Tag Archives: Tax Subsidies

Insuring Health Insurability

22 Saturday Dec 2018

Posted by in Health Insurance

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The latest blow to Obamacare went down just before the holidays when a federal judge in Texas ruled that the individual mandate was unconstitutional. The decision will be appealed, so it will have no immediate impact on the health-care law or insurance markets. But as Eugene Volokh noted, the mandate itself became meaningless from an enforcement perspective after the repeal of the penalty tax for non-coverage in 2017, despite the fact that some individuals might still opt for coverage out of “respect for the law”. What will really matter, when and if the decision is upheld, is the nullification of the complex web of regulations created by Obamacare, officially known as the Affordable Care Act or ACA. Perhaps most important among these is the requirement that buyers in good health and those in poor health must be charged the same price for coverage. That is “community rating” and it is the chief reason for the escalation of insurance premiums under Obamacare.

One Size Misfits All

Community rating means that everyone pays the same premium regardless of health. Those in good health must pay higher than actuarially fair premiums to subsidize the sick or high-risk with premiums that are less than actuarially fair. Two provisions of the ACA were intended to make this work: first, the individual mandate required everyone to remain in the game (and paying the subsidies) rather than going uninsured and paying the “tax” penalty. But the penalty was so light that many preferred it to actually buying insurance. Now, of course, the penalty has been repealed. Second, individuals with incomes below 250% of poverty line receive premium subsidies from the federal government to offset the high cost of coverage. That means low-income buyers do not have to confront the high premiums, which was hoped to keep them in the game.

Community rating caused premiums in the individual insurance market to increase dramatically. This was compounded by the law’s minimum coverage requirements, which are more comprehensive than many consumers would have preferred. Lots of younger, healthier consumers opted out while the sick opted in, or even worse, opted in only when they became sick. This deterioration in the “risk pool” is the so-called insurance “death spiral”. The pool of insureds becomes increasingly risky, premiums escalate, more healthy consumers opt out, and the process repeats. At the root of it is the distortion in the way that risk is priced by community rating.

Tailored Coverage

The coverage and pricing of risk is better left to markets. That means consumers and insurers will reach agreement on policy provisions that are mutually beneficial ex ante. Insurers will offer to cover risks up to the point at which the expected marginal cost of underwriting is equal to value, or the buyer’s willingness to pay. An insurer who offers unattractive policies or charges too much will find its business undercut by competitors. But when risk is priced by government fiat and community rating, this natural form of market information discovery is impossible.

Tax vs. Premium Subsidies

Many in the high-risk population will be unable to afford coverage in the absence of community rating. There are only two general options: they pay what they can for care but otherwise go without insurance coverage, accepting charity care if they are willing; or, taxpayers pay, as under Medicaid. Most lack coverage because they simply cannot afford it, even when they earn too much to qualify for Medicaid.

That situation can be resolved in the long-term (as I’ll describe below), but an overhang of individuals with pre-existing conditions in need of subsidies will persist for a period of years. Under Obamacare, subsidies were paid by charging higher premia to healthy individuals through community rating. Again, that distorted signals about risk and value, creating unhealthy incentives among insurance buyers. The death spiral is the outcome. Subsidies funded by general taxation do not create these price distortions, however, and should be relied upon for assisting the high-risk population, at least those who are determined to qualify.

Health Status Insurance

The overhang of individuals with pre-existing conditions requiring subsidies can never be eliminated entirely—every day there are children born with critical, unanticipated health needs. However, the overhang can shrink drastically over time under certain conditions. A development that is already receiving meaningful attention in the market is the sale of health insurance options, as described by John Cochrane. I have written about this method of protecting future insurability here.

Cochrane raises the subject within the context of new HHS rules allowing insurance companies to offer “temporary” insurance coverage up to a year, but with guaranteed renewability through a total of 36 months of coverage. Unfortunately, if you get sick before the end of the 36th month, you’ll have to give up your policy and pay more elsewhere.  But Cochrane speculates:

“Unless, perhaps, they really are letting insurance companies offer the right to buy health insurance as a separate product, and that can have as long a horizon as you want? If they haven’t done that, I suggest they do so! I don’t think the ACA forbids the selling of options on health insurance of arbitrary duration.”

Cochrane links to this earlier article in which John C. Goodman discusses the ruling allowing the sale of temporary plans:

“The ruling pertains to ‘short-term, limited duration’ health plans. These plans are exempt from Obamacare regulations, including mandated benefits and a prohibition on pricing based on expected health expenses. Although they typically last up to 12 months, the Obama administration restricted them to 3 months and outlawed renewal guarantees that protect people who develop a costly health condition from facing a big premium hike on their next purchase.

The Trump administration has now reversed those decisions, allowing short-term plans to last up to 12 months and allowing guaranteed renewals up to three years. The ruling also allows the sale of a separate plan, call ‘health status insurance,’ that protects people from premium increases due to a change in health condition should they want to buy short-term insurance for another 3 years.”

That is far from permanent insurability, but the concept has nevertheless taken hold. An active market in health status insurance would reduce the pre-existing conditions problem to a bare minimum. The financial risks of deteriorating health would be underwritten in advance. Once stricken with illness, those unlucky individuals would then have coverage at standard rates by virtue of the earlier pooling of the risk of future changes in health status. At standard rates, relatively few high-risk individuals would require subsidies in order to afford coverage .

Will healthy, temporarily insured or uninsured individuals buy these options? Some, but not all, so subsidies will never disappear entirely. Still, the population of uninsured individuals with pre-existing conditions will shrink drastically. In the meantime, a healthy market for health insurance coverage should flourish, reestablishing the authority of the consumer over the kind of health care coverage they wish to purchase and the kinds of financial risks they are willing to bear.

 

 

A Trump Tax Reform Tally

03 Wednesday May 2017

Posted by in Big Government, Taxes, Trump Administration

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The Trump tax plan has some very good elements and several that I dislike strongly. For reference, this link includes the contents of an “interpretation” of the proposal from Goldman Sachs, based on the one-page summary presented by the Administration last week as well as insights that the investment bank might have gleaned from its connections within the administration. At the link, click on the chart for an excellent summary of the plan relative to current law and other proposals.

At the outset, I should state that most members of the media do not understand economics, tax burdens, or the dynamic effects of taxes on economic activity. First, they seem to forget that in the first instance, taxpayers do not serve at the pleasure of the government. It is their money! Second, Don Boudreaux’s recent note on the media’s “taxing” ignorance is instructive:

“In recent days I have … heard and read several media reports on Trump’s tax plan…. Nearly all of these reports are juvenile: changes in tax rates are evaluated by the media according to changes in the legal tax liabilities of various groups of people. For example, Trump’s proposal to cut the top federal personal income-tax rate from 39.6% to 35% is assessed only by its effect on high-income earners. Specifically, of course, it’s portrayed as a ‘gift’ to high-income earners.

… taxation is not simply a slicing up of an economic pie the size of which is independent of the details of the system of taxation. The core economic case for tax cuts is that they reduce the obstacles to creative and productive activities.“

Boudreaux ridicules those who reject this “supply-side” rationale, despite its fundamental and well-established nature. Thomas Sowell makes the distinction between tax rates and tax revenues, and provides some history on tax rate reductions and particularly “tax cuts for the rich“:

“… higher-income taxpayers paid more — repeat, MORE tax revenues into the federal treasury under the lower tax rates than they had under the previous higher tax rates. … That happened not only during the Reagan administration, but also during the Coolidge administration and the Kennedy administration before Reagan, and under the G.W. Bush administration after Reagan. All these administrations cut tax rates and received higher tax revenues than before.

More than that, ‘the rich’ not only paid higher total tax revenues after the so-called ‘tax cuts for the rich,’ they also paid a higher percentage of all tax revenues afterwards. Data on this can be found in a number of places …“

In some cases, a proportion of the increased revenue may have been due to short-term incentives for asset sales in the wake of tax rate reductions. In general, however, Sowell’s point stands.

Kevin Williamson offers thoughts that could be construed as exactly the sort of thing about which Boudreaux is critical:

“It is nearly impossible to cut federal income taxes in a way that primarily benefits low-income Americans, because high-income Americans pay most of the federal income taxes. … The 2.4 percent of households with incomes in excess of $250,000 a year pay about half of all federal income taxes; the bottom half pays about 3 percent.”

The first sentence of that quote highlights the obvious storyline pounced upon by simple-minded journalists, and it also emphasizes the failing political appeal of tax cuts when a decreasing share of the population actually pays taxes. After all, there is some participatory value in spreading the tax burden in a democracy. I believe Williamson is well aware of the second-order, dynamic consequences of tax cuts that spread benefits more broadly, but he is also troubled by the fact that significant spending cuts are not on the immediate agenda: the real resource cost of government will continue unabated. We cannot count on that from Trump, and that should not be a big surprise. Greater accumulation of debt is a certainty without meaningful future reductions in the growth rate of spending.

Here are my thoughts on the specific elements contained in the proposal, as non-specific as they might be:

What I like about the proposal:

  • Lower tax rate on corporate income (less double-taxation): The U.S. has the highest corporate tax rates in the developed world, and the corporate income tax represents double-taxation of income: it is taxed at the corporate level and again at the individual level, perhaps not all at once, but when it is actually received by owners.
  • Adoption of a territorial tax system on corporate income: The U.S. has a punishing system of taxing corporate income wherever it is earned, unlike most of our trading parters. It’s high time we shifted to taxing only the corporate income that is earned in the U.S., which should discourage the practice of tax inversion, whereby firms transfer their legal domicile overseas.
  • No Border Adjustment Tax (BAT): What a relief! This was essentially the application of taxes on imports but tax-free exports. Whatever populist/nationalist appeal this might have had would have quickly evaporated with higher import prices and the crushing blow to import-dependent businesses. Let’s hope it doesn’t come back in congressional negotiations.
  • Lower individual tax rates: I like it.
  • Fewer tax brackets: Simplification, and somewhat lower compliance costs.
  • Fewer deductions from personal income, a broader tax base, and lower compliance costs. Scrapping deductions for state and local taxes in exchange for lower rates will end federal tax subsidies from low-tax to high-tax states.
  • Elimination of the Alternative Minimum Tax: This tax can be rather punitive and it is a nasty compliance cost-causer.

What I dislike about the proposal:

  • The corporate tax rate should be zero (with no double taxation).
  • Taxation of cash held abroad, an effort to encourage repatriation of the cash for reinvestment in the U.S. Taxes on capital of any kind are an act of repeated taxation, as the income used to accumulate capital is taxed to begin with. And such taxes are destructive of capital, which represents a fundamental engine for productivity and economic growth.
  • Retains the mortgage interest and charitable deductions: Both are based on special interest politics. The former leads to an overallocation of resources to owner-occupied housing. Certainly the latter has redeeming virtues, but it subsidizes activities conferring unique benefits to large donors.
  • Increase in the standard deduction: This means fewer “interested” taxpayers. See the  discussion of the Kevin Williamson article above.
  • We should have just one personal income tax bracket, not three: A flat tax would be simpler and would reduce distortions to productive incentives.
  • Tax relief for child-care costs: More special interest politics. Subsidizing market income relative to home activity, hired child care relative to parental care, and fertility is not an appropriate role for government. To the extent that public aid payments are made, they should not be contingent on how the money is spent.
  • Many details are missing: Almost anything could happen with this tax “plan” when the real negotiations begin, but that’s politics, I suppose.

Mixed Feelings:

  • Descriptions of the changes to treatment of pass-through” income seem confused. There is only one kind of tax applied to the income of pass-through entities like S-corporations, and it is the owner’s individual tax rate. Income from C-corporations, on the other hand, is taxed twice: once at a 15% corporate tax rate under the Trump plan, and a second time when it is paid to investors at an individual tax rate, which now range from 15% to almost 24% for “qualified dividends” (most dividend payments), but are likely to range up to 35% for “ordinary” dividends under the plan. So effectively, double-taxed C-corporate income would be taxed at total rates ranging from 30% to 50% after tallying both the C-corp tax and the individual tax. (This is a simplification: C-corp income paid as dividends would be taxed to the corporation and then immediately to the shareholder at their individual rate, while retained corporate income would be taxed later).

Presumably, the Trump tax plan is to reduce the rate on “pass-through” income to just 15% at the individual level, regardless of other income. (It is not clear how that would effect brackets or the rate of taxation on other components of individual income.) Is that good? Yes, to the extent that lower tax rates allow individuals to keep more of their hard-earned income, and to the extent that such a change would help small businesses. S-corps have always had an advantage in avoiding double taxation, however, and this would not end the differential taxation of S and C income, which is distortionary. It might incent business owners to shift income away from salary payments to profit, however, which would increase the negative impact on tax revenue.

  • Interest deductibility and expensing of capital expenditures are in question. Interest deductibility puts debt funding on an equal footing with equity funding only if the double tax on C-corp income is fully repealed. Immediate expensing of “capex” would certainly provide an investment incentive (as long as “excess” expenses can be carried forward), and for C-corporations, it would certainly bring us closer to elimination of the double-tax on income (the accounting matching principle be damned!).
  • There is no commitment to shrink government, but that’s partly (only partly) a function of having abandoned revenue neutrality. It’s also something that has been promised for the next budget year.
  • The tax reform proposal represents a departure from insistence on revenue neutrality: On the whole, I find this appealing, not because I like deficits better than taxes, but because there may be margins along which tax policy can be improved if unconstrained by neutrality, assuming that the incremental deficits are less damaging to the economy than the gains. The political landscape may dictate that desirable changes in tax policy can be made more easily in this way.

Shikha Dalmia wonders whether a real antidote for “Trumpism” might be embedded within the tax reform proposal. If the reforms are successful in stimulating non-inflationary economic growth, a “big if” on the first count, the popular preoccupations inspired by Trump with immigration policy, the “wall” and protectionism might just fade away. But don’t count on it. On the whole, I think the tax reform proposal has promise, though some of the good parts could vanish before a bill hits Trump’s desk, and some of the bad parts could get worse!