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One of the more baffling quirks of the federal tax code is the different treatment of health insurance premiums, depending on who pays them. When an employer pays the premium, the cost is deductible as a business expense, and is also excluded from the employee’s taxable income. However, when a person buys an insurance policy through the individual insurance market, the premium costs are generally not deductible from his income. This means that employer-based health insurance receives a tax break that is not available to individual buyers. It is one of the factors that drive our employer-based private health insurance system, and also makes insurance more expensive, on an after-tax basis, to individual buyers.
One way to level the playing field and make individual health insurance more affordable would be to change the tax code and allow individuals to deduct the cost of their health insurance from their taxable income. If you paid $10,000 for a policy, you would get a $10,000 deduction.
It’s not clear why this change has never been made. There are no obvious special-interest groups to oppose it. The main concern may have been the potential cost to the Treasury in lost tax revenue. But Congress has enacted many other costly tax breaks that made a lot less sense.
Making premiums tax-deductible for everyone would not be a panacea. For one thing, the deduction is valuable only to individuals who have taxable income. Yet in 2007, one third of all taxpayers filing federal returns reported zero taxable income. A new deduction will not cut your tax bill if it is already zero.
Also, this change would not make insurance “affordable” for everyone, because the tax savings for an individual would be much smaller than the premium cost of the policy. If you’re in the 28 percent tax bracket, deducting $10,000 from your taxable income saves you $2,800 in taxes – not the $10,000 cost of the policy.
Still, one of the principles of a fair tax code is that people in similar economic circumstances should pay similar taxes. All else equal, your tax bill should not be higher than your neighbor’s simply because you buy health insurance on your own and she gets her policy through her employer. And this change would make individual insurance more affordable than it is now.
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