President George W. Bush made health care a key piece of his budget proposal for fiscal year 2007, out­lining a variety of initiatives focused on improving "the Nation's health care system by making it more affordable, transparent, portable, and efficient."[1] The President accurately articulates the problems facing today's health care system, lays out a clear vision for the future, and proposes various policy initiatives to reach those goals. Members of Congress should seize this opportunity and build on the policy foundation set forth by the President.

The President's Vision

President Bush envisions a better health care sys­tem in the 21st century for all Americans. This better system would be based on personal choice, individ­ual ownership of health insurance, and genuine free-market competition among plans and providers. The President aims to increase personal freedom by:

• Establishing tax equity in health care;
• Promoting health insurance portability;
• Expanding health coverage options;
• Improving health savings accounts (HSAs); and
• Advancing information access, prevention, and better medical liability laws.

The President's vision is the right one, but it differs in some respects from the program that he outlined during his 2004 presidential election campaign.[2] Congress should enact specific policy changes that are consis­tent with that vision and that would fulfill its prom­ises. However, Congress should be bolder than the White House and broaden the scope of change well beyond the President's specific policy recommenda­tions by:

• Expanding the proposed tax provisions to cover all health plans, not just HSA-qualified plans;
• Encouraging health insurance portability through individual ownership, a defined-contribution sys­tem, and establishment of a consumer-based "health exchange" marketplace; and
• Transforming the health care market into a more consumer-based system in which individ­uals are empowered to take direct control of their health care decisions.

Establishing Tax Equity in Health Care

The current tax code provides various tax breaks for health care. In 2004, these tax benefits (federal and state) totaled an estimated $209.9 billion, of which $188.5 billion was federal.[3] Over half ($101 billion) of the federal share benefited individuals who obtained their health insurance at their places of work.[4] (See Chart 1.)

The employer tax exclusion allows workers to exclude from their taxable income the total value of health care benefits provided by their employer. However, this benefit is limited to those who obtain coverage through their places of work. Individuals who purchase coverage outside the workplace must use after-tax dollars.

The President's Proposal.The President pro­poses giving a tax break to individuals who purchase an HSA-qualified high-deductible health plan (HDHP) outside their places of work. An HSA allows individuals to set aside funds in a tax-preferred sav­ings account if they purchase an HDHP. Under the President's plan, individuals purchasing an HSA-qualified HDHP could take an "above the line" deduction for the HDHP premium. These individu­als would also qualify for a refundable tax credit worth up to 15.3 percent to offset payroll taxes paid.

For lower-income individuals, for whom a tax deduction is not as valuable because of their lim­ited tax liability, a refundable tax credit would be available to assist them in purchasing an HSA-qual­ified HDHP. Individuals with incomes up to $15,000 could receive a tax credit worth 90 per­cent of their HDHP premium with a maximum credit of $1,000. Families with incomes up to $25,000 could receive a similar 90 percent credit with a maximum credit of $3,000. These credits would phase down by income and end at $30,000 for individuals and $60,000 for a family.[5]

What Congress Should Do. The President's effort to provide similar tax relief to those who pur­chase coverage on their own is a worthy goal, but limiting such tax relief to HSA-qualified HDHPs perpetuates the manipulation of the tax code for certain health insurance arrangements, limits indi­vidual choice, and is incompatible with overall tax simplification.

Source: John Sheils and Randall Haught, "The Cost of Tax-Exempt Health Benefits in 2004," Health Affairs Web Exclusive, February 25, 2004, p. W4-109, at http://content.healthaffairs.org/cgi/reprint/hlthaff.w4.106v1.pdf (April 27, 2006).

Instead of adding to the already complex patch­work of health care tax subsidies, Congress could accomplish true tax equity by adopting a simple system of universal tax credits-an approach long recommended by The Heritage Foundation.[6] Under such an approach, health care tax credits would replace the existing system of federal and state tax preferences. However, given budgetary constraints and a limited political appetite for broad health reform, Congress could design a health care tax credit in a variety of other ways besides a universal credit, such as targeting a tax credit to a certain group or population.[7]

Congress should start by building on the Presi­dent's tax credit proposal for lower-income Ameri­cans. Specifically, Congress should enact a meaningful health care tax credit similar to the Pres­ident's plan but without restrictions on the type of coverage. In fact, offering health care tax credits without coverage restriction is a long-standing posi­tion of the Bush Administration.[8]

To avoid limiting the tax credit to HSA-qualified HDHPs, Congress should set a maximum dollar amount for the tax credit and allow the individual to apply the credit to the premium of a health plan of choice. An individual who chooses to spend above the allocated tax credit would be responsible for paying the difference. If an individual spent less (e.g., by purchasing a high-deductible, low-pre­mium option), any remaining tax credit funds could be used for other related health care costs, such as co-pays and deductibles. This approach would allow individuals the freedom to choose the plan design that best suits their needs, encourage prudent plan selection, and-most important- promote tax equity and neutrality.

Promoting Health Insurance Portability

The lack of health insurance portability is a major problem with the employer-based coverage that dominates the private sector. Today's work­force is far more mobile and transient than it was 50 years ago, when a worker would take a job at 18 years of age and stay with that same employer until retirement.

Today, each job change typically means a change in health insurance coverage. Furthermore, individ­uals who are laid off, leave the workforce for a period of time, or retire early face the same prob­lems. A break or change in coverage, whether vol­untary or involuntary, can result in severed ties with trusted providers, episodes without insurance, and an overall disruption in the continuity of care.

The President's Proposal. The President pro­poses the development of portable HSA-qualified HDHPs to complement the HSA component, which is a portable, individually owned account. Under this concept, national high-deductible plans would be available for employers to offer their workers, and workers could take their health policies with them when they leave their jobs. After leaving an employer, an individual could pay the premiums on a pre-tax basis, and any new employer could also contribute to such a plan on a tax-free basis.

What Congress Should Do.The President is right to encourage portability, but establishing portability for only one type of insurance prod­uct-HSA-qualified HDHPs-and depending on employers to offer it compromises the principle of personal choice and freedom. The government should not be in the business of picking winners and losers or stacking the deck in favor of one type of health insurance over another.

The best way to achieve true portability is to enable individuals to purchase and own their health care coverage. In conjunction with enacting an individual health care tax credit, Congress should also facilitate a defined-contribution option for employers and encourage the adoption of a health exchange-a consumer-based marketplace for purchasing health care coverage.

Defined-Contribution Model. Congress should focus on creating an alternative to the existing employer-based system. In today's all-or-nothing system, an employer either offers coverage or does not offer coverage. Congress should help employ­ers who want to make the transition to a defined-contribution model by allowing them to provide a financial contribution to an employee's individual health plan without subjecting the plan to new rules or jeopardizing the existing tax treatment.

The President has proposed using the HSA-model to achieve a similar goal. However, the pro­posal is limited and contingent on an individual's having an HSA and a qualified HDHP. Congress should pursue an approach that is simpler and broader in its application by clarifying existing laws so that employer contributions to an employee's individual health plan do not subject that plan to the rules and regulations for group plans. Congress should also clarify that such contributions retain their tax preference to the worker.

Changing to a defined-contribution model would benefit both employers and workers. Employers would be able to establish a more predictable bud­get for health care, and those that cannot afford to provide coverage under the current system might choose to provide modest contributions to their workers' individual health care plans. Under a defined-contribution system, workers would no longer be limited to the plans offered through their employers. Instead, they would be free to choose the health plans that best meet their needs and the needs of their families. Finally, workers who are excluded in current system, such as part-time and contract workers, could benefit from receiving con­tributions from multiple employers.

Health Exchange Model. Congress should also encourage the development of a simpler, more con­sumer-based marketplace for purchasing private health coverage. Health insurance is predominately regulated at the state level, where distinctions are made between the small-group and non-group market. These distinctions can complicate and seg­ment the marketplace.

On the other hand, in a health exchange, these distinctions would be eliminated and replaced with a central market in which individuals, employers, and the self-employer could buy personal, portable, tax-advantaged health care coverage. Individuals would choose from a menu of competing insurers for their coverage. This approach also has the bene­fit of preserving the favorable tax treatment by allowing an employer to designate the health exchange as its "group" health plan, but federal clar­ification from Congress still would be useful.

Variations on this concept have been considered at the state level, including the small-business health insurance market reform provisions recently enacted in Massachusetts.[9] Congress could also consider establishing a demonstration project to encourage other states to test variations on the idea.

Expanding Health Coverage Options

Affordability of coverage varies greatly among the states. Some states have overregulated the insurance market, making it unaffordable and unattractive for small businesses or individuals to purchase health care coverage. Policies such as the combination of strict community rating and guar­anteed issue price many individuals and businesses out of the health insurance market. In New Jersey, which has both strict community rating and guar­anteed issue, premiums for individual coverage cost an average of $6,048 per year, and premiums for family coverage cost an average of $14,403.[10]

Costly coverage mandates can also affect afford­ability. Today, there are over 1,843 state man­dates.[11] Minnesota and Maryland top the list with 60 or more mandates each.[12] In Maryland, even costly but optional procedures, such as in vitro fer­tilization, are a mandated benefit.[13]

The President's Proposal. The President pro­poses a multi-pronged strategy at both the state and federal levels to ease the troubles facing small busi­nesses and individuals. The proposals intend to expand health care coverage options for small busi­nesses and individuals through three specific pol­icy initiatives:

• Allowing small businesses to pool together nationally to offer coverage to their workers through association health plans (AHPs). These plans would be regulated at the federal level and would hope to gain advantages of scale similar to those of large, federally regulated employer plans.
• Applying the small-business AHP concept to individuals by allowing associations, such as civic and religious organizations, to offer coverage to their individual members on a national level.
• Allowing individuals to purchase health care coverage from other states. This would give individuals-especially individuals in highly regulated states where there are few affordable options-more coverage choices.

What Congress Should Do.The AHP concept would create new coverage options for associations offering health care coverage to their members by replacing costly state regulations with a federal reg­ulatory structure. These arrangements have tradi­tionally been offered as a solution for small businesses.[14] However, as the President rightly rec­ognizes, the AHP concept should also apply to individuals, and efforts to extend new federal pool­ing arrangements for health insurance should apply to both business-oriented associations and individual-oriented associations, such as churches and civic organizations.

There are valid concerns with expanding the fed­eral role in health insurance, in particular the cre­ation of a new federal pooling arrangement solely for the small-business sector.[15] If Congress intends to pursue this approach, however, the broader application of AHPs to individual associations, as proposed by the President, must be adopted. These individually based groups are compatible with a health care system that is based on personal choice, true portability, and individual ownership-all of which are lacking in today's employer-based system.

A better approach would be for Congress to expand individual coverage options and promote competitive state health insurance markets by per­mitting the purchase of health care coverage across state lines. Under the President's proposal, individu­als would no longer be limited to the coverage options offered within their states; instead, they could purchase a health care policy from another state where coverage might be more affordable. Represen­tative John Shadegg (R-AZ) has developed the Health Care Choice Act (H.R. 2355) based on this concept, and companion legislation (S. 1015) has been intro­duced by Senator Jim DeMint (R-SC) in the Senate.

The benefit of such an approach is that it pro­tects the prerogative of the states to regulate health insurance while also giving individuals more cover­age choices. Moreover, it would spur competition among the states to design a competitive and con­sumer-friendly marketplace for the purchase of health insurance and would promote a national health care market.

Improving Health Savings Accounts

The enactment of health savings accounts was an important step toward providing individuals with more health care choices. Instead of the traditional high-premium, low-deductible plans, HSAs allow those who purchase a low-premium, high-deduct­ible plan to set aside tax-preferred funds to pay for their health care expenses.[16] The Association of Health Insurance Plans (AHIP) estimates that since its enactment, over 3.2 million Americans have enrolled in HSA-HDHP plans.[17]

The President's Proposal.The President has proposed several technical improvements to exist­ing HSAs:

• Increasing the maximum amount that can be contributed to an HSA to match total out-of-pocket expenses, not just the deductible as under current law;[18]
• Making existing health reimbursement arrange­ments (HRAs) more compatible with HSAs;[19]
• Allowing employers to make larger contribu­tions to chronically ill workers; and
• Allowing individuals who purchase an HSA-qualified HDHP on their own to use their HSA to pay their premium.

What Congress Should Do. The Administra­tion's proposed changes in HSAs take into consider­ation the experience of the past three years and work to improve the function and administration of HSAs, and Congress should support these efforts. Specifi­cally, the current HSA law limits the amount that can be contributed to an HSA, based in part on the health plan's deductible.[20] However, once the deductible is met, an individual may still be respon­sible for other out-of-pocket expenses related to the traditional insurance structure. Thus, the President's proposal to increase the contribution limits to meet total out-of-pocket expenses is an improvement. Senator George Allen (R-VA) has introduced S. 2424 to amend the law to reflect this change.

The President proposes facilitating an HRA-HSA conversion that would enable employers to transfer HRA balances to an employee's HSA without penalty. Under current law, an individual cannot have both an HSA and an HRA, except in limited instances. If an HRA is suspended, an individual can have an HSA, but the balance in the HRA cannot be trans­ferred to the HSA. The President's proposal would allow a one-time transfer of HRA balances into HSAs.

The President also wants to allow greater flexibil­ity in allocating contributions to workers, specifi­cally those with chronic illnesses. Under the President's proposal, employers could contribute more to workers who face greater health care costs without violating comparability rules. Congress may want to consider allowing employers to con­tribute more to their lower-wage workers as well.

Finally, the President's proposal to allow individu­als who purchase their own HDHPs to use their HSAs to pay their premiums is also a good idea. Sen­ators John Ensign (R-NV) and Mike DeWine (R- OH) have introduced the Affordability in the Indi­vidual Market Act (S. 2554) to facilitate this change.

Ideally, Congress should eliminate the HDHP requirement for HSAs altogether and simply allow individuals to use their HSAs as a savings mecha­nism for overall health care expenses, such as premi­ums, deductibles, and other cost-sharing require­ments. Under such a change, the free-standing HSA could be a conduit for employer contributions as well as for other subsidies, such as tax credits for lower-income individuals.[21] National Center for Policy Analysis President John Goodman, a health care economist and leading expert on HSAs and health care reform, has recommended a more flexi­ble HSA model.[22] Besides encouraging individuals to save for their health care expenses, a flexible HSA design would enable individuals to select a health plan of choice, whether high-deductible or low-deductible, and use remaining balances from their HSAs for other health care expenses.

Advancing Information Access, Prevention, and Better Liability Laws

Efforts to improve consumer information and engagement in the delivery of health care are also desirable goals, but legislation to achieve them should not add new layers of complex and cumber­some federal rules and regulations to the health care system. These would undercut efficiency and expand federal control of a dynamic sector of the American economy.

The President's Proposal. The President stresses continuing efforts on health information technology, improving access to price and quality information, enacting medical liability reform, and promoting health prevention, wellness, and fitness. These are well-intentioned initiatives that focus on ancillary issues affecting the health care sector.

What Congress Should Do.Congress should exercise extreme caution before recommending federal legislative solutions in these areas. For example, medical liability has traditionally been a state issue under state jurisdiction, and many states have already taken positive steps in reforming their state medical liability laws. Federal efforts should work to encourage more states to review and reform their medical liability laws. Various policy options are available to state lawmakers.[23]

It would be best for Congress to focus on reorga­nizing the health care market and transforming it into a more consumer-based system in which indi­viduals are empowered to act on quality and price information, to maintain their personal medical records, and to take direct control of their health care decisions. Such a transformation would go a long way toward improving the functioning and performance of health care institutions. The more consumers are in control, the more receptive the insurers and providers will be in meeting their demands, and the more incentives consumers will have to practice and live a healthy lifestyle.

Conclusion

The core elements of the President's health care agenda are sound: providing tax equity, promoting portability, improving HSAs, and expanding cover­age options.

Members of Congress should build on these ele­ments and enact solid policy initiatives that reflect a health care system that is based on personal choice and free-market competition. The cornerstone of this system should be a robust individual tax credit that would give individuals the freedom to choose the health plan and design that best suits their per­sonal needs and preferences.

The President has outlined a laudable vision for health care policy that is based on expanding per­sonal ownership of insurance and individual con­trol of health care dollars. Congress should take this opportunity to enact health policies that will transform that vision into reality.

Nina Owcharenko is Senior Policy Analyst for Health Care in the Center for Health Policy Studies at The Heritage Foundation.