Tax Subsidies for Expanding Health Insurance Coverage: Selected Policy Issues for the 108th Congress

Tax Subsidies for Expanding Health Insurance Coverage: Selected Policy Issues for the 108th Congress

Order Code RL30762
CRS Report for Congress
Received through the CRS Web
Tax Subsidies for Expanding Health
Insurance Coverage: Selected Policy
Issues for the 108th Congress
Updated August 5, 2003
Gary Guenther
Analyst in Business Taxation and Finance
Government and Finance Division
Congressional Research Service ˜ The Library of Congress

Tax Subsidies for Expanding Health Insurance
Coverage: Selected Policy Issues
for the 108th Congress
Summary
An issue of continuing concern to Congress is the number of Americans who
lack health insurance coverage. In 2001, an estimated 41.2 million Americans were
uninsured for the entire year, 99% of whom were under age 65. The number of non-
elderly uninsured rose each year from 1987 to 1998 and then declined in both 1999
and 2000, before increasing again in 2001.
In response to the increase in the uninsured population, policymakers at the state
and federal levels of government have been searching for effective, affordable, and
politically feasible ways to expand access to health insurance coverage. While a
variety of proposed solutions have been examined and debated, recent Congresses
have shown a growing interest in tax-based approaches. In the 107th Congress, the
Trade Act of 2002 established a refundable and advanceable tax credit for the
purchase of qualified health insurance by individuals who lose their jobs because of
foreign trade. A number of proposals to create tax subsidies for the expansion of
health insurance coverage have surfaced in the 108th Congress, including measures
to create two new tax-preferred health savings accounts (H.R. 2596 as incorporated
into H.R. 1) and tax credits for small employers that provide health insurance
coverage for eligible employees (H.R. 450, S. 10, S. 53, S. 86, and S. 414).
This report summarizes what is known abut the factors shaping the cost-
effectiveness of tax subsidies for expanding health insurance coverage. In doing so,
it reviews the principal findings of recent studies assessing the cost-effectiveness of
a variety of proposed subsidies, many of which have been considered in recent
Congresses. The report will be updated or revised to reflect important legislative
activity, or to incorporate significant new research findings on the use of tax policy
to improve health insurance coverage.
Tax policy can influence the demand for health insurance by altering its after-tax
cost and terms of coverage. If the principal aim of policymakers is to expand health
insurance coverage at a politically acceptable cost through the use of new tax
subsidies, then certain factors would be critical in designing such subsidies. One is
the type of subsidy being offered. Tax deductions are more valuable to individuals
in higher tax brackets than those in lower tax brackets, but the vast majority of
uninsured households fall in the lower brackets. Moreover, non-refundable tax
credits for the purchase of health insurance may have little impact because nearly half
of uninsured households have no federal income tax liability. Another factor to
consider is who would be eligible for the tax subsidy. The cost per newly insured
appears to depend critically on how narrowly a subsidy is targeted. Likely targets
include low-wage firms, low-income workers whose employers do not offer health
insurance, and all individuals who are ineligible for public or employer-provided
insurance. Other important factors shaping the efficacy of proposed tax incentives
to expand health insurance coverage include the type of health insurance policies
eligible for the incentives, the shares of individual and family premiums they cover,
and their ultimate policy objectives.

Contents
Rationale for Government Intervention in the Market for Health Insurance . . . . . 5
Important Considerations in Designing Tax Incentives to Expand
Health Insurance Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Current Federal Tax Subsidies for Health Insurance . . . . . . . . . . . . . . . . . . . 7
Relevant Characteristics of the Non-Elderly Uninsured Population . . . . . . . 8
Relevant Features of Health Insurance Market for the Non-Elderly . . . . . . . 9
Price Sensitivity of the Demand for Health Insurance . . . . . . . . . . . . . . . . 11
Potential Effectiveness and Cost of Some Proposed Tax Subsidies To
Expand Health Insurance Coverage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Lewin Group Study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
Lewin Group’s Findings on Cost-Effectiveness . . . . . . . . . . . . . . . . . 14
Lewin Group’s Findings on Effectiveness . . . . . . . . . . . . . . . . . . . . . . 15
Lewin Group’s Findings on Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Gruber 2000 Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Gruber’s Findings on Cost-Effectiveness . . . . . . . . . . . . . . . . . . . . . . 17
Gruber’s Findings on Effectiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Gruber’s Findings on Cost . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Gruber’s Findings on Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
Gruber’s Findings on Employer Health Insurance Coverage . . . . . . . 18
Gruber’s Findings on Key Administrative Issues . . . . . . . . . . . . . . . . 19
Gruber 2001 Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
New Subsidies to Employers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19
New Subsidies to Employees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20
New Subsidies for Non-Group Coverage . . . . . . . . . . . . . . . . . . . . . . 20
Gruber 2002 Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21
Conclusions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Tax Subsidies for Expanding Health
Insurance Coverage: Selected Policy
Issues for the 108th Congress
An issue of continuing concern to Congress is the number of Americans who
lack health insurance coverage. In 2001, the most recent year for which estimates are
available, 41.2 million persons were uninsured1, 40.9 million (or 99%) of whom were
under age 65. Among the non-elderly population, this is the highest total ever
reported by the U.S. Census Bureau, and it marks the first time since 1998 that the
number of uninsured under age 65 exceeded 40 million. The number of non-elderly
uninsured rose each year from 1987 to 1998 and then declined in both 1999 and
2000, before rising again in 2001. Much of the expansion since the mid-1980s has
been due to sustained increases in the cost of health care, which in turn drive up
private health insurance premiums.2
Congressional concern about the size of the uninsured population has multiple
roots. One is the adverse health effects associated with a lack of health insurance
coverage. Compared to insured individuals, individuals with no or inadequate health
insurance are more likely to postpone or do without needed health care, incur
burdensome personal debts for care they receive, be denied access to health care, be
hospitalized for preventable health problems, and have a greater likelihood of being
diagnosed with late-stage breast, prostate, colorectal, or skin cancer.3 Another source
of congressional concern is the economic costs arising from being uninsured.
According to recent study of the tradeoffs in using tax credits to expand health
insurance coverage, the uninsured pay only 30% of the actual cost of their care.4 The
cost of uncompensated medical care received by uninsured individuals is passed on
to the insured in the form of higher health insurance premiums; to local, state, and
1 There is some question about how many of these individuals can be considered chronically
uninsured. The estimate is intended to capture those who were without health insurance
during all of 2001. Nonetheless, in recent testimony before the Senate Special Committee
on Aging, former Congressional Budget Office Director Dan Crippen claimed that the
number of Americans who are uninsured for more than one year at a stretch “is substantially
lower then 40 million, perhaps as much as 20 million lower than 40 million.” (See “Ex-
CBO Head Urges Focus on Uninsured Who Remain Without Coverage Over Time,” Daily
Report for Executives, Bureau of National Affairs, March 11, 2003, p. A-37.)
2 Harvey S. Rosen, Public Finance, 6th edition (New York: McGraw-Hill Irwin, 2002), p.
211.
3
Kaiser Commission on the Uninsured and Medicaid, The Uninsured: A Primer
(Washington: Henry J. Kaiser Family Foundation, March 2002), pp. 6 and 8.
4 Mark Pauly and Bradley Herring, “Expanding Coverage Via Tax Credits: Trade-Offs and
Outcomes,” Health Affairs, vol. 20, no. 1, Jan./Feb. 2001, p. 15.

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federal governments in the form of higher subsidies for uncompensated care; and to
health care providers in the form of reduced incomes.5 Finally, congressional
concern about the uninsured population also reflects a view held by many Americans
that health care is a merit good. According to this view, all individuals, regardless
of ability to pay, ought to have access to adequate health care. Exponents also argue
that if choices must be made, they should be done so on the basis not of a patient’s
income or wealth but of factors related to the cost-effectiveness of recommended
medical care, such as the age and sex of a patient or the appropriateness and cost of
prescribed treatments.
These concerns have led policymakers at the state and federal levels of
government to search for effective, affordable, and politically feasible ways to
expand access to adequate health insurance coverage. While a variety of proposed
solutions have been analyzed and debated – including the creation of unrestricted
medical savings accounts and a single-payer health care system – recent Congresses
have shown a growing interest in tax-based approaches to increase this coverage.6
In the 107th Congress, the Trade Act of 2002 (P.L. 107-210) established a new
refundable tax credit for the purchase of health insurance by individuals who receive
or are eligible to receive trade adjustment assistance and who are between the ages
of 55 and 64 and receive benefits from the Pension Benefits Guaranty Corporation.7
A number of proposals to establish new or expand existing tax incentives for
health insurance coverage have surfaced in the 108th Congress.8 For example, in late
5 There is some uncertainty over the amount of uncompensated care received by the
uninsured. A major difficulty with many available estimates is that the data used to generate
them are flawed. The latest attempt to avoid this difficulty is a study by two senior analysts
from the Urban Institute. According to the study, uninsured individuals received an
estimated $35 billion in uncompensated care in 2001, or about 3% of total personal health
care spending. Federal, state, and local governments covered an estimated 87% of that
amount through a combination of grants, direct provision of care, appropriated funds, and
special payments under Medicare and Medicaid. See Jack Hadley and John Holahan, “How
Much Medical Care Do the Uninsured Use, and Who Pays for It?,” Health Affairs, Web
Exclusive: [http://www.healthaffairs.org], visited Feb. 12, 2003, pp. W3-78.
6 This is not to imply that there are no significant differences between congressional
Republicans and Democrats over the use of tax subsidies to reduce the uninsured population.
The two sides do not fully agree on some critical issues, such as the merits of targeting
subsidies at non-group coverage and the need for reforms of the private health insurance
industry to discourage rating and underwriting practices that make it difficult for high-risk,
low-income individuals to obtain adequate, affordable coverage. See Robert Cunningham,
“Joint Custody: Bipartisan Interest Expands Scope of Tax-Credit Proposals,” Health Affairs,
Web Exclusive [http://www.healthaffairs.org], visited Sept. 18, 2002, pp. W290-W298.
7 The credit is equal to 65% of health insurance premiums paid by eligible persons for
policies covering themselves and qualifying family members. It can be paid in one of two
ways. First, the Internal Revenue Service can pay the credit directly to taxpayers when they
file their annual tax returns. Second, the IRS can pay the credit directly to a health insurer
on a monthly basis, provided the eligible taxpayers first pay their 35% share of the premium.
8 For a brief overview of legislative proposals in the 108th Congress to expand tax benefits
for health insurance, see CRS Issue Brief IB98037, Tax Benefits for Health Insurance:
(continued...)

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June, the House passed a bill (H.R. 2596 as incorporated into the version of H.R. 1
passed by the House) that, among other things, would create two new personal
savings accounts to pay for medical expenses not reimbursed under health insurance
plans with tax advantages similar to those available to current holders of Archer
medical savings accounts: health savings accounts (HSAs) and health savings
security accounts (HSSAs).9 The former would apply to individuals covered under
health plans with an annual deductible of at least $1,000 for individual coverage and
at least $2,000 for family coverage; the latter would apply to uninsured individuals
or to individuals covered under health plans with an annual deductible of at least
$500 for individual coverage and at least $1,000 for family coverage. For both
accounts, individual contributions would be tax-deductible, even if the taxpayer does
not itemize; employer contributions would be tax-exempt; family member
contributions would be made on an after-tax basis; investment earnings would accrue
free of tax; and distributions would be tax-exempt if they are used for qualified
medical expenses. H.R. 2596 (as incorporated into the version of H.R. 1 passed by
the House) also would permit up to $500 in unused health care flexible spending
accounts to be carried over, contributed to a qualified retirement or deferred
compensation plan, or contributed to a HSA.
In addition, Representative Cliff Stearns has introduced a bill (H.R. 198) to
permit individuals to deduct 100% of out-of-pocket payments for health insurance
coverage and prescription drugs, regardless of whether they itemize. H.R. 583,
introduced by Representative Mark Kennedy, would establish a refundable,
advanceable tax credit for the purchase of qualified health insurance by individuals
not covered by public insurance programs or subsidized employer health plans. And
at least five bills (S. 10, S. 53, S. 86, S. 414, and H.R. 450) to establish tax credits for
small firms that offer health insurance to employees have been introduced; in each
case, the credit would equal a certain percentage of the cost incurred by an eligible
employer in providing health insurance coverage to employees.
The Bush Administration also favors a tax-based approach to reducing the
uninsured population. In his budget request for FY2004, President Bush proposes
that Congress pass a limited, means-tested refundable tax credit for the purchase of
non-group health insurance by individuals not covered under employer or public
health plans.10
8 (...continued)
Current Legislation, by Bob Lyke, pp. 9-13.
9 For more details on the design of the two proposed health savings accounts and the
similarities and differences between them and existing health savings accounts, see CRS
Report, Tax-Advantaged Accounts for Health Care Expenses: Side-by-Side Comparison, by
Bob Lyke and Chris L. Peterson.
10 More specifically, the Bush Administration wants to establish a refundable tax credit for
the purchase of health insurance by individuals under age 65 who are not covered under
public or employer health plans. The credit would subsidize up to 90% of the health
insurance premium and would be capped at $1,000 per adult and $500 per child for up to
two children. Single filers with no dependents and a modified adjusted gross income
(MAGI) of up to $15,000 would be eligible for the maximum credit; the credit phases out
(continued...)

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The use of tax policy to shrink the uninsured population appeals to some for a
variety of reasons – although proponents of tax subsidies to expand health insurance
coverage do not necessarily agree on which reasons are paramount. Foremost among
them are a preference for tax incentives to government spending in achieving
important social goals; a recognition that existing federal tax subsidies for health
insurance coverage are inequitable in that they exclude the non-elderly who are
unemployed or drop out of the workforce; and the belief that private insurance
companies would be more efficient and effective than government agencies in
providing Americans with a range of desirable health insurance plans. Others,
however, doubt that tax subsidies are an efficient or effective way to achieve
substantial reductions in the size of the uninsured population. They tend to favor
more direct solutions, such as public health insurance programs targeted at the
uninsured.
This report summarizes what is known about the key factors shaping the cost-
effectiveness of tax subsidies for expanding health insurance coverage. It opens with
an examination of the economic justification for government intervention in the
market for health insurance.
The report then moves on to discuss important
considerations in designing tax subsidies for expanding health insurance coverage
and concludes with a review of the principal findings of recent studies assessing the
cost-effectiveness of a variety of proposed tax subsidies, many of which mirror
proposals considered in recent Congresses. The report will be updated or revised to
reflect legislation to expand federal tax incentives for health insurance passed by a
full committee in the House or Senate, or to incorporate the findings of significant
new studies of the cost-effectiveness of such incentives.
10 (...continued)
completely at a MAGI of $30,000. All other filers with a MAGI up to $25,000 would be
eligible for the maximum credit. In the case of a household consisting of two adults and two
children, the credit would phase out completely at a MAGI of $60,000. Taxpayers could
claim the credit either on their federal tax returns or through reductions in their premium
payments equal to the credit they are due. If they choose the second option, health insurers
would receive reimbursements from the Treasury Department equal to the amount of the
credit. Eligibility for the advance credit would be based on an individual’s tax return for the
previous year. Health plans eligible for the credit would need to meet minimum coverage
criteria. Individuals could purchase these plans through the non-group market, private
purchasing groups, state-sponsored purchasing pools, or state high-risk pools.

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Rationale for Government Intervention in
the Market for Health Insurance
Mainstream economic theory holds that markets are most likely to achieve their
best possible outcomes when governments refrain from intervening in their
operations. Yet one of the defining characteristics of the U.S. health insurance market
is the dominant role played by state and federal health insurance programs and tax
subsidies for health insurance.11 In 2001, for example, spending on Medicare and
Medicaid (which provide health insurance for the elderly and a large number of the
poor and disabled) and the State Children’s Health Insurance Program totaled $454.8
billion; and the federal government lost an estimated $65.7 billion in tax revenues
because of the tax exclusion for employer-provided health insurance, according to
the Joint Committee on Taxation. On what economic grounds can such involvement
be justified?
Conventional economic analysis suggests two possible grounds. On the one
hand, mainstream economic theory holds that social welfare is enhanced by the
widespread availability of actuarially fair insurance. Most individuals are risk-averse
to some degree, and risk-averse individuals are thought to be better off when they can
reduce their financial risks by transferring them to entities with a comparative
advantage in risk bearing because of their capacity for risk pooling and
diversification (e.g., private insurance companies). Thus, most individuals would
want to buy enough health insurance, provided the cost reflects their expected annual
losses from health problems. Health economists seem to agree that health insurance
is likely to yield maximum social welfare gains when coverage is widespread among
all risk groups, the potential losses from health problems are large, and the
probabilities of suffering such problems cannot be known for specific individuals.
On the other hand, if the market for health insurance were left to its own
devices, there would be no certainty that health insurance coverage would produce
a net welfare gain. Instead of the emergence of broad, actuarially fair insurance
coverage, one might find that available coverage would be excessive in many cases,
and too few individuals would have adequate and affordable insurance coverage.
Undesirable outcomes such as these may arise because the provision of health care
is vulnerable to four market failures:
adverse selection, moral hazard,
incompleteness, and the existence of free riders in the utilization of medical care.12
11 For an overview of existing federal tax subsidies for health insurance, see CRS Issue Brief
IB98037, Tax Benefits for Health Insurance: Current Legislation, by Bob Lyke, pp. 2-7.
12 The health care market appears riddled with imperfections. In addition to the three
problems discussed here, consumers and health insurance companies face imperfect
information relating to the skills of doctors, health profiles of patients, and the benefits of
treatments and procedures; competition in the provision of health care services is limited;
and providers whose principal objective goes beyond the minimization of costs or
maximization of profits play a large role in the delivery of health care. For more details on
these market failures, see Joseph E. Stiglitz, Economics of the Public Sector, 3rd edition
(New York: W.W. Norton, 2000), pp. 308-311.

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Adverse selection refers to a process which is likely to emerge in the health
insurance market when buyers of particular policies have greater risks of illness and
injury than the average potential buyer. It is most likely to materialize when
participation in health insurance coverage is voluntary, risk pools are small and
dominated by experience rating, and a multitude of insurers vie for market share by
offering consumers a range of plans with varying benefits. In general, the average
buyer of a health insurance plan has an above-average risk of developing serious
health problems. Such a tendency is rooted in the fact that a very small share of the
U.S. population accounts for a large share of spending on health care in a given
year.13 This disparity, if uncorrected by policy intervention, can touch off an upward
spiral in insurance premiums driven by efforts by insurers to raise rates to cover
losses from unanticipated claims. In response, individuals with relatively low risks
(e.g., young, healthy adults) may choose to become uninsured or switch to cheaper
policies offering less coverage, while individuals with relatively high risks (e.g.,
middle-aged adults who smoke, do not exercise regularly, and are overweight) face
the choice of paying premiums far above their expected losses, switching to cheaper
policies offering inadequate coverage, or becoming uninsured and relying on charity
care as needed. The prevalence of adverse selection in non-group markets gives
insurance companies an incentive to engage in a practice known as “cherry picking,”
where they focus on selling health insurance to those with relatively low risks.
Among health economists, moral hazard refers not to a character defect but to
the excessive utilization of health care fostered by having health insurance and the
associated efficiency losses. Health insurance can have this effect mainly because
insured individuals bear only a fraction of the actual cost of the health care they
receive, weakening their incentive to avoid behaviors that are known to contribute
to health problems and dulling their awareness of the relationship between the
marginal costs and benefits of the care they receive. In theory, insured individuals
will consume health care until the marginal benefits match the marginal out-of-
pocket costs, which under most policies are equivalent to deductibles and co-
payments. Generous health insurance coverage can push these costs far below the
actual marginal costs of the medical services. Of course, insurance companies are
well aware of the damage moral hazard can inflict on their financial viability; so they
try to contain or limit it through the imposition of deductibles, co-payments, coverage
limits and exclusions, managed care plans, mandatory prior approvals of certain
treatments and procedures, and financial incentives for health-care providers to
restrict the use of costly procedures.
Moreover, it appears that the health insurance market fails to satisfy a necessary
condition of economic efficiency: the existence of what economists call “complete
markets.” When a market fails to provide a good or service even though individuals
would be willing to pay more than the average cost of providing it, economists
consider the market to be incomplete. And they regard the lack of completeness as
a market failure. Some argue that the private health insurance market is incomplete
because it usually does not provide guaranteed renewability or insurance against
13 In 1992, for example, 10% of Americans accounted for 72% of personal health
expenditures.

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future health risks, only current ones.14 Most individuals cannot purchase health
insurance at fixed rates and under fixed terms for more than one year in advance. Yet
it is thought that many individuals would be willing to purchase insurance against
future health risks at a reasonable cost, if it were provided.
Finally, in every state, certain health care providers – mainly public hospitals –
have a legal obligation to provide treatment to someone suffering from a life-
threatening or serious health problem, irrespective of his or her ability to pay.
Although these mandatory-care laws can enhance social welfare by ensuring that
everyone receives at least a modicum of health care when it is urgently needed, they
can also undermine welfare by diluting the incentive to purchase actuarially fair
health insurance, especially for low-income individuals with few financial assets to
protect. As a result, mandatory-care laws have the unintended effect of laying the
foundation for a classic market failure known as the free rider problem. In general,
this problem can be seen as a byproduct of the existence of public goods, one of
whose defining traits is the impossibility of excluding anybody from consuming
them. Laws granting everyone the right to receive emergency care, regardless of
ability to pay, effectively endow health care with this trait, thereby giving rise to a
free-rider problem. It is not clear how the welfare gains from these laws compare
with the welfare losses.
For most health economists, the presence of these market failures provides
ample justification for government intervention in the health insurance market. In
their view, a central issue for policymakers is not whether to intervene. Rather, it
is to devise politically acceptable policy measures that attempt to strike a balance
between the welfare losses arising from moral hazard and the welfare gains inherent
in the risk spreading provided by actuarially fair health insurance coverage.
Important Considerations in Designing Tax
Incentives to Expand Health Insurance Coverage
If the policy objective is to achieve a sizable reduction in the uninsured
population and the preferred policy instrument is tax policy, then a critical task for
policymakers is to devise tax subsidies that accomplish the goal at an acceptable
budgetary cost. Recent research into the probable effects of tax policy on health
insurance coverage sheds light on several factors that should be carefully considered
in designing such subsidies. Each is examined in some detail below.
Current Federal Tax Subsidies for Health Insurance
This may seem obvious, but one important factor to weigh in devising a tax-
based approach to expanding health insurance coverage is the current mix of federal
tax subsidies for health insurance coverage. Any such approach cannot avoid being
constructed around a decision about whether to jettison, modify, or retain these
14 See Leonard E. Burman and Amelia Gruber, “First, Do No Harm: Designing Tax
Incentives for health Insurance,” National Tax Journal, vol. 59, no. 3, Sept. 2001, p. 480.

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subsidies. The reason lies in the central role they play in the current system of health
insurance coverage for the non-elderly.
Although the present tax code contains a variety of subsidies for health
insurance, three in particular have facilitated the emergence of this system: the tax
exclusions for employer-paid health insurance premiums, so-called cafeteria plans,
and flexible spending accounts.15 They are related in that each pertains to health
insurance coverage obtained through employers. Under these exclusions, it is
possible for individuals who receive health insurance through employers to pay no
federal or state income and payroll taxes on their own and their employers’
contributions for the premiums. In combination, the exclusions substantially lower
the after-tax price of health insurance relative to other goods and services workers
may consume and subsidize the purchase of employment-based group health
insurance relative to non-group coverage.16
These exclusions are so deeply
embedded in the current structure of health insurance coverage for the non-elderly
that their removal could trigger a significant increase in the uninsured population.
In a recent study, Jonathan Gruber, an economist at MIT who has written extensively
on the impact of tax policy on health insurance coverage among the non-elderly,
estimated that the elimination of the exclusions at the federal and state levels would
lead to a 14% drop in the number of employers offering health insurance to
employees, which in turn would result in a decrease in the number of individuals
covered under employment-based health plans of over 22 million and a 50% decline
in total spending on these plans.17
Relevant Characteristics of the
Non-Elderly Uninsured Population
Policymakers seeking to craft cost-effective tax subsidies to expand health
insurance coverage should also take into account characteristics of the non-elderly
uninsured population that are relevant to tax policy.
Several such characteristics deserve mention. First, the non-elderly uninsured
are disproportionately concentrated in low-income households: in 2001, nearly 38%
of uninsured individuals resided in households with annual incomes below $20,000.
It comes as no surprise, then, that a very high proportion of uninsured taxpayers fall
in lower tax brackets, and that a significant proportion have no federal income tax
liability.18 Second, while most uninsured individuals under age 65 live in households
15 For an overview of current federal tax benefits for health insurance, see CRS Issue Brief
IB98037, Tax Benefits for Health Insurance: Current Legislation, pp. 1-8.
16 Jonathan Gruber, an economist at MIT, has estimated that the typical worker in the 15%
federal income tax bracket, facing a state income tax rate of 5% and a combined payroll tax
rate of 15.3%, pays $0.65 after taxes for $1 of health insurance, meaning that the tax price
is 0.65.
See Jonathan Gruber, Taxes and Health Insurance, Working Paper 8657
(Cambridge, MA: National Bureau of Economic Research, Dec. 2001), p. 4.
17 Ibid., pp. 26-27.
18 Gruber has also estimated that in 1997, 90% of uninsured taxpayers with tax liabilities
(continued...)

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headed by individuals holding full- or part-time jobs, over 75% of uninsured workers
are not offered health insurance by their employers.19 Third, many uninsured workers
are employed by small firms: in 2001, over 50% of uninsured workers held jobs with
firms having fewer than 100 employees.20 Finally, the previous characteristics
notwithstanding, the uninsured under age 65 do not constitute an isolated, easily
identified or targeted, and stable population group. Rather, they are scattered in
varying and shifting degrees throughout all income groups and firm sizes. For
instance, in 2001, 24% of uninsured individuals lived in households with annual
incomes of $50,000 or more, and 23% of uninsured workers were employed by firms
with 500 or more employees.21
Relevant Features of Health Insurance
Market for the Non-Elderly
It is also useful to consider certain features of the existing structure of health
insurance coverage for the non-elderly in designing tax-based subsidies to expand
health insurance coverage. Of particular interest for policymakers are the dominant
role of employers as sources of health insurance coverage, the advantages and
disadvantages of group coverage provided through the workplace, and the limitations
of coverage provided in the non-group market.
In 2001, nearly 66% of non-elderly Americans received health insurance
coverage through employers; another 15% were covered through public health
insurance programs; and about 7% obtained coverage through insurance plans
purchased in the non-group or individual market. Gruber has noted that in recent
decades, more than nine out of 10 privately insured non-elderly individuals received
their coverage from an employer, either their own, their spouse’s or their parents’.
Most workers who are offered insurance by their employers, regardless of wage and
salary income, decide to take it, although the take-up rate appears to have declined
somewhat in recent years as employers have passed on to employees increases in the
cost of enrolling in health plans.22 The offering of insurance varies considerably by
firm size. In general, smaller firms are much less likely to offer coverage: in 2001,
a worker in a firm with fewer than 10 employees was almost three times as likely to
be uninsured as a worker in a firm with 1,000 or more employees. Nevertheless,
small firms paying high average wages are as likely to offer coverage as large firms;
18 (...continued)
belonged to the 15% tax bracket, and 50% had no federal tax liability. See Jonathan Gruber,
Tax Subsidies for Health Insurance: Evaluating the Costs and Benefits, Working Paper 7553
(Cambridge, MA: National Bureau of Economic Research, Feb. 2000), p.7.
19 Gruber, Taxes and Health Insurance, p. 7.
20 CRS Report 96-891, p. 6.
21 EBRI, pp. 11 and 12.
22 David M. Cutler, Employee Costs and the Decline in Health Insurance Coverage,
Working Paper 9036 (Cambridge, MA: National Bureau of Economic Research, July 2002),
pp. 25-27.

CRS-10
and eligibility, coverage, and take-up rates are similar among employees in small and
large firms that offer health insurance coverage.23
There are noteworthy advantages and disadvantages to tying health insurance
coverage to employment. On the one hand, the work place serves as a convenient,
almost logical way to pool health insurance risks, since most individuals choose their
employers for reasons other than expected usage of medical care in coming years.
In general, the larger the employment group, the greater the scope for the risk sharing
and community rating that enhances social welfare. Seen from this perspective,
employment-based insurance has the potential to preclude the adverse selection
prevailing in the non-group insurance market.
Furthermore, insurance
administrative, underwriting, and marketing costs are lower for large groups than
individuals.24 Large groups also have greater bargaining power in extracting price
and other concessions from insurers and health-care providers.
On the other hand, employer-based health insurance serves as an imperfect risk-
pooling mechanism in the case of small firms. In a firm with 20 employees, for
instance, if two individuals suffer a serious illness, the average cost of health
insurance can rise markedly the following year. In addition, making employers the
primary source of health insurance coverage for the non-elderly can contribute to
efficiency losses by retarding job mobility. Insured workers may be disinclined to
work for another employer out of fear of losing their coverage or having less
desirable options for coverage. Another drawback to employer-provided health
insurance is that it offers limited renewability. Those who become unemployed may
lose their coverage, and there are no federal laws to keep employers from dropping
coverage when faced with huge premium increases.
Finally, a system of
employment-based health insurance coverage can foster production inefficiencies by
implicitly favoring large firms over small firms. The source of the inefficiencies is
the considerable cost advantages that large firms typically enjoy over small firms in
offering the same package of health benefits to employees.25
Some proposals to establish new tax subsidies to expand health insurance
coverage would rely on the non-group market to achieve their objectives. In 2001,
16.4 million individuals were covered under non-group policies. Coverage under
these policies declined gradually between 1993 – when it reached 17.5 million
23 Jason Lee, Are Health Insurance Premiums Higher for Small Firms?, Research Synthesis
Report No. 2 (Princeton, NJ: Robert Wood Johnson Foundation, Sept. 2002), pp. 4-6.
24 According to one authoritative estimate, health insurance loading fees as a percent of
benefits paid fall in the range of 60% to 80% for individual policies, compared to 8% to
15% for groups of 201 to 1,000 persons. These fees cover the operating costs of insurance
companies and represent a mark-up over the expected payout of benefits under a policy. See
Charles E. Phelps, Health Economics, 3rd Edition (Boston: Addison Wesley, 2003), pp. 342-
343.
25 Small firms pay more than large firms for the same health insurance coverage because the
costs of marketing and administration are spread over fewer workers in small firms and
underwriting costs typically are greater for small firms. See U.S. Congressional Budget
Office, The Tax Treatment of Employment-Based Health Insurance (Washington: March
1994), pp. 21-22.

CRS-11
persons – and 2000. Many of those who purchase insurance in the non-group market
are self-employed, retired but not yet eligible for Medicare, working part-time, or
divorced or widowed.26 Access to and the cost of non-group coverage depend
critically on a person’s health status, age, and place of residence. For young adults
in good health, premiums can be lower than in the employer-based group market; but
for older adults with chronic health problems, premiums tend to be much higher.
Generally, individuals in poor health can face formidable obstacles to obtaining
adequate and affordable coverage. Insurers often decline to cover persons with pre-
existing conditions, impose severe limits on the coverage they will provide for those
conditions, or add high premium surcharges to cover those conditions.27 Many states
have responded to these practices by establishing high-risk insurance pools; and some
have enacted law barring insurers from excluding coverage of pre-existing
conditions. But they seem to have had little impact on trends in the uninsured
population in the past 10 to 15 years.
Price Sensitivity of the Demand for Health Insurance
Tax subsidies attempt to boost the demand for health insurance by reducing its
tax price (or after-tax cost). This relationship implies that in designing tax subsidies
to shrink the uninsured population, it is useful to know how sensitive the decision to
purchase health insurance is to reductions in its tax price. Given the structure of the
health insurance coverage for the non-elderly, tax policy can work through three
basic channels to expand coverage: (1) subsidies to employers to offer coverage; (2)
subsidies to employees to accept coverage that is offered; and (3) subsidies to
uninsured individuals to purchase non-group coverage. These options suggest that
policymakers might consider the responsiveness to tax price changes of the decision
by employers to offer coverage, the decision by employees to take up coverage if it
is offered, and the decision of uninsured individuals to purchase non-group coverage,
together with the ways in which these decisions may feed back on one another.
Considerable research has been done on the behavioral responses of firms and
individuals to changes in the cost of health insurance. A recent study by Gruber
reviewed this literature.28 One of his findings was a striking lack of consensus on the
price sensitivity of the three decisions shaping the efficacy of tax subsidies as a
policy tool to expand health insurance coverage. But such a lack was not as
problematic for policymakers as it may have seemed upon first glance because of
important differences in focus, methodology, data, and applicability of results among
the studies considered by Gruber. He compared the strengths and weaknesses of
available estimates of price sensitivity and identified those he thought were useful for
the purpose of forecasting the impact of proposed tax subsidies on health insurance
coverage.
26 Karen Pollitz, Richard Sorian, and Kathy Thomas, How Accessible is Individual Health
Insurance for Consumers in Less-Than-Perfect Health? (Washington: Kaiser Family
Foundation, June 2001), p. 1.
27 Ibid., p. iv.
28 See Gruber, Taxes and Health Insurance, pp. 12-25.

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On the question of how responsive the decision by firms to offer health
insurance to employees was to changes in its tax price, Gruber concluded that the
best available estimate of this responsiveness was one of his own. In a 2000 study
done with Michael Lettau, he estimated that the price elasticity of employer offering
of health insurance fell between -0.3 and -0.4. This implied that a 10% rise in the tax
price of health insurance could lead to a decline in the number of firms offering
coverage to employees of three to four percentage points.29
On the question of how responsive the decision of employees to accept health
insurance coverage offered by their employers was to changes in its tax price, Gruber
found that the decision seemed to be independent of such changes. In other words,
available evidence indicated that employees did not measurably alter their take up of
employer health plans in response to changes in their tax price. He noted that this
finding was consistent with “a growing body of evidence” that the decisions of
employers appear to have much more influence than the preferences of employees
over the availability of fringe benefits like health insurance.30
And on the question of how responsive the decision of individuals who lack
public or employer-provided health insurance coverage to purchase non-group
coverage was to changes in its tax price, Gruber noted that only one meaningful study
had been done, and that it was too flawed to provide helpful guidance for
policymakers. The study estimated a tax-price elasticity of non-group coverage of
-0.3, implying that a 10% drop in the after-tax cost of non-group health insurance
would lead to a 3% increase in the number of individuals covered under such
policies. In his view, the study’s shortcomings meant that the estimate should be
construed as a “lower bound” on the tax-price sensitivity of the demand for non-
group coverage among those not eligible for public or employer health insurance.31
Gruber’s study indicated that neither firms nor individuals were especially
sensitive to reductions in the tax price of health insurance. But it did offer fresh
evidence that the offering decisions of firms tended to be more responsive to such
reductions than the acceptance decisions of employees. The study also served the
purpose of highlighting some of the significant gaps in our understanding of the
forces shaping behavioral responses to tax subsidies for health insurance coverage.
Of particular interest was a paucity of conclusive evidence on the price elasticity of
demand for non-group insurance among those currently lacking public or employer
health insurance. Little is also known about the price sensitivity of the uninsured
who are not offered health insurance by their employers.
29 Ibid., p. 16.
30 Ibid., p. 19.
31 Ibid., p. 22.

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Potential Effectiveness and Cost of
Some Proposed Tax Subsidies
To Expand Health Insurance Coverage
Recent proposals to use tax subsidies to achieve substantial reductions in the
uninsured population raise the question of what approach is likely to be most cost-
effective. Several recent studies have addressed this question. Among other things,
they shed light on the critical factors determining the cost-effectiveness of tax
subsidies to expand health insurance coverage. The principal findings of these
studies are reviewed below.
Lewin Group Study
In 1999, Lewin Group issued a study which assessed the effectiveness and
revenue cost of nine proposed tax subsidies for the purchase of health insurance. The
proposals ranged from something as simple as a tax deduction for the purchase of
non-group health insurance to something as complex as the replacement of current
federal tax subsidies for health insurance with individual insurance mandates and
refundable tax credits for the purchase of non-group health insurance. Some were
modeled after legislative initiatives then being considered in Congress. For each
proposal, the Lewin Group used a micro-simulation model of the U.S. health care
system (known as the Lewin Group Health Benefits Simulation Model) to estimate
the number of persons who would be eligible for the proposed tax subsidy, the
change in the number of insured persons in response to its adoption, and its federal
revenue cost in 2000 dollars. These estimates then were used to compute the
percentage change in the uninsured population relative to 1997 – the most recent year
at the time for which figures on the uninsured population were available – and the
revenue cost per newly insured person.
The micro-simulation model generated these estimates on the basis of several
key assumptions. Two are worth mentioning here.
One assumption addressed the sensitivity of consumers in general to changes in
the after-tax price of health insurance – or the tax-price elasticity of demand for
health insurance. The proposed tax subsidies lowered the after-tax price of health
insurance for eligible individuals, which in turn sparked an overall increase in health
insurance coverage among these individuals.
Naturally, the magnitude of the
increase depended critically on the price elasticity of demand. The study used an
elasticity of -0.2, which implied that a 10% decrease in the after-tax price of
insurance would trigger a 2% rise in coverage nationwide. Nonetheless, considerable
uncertainty surrounded the actual price elasticity. Health economists who had
studied the issue came up with estimates ranging from 0.0 to -2.7.32
32 The coefficient for the price elasticity used in the Lewin Group study came from a 1998
analysis by the same organization that analyzed the effect of changes in employee
contributions to employer health insurance on the number of workers and dependents
purchasing employer-provided health insurance. Other studies have come up with different
(continued...)

CRS-14
Another important assumption concerned the number of individuals who would
claim or take up the proposed tax subsidies. For subsidies supplementing existing
federal tax subsidies for health insurance, the study assumed every eligible individual
currently covered by non-group insurance would claim them, whether a deduction or
refundable tax credit. The rate at which a tax subsidy was taken up mattered because
its revenue cost and overall efficacy depended in part on how many individuals
actually took advantage of it. Available evidence in 1999 suggested, however, that
the take-up rate for these individuals was significantly less than 100%.33
Several of the study’s findings have important implications for the potential cost
and effectiveness of tax subsidies to expand health insurance coverage. They are
highlighted below.
Lewin Group’s Findings on Cost-Effectiveness.34
! The most cost-effective subsidy was a refundable tax credit for the
purchase of non-group insurance by taxpayers not covered by
employment-based health insurance, Medicare, or Medicaid that was
capped at $500 for single persons and $1,000 for families; the cost
per newly insured person was $1,246 (2000 dollars).
! The least cost-effective subsidy was one that scrapped existing
federal tax subsidies for the purchase of health insurance – except
for medical savings accounts – and substituted a fixed refundable tax
credit of $800 per adult and $400 per child (capped at $2,400 per
family) for the purchase of health insurance by all taxpayers except
those who are covered under Medicare or Medicaid; the cost per
newly insured person was $10,541 (2000 dollars).
! Refundable tax credits for the purchase of health insurance by low-
income working and non-working individuals were more effective
but more costly (per newly insured person) than an above-the-line
tax deduction for the purchase of non-group health insurance by
32 (...continued)
estimates of the price elasticity of demand for health insurance, but in doing so they
employed different estimation methods, for the most part. For a discussion of these studies,
see Gruber and Poterba, “Fundamental Tax Reform and Employer-Provided Health
Insurance,” pp. 159-162.
33 In a 1993 study of the response of self-employed individuals to the creation of a partial
tax deduction for their health insurance expenditures by the Tax Reform Act of 1986,
economists Jonathan Gruber and James Poterba found that from 1986 to 1989, between 15%
and 20% of the self-employed with incomes below $20,000 and about 50% of those with
incomes above $50,000 claimed the deduction. From these response rates, they concluded
that a lack of awareness of the presence of the subsidy undercut its effectiveness. See U.S.
Congress, House Committee on Ways and Means, Subcommittee on Health, Health
Insurance Premium Deductions for the Self-Employed, hearing, 104th Cong., 1st sess., Jan.
27, 1995 (Washington: GPO,1996), pp. 42-43.
34 Cost-effectiveness in this context denotes the revenue cost per newly insured person.

CRS-15
taxpayers who were not covered by employment-based insurance,
Medicare, or Medicaid.
Lewin Group’s Findings on Effectiveness.35
! The most effective subsidy was a plan developed by the Heritage
Foundation which would make sweeping changes in the structure of
health insurance coverage for the non-elderly. Among other things,
it abolished existing federal tax subsidies for health insurance,
substituted a refundable tax credit for health insurance and medical
care expenditures, and required all individuals to purchase a
minimum level of health benefits and all employers to convert their
health benefit plans to wages. The plan resulted in the elimination
of the entire uninsured population, which was assumed to total 43.3
million in 2000.
! The least effective subsidy was a 30% refundable, means-tested tax
credit for non-group health insurance purchased by taxpayers
without access to employment-based health insurance and not
covered under Medicare or Medicaid. The credit phased out for
single persons with adjusted gross incomes between $25,000 and
$35,000, and for married couples with adjusted gross incomes
between $40,000 and $50,000. It reduced the uninsured population
by 1.5 million persons.
Lewin Group’s Findings on Cost.
! The most costly subsidy was the Heritage Foundation plan: its net
revenue cost was $55.3 billion (2000 dollars).
! The least costly subsidy was the 30% refundable tax credit for the
purchase of non-group health insurance by individuals without
access to employment-based health insurance and not covered by
Medicare or Medicaid: its net revenue cost was $3.3 billion (2000
dollars).
Gruber 2000 Analysis
Gruber’s 2000 study and the Lewin Group study had much in common. The
Gruber study had a similar focus: the potential effects of alternative tax subsidies for
health insurance on the number of uninsured and the federal budget. Like the Lewin
Group study, many of the tax subsidies Gruber evaluated were modeled after
legislative proposals stirring interest in recent Congresses. And the Gruber study also
employed a computerized model of the links between tax policy and the U.S. health
insurance market to analyze these effects.
35 Effectiveness in this context denotes the total decrease in the uninsured population, if any.

CRS-16
But the Gruber study went beyond the Lewin Group study in that it addressed
two important issues raised by tax-based approaches to expanding health insurance
coverage which were excluded or given marginal treatment in the Lewin Group
study. One issue was the extent to which different income groups benefitted from the
proposed subsidies; and the second concerned the impact of the subsidies on the
market for group health insurance. The Gruber analysis also differed somewhat in
approach (but not in basic methodology). It simulated the effects of a “base case”
along a number of dimensions, including the federal revenue cost, the size of the
uninsured population, the number of individuals with employment-based health
insurance, and the distribution of the net cost of the subsidy among major income
groups.36 Gruber then simulated the effects of other proposed tax subsidies (e.g., a
non-refundable tax credit for the purchase of non-group insurance and an above-the-
line tax deduction for the same purpose) on the same variables and compared the
results to those of the base case.
For each proposed tax subsidy, Gruber estimated the revenue cost to the federal
government, how many individuals would become insured, how the benefits would
be distributed among income groups, and how many individuals with employment-
based health insurance would drop it or lose it in response to the subsidy.37 In
simulating these effects, he had to make assumptions about a number of key
behavioral variables, including the extent to which those who were uninsured took
up the subsidies to purchase non-group coverage, the extent to which those already
covered by non-group health insurance claimed the proposed subsidies, and the
extent to which firms reacted to the subsidies by eliminating or cutting health
benefits for employees. Not surprisingly, the results of Gruber’s analysis hinged on
the sensitivity of the demand for health insurance coverage to declines in its after-tax
price. Gruber assumed a higher price elasticity than the Lewin Group study: -0.53
compared to -0.2. This difference was hardly trivial: a 1% fall in the after-tax price
of health insurance in both studies led to an increase in insurance coverage among
the uninsured that was 2.6 times greater in Gruber’s analysis. While the validity of
Gruber’s assumed price elasticity is open to question, it should be noted that it was
closer to the middle of the range of available elasticity estimates than the one used
in the Lewin Group study.
Several results of Gruber’s analysis also should be highlighted because they
have important implications for the effectiveness and cost of tax subsidies to expand
health insurance coverage:
36 The base case involved a refundable tax credit for the purchase of non-group health
insurance by individuals not covered by Medicare or employment-based health insurance.
The credit was limited to $1,000 for single filers and $2,000 for joint filers and head-of-
household filers, and it phased out for single filers with adjusted gross incomes between
$45,000 and $60,000 and for joint and head-of-household filers with adjusted gross incomes
between $75,000 and $100,000.
37 Gruber, Tax Subsidies for Health Insurance: Evaluating the Costs and Benefits, p. 9.

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Gruber’s Findings on Cost-Effectiveness.38
! The most cost-effective subsidy was a means-tested refundable tax
credit for the purchase of non-group health insurance by individuals
not covered by Medicare or employment-based health insurance.
Under terms specified by Gruber, the credit could not exceed $500
for single filers and $1,000 for joint and head-of-household filers;
and it phased out for single filers with adjusted gross incomes
between $45,000 and $60,000 and for joint and head-of-household
filers with adjusted gross incomes between $75,000 and $100,000.
The cost per newly insured person was $2,239 (1999 dollars).
! The least cost-effective subsidy was a refundable tax credit for out-
of-pocket health insurance expenditures by individuals not covered
by Medicare: the cost per newly insured person was $5,003 (1999
dollars).
Gruber’s Findings on Effectiveness.39
! The most effective tax subsidy was a refundable tax credit for all
out-of-pocket health insurance expenditures by individuals not
covered by Medicare that was limited to $1,000 for single filers and
$2,000 for joint and head-of-household filers:
it reduced the
uninsured population by 12.4 million.
! Running a close second was a refundable tax credit for the purchase
of non-group health insurance by individuals not covered by
Medicare or employment-based health insurance. The credit was
limited to $2,000 for single filers and $4,000 for joint and head-of-
household filers and was paid directly to insurers when premium
payments were due. It reduced the uninsured population by 12.1
million.
! The least effective subsidy was an above-the-line tax deduction for
the purchase of non-group health insurance by individuals not
covered by Medicare or employment-based insurance: it lowered the
uninsured population by 250,000.
38 In a 1993 study of the response of self-employed individuals to the creation of a partial
tax deduction for their health insurance expenditures by the Tax Reform Act of 1986,
economists Jonathan Gruber and James Poterba found that from 1986 to 1989, between 15%
and 20% of the self-employed with incomes below $20,000 and about 50% of those with
incomes above $50,000 claimed the deduction. From these response rates, they concluded
that a lack of awareness of the presence of the subsidy undercut its effectiveness. See U.S.
Congress, House Committee on Ways and Means, Subcommittee on Health, Health
Insurance Premium Deductions for the Self-Employed, hearing, 104th Cong., 1st sess., Jan.
27, 1995 (Washington: GPO,1996), pp. 42-43.
39 Cost-effectiveness in this context denotes the revenue cost per newly insured person.

CRS-18
Gruber’s Findings on Cost.
! The most costly subsidy was a refundable tax credit for out-of-
pocket health insurance expenditures by individuals not covered by
Medicare that was limited to $1,000 for single filers and $2,000 for
joint and head-of-household filers: its net revenue cost was $62.2
billion (1999 dollars).
! The least costly subsidy was the above-the-line tax deduction for the
same expenditures: it carried a net revenue cost of $0.9 billion
(1999 dollars).
Gruber’s Findings on Equity.
! The subsidy engendering the largest share of benefits for low-
income households was a refundable tax credit for the purchase of
non-group health insurance by individuals not covered by Medicare
or employment-based health insurance. It was limited to $1,000 for
single filers and $2,000 for joint and head-of-household filers and
phased out for single filers with adjusted gross incomes between
$18,000 and $25,000 and for joint and head-of-household filers with
adjusted gross incomes between $30,000 and $50,000. Households
with incomes below 200% of the federal poverty level in 1999
received 69% of the net revenue cost of the subsidy.
! The subsidy granting the lowest share of its benefits to low-income
households was a non-refundable tax credit for the purchase of non-
group health insurance by individuals not covered by Medicare or
employment-based health insurance. It was limited to $1,000 for
single filers and $2,000 for joint and head-of-household filers.
Households with incomes below 200% of the federal poverty level
in 1999 received 22% of the net revenue cost of the subsidy.
! On the whole, refundable tax credits for the purchase of non-group
health insurance were of much greater benefit to low-income
households than either a non-refundable tax credit or a tax
deduction.
Gruber’s Findings on Employer Health Insurance Coverage.
! Only one subsidy engendered an increase (6.6%) in the number of
individuals covered by employment-based health insurance:
a
refundable tax credit for out-of-pocket health insurance expenditures
by all individuals not covered by Medicare. Those already covered
by employer plans were eligible for the credit.
! The subsidy leading to the smallest decline (-0.9%) in the number of
individuals covered by employment-based insurance was a tax
deduction for the purchase of non-group health insurance.
! Two almost identical subsidies generated the largest decline (-9.6%)
in the number of individuals covered by employment-based

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insurance: (1) a refundable tax credit for the purchase of non-group
health insurance by individuals not covered by Medicare or
employment-based health insurance that was limited to $2,000 for
single filers and $4,000 for joint and head-of-household filers and
phased out for single filers with adjusted gross incomes between
$45,000 and $60,000 and for joint and head-of-household filers with
adjusted gross incomes between $75,000 and $100,000; (2) a version
of the same credit which could be paid directly to insurers in
advance of the tax year in which it was claimed.
Gruber’s Findings on Key Administrative Issues.
! Avoiding mismatches between the timing of health insurance
premium payments and the timing of subsidy transfers to eligible
individuals with minimal or no household savings had a significant
impact on the efficacy of the base case. The reduction in the
uninsured population was 37% greater when the base case was
simulated on the assumption that such mismatches were prevented
than when it was simulated without such an assumption.
Gruber 2001 Analysis
In a follow-up to his 2000 study, Gruber explored the potential cost and
effectiveness of what he viewed as three likely directions for the use of tax policy to
enlarge the insured population.40 The directions involved offering new tax subsidies
to employers; offering new tax subsidies to employees; and offering new tax subsides
for the purchase of non-group insurance to individuals not eligible for public or
employer-provided insurance coverage. Gruber assessed and compared the efficiency
– as measured by the estimated revenue cost per newly insured individual – of these
basic options. His key findings are summarized below.
New Subsidies to Employers.
As Gruber has noted, many firms already offer health insurance to employees.
So an important consideration in devising new tax subsidies for employers to expand
health insurance coverage is which firms would be eligible. If the subsidies are not
narrowly or properly targeted, the cost per newly insured individual could quickly
reach unsustainably high levels. Available data on the links between the uninsured
and the workplace suggest a relatively simple and efficient solution: offering the
largest tax subsidy to the smallest firms paying the lowest wages and phasing it out
as firm sizes and average wages rise.
Gruber simulated the effects of just such an approach. He assumed a maximum
tax subsidy rate of 0.4 for firms with 10 or fewer employees and average annual
wages of $10,000 or less. Such a rate was equivalent to a tax credit for 40% of the
cost to the firm of providing health insurance to each employee. In addition, he
assumed that the amount of the subsidy was reduced by 2.5% for every additional
40 See Gruber, Taxes and Health Insurance.

CRS-20
employee beyond 10, so that it reached zero at 50 employees; and that it was also
reduced by any increase in average annual wages beyond $10,000. Gruber found that
such a tax subsidy added 2.3 million individuals to the ranks of the non-elderly
insured at an annual cost of $4.7 billion, or $2,005 (2000 dollars) per newly insured
individual.41 He also found that by increasing the subsidy rate to 0.6, the annual cost
rose by 70% (to $8 billion per year) but coverage expanded by 50%, resulting in a
higher cost per newly insured individual: $2,300.42
New Subsidies to Employees.
Another policy option for expanding health insurance coverage among the non-
elderly analyzed by Gruber consisted of a new tax subsidy to employees to take up
coverage offered by employers. He determined that it would have little effect on
coverage rates and would be relatively inefficient.43 There were two reasons for this
outcome. First, only 5% of those who are offered insurance by employers were
uninsured. Second, the decision to take up coverage was insensitive to changes in
its tax price. Gruber did note that this option offered the advantage of targeting low-
income workers; but it had the disadvantage of not being able to target low-wage
firms, as many low-wage workers are employed by firms that pay relatively high
average wages and already offer insurance.
New Subsidies for Non-Group Coverage.
The final alternative analyzed by Gruber consisted of a new tax subsidy for the
purchase of non-group insurance by individuals not covered under public or
employment-based insurance. He identified three major hurdles lying in the path of
such an approach. One was that about half of uninsured households pay no income
taxes. This fact suggested that if the subsidy were a tax credit, it should be made
refundable. A second hurdle was that most uninsured households lack access to the
liquid assets required to pay insurance premiums before receiving a tax subsidy such
as a refundable tax credit. As a result, the effectiveness of a tax subsidy would be
greatly enhanced if it were made payable in advance. Finally, non-group coverage
was costly; so any tax subsidy would need to cover a large share of premiums if it
were to be highly effective.
Gruber simulated the effects of a tax subsidy similar to what the Bush
Administration proposed in its budget request for FY2002. He assumed that the
subsidy involved a refundable credit of $1,000 for single filers with incomes up to
$75,000, and $2,000 for joint and head-of-household filers with incomes up to
$100,000. In addition, he assumed that it was not payable in advance. Swayed by
such a subsidy, the uninsured population shrank by 4 million persons, and the
estimated cost per newly insured came to $3,300 (2000 dollars).44 Gruber performed
another simulation under the assumption that the credit was payable in advance and
41 Ibid., p. 29.
42 Ibid., p. 30.
43 Ibid., p. 31.
44 Ibid., p. 33.

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found that the cost per newly insured fell to about $2,500. Both estimates were well
above his estimated cost of a new tax subsidy for employers.
Gruber 2002 Analysis
Still another recent study by Gruber is worth considering, since it focused on the
cost and effectiveness of the tax credit for health insurance coverage proposed by the
Bush Administration in its budget request for FY2003. He presented his findings in
a statement made to the House Ways and Means Committee in connection with a
hearing on tax credits for expanding health insurance coverage it held on February
13, 2002.45 The credit had the following features: it was refundable, available only
for the purchase of non-group insurance by those not covered under public or
employer-provided health insurance, payable in advance, and limited to $1,000 for
single individuals with adjusted gross incomes of up to $30,000 and to $3,000 for
families with adjusted gross incomes of either $40,000 (if only one adult purchased
insurance) or $60,000 (if more than one adult purchased insurance).
Gruber’s analysis again involved the use of a micro-simulation model. This one
was similar in design to the one he employed in his 2000 analysis and took into
account what was known about the behavioral responses of non-elderly individuals,
firms, and insurance companies to changes in the tax price of health insurance. One
of his assumptions was that individuals and families who purchased non-group
coverage in response to the credit paid average market prices for that insurance.
He estimated that the subsidy would have a total annual cost of $5.2 billion
(2001 dollars) and result in a net decline in the uninsured population of 1.9 million,
yielding a cost per newly insured individual of nearly $2,800.46 In addition, an
estimated 10.5 million individuals took up the new credit, 3.3 million of whom were
previously uninsured. Nearly 2.5 million of the individuals taking up the credit had
been covered by employment-based coverage.
Of these, 1.5 million persons
voluntarily switched to non-group coverage because they found it to be a better deal
with the credit, and 1.0 million persons involuntarily switched because their
employers dropped health insurance coverage in response to the credit. Some of the
individuals who lost employer-provided insurance ended up uninsured, which
explained why the net decrease in the uninsured population was 1.9 million persons
and not 3.3 million. For these newly uninsured, the cost of non-group coverage
proved too high even with the credit.
Some analysts have contended that the adoption of a tax credit for health
insurance coverage modeled on the President’s proposal but somewhat more
generous would trigger a major overhaul of the non-group market, leading to the
emergence of new low-cost plans with fewer gaps in coverage and less premium
45 U.S. Congress, House Ways and Means Committee, Health Care Tax Credits to Decrease
the Number of Uninsured, hearing, 107th Cong., 2nd sess., Feb. 13, 2002 (Washington: GPO,
2002), pp. 123-128.
46 Ibid., p. 125.

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variation by age and geographic location.47 To explore the cost and efficacy of plans
such as these, Gruber performed another two simulations. In one, he assumed that
half of all persons buying non-group coverage with the credit were able to do so at
prices 25% below average market prices; and in the other, he assumed that the same
group of individuals were able to obtain coverage at prices 50% below average
market prices. His results suggested that the greater the decrease in non-group
premiums under the credit, the larger the decline in the uninsured population and the
greater the displacement of those previously covered by employment-based
insurance.48 Specifically, with a 25% reduction in non-group premiums, the total cost
per year was $5.4 billion (2001 dollars), and the uninsured population fell by 2.2
million persons at a cost per newly insured of $2,503. By contrast, with a 50%
reduction in premiums, the total annual cost came to $6.0 billion (2001 dollars), and
the uninsured population declined by 3.6 million persons at a cost per newly insured
of $1,663.
Conclusions
A central challenge for policymakers interested in using tax policy to achieve
a substantial and lasting reduction in the uninsured population is to devise a tax
subsidy that can accomplish this goal without having undesirable effects on the
allocation of economic resources, the distribution of disposable income among
households, and the cost of tax administration. Generally, tax policy can and does
affect the price and terms of health insurance coverage. The material examined here
has important implications for the use of tax policy to expand this coverage. Its
significance can be illuminated in a series of questions focusing on factors to
consider in designing tax subsidies to expand health insurance coverage.
! Is the subsidy a tax deduction or a tax credit? Many uninsured
individuals reside in low-income households. Gruber has estimated
that up to 90% of uninsured taxpayers with tax liabilities belonged
to the 15% income tax bracket in 1997. Tax deductions become
more valuable as a taxpayer’s marginal tax rate increases. But
generally, one dollar of a tax deduction has a lower revenue cost
than one dollar of a tax credit.
! If the subsidy is a tax credit, is it refundable? Gruber has also
estimated that 50% of uninsured taxpayers have no tax liability –
though the proportion may be smaller today owing to the reduction
in marginal tax rates and the creation of 10% bracket under the
Economic Growth and Tax Relief Reconciliation Act of 2001 and
the increase in wages and salaries since 1997, the year to which
Gruber’s estimate applies. Non-refundable tax credits are valuable
47 For a discussion of policy debate over this possible outcome, see Mark V. Pauly and Len
M. Nichols, “The Nongroup Health Insurance Market: Short on Facts, Long on Opinions
and Policy Disputes,” Health Affairs, Web exclusive [http://www.healthaffairs.org], Oct.
23, 2002, pp. W325-W344.
48 Gruber, Health Care Tax Credits to Decrease the Number of Uninsured, pp. 127-128.

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only if a taxpayer has a tax liability against which it can be claimed.
Refundable tax credits, by contrast, are valuable to all low-income
taxpayers because they can be claimed regardless of whether there
is a current tax liability.
! If the subsidy is a refundable tax credit, is it fixed or
proportional in amount? Another factor shaping the effectiveness
of a tax subsidy to expand health insurance coverage is the share of
premiums it covers. As many uninsured individuals reside in low-
income households, the greater the share of individual and family
premiums met by the subsidy, the greater the rate at which the
subsidy is likely to be taken up by the uninsured. Fixed refundable
tax credits may cover smaller and smaller portions of premiums as
health care costs rise over time. In addition, premiums in the non-
group market vary by age, sex, and geographic location, and in the
group market by size of employer or risk pool. And premiums in the
non-group market tend to be lower for young adults in good health
and higher for older adults in poor health.
! Who is eligible for the subsidy? Recent studies suggest that the
most cost-effective subsidies are apt to be ones which are narrowly
targeted at groups with large proportions of uninsured individuals.
Tax subsidies targeted at low-income households headed by
someone not covered by employer-provided or public insurance are
likely to have a lower revenue cost per newly insured individual than
subsidies with a broader reach, such as a tax deduction for all out-of-
pocket expenditures for health insurance.
But there is some
evidence that targeting firms in the hope of inducing them to offer
coverage to employees may be more effective than targeting
individuals who lack coverage. Gruber has estimated that over
three-quarters of uninsured workers are not offered health insurance
by their employers. In addition, eligibility matters because of the
different ways that firms, individuals, and private insurers can
respond to tax subsidies for health insurance.
! Does the subsidy address key administrative issues? Yet another
factor affecting the cost and efficacy of proposed tax subsidies to
expand health insurance coverage is administrative issues that could
impede their smooth implementation.
At least three can be
mentioned here. One concern is possible mismatches between the
timing of health insurance premium payments and the timing of
subsidy transfers to eligible individuals. Because relatively few
uninsured households appear to have sufficient liquid assets to draw
upon in paying health insurance premiums, making the subsidies
payable in advance of the due date for filing tax returns may enhance
their efficacy.
A related concern is the rate at which eligible
individuals might take up tax subsidies that are payable in advance.
Experience with the federal earned income tax credit suggests that
low-income taxpayers are reluctant to claim advanceable tax credits
because many fear they will end up facing a tax liability when they

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file their tax returns.49 Finally, there is some concern that the IRS
lacks the resources to efficiently administer any advanceable tax
subsidy for health insurance coverage.50 It should also be kept in
mind that there appear to be significant trade-offs between ease of
administration and precision of targeting in tax subsidies to expand
health insurance coverage.
! Does the subsidy address barriers to coverage of high-risk
groups in the private insurance market? Persons with relatively
high risks of certain health problems are likely to find it difficult to
obtain affordable and adequate coverage in the non-group market.
Premiums vary widely by age, sex, and region. And in many states,
insurers are free to exclude pre-exiting conditions from coverage or
to severely restrict coverage for these conditions.
These
underwriting practices raise the question of whether a tax subsidy to
expand health insurance coverage should include regulations aimed
at curbing these practices.
! What is the ultimate policy objective of the tax subsidy? The
design of cost-effective tax subsidies to expand health insurance
coverage also depends in part on the ultimate policy objective. If the
main goal is to improve equity in access to federal tax subsidies for
health insurance, a tax deduction for personal expenditures on health
insurance by those ineligible for existing subsidies may suffice. Or
if the main goal is to reduce substantially the uninsured population,
then a proportional, advanceable, refundable tax credit targeted at
uninsured workers not offered health insurance coverage by their
employers may suffice. But if the main goal is to achieve universal
coverage, then it may be necessary to couple a subsidy such as a
refundable, advanceable, means-tested tax credit with reforms of the
private health insurance market and a requirement that all
individuals purchase health insurance or all firms provide health
insurance to their employees.
49 Gruber, Taxes and Health Insurance, p. 32.
50 See George Guttman, “Another IRS Burden: The New Health Insurance Credit,” Tax
Notes, March 3, 2003, pp. 1322-1324.