FROM THE OFFICE OF PUBLIC AFFAIRS

Mr. Chairman, Congressman Rangel, and distinguished Members of the Committee, we appreciate the opportunity to discuss with you today the President's proposals for tax credits for the purchase of health insurance.

Mr. Chairman, the Administration looks forward to working with Congress, in a bipartisan manner, to address the pressing need to expand access to health insurance for uninsured Americans. Almost 40 million Americans are reported to go without health insurance coverage for an entire year, and as many as 20 million more are without health insurance coverage during some part of the year. In addition, millions more Americans are struggling to afford rising health insurance premiums, with little help from the government. The scope and persistence of this issue highlights the importance of our making progress this year.

The President's proposals to introduce health credits for the purchase of health insurance will enable millions of Americans to purchase private health insurance, improving the functioning of private markets, empowering patients to make informed decisions, and increasing utilization of high quality health care. This proposal is part of a broader vision for promoting health care quality and access by developing flexible, market-based approaches to providing patient-centered health care coverage for all Americans.

Health insurance credits use the infrastructure of the tax system to expand access to health insurance. They are a common element of proposals from both Republicans and Democrats. Many of the distinguished Members of this Committee have supported such proposals and sponsored such legislation in prior sessions of Congress. We must seek to bridge partisan divides to come to agreement on this key issue which enjoys such wide bipartisan support.

To help do so, the President has proposed health insurance credits that build on the best features of previous proposals, and that include new innovations to address past criticisms of tax credit proposals. And the President's budget backs up his agenda for using health insurance credits to improve access to good coverage with over $100 billion in funding. We hope that these steps forward will provide a foundation for decisive action in Congress this year to address the serious problem of health care affordability and the uninsured.

The Problem of the Uninsured

In 2000, 14 percent of Americans reported that they were uninsured for the entire year. They may go without effective health care, or may rely on inefficient episodic care at hospital emergency rooms. As a result, our health system spends more than it should on complications of diseases that could have been prevented and on inefficient ways of delivering health care. Even worse, the absence of insurance makes it harder for Americans to work with health care professionals to stay healthy.

The uninsured population does not consist only of the poor or the unemployed. In 1999, 81 percent of the uninsured population were in families with at least one full-time worker. Furthermore, while 36 percent of the uninsured had incomes below the poverty line, a large fraction, 29 percent, had incomes between 100 and 200 percent of poverty. Nearly three-quarters of the uninsured below 200 percent of poverty are adults, many of whom do not live in households with children.

Insurance coverage differs significantly by race and ethnicity. In 2000, 32 percent of Hispanics were uninsured, compared to 20 percent of blacks and 19 percent of Asians. In contrast, just 10 percent of whites were uninsured.

The benefits of increasing participation in health insurance markets extend beyond the ability to have more control over their health care and health realized by the individuals themselves. First, although some people without insurance could receive subsidized basic health care through emergency rooms, it is a very expensive way to provide care, and it is either paid at governmental expense or is uncompensated care that imposes higher costs on others. Second, improved public health through expanded health insurance coverage is important to control the spread of disease. Third, as discussed below, greater participation in insurance markets allows better pooling of health risks - the insurance markets themselves work better.

The major goal of health insurance is to allow individuals to join together to reduce their risk of high medical expenses by sharing that risk. Individuals trade the uncertainty of very unpredictable health care costs for the greater certainty of a known premium and protection from very high medical expenses. An important element of insurance is thus the "pooling" of risk - people sign up for insurance before they know how much they will spend on health care, and then the premiums of those who have low expenses help subsidize spending on those with high expenses.

Another important goal of health insurance is to make sure that Americans have access to the most innovative, high-value health care available. The American health care system leads the world in Nobel prizes and in the development of new drugs, devices, and other treatments to prevent and cure illnesses. To make sure these impressive medical breakthroughs translate into good care, health care coverage must be innovative as well. One need look no further than the lack of prescription drug coverage in Medicare to understand the consequences of out-of-date health care coverage. In the years ahead, far more breakthroughs are possible - such as customized treatments based on a clear understanding of an individual's genetic makeup, and specialized "disease management" programs that rely on the Internet and other modern telecommunications technologies that allow patients with chronic illnesses not only to stay out of the hospital, but also out of the doctors office. Innovative health care coverage is essential for creating an environment for medical practice that encourages innovation, value, and continuous improvement in health care.

Several problems can interfere with the ability of insurance markets to achieve these goals. A key problem is lack of choice and competition. As the President has said, our health care system works best when it is centered on helping patients work with health care professionals to decide the best possible treatments. To give control to patients, Americans need the opportunity to choose the health care coverage that is best for them. Without good choices, patients do not have the power to make sure that they are getting the best value from the health care system for their own needs. Instead, government or health plan bureaucrats effectively make decisions for them about what is covered, how their care is reimbursed, and how treatments are provided. In other countries, this has led to queues for treatments, poor quality, and lagging availability of innovative care. Our country has chosen another path: private sector health care based on trust in patients and their physicians. This path rewards innovation in delivering the best possible health care. But the tremendous potential of our health care system is threatened when patients do not have choices about how to get health care coverage. For this reason, the President strongly believes that we must take action to improve the health care coverage options available to Americans

A second problem is adverse selection. If only individuals whose health insurance expenditures are likely to be high sign up for insurance, then the pooling of risk that is the key to insurance is undermined. Just as individuals with higher expenses want more insurance, insurance companies want customers with lower expenses, and may design their plans to appeal to those with low risk.

Health insurance credits can help solve these problems in health insurance markets by making more coverage options affordable, increasing participation, and reducing adverse selection. Greater affordability and participation will encourage competition to provide coverage that delivers high-value, innovative care. Thus, well-designed health insurance credits reinforce the best features of our private, highly innovative health care system.

In the remainder of our testimony, we discuss the critical design issues in more detail. Design issues include the mechanics of how people actually use the credits to get assistance with health insurance purchases. To work effectively, especially for families with modest means, credits must be refundable, advanceable, and nonreconcilable.

• Refundability means that the value of the credit does not depend on taxes owed; even persons who owe no taxes can still receive its full value.
• Advanceability means that those eligible for the credit have the option of using it when they are actually purchasing insurance, to reduce their monthly premium payments, rather than having to wait until they file their tax return at the end of the year.
• Nonreconcilability means that eligible persons do not have to wait until they know their actual income at the end of the year before they know exactly how much assistance they are eligible to receive. Rather, they can be confident that - as long as they are not committing fraud - they are entitled to the full value of an advanceable credit.

Health insurance credits are not the only promising direction for a health care policy that helps patients get high-quality, innovative care. There is no single approach that can work with the best features of all of our health care institutions to help ensure that our health care system remains the best in the world. Given the need for a broad approach to this problem, the President supports both an immediate temporary health insurance tax credit for displaced workers, as contained in the economic security package, and a permanent new health insurance tax credit to expand health insurance coverage for others that is not dependent on employment status. The President 's Budget also contains a number of other initiatives designed to expand health insurance coverage. These include: (i) an above-the-line deduction for the purchase of long-term care insurance; (ii) expanded flexibility of health flexible spending arrangements; (iii) reform and permanent extension of Archer Medical Savings Accounts, to permit Americans to set up health accounts to help them meet the out-of-pocket payments required in many health plans that do not restrict choices of doctors and treatments; and (iv) an additional personal exemption for home caretakers of family members.

These proposals are designed to target a diverse group of people while improving the functioning of insurance markets. In addition, as the President outlined in an address on his health care agenda on Monday, the President's budget includes many other proposals to give all Americans access to high-quality, affordable options for health care coverage. Together, these proposals will provide health security and additional health insurance coverage for millions of Americans, while preserving the best features of our highly innovative health care system.

Current law provides a number of tax incentives for individuals to obtain health insurance coverage. Employer-provided health insurance and reimbursements for medical care are generally excluded from gross income for income tax purposes and from wages for employment tax purposes. Active employees participating in a cafeteria plan may pay their employee share of premiums and other medical care expenses on the same pre-tax basis. In addition, for self-employed individuals who are not eligible for subsidized employer coverage, 70 percent of health insurance premiums are deductible for 2002, and 100 percent are deductible for 2003 and thereafter.

However, as noted above, millions of Americans still are without health insurance coverage. The refundable health insurance credit proposed in the President's Budget is designed to provide these incentives to assist uninsured individuals in purchasing health insurance.

The credit is refundable, so even those without income tax liability can receive the benefit of the credit. In addition, the largest subsidies will be targeted to low-income families, and only individuals who are not covered by public or employer-based health insurance will be eligible for the credit. Therefore, the credit will be of most help to individuals who are most likely to be uninsured-childless adults who are generally not eligible for public insurance and persons in families with incomes too high to participate in public insurance programs and too low to find affordable coverage options in the private market. The credit will help families who prefer the innovation and flexibility of private insurance options to public insurance, and will enable families to obtain coverage for the entire family from the same providers. The credit is also designed to be available at the time the individual purchases health insurance. That is, people eligible for the credit can receive it in advance, before filing their tax returns, to reduce their monthly checks for insurance premium payments. Finally, because the credit is based on income from the previous year, it is nonreconcilable - earning more income in the current year does not reduce the value of the credit. We believe that the availability and certainty of the advance credit will increase the credit's attractiveness, making it more effective in expanding health insurance coverage.

The proposal would create a refundable, advanceable income tax credit for the cost of health insurance purchased by individuals under age 65. Individuals participating in public or employer-provided health plans would generally not be eligible for the tax credit. In addition, individuals would not be allowed to claim the credit and make a contribution to an Archer MSA for the same taxable year. Eligible health insurance plans would be required to meet minimum coverage standards, including coverage for high medical expenses.

The credit would provide a subsidy of up to 90 percent of a capped amount of health insurance premiums. The maximum credit would be $1,000 per adult and $500 per child for up to two children. The maximum subsidy percentage of 90 percent would apply for low-income taxpayers and would be phased down at higher incomes. While the subsidy percentage would be phased down with income, the maximum premium that could be taken into consideration in calculating the credit amount would be fixed at $1,111 for an adult and $556 for a child. These dollar amounts would be indexed by the Consumer Price Index for all-urban consumers.

Individuals with no dependents who file a single return and have modified Adjusted Gross Income (AGI) up to $15,000 would be eligible for the maximum subsidy rate of 90 percent and a maximum credit of $1,000. The subsidy percentage for these individuals would be phased down ratably from 90 percent to 50 percent between $15,000 and $20,000 of modified AGI, and then phased out completely at $30,000 of modified AGI. For example, the maximum credit for these individuals would be $556 at $20,000 of modified AGI.

All other filers (including single filers with dependents, heads of households, and joint filers) with modified AGI up to $25,000 would be eligible for the maximum subsidy rate of 90 percent, and the maximum credit of $1,000 per adult and $500 per child for up to two children. The subsidy percentage would be phased out ratably between $25,000 and $40,000 of modified AGI in the case of a policy covering only one individual, and between $25,000 and $60,000 of modified AGI in the case of a policy or policies covering more than one person.

The maximum credit for these other filers would vary by income and the number of adults and children covered by a policy. For example, the maximum tax credit would be $3,000 for a low-income family with modified AGI up to $25,000 who obtained a policy covering two adults and two or more children. The maximum credit would be phased down to $1,714 as the family's modified AGI rose to $40,000. For a policy covering only two adults, the maximum credit would be $2,000 for families with modified AGI up to $25,000 and $1,143 for families with $40,000 of modified AGI.

Examples of the maximum credit:

1. Individuals with No Dependents Filing a Single Return

   Modified AGI	$15,000	$20,000	$30,000
   Maximum Credit	$1,000	$556	$0

      

2. Other Filers Obtaining a Policy Covering Only One Adult

   Modified AGI	$25,000	$30,000	$40,000
   Maximum Credit	$1,000	$667	$0

     

3. Other Filers Obtaining a Policy Covering Two Adults

   Modified AGI	$25,000	$40,000	$60,000
   Maximum Credit	$2,000	$1,143	$0

     

4. Other Filers Obtaining a Policy Covering Two Adults and One Child

   Modified AGI	$25,000	$40,000	$60,000
   Maximum Credit	$2,500	$1,429	$0

     

5. Other Filers Obtaining a Policy Covering Two Adults and Two or More Children

Individuals could claim the tax credit for health insurance premiums paid as part of the normal tax-filing process. Alternatively, the tax credit would be available in advance at the time the insurance is purchased.

Individuals would reduce their premium payment by the amount of the credit and the health insurer would be reimbursed by the Department of Treasury for the amount of the advance credit. Eligibility for the advance credit would be based on the individual's prior year's tax return.

The credit would be used for qualifying health insurance purchased in the non-group market. In addition, qualifying health insurance could also be purchased through private purchasing groups, state-sponsored insurance purchasing pools and state high-risk pools. At state option, effective after December 31, 2003, the tax credit would be allowed for certain individuals not otherwise eligible for public health insurance programs to purchase insurance from private plans that already participate in State sponsored purchasing groups, such as Medicaid, SCHIP, or state government employee programs.

States could, under limited circumstances, provide an additional contribution to individuals who claim the credit in connection with purchases of private insurance through Medicaid or SCHIP purchasing groups. The maximum state contribution would be $2,000 per adult for up to two adults for individuals with incomes up to 133 percent of poverty. The maximum state contribution would phase down ratably reaching $500 per adult at 200 percent of poverty. Individuals with income above 200 percent of poverty would not be eligible for a state contribution. States would not be allowed to provide any other explicit or implicit cross subsidies.

The health insurance tax credit would be effective for taxable years beginning after December 31, 2002.

This proposal contains a number of important and innovative features. First, the credit amount varies with family size and composition, reflecting the impact of these factors in the non-group market. For example, two adults face higher premiums, and will receive a larger credit, than a single adult. Likewise, families with children face higher premiums, and will receive a larger credit, than families without children. Second, the credit is "advanceable," and eligibility for the advance credit is based on the individual's prior year's tax return. This design guarantees certainty of the amount of the credit and makes it available at the time individuals purchase health insurance; they do not have to wait until they file their tax returns after the year is over. Third, the proposal allows the credit to be used toward private insurance purchased through private purchasing groups, state-sponsored insurance purchasing pools and state high-risk pools. This provision will increase coverage options, achieve economies of scale, and encourage risk pooling in the non-employer market.

In designing a policy to expand health insurance coverage to the uninsured, one concern is that the policy does not inadvertently decrease health insurance options to those presently insured. Some have suggested that if the purchase of health insurance outside of the employer market became sufficiently attractive, employers might stop providing health insurance coverage to their workers, potentially resulting in a net decrease in health insurance coverage among the population.

Based on these concerns, the Administration's proposal has been carefully designed to avoid "crowdout" of subsidized employer coverage, and thus will expand coverage substantially. Several elements of the credit design contribute to this desirable result. Most importantly, low-income individuals and families, who are least likely to have employer-based health insurance, will receive the largest incentives under this proposal. In addition, the health credit subsidy rate decreases with income, requiring larger individual contributions for any given policy and making it a less attractive alternative to the employer-provided insurance at higher income levels. The health credit is further limited by a cap on the amount of premium eligible for subsidy. Although this capped premium amount is adequate for many individuals to purchase health insurance, it is typically less generous than most employer plans.

The credit is also designed to be targeted to the individuals who are most likely to be uninsured during at least some part of the year. Approximately six million such individuals are expected to gain coverage as a result of the credit. Most of these individuals are neither offered employer-based insurance nor eligible for public programs over the course of their uninsured spells. The credit will provide a strong new incentive for these persons to find coverage in the individual market. It will also allow many families that are already purchasing coverage in the individual insurance market, and receiving very little government assistance in doing so, to obtain better coverage at a lower out-of-pocket cost.

The credit will significantly increase participation and quality of coverage in non-group health insurance markets. These improvements will not come at the expense of employer group markets. Those low-income Americans who are eligible for the largest credit are less likely to have employer-sponsored health insurance. Around 80 percent of uninsured workers are not offered health insurance by their employers. Only 36 percent of people under age 65 with income below 200 percent of the federal poverty line have employer-sponsored health insurance, while 77 percent of those above do. Furthermore, the generosity of employer-sponsored insurance is determined by the tax benefits for the group of employees, not the attractiveness for low-income employees only. Tax benefits for employer coverage will remain large for the middle- and higher-income workers that make up most of the employees of most firms that offer generous employer-sponsored plans. Those workers' incomes are too high for them to get more attractive benefits from the proposed health credit. Thus, employer-provided coverage will remain more attractive for firms that offer generous coverage today. That is, the phase-out and cap on the credit ensure that employers will continue to offer insurance and that employees will continue to enroll. The proposed credit will simply eliminate an inequity in the current system that disadvantages workers without employer coverage, helping them to purchase the coverage that meets their needs.

Recent research also suggests that the credit would provide good, affordable health insurance options for the vast majority of individuals who are eligible for the credit. This is the subject of a detailed analysis by the Council of Economic Advisers. The minority of less healthy persons who lack any insurance options and find insurance unaffordable or unavailable for their health status in the individual market could use the credit to buy into the state high-risk pool for which the premium is usually subsidized. The proposal also permits certain low-income individuals to purchase private insurance through other state-sponsored health insurance purchasing groups.

Coupled with the Administration's other proposals for strengthening employer coverage and for providing more assistance to individuals with the greatest health care needs, the health credit is a critical part of our approach for ensuring that all Americans have good, affordable private health care coverage options.

This proposal is part of a broader Administration goal of achieving more patient-centered health care by encouraging innovations in the financing and delivery of health care services. Market-based approaches such as this will encourage high-quality, high-value coverage by giving patients the ability to choose the coverage that best meets their needs. In turn, innovative coverage will permit Americans to benefit from the tremendous potential of our health care system in the 21^st century.

Because the permanent health insurance credit would not be effective until next year, the President continues to support the immediate health insurance credit for displaced workers, which was one component of the economic security bill supported by a bipartisan group of centrist Senators and passed by the House last December.

The health credit for displaced workers is a refundable, advanceable tax credit that could be claimed by unemployed workers for a period of up to 12 months. The credit can be used to offset 60 percent of the cost of health insurance premiums for unemployed workers and their families.

The credit can be applied to the purchase of COBRA or "super-COBRA" continuation coverage, and other types of qualified private non-employer health insurance. Eligible unemployed workers include those receiving unemployment insurance benefits and those who would be eligible for benefits except that their rights to benefits were exhausted or the period during which their benefits were payable ended.

The design of the health credit for displaced worker reflects the President's goals of providing targeted, quick assistance to Americans who have lost their jobs in the recession. Because the proposal builds on the existing infrastructure of programs to assist displaced workers, and because it strengthens all of the coverage options available to displaced workers now, it can be fully implemented in a matter of a few months. In particular, state workforce agencies will certify eligibility for the health insurance credit when they certify that a displaced worker is eligible for unemployment insurance benefits. Almost all unemployed workers who lose their job involuntarily are eligible for unemployment insurance, at least initially. The Administration also supports emergency grants to states to enable them to quickly provide additional health insurance assistance, without the need for state legislative action. Displaced workers can claim an advance credit at the time of purchasing health insurance coverage by providing their insurer their certification along with the remainder of the premium. The insurer will be reimbursed by the U.S. Treasury for the amount of advance credits it provides.

We believe the displaced worker credit offers a number of advantages over competing proposals that limit tax credits or subsidies to COBRA-only policies. Medicaid expansion is also not an ideal way to provide quick and efficient replacement insurance to the affected individuals.

A COBRA-only credit would provide no benefit to 40 to 50 percent of displaced workers with health insurance, because they work for small firms not covered by COBRA or they purchase non-employer policies. The alternative of forcing workers not covered by COBRA into a State Medicaid plan would require these workers to drop their current insurance coverage and possibly change health care providers if they do not participate in Medicaid. Extending Medicaid to cover these displaced workers would require State legislation, and would necessitate delays before State legislatures were even in session to address this issue. Many States have made clear that, because of tight budgets, they cannot afford such unprecedented expansions beyond their core target populations anyway. Moreover, such expansions would take away resources from their ability to fund better coverage for their priority populations: low-income children, families, and seniors.

In addition, a COBRA-credit would impose a costly new mandate that employers would be required to implement immediately. The mandates are most burdensome on smaller firms and those that have had significant layoffs - precisely the firms that need the most help now to prevent further job losses. Further, a COBRA-credit is poorly targeted to workers who lose their jobs because of the economic downturn. At least 60 percent of those eligible for the COBRA-credit are workers who voluntarily leave their job, not displaced workers. According to independent estimates, twice as many workers who have lost their jobs in the recession would be helped by the health credit for displaced workers than by a COBRA credit or subsidy.

As a result, for a similar budgetary cost (and at no budgetary cost to States), the health insurance credit for displaced workers would be available for a longer period of time, would be more efficiently targeted, would offer workers a greater choice among health insurance plans, and would not weaken employer incentives to continue to provide health insurance to their workers. The credit would also reduce adverse selection in both the employer market (because more healthy workers would choose to remain in COBRA coverage) and in the individual market (because many people who otherwise would have gone without health insurance will purchase coverage).

The absence of health insurance coverage for some 40 million Americans is a problem calling for immediate solutions. The President's Budget sets forth a package of solutions, including most importantly a proposal for the use of tax credits to offset the cost of obtaining health insurance that has received broad bipartisan support. If enacted, this proposal can lead to a significant reduction in the uninsured population and at the same time lead to improvements in the market for individually purchased health insurance, greater choice and flexibility for individuals in determining the coverage that best fits their needs, and improvements in the quality and price of health care provided to all Americans. This Administration desires to work closely with Congress, in a bipartisan manner, to make this vision a reality.