The McCain health-care insurance tax credit may well be one of the most misunderstood proposals of this presidential election.

[Guest guest]

Almost Everyone

Would Do Better Under the McCain Health Plan

His tax credit

is larger than the current tax subsidy for insurance.

The McCain

health-care insurance tax credit may well be one of the most misunderstood

proposals of this presidential election. Barack Obama has been ruthless in his

attacks. But the tax credit is highly progressive and will provide a powerful

incentive for people to purchase health insurance. These features under normal

circumstances should endear Democrats to the proposal.

There has been a

lot of rhetoric and misstatements, but what exactly does Sen. McCain have in

mind? He would replace the current income tax exclusion for employer-sponsored

health insurance with a refundable tax credit -- $5,000 for those who purchase

family coverage and $2,500 for individual coverage. Mr. McCain would also

reform insurance markets to stem the growth in health insurance premiums.

What many may

not realize is that the federal government already " spends " roughly

$300 billion to $400 billion through the tax code to encourage people to pay

for their health care through employer-sponsored health insurance. This subsidy

takes the form of the exclusion for employer-sponsored health insurance from

both income and payroll taxes.

Still, some 45

million Americans are uninsured; and the growth in health-care spending

continues to outpace the growth in incomes and the economy, which portends

further increases in the number of uninsured. The employer-based system itself

is eroding. Voters should be wondering whether there is a better approach than

this subsidy.

Consider the

current exclusion. Its value rises with how much someone spends on health care,

and how much of this spending is funneled through employer-sponsored

health-care coverage. This creates an incentive for people to purchase policies

with low deductibles, or which cover routine spending. These policies look a

lot less like insurance and more like prefunded spending accounts purchased

through employers and managed by insurance companies. Consider homeowners and

auto insurance policies. Do these cover routine spending on cleaning the

gutters or tuning up a car?

The subsidy

encourages people to buy bigger policies that cover more, and leads to greater

health-care spending. Moreover, lower deductibles and coverage of routine

spending dulls consumers' sensitivity to price. Reducing the tax bias should

result in insurance that is more focused on catastrophic coverage and less on

routine spending.

By replacing the

income tax exclusion with a fixed, refundable credit, the McCain proposal

reduces the tax bias for large insurance policies. Because the credit is for a

fixed amount, regardless of how much you spend on health care, it helps break

the link between the existing tax subsidy and how much is spent on health care.

This improves incentives in the health-care market by reducing the bias that

has contributed to such a high level of health-care spending.

Moreover, the

credit provides a powerful incentive for people to purchase insurance. The two

tax provisions -- the new credit and the repeal of the income tax exclusion --

on net provide a substantial tax cut of $1.4 trillion over 10 years. Not only

do most Americans receive a tax cut under the McCain proposal, but the tax cut

is directed toward low and moderate income taxpayers.

Consider the

family of four shown in the chart nearby, assumed to purchase a $14,000 health

insurance policy. The straight line reflects what the family would get under

the $5,000 McCain tax credit. The lower line shows the value of the current

income tax exclusion, which rises and falls with a taxpayer's tax rate.

What is striking

about this picture -- and contradicts Mr. Obama's public comments -- is that

the McCain tax credit for the purchase of health insurance exceeds the value of

the current exclusion for all income levels shown. Indeed, it generally

provides more resources to purchase health insurance than the existing

exclusion. The total subsidy for health care would rise from about $3.6

trillion over 10 years today to roughly $5 trillion under his proposal.

How large an

effect does this proposal have on the number of uninsured? Based on estimates

by career economists in the Treasury Department's Office of Tax Analysis of

similar proposals discussed in the Washington Beltway several years ago, the

McCain health-care tax credit can be expected to increase the number of insured

by 15 million and probably more. The Lewin Group, a respected private

health-care research outfit, recently estimated that the McCain credit would

increase the number of insured by as much as 21 million. It is true that many

may no longer get their insurance through their employer, but they will be

given the resources to purchase insurance on their own.

Will the

insurance that is purchased be a generous plan with first dollar coverage or

low deductibles? It is much more likely to be a plan with higher deductibles

that is more focused on providing true insurance against catastrophic losses

rather than a more generous plan that includes a lot of prepayment for routine

and predictable medical expenses. But this is precisely one of the objectives

of the policy: to reduce the current tax bias that encourages people to funnel

routine health expenses through insurance policies.

Finally, the

credit has important implications for the nation's finances down the road. This

is perhaps the most important aspect of the proposal.

There is an

enormous unfunded liability associated with the major entitlement programs of

Social Security, Medicare and Medicaid. If left unchecked, the growth in these

programs will nearly double the size of the federal government by 2040,

consuming roughly 40% of the nation's output rather than the 20% today. While

the growth in Social Security is largely the result of demographics, the growth

in Medicare and Medicaid is also driven by the rapid growth in health-care

spending. This is where a proposal like Sen. McCain's can be so important.

The elimination

of the income-tax exclusion should reduce private health-care spending; to the

extent this reduces the cost of health care, it should also put downward

pressure on the growth of Medicare and Medicaid costs. Thus, by removing the

tax bias for more generous health coverage, the McCain health credit also has

the potential to provide important dividends to the entitlement problem down

the road.

Mr. Carroll

served as deputy assistant secretary for tax analysis at the U.S. Treasury. He

is now vice president for economic policy at the Tax Foundation, and an

executive-in-residence with American University's School of Public Affairs.

http://online.wsj.com/article/SB122506862956370705.html?mod=googlenews_wsj