Of head taxes, income taxes, and distributive justice in American health care

Law and Contemporary Problems

Volumn 69, Issue 4, 2006, Pages 103-120

  Zelenak, Lawrence ^a  

^a DUKE UNIVERSITY   (United States)

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EID: 33947394898     PISSN: 00239186     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (92)

1. Clark C. Havighurst & Barak Richman, Distributive Injustice(s) in American Health Care, 69 Law & Contemp. Probs. 7, 7-82 (Autumn 2006).
2. Id. at 36.
3. Id. at 28.
4. Id. at 22-25.
5. Other important instances of subsidized activities include providing services under Medicare and Medicaid (to the extent the costs of rendering services exceed allowable payments) and complying with the unfunded federal mandate imposed on any hospital that maintains an emergency room and accepts Medicare payments to treat emergency room patients without regard to ability to pay. 42 U.S.C. § 1395dd(a) (2000).
6. Havighurst & Richman, supra note 1, at 26-27.
7. Id. at 28-29.
8. Id. at 28.
9. On the higher income levels of those with health insurance, as a group, than those without health insurance, see U.S. Census Bureau, Current Population Reports, P60-229, Income, Poverty, and Health Insurance Coverage in the United States: 2004, at 25 tbl.7 (2005) (reporting that of persons living in households with less than $25,000 of income, 24.3% lacked health insurance coverage in 2004; that percentage fell to 20.0% for persons in households with income of $25,000 to $49,999, to 13.3% for persons in households with income of $50,000 to $74,999, and to 8.4% for persons in households with income of $75,000 or more).
10. Corrado Gini, Measurement of Inequality of Incomes, 31 Econ. J. 124 (1921).
11. For a description of alternative measures of inequality (including the Theil index), with a discussion of the advantages and disadvantages of the various measures, see Julie A. Litchfield, World Bank Poverty Net, Inequality: Methods and Tools (1999), www1.worldbank.org/prem/poverty/ inequal/methods/litchfie.pdf. The example in the text employs the Gini coefficient because it is both the most commonly used and the most intuitive of the inequality measures.
12. See Max Lorenz, Methods of Measuring the Concentration of Wealth, 9 Pub. of the Am. Stat. Ass'n 209, 217-18 (1905).
13. Although those without health insurance are poorer as a group, as in the real world there is some overlap in the income ranges of those with and without insurance. See Census Bureau, supra note 8, at 25.
14. All Gini coefficient calculations in this paper were done by the author, with the use of the Resa Corporation's Gini coefficient calculator. P. Wessa, Office for Research Development and Education, Free Statistics Software Version 1.1.18 (2006), http://www.wessa.net.
15. The Gini coefficient for an eight-person population with incomes of $200,000, $150,000, $100,000, $75,000,$75,000, $50,000, $50,000, and $25,000, is 0.323276. The Gini coefficient for an eight-person population with incomes of $198,000, $148,000, $98,000, $73,000, $73,000, $48,000, $48,000, and $23,000 is 0.330571.
16. For example, suppose a society has three insured persons with initial incomes of $200,000, $25,000, and $20,000, and one uninsured person with an initial income of $30,000. The Gini coefficient of the four-person society is 0.495455. If each insured person is taxed $2000 in order to finance a $6000 benefit for the uninsured person, the resulting Gini coefficient (for incomes of $198,000, $23,000, $18,000, and $36,000) is 0.502727. The example is a bit rigged, however, because $4000 of the $6000 in the tax-and-transfer system is taken from people who are poorer - even before the transfer - than the person to whom that $4000 is transferred.
17. This depends, of course, on the assumptions one makes about the distribution of the benefits of R&D.
18. Havighurst & Richman, supra note 1, at 29.
19. Havighurst and Richman are of this view: "[A]ny projects that public lawmakers would be willing to support would almost certainly be financed in less regressive ways [than a head tax]." Id.
20. The 2.9% rate is the sum of the 1.45% tax imposed on employees, I.R.C. § 3101(b)(6) (2005),
21. and the 1.45% tax imposed on employers, I.R.C. § 3111(b)(6) (2005).
22. See I.R.C. § 3121(a)(1) (2005) (limiting the imposition of the employer and employee taxes to finance Social Security benefits to the "contribution and benefit base").
23. Havighurst & Richman, supra note 1, at 36.
24. See, e.g., Joel Slemrod & Jon Bakija, Taxing Ourselves 62-64 (3d ed. 2004).
25. But see Liam Murphy & Thomas Nagel, The Myth of Ownership (2002) (arguing that distributive justice should be concerned with the distribution of after-tax income, rather than with the distribution of tax burdens relative to pre-tax income).
26. See, e.g., Harold M. Groves, Federal Tax Treatment of the Family 10 (1963);
27. Gerard M. Brannon & Elliott R. Morss, The Tax Allowance for Dependents: Deductions Versus Credits, 26 Nat'l Tax J. 599 (1973);
28. Theodore P. Seto & Sande L. Buhai, Tax and Disability: Ability to Pay and the Taxation of Difference, 154 U. Pa. L. Rev. 1053, 1083 (May 2006) ("[T]here appears to be widespread consensus that... some initial portion of every taxpayer's income should not be subject to income tax.");
29. Lawrence Zelenak, Children and the Income Tax, 49 Tax L. Rev. 359, 361-72 (1994) (discussing the history and implications of the clear-income concept).
30. See S. Rep. No. 99-313, at 31-33 (1986), as reprinted in 1986-3 C.B. 31-33 (indicating that one goal of the Tax Reform Act of 1986 was to prevent the imposition of the income tax on families at or below the poverty level).
31. Since 1986, the dependency exemption amount has been nearly identical with the increase in the Department of Health and Human Services (HHS) poverty threshold caused by the addition of one family member. For 2006, for example, the $3300 exemption amount differs by only $100 from the $3400 amount in the HHS guidelines. Rev. Proc. 2005-70, 2005-2 C.B. 979, § 3.17;
32. Annual Update of the HHS Poverty Guidelines, 71 Fed. Reg. 3848 (Jan. 24, 2006).
33. The phaseout of personal and dependency exemptions for high-income taxpayers is contained in I.R.C. § 151(d)(3) (2005).
34. In 2006, the phaseout begins for married couples filing joint returns at an adjusted gross income (AGI) of $225,750, and is completed at an AGI of $348,250. Rev. Proc. 2005-70, 2005-2 C.B. 979, § 3.17.
35. The denial of exemptions to high-income taxpayers is scheduled to be gradually phased out, with the phaseout beginning in 2006 and to be completed in 2010. I.R.C. § 151(d)(3)(E), (F) (2005).
36. The complete repeal of the phaseout is effective for only one year, however. As with all the provisions of the 2001 tax legislation, the repeal of the phaseout is subject to sunset at the end of 2010. Economic Growth and Tax Reconciliation Act of 2001 § 901, Pub. L. No. 107-16, 115 Stat. 38, 150.
37. The exclusion of employer-provided health insurance does not extend to insurance provided to an unmarried domestic partner of an employee unless the domestic partner qualifies as a dependent of the employee. Treas. Reg. § 1.106-1 (2004).
38. Because many employers now provide such non-excludable coverage, the IRS has been required to explain, in private letter rulings, how taxable employer-provided insurance is to be valued. In its first ruling in this area, the IRS stated that the taxable value of a non-excluded fringe benefit is "the amount that an individual would have to pay for the particular fringe benefit in an arm's length transaction" and that, in the health-insurance context, it is "the amount that an individual would have to pay for the particular coverage in an arm's-length transaction (i.e., at individual policy rates)." I.R.S. Priv. Ltr. Rul. 90-34-048 (May 29, 1990)
39. (citing and applying Treas. Reg. § 1.61-21(b)(2)). The IRS soon changed its position, however. In Private Letter Ruling 91-09-060, the IRS stated that in the case of group health insurance "the amount includible... is the fair market value of the group medical coverage, notwithstanding that the fair market value of the group coverage may be substantially less than the fair market value of individual coverage or the subjective value of the coverage to the employee."
40. I.R.S. Priv. Ltr. Rul. 91-09-060 (Dec. 6, 1990).
41. The IRS has adhered to this position ever since. See, e.g., I.R.S. Priv. Ltr. Rul. 92-31-062 (May 7, 1992);
42. I.R.S. Priv. Ltr. Rul. 97-17-018 (Jan. 22, 1997);
43. I.R.S. Priv. Ltr. Rul. 2003-39-001 (June 13, 2003).
44. Although the rulings are not explicit on the point, it is reasonably clear that the IRS contemplates that coverage within a particular group has the same value for each covered individual, regardless of an individual's age, sex, or other attributes. See William V. Vetter, Restrictions on Equal Treatment of Unmarried Domestic Partners, 5 B.U. Pub. Int. L.J. 1, 7 (1995) (reading the rulings in this way). If this is the correct way to value employer-provided health insurance, then I.R.C. § 106 does not actually feature sensitivity to age- and sex-based differences in the cost or value of health insurance excluded from gross income, because there are no such differences in the group-insurance context. The later private letter rulings, however, are clearly inconsistent with general tax principles of valuation and are best understood as an IRS retreat in the face of political and administrative objections to the application of general valuation principles in this context. It is reasonable for the valuation of taxable employer-provided insurance to reflect the lower cost of group coverage than individual coverage, but it is not reasonable to pretend that group coverage has the same value for a twenty-five-year-old male as for a sixty-five-year-old (of either sex).
45. Insurers use indices to express how the cost of health insurance coverage varies according to age and sex. An index number of one for a particular age and sex indicates that the cost of coverage for a person of that age and sex is the same as the average cost of coverage for the entire insured population. For example, the index for a thirty-year-old man is 0.574, so if the average cost of coverage for the entire population is $2000, the cost of his coverage would be $1148. The index for a fifty-year-old woman is 1.762, so the cost of her coverage would be $3524 - more than triple the cost of coverage for the younger man. Lawrence Zelenak, A Health Insurance Tax Credit for Uninsured Workers, 38 Inquiry 106, 108 (2001).
46. Similarly, a fixed allowance cannot distinguish between the person who remains healthy all year and so incurs no cost-sharing expenses (that is, co-payments and deductibles) and the person who incurs several thousand dollars of such expenses.
47. Of course, if the cost of basic health insurance were built into the standard deduction and the exemptions, also providing an exclusion for the actual value of health insurance received from one's employer would amount to two tax-free allowances for the same cost. It does not appear, however, that the cost of basic health insurance is built into the standard deduction and the exemptions because the standard deduction and the exemptions do not feature the age and sex-based adjustments which would be required to reflect the cost of basic health insurance. But see I.R.C. § 63(f)(1) (2005) (allowing a larger standard deduction to taxpayers sixty-five or older).
48. To be sure, the Staff of the Joint Committee on Taxation (Staff) lists the exclusion for employer-provided health insurance, I.R.C. § 106 (2005), as an item in the tax-expenditure budget, thus indicating a view of the exclusion as a subsidy.
49. Staff of the J. Comm. n Taxation, JCS-1-05, Estimates of Federal Tax Expenditures for Fiscal Years 2005-2009, at 37 tb1.1, (Comm. Print 2005).
50. This contrasts with the Staff's "clear income" view of personal and dependency exemptions, as well as the standard deduction, as part of "the normal structure of the individual income tax." Id. at 3.
51. Although the Staff's treatment of the entire exclusion as a tax expenditure is dubious, two points are worth noting. First, under current law the exclusion is not limited to the cost of basic insurance, and the Staff is correct that the exclusion of the cost of more-than-basic insurance should be classified as a tax expenditure. Second, the Staff has an announced bias in favor of tax expenditure classification in debatable cases; the Staff categorizes an item as a tax expenditure whenever there is "a reasonable basis for such classification." Id. at 2.
52. I.R.C. § 213(a) (2005) (imposing 7.5% of AGI floor).
53. Under I.R.C. § 162(l) (2005), however, self-employed taxpayers may deduct their health-insurance costs in full, whether or not they itemize, and without the application of any percentage-of-AGI floor.
54. As described later in this article, under some circumstances health savings accounts (HSAs) and health flexible spending arrangements (health FSAs) permit the exclusion from the tax base of cost-sharing expenses, without regard to the limits imposed on deductions under I.R.C. § 213.
55. See infra notes 43-50 and accompanying text. As also described later in this article, however, in many cases HSAs and FSAs are not adequate substitutes for an unrestricted deduction for basic health care costs not covered by insurance.
56. Havighurst and Richman make this point. See Havighurst & Richman, supra note 1, at 36-37 n.86.
57. See Abigail Zuger, For a Retainer, Lavish Care by "Boutique" Doctors, N.Y. Times, Oct. 30, 2005, § 1, at 1 (describing the trend toward "concierge" personal physicians).
58. Although the exclusion of insurance coverage for more-than-basic health care is objectionable under clear-income analysis, the exclusion for insurance coverage featuring little or no cost sharing is not. As explained in the text, the entire cost of basic health care should be excluded from the tax base, whether that cost consists of (1) the higher cost of insurance with no cost sharing or (2) the sum of the lower cost of insurance with high cost sharing and the deductibles and co-payments paid by a person with such insurance.
59. But see I.R.S. Priv. Ltr. Rul. 91-09-060, supra note 25 (taking the unreasonable position that the value of taxable employer-provided health insurance does not depend on any attributes of the covered individual).
60. Havighurst & Richman, supra note 1, at 36.
61. Id at 37 (describing them as "provid[ing], at best, only weak evidence of the pervasive injustice we observe in U.S. health care").
62. In downplaying the significance of these criticisms, they note that "the regressive consequences would be entirely offset if, as is arguably the case, the government replaces the revenue it loses through such tax expenditures by taxing other income at higher progressive rates." Id.
63. Stanley S. Surrey, Pathways to Tax Reform 134-38 (1973) (expressing this view of deductions and exclusions);
64. see also Harvey E. Brazer, The Federal Income Tax and the Poor: Where Do We Go from Here?, 57 Cal. L. Rev. 422, 441 (1969) (noting that the tax benefit from a dependency exemption of any given dollar amount is greatest for a taxpayer in the highest bracket).
65. For criticisms of other attempts to apply the upside-down subsidy critique to adjustments to the tax base designed to measure ability to pay, see Zelenak, supra note 22, at 363-65 (regarding dependency exemptions),
66. and Seto & Buhai, supra note 22, at 1093 (explaining that a deduction or an exclusion, rather than a credit, is the proper tax mechanism if the goal is "to adjust for differences in ability to pay").
67. Havighurst & Richman, supra note 1, at 37 n.86.
68. Notice, incidentally, that this part of the complaint does not depend on the existence of progressive marginal rates; even under a flat tax it would be inappropriate to subsidize extravagant health-insurance benefits for the well-to-do.
69. Havighurst & Richman, supra note 1, at 36.
70. Id at 38;
71. see also I.R.C. § 223 (2005) (allowing a deduction for contributions by the taxpayer to the taxpayer's HSA).
72. If the taxpayer's employer makes contributions to the taxpayer's HSA to cover the taxpayer's cost-sharing expenses, including contributions made under a salary-reduction agreement, those contributions are excluded from the taxpayer's gross income. I.R.C. § 106(d) (2005).
73. However, the sum of deductible and excludable annual contributions may not exceed an inflation-adjusted ceiling amount, which is $2700 (self-only coverage) or $5450 (family coverage) in 2006. I.R.C. §§ 223(b), 106(d) (2005); Rev. Proc. 2005-70, 2005-2 C.B. 979, § 3.22.
74. The minimum deductible increases to $2000 in the case of family coverage.
75. As Havighurst and Richman note, in one respect taxpayers with HDHPs and HSAs receive better tax treatment than taxpayers with employer-provided health insurance with little or no cost sharing - contributions may accumulate within an HSA, and no tax is imposed on the HSA's resulting investment income. They accurately characterize this as a "new tax shelter for the well-to-do." Havighurst & Richman, supra note 1, at 39 n.96.
76. In a recent survey by the Kaiser Family Foundation, only 2.3% of employers reported offering HSA-qualified HDHPs, and only 15% of employees offered that option selected it; the Foundation estimated that a total of 810,000 workers were enrolled in HSA-qualified HDHPs nationwide. Kaiser Family Foundation, Employer Health Benefits 205 Annual Survey § 8 (2005), available at http://www.kff.org/insurance/ 7315/upload/7315.pdf.
77. In the same survey, 2% of employers not currently offering HSA-qualified HDHPs (including 7% of employers with 1,000 or more employees) indicated they were likely to do so next year. Id;
78. see also Staff of the J. Comm. on Taxation, supra note 29, at 37 (estimating expected tax-expenditure amounts for the five-year period 2005-2009, and indicating only $2.7 billion for HSAs over the five years, compared with $493.7 billion for exclusions under I.R.C. § 106 and $44.1 billion for deductions under I.R.C. § 213).
79. See I.R.C. § 125 (2005);
80. Prop. Treas. Reg. § 1.125-2, Q&A (7) (Mar. 7, 1989);
81. I.R.S., Dep't of the Treasury, Publ'n No. 969, Health Savings Accounts and Other Tax-Favored Health Plans 12-13 (2004), available at http://www.irs.gov/pub/irs-pdf/p969.pdf (describing health FSAs). Arguably, Health Reimbursement Arrangements (HRAs) constitute a third means of paying cost-sharing medical expenses with before-tax dollars. If, pursuant to an HRA, an employer reimburses an employee (up to a maximum annual amount specified in the HRA plan) for cost-sharing medical expenses, the reimbursement is excluded from the employee's gross income. See generally I.R.S. Notice 2002-45, 2002-2 C.B. 93 (describing in detail the rules applicable to HRAs). HRA reimbursements must be financed solely by the employer; they may not be made pursuant to a salary-reduction agreement. (Any excess of the ceiling on annual reimbursements over actual reimbursements during the year may be carried forward for reimbursements in later years.) From the employee's perspective, having cost sharing covered by an HRA is the equivalent of having health insurance with no cost sharing at all. For this reason, HRAs are not discussed in the text as a means of obtaining favorable income tax treatment for cost-sharing expenses.
82. On the complexities of how a fully rational taxpayer should balance the tax savings from health FSAs against the use-it-or-lose-it risk, see Franklin Lowenthal and Phillip Storrer, Medical FSAs: An Expected Value Analysis, 100 Tax Notes 521 (2003).
83. In a 2003 national survey by the Kaiser Family Foundation, 42% of employees surveyed indicated their employer or their spouse's employer offered a health FSA option, 49% indicated the option was not available, and 9% did not know. Of those with the option, 34% indicated they participated, 65% indicated they did not participate, and 1% did not know. Kaiser Family Foundation, The Kaiser Family Foundation Health Insurance Survey (2004), available at http://www.kff.org/insurance/ upload/2003-health-insurance-survey-toplines.pdf.
84. Havighurst & Richman, supra note 1, at 43.
85. Id. at 45.
86. Id. at 55-57.
87. Id. at 38.
88. The President's Advisory Panel on Federal Tax Reform, Simple, Fair and Pro-Growth: Proposals to Fix America's Tax System 78-82 (2005). The Panel's stated reasons for its proposal resonate with Havighurst's and Richman's critique of current law: Because of the tax-preferred status of health insurance, people are more likely to buy health insurance that provides more coverage than they would in the absence of the incentive. Workers who purchase more health insurance may, in turn, use more health services, thereby increasing overall health spending. Estimates are imprecise, but removing subsidies for employer-provided health insurance could lower private spending on healthcare by 5 to 20 percent.... The Treasury Department estimates that the Panel's recommendation to cap the health insurance amount at the average premium and provide an equal deduction to all taxpayers would reduce the number of uninsured Americans by 1 to 2 million people.
89. Id. at 80, 82.
90. Id. at 81. These are "the national average amount[s] projected to be spent on health insurance premiums in 2006."
91. Id. at 82.
92. Given the purpose of equalizing the tax treatment of employer-provided and individually purchased health insurance, there appears to be a technical error in the proposal. In applying the $5000 /$11,500 ceiling to the exclusion of employer-provided insurance, the proposal seems to contemplate valuing the coverage in the manner currently used by the IRS in valuing taxable coverage provided to the domestic partners of employees - by disregarding the effect of the age and sex of an insured person on the value of her coverage. See I.R.S. Prvt. Ltr. Rul. 91-09-060, supra note 25; see also supra text accompanying note 25. Thus, the proposal would exclude the entire value of employer-provided coverage for all members of an employer group as long as the average cost of coverage within the group was within the dollar ceilings, even if the value of coverage for some members of the group would exceed the ceilings if the valuation of the coverage reflected age- and sex-based differences. This is reasonable, as it approximates the results that would be achieved under the more theoretically proper approach of (1) valuing the coverage taking the age and sex of the insured into account and (2) adjusting the ceiling on the exclusion to take age and sex into account. The problem arises with respect to the treatment of individually purchased coverage, where a twenty-five-year-old-male might be able to deduct the entire cost of more-than-basic coverage under the $5000 ceiling, whereas a sixty-five-year-old of either sex subject to the same ceiling might not be able to deduct much of the cost of even barebones coverage. The solution, of course, would be to adjust the deduction ceilings to reflect differences in the cost of basic insurance for taxpayers in different age and sex categories.