Tax-Free Savings Accounts for Medical Expenses:
A Tax Cut Masquerading as Help to the Uninsured

July 2003

The U.S. House of Representatives has approved legislation (H.R. 2596, the "Health Savings and Affordability Act of 2003") that will increase the cost of health insurance for people who are sick and don't have cash to pay for health carethe people who need assistance most. At the same time, it will do very little to help uninsured workers. In fact, these accounts have the potential to increase the number of uninsured workers in our country. The price tag for this misguided bill is estimated to be $174 billion over 10 years, an enormous tax break for those who can benefit from a tax deduction and for those who can afford to set aside dollars to invest and earn income tax-free.

Worse, this costly tax cut bill was attached to the Medicare prescription drug legislation that passed the House of Representatives. Therefore, this tax break is not only masquerading as help to the uninsured, but is has been further hidden among the many critical issues under consideration as Congress struggles to work out the differences between the House and Senate Medicare prescription drug bills. If there is an additional $174 billion on the table, Congress should use these funds to improve the Medicare prescription drug benefit.

Tax-Free Personal Savings Accounts: If You Have the Money to Spare

H.R. 2596 creates two kinds of personal savings accounts that people who have the ability to set aside cash can use to reduce their income taxes and to earn investment income tax-free. Money that is deposited in these accounts is tax deductible, and the funds in the account can be invested in stocks and bonds, and the earnings from these investments are tax-free. Withdrawals for certain medical expenses are not taxed. Withdrawals not used for these certain medical expenses incur tax and a 15 percent penalty. Withdrawals for non-medical purposes after age 65 carry no penalty. Thus, these personal savings accounts can be a way for peoplewho can spare the moneyto shelter significant funds from taxes. The two types of accounts in H.R. 2596, Health Savings Security Accounts (HSSAs) and Health Savings Accounts (HSAs), are compared in the table on page 4 (see below for link to table).

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Tax-Free Accounts Will Not Reduce the Number of People Who are Uninsured

Workers can use HSSA funds to pay the premiums of employer-based coverage if their employers don't pay any part of the premiums. HSSA funds can also be used to pay for health insurance coverage in the private individual market. Thus, proponents of HSSAs argue that currently uninsured workers will be able to use the funds to buy insurance.

However, many uninsured workers have incomes that are too low to owe federal income tax and certainly don't have $2,000 or $4,000 in cash to set aside for this purpose: Thirty-six percent of uninsured people have incomes under 100 percent of the federal poverty level, or $18,400 for a couple with two children. These people gain no benefit from an HSA or an HSSA because they owe no taxes.

For another large segment of the uninsured, the accounts provide, at best, a 10 cent tax subsidy for each dollar they would have to spend on health insurance premiums: Twenty-nine percent of the uninsured have incomes between 100 and 200 percent of poverty, or between $18,400 and $36,800 for a couple with two children.

For these low-income uninsured, even if a worker were able to put away cash into an HSSA, this small subsidy won't go far to pay for the high cost of health insurance coveragewhether through an employer or in the individual private market. The average price of employer-sponsored family coverage was $7,954 in 2002. Prices of coverage in the individual private market, which generally charges people more if they are older or in less-than-perfect health, are much higher. Of course, if a worker or a family member has any serious health condition, it is likely that individual coverage will not be available at all.

For the two-thirds (65 percent) of uninsured people living on incomes below 200 percent of poverty, setting aside almost $8,000 to pay for health insurance is not an economic possibility. A small tax deductionif they have taxable incomedoes not make health insurance affordable for these families.

For Workers with Insurance, Tax-Free Accounts Will Increase Out-of-Pocket Costs

Some employers will gravitate to these accounts as a way to shift rising costs to workers by offering only cheaper health insurance plans with higher deductibles and higher copayments. Since employers and workers can both contribute to the same HSSA, employers can ask their workers to "match" the employer's contribution and, at the same time, can justify offering a higher-deductible, higher-copayment plan to workers. This cost equation will work against sicker workersthe high copays will add up to more than the value of the employer contribution to the HSSA. Low-income workers who cannot afford to divert dollars from their pay to an HSSA will see an even greater net loss in the value of their employer-based insurance coverage while their employer saves money on the cheaper plan. And in many cases, the new cheaper plan will be the only option available to workers. Thus, the employer-based coverage package will be eroded, and the same low-income workers who cannot afford to put cash into an HSSA will face increased out-of-pocket costs that they can't afford.

Here is what happens if an employer offers workers a choice between a high-deductible, high-copayment health insurance plan with a tax-break account and more traditional health insurancethat is, insurance with reasonable deductibles and copayments: The HSA/HSSA plans, with high deductibles and high copayments, are likely to siphon off healthier people who anticipate few medical treatment costs and hope to shelter some income from taxes in the account. The people who can't afford to put cash into an HSA/HSSA will stay in insurance plans with a smaller deductible and lower copayments. So will people who have health problems and who expect to have health care expenses. As these plans lose their healthier enrollees, they will be left with a higher proportion of unhealthy people. More unhealthy people will mean higher costs, so premiums will have to be raised. The higher the premiums rise, the more healthy people with financial wherewithal will decide to opt into HSAs/HSSAs. This continuing cycle of "cherry picking" healthy people will make the insurance we're used toplans with smaller deductibles and low copaymentsextremely expensive, leading more and more employers to drop this kind of coverage.

This scenario is not the alarmist prediction of a few; it has been documented in research by the RAND Corporation, the Urban Institute, and the American Academy of Actuaries. In fact, the American Academy of Actuaries found that premiums for traditional insurance could more than double if use of these kinds of personal savings accounts becomes widespread.

Fix the Coverage Holes in Medicare Instead of Creating a New Tax Loophole

Rather than spend $174 billion on tax cuts, the U.S. House of Representatives could allocate the money to fix holes in the prescription drug coverage package they've proposed for Medicare beneficiaries. For example, $174 billion could pay for coverage for seniors' or disabled people's drug spending between $2,000 and $4,900which, under the current House bill, must be paid entirely by Medicare beneficiaries. Forty-three percent of these beneficiaries are struggling to make ends meet on incomes below $18,000 a year.

This issue brief includes a table comparing Health Savings Security Accounts (HSSA) and Health Savings Accounts (HSA). Click on pdf button above to access full brief.

Contact Families USA for sources and additional materials.
Families USA, 1201 New York Avenue NW, Suite 1100, Washington, DC  20005
Phone: 202-628-3030  E-mail: info@familiesusa.org 

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