Budget Costs of Tax Deductibility of Out-of-Pocket Spending (Without IHAs)
As the differential tax treatment between ESI premiums and OOP spending is reduced, more consumers would opt for lower-premium plans with more cost sharing. We estimate that the behavioral changes would reduce total health spending among those with ESI coverage by about $20 billion annually, or about 3.7 percent of health spending among those with ESI coverage (or self-employed) and enrolled in plans without HSAs or HRAs. The shift to higher cost-sharing would reduce premiums by as much as 10 percent among this group.
After accounting for these behavioral effects, we estimate that OOP deductibility would reduce federal tax revenue by $6 billion in 2023 and $79 billion over the ten-year budget window. We estimate income tax revenue would fall by $167 billion over ten years, but this would be offset by $88 billion in additional payroll tax revenue from reduced ESI premiums.
The $79 billion revenue loss over ten years is significant, but as noted above, it would mean a $20 billion initial reduction in health spending with larger savings in future years.
Budget Costs of Tax Deductibility of IHAs (Without Extending Deduction for OOP Spending)
All else constant, IHAs would reduce income tax revenue, particularly in the near term. While IHAs would be available to all non-Medicare recipients with public or private health insurance, changes in tax revenue would largely be due to tax-preferred contributions by those with ESI coverage who currently don’t use HSAs or HRAs. Consequently, our analysis here focuses on this subgroup. We consider two contribution limits for IHAs: the 50th percentile of current premiums and the 75th percentile of current premiums. The 50th percentile of premiums corresponds to approximately $25,000 for family plans and $8,600 for self-only plans (the 75th percentile thresholds would be $29,800 and $10,100). We assume the thresholds would grow with overall health care premium growth. Estimated revenue losses could be lower if the thresholds only grew at the rate of medical inflation.
We estimate that if the maximum contribution limit is set at the 50th percentile of ESI premiums, taxpayers would save approximately $30 billion in their IHAs in 2023. Over ten years, the federal government would lose $82 billion in revenue. If, instead, the maximum contribution limit was set at the 75th percentile of ESI premiums, taxpayers would save $66 billion in their IHAs in 2023. The loss in income tax revenue would be $12 billion in 2023 and $176 billion over the ten-year budget window.
Budget Effects of IHAs Paired with OOP Deductibility
Over the long-term, all IHA contributions would either be taxed or go to qualified out-of-pocket spending. The additional budget effects from adding IHAs to our extended OOP deductibility proposal are thus relatively small. Nevertheless, here we estimate short-run effects from both proposals. As noted above, our method here likely overstates the long-term cost of IHAs as it does not account for IHA withdrawals in subsequent years or changes in plan selection due to the availability of IHAs.
We estimate the combined revenue losses from IHAs and extending OOP deductibility would be $7 billion in 2023 and $94 billion over the ten-year budget window. While these costs should be viewed as an upper bound, they are nevertheless minor compared to recent health care reforms. The ACA’s coverage provisions, for example, were initially scored as costing $938 billion over its first 10 years—with nearly $900 billion in the second half the budget window. More recently, the Biden Administration has proposed permanently extending expanded ACA subsidies, which would increase ten-year budget deficits by $183 billion.
Potential “Pay-For” Options
Here we propose two potential pay-fors that will reduce federal health care costs while improving the system’s incentives. While we do not explicitly endorse either policy alternative, we present them here to illustrate possible policy alternatives that could produce necessary savings to compensate for the costs of instituting our own proposals.
The first potential pay-for proposes the end of temporary expansions of the ACA premium tax credits. While ACA enrollment has increased over the past years due to expansion reforms in the American Rescue Plan Act of 2021 and the Inflation Reduction Act of 2023, it has occurred at a high cost. While the extensions are now due to expire in January 2026, the Biden Administration is proposing to make these changes permanent. The President’s FY2024 budget request proposed $183 billion over ten years to “make the enhanced premium tax credits previously extended under the Inflation Reduction Act permanent.”
Ending these expansions beginning in 2024 would reduce current law baseline deficits by approximately $45 billion during the ten-year budget window. It would reduce the current policy baseline deficit by $227 billion.
The second potential pay-for proposes to create work requirements for able-bodied Medicaid recipients without dependents…Work requirements are not a new concept. In fact, they were used to great effect through the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA) in 1996 when the Aid to Families with Dependent Children program was replaced by the Temporary Assistance for Needy Families program. It stands as one of the most successful welfare reforms in American history. Dependency fell and employment increased.
Health care reform presents unavoidable trade-offs among cost, quality, and coverage, particularly in the short run. Our proposed reforms are no exception.
You can learn more about cost estimates and pay-fors here.
David and Diane Steffy Fellow in American Public Policy Studies
About Lanhee J. Chen
Lanhee J. Chen, Ph.D. is the David and Diane Steffy Fellow in American Public Policy Studies at the Hoover Institution and Director of Domestic Policy Studies and Lecturer in the Public Policy Program at Stanford University. A veteran of several high-profile political campaigns and himself a candidate for statewide office in California, Chen has worked in politics, government, business, and academia. Chen was a candidate for California State Controller in 2022. He was the strongest-performing statewide Republican, earned more votes than any other Republican candidate in the country in the general election, and won endorsements from every major newspaper in the state. Chen has advised numerous major campaigns, including four presidential efforts. In 2012, he was policy director of the Romney-Ryan campaign, and served as Governor Mitt Romney’s chief policy adviser, a senior strategist on the campaign, and the person responsible for developing the campaign’s domestic and foreign policy. During the 2014 and 2018 campaign cycles, Chen served as a Senior Adviser on Policy to the National Republican Senatorial Committee (NRSC). In addition to his academic appointments, Chen is a Partner at the Brunswick Group, a global business advisory firm, and a member of the Board of Directors at El Camino Health in Northern California. He also advises and invests in early-stage companies and was an operating partner and strategic advisor at NewRoad Capital Partners, a private equity fund. From 2014 to 2018, Chen served as a presidentially-appointed and Senate-confirmed member of the Social Security Advisory Board—an independent, bipartisan panel that advises the president, Congress, and the Commissioner of Social Security on matters related to the Social Security and Supplemental Security Income programs. He also served in the George W. Bush Administration as a senior official at the U.S. Department of Health and Human Services. Chen’s writings have appeared in a variety of outlets, including The Wall Street Journal, The New York Times, and The Washington Post, and he is a regular contributor at CNN Opinion. He has also provided political analysis and commentary on every major television network. Chen was honored in 2015 as one of the POLITICO 50, a list of the “thinkers, doers, and visionaries transforming American politics.” He earned a similar honor in 2012 when he was named one of POLITICO’s “50 Politicos to Watch.” In 2017, Chen was the William E. Simon Visiting Professor in the School of Public Policy at Pepperdine University. At Stanford, he is also an affiliated faculty member of the Center on Democracy, Development and the Rule of Law (CDDRL) at the Freeman-Spogli Institute for International Studies and was Lecturer in Law at Stanford Law School. An eight-time winner of Harvard University’s Certificate of Distinction in Teaching, Chen’s scholarship has appeared or been cited in several of the nation’s top political science journals. Previously, Chen practiced law at Gibson, Dunn & Crutcher LLP and was the Winnie Neubauer Visiting Fellow in Health Policy Studies at The Heritage Foundation. Chen serves in a variety of leadership and advisory roles in nonprofit organizations. He is a Director of the Foundation for Research on Equal Opportunity (FREOPP); Co-Chair of the Policy Advisory Board for Free the Facts, a policy education organization; a member of the Board of Directors of the Winston Health Policy Fellowship; a member of the external advisory committee for the AAMC Research and Action Institute; and a member of the Council of Scholars for the Better Medicare Alliance. He is also a member of the Committee of 100, an organization of prominent Chinese Americans. Chen earned his Ph.D. and A.M. in political science from Harvard University, his J.D. cum laude from Harvard Law School, and his A.B. magna cum laude in government from Harvard College. He is a member of the State Bar of California. A native of Rowland Heights, California, he currently lives in the San Francisco Bay Area with his wife and children.
About Tom Church
Tom Church is a policy fellow at the Hoover Institution. He studies health care policy, entitlement reform, income inequality, poverty, and the federal budget. He also contributes to PolicyEd, the Hoover Institution’s initiative to educate Americans about public policy. He has researched the fiscal effects of major health care proposals. In 2015 he edited the book Inequality & Economic Policy: Essays in Memory of Gary Becker with John B. Taylor and Chris Miller. He also hosts The Libertarian podcast with Richard Epstein. Church received his master’s degree in public policy with honors from Pepperdine University, specializing in economics and international relations. He has a bachelor’s degree in mathematics and political science from the University of Michigan.
About Daniel Heil
Danny Heil is a policy fellow at the Hoover Institution whose focus is on the federal budget, tax policy, and the federal antipoverty programs. Heil’s interests include replacing failed policies with state and federal initiatives that alleviate poverty by encouraging workforce participation and human capital development. He has also written on the perils of telecommunication regulations and the economic effects of e-business. Heil served as Governor Jeb Bush’s economic policy adviser during the 2016 presidential campaign, counseling him on the federal budget, tax policy, and the federal antipoverty programs. Heil received a master’s of public policy degree with a specialization in economics and American politics from Pepperdine University.