Chapter
2

Approaches for Reducing the Number of Uninsured People

About one in six nonelderly people in the United States will be without health insurance at any given time during 2009. Those without insurance will include nearly 10 million children, over 14 million adults living in fami­lies with children, and another 21 million adults who do not reside with children. Nearly two-thirds of the unin­sured are in families whose income is less than 200 percent of the federal poverty level.

Concerns about the number of people who lack health insurance have generated proposals that seek to increase coverage rates substantially or to achieve universal or near-universal coverage. Coverage could be expanded by:

• Subsidizing health insurance premiums, either through the tax system or spending programs, which would make insurance less expensive for people who are eligible.
• Mandating health insurance coverage, either by requiring individuals to obtain coverage or by requir­ing employers to offer health insurance to their work­ers. If effective penalties were imposed on those who did not comply, a mandate would increase insurance coverage by making it more costly for individuals to be uninsured and for employers not to offer coverage to their employees.
• Automatically enrolling individuals in health plans, giving them the option to refuse coverage or switch plans. Recent studies suggest that automatic enroll­ment in plans that subsidize savings for retirement substantially increases participation rates, especially among young and low-income workers.

The three approaches could also be used in combination to reduce the number of people who are uninsured.

At the federal level, subsidies for health insurance premi­ums have been provided through spending programs and tax provisions. Millions of low-income children and their parents receive subsidized health insurance coverage through Medicaid and the State Children’s Health Insur­ance Program; tax subsidies, such as the exemption of employer-paid premiums from taxation, encourage mid­dle- and higher-income taxpayers to purchase private health insurance (primarily through their employer). Those subsidies, however, are distributed unevenly. Some low-income adults—particularly those who are under the age of 65, childless, and able-bodied—are generally not eligible for Medicaid or SCHIP. Taxpayers who do not work for a firm that offers coverage may not receive any tax subsidies for purchasing private health insurance.

Coverage could be expanded by restructuring tax subsi­dies, spending programs, or both. However, redesigning existing subsidies or creating new benefits raises several issues. First, the form of the subsidy can determine who would benefit. Tax preferences, such as the current-law exclusion or a tax deduction, reduce taxes but do not pro­vide benefits to those who do not have any income tax liability. A refundable tax credit would provide full bene­fits to individuals, regardless of whether they have any income tax liability, but might require some people to file returns solely to obtain the subsidy. A second consider­ation is costs, which could be high depending on the numbers of uninsured receiving the subsidies and the amounts necessary to encourage them to enroll in health plans. Targeting benefits toward specific segments of the population would reduce costs but could also add to the burden of administering a program. A third consideration is the impact of the subsidies on people who already have coverage; although subsidies would probably increase coverage on net, some subsidies would go to people who would have coverage anyway, and the availability of subsi­dies might cause some people to lose coverage because firms might drop existing plans if their workers could obtain comparable health insurance elsewhere at equal or lower cost.

Because subsidies may not be sufficient to achieve univer­sal coverage, some analysts have suggested imposing a mandate on individuals to obtain health insurance or on employers to offer plans. The effectiveness of a mandate in expanding coverage would depend on its scope, the incentives to comply, and the ease of enforcement. Many factors affect compliance with a mandate, and the Con­gressional Budget Office will consider the specifics of each proposal requiring individuals or employers to pur­chase health insurance in determining the proposal’s effect on coverage.

Coverage could also be increased by automatically enroll­ing individuals in health insurance plans, giving them the option to refuse coverage. Automatic enrollment has increased participation in employer-sponsored 401(k) plans and certain government programs. Firms that offer health insurance might be encouraged or required to automatically enroll employees in a basic plan, unless the employees chose to opt out of coverage or signed up for a more comprehensive plan. Automatic enrollment, how­ever, might be more difficult to implement in settings other than the workplace or public programs because of the complexities of determining eligibility, collecting pre­mium payments, and other factors.

All three approaches to expanding coverage could affect participation in employment-based health plans. To the extent that employers’ payments for health insurance increased as a consequence, firms would respond over the long term by paying lower wages and providing fewer fringe benefits than they otherwise would in order to maintain the same level of compensation. Because employers’ contributions for health insurance (unlike wages) are exempt from income and payroll taxes, such changes could have substantial effects on the federal bud­get.

Methods of Subsidizing Premiums

Proposals that are designed to increase substantially the number of people who have health insurance typically include federal subsidies to cover some portion of the pre­mium for that coverage.¹ In addition, proposals may set eligibility for subsidies or the size of the subsidy payment on the basis of income, family structure, availability of insurance, or other factors. By lowering the costs of health insurance to enrollees, subsidies encourage unin­sured individuals to obtain coverage. The design of the subsidies, however, may involve trade-offs with other pol­icy goals that could affect their costs.

A basic set of trade-offs arises between the share of the premium that is subsidized, the number of people who enroll in an insurance plan as a result, and the total costs of the subsidies. As the rate of the subsidies increases, more people will be inclined to take advantage of them, but the higher subsidy payments also go to those who would have purchased insurance anyway. Beyond a cer­tain point, therefore, the cost per newly insured person can grow sharply because a large share of the additional subsidy payments is going to individuals who are other­wise uninsured.

To hold down the costs of subsidies, proposals could seek to limit eligibility for subsidy payments to individuals who are currently uninsured. That restriction, however, increases incentives for people who have insurance to drop their coverage (or for their employers to stop offer­ing coverage) in order to qualify for the new subsidies. Some proposals may try to distinguish between people who become uninsured in response to subsidies and those who would have been uninsured in the absence of a gov­ernment program, but such proposals raise significant administrative challenges. In addition, providing benefits only to the uninsured may be viewed as unfair by people with similar income and family responsibilities who pur­chase health insurance and are therefore ineligible for the subsidies.

Another way to limit costs would be to target subsidies toward lower-income groups, who are most likely to be uninsured otherwise, but such approaches can also have unintended consequences that affect the costs of the pro­posal. If eligibility was limited to people with income below a certain level, then those with income just above the threshold would have strong incentives to work less or hide income in order to qualify for the subsidies or to maintain their eligibility. Phasing out subsidies gradually

as income increases would reduce, but would not elimi­nate, those incentives. At the same time, the more gradu­ally the subsidies were phased out, the greater the number of people who would be eligible for them—and the more likely that subsidy payments would go to those who would have had insurance in any event. The number of uninsured—regardless of the individual’s age or the pres­ence of children in his or her home—gradually declines as family income rises above 200 percent of the federal poverty level. Still, nearly 4 million uninsured individuals have family income that is greater than 400 percent of the federal poverty level; however, over 80 million insured individuals have income that exceeds that level (see Table 2-1).

Table 2-1.  

Distribution of the Nonelderly Population, by Insurance Status, Family Income, and Family Structure, 2009

(Millions)

							Adults
Family Income Relative to Poverty		Children					With Children					Without Children					Total
Level (Percent)		Insured		Uninsured			Insured		Uninsured			Insured		Uninsured			Insured		Uninsured
Below 100		17.2		2.7			6.5		3.5			7.3		6.9			30.9		13.1
100 to 200		15.5		3.4			10.8		5.8			9.1		6.6			35.3		15.8
200 to 300		11.9		1.8			12.9		2.9			10.9		3.6			35.7		8.3
300 to 400		9.6		0.9			12.3		1.3			10.3		2.0			32.2		4.2
Above 400		17.2		0.8			28.9		1.0			36.1		1.9			82.2		3.7
		____		___			____		___			____		___			____		___
	Total	71.3		9.6			71.3		14.5			73.7		20.9			216.3		45.1

Source: Congressional Budget Office’s health insurance simulation model.

Note: Children are age 22 or younger.

Whatever eligibility rules are applied, subsidy systems generally need to establish methods for determining who is eligible, how much of a subsidy each person receives, and how the subsidy will be delivered. In particular, bas­ing subsidies on income requires a system for measuring and verifying income, and trade-offs can arise between the timeliness and accuracy of that information. Verifying eligibility could impose costs not only on the agencies that administer the programs but also on the individuals applying for subsidies who might choose to forgo benefits rather than bother with administrative hassles and the perceived stigma of participating in such programs. Sub­sidy payments could go directly to individuals or could instead be channeled through insurers, employers, state governments, or other intermediaries.

The design issues raised by various subsidy systems and their implications for the federal budget can be illustrated by examining more closely the two largest subsidies cur­rently provided to the nonelderly population: the tax exclusion for employment-based insurance and the Med­icaid program (along with the smaller SCHIP program). Both the tax exclusion and Medicaid also illustrate the many challenges involved in providing subsidies to lower-income individuals and families, who typically have lim­ited tax liabilities—and thus might derive little benefit from certain types of tax-based subsidies—but may find it burdensome to apply for programs like Medicaid or SCHIP or may be ineligible for those two programs under current rules.

Subsidizing Premiums Through the Tax System

Most workers receive a subsidy through the tax system when they purchase private health insurance through their employer. Employers’ payments for health insurance are a form of compensation, but those payments are exempt from income and payroll taxes (as are most employees’ payments for their share of health insurance premiums). Changes to those subsidies could have sub­stantial effects on coverage rates and the federal budget.

Current Tax-Based Subsidies

The favorable tax treatment currently provided for health insurance purchased through an employer represents the largest single source of federal premium subsidies for the nonelderly population. Employers may compensate their employees by paying health insurance premiums in lieu of cash wages, but the two types of compensation receive very different tax treatment.² Employers may deduct the costs of providing that coverage as a business expense—just as they deduct employees’ wages and other forms of compensation—and thus those payments are not subject to corporate income taxes. But unlike wages, the costs that employers pay for health insurance are also excluded from the taxable income and earnings of the covered employees. That portion of employees’ compen­sation is therefore exempt from individual income and payroll taxes.

Partly as a result of that favorable tax treatment, employ­ers that offer health insurance to their workers typically pay a substantial share of the premium for that coverage; that is, the amount that employees pay directly usually covers a relatively small fraction of the total premium. Many firms also offer their workers a "cafeteria plan," which allows employees to choose cash or other taxable benefits in lieu of receiving nontaxable benefits. (Such plans are referred to as Section 125 plans, after the section of the tax code that authorizes them.) Under that arrangement, employees are able to exclude the portion of the health insurance premium that they pay from their taxable income—so for most workers, the full cost of the employer-sponsored plan receives favorable tax treat­ment.³

The subsidy provided by the current tax exclusion shows up as a reduction in taxes (commonly referred to as a tax expenditure) rather than as an overt payment. The man­ner in which the tax exclusion subsidizes health insurance can be seen by comparing the tax liabilities of two other­wise identical workers employed at different firms. Both workers receive $40,000 in compensation from their respective employers in 2009, but that compensa­tion—which is a combination of wages, employers’ con­tributions for payroll taxes, and fringe benefits—takes different forms at the two firms:

• Employee A works for a firm that does not offer health insurance. He receives about $37,160 in cash wages, and his employer pays the remaining compensa­tion—about $2,840—to the government in the form of payroll taxes. Employee A pays $5,000 for a health insurance plan in the individual market.
• Employee B works for a firm that offers health insur­ance. She receives about $32,500 in wages, and her employer pays nearly $2,500 in payroll taxes on her wages. In addition, she has an employment-based health insurance plan valued at $5,000 per enrollee.

For simplicity, assume that both workers have no other sources of income and are in the 15 percent income tax bracket; that the employee’s and the employer’s portions of the Social Security and Medicare payroll taxes (which have a combined rate of 15.3 percent) are ultimately paid by the workers; and that the costs of the second firm’s health plan are borne evenly across its workforce.⁴

Although the two workers receive the same total compen­sation and have comparable health insurance coverage, their tax liabilities differ. Employee A, who purchases health insurance in the individual market, pays $9,439 in income and payroll taxes, or $1,407 more than the worker who receives part of her compensation in the form of health insurance premiums. For Employee B, federal taxes have effectively reduced the cost of insurance by more than 28 percent, to $3,593 (see Table 2-2). The effective subsidy rate increases by several percentage points if the employee lives in one of the 41 states (or the District of Columbia) that have an individual income tax; those states generally follow federal definitions of earn­ings and other income and thus exclude employers’ con­tributions for health insurance from their calculation of taxable income.⁵

Table 2-2.  

Illustrative Tax Subsidy for Employment-Based Health Insurance for a Single Worker Who Receives $40,000 in Total Compensation, 2009

(Dollars)

			Employee A: Pays $5,000 for Individual Health  Insurance		Employee B: Receives $5,000 of Employment-Based Health Insurance		Difference
Compensation
	Cash wages		37,157		32,513		4,644
	Premiums for employment-based health insurance		0		5,000		-5,000
	Employers' contribution for payroll taxes		2,843		2,487		355
			______		_______		_____
		Total compensation	40,000		40,000		0
Premiums for Health Insurance in Individual Market			5,000		0		5,000
Income Tax
	Adjusted gross income		37,157		32,513		4,644
		Minus personal exemption	3,650		3,650		0
		Minus standard deduction	5,700		5,700		0
			______		______		_____
	Taxable income		27,807		23,163		4,644
	Income tax		3,754		3,057		697
Payroll Tax
	Employee's contribution at 7.65 percent		2,843		2,487		355
	Employer's contribution at 7.65 percent		2,843		2,487		355
			_____		_____		____
		Total payroll tax	5,685		4,974		711
Total Income and Payroll Taxes			9,439		8,031		1,407
After-Tax Cost of Health Insurance			5,000		3,593		1,407
Subsidy as a Percentage of Costs of Health Insurance			0		28		-28

Source: Congressional Budget Office.

Note: To simplify the example, both workers are assumed to be unmarried, to have no dependents, to receive $40,000 in total compensa­tion, and to have no sources of income other than wages and salaries.

The aggregate effects of that exclusion on the federal bud­get are large, exceeding federal spending on Medicaid. The Joint Committee on Taxation has estimated that the total federal tax expenditure associated with the exclusion for employment-based health insurance was $246 billion in 2007, consisting of $145 billion in individual income taxes and $101 billion in payroll taxes.⁶ (By comparison, the federal government spent over $195 billion on Med­icaid in 2007.) In addition, the federal government incurs an additional tax expenditure of about $5 billion annu­ally by allowing self-employed individuals to deduct the costs of health insurance from their taxable income (but health insurance costs for the self-employed are not deductible for purposes of payroll taxes). However, the magnitude of the estimated tax expenditures is not the same as the increase in revenues that would result from repealing the current exclusion or the deduction for the self-employed, because the calculation of the tax expendi­tures does not account for any changes in taxpayers’ behavior that would result if the exclusion was repealed. (The revenue gain from repeal would be less than the esti­mated tax expenditures because some individuals would find other ways to reduce their tax liabilities if the exclu­sion was repealed; some individuals, for example, might claim their health insurance premiums as an itemized deduction.)

The current tax treatment of health insurance premiums encourages employers to offer health insurance to their employees and encourages employees to enroll in those plans, but it has also raised several concerns. In particular, the exclusion does not provide benefits for health insur­ance evenly. Individuals with the same income and simi­lar family responsibilities can receive very different tax benefits for medical costs. Employees who can exclude premiums for employment-based insurance from payroll taxation, as well as from individual income taxes, typi­cally receive more generous tax subsidies than do self-employed individuals. Employees who work for firms that do not offer insurance do not benefit from the exclusion.

In addition, the current system provides different tax sub­sidies to people at different income levels. Because the rate structure of the income tax is progressive—that is, as income rises, each additional dollar of income may be taxed at a higher rate—the value of the exclusion gener­ally grows as income increases. If, in the example above, the single employee with an employer-sponsored health insurance policy worth $5,000 had earned $70,000 in total compensation instead of $40,000, that individual would probably be in the 25 percent rate bracket; being in that higher bracket would increase the total tax savings by $465 (from $1,407 to $1,872) and raise the federal tax subsidy to over 37 percent. The share of the premiums that the federal exclusion offsets can be somewhat lower at higher levels of income if taxpayers reach the wage ceil­ing for Social Security payroll taxes ($106,800 in 2009). The value of the exclusion represents a larger percentage of income for middle-income households than for high-income households, however, largely because average pre­miums for health insurance do not vary substantially with income and therefore decline as a share of income as income rises.

Although the exclusion of employer-paid premiums is by far the largest tax expenditure related to health care, two others worth noting are the itemized deduction for medi­cal expenses and the health coverage tax credit that is available for workers displaced from their jobs by interna­tional trade. (For a general discussion of the key differ­ences between tax exclusions, tax deductions, and tax credits, see Box 2-1.)

Box 2-1. 

Tax Exclusions, Tax Deductions, and Tax Credits

Several types of subsidies for health care costs are embedded in the current structure of the individual income tax. Proposed tax subsidies can take the form of exclusions, deductions, or credits, each of which has a different structure and different effects on individual income tax liabilities. Briefly, A tax exclusion reduces the amount that tax filers report as their total, or gross, income. A tax deduction is an expense that is subtracted from total income when calculating taxable income. It reduces tax liability in proportion to an individual’s tax bracket. A tax credit is the direct dollar-for-dollar reduction of an individual’s tax liability. If the tax credit is refundable, individuals can receive its full amount even if they do not have any income tax to offset. Tax Exclusions Certain forms of compensation are excluded from taxable income, effectively providing a subsidy for the excluded amount. Some types of income are excluded because they are difficult to measure. Other types of income are excluded to reflect policy choices to encourage taxpayers to engage in a particular activity. For example, employers’ contributions to 401(k) retirement savings plans are not counted as income for employees, and employees’ contributions are  subtracted from their earnings when determining the amount that is reported as taxable. (Contributions to 401(k) plans are still subject to payroll taxes, however.) Similarly, the amounts that employers pay for employees’ health insurance are not counted as taxable income for employees, thus subsidizing the purchase of employment-based health insurance. Tax Deductions There are several types of income tax deductions. All taxpayers may subtract certain types of income or expenses—commonly referred to as above-the-line deductions—from total income to derive their adjusted gross income. Those deductions may try to adjust for differences among taxpayers in terms of family or other personal characteristics or to meet other goals of tax and social policy. For example, people who move more than a specified distance may deduct their moving expenses, and contributions to individual retirement accounts may also qualify (up to an annual limit) for an above-the-line deduction. Similarly, self-employed individuals may deduct the full cost of their health insurance. (However, the self-employed are not allowed to exclude health insurance premiums from their income for purposes of payroll taxes.) Starting from adjusted gross income, taxable income is computed by subtracting personal exemptions and either a standard deduction amount or the total amount of itemized deductions, and it is generally to taxpayers’ advantage to subtract the larger of the two. In 2009, the standard deduction ranges from $5,700 for single filers to $11,400 for married couples filing jointly. Expenses that are allowed as itemized deductions include property taxes and mortgage interest, state and local income taxes, and charitable contributions; medical expenses not covered by insurance are also allowed, but only to the extent that those expenses exceed 7.5 percent of adjusted gross income. The value to taxpayers of allowing itemized deductions for certain expenses thus depends in part on what other expenses they have that can be itemized and how those expenses compare with their standard deduction. In general, higher-income households are more likely to itemize their deductions, although the total amount of itemized deductions that can be taken is gradually reduced for taxpayers whose adjusted gross income exceeds $166,800. Tax liabilities are next determined by applying the statutory tax rates, currently ranging from 10 percent to 35 percent, to taxable income. The value of tax exclusions and deductions generally depends on an individual’s marginal tax rate—the rate that applies to the last dollar of income. For example, a self-employed person who is in the 25 percent tax bracket and deducts the cost of a $5,000 health insurance policy reduces his or her taxes by $1,250; in the 35 percent bracket, the tax savings is $1,750. Tax Credits Tax liabilities can be reduced by tax credits. For example, a portion of the costs that working parents incur for child care can be taken as a tax credit. An important distinction between tax credits, on the one hand, and exclusions and deductions, on the other, is that a tax credit can be designed so that its dollar value does not depend on one’s tax bracket. Most tax credits are nonrefundable, however, meaning that the actual credit that taxpayers receive cannot exceed their income tax liability. Because lower-income individuals and families generally owe less in income taxes than those with higher income, they are less likely to benefit from nonrefundable tax credits. Some tax credits are refundable, however, allowing individuals to receive the entire credit amount regardless of their income tax liability. The only example of a tax credit related to health care is a refundable one for workers who lost their job as a result of international trade and are receiving trade adjustment assistance (certain other workers are also eligible); they may be eligible for a tax credit for 65 percent of the costs of their health insurance.

Taxpayers who itemize deductions on their income tax return may deduct unreimbursed medical expenses, including any premiums and out-of-pocket expenses that they paid out of after-tax income. The deduction is gen­erally limited to expenses in excess of 7.5 percent of adjusted gross income; for example, a taxpayer with $50,000 in adjusted gross income could deduct medical costs in excess of $3,750. Furthermore, the total amount of itemized deductions is gradually reduced for taxpayers with adjusted gross income above $166,800 in 2009. In 2007, the tax expenditure for the itemized deduction for medical expenses was about $9 billion.

The health coverage tax credit covers up to 65 percent of the cost of health insurance for certain dislocated work­ers. Because the credit is refundable, individuals can claim the full benefit even if its value exceeds their income tax liabilities. To be eligible, individuals must be receiving either trade adjustment assistance or payments from the Pension Benefit Guaranty Corporation (which pays at least a portion of the pension benefit promised to retired workers if their company goes out of business or otherwise defaults on its obligations). The credit is not available to people receiving certain other government health benefits, including Medicare. In 2007, the tax expenditure for the credit was about $100 million.⁷

Options to Modify Tax Subsidies for Health Insurance

Tax subsidies could be redesigned in several ways to expand coverage. One option would be to replace the current exclusion of premiums for employment-based health insurance with a tax deduction or a tax credit. Another option would be to provide new subsidies to employers, in the form of tax credits, to encourage them to offer health insurance and to pay a portion of their employees’ premiums. (Such an option could replace or supplement the current-law exclusion or be combined with new credits or deductions for individuals.)

Replacing the Exclusion with a Tax Deduction or a Tax Credit. The exclusion of premiums for employment-based insurance could be replaced with a deduction or a tax credit that is designed to encourage coverage. In addi­tion, eligibility for those tax deductions or credits could be extended to all taxpayers who purchase health insurance, including those who purchase policies in the indi­vidual market. Providing tax preferences for individually purchased health insurance, however, could cause some employers to drop plans because they realize their workers have alternative tax-preferred options. In response, some of those workers may switch to individually purchased insurance, and others may become uninsured. (The likely magnitudes of those responses are discussed later in this chapter.)

The different structure of tax deductions and tax credits affects not only the value that various types of individuals and families will derive from them but also the impact that those subsidies will have on insurance purchases. Like the current exclusion for health insurance premi­ums, a deduction reduces taxable income, causing the value of the deduction to increase as income and mar­ginal tax rates rise. A deduction is subtracted from total income solely for purposes of computing the income tax and thus may have no impact on payroll taxes—unlike the existing exclusion.⁸ In some cases (as with the current itemized deduction for medical expenses), taxpayers can claim the deduction only if they itemize instead of claim­ing the standard deduction. In contrast, taxpayers can claim "above-the-line" deductions along with their stan­dard deduction.

Consider, again, the two single workers who each earn $40,000 in total compensation but one receives health insurance at work and the other purchases a comparable policy in the individual market. Employee A, who pur­chases a health insurance policy for $5,000 in the individ­ual market and does not itemize deductions, receives no tax benefit for his or her premiums under current law; an above-the-line deduction for the costs of health insurance would lower that worker’s taxes by $750 (see Table 2-3). That same proposal would increase taxes by $657 for Employee B, who receives $5,000 in employment-based health insurance; that worker’s taxes would rise because the amount spent on employment-based health insurance would no longer be exempt from payroll taxes. In con­trast to current law, both workers would pay the same total amount of taxes—$8,689—if the above-the-line deduction replaced the current exclusion.

Table 2-3.  

Effects on a Single Worker of Repealing the Tax Exclusion and Replacing It with an Above-the-Line Deduction, 2009

(Dollars)

				Change from Current Law
Type of Tax		Current-Law Taxes		Effect of Repealing Exclusion for Employment-Based Health Insurance			Effect of Above-the-Line Deduction for All Health Insurance		Combined Effect		Taxes After Change
		Employee A: Pays $5,000 for Individual Health Insurance
Individual		3,754		0			-750		-750		3,004
Payroll		5,685		0			0		0		5,685
		___		_			_____		_____		______
	Total taxes	9,439		0			-750		-750		8,689
		Employee B: Receives $5,000 of Employment-Based Health Insurance
Individual		3,057		697			-750		-53		3,004
Payroll		4,974		711			0		711		5,685
		______		______			_____		____		______
	Total taxes	8,031		1,407			-750		657		8,689

Source: Congressional Budget Office.

Notes: To simplify the example, both workers are assumed to be unmarried, to have no dependents, to receive $40,000 in total compensa­tion, and to have no sources of income other than wages and salaries. For Employee B, repealing the exclusion causes the employer’s contributions for payroll taxes to rise by $355 and cash wages to fall by an offsetting amount.

An above-the-line deduction is subtracted from total income to derive adjusted gross income. Taxpayers can claim both an above-the-line deduction and the standard deduction.

In contrast, tax credits can be designed to provide lower- and moderate-income taxpayers with larger subsidies than they would receive from tax deductions or exclu­sions. A credit could reduce income tax liabilities by a fixed amount, or it could have a progressive rate schedule, thereby reducing the dollar value of the tax credit as income rises.

An important issue with tax credits—particularly for lower-income individuals and couples that pay relatively little in income taxes and are more likely to be uninsured—is whether the credits are refundable. If they are not, the value of the credit may not exceed a taxpayer’s income tax liability. Compare two workers who each purchase a health insurance policy in the individual mar­ket that costs $2,000; however, one worker earns $40,000 and the second earns $20,000. Under current law, the worker who earns $40,000 pays $4,180 in income taxes. Because that worker has more than $2,000 of income tax liability, he or she would be entitled to the full $2,000 tax credit; the credit thus effectively reduces the costs of health insurance to zero. In contrast, the worker with lower earnings owes $1,180 in income taxes. The value of the tax credit would be limited by the amount of the sec­ond worker’s income tax liability, effectively reducing the costs of his or her health insurance by $1,180 (to $820). If, instead, the credit was made refundable, the second worker would receive the full amount of the tax credit—providing the lower-earning worker with the same subsidy for health insurance as the higher earner.

Recent expansions in child-related tax credits have increased the amount of income a taxpayer with children must have before he or she owes any individual income tax, making it more difficult to target assistance toward lower-income families through the tax system unless credits are made refundable. In 2009, a married couple with two children may not owe any income taxes unless their adjusted gross income is about 200 percent of the federal poverty level (approximately $44,000 for a family of four); in contrast, for workers without children, the threshold for owing income taxes is close to the poverty level. In 2009, over 20 percent of the people who are pro­jected to be uninsured at any given time either do not have any income tax liability or are claimed as a depen­dent by others who do not owe any income taxes. Nearly half as many are in the 10 percent income tax bracket and thus may not have sufficient income tax liability to receive the full benefit of a nonrefundable tax credit (see Figure 2-1).

Figure 2-1. 

Distribution of Marginal Tax Rates on Income for the Nonelderly Uninsured Population, 2009

(Percent)

Source: Congressional Budget Office’s health insurance simulation model.

Note: A dependent is assigned the marginal tax rate for the tax­payer who claims him or her as a dependent.

Because low-income individuals are also more likely to be uninsured, a refundable tax credit could be more effective in increasing health insurance coverage than other forms of tax-based subsidies for the same budgetary costs. The effectiveness of a tax credit, however, could be lessened if low-income individuals with limited resources had to wait until they filed tax returns to claim the benefit or if it was difficult to reach eligible individuals because they do not file tax returns. For those reasons, some proposals would make tax credits payable in advance as well as refundable, but doing so would raise a number of addi­tional administrative issues (see Box 2-2).

Box 2-2. 

Issues with Refundable Tax Credits

The value of a tax credit to people who owe little or no income tax depends crucially on whether the credit is refundable, because the value of a nonrefundable credit cannot exceed the recipient’s income tax liability. Implementing refundable tax credits in a way that helps low-income households purchase health insurance, however, presents at least two -challenges: Reaching all eligible individuals, many of whom may not file income tax returns; and Making the funds available in a timely manner—that is, before the premium payments are due. Reaching Eligible Individuals, Including -Nonfilers Making tax credits refundable allows people who have little or no income tax liability to receive a benefit, but many may have to file forms with the Internal Revenue Service (IRS) solely for the purpose of obtaining the subsidy. Filing behavior differs among those who have no income tax liability, largely depending on whether they work or not. In early 2008, the Joint Committee on Taxation (JCT) estimated that more than 66 million potential tax filing units (primarily individuals or married couples) did not have any income tax liability.1 Of those, more than half were expected to file a tax return for 2007. Many were required to file because their income was above the IRS filing threshold or they owed self-employment taxes. Others may have filed to obtain a refund of overwithheld amounts or to claim a refundable tax credit like the earned income tax credit (EITC). Nearly all of those "nontaxable filers" were employed. In contrast, nearly all individuals with legitimate reasons for not filing a return had low income and little or no attachment to the workforce. For the estimated 28 million nonfilers with no income tax liabilities, obtaining subsidies through the income tax system could require them to file a return. Experience with the recent economic stimulus package illustrates that many such individuals may not file, even though they would gain financially by doing so. In 2008, individuals were eligible for stimulus payments if they had at least $3,000 of income from earnings, Social Security, or veterans’ benefits, even if they had no income tax liabilities. As of September 2008, however, about 4.2 million retirees and disabled veterans who normally do not file a tax return but were eligible for the stimulus payments had not yet claimed the one-time benefit. (Individuals who were induced to file a return by the stimulus package were not included in JCT’s analysis cited above, which was prepared before the enactment of that legislation.) Paying Credits in a Timely Manner A tax benefit meant to encourage the purchase of health insurance is less effective if beneficiaries must wait a long time to receive the subsidy. Some low-income individuals will lack the resources to purchase health insurance until they receive the subsidy. Several studies have found that individuals procrastinate when faced with large up-front costs and complicated choices.2 Long lags between the premium’s due dates and the receipt of tax subsidies may result in low enrollment rates. Generally, however, taxpayers do not claim tax credits until they file their tax return at the end of the year, so they might not receive any benefit from reduced tax payments or larger refunds until after their insurance premiums are due. In principle, individuals can adjust the amount of taxes withheld from their paychecks in order to accelerate the receipt of tax benefits, but many low-income individuals have little or no income tax withholdings to adjust and cannot reduce their withholding below zero. Tax credits could also be paid in advance. For example, eligible individuals can claim advance payments of the EITC and the health coverage tax credit. One challenge of providing advance payments of tax credits is verifying eligibility before the end of the tax year—particularly if eligibility or payment amounts depend on total income received during the year. Workers may claim advance payments of the EITC by giving a form to their employer, who then provides them with a prorated amount of the credit in their paycheck based on their projected earnings. A change in circumstances during the year (for example, a spouse’s entering the workforce) could cause the couple’s income to rise, reducing the amount of the EITC to which they are entitled for the tax year. As a consequence, they would be required to repay the overpayment when they filed their tax return. Some analysts believe that the risk of such overpayment discourages eligible individuals from claiming the EITC in advance. One recent study found that only 3 percent of eligible taxpayers claim the EITC in advance, and that among those who do claim advance payments, erroneous payments are prevalent and difficult to recapture.3 1. Joint Committee on Taxation, Overview of Past Tax Legislation Providing Fiscal Stimulus and Issues in Designing and Delivering a Cash Rebate to Individuals, JCX-4-08R (February 13, 2008). 2. See, for example, Janet Currie, The Take-Up of Social Benefits (paper prepared for the Conference in Honor of Eugene Smolensky, Berkeley, Calif., December 2003; revised June 2004). 3. Government Accountability Office, Advance Earned Income Tax Credit: Low Use and Small Dollars Paid Impede IRS’s Efforts to Reduce High Noncompliance, GAO-07-1110 (August 2007).

Providing Tax Credits for Employers. To encourage firms to offer health insurance to their employees, some pro­posals would provide subsidies to businesses that contrib­ute toward their employees’ health insurance, with the expectation that those subsidies would ultimately benefit workers. Employers could receive a tax credit to cover a specified percentage of the per-worker cost of health insurance or a fixed-dollar amount per worker. As with tax credits for individuals, tax credits for businesses can be designed so that their value does not depend on the business’s marginal tax rates. In a competitive labor mar­ket, such subsidies would be passed on to employees in the form of higher wages or lower premiums for health insurance.

Providing subsidies to businesses entails many of the same issues and trade-offs that arise in providing subsidies to individuals. Small firms are less likely to offer health insurance to their workers, particularly if a large share of those workers has low income. Thus, in firms with fewer than 25 employees, more than half of full-time workers who have income between 100 percent and 200 percent of the federal poverty level lack insurance (see Figure 1-2). Partly as a result, small businesses are more likely to respond to a subsidy for insurance than are larger firms. To reflect those relationships, proposals might target tax credits toward smaller firms or to firms that do not cur­rently offer health insurance.

Such targeting strategies could reduce the cost of a sub­sidy proposal but would also lead some employers to respond in ways that would diminish the budgetary bene­fits of targeting. Basing subsidies on the size of a firm’s workforce might discourage some businesses from expanding and encourage others to reorganize into smaller entities in order to take advantage of the subsi­dies. Phasing out subsidies as the size of firms increases would reduce those incentives but would also make more firms eligible for the subsidies than would a strict cutoff based on size. As with subsidies provided directly to indi­viduals, requiring that recipients had not previously offered insurance to their workers could raise concerns about equitable treatment of similar firms—some of whom had already offered coverage—and would also create an incentive for firms to drop coverage in order to qualify.

Proposals to provide tax credits to employers would also need to address the issue of whether the credits are refundable or payable in advance. As is the case with tax credits for individuals, some employers—particularly smaller employers—may not have sufficient income tax liability to take full advantage of a credit. Similarly, smaller employers may have liquidity problems, making it difficult for them to cover the costs of an insurance pol­icy if they have to wait until they file their tax return to receive a tax credit for health insurance. Those consider­ations would affect whether firms took advantage of the subsidies that they are offered.

Trying to target subsidies according to the size of a firm and the characteristics of workers would also raise admin­istrative challenges. For example, the Internal Revenue Service currently does not have sufficient information to target subsidies on the basis of the size of a business’s workforce. Quarterly and annual reports on withholding taxes contain some information on the number of employees, although those reports do not specify whether employees work full or part time or on a temporary or permanent basis. Tax subsidies could, instead, be targeted toward businesses on the basis of gross receipts (as reported to the IRS), but some small firms might not qualify as a consequence. Basing subsidies on workers’ characteristics (such as their earnings or the number of hours they work each week) would raise additional com­plexities.

Subsidizing Premiums Through Spending Programs

Proposals designed to increase coverage rates may use spending programs rather than tax provisions to subsidize insurance premiums. One reason for taking that approach is the difficulty of reaching many uninsured individuals through the income or payroll tax systems in a timely fashion. Subsidies provided through spending programs could take the form of direct payments to indi­viduals for purchasing health insurance. Alternatively, individuals could receive the subsidy indirectly through reductions (or elimination) of premiums, with the insurer receiving payments from the government for the differ­ence between the average cost of providing coverage and the premium (if any) that enrollees are charged. The pri­mary determinants of a proposal’s cost would be the amount of the subsidy per enrollee and the number of participants.

Many of the factors that would affect eligibility for and participation in a publicly funded program—and thus the federal costs involved—can be illustrated by examin­ing the current rules for Medicaid and SCHIP. Whether new subsidies would be provided by expanding those pro­grams or creating a new program, similar design issues would arise. In particular, CBO’s estimates of program participation and costs would depend heavily on such factors as:

• Whether and how family and personal characteristics affect eligibility,
• Whether and how income is counted and used to determine eligibility or the size of the subsidy (or both),
• Whether and how asset holdings will be taken into account,
• Whether and how eligibility will be targeted toward individuals who are otherwise uninsured,
• The process for determining and recertifying eligibility, and
• The incentives for states to participate if some state financing is required.

Family and Personal Characteristics

As with tax-based subsidies, spending programs that are designed to provide subsidies to or coverage for families or children need to define rules for determining who counts as a family member and who is responsible for the health care of children. In many cases, those relationships will be straightforward, but a variety of challenges may arise. For example, determining who may claim a dependent for a benefit can be difficult, particularly when children live with a divorced parent or in an extended family. One option is to provide the benefit to the custodial parent, who is generally the recipient of other child-related benefits. In many instances, however, health insurance is obtained by noncustodial parents (who, in fact, may be required to do so under provisions for child support). In the Medicaid program, custodial parents may apply for benefits for themselves and their children, but the state is authorized to take cost-effective measures to determine the legal liability of noncustodial parents to contribute toward the costs of the children’s benefits.

Eligibility could be narrowed on the basis of other factors, including age, disability, or participation in another public assistance program. For example, Medicaid eligibility is limited to individuals who are elderly, disabled, or pregnant and to families with children; able-bodied adults who do not have children are generally ineligible. Individuals are presumed to be eligible for Medicaid in most states if they receive Supplemental Security Income (SSI) benefits (which go to elderly and disabled individuals) or would have met the eligibility criteria for Aid to Families with Dependent Children (AFDC) that were in effect when welfare reform was enacted in 1996. SCHIP primarily covers children under the age of 19. Medicaid and SCHIP both provide mechanisms for states to extend eligibility to other groups by requesting waivers of existing rules from the Department of Health and Human Services. For example, some states have been granted waivers to cover able-bodied individuals who have no dependents under Medicaid or to cover parents of eligible children under SCHIP.

Income

Subsidies can be targeted toward lower-income individuals and families by reducing or eliminating the subsidy as income rises. Medicaid covers pregnant women and children under age 6 whose family income is below 133 percent of the federal poverty level. Older children (younger than 19) are covered if their family income is below 100 percent of the poverty level. Elderly and disabled enrollees must generally have low income as well. SCHIP covers children in families with income up to 200 percent of the poverty level, although some states use higher income limits. Those income cutoffs provide incentives for potential enrollees to reduce or hide their income in order to maintain their eligibility. Those incentives may be reduced (but not eliminated) by phasing out subsidies more gradually as income rises—for example, by charging premiums to enrollees on a sliding scale—but that approach tends to increase the number of people who are eligible and thus raises the program’s costs.

Tying subsidies to income requires rules for determining how to count the income of individuals and families. That requirement raises several issues: whose income to include, what types of income to include, and the period over which to measure income.

Whose Income to Include. Eligibility for Medicaid and SCHIP is based on family income, including income received by the head of a family, his or her spouse, and possibly their children. States, however, have some discretion in defining whose income to include in the family unit.

What Types of Income to Include. Some sources of income may be excluded because they are difficult to measure. Public programs such as Medicaid or SCHIP generally reduce gross income by deducting the amount of the costs that individuals incur in earning income; such "income disregards" include costs for child care and other work-related expenses. In addition, individuals with higher income may qualify for the program if they incur high medical expenses, which may be deducted from their income so that they "spend down" to become eligible. Not surprisingly, broader measures of income would tend to reduce the number of people who could meet a given income standard, whereas greater use of income disregards would tend to expand eligibility.

Choosing a Period Over Which to Measure Income. Current income best reflects a potential beneficiary’s ability to pay for health insurance, but income may fluctuate and may be more difficult to measure accurately. Many federal programs use relatively short accounting periods to measure income (for example, the current month). For any given income standard, using shorter accounting periods is likely to increase eligibility because monthly income tends to vary more than annual income. The income tax system bases eligibility for tax subsidies on all income received during a year, but that information is not available until the following year, and data from a previous year’s tax return may overstate or understate current resources.

Assets

Proposals may further target subsidies through asset tests. Such tests measure the value of certain investments that families could liquidate to pay for their needs (in this case, health insurance) in order to determine eligibility. Some types of assets may be excluded because they are difficult to sell or are viewed as a necessity. For example, to be eligible for the Supplemental Security Income program, applicants’ assets must be worth less than $2,000 for individuals or $3,000 for couples, but the program does not include the value of a person’s home, burial sites, or, in most cases, car. Asset tests, however, can be difficult to administer and may discourage saving. Beneficiaries and program administrators may have to assess the value of property and other investments for which complete and reliable information may not be available. Asset tests also create incentives for individuals to divest themselves of current investments and avoid accumulating new assets in order to qualify for assistance.⁹

Under current law, states may restrict eligibility for Medicaid or SCHIP on the basis of assets but are not required to do so. As of January 2008, 45 states plus the District of Columbia did not consider assets when determining whether children qualify for Medicaid or SCHIP; 21 states and the District of Columbia disregarded assets for determining parents’ eligibility for those programs. For disabled and elderly enrollees, however, eligibility for Medicaid can be linked to SSI, so the same asset tests may apply.

Insurance Status

One of the more vexing issues that arise when providing assistance for health insurance is whether applicants have to be currently uninsured to receive a subsidy. On the one hand, it may be considered inequitable to subsidize uninsured individuals and families while providing no assistance to those with similar income and family responsibilities who have incurred the costs of purchasing health insurance. On the other hand, offering subsidies to those who are already covered by insurance—referred to as "buying out the base"—can substantially increase a program’s costs. As a result, many policy proposals, particularly those that would expand Medicaid or SCHIP, seek to contain federal costs by targeting subsidies toward the uninsured alone. However, determining who is uninsured and thus qualified for subsidies raises a number of policy and administrative concerns that could affect a program’s costs.

One concern is that determining who is uninsured can be difficult because of the dynamic nature of insurance status. Many people are uninsured for short periods of time—for example, they may lose coverage for a few months while between jobs. During the period that they are uninsured, they may qualify for subsidies; however, unless program administrators can certify eligibility continuously—which would raise administrative costs substantially—they may continue to receive the subsidies for some time after they start their new job and health plan.

Another concern is that public programs that are targeted toward the uninsured increase incentives for individuals (or their employers) to drop their current coverage and switch to the new subsidized program.¹⁰ To the extent that such crowd-out occurs—with public insurance replacing private insurance—program costs rise without reducing the number of people who are uninsured. Determining whether applicants were previously uninsured may not be difficult; most private insurance is provided through employers, and program administrators can check with them about an applicant and do not have to rely on self-reporting. Yet program administrators cannot easily determine the reason an applicant is uninsured or distinguish between applicants who would have been uninsured in the absence of the subsidized program and those who lack insurance because of incentives to drop coverage.¹¹

States’ experiences with SCHIP provide some insight into the challenges of minimizing crowd-out. One common approach has been to impose a waiting period, specifying the length of time that previously insured children must be uninsured before they are permitted to enroll in the program. As of July 2007, 37 states imposed a waiting period (usually three to six months). Although that approach discourages privately insured individuals from dropping their coverage, it also imposes a hardship on affected applicants by making them wait longer to receive coverage.

The trade-off between strict policies to prevent crowd-out and efforts to encourage maximum enrollment among the targeted population has led many states to allow exceptions to waiting periods (for example, if a family loses insurance coverage because of a job loss). However, states’ strategies to prevent crowd-out have apparently met with limited success. A number of studies analyzing crowd-out in the Medicaid and SCHIP programs have varied widely in their methodologies and in their findings. On the basis of a review of that empirical literature, CBO has estimated that for every 100 children who gain coverage as a result of SCHIP, there is a corresponding reduction in private coverage of between 25 and 50 children.¹² The extent to which that finding would apply to new proposals is difficult to predict, but as a general matter the probability of crowd-out increases as eligibility for a public program is extended to people at higher income levels, simply because a greater share of the population already has private insurance. Because incomes, the costs of health insurance, and coverage rates vary geographically, the extent of crowd-out under a given subsidy schedule is also likely to vary from region to region.

Crowd-out may occur even if eligibility for a public program is not limited to the uninsured. If a new public program provides a larger effective subsidy than the one that privately insured individuals receive, those individuals will have a financial incentive to shift to the public program. That incentive can be blunted if the subsidies are actively extended to privately insured individuals who would otherwise qualify, as was done for the Medicare drug benefit. Extending new subsidies to individuals who already have private insurance tends to increase total program costs, however, and also generates crowd-out of another type—substituting public spending for private spending without changing the source of insurance for those individuals.

Certifying and Verifying Eligibility

Targeted benefits require that program administrators certify eligibility and enforce the program’s rules. Benefit programs differ in their approaches toward certification and enforcement, and those differences have effects on coverage and program costs. Two common approaches are the self-assessment model (generally with third-party verification) and the caseworker model, each of which has different implications for accuracy rates and for administrative burdens on the programs and applicants. A related issue is the time between recertifications of eligibility for enrollees, which raises the same trade-offs between accuracy and administrative burdens.

Self-Assessment Model. Under this model, individuals assert their eligibility on an application form, and agencies try to verify at least some applicants’ statements with information from reliable third parties. That approach is used to verify eligibility for many tax subsidies, including the earned income tax credit, as well as some spendingprograms (such as the school lunch program).

The self-assessment model appears to work best when third-party information is readily available and can be matched to the applications (or tax returns) automatically—and worst in the opposite case. For example, studies of compliance with the EITC have shown errors to be most prevalent for family-related eligibility criteria (for example, the taxpayer’s marital status or whether a child claimed as a dependent actually resides in the taxpayer’s home), for which the IRS has lacked administrative data.¹³ Conversely, rates of misreported income are generally lower because the IRS receives information on most earnings from employers. For other administering agencies, which have different monitoring capabilities, the sources of error may be reversed. For example, misreported income constitutes the largest source of error in the school lunch program; schools generally rely on parents’ reports of income to certify eligibility for subsidies.¹⁴ Schools may be in a stronger position to monitor a child’s living arrangements than to monitor his or her family income.

Caseworker Model. This model is typically used to determine eligibility for the Supplemental Nutrition Assistance Program (SNAP), which was formerly known as the Food Stamp program, and for the Temporary Assistance for Needy Families (TANF) program. The caseworker model uses in-office visits, up-front requests for documentation (such as pay stubs), and phone calls to third parties to validate nearly all statements made by every applicant. As a result, the application process may be time-consuming for program administrators and for applicants. That factor, and any stigma that applicants may associate with being in the program, tends to reduce participation.

The differences in the verification processes used by various programs affect participation, compliance with the programs’ stated rules, and administrative costs. For example, when some EITC claimants were asked to obtain and submit documentation showing that they met the credit’s child residency requirements, compliance improved but the number of claims by eligible taxpayers dropped and administrative costs increased. Studies of Medicaid and federal nutrition programs also find that participation decreases as the complexity of the application process increases.¹⁵ In response to those concerns, most states have eliminated face-to-face interviews for determining eligibility for families with children under Medicaid and SCHIP and have simplified their application processes.

Exceptions for Retroactive and Presumptive Eligibility. Another issue concerns the timing of enrollment in a public program. Some people may be eligible to participate in a public program but do not apply for benefits until the onset of a medical emergency. Some programs would deem those individuals covered—at least for a short period before their application for benefits. Medicaid coverage, for example, may be retroactive: Once an application is approved, the plan may cover costs incurred in any or all of the three months before application.¹⁶

Another way that a public plan may provide coverage to those who have not completed the application process is through presumptive eligibility. States have the option of allowing qualified entities—including Medicaid provid­ers and certain other programs serving low-income chil­dren (for example, Head Start)—to deem that a child is temporarily eligible for Medicaid; if the child’s parent or guardian does not submit a completed application during the time period established by the state, the child’s pre­sumptive eligibility ends. States can also extend presump­tive eligibility to women who are pregnant or who need treatment for breast or cervical cancer.

Time Between Recertifications. The length of time between certification periods affects participation, cover­age, and program costs. Basing eligibility on current resources provides the best measure of ability to pay, but continuously monitoring eligibility is costly. Beneficiaries also may be more likely to drop out of a program if they are frequently asked to recertify their eligibility. Most states have a 12-month renewal period for SCHIP, which enables children to remain enrolled unless their family reports a change in income or other circum­stances—something they may be reluctant to do if it would cause them to lose eligibility. For SNAP, states have the option to allow households with earned income to retain the same benefits for six months even if their income fluctuates over that certification period, as long as their total income remains below 130 percent of the fed­eral poverty level.

Providing Incentives for States

The effects of any proposal that requires action by the states—and, in particular, funding from them—depends on the incentives states have to participate. States cur­rently have substantial latitude to expand Medicaid; indeed, over half of current Medicaid spending is for cov­erage of populations or benefits beyond those required by federal law. States could expand their programs even more (with approval from the Department of Health and Human Services), but the fact that they have not pursued substantial further expansions of Medicaid suggests that the current federal matching rate—which averages 57 percent for medical costs—is not a sufficient induce­ment to do so. Indeed, states’ budgetary pressures some­times lead them to limit eligibility or benefits, but those changes have generally been modest. Proposals that would expand insurance coverage by, in effect, subsidiz­ing states’ efforts would probably require a higher federal subsidy rate to generate a substantial response. At the same time, increases in the share of costs borne by the federal government not only raise federal spending but also reduce the incentives that states have to manage those funds in a prudent manner.

Effects of Premium Subsidies on Rates and Sources of Insurance Coverage

Because of the central role played by employment-based insurance, the effects of any proposal to offer new pre­mium subsidies or to modify existing ones depend not only on how individuals respond to those provisions but also on how firms respond in their decisions about offer­ing coverage to their employees and about subsidizing that coverage. To capture those complex interactions, CBO has developed a microsimulation model to estimate how rates of coverage and sources of insurance would change from those currently projected as a result of pro­posals that alter the subsidies for—and thus the net cost of—various insurance options. That model is based on survey data and includes a wide range of information about a representative sample of individuals and families, including their income, employment, health status, and health insurance coverage. This section discusses some of the key parameters and assumptions that CBO uses to estimate coverage rates and sources of insurance.¹⁷

Employers’ Decisions to Offer Health Insurance

Most nonelderly Americans obtain health insurance through their employers, but before individuals can enroll in such private group coverage, employers must offer it to their employees. In general, businesses compete for workers by offering wage and benefit packages that will attract and retain employees. Employers offer health insurance (and other benefits) if they believe their employees want such coverage enough, in effect, to trade cash wages for it. Consequently, an employer’s response to a policy will be a function of how that policy affects its workforce, on average. Those effects could arise from proposals that would change the subsidies for employment-based health insurance, but they could also stem from changes to employees’ other health insurance options—either in the individual insurance market or from a public program such as Medicaid.

Changes in Subsidies for Employment-Based Insurance. For several reasons, large employers are more likely than small employers to offer health insurance. Reflecting that fact, the response of firms to changes in the subsidies for employment-based insurance would depend not only on the impact of those changes on the net price of insurance but also on the size of their workforce. To estimate the likelihood that firms would offer (or drop) health insur­ance in response to a change in price, CBO multiplies the average change in price for a firm’s employees by an "elas­ticity of offer"—a factor that measures how employers’ offers of insurance respond to changes in price. The elas­ticity of offer varies with the size of the firm and is based on estimates from several studies (see Table 2-4).¹⁸ For example, for firms with between 25 and 99 employees, CBO estimates the elasticity of offer to be -0.38; thus, a 10 percent increase in the premiums for firms of that size would cause a 4 percent decline in the number of employees offered coverage. Consistent with the available evidence, the relevant "price" in that calculation is the total cost of insurance to the employer and employee combined—net of any federal (or state) subsidies—not just the portion that the employer pays directly.

Table 2-4.  

Effects of a Premium Subsidy on Offer Rates for Employment-Based Coverage, by Size of Firm, 2009

			Employees Offered and Eligible for Coverage
Size of Firm (Number of employees)	Employees (Millions)		Number (Millions)		Percent		Elasticity of Offera
Fewer Than 25	30.6		14.7		48.0		-1.14
25 to 99	17.4		12.5		72.0		-0.38
100 to 999	26.9		20.8		77.2		-0.15
1,000 or More	62.9		54.0		85.7		-0.07
All	137.8		102.0		74.0		-0.28

Source: Congressional Budget Office’s health insurance simulation model.

a. Elasticity of offer is a factor that measures how employers’ offers of health insurance respond to changes in price. It is based on estimates from several studies: Jonathan Gruber and Michael Lettau, "How Elastic Is the Firm’s Demand for Health Insurance?" Journal of Public Economics, vol. 88, nos. 7–8 (July 2004), pp. 1273–1293; Jack Hadley and James D. Reschovsky, "Small Firms’ Demand for Health Insur­ance: The Decision to Offer Insurance," Inquiry, vol. 39, no. 2 (2002), pp. 118–137; and Len Nichols and Linda J. Blumberg, "Estimating Employer Elasticity of Demand for Health Insurance" (paper presented at Academy Health Annual Research Meeting, Washington, D.C., 1999).

Consider, for example, how firms of different sizes would respond to a subsidy proposal that reduced the net price of employment-based insurance by 20 percent. CBO anticipates that such a subsidy would increase the avail­ability of health insurance at very small firms (those with fewer than 25 employees) by about 23 percent (the 20 percent reduction in price multiplied by -1.14, the elasticity of offer). The share of employees at such firms that are currently offered insurance is estimated to be 48 percent, so the proposal would be expected to increase that share by 23 percent, to 59 percent, or a gain of 3.4 million workers. Larger firms would be less respon­sive to the subsidy, and analogous calculations for all firms would yield an overall increase in the offer rate of about 6 percent (an average elasticity of offer of -0.28 times -20 percent); that translates into an increase of about 6 million in the number of workers offered cover­age, roughly half of whom would have been uninsured before receiving the new offer.¹⁹

Changes in Employees’ Other Insurance Options. Employers’ decisions about offering coverage are also affected by changes in the relative attractiveness of their employees’ other insurance options, such as individually purchased plans or Medicaid coverage. For example, leg­islation that expanded eligibility for Medicaid could make some of a firm’s employees (or their dependents) eligible for that program; alternatively, a proposal could provide a new tax credit for policies that are purchased in the individual market. Other factors held equal, a firm would be less likely to offer coverage if the relative attrac­tiveness of its employees’ other options increased.²⁰ The magnitude of that effect is estimated to be roughly one-third as large as the direct effect of changes in the price of employment-based insurance; that is, a proposal that pro­vided a 10 percent subsidy for policies purchased in the individual insurance market would have about the same effect on employers’ offers as a proposal that increased the net price of insurance purchased through an employer by 3 percent to 4 percent. (Both proposals would increase the relative attractiveness of individually purchased insurance.)

In addition to a firm’s size, the other factors that would affect whether employers drop coverage include the aver­age tax rate its employees face (lower rates mean that employees obtain less of a benefit from the current exclu­sion for employment-based insurance) and the relative value of the alternative insurance. Some firms that con­tinue to offer coverage may also change the amount they contribute toward premiums in response to changes in the attractiveness of outside insurance options. On the basis of the limited evidence that is available, CBO esti­mates that firms would increase the share of the total pre­mium employees pay by about 2 to 3 percentage points if the share of their workers eligible for Medicaid increased from 20 percent to 40 percent.²¹

Individuals’ Decisions to Enroll in an Insurance Plan

Individuals’ decisions to enroll in a plan are affected by the price of insurance, their income, and the options available to them. In the private market, those options may include enrolling in an employment-based plan (if they work for a firm that offers insurance) and purchasing insurance in the individual market. Individuals’ decisions to enroll in a private plan will also be affected by whether they are eligible to participate in a public program.

Purchasing Employment-Based Insurance. After firms make their decisions about offering and subsidizing insurance—reflecting the average effects of the policy proposal on their workers and the aggregate cost of insur­ance—workers choose whether to enroll and where to obtain their coverage. As with employers’ decisions to offer health insurance, the choice to enroll in a plan will depend on the price of employment-based health insur­ance and alternative options. In this case, however, the key factor affecting enrollment rates is the premium that employees themselves pay, not the total cost to the employer and employee combined. Even though workers ultimately "pay" for employers’ contributions toward their health insurance, primarily through reduced wages, studies have found that employees’ decisions about enrollment are not sensitive to the amount the employer pays. That finding reflects the fact that once an individ­ual has decided to work for an employer that offers insur­ance, it is generally infeasible for that worker to recoup the employer’s contribution by declining coverage.

Several studies have attempted to estimate employees’ responses to changes in the amount they have to pay for employment-based insurance by comparing the behavior of workers who face lower insurance premiums with that of workers who face higher premiums.²² The results of those studies can be illustrated by examining what would happen to enrollment in employment-based plans as the share of the premium that the employee pays is reduced from current levels to zero; for simplicity, the illustration focuses on the 149 million nonelderly individuals, including workers and their dependents, who work for employers that offer health insurance but who are not eli­gible for public coverage.

According to a survey of employers conducted by the Kaiser Family Foundation, employees’ premiums cur­rently average about 16 percent of the cost of single cov­erage and about 27 percent of the cost of family coverage, and at those subsidy rates approximately 137 million peo­ple are covered through an employment-based plan in 2009. Another 1 million choose to purchase insurance in the individual market. Of the 11 million who are not covered, CBO estimates that about 3 million would obtain coverage if their contribution was cut in half, and about 4 million more would do so if that contribution was reduced to zero. In other words, even if they were offered insurance for free, the remaining 4 million—or 3 percent of the individuals who could be covered through their employer—would decline that coverage and remain uninsured.

Those enrollment rates are average measures of the expected response by employees to a change in the price of insurance, but other factors would also play a role. For example, the probability of uninsured individuals’ enroll­ing in their firm’s plan is affected by their income and by the availability and attractiveness of other coverage options. Workers with higher income tend to have higher enrollment rates than those with lower income, although those rates would be expected to converge as subsidies approached 100 percent. By contrast, individuals with access to Medicaid or other public coverage or whose children have public coverage would be less likely to enroll in family coverage offered by an employer, and the likelihood would be reduced in proportion to the per­centage of children covered by a public program.

Purchasing Insurance in the Individual Market. Proposals could seek to expand coverage through the individual insurance market—for example, by equalizing the tax treatment of employment-based and individually pur­chased coverage or by subsidizing individually purchased insurance through new tax credits and tax deductions. As with their choices regarding employment-based coverage, individuals’ decisions about whether to purchase coverage in the individual market are affected by its price, their income, and the availability of other insurance options.

Estimates of the response to changes in the price of indi­vidually purchased insurance are most reliable if subsidy rates are low, because that situation is similar to current experience. The available studies suggest that a new 25 percent subsidy for individually purchased coverage would cause 2 percent to 6 percent of the uninsured pop­ulation to buy that coverage. The academic literature is not very informative, however, when prices are close to zero (that is, when subsidies approach 100 percent), because that situation is currently not observed in the individual market. CBO therefore estimates the effects of high subsidies using evidence about participation rates in existing public programs (which are, in general, highly subsidized).

On the basis of that evidence, CBO estimates that people would gradually become more responsive to changes in the price of individually purchased insurance as subsidy rates increased; moreover, they would become increas­ingly likely to obtain coverage when subsidy rates exceeded 70 percent (see Figure 2-2). Of the roughly45 million nonelderly individuals who do not work for employers that offer health insurance or who are not eli­gible for public coverage, about 20 percent are covered by an individually purchased policy in 2009; the current subsidy rate is close to zero. Adding a 25 percent subsidy for individually purchased coverage would increase the participation rate for that population by 3 percentage points, to 23 percent, CBO estimates, reducing the unin­sured by about 1.4 million people. Increasing the subsidy rate to 50 percent would roughly double the impact, but increasing the participation rates above 50 percent would require the subsidy rate to exceed 80 percent (holding other factors equal). Such subsidies, moreover, would make insurance in the individual market more attractive relative to employment-based plans, causing some employers to decide not to offer coverage to their employees.

Figure 2-2. 

Probability of Enrolling in an Individually Purchased Insurance Plan with a Subsidy

(Percentage taking subsidy)



Source: Congressional Budget Office’s health insurance simulation model.

Note: Roughly 45 million nonelderly U.S. residents lack access to an offer of employment-based insurance and are ineligible for Medicaid or the State Children’s Health Insurance Pro­gram. The curve displays the estimated probability of that population enrolling in an individually purchased insurance plan as a function of a subsidy set at a percentage of the insurance premium.

Impact of Eligibility for Public Programs. People who are eligible to participate in public programs, such as Medic­aid and SCHIP, will also be affected by proposals that lower the costs of employment-based or individually pur­chased plans. Their response will be influenced by many of the same factors that affect the decisions of those who are not eligible for public programs to purchase health insurance in the private market—the price of health insurance, their income, and the availability of other insurance options.

In addition, other nonmonetary factors appear to affect whether an individual who is eligible for a public plan purchases private insurance—and, more generally, whether that person instead enrolls in a public plan or does not obtain any coverage. Applying for a public pro­gram may impose burdens that people do not encounter when they apply for private health insurance. Those bur­dens include learning about the program and its eligibil­ity rules, the additional expenses incurred when applying for benefits (for example, the amount of time it takes to complete an application, collect documentation proving eligibility, and—if required—visit a government office for an interview); and concerns that enrolling in a public program will somehow stigmatize the participant. Retro­active and presumptive eligibility rules may also affect the timing of a decision to enroll, by allowing people to delay applying for a public program until the onset of a medical emergency.

Those factors may help explain why many people who are eligible for Medicaid or SCHIP purchase coverage in the private market. In 2009, about 23 percent of nonelderly people who are eligible for Medicaid or SCHIP will have employment-based insurance coverage and about 2 per­cent will have individually purchased coverage. Reflecting that evidence, CBO models the purchase of private cover­age among people who are eligible for or enrolled in Medicaid in a manner that is similar to enrollment rates among the uninsured but is reduced by a factor (generally more than half) to reflect that those people would be giv­ing up free or low-cost public coverage to take private coverage.

Decisions to Switch or Drop Coverage

Changes in the relative attractiveness of health insurance options could affect whether individuals who already have insurance would remain in their current plans. A proposal to expand coverage could cause some people to switch from one type of plan to another and still others to become uninsured, even though the proposal would, on net, result in an increase in coverage.

A proposal, for example, might increase the attractiveness of individually purchased coverage through a deduction or tax credit for health insurance premiums. Because their employees could receive tax benefits for purchasing health insurance elsewhere, some employers would drop existing plans. In response, some of their workers would obtain coverage in the individual market; others might (if able) obtain employment-based insurance through a spouse’s job, enroll (if eligible) in Medicaid, or become uninsured. A number of workers at firms that continued to provide coverage might switch to an individually pur­chased plan. Workers in relatively good health would be the most likely to prefer individually purchased insurance because they might pay lower premiums in that market (in which premiums usually vary to reflect enrollees’ age and health status) than in the employment-based insur­ance market (in which healthier workers are pooled with less healthy coworkers).

Suppose, for example, that a subsidy for individually pur­chased insurance was provided to low-income individuals and families in the amounts of $1,500 for single coverage and $3,000 for a family policy. Under that scenario, CBO estimates that about 2.3 million people who would have been uninsured would instead use the voucher to obtain coverage. In addition, 100,000 people who would have otherwise had employment-based insurance would be covered in the individual market; roughly half of them would no longer be offered insurance by their employer as a result of the new policy, and half of them would have individually purchased coverage despite being offered coverage by their employer. About 100,000 people would become uninsured because their employer elected not to offer coverage and they neither purchased an individual plan nor enrolled in a public program.²³

Individual and Employer Mandates

Premium subsidies would increase the number of people with insurance but would not be sufficient to achieve universal coverage, even if the subsidies covered a very large share of policy premiums. To increase coverage rates further, policymakers could impose a mandate that indi­viduals obtain insurance or that employers offer coverage. Individual mandates can be applied broadly (to the entire population of the United States) or to a specific group (for example, children). Employer mandates target a more specific subpopulation of the uninsured: workers without insurance and, depending on the scope of the mandate, their spouses and dependents. Under an employer mandate, firms could be required to provide health insurance for their workers or contribute to a fund—an approach commonly referred to as "play or pay." If effective penalties were imposed on individuals and firms that did not comply, mandates would increase coverage rates by raising the cost of remaining uninsured or of not offering coverage—that is, by using a stick rather than a carrot. However, the ultimate impact of a mandate would depend largely on its scope, the extent of its enforcement provisions, and the resulting incentives to comply.

An important distinction between the two types of man­dates is that individual mandates generally require people to have insurance coverage, whereas employer mandates generally require employers to offer coverage. Employer mandates could also require that employers subsidize a certain percentage of the premium, which would encour­age their workers to purchase coverage, but the ultimate effect on coverage rates would depend on how those workers responded to the subsidies (and to the ensuing offsetting changes in other aspects of their compensa­tion). As a result, determining the degree of employers’ compliance with mandates is only the first step in esti­mating the impact of the mandate on rates of insurance coverage.

Experience with Mandates

The federal government does not have any experience administering a health insurance mandate, but Hawaii and Massachusetts, which have enacted such require­ments, provide some insights. In addition, it is useful to examine the impact of other mandates that may be analo­gous, such as requirements to pay taxes, purchase auto­mobile insurance, and vaccinate children.

Existing State Mandates for Health Insurance. Since 1974, Hawaii has required employers to provide health insurance for their full-time, permanent employees. Employers also must pay at least half of the premium for single coverage for each eligible employee (with the exception of part-time employees, government employ­ees, and seasonal workers).

In 2007, Massachusetts began phasing in a mandate that all adult residents have health insurance. By 2009, all adults must have a policy that covers a basic set of bene­fits or they will have to pay a penalty—for each month not covered—equal to half the premium for the cheapest health insurance plan that provides the minimum benefit package. Penalties are waived, however, for people who are deemed unable to afford insurance. Massachusetts also requires all but the smallest employers to provide health insurance for their workers or pay $295 per year for each uncovered worker to a state fund. (For additional details about the mandates in each state, see Box 2-3.)

Box 2-3. 

Health Insurance Mandates in Hawaii and Massachusetts

Both Hawaii and Massachusetts have enacted health insurance mandates. In Hawaii, the mandate is imposed on employers, requiring them to offer coverage to most of their workers and to subsidize the premium; in Massachusetts, both adults and employers are subject to mandates. Hawaii The state’s Prepaid Health Care system, as it is known, was enacted in 1974 and requires all employers in Hawaii to offer employees a health insurance plan that covers at least a minimum set of specified benefits. Most employers with at least one employee are subject to the requirement, but they do not have to offer coverage to employees who work less than 20 hours a week or whose monthly wages fall below a specified amount (about $600 in 2008). In addition, the mandate can be waived for employees covered by Medicare, Medicaid, or their own (or their parents’) health plan and for members of certain religious groups. Employers must generally pay at least half of the premium for individual coverage, subject to limits on how much the employee must pay. Employers may demonstrate compliance with the mandate by purchasing an approved plan from an insurer or by obtaining certification for their own health care plan.1 The minimum penalty for failure to comply with the employer mandate is $25, or $1 per employee for each day of noncompliance, whichever is greater. The business may be closed if the employer fails to provide health insurance for more than 30 days. Additional penalties are imposed for willful noncompliance. The mandate is administered by the state’s Department of Labor and Industrial Relations. Massachusetts As a result of a law enacted in 2006, every Massachusetts resident who is age 18 or older is now required to have health insurance. (New subsidies were also offered to encourage families to obtain coverage, but insurance is not mandatory for children.) The state’s individual mandate is being phased in over three years. By the end of 2007, individuals had to have health insurance or they would be subject to income tax penalties. In 2008, they must have coverage each month. In 2009, they must have coverage under a health plan containing specified benefits. Beginning in 2008, the penalty for noncompliance equals half of the premium for the minimum affordable health insurance plan (a fixed amount determined by Massachusetts officials at the beginning of each year) for each month not covered. Subsidies are provided to lower-income households to help them pay for insurance, and individuals with income under 150 percent of the federal poverty level are exempted from the mandate (and those with somewhat higher income may also be exempt if they cannot find affordable insurance). Individuals may also apply for exemptions on the basis of religious beliefs or personal hardship. The individual mandate is administered by the state’s Department of Revenue; residents receive a form from their insurer that they must submit along with their tax return to verify that they have qualified coverage, and insurers and state agencies also report health insurance coverage to that agency. Employers with 11 or more full-time-equivalent employees must offer health insurance to their workers and must also establish a "cafeteria plan" that allows employees to exclude payments for their portion of the premium from income and payroll taxes. The state has also established an insurance "connector" agency through which small businesses (as well as individuals) may purchase qualified insurance plans. In addition, employers must either make a "fair and reasonable contribution" to their employees’ health insurance or pay the state up to $295 per employee. Employers are also subject to a surcharge if employees and their dependents use more than $50,000 of care a year from a state-funded pool that has been established to finance free care for the uninsured. The amount of the surcharge varies with such factors as the number of employees and the amount of free care used. 1. Shortly after Hawaii enacted the Prepaid Health Care Act, the Congress passed the Employee Retirement Income Security Act (ERISA), which exempts many employers from state health insurance mandates and other regulations. (For a discussion of ERISA, see Box 1-1.) The Supreme Court ruled in 1981 that ERISA preempted Hawaii’s legislation, but in 1983 the Congress granted Hawaii a waiver from the ERISA provisions.

Several studies have examined the effects of the employer mandate in Hawaii. Although Hawaii has relatively high rates of insurance coverage compared with other states, determining how much of that difference is due to the mandate itself and how much reflects other factors, such as population characteristics, is a challenge. One study found that the number of uninsured fell by roughly 1 percentage point—from about 11 percent to about 10 percent—after Hawaii implemented the mandate, attributing that relatively small effect to the exclusion of dependents and certain classes of workers as well as limited enforcement.24 Other studies have examined the effects of the mandate on exempted sectors, particularly part-time workers. Although part-time employment in Hawaii increased after the mandate relative to part-time employment in the rest of the country, the evidence is mixed regarding the mandate’s effects on rates of insur­ance coverage in the exempt sectors.²⁵

Although it is still too soon to evaluate the full effect of the mandates in Massachusetts, preliminary data suggest that the number of uninsured has fallen substantially since the state implemented its health reform plan. According to one recent study, the share of nonelderly adults who were uninsured declined from 13 percent in the fall of 2006 to 7 percent in the fall of 2007.²⁶ How­ever, the study did not attempt to isolate the effects of the coverage mandates from other aspects of the state’s initia­tive, which included reforms in the insurance market and new premium subsidies for lower-income individuals and families.

Other Types of Mandates. Although the U.S. experience with enforcing health insurance mandates is limited, some lessons can be drawn from other types of mandates. For example, both federal and state governments require individuals and businesses to pay taxes; many states have imposed mandates for drivers to have auto insurance and to wear seat belts; and many school districts require chil­dren to be immunized in order to attend public schools. For those mandates, national compliance rates range from 63 percent to 86 percent (see Table 2-5). Those rates, however, do not clearly identify the effect of the mandate itself because they include people who might have acted in the desired manner even if there were no legal requirements—which may reflect the intrinsic value of a mandated item (such as auto insurance), subsidies (such as free or low-cost vaccinations), or social norms (such as a perceived obligation to pay taxes). For example, studies indicate that about 77 percent of young children were vaccinated against chicken pox in states without immunization requirements and that mandates increased vaccination rates by about 8 percentage points (to 85 per­cent).

Table 2-5.   U.S. Experience with Enforcing Mandates

Mandate		Administering Agency		Availability of Data		Methods of Verification		Penalties		Evidence of Compliance
Individual Mandate
Immunization		School districts		Parents must provide proof of immunization.		School officials review documentation provided by parents.		Exclusion from schools.		Immunization rates for chicken pox among children ages 19 to 35 months range from 76.8 percent in states without mandates to 84.9 percent in states with mandates.a
Auto Insurance		State Departments of Motor Vehicles		Self-reporting; some states receive information from insurers.		Vary by states.		Vary by states, ranging from none to $50 to $5,000.		85.4 percent of drivers were insured in 2004, but rates range from 74 percent in Mississippi to 96 percent in Maine;b compliance is better in states with third- party reporting.c
Seat Belts		State and local law enforcement agencies		None.		Vary by states; 26 states and the District of Columbia allow police to stop cars solely to check if seat belts are worn.		Citations, with cash penalties.		Seat belt use was 82 percent in 2007, but rates vary by states with scope and enforcement, ranging from 63.8 percent in New Hampshire (where adults are not required to wear seat belts) to 97.6 percent in Hawaii.d
Income Taxes		Internal Revenue Service		Self-reporting; third-party data for many (but not all) types of income.		Matching; audits.		Back amount due plus interest; civil and criminal penalties.		86.3 percent of tax liabilities was collected in tax year 2001.e
Employer Mandate
Minimum Wage		Department of Labor (DOL)		Complaints filed by workers.		DOL’s investigations and employees’ lawsuits.		Back pay; criminal prosecution and fines if there is evidence of egregious abuse.		63 percent to 75 percent in 1973.f

Source: Congressional Budget Office based on data from sources listed below. a. Matthew M. Davis and Michael A. Gaglia, "Associations of Daycare and School Entry Vaccination Requirements with Varicella Immuniza­tion Rates," Vaccine, vol. 23, no. 23 (2005), pp. 3053–3060. b. Insurance Research Council, Uninsured Motorists, 2006 Edition (Malvern, Pa.: Insurance Research Council, June 2006). The IRC com­putes the uninsurance rate as the probability that an at-fault driver in an accident was uninsured or unable to meet the liability for some­one else’s injury caused by the accident. The estimate is derived from insurance claims for 11 insurers (representing 58 percent of premiums for private passenger auto liability insurance in the United States). The insurance rate is equal to one minus the uninsurance rate. c. Yu-Luen Ma and Joan T. Schmit, "Factors Affecting the Relative Incidence of Uninsured Motorists Claims," Journal of Risk and Insurance, vol. 67, no. 2 (2000), pp. 281–294. d. Department of Transportation, National Highway Transportation Safety Administration, National Center for Statistics and Analysis, Seat Belt Use in 2007—Use Rates in the States and Territories, DOT HS 810 949 (May 2008). e. Internal Revenue Service, Reducing the Federal Tax Gap: A Report on Improving Voluntary Compliance, IR-2007-137 (August 2, 2007). f. Orley Ashenfelter and Robert S. Smith, "Compliance with the Minimum Wage Law," Journal of Political Economy, vol. 87, no. 2 (1979),  pp. 333–350.

Factors Affecting Compliance with Mandates

The observed variation in compliance with existing man­dates reflects the fact that their impact depends largely on their scope and on the expected costs of noncompliance for people who are subject to them. In the case of a man­date to have health insurance, individuals would generally weigh the benefits of that coverage against those expected costs when determining whether to comply.

Scope of a Mandate. An individual mandate could apply to the entire population or be limited to certain subpopu­lations. Requiring all residents to have health insurance coverage would encompass the largest number of unin­sured but could be more difficult to implement quickly than a more narrowly targeted mandate. For example, it might take government agencies longer to develop the administrative apparatus necessary to enforce mandates covering the entire population. Alternatively, a mandate could be limited, at least initially, to adults, children, or another subpopulation; that approach would allow insur­ers, providers, and government administrators to adapt more gradually to new responsibilities but could poten­tially reduce or slow the impact on the uninsured popula­tion.

Proposals could also limit the scope of individual man­dates by allowing for certain exemptions. In particular, individuals who are not able to afford health insurance could be exempted from the mandate. In Massachusetts, for example, uninsured individuals whose income is below 150 percent of the federal poverty level are not penalized if they fail to obtain health insurance.²⁷

Establishing such exemptions would involve defining a standard for affordability—and, depending on the definition, such provisions could vary in their ease of administration. Massachusetts also allows exemptions for religious beliefs and personal hardships; verifying whether hardship exemptions are valid would require developing review and appeals procedures, adding to administrative costs.

Exemptions and subsidies could reduce the costs of com­plying with an employer mandate for certain types of employers, such as small businesses. Massachusetts exempts employers with 10 or fewer employees from its play-or-pay requirements. In addition, employers that have 50 or fewer employees receive subsidies for each employee whose family income is at or below 300 percent of the federal poverty level. Definitions of a "small" business vary, however, in terms of the threshold for determining who counts as an employee and the number of employees involved. A small business could be defined on the basis of the number of full-time permanent employees, although the administering agency might find it difficult to determine who meets those qualifications without on-site visits (an administratively burdensome and costly activity). Depending on the definition used, businesses might find it advantageous to reorganize to avoid mandates or to qualify for subsidies on the basis of the number of employees.

Expected Penalty for Noncompliance. An individual’s decision to purchase health insurance or an employer’s choice to offer health insurance will largely depend on the costs of policies and the availability of subsidized alterna­tives (such as Medicaid). Mandates could affect those decisions by imposing penalties on individuals who remain uninsured or on employers who fail to offer health insurance.

As is the case with other legal requirements, individuals and employers will generally comply with mandates when the costs of noncompliance exceed the net costs of com­pliance. Thus, a mandate can become more effective in expanding coverage by either increasing the penalties for noncompliance or raising the probability of being "caught"—either of which would raise the expected value of the penalty.

Health insurance mandates differ from many other requirements, such as payment of taxes, because individu­als receive a tangible item that has some value in exchange for their compliance. Thus, individuals’ responsiveness to mandates would depend, in part, on the amount of the penalty relative to the net value of insurance. For exam­ple, the penalty for noncompliance with the individual mandate in Massachusetts is equal to half the cost of the lowest-cost qualifying plan. Although that penalty repre­sents a significant portion of the insurance premium, it is still less than the cost of paying for coverage—at least for higher-income individuals who do not receive premium subsidies—and individuals who place a small value on insurance coverage may not be induced to purchase it. For such individuals, the lower-cost option is to simply pay the penalty. For others, however, the value of the insurance coverage gained plus the penalty avoided by complying may be sufficient to induce enrollment.

The degree to which individuals who are subject to a mandate believe that their noncompliance would be detected, and that fines would be levied as a result, also greatly affects a mandate’s impact on coverage. The probability of detection is higher when enforcement agencies have access to accurate and timely information regarding individuals’ coverage status and have sufficient resources to use the information collected to identify noncompliance.

Evidence from the individual income tax system illus­trates how compliance can vary with the likelihood of detection and enforcement. Taxpayers are generally sub­ject to the same penalties for misreported income and deductions, regardless of the source of the error. However, compliance rates vary substantially across income types, reflecting differences in the IRS’s ability to detect report­ing errors. Tax compliance is relatively high when the agency can match information in reports from third par­ties (such as employers and financial institutions) to income tax returns and send notices to taxpayers when discrepancies are found. The net misreporting rate for income subject to third-party reporting was about 5 per­cent in 2001 (see Table 2-6). In contrast, the IRS in many cases cannot verify individuals’ reports of their self-employment income (including net income from both nonfarm proprietors and farms) on tax returns because third-party data are not independently reported to the IRS and resources for audits are limited.²⁸ Largely as a consequence, the net misreporting rate for self-employment income and other forms of income that are not subject to third-party reporting exceeded 50 percent in 2001.

Table 2-6.   Impact of Third-Party Data and Enforcement Methods on Income Tax Compliance, 2001

Income or Tax Preference		Third-Party Data		Enforcement		Net Misreporting Ratea (Percent)
Wages and salaries		Employers file W-2s with IRS.		W-2s are matched to tax returns, generating notices to taxpayers when discrepancies are detected.		1
Interest, dividends, Social Security benefits, pensions, and unemployment compensation		Payers file 1099s with IRS.		1099s are matched to tax returns, generating notices to taxpayers when discrepancies are detected.		5
Partnerships, S corporations, deductions, exemptions, capital gains, and alimony		Some, but not complete, information from third parties.		Some matching, but largely audits.		9
Nonfarm proprietor income, farm income, other income, rents and royalties, Form 4797 income, and adjustments		None.		Audits.		54

Source: Congressional Budget Office based on data from Internal Revenue Service, Reducing the Federal Tax Gap: A Report on Improving Voluntary Compliance, IR-2007-137 (August 2, 2007). Note: IRS = Internal Revenue Service. a. The net misreporting rate is the ratio of the amount misreported (including errors in both the taxpayers’ and government’s favor) to the amount that taxpayers should have reported. The estimates do not include amounts that should have been reported by individuals who failed to file an individual income tax return.

Although compliance generally improves as penalties increase, there may be diminishing returns beyond a cer­tain point. As penalties increase, some individuals may respond by taking more aggressive action to avoid detec­tion; at the same time, program administrators may be reluctant to impose penalties that seem excessive.²⁹ Another issue is that penalties are not costless to impose. If penalties are increased, administering agencies may devote more resources to ensure that their determinations are correct, and individuals may be more vigorous in defending themselves against the charge of noncompli­ance so that they can avoid the penalty.³⁰

Personal Values and Social Norms. Economic models that focus solely on monetary benefits and costs would probably overstate noncompliance with a mandate. In a number of areas, program administrators and the judicial system lack complete information to monitor every individual’s compliance with government rules and regu­lations. Yet some compliance is generally observed, even when there is little or no enforcement of mandates.

Compliance, then, is probably affected by an individual’s personal values and by social norms. Many individuals and employers would comply with a mandate, even in the absence of penalties, because they believe in abiding by the nation’s laws. However, such compliance may also be moderated by perceptions of fairness; individuals may comply more readily if they believe that a mandate is fair and is consistently enforced. If enforcement efforts appear to be unevenly applied, compliance may dimin­ish.³¹ Social psychologists find that compliance could be affected not only by personal values but also by individu­als’ perceptions of how others will act. Such studies find that many people want to take the popular—as well as the moral—course of action.³²

Finally, a small number of individuals may refuse to com­ply with mandates on religious or philosophical grounds. Thus, even in the face of strict penalties and rigorous detection and enforcement mechanisms, it is unlikely that everyone targeted by mandates would comply.

Automatic Enrollment Provisions

Some experts have suggested that proposals to facilitate automatic enrollment in health insurance plans could achieve coverage goals similar to those of a mandate but without requiring a complicated administrative system. Under those proposals, individuals would be automati­cally enrolled in insurance plans for which they qualify, but they could "opt out" if they chose to refuse coverage. A person could begin receiving health insurance benefits without completing any additional forms, simply by vir­tue of his or her participation in another public program or employment with a firm offering coverage. People who chose to opt out of insurance coverage would be required to initiate action and complete the necessary forms.

Evidence of Effects

Some evidence indicates that provisions for automatic enrollment encourage higher participation in public pro­grams (Medicare and welfare programs, for example) and in employment-based benefits such as 401(k) plans.

Public Programs. Most eligible individuals are enrolled automatically in Part B of Medicare (which covers physi­cian and outpatient services) when they turn 65; although they have the option of declining that coverage, they must send in a form to do so. Enrollees also receive a substantial premium subsidy—covering about 75 percent of average program costs—and face a penalty for late enrollment, both of which encourage prompt sign-up for Part B. Nearly 95 percent of those eligible are enrolled in Part B, and many of those who are eligible but are not enrolled have other coverage that substantially reduces the benefits of enrolling in Part B.

By contrast, the new Medicare prescription drug benefit (known as Part D) features a similar premium subsidy and late-enrollment penalty but does not feature auto­matic enrollment (except in the case of some low-income enrollees). Overall, roughly 70 percent of eligible individ­uals are now enrolled in the Medicare drug benefit pro­gram in some way, including those receiving subsidized coverage through a former employer. Although many individuals who are eligible for Part D have not enrolled because they have other qualified drug coverage, recent estimates indicate that about 10 percent of the Medicare population has not enrolled and does not have other insurance for their drugs, even though it would generally be financially beneficial for them to enroll.

Although the differences in participation rates between Part B and Part D suggest that automatic enrollment strategies increase participation, other differences between the two programs may also have played a role. Both programs provide relatively high premium subsidies and conduct extensive outreach campaigns; automatic enrollment could have a larger effect if combined with less generous subsidies or less extensive outreach.

Another example of the impact of automatic enrollment stems from recent changes to federal welfare programs. Until 1996, recipients of Aid to Families with Dependent Children were automatically enrolled in Medicaid and the Food Stamp program. After the enactment of welfare legislation, which replaced AFDC with a new program called Temporary Assistance for Needy Families, some former AFDC recipients did not qualify for TANF but still retained eligibility for Medicaid and the Food Stamp program. Nonetheless, participation in the two programs fell among those families, and studies largely attribute that effect to the fact that the families were no longer enrolled automatically.³³

Employment-Based Plans. Other recent studies of auto­matic enrollment have focused on decisions about saving, especially the choice to participate in 401(k) plans offered by employers. Those plans allow workers to defer pay­ment of income taxes on money they save for retirement (and on the interest accumulated on those savings); in many cases, employers also contribute to their employees’ accounts, so workers who do not participate are leaving some money "on the table." Until recently, the vast majority of employers who offered 401(k) plans required their workers to take action to enroll; that is, the default option was to not participate in the plan. With such"opt-in" arrangements, participation in 401(k) plans tends to be low for newly hired workers, although it increases sub­stantially with tenure at a firm.

Several case studies have found that participation in 401(k) plans increases substantially, particularly among new hires, as a consequence of automatic enroll­ment—that is, when the default case is to participate in the plan, with the choice to opt out. A study of one For­tune 500 company found that participation in a 401(k) plan increased from 37 percent to 86 percent among employees with 3 to 15 months of tenure with the firm after the plan switched to automatic enrollment. The effects of automatic enrollment are greatest among work­ers who are least likely to participate under opt-in sys­tems, including younger and lower-income workers.³⁴ Three years later, participation in plans with automatic enrollment was higher than in plans requiring active enrollment; about half of the participants who were auto­matically enrolled also continued to accept both the default contribution rate and the choice of investment fund.³⁵ Reflecting those findings, many firms have switched to automatic enrollment for their 401(k) plans in the past few years.

Implications for Enrollment Rates

The results from public and private programs suggest that inertia is a factor in decisionmaking and that the framing of choices affects behavior—aspects that have been a focus of recent research on behavioral economics. Many individuals are likely to remain with the default option, even when they can choose a better option with little effort. The studies of retirement savings also suggest rea­sons for such inertia. It may be a response to complexity; that is, faced with complicated choices, people may opt for the path of least resistance. Or they may procrastinate if the costs associated with a decision are certain and immediate and the benefits do not accrue for some time or depend on the outcome of an uncertain event. People may also stay with the default option because they view the choice as "endorsed" by their employer or the firm’s benefit advisers.³⁶

Decisions regarding health insurance share some features with choices about retirement saving. Retirement plans may vary considerably in the riskiness of their invest­ments, their expected returns, and their fees. Similarly, health insurance plans may differ in their selection of benefits, provider networks, and costs. In both cases, an individual’s decision to participate involves trade-offs that may be difficult to weigh.

The two decisions differ, however, in some important ways. For example, the timing and nature of the costs and benefits surrounding the two decisions are not identical. The benefits of saving for retirement may seem remote, particularly for younger or newly hired workers, but con­tributions can be withdrawn at any time if the worker is willing to pay income taxes and a 10 percent penalty on the withdrawal. For younger workers in good health, hav­ing health insurance may not provide immediate financial returns, but enrollees gain protection against unpredict­able risks right away. At the same time, premium pay­ments (or forgone wages) cannot be recouped at a later date by withdrawing past contributions, so enrollees might see their payments as wasted if they do not end up needing expensive care.

Options for Implementing Automatic Enrollment

As with mandates, the effectiveness of an automatic enrollment provision would depend partly on its scope. Employers, for example, could be encouraged or required to provide a "default" health insurance plan for their employees if they offer insurance. Employees’ shares of premiums for a default plan, as with other employment-based plans, would be collected through payroll deduc­tions. However, unless employers were also required to provide health insurance, the effects of an automatic enrollment provision would extend only to uninsured workers at firms offering insurance. On the basis of recent studies, CBO estimates that about 30 percent of the uninsured are workers (and their dependents) who turn down insurance offered by their employers (see Chapter 1). Whether or not they would simply opt out again if automatically enrolled would depend heavily on what premiums they would have to pay (net of any subsi­dies). If automatic enrollment requirements increased participation in employment-based health plans, wages or employers’ contributions toward health insurance premi­ums might be lower than they otherwise would be, so that the total amount of compensation paid to workers would not change as a result.

Another approach might be to automatically enroll indi­viduals in health plans if they participate in any public assistance program. Under current law, individuals receiv­ing Supplemental Security Income are automatically enrolled in Medicaid in most states. Similarly, individuals who are dually eligible for full benefits under the Medi­care and Medicaid programs are enrolled by default in one of the lower-cost drug plans available to them (for which they pay no premiums) if they do not select a plan. Automatic enrollment could be extended to participants in other needs-based programs such as TANF or SNAP or to programs like unemployment compensation. The effects of such a strategy would depend, in large part, on the number of individuals who are uninsured and partici­pating in those programs. In contexts other than the workplace or public programs, automatic enrollment pro­visions might be more difficult to implement—depend­ing on the complexities involved in determining eligibil­ity, collecting premium payments, or other factors.

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1

This chapter focuses on subsidies to individuals or their employ­ers. Another approach would be a federal reinsurance program that would seek to reduce premiums by covering a portion of the spending insurers incur for their high-cost cases.



2

See Chapter 1 for further discussion of the incidence of employ­ers’ contributions for health insurance.



3

Employees of a firm that does not offer cafeteria plans cannot exclude their share of health insurance premiums from taxable income for income and payroll tax purposes. However, they may be able to claim those premiums as an itemized deduction on their income tax return if their total medical expenses exceed 7.5 per­cent of adjusted gross income.



4

Although considered part of compensation, employers’ contribu­tions for payroll taxes are not subject to income taxes or the employees’ portion of payroll taxes.



5

An offsetting consideration is that excluding health insurance premiums from taxable wages reduces future Social Security bene­fits, which are based on average earnings, at the same time that it reduces payroll tax payments (see Chapter 6 for further discussion).



6

Joint Committee on Taxation, Tax Expenditures for Health Care, JCX-66-08 (July 30, 2008).



7

The estimate of the tax expenditure includes the amounts (or out­lays) paid to taxpayers in excess of their income tax liability, which result from the refundable nature of the health coverage tax credit.



8

In its 2008 and 2009 fiscal year budgets, the Bush Administration proposed a deduction that applied to both the individual income and payroll tax bases. However, exempting premiums for individ­ually purchased health insurance from payroll taxes presents administrative challenges; employers cannot easily adjust with­holding for such premiums because they do not have independent information regarding how much each of their workers paid for health insurance in the individual market.



9

See Chapter 8 for a discussion of the impact of asset tests on savings.



10

Such a change in coverage need not result from previously insured individuals dropping their current policies to enroll in public plans, although that is one possibility. Another possibility, for example, is for people who lost their coverage to decline coverage at a new job if they now qualify for a public program.



11

Efforts to minimize crowd-out become even more challenging over time, as some firms go out of business and other firms are created. A new firm, which previously might have offered its employees health insurance, may decide not to offer coverage, knowing that many of its workers can obtain public subsidies instead. The likelihood of that effect goes up as the share of the firm’s workforce that qualifies for subsidies increases.



12

Congressional Budget Office, The State Children’s Health Insurance Program (May 2007), pp. 11–12.



13

Janet Holtzblatt and Janet McCubbin, "Issues Affecting Low-Income Filers," in Henry J. Aaron and Joel Slemrod, eds., The Crisis in Tax Administration (Washington, D.C.: Brookings Insti­tution, 2004), pp. 148–200.



14

Michael Ponza and others, NSLP/SBP Access, Participation, Eligi­bility, and Certification Study: Erroneous Payments in the NSLP and SBP, vol. 1, Study Findings (Report No. CN-07-APEC, submitted by Mathematica Policy Research, Inc., to the Department of Agri­culture, November 2007).



15

See Jennifer Stuber and others, Beyond Stigma: What Barriers Actu­ally Affect the Decisions of Low-Income Families to Enroll in Medic­aid? George Washington University Medical Center Issue Brief (July 2000); Janet M. Currie and Jeffrey Grogger, "Explaining Recent Declines in Food Stamp Program Participation," in Wil­liam G. Gale and Janet Rothenberg-Pack, eds., Brookings-Wharton Papers on Urban Affairs, 2001 (2001), pp. 203–244; and Mari­anne P. Bitler, Janet Currie, and John Karl Scholz, "WIC Eligibil­ity and Participation," Journal of Human Resources, vol. 38 (Supplement 2003), pp. 1139–1179.



16

The counts of the insured population, however, do not reflect those who have such "provisional" insurance.



17

A more complete description of the model, the key parameters and assumptions it uses, and the academic literature on which it is based can be found in Congressional Budget Office, CBO’s Health Insurance Simulation Model: A Technical Description, Background Paper (October 2007).



18

See Jonathan Gruber and Michael Lettau, "How Elastic Is the Firm’s Demand for Health Insurance?" Journal of Public Econom­ics, vol. 88, nos. 7–8 (2004), pp. 1273–1293; Jack Hadley and James D. Reschovsky, "Small Firms’ Demand for Health Insur­ance: The Decision to Offer Insurance," Inquiry, vol. 39, no. 2 (2002), pp. 118–137; and Len Nichols and Linda J. Blumberg, "Estimating Employer Elasticity of Demand for Health Insur­ance" (paper presented at Academy Health Annual Research Meeting, Washington, D.C., 1999).



19

CBO generally assumes a "linear" relationship between the change in the price of insurance and the elasticity of offer; that is, the elas­ticity of offer does not vary with the magnitude of the price change.



20

For a more extensive discussion, see Congressional Budget Office, The State Children’s Health Insurance Program.



21

See Thomas Buchmueller and others, "The Effect of SCHIP Expansions on Health Insurance Decisions by Employers," Inquiry, vol. 42, no. 3 (2005), pp. 218–231; and M. Susan Mar­quis, "The Role of the Safety Net in Employer Health Benefit Decisions," Medical Care Research and Review, vol. 62, no. 4 (2005), pp. 435–457.



22

See Linda J. Blumberg, Jessica Banthin, and Len Nichols, "Worker Decisions to Purchase Health Insurance," Journal of Health Care Finance and Economics, vol. 1, nos. 3–4 (2001), pp. 305–325; and Jonathan Gruber and Ebonya Washington, "Subsi­dies to Employee Health Insurance Premiums and the Health Insurance Market," Journal of Health Economics, vol. 24, no. 2 (2005), pp. 253–276.



23

For further discussion of that option, see Congressional Budget Office, Budget Options, Volume 1: Health Care (December 2008).



24

Andrew Dick, "Will Employer Mandates Really Work? Another Look at Hawaii," Health Affairs, vol. 13, no. 1 (1994), pp. 343–349.



25

See Norman Thurston, "Labor Market Effects of Hawaii’s Manda­tory Employer-Provided Health Insurance," Industrial and Labor Relations Review, vol. 51, no. 1 (1997), pp. 117–135; and Sang-Hyop Lee and others, The Effect of Mandatory Employer-Sponsored Insurance (ESI) on Health Insurance Coverage and Labor Force Uti­lization in Hawaii: Evidence from the Current Population Survey (CPS) 1994–2004, Working Paper No. 05-12 (Honolulu, Hawaii: University of Hawaii at Manoa, Department of Economics, July 6, 2005), www.economics.hawaii.edu/research/workingpapers/WP_05-12.pdf.



26

Sharon K. Long, "On the Road to Universal Coverage: Impacts of Reform in Massachusetts at One Year," Health Affairs, vol. 27, no. 4 (July/August 2008), pp. W270–W284 (published online as a Web Exclusive, June 3, 2008).



27

Massachusetts’s affordability standards use information from tax returns to verify eligibility for income-related exemptions and also take into account the cost of premiums. In 2008, individuals with annual income of up to $52,500 were exempt from the mandate if they could not find health insurance with a premium of less than $330 a month. For families, the corresponding income and pre­mium amounts were, respectively, $110,000 and $792.



28

For individual income tax returns, the audit rate is about 1 per­cent, with audit rates somewhat higher for returns reporting busi­ness income.



29

James Andreoni, "Criminal Deterrence in the Reduced Form: A New Perspective on Ehrlich’s Seminal Study," Economic Inquiry, vol. 33, no. 3 (July 1995), pp. 476–483.



30

Janet G. McCubbin, Optimal Tax Enforcement: A Review of the Literature and Practical Implications, Working Paper 90 (Washing­ton D.C.: Department of the Treasury, Office of Tax Analysis, December 2004).



31

Studies find conflicting evidence regarding the impact of percep­tions of fairness on tax compliance. In one experiment, partici­pants were more likely to engage in tax evasion when told that their tax burden was high relative to that of others; compliance improved if, instead, they were told that their tax burden was rela­tively small. See Michael W. Spicer and Lee A. Becker, "Fiscal Inequity and Tax Evasion: An Experimental Approach," National Tax Journal, vol. 33, no. 2 (June 1980), pp. 171–175. However, a second study found that perceptions of fairness had no impact on compliance. See Paul Webley and others, Tax Evasion: An Experi­mental Approach (Cambridge, England: Cambridge University Press, 1991).



32

Robert B. Cialdini, "Crafting Normative Messages to Protect the Environment," Current Directions in Psychological Science, vol. 12, no. 4 (2003), pp. 105–109.



33

Leighton Ku and Bowen Garrett, How Welfare Reform and Eco­nomic Factors Affected Medicaid Participation: 1984–96, Assessing the New Federalism Discussion Papers 00-01 (Washington, D.C.: Urban Institute, February 2000); Currie and Grogger, "Explain­ing Recent Declines in Food Stamp Program Participation."



34

Brigitte C. Madrian and Dennis F. Shea, "The Power of Sugges­tion: Inertia in 401(k) Participation and Savings Behavior," Quar­terly Journal of Economics, vol. 116, no. 4 (November 2001), pp. 1149–1187.



35

James Choi and others, "For Better or For Worse: Default Effects and 401(k) Savings Behavior," in David A. Wise, ed., Perspectives in the Economics of Aging (Chicago.: University of Chicago Press, 2004).



36

John Beshears and others, The Importance of Default Options for Retirement Saving Outcomes: Evidence from the United States, Working Paper No. 12009 (Cambridge, Mass.: National Bureau of Economic Research, January 2006).