Paul L. Caron

Wednesday, July 18, 2012

Rosenzweig: The Individual Mandate and the Tax Treatment of Health Insurance

Adam Rosenzweig Rosenzweig(Washington U.), The Individual Mandate and the Tax Treatment of Health Insurance:

The most controversial aspect of the ACA has been the so-called "individual mandate" — or the requirement that all individuals acquire health insurance or face a penalty. ... [F]rom a tax policy standpoint it is interesting to note that there is little substantive difference between an individual mandate and the long-standing treatment of health insurance under the Internal Revenue Code.

Consider the following hypothetical: Erica Chang works for an employer that provides the option to receive $10,000 per year in additional cash compensation or to pay $10,000 in premiums towards health insurance. Section 106 would generally exclude the payment of premiums by the employer from gross income, while the cash would clearly be included in gross income. The power to choose between insurance and cash would typically render the provisions of § 106 inapplicable, but § 125 permits employees to make the choice between health care and cash without endangering the § 106 exclusion. Consequently, if Erica chooses the health insurance, she receives $10,000 in compensation tax free, while if she chooses the $10,000 in cash she has gross income. Assume Erica chooses the cash and pays $3,000 in tax, and then purchases health insurance for $7,000. During the year, Erica needs surgery which costs $15,000. Under either scenario, the health insurance pays the $15,000 and Erica would have no gross income under § 104. By contrast, assume she chooses to receive the $10,000 in cash, pay $3,000 in tax, and then invest $7,000 in stocks rather than purchase health insurance. During the year the stocks appreciate to $15,000, at which time she needs the surgery. Erica sells the stocks to pay for the surgery, resulting in $8,000 of gross income and a tax liability of $1,250.

Notice the consequences. If Erica chooses employer-provided health insurance, she has no tax liability, while if she chooses privately purchased health insurance, she pays a tax "penalty" of $3,000, and if she chooses not to carry health insurance at all she incurs a tax "penalty" of $3,000 plus an additional "penalty" of $1,250 when she does in fact get sick. This is functionally equivalent to an individual mandate to purchase health insurance backed by a tax penalty for failure to do so, calculated in reference to the taxpayer’s income. Thus, §§ 104, 105, and 106 work to substantially replicate the mandate, although in a more implicit manner, for anyone who earns enough salary to pay income taxes. Regardless of the litigation over the ACA’s individual mandate, it seems like a waste of time and energy to endlessly fight over a provision as if it were unprecedented when the basic premise has served as the basis for U.S. tax policy towards health insurance for over fifty years.

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Technical analysis: The discussed mandate is the mandate as defined by Chief Justice Roberts. If he had not changed the definition of the mandate to a tax penalty the door would have been open to jail people for not buying health insurance. Obamacare is a wealth tax. Medicare is a labor tax and also a politically painless way to reduce Social Security payments. Justice Roberts rewrote the mandate in a way that weakens its political appeal to members of Congress and the President.

Posted by: Huggy | Jul 19, 2012 10:41:39 AM

Using your example in the following hypothetical: Erica was a very hardworking and savvy investor and as such has amassed enough assets to live off capital gains and tax free municipal bond interest.
See where that leads you.

Posted by: cubanbob | Jul 19, 2012 8:02:25 AM

No, that's wrong.

Though having paid lifelong Medicare premiums, when I'm at my overseas home in Brazil, I get no Medicare benefits.

The same holds true of Obamacare for all 15 million or more American expatriates.

Posted by: Jimbino | Jul 18, 2012 10:50:43 PM