisconsin.
    Mrs. Moore of Wisconsin. Well, thank you very much, Mr. 
Chair.
    And thank the witnesses for appearing.
    I regret that I wasn't here for the beginning of the 
meeting, because I feel like I have missed so much. And so, I 
ask the members and the Chair and ranking member's indulgence 
if I cover ground that has already been covered or I repeat 
myself.
    I guess I would like to go to the bottom of page 11, Dr. 
Burman, of your testimony, where you indicate that replacing 
the ESI exclusion with a regressive refundable tax credit would 
be an improvement over the current tax law. And then you go on 
to page 12 to say that it would encourage low-income employees 
to take up employers' offer of insurance. I am a little bit 
confused about this, for a variety of reasons.
    Number one, you know, I think about the time that I did my 
daughter's Earned Income Tax Credit when I did her taxes for 5 
years in a row. She kept begging me for money, and I finally 
did her--she had no tax liability, and she was stunned to see 
how much money she got back.
    I am concerned about access of poor people, if they, in 
fact, get a refundable tax credit. They would have to make the 
initial expenditures for health care, which might mitigate 
against them dealing with preventive health care.
    You also seemed to indicate, you also seemed to assume, in 
that one statement, that employers would still have an 
incentive to offer health care without the exclusion. And I 
guess I am not quite understanding how this would work.
    Dr. Burman. Well, there are two issues.
    One is there is certainly an issue of timing of tax 
credits. If we, the middle class, upper-income people, get tax 
breaks at the end of the year, we can front the money and then 
we get it back on our tax returns. There is a big problem with 
timing, that if you have to pay $12,000 for your health 
insurance and you get even a big credit 16 months later, that 
will be too late.
    Mrs. Moore of Wisconsin. Exactly.
    Dr. Burman. There have been proposals. Both President 
Bushes, actually, have proposed transferable credits that could 
go directly to insurers. I think the first President Bush had a 
proposal that would have gone to employers in advance. And 
there are a lot of administrative challenges, but you could at 
least conceivably design a credit that could be advanced, and 
you would get the money when you needed it.
    The problem with the current system is it really provides 
almost no help to low-income households. It doesn't help you to 
reduce your taxable income if you don't owe taxes anyway. You 
might even be worse off. If you are on the Earned Income Tax 
Credit and you are in the phase-in range for the ITC, reducing 
your income could actually raise your taxes, because you--I am 
sorry, yeah, reducing your income would raise your taxes, 
because you would lose some of the Earned Income Tax Credit.
    But I think those problems, at least conceivably, can be 
dealt with. And the fact is, a credit is a lot more progressive 
than a deduction or exclusion.
    The second issue you asked is, why would employers still 
provide health insurance if it wasn't excluded from the income 
of their employees? I am not talking about eliminating----
    Mrs. Moore of Wisconsin. I am talking about the income--not 
excluded from their employees. The income tax liability, their 
deduction.
    Dr. Burman. I should have made clear that the health 
insurance premiums paid by employers would always be deductible 
for employers. It is just the legitimate cost of doing 
business, just like wages are. The proposal is that it would be 
included in the income of the employees, but they would get a 
tax credit instead.
    So right now, if your employer provides you with $10,000 
worth of health insurance, your income for tax purposes is 
reduced by $10,000. The employer gets to deduct it, as it would 
wages. But the difference is that, unlike cash compensation, 
you don't have to pay tax on it as an individual.
    The alternative I am suggesting is that you would add that 
$10,000 back into your income, or the employer would report 
that on your W-2 form as taxable income, but you would get a 
tax credit. And maybe the credit would be 40 or 50 percent for 
a low-income person, or even more. And that would be a much 
more valuable tax subsidy than the exclusion. You could target 
it to the people who most need help. And that is the basic idea 
behind it.
    Is that clear?
    Mrs. Moore of Wisconsin. Well, it is clear, to some extent. 
But 70 percent of working people are covered by the current 
system, and I don't think necessarily that people's health 
insurance ought to be necessarily tied to work, because, at 
some point, we all don't work. We are fired, we are retired, we 
are too sick, we are too young, we are too old. And so, it is a 
system where, at some point, you won't have health coverage, 
maybe at a point at which you really need it.
    I guess the confusion for me comes in with, you know, with 
I guess both of you not necessarily proposing some system that 
is not tied to folks' employment.
    Dr. Burman. The concern is--I mean, you are right that the 
employer-based system is not the ideal, and people can lose 
insurance just because they lose their jobs. Although there are 
some provisions that allow them to continue coverage, if they 
can afford it.
    The concern is that you might throw a bunch of people in 
the individual, nongroup market; some would pick up insurance, 
but others wouldn't be able to find it in the system as it is 
currently formulated.
    I think Ms. Turner and I agree that there need to be 
reforms in the nongroup market. If we have reforms that 
guarantee that low-income people can afford insurance, that 
people who are ill can find insurance that is affordable in a 
nongroup market, you could conceivably significantly expand 
coverage.
    But all of the tax credit proposals that I have seen don't 
seriously address the fundamental problems. The President had a 
proposal for the standard deduction for health insurance, which 
had some very good ideas in it. And he said that there were 
problems in the nongroup market, but there were no details on 
how those problems would be solved and no money to help States 
solve it.
    So I think those problems need to be taken very, very 
seriously. Otherwise, you could end up further unraveling the 
employer-based system, which, admittedly, already has problems, 
and not having a good alternative in the nongroup market, and a 
lot of people would end up losing coverage.
    Ms. Turner. One of the options would be--I absolutely agree 
that tying health insurance to the workplace--we just need to 
give other people other options. It is not just working for an 
increasing number of people.
    One option would be to boost the value of the Earned Income 
Tax Credit, so that if people used the extra amount to buy 
health insurance, then they get an enhanced Earned Income Tax 
Credit. And some of the President's proposals would have made 
the tax credit not only refundable but advanceable, so you 
could get it in advance; assignable, so it could be assigned to 
an insurance company right then, so you don't have to wait 16 
months; and nonreconcilable, which means that if your income 
changes during that year and you were advanced money to buy 
that health insurance, then that is just too bad for the 
Government. You have had health insurance coverage.
    So refundable, advanceable, assignable, nonreconcilable all 
make the IRS crazy, but there are solutions, I think, to help 
make that coverage more stable for individuals.
    Mrs. Moore of Wisconsin. Thank you so much.
    Thank you, Mr. Chairman.
    Chairman Spratt. One last question from me, if I could.
    Jose, do you have that map of the United States with the 
variation in cost?
    This map is a little hard to read from your vantage point, 
but you can see the basics of it, and you have seen it before, 
I am sure. The variation in cost varies from region to region, 
as much as $11,352 in certain places like Miami, and as little 
as $4,272 in other places like, probably, in Minneapolis.
    How do you have one certificate, call it what you will, one 
tax credit, equal across the United States that will respond to 
each one of those districts, with that spread, from $4,200 to 
$11,300? How do you deal with that variation?
    Ms. Turner. That is one of the reasons that the President, 
I think, decided on a deduction, because that is based upon how 
much you spend. So people that live in Los Angeles or people 
that live in Houston would get a bigger credit simply because 
they are able to spend more on their health insurance.
    But I think there are also ways to make the credit 
adjustable and to make it be--even the credit be contingent 
upon the percentage that a person spends for their health 
insurance. So that if you talk about a fixed-dollar credit of 
$3,000, it is going to be a very different value to somebody 
living in Idaho than it is to somebody living in south Florida 
or LA. So a percentage-adjusted credit is also a way to begin 
to address that.
    Dr. Burman. Just to clarify, the President's proposal would 
have been a fixed--it was the same amount regardless.
    But, I mean, I think what you raise is an extremely 
difficult issue. For one thing, you have to determine how much 
of that difference is due to legitimate differences in costs 
and how much of it is due to just differences in taste for 
health insurance. And I think----
    Chairman Spratt. I am told it is largely due to how they 
practice medicine.
    Dr. Burman. Yeah. And, actually----
    Chairman Spratt. And in Miami it is a much more diagnostic-
intensive, instrument, procedural thing. And in some other part 
of the country where the cost per patient is lower, it is a 
more judgmental practice of medicine.
    Dr. Burman. But, I mean, that would be an argument for not 
varying the credit by regions and giving people an incentive--
having a credit for purchase of insurance but not a credit that 
is larger if you spend more on insurance, because that would 
give people an incentive--give people in Miami an incentive to 
say, ``I would like you to practice medicine like they do in 
Iowa.''
    But, I mean, that is a lot of theory, too.
    Chairman Spratt. If you accommodate this variation with 
differential values depending on where you live, you lock in 
these costs and the cost differential.
    Dr. Burman. I think there would also be a lot of game-
playing, too. A lot of people live near--like, we have three 
different jurisdictions within 10 miles of each other. Are you 
going to have different rates for Maryland and for D.C. and for 
Virginia, and will people take advantage of that?
    Chairman Spratt. Would you both agree, then, that this is a 
problem that has to be more or less fixed in order for these 
tax certificates, these tax refunds to be issued on a 
nationwide scale?
    Ms. Turner. Well, I--yes, absolutely. I think that it is a 
fundamental issue that is going to have to be addressed.
    But I also think that it is important to recognize that the 
current system is also subsidizing health insurance in an 
equally and equitable way; it is just invisible. That somebody 
who lives in Boston and has much higher health-insurance costs 
through their employer is still getting a much higher value 
from the tax break than somebody who lives in Iowa, where 
health insurance costs a lot less, for example, simply because 
of that differential.
    So you have inequities today; it is just that it is not 
visible. And I do think, though, that it is something that 
would have to be addressed if you are going to be talking about 
a uniform new credit, some sort of subsidy to help people 
purchase health insurance, especially those currently left out 
of the system.
    Dr. Burman. I agree; it is an important issue. But I can't 
figure out how you would fix it.
    This actually comes up in a lot of other contexts, too. I 
have had people say to me that the standard deduction ought to 
be higher in New York City than it is in Des Moines, because 
the cost of living is so much higher. Tax brackets ought to be 
adjusted for differences in cost of living across regions. I 
don't think there is any practical way to do that.
    Chairman Spratt. Well, under the existing system, the 
constant factor is, from place to place, the services provided, 
the coverage extended is basically the same. There is some 
variation. In the HMO programs, you might get eye glasses or 
something, but basically it is the same.
    So, as long as you are measuring only whether or not the 
coverage is the same in Phoenix as it is in Atlanta, it comes 
out basically the same on the bottom line. But when you start 
assigning a dollar value to the refundable tax credit, and 
people from region to region see the differential, I think the 
issue becomes extremely difficult.
    Been around here a long time, you know. These allocation 
formulas from place to place can be a huge food fight. It is a 
very difficult matter to handle. It could be that you would 
force the issue by having stickers like that and eventually 
come up with some resolution of it. But we have forced the 
issue before, and, generally speaking, the solutions are pretty 
jerry-rigged.
    Ms. Turner. And I think it also--the practice pattern 
variation is something that is really an issue in the medical 
profession. Why do you need to have so much more diagnoses just 
because you live in south Florida or in Boston? Is that 
actually adding value?
    And, of course, the same thing is true with the 
differentiation in Medicare spending, in spending for Medicare 
and even in Medicaid. You know, New York spends a lot more per 
capita than other States do.
    So I think that beginning to have a serious conversation 
about this issue is really--because Federal tax dollars and 
State tax dollars are really at stake--is important not only to 
figure out how we are going to address the issue of the 
uninsured but how we make the spending more equitable and more 
reasonable and more responsible, even for those who do have 
coverage.
    Chairman Spratt. Thank you once again, both of you, for 
your excellent testimony. Very provocative and very useful for 
us. And we appreciate the effort and time you put into coming 
here and giving your statements.
    Ms. Turner. Thank you, Mr. Chairman, very much for holding 
this hearing. You have shown, once again, your good bipartisan 
spirit and really showing that I think this is an issue that 
both sides agree on. Thank you very much.
    Chairman Spratt. Just a few final housekeeping measures.
    I ask unanimous consent that members who didn't have an 
opportunity to pose questions to the witnesses be given 7 days 
to submit questions for the record.
    [Questions for the record submitted by Mr. Smith follow:]

           Question for Ms. Turner From Mr. Smith of Nebraska

    As we look at ways to use the tax code to reduce the number of 
uninsured, we have seen different proposals including either tax 
credits or tax deductions to individuals and families for health care. 
In a general sense, as we look at the differences between credits, 
deductions, or a combination of the two, which approach will 1) be more 
fiscally responsible; and 2) do more to reduce the number of uninsured?

                    RESPONSE FROM GRACE-MARIE TURNER

    Thank you for your question, Mr. Smith. As I discussed in my 
testimony, many members of Congress from both sides of the aisle have 
offered proposals that would move public policy forward regarding the 
tax treatment of health insurance. Ranking Member Rep. Paul Ryan, for 
example, is developing a proposal that would provide a universal tax 
credit for health insurance. President Bush has offered a proposal to 
replace the current tax exclusion with a generous universal tax 
deduction. Others have offered proposals for income adjusted, 
refundable tax credits. And some are considering a combination of a tax 
deduction and credit. Senator Hillary Clinton in her recent health 
proposal recommends capping the amount of income that higher-income 
employees can exclude from taxes through health insurance. And Sen. Ron 
Wyden has received a great deal of attention for his proposal to 
replace the current tax exclusion for job-based health insurance with a 
direct, income-adjusted subsidy to individuals.
    The Health Policy Consensus Group, a group of leading health policy 
experts from the market-oriented think tanks, has long advocated 
addressing the tax treatment of health insurance, and many of our 
members support refundable tax credits for health insurance.
    President Bush's proposal in 2007 to allow a universal tax 
deduction brought a new idea to the table in allowing a generous 
deduction for health insurance combined with a credit against payroll 
taxes. Because all workers pay payroll taxes, this latter proposal 
would provide help to those at the lower end of the income scale who 
may not owe income taxes or are in lower tax brackets.
    There are always going to be constituencies that argue for credits 
over deductions and vice versa and a case can be made for both. I 
personally believe that a combination of credits and deductions would 
be most beneficial and believe that merging them into a single policy 
initiative might provide the impetus to finally move policy forward on 
this important issue.
    The refundable credit would be more valuable to those at the lower 
end of the economic scale by providing meaningful help to purchase 
health insurance. And a deduction would be more like the tax benefit 
which those with job-based insurance currently receive through the tax 
exclusion. Alternatively, Congress could cap the tax exclusion for job-
based health insurance in order to limit the open-ended tax benefit it 
provides to those with higher incomes and the most generous health 
benefits.
    If you were to develop a new system of subsidies, the amount could 
flow from the numbers to determine the amount of the credits and 
deductions and what the cutoff and trigger points would be. It even may 
be possible to give people the option to choose between the two.
    See below for a discussion in the academic literature about the 
issue of credits vs deductions for health insurance. I am greatly 
indebted to my colleague Thomas Miller of the American Enterprise 
Institute for providing me with the following excerpts and citations 
from the academic literature.
    Thank you again for the opportunity to testify before your 
committee on this important issue and for this follow-up question. I 
would be very happy to come in to discuss this research and these 
options further with you. As you will see, there clearly is much more 
room for research on this issue.
    Thomas Miller, ``Expanding Access to Care by Empowering Workers 
with Better Incentives and New Options,'' in Covering America: Real 
Remedies for the Uninsured, Washington, D.C.: Economic and Social 
Research Institute, November 2002, online at http://www.cato.org/
research/articles/miller-coveringamerica.pdf.
    The primary vehicle for accomplishing various market-strengthening 
reforms that lower future health care costs and expand access to health 
care would be a new federal tax credit option. The tax credit would 
amount to 30 percent of the cost of qualified insurance coverage * * * 
Essentially, individuals could subtract this portion of their insurance 
costs directly from their federal income tax liability. The tax credit 
is an option; it would not eliminate the current tax exclusion that is 
available for workers insured by employer-sponsored insurance (ESI) 
plans. (A similar federal income tax deduction also is available on a 
partial basis--70 percent of the cost of qualified health insurance--
for the self-employed, and it will become 100-percent deductible from 
federal taxable income in 2003.) Instead, it would provide a 
competitive alternative to the tax exclusion for those workers to opt 
for in place of the tax exclusion. It would encourage a more gradual 
transition toward other forms of private insurance coverage. Workers 
who choose to enroll in an ESI group plan would continue to use the 
current tax exclusion. Employees who choose to decline ESI coverage and 
not take advantage of the current tax exclusion could use the tax 
credit option instead to purchase other forms of health insurance 
coverage.
    From Mark V. Pauly and Bradley Herring, Cutting Taxes for Insuring: 
Options and Effects of Tax Credits for Health Insurance, Washington, 
D.C.: AEI Press, 2002, full text and other information available at 
http://www.aei.org/books/bookID.45,filter.all/book--detail.asp.

                         * * * THE KEY TRADEOFF

    Our simulation estimates serve to illustrate numerically a key 
tradeoff suggested earlier. For a given amount ``spent'' on credits, 
there is a tradeoff between the breadth of the reduction in the number 
of uninsured and the depth of the increase in the coverage they take. 
There is also an interaction with risk levels. At one extreme, a flat 
credit that does not specify a minimum policy will cause all of the 
previously uninsured to obtain some insurance coverage. At very low 
risk levels, the previously uninsured will probably be able to buy 
coverage society would regard as ``adequate.''(There is no objective 
standard for ``adequate coverage. '')
    But persons with high risks who are unwilling or unable to pay more 
of the premium themselves will have to select coverage with deductibles 
and (especially) upper limits. While the new coverage will provide both 
more protection against out-of-pocket payments and more encouragement 
for the use of beneficial care, the protection and encouragement will 
obviously be smaller than if nominal coverage were more generous.
    Under a policy of fixed-dollar credits and a requirement to buy an 
``adequate'' benchmark policy, some of the uninsured will reject the 
subsidy and remain uninsured. Persons with lower risks and those who 
place high value on avoiding being a charity or bad debt case will move 
to coverage which, by definition, is ``adequate.'' Compared to the 
alternative policy discussed in the previous paragraph, this policy 
will convert fewer people from uninsured to insured, but among those 
who are converted we will see a larger effect on their use of and 
protection by health insurance.
    Finally, a policy of proportional credits will move fewer people 
out of the ranks of the uninsured, but, of those it does cause to 
become insured, more will come from the higher risk categories. But 
such a policy may also stimulate (and subsidize) the purchase of 
coverage in excess of the benchmark level; it could lead to ``lavish 
plans,'' especially among those who were formerly insured but can 
become eligible for the credit.
    Which of these three alternatives is best? The answer clearly 
cannot be given with objective certainty; it all depends on how the 
different patterns of changes are valued. If one invokes the principle 
that the first few dollars of insurance coverage (like the first few 
dollars of anything beneficial) are likely to do the most good, a 
design that places rather light obligations on the comprehensiveness of 
coverage and uses fixed-dollar credits may make sense. But ultimately 
the choice itself will require consensus on exactly why ``we'' want the 
uninsured to become insured, and what benefits we expect to accrue to 
all from that change.
    Another key issue when choosing tax credit options is how generous 
the credit is to be. At a given income level, small credits will have 
little effect on the number of uninsured, whereas large credits will 
have large effects. If we focus on the large majority of the uninsured 
who have incomes above the poverty line, our general conclusion is that 
credits will need to be substantial to make much of a dent in the 
number of uninsured. For low-income workers (and their dependents) 
below 300 percent of the poverty line (where the uninsured are 
disproportionately found), we conclude that substantial reductions in 
the numbers of uninsured will require credits in the range of 
approximately half of the individual insurance premiums, with even 
greater credits needed for families with incomes at the bottom of this 
range. Thus another important tradeoff occurs between reductions in the 
number of the uninsured versus tax revenues that could be spent on 
other public programs.
    But note that much of the ``cost'' of tax credits does not 
represent a reallocation of real resources away from other uses and 
toward the health care needs of the previously uninsured. Instead, much 
of the credit effectively represents a tax reduction for the majority 
of lower-middle-income people who formerly had obtained health 
insurance for themselves and their families in some fashion. Limiting 
eligibility for the credit to a subset of those at the same income 
level engaging in the same health insurance purchasing behavior can 
reduce the ``cost,'' but at the real expense of horizontal inequity and 
substantial distortion in the labor market.
    To make any such judgments rationally, however, one would need more 
information than just a head count of the formerly uninsured. The 
missing piece of information is important for the entire policy 
exercise: How much of an improvement in health is generated by the 
presence of insurance coverage (compared to its absence) for people at 
different income and risk levels? It is possible, for example, that 
insurance coverage for people who are initially low risks may produce 
more of an improvement in health than coverage for those who are 
initially high risks. Almost all of the research on the impact of 
insurance coverage either looks at the uninsured as a group or singles 
out poor uninsured people, but the most relevant question is the amount 
of good that health insurance would produce for a lower- middle-income 
family (compared to their being uninsured). As noted elsewhere by Pauly 
and Reinhardt (1996), our failure as researchers to produce this 
information on effectiveness makes it more difficult to persuade our 
fellow citizens to support tax credits or any other programs to reduce 
the numbers of the uninsured.
    The fiscal design of tax credit programs is not the only influence 
on the number of uninsured. Most programs envision making everyone who 
is uninsured (at some income level) eligible for subsidy. This design 
stands in strong contrast to the Medicaid program, for which only some 
low-income uninsured are eligible. The universal character of tax 
credit programs would thus allow the government to direct subsidies or 
credit vouchers to everyone below a certain income level who is not 
insured; it would not be necessary for people to apply. In addition, 
once people at some income level had all been made eligible for credits 
judged to provide adequate subsidies to permit them to afford 
insurance, there would be less justification for someone to remain 
uninsured, and therefore less need to have a permissive charity care or 
bad debt policy applied to that person. Changes in the financial 
responsibilities imposed on uninsured people might themselves stimulate 
people to become insured, although some safety net will need to remain 
for those who truly fall through the cracks. Finally, rewarding the 
great majority of lower-middle-income people who do choose to be 
insured with a substantial tax reduction might both call attention to 
the social value of being insured and offer the uninsured further 
incentive to change their status. While it is unlikely that the number 
of uninsured will ever be literally zero, carefully designed credit 
programs can both reduce the numbers of uninsured and improve the 
equity of tax treatment of the insured.
    Footnote citation from Lily L. Batchelder, Fred T. Goldberg Jr., 
and Peter R. Orszag, ``Efficiency and Tax Incentives: The Case for 
Refundable Tax Credits,'' New York University School of Law, NYC Center 
for Law and Economics, November, 2006, at http://ssrn.com/
abstract=941582.
    For example, Zelinsky has discussed why tax incentives may enhance 
economic efficiency by correcting for positive externalities and has 
applied his analysis to the home mortgage interest deduction and 
accelerated depreciation. See Edward A. Zelinsky, Efficiency and Income 
Taxes: The Rehabilitation of Tax Incentives, 64 TEX. L. REV. 973 
(1986). However, his article is concerned with the decision of whether 
to retain or institute a tax incentive and not with what form of tax 
incentive is most efficient. Id. at 1023. Weiss has proposed converting 
certain investment tax incentives to credits, but this proposal was 
based on equity and not efficiency concerns. See Deborah M. Weiss, Tax 
Incentives Without Inequity, 41 UCLA L. REV. 1949 (1994).
    The economics literature has examined the merits of credits 
relative to deductions only in a few specific examples, such as the 
deduction for charitable giving and the exclusion for gifts. See, e.g., 
Louis Kaplow, A Note on Subsidizing Gifts, 58 J. PUB. ECON. 469 (1995) 
(considering the optimal subsidy for gifts in the presence of 
externalities and concluding that a tax deduction is not obviously 
inferior to a credit); Peter Diamond, Optimal Tax Treatment of Private 
Contributions for Public Goods With and Without Warm Glow Preferences, 
90 J. PUB. ECON. 897 (2006) (concluding that the optimal subsidy for 
private contributions to public goods may rise with earnings but not 
reaching any policy conclusions about whether the optimal subsidy is a 
deduction). Rosen provides a brief general discussion of the choice 
between a deduction and a credit when the purpose of a provision is to 
encourage certain behavior. See HARVEY ROSEN, PUBLIC FINANCE 377 (7th 
ed. 2005) (``If the purpose is mainly to encourage certain behavior, it 
is unclear whether credits or deductions are superior * * * If people 
differ with respect to their elasticities of demand, it may make sense 
to present them with different effective prices. ''). Gruber also 
provides a brief general discussion of the choice between deductions 
and credits but does not discuss the possibility that externalities or 
elasticities vary by income level. See JONATHAN GRUBER, PUBLIC FINANCE 
AND PUBLIC POLICY 507 (2005). He also briefly discusses the debate 
about refundability but only from an equity and not an efficiency 
perspective. See id. at 508. Seidman argues for converting some 
deductions and exclusions into refundable credits but largely on equity 
grounds. LAURENCE S. SEIDMAN, POURING LIBERAL WINE INTO CONSERVATIVE 
BOTTLES 20-27 (2006). He also differs in his skepticism of uniform 
credits, arguing that ``a better prescription would simply be [that] * 
* * each refundable tax credit should utilize a schedule that the 
citizenry judges to be equitable.'' Id. at 26.

   ADDITIONAL LITERATURE CITATIONS THAT MAY BE USEFUL TO YOU INCLUDE

James D. Reschovsky and Jack Hadley, ``The Effect of Tax Credits For 
        Nongroup Insurance on Health Spending By the Uninsured,'' 
        Health Affairs, February 25, 2004, at http://
        content.healthaffairs.org/cgi/content/full/hlthaff.w4.113v1/
        DC1.
Mark Pauly and Bradley Herring, ``Cutting Taxes for Insuring: Options 
        and Effects of Tax Credits for Health Insurance,'' University 
        of Pennsylvania, May, 2000, at http://council.brandeis.edu/
        pubs/Paulytx.PDF
Jonathan Gruber, ``Coverage and Cost Impacts of the President's Health 
        Insurance Tax Credit and Tax Deduction Proposals,'' Kaiser 
        Family Foundation, March 2004, at http://www.kff.org/insurance/
        upload/Coverage-and-Cost-Impacts-of-the-President-s-Health-
        Insurance-Tax-Credit-and-Tax-Deduction-Proposals.pdf.

    Thank you very much, indeed.
    The committee is now adjourned.
    [Whereupon, at 12:25 p.m., the committee was adjourned.]

                                  
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