As Congress returns, so does the health-care debate, including an important intramural squabble among Republicans. To wit, what is the better way to move to an individual based insurance system -- via a tax credit, or a tax deduction?

This may seem like an arcane policy point, but it has major consequences for the tax system, and ultimately for the cause of broader tax reform. Nearly all Republicans agree that giving individuals the same tax benefits that businesses now have for health care is the key to building a more competitive and equitable insurance market. The dispute is about how to do it.

One camp, led by President Bush and Arizona's Jon Kyl in the Senate, supports a "standard deduction" along the lines unveiled by the White House earlier this year. Mr. Bush's proposal would replace the unlimited health-care tax deduction for employers with a $15,000 deduction for a family, or $7,500 for an individual. The deduction would apply both against the income and payroll tax, and would go a long way toward creating a more affordable private insurance market. Presidential candidates Rudy Giuliani and Mitt Romney also now favor a version of the tax deduction policy.

On the other side are several Senators, led by South Carolina's Jim DeMint and Oklahoma's Tom Coburn, who agree on ending employer subsidies but want to give individuals a "refundable" tax credit. North Carolina Senator Richard Burr has proposed a tax credit of $5,400 per family, and $2,160 per individual. Because it's "refundable," the tax credit would also go to individuals who pay no taxes at all -- essentially in the form of a government handout to buy individual insurance.

We think the tax deduction has the better argument, especially as a matter of tax policy. Tax credit proponents tout their reform as "budget neutral," meaning that it neither raises nor lowers overall federal revenues. But that masks the enormous shift in the tax burden that it would require, including a big tax increase on large portions of the middle class.

Congress's Joint Tax Committee has estimated that, among families earning adjusted gross income of $75,000 a year, more would lose more tax benefits than they'd gain under the tax credit by 2009. By 2018, some 60.7 million filers -- or two-thirds of today's taxpayers -- would face a net tax increase. Most of those happen to be Republican voters.

Meanwhile, the "refundable" tax credit would require some $800 billion over 10 years in new health-care spending for those who don't pay any income taxes. In other words, a "universal" tax credit would mean a major redistribution of wealth from middle- and upper-middle-income families to subsidize health care for lower earners. Once embedded in the tax code, this would become a new "entitlement" that would be nearly impossible to repeal.

Such a universal credit would also continue the trend of removing even more Americans from the tax rolls -- by some estimates as many as 12 million more. Nearly half of the American public already pays no income tax, and increasing that percentage would make it politically easier to raise marginal tax rates in the future. It would also mean that any future tax reform would result in a net tax increase on most Americans -- a political loser save perhaps in an economic crisis.

The tax deduction strategy, by contrast, introduces fewer distortions into the tax code. The Bush plan might result in a slight tax increase for those who currently have the most gold-plated health insurance plans. But an estimated 80% of the 160 million Americans who are now insured by their employers would get a net tax cut -- and that's before calculating the potential wage gains that employers could pass along if they no longer paid for increasing health-care costs.

The real argument for the tax credit idea is political -- namely, that it can be called "universal" and thus claim to cover all Americans the way a government-run system would. Senators DeMint and Coburn believe this is a better strategy to counter HillaryCare and its variations. But we think they're selling short the appeal of the deduction to most tax-paying voters.

The Treasury Department estimates the Bush proposal would add at least five million Americans to the ranks of the insured, and that's before the tax change led to a far more robust and affordable individual insurance market than we have currently. Our guess is that the deduction strategy is also likely to produce something close to "universal coverage" down the road -- and at a far lower cost in terms of tax distortions and incentives for higher income-tax rates than with a tax credit.

Both Republican ideas are preferable to the current slow march to government-run health care. But if Republicans want to make the sharpest break with that march, they'll unite around the Bush-Giuliani-Romney tax deduction strategy.

Date Title
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