The Senate Finance Committee released a set of policy options for financing health care reform, including modifying the current tax treatment of health-related expenses.

“Health care reform must preserve the things Americans like about our health care system,” said Senate Finance Committee Chairman Max Baucus, D-Mont., in a statement. “But it must also begin to slow the rapid increases in health care costs that take up more and more of the budget for American families and businesses.”

Baucus and his colleague, ranking member Chuck Grassley, R-Iowa, held a hearing last week to explore some of the options (see Senate Mulls Health Insurance Taxes).

“Everybody agrees we spend too much money on health care, especially to have 46 million uninsured people,” said Grassley (pictured). “The policy options are meant to bring current spending under control and also help cover the uninsured and make coverage more secure for the people who already have it.”

The policy options focus on increasing payment accuracy and reducing disparities in payment and spending amounts among different geographic regions across the country. Additionally, tax provisions are included that promote wellness and healthy lifestyle choices, as well as proposals President Obama included in his budget.

The policy options explore several ways to modify the current tax treatment of health-related expenses to eliminate inconsistencies and discourage wasteful health care spending.

For example, under current law, employer-provided health insurance is not counted as income for tax purposes and the amount of health care benefits that are counted as tax-free is unlimited. This tax-free status encourages employers to offer so-called “Cadillac plans,” or purportedly overly generous health care plans that promote the overuse of health care services and drive up health care costs. Moreover, the plans are subsidized by taxpayers as a result of being tax free.

The policy options explore five changes to make the exclusion more equitable and efficient. These options include capping the exclusion based on the value of the health insurance policy or the income level of the employee eligible for the exclusion. A third option would be to cap the exclusion based on both the value of the health insurance policy and income level.

Another option would be to convert the employer-provided health insurance exclusion to an individual tax deduction or credit. The options under consideration include whether to grandfather in existing plans so that benefits provided under existing collective bargaining agreements are not limited.

HSAs and FSAs

Another policy option involves health savings accounts. Individuals enrolled in high-deductible health insurance plans can set up health savings accounts  from  which they can withdraw funds for qualified medical expenses without paying taxes. Likewise, contributions made to HSAs by individuals and employers are not considered income for tax purposes, and earnings on HSAs accumulate tax free as the balances roll over from year to year.

The policy options explore three ways to modify HSAs. The first option would restrict HSA contributions to the lesser of the individual’s deductible or the statutory limit. The second option would increase the penalty for withdrawing from an HSA for non-medical expenses from 10 percent to 20 percent. The third option would require certification from the employer or from an independent third party that the HSA withdrawals were made for medical expenses.

In addition, the Senate is consider eliminating flexible spending accounts. Similar to HSAs, FSAs allow individuals and their employers to contribute an unlimited amount of tax-free income to a flexible spending account. Employees can withdraw from their FSA to pay out-of-pocket medical expenses besides premiums. But unlike HSAs, FSAs do not roll over from year to year and operate on a “use it or lose it” principle. The policy options explore limiting the amount that can be contributed to an FSA or eliminating FSAs altogether.

Scrutinizing Medical Expense Deductions

Another option involves standardizing the definition of qualified medical expenses. Under current law there is no standard definition for what qualifies as a medical expense for HSAs, FSAs or itemized medical expense tax deductions. The policy option would apply a standard definition of qualified medical expenses across the board.

The committee is also considering modifying the itemized deduction for medical expenses. Under current law, a taxpayer that itemizes deductions may take a deduction for medical expenses – including insurance premiums and out-of-pocket medical costs – in excess of 7.5 percent of adjusted gross income. According to the Congressional Research Service, only 6 percent of all tax returns take the medical expense deduction. The policy options include the possibility of eliminating the itemized deduction for medical expenses or raising the 7.5 percent floor for claiming deductions.

Reexamining Blue Cross/Blue Shield Deductions

Yet another option involves modifying the special deduction for Blue Cross and Blue Shield. Under current law, Blue Cross/Blue Shield and similar organizations are eligible for a 25 percent tax deduction of total claims and certain expenses each year. These organizations are also exempt from the requirement to reduce deductions for unearned premiums by 20 percent. Blue Cross/Blue Shield has historically received a tax-preferred status because it was originally created to provide a more significant community benefit than other insurance companies.

However, an overhaul of health-related tax policies provides the opportunity to reassess that tax treatment. The policy options under consideration look to either reduce the special tax deduction from 25 to 10 percent, or eliminate the deduction and unearned premium exclusion altogether.

Another option involves modifying the FICA tax exemption for students. Current law exempts students employed by a college or university from contributing to FICA through payroll taxes. Teaching hospitals have applied this exception to medical residents receiving stipends. The IRS has issued regulations to narrow the definition of school for the purpose of the exemption and better describe student employment. The policy option would formally adopt the IRS regulation as law.

The committee also noted that certain state and local governments do not currently pay Medicare payroll taxes for their employees. One policy option under consideration would extend the Medicare payroll tax to all state and local government employees.

In addition, the committee is considering modifying the rules pertaining to nonprofit hospitals. Under this policy option, nonprofit hospitals would be required to maintain a minimal level of charitable activity; limit their charges to uninsured, indigent patients; and restrict aggressive collection actions. Hospitals that do not meet those requirements would be subject to an excise tax.

Taxing Beverages

Other policy options include two proposals to promote wellness and healthy choices, and curb activities that increase overall health care costs. They include increasing taxes on alcoholic beverages.

Current law imposes an excise tax on alcoholic beverages, charging $13.50 per proof gallon, which translates to about 21 cents per ounce of alcohol. Because of this measurement, the excise tax treats different types of alcohol differently. Beer is measured by the barrel and the tax rate per barrel is $18, or about 10 cents per ounce of alcohol.

The current tax on wine is $1.07 per gallon, or about 8 cents per ounce of alcohol. The policies present the option of standardizing the tax on alcohol and increasing the excise tax to $16 per proof gallon.

Finally, the Senate is considering imposing an excise tax on sugar-sweetened beverages. The beverages, the Finance Committee leaders contend, contribute to obesity, driving up health care costs within the system. The policy options under consideration would expand on what some states have already done by imposing a federal tax on beverages sweetened with sugar, high-fructose corn syrup or other similar sweeteners. The tax would not apply to artificially sweetened beverages.

The complete text of the policy options on financing comprehensive health care reform can be found at at

Public comments should be directed to Health_Reform@financedem. The deadline for public comments on the financing policy options is May 26, 2009.

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