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How does the FAIRtax affect the cost of health care?

Explanation and Case Study

 

There seems to be some confusion about how the FAIRtax would affect health care.

The first thing to understand is that as a tax on final consumption, the FAIRtax taxes each new good or service once, and only once.   

Under the FAIRtax, health insurance is taxable.  When you pay the FAIRtax on your health insurance premiums, you are, in effect, pre- paying the FAIRtax on your health care spending.  So when the hospital or your doctor submits a bill to the insurance company to pay your claim, there is no FAIRtax on this transaction.  Taxing both premiums and benefit payments would result in double taxation.  

For example, if your premium is $400 per month for health insurance including the FAIRtax, you would be paying $308 for the insurance and $92 for the FAIRtax.  This is appropriate because it is a retail service.  Of course, you have to compare this to the tax treatment under the present income tax system.  For most people who have a combined income tax and payroll tax rate of 22.5%, they will have to earn $398 in gross pay to net the $308 needed to pay their health insurance premium.

If you purchase health care services directly from the doctor or hospital (for example, co-pays and deductibles), then the charges are taxable.  If the insurance benefit is paid directly to you, it would include a credit (an additional amount equal to the taxes due) to prepay any taxes due as the benefit is spent.  So if you paid $100 for an exam ($77 for the exam and $23 in tax) and then filed an insurance claim, you would receive a benefit check of $100, $77 for the cost of the exam and $23 as a credit for the taxes paid when you paid the doctor directly.  

The FAIRtax will reduce doctors’ cost of doing business substantially, thereby allowing for lower pre-tax charges.  The FAIRtax removes the cost of employer payroll taxes, business income taxes, self-employment taxes, the cost of administering income tax withholding and payroll tax deductions for their employees, and their personal income taxes, and the associated compliance costs.  Instead of paying all of these costs, health care providers will collect the FAIRtax only on direct payments for services from patients, and will remit the taxes collected on a monthly or quarterly basis (depending on volume) to their state sales tax authority.  They retain one-quarter of 1 percent (0.25%) of the amount collected as an administration fee.  

The FAIRtax  treats health care services the same as the purchase of any other good or service in the market place.  It makes no difference whether an employer or an individual purchases the health insurance; the tax treatment is the same.  This helps to create a competitive market for health insurance and restores economic based decision-making free of tax distortions resulting in greater competition.  

Under the income tax system, there is a tax deduction for employer provided health care.  This tax expenditure is the largest “loophole” in the federal tax code, resulting in nearly $300 billion in forgone revenue in Fiscal Year 2012, according to the Office of Management and Budget.  This means that employers can write-off the entire cost of employee health insurance so they have no incentive to negotiate competitive deals with insurers and they have no incentive to have workers pay part of the premium or to pay co-pays.  Such a system leaves individuals with little or no idea how much health care and medication actually costs.  There is no way that they are effective consumers of health & medical services. 

According to testimony to the President’s Tax Panel, health care expenditures would drop by 5 to 20% depending upon what type of tax reform was adopted.  It was recommended that there be no income tax deduction for employer provided health care.  Since the FAIRtax gets rid of all special treatment of health care expenses, it would result in the greatest efficiency, thus putting its effect closest to the 20% mark.

 Case Study:  In 2013, my husband had colon cancer.  During the course of his illness, he had colon surgery, a week hospital stay, and 6 months of chemotherapy, at least 3 colonoscopies and several PET scans and MRIs.  His doctors and the hospital billed his health insurance $202,333 in 2013.  My husband's total “out of pocket” health care expenses (his Medicare and Medigap premiums, co-pays and deductibles) were approximately $7,100.  Under the income tax system, since my husband was self-employed and in the 25% tax bracket, he had to earn over $11,894 gross wages to net the $7,100, making the effective income/payroll tax cost nearly $4,794.  

Although $202,333 was billed to Medicare and his MediGap insurance, the insurers approved benefit payments to the doctors and hospital of only $45,000 [an example of just how distorted the health care market has become].  If the FAIRtax had been in effect then, neither the total $203,333 billed nor the $45,000 of benefits paid would have been taxable.  The FAIRtax would have been owed on just the total of his insurance premium payments and out of pocket expenses, or $7100.  So, out of a total of $52,000+ in premiums and benefits paid, the FAIRtax cost would have been only $2,130 compared to $4,794.

 

To sum up the benefits of the FAIRtax to the insurance industry and consumers:

  1. The pre-tax cost of insurance should drop as income and payroll taxes and their compliance costs are eliminated. 
  2. The average American takes home their whole paycheck. 
  3. Health insurance premiums are taxable, but health insurance benefits received are tax-free. 
  4. Natural markets are restored to the purchase of health insurance, helping to control and even lower future health care costs.

 

 

Karen Walby, Ph.D., Director of Research, Americans For Fair Taxation, Sept. 18, 2015.

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