Bush Proposes New HSA Tax Breaks

Arguing that a consumer-directed approach to health care has the potential for providing more Americans with medical insurance while reining in rapidly escalating costs, President George W. Bush has called for enhancing tax incentives associated with Health Savings Accounts (HSAs) and other types of consumer-directed plans. Among other proposals, Bush advocates raising the limit on tax-deductible contributions to HSAs and creating new deductions and tax credits for the purchase of individual health insurance policies.

In the president’s State of the Union address on January 31, Bush said, "We will strengthen health savings accounts—making sure individuals and small business employees can buy insurance with the same advantages that people working for big businesses now get. We will do more to make this coverage portable, so workers can switch jobs without having to worry about losing their health insurance."

To accompany the State of the Union address, the White House released a plan for expanding HSA-related tax breaks that would cost an estimated $59 billion over five years and $156 billion over ten years. The president proposes raising the limit on tax-free contributions to HSAs to cover all out-of-pocket medical costs and granting individuals who purchase HSA-compatible insurance policies an income tax deduction on premiums equivalent to the tax break currently available on employer-sponsored insurance. Bush’s plan would also provide a 15.3% credit for payroll taxes paid on HSA contributions made by individuals.

To help "vulnerable Americans," the president further advocates providing lower-income families with a refundable tax credit of up to $3,000 to purchase an HSA-compatible policy and fund the account. In addition, Bush would like to make it easier for employees who are changing jobs to take their HSAs with them.

Established by the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, HSAs are tax-advantaged savings accounts used in conjunction with high-deductible health plans (HDHPs). Under current rules, the ceiling on tax-free contributions to HSAs is set at the lower of the deductible amount or a maximum of $2,700 for individuals and $5,450 for families, with catch-up contributions of $700 permitted for those over age 55. Employers are permitted to make tax-free contributions on behalf of employees. Earnings accumulate tax free, and withdrawals are not taxed, provided they are used to pay for qualified medical expenses. HSA enrollees may roll over any unused funds from year-to-year, building up savings that may be used to pay for medical expenses in retirement. After age 65, enrollees can take distributions for any reason without penalty, but non-medical withdrawals are taxed.

As the cost of providing health insurance strains the budgets of many businesses, a small but growing number of employers are offering HSAs as a benefit option. According to a recent report by Mercer Health & Benefits, just 2% of all employers with 10 or more employees offered a consumer-directed health plan in 2005. The study also found, however, that larger companies are adding consumer-directed plans to their benefits packages at a much faster rate than smaller firms. According to the trade association America’s Health Insurance Plans, an estimated three million Americans are currently enrolled in HSAs.

Advocates of consumer-directed plans argue that people who have more of their own money invested in health care are likely to use health care services more judiciously and shop around for better deals from providers. But HSA opponents contend that consumers will find it difficult to take charge of their own health care if, for example, they have little hospital and physician choice in their local area, lack adequate pricing and quality information, or are faced with a medical emergency. Critics of the consumer-directed approach also point out that HSA enrollees may try to save on out-of-pocket costs by skimping on preventive care and other necessary medical services, leading to more expensive problems later.

According to White House estimates, the president’s HSA expansion plan could increase the number of Americans with HSAs from the currently projected figure of 14 million to 21 million by 2010. But because the majority of Americans lacking health insurance pay little or nothing in federal tax, skeptics of the proposed plan dispute whether HSAs would go far in helping the uninsured obtain coverage. Instead, the plan’s detractors reason, generous tax incentives for HSA enrollment would encourage those who are richer and healthier to sign up for the plans, while most Americans with lower incomes or chronic illnesses would still be unable to pay for or—due to medical conditions—even obtain health coverage.

Commenting on the president’s HSA expansion proposals, Bill Vaughan, a senior policy analyst for Consumers Union, said, "Giving tax breaks only encourages healthier and wealthier people to opt-out of traditional employer-based insurance, leaving behind a fractured insurance pool that hurts the older and sicker."

Vaughan added, "Tax deductions do little or nothing for those people who are uninsured and devastated by high health care costs. Most uninsured are in the 0% or 10% tax bracket so tax deductions do little or nothing for them." Vaughan also dismissed the proposed tax credits for lower-income families, observing that credits of $1,000 to $3,000 would be "almost meaningless" given the high cost of family health coverage.

As the controversy surrounding HSA adoption heats up, opponents of the president’s plan point to recent studies indicating that high-deductible and consumer-directed plan participants may be less satisfied with their health coverage than those in traditional managed care plans. According to a survey by the Employee Benefit Research Institute (EBRI) and the Commonwealth Fund, 42% of consumer-directed health plan enrollees and 33% of high-deductible plan enrollees reported feeling extremely or very satisfied with their health coverage, compared with 63% of enrollees in comprehensive health insurance plans.