What Bush's health plan means to you

NEW YORK (CNNMoney.com) -- President Bush in his State of the Union address Tuesday laid out a plan intended to make healthcare more affordable, give everyone who buys insurance the same tax break and incentivize you to be more cost-conscious in how you spend your healthcare dollars.

And all without increasing federal spending.

Specifically, Bush proposed changing how spending on health insurance is taxed, and reallocating federal funds to help those states with affordable insurance subsidize low-income and hard-to-insure people.

"When it comes to healthcare, government has an obligation to care for the elderly, the disabled, and poor children," the president said. "We will meet those responsibilities. For all other Americans, private health insurance is the best way to meet their needs. But many Americans cannot afford a health insurance policy."

Even those critical of the proposal's details give the president credit for taking on inequities in the healthcare system. "The President has shown leadership in placing the tax treatment of employer-based coverage on the table as part of health care reform," said Robert Greenstein, executive director of the liberal leaning Center for Budget and Policy Priorities.

Bush's proposal to change how health money is taxed would make health insurance more affordable for those who are currently uninsured (more than 46 million) and for those who buy coverage on their own (18 million) by offering them a tax break that currently doesn't exist.

But it could ultimately mean a tax hike for many who are covered by their employers, if they don't change their health spending habits.

At first, an estimated 80 percent of the 160 million people insured through work will actually see a bigger tax break than they currently enjoy. But if they don't become more cost-conscious in selecting their healthcare plans, a larger portion of people may end up paying some tax on money used to buy health insurance where currently they pay none.

Besides making the tax break for health care more equitable, "The plan is very innovative ... [It] attempts to move forward on the twin problems of the rising number of uninsured and rising health spending without increasing the deficits - and in fact as proposed would even reduce the long-run deficit," according to a preliminary analysis by the Tax Policy Center.

But the president's proposal also raises concerns. Based on conversations with tax experts and health policy experts at the Brookings Institution, the Cato Institute, the Tax Policy Center, the Kaiser Family Foundation, the Employee Benefit Research Institute, CCH and Ashwaubenon Tax Professionals, here's a breakdown of how the proposal would work and how to estimate the tax consequences for you.

• How would it work?
• How much of a tax break or hike would you see under the proposal?
• Who is most likely to get the biggest benefit?
• Who is most likely to see a tax increase?
• How might this proposal change your behavior?
• Who might not be affected by the deduction?
• What are the pros and cons of the proposal?

How would it work? Everybody who buys health insurance, whether through work or independently, would get a standard deduction of $7,500 for individual coverage and $15,000 for family coverage.

This standard deduction would be available to everyone, whether they itemize on their tax return or not. And you can take the full deduction even if your health plan costs less.

So if you paid $10,000 for family coverage, you could still deduct $15,000.

The proposal differs from current law in two key ways: 1) under current law, people who buy insurance on their own typically don't get a tax break at all; under the proposal they would; and 2) those who are insured through work can currently buy coverage with an unlimited amount of tax-free money. Under the proposal, a limit would be set.

A primary goal of the proposal is to level the playing field, in terms of tax breaks, between those who buy insurance on their own and those who buy it through an employer.

How much of a tax break or hike would you see under the proposal?

Figure out the difference between the total cost of your healthcare plan and the federal cap on your health tax benefit ($7,500 for single coverage; $15,000 for family coverage). Then multiply that difference by the sum of your top tax rate plus 7.65 percent (which is the portion of payroll taxes you pay for Social Security and Medicare).

This will give you a ballpark idea of your tax savings or tax increase.

So if your plan costs $12,000, the difference between your expense and the $15,000 family deduction is $3,000. If you're in the 25 percent tax bracket, you'd multiply $3,000 by 32.65% (25% + 7.65%), which would give you tax savings of about $980.

Conversely, if you pay $3,000 more than the deduction cap for insurance, you'd pay an extra $980 in income tax and payroll tax.

Economists would suggest you use 15.3 percent to reflect your payroll tax credit (your half of payroll taxes -- 7.65% -- plus your employer's, also 7.65%). That's because they believe workers bear the brunt of the employer's portion through lower wages. So, in the example above, instead of multiplying $3,000 by 32.65% you'd multiply it by 40.3% (25% +15.3%). That would result in effective tax savings or an effective tax increase of $1,209.

If implemented, the proposal wouldn't go into effect until 2009, when the average cost to cover a family of four is estimated to be $13,500, up from $11,500 today.

Who is most likely to get the biggest benefit? Those who buy insurance on their own and those who are currently uninsured and choose to buy it and take the deduction.

Currently, if you buy insurance on your own and your medical costs do not exceed 7.5 percent of your adjusted gross income (most people's medical costs don't) you get no tax break under the current system. Under the proposal, your tax bill would be lower relative to what it was before, even if your plan costs exceed the deduction cap by a bit.

The White House Council of Economic Advisors estimates that a family buying insurance on their own today would save an average of $3,650 in taxes under the proposal. It also estimates a family which is currently uninsured could save an estimated $3,350 in taxes if they purchase healthcare coverage under the proposal.

Who is most likely to see a tax increase? Health insurance costs vary by region, so those who live in high-cost states like New York and California will be more likely to see their plan costs exceed the deduction cap, and that difference would be subject to income and payroll tax.

The chronically ill -- who are more likely to pay high premiums -- may also be more susceptible.

But, ultimately, it's not just those in high-tax states and those in poor health who may see a tax increase. It could affect a much broader swath of workers, unless they choose to buy lower cost plans.

Initially, only 20 percent of those who are covered through work will see a tax increase, according to White House estimates. But that number will go up over time, because while the deduction cap would be indexed to inflation, health care costs rise much more quickly. Hence, your plan costs could exceed the deduction cap within a few years of the cap's implementation, depending on your circumstance.

Ten years after the proposal is in effect, 40 percent of plans will exceed the standard deduction, according to a preliminary analysis of the proposal by the Tax Policy Center.

How might this proposal change your behavior? If you buy your health insurance at work, the compensation you use to do that is tax-free, so there is little incentive to buy a lower cost plan. With a cap on the tax benefit for health coverage, the knowledge that you will be taxed on money you use to buy coverage above that cap will push more people to look for lower cost plans. And that, proponents say, will increase competition among insurers and healthcare providers, thereby lowering healthcare costs.

"One of the goals of this policy is really to rationalize our health care spending so that we're getting higher value, more efficient care, and we hope in the long run that that substantially brings down the trajectory of growth in national health spending, because [people will] be allocating their health care dollars more efficiently," said Katherine Baicker, a member of the Council of Economic Advisers, in a briefing on Monday.

The move, if enacted, could make high-deductible plans more popular. A high-deductible health insurance plan covers you only in the event of a serious medical condition or catastrophe, and typically its premiums are lower than they are with more traditional plans.

Who might not be affected much if at all by the deduction? Many low-income and uninsured people.

According to Treasury Department and White House estimates, the proposal would reduce the number of uninsured by 3 million to 5 million people. That number is low relative to the total number of uninsured (over 46 million) for two reasons primarily:

• 43 percent of the uninsured have no income tax liability, according to Kaiser Family Foundation. But they would still get a payroll tax credit on the wages they earn if they buy health insurance.
• Many uninsured still won't be able to afford coverage even with the new deduction. (More than 50 percent of the uninsured are in the 15 percent tax bracket or less). Others won't want to part with the cost of insurance premiums up front, even though they'll get it back on their tax return.

To provide more of the uninsured with coverage, President Bush is also proposing the Affordable Choices Initiative. Although details are still sketchy, the program would offer funding to states that reform their insurance market so as to provide affordable basic coverage for all.

The federal funds would be redirected from other programs to help states subsidize coverage for low-income people.

What are the perceived pros and cons of the proposal? Whatever their political persuasion, tax and health policy experts agree on a few things: Health care costs are out of control, something has to be done to make health insurance more affordable, and it's a good thing to level the playing field between those who buy insurance at work, with the tax advantages that affords, and those who buy it on their own.

From this perspective the president's plan gets kudos. "This proposal would eliminate the cruelest inequity in the tax code, make coverage more affordable for millions, and encourage all Americans to be more responsible health care consumers," said Michael Cannon, health policy director at the Cato Institute.

And Cannon noted that for some who buy insurance on their own -- primarily younger, healthier people who don't cost insurers much -- what they would save in taxes as a result of the deduction might equal or even exceed the cost of their health insurance.

That would be an incentive for healthy people to join plans, which lowers the cost of premiums for everyone.

But, said Paul Fronstin, director of the Employee Benefit Research Institute's health research program, a lot of older, less healthy people who are currently uninsured would also buy insurance, and that might negate some of the effect of adding healthy people to the pool.

Some are concerned, too, that employers may decide to stop offering healthcare plans at work and just give money to employees to buy insurance on their own. That could make it harder for less healthy individuals to buy affordable coverage, because they're not as desirable to insurers as healthy people. And some of those healthy people may decide to forego coverage altogether if it's not a default offering at work, said Roberton Williams, principal research associate at the Tax Policy Center.

Advisers to the president say that the decision by employers to either sponsor health insurance plans or just give money to workers to buy coverage on their own will be determined by demand.

"There are dynamics there that will work out between businesses and their employees," said White House spokesman Tony Fratto at Monday's briefing. Business owners may "feel that their employees want employer-provided health coverage, and they want to provide it because it's their way of attracting the best talent."