By Michael R. Strain 

ObamaCare may be constitutional but it isn’t the answer. A refundable tax credit is.

The Supreme Court has just told us that ObamaCare’s mandate to buy health insurance is constitutional under the government’s taxing authority, but this decision will not settle the debate. Republicans have vowed to repeal and replace ObamaCare—and if Mitt Romney wins the presidency, they just might succeed. But Republicans have been vague about the replacement. Here’s a suggestion: Replace ObamaCare with a refundable tax credit funded by taxing employer-provided health insurance.

Each year, some Americans contract a dire illness or suffer a serious injury but can’t pay their medical bills. They usually still get treatment, but the costs are passed on to the rest of society. Sometimes taxpayers pick up the tab. Other times, hospitals and doctors absorb the cost, which shows up in higher health insurance premiums for all of us. To address this challenge and move towards universal coverage, Congress should tax employer-provided health insurance and use the revenue to offer a refundable tax credit that will empower the uninsured to purchase coverage against catastrophic health costs.
As the government correctly argued in the ObamaCare case, in a very real sense everyone is in the market for catastrophic medical care every year. We all face the risk of getting cancer or being hit by a bus, and no one would be refused needed treatment. Some of us pay for that treatment in advance by buying health insurance. Others do not insure, creating the risk that much of their costs will be passed on to the rest of society—a risk that is often realized.
In a nation that values self-reliance and personal responsibility, people should not foist the costs of treatment onto others by refusing to carry insurance. And in a nation as wealthy as ours, no one should go broke because they get sick or injured. Universal coverage is an appropriate goal of government—it benefits both the individual and society, and it helps to make sure that you won’t have to pay for your neighbor’s health expenses.

Congress should tax employer-provided health insurance and use the revenue to offer a refundable tax credit that will empower the uninsured to purchase coverage against catastrophic health costs.

A tax credit for purchasing catastrophic insurance could move our society towards universal coverage. You would be offered a certain amount of money in the form of a tax credit—a reduction in your tax liability—provided that you buy an insurance policy that provides coverage for at least catastrophic care. The credit would not depend on the cost of the insurance that you chose to buy. If you buy a policy that provides the required coverage for less than the credit, you can pocket the difference. Of course, you’re free to buy a policy more expensive than the credit, paying the extra cost out of pocket. You decide what’s best for you and your family—not the government. The tax credit should be refundable, so that the nearly half of American households which don’t pay income tax will receive it as a cash payment. It should be progressive, so that the government focuses its financial resources on those Americans who most need financial assistance.
Offering tax credits to those who purchase health insurance has been advocated by prominent Republicans previously, and should be strongly considered in the wake of the Court’s decision. As a couple of examples, President George W. Bush proposed tax credits in his 2005 budget and Representative Paul Ryan, currently chairman of the House Budget Committee, proposed them in his 2010 economic reform plan. And not just Republicans. Jason Furman, now a senior economic advisor to President Obama, has written favorably about using refundable tax credits to induce the uninsured to purchase coverage, provided that measures are taken to enhance risk-pooling in the individual market.
A costly tax break for health insurance may not seem affordable when the country faces such serious fiscal challenges. But if Congress were to end the existing tax exclusion for employer-provided healthcare, there would be more than enough money to provide the credit. Under the current tax code, the money that your employer spends on your health insurance is not subject to payroll or income tax, even though it is part of your compensation. The CBO estimates that this implicit subsidy will cost a whopping 1.8 percent of GDP in 2013-2022. Ending this exclusion means that employees will pay tax on the value of their employer-provided insurance, but their coverage will also entitle them to claim the new tax credit.
Replacing the tax exclusion with a refundable tax credit has several benefits. Depending on the size of the credit, it could bring down the deficit. It is also likely that the overwhelming majority of Americans, including those who are currently uninsured, will buy health insurance and claim the credit, bringing us much closer to the goal of universal coverage and putting downward pressure on premiums by bringing healthy people into the insurance pool. Unlike the tax exclusion, which is regressive because it provides a relatively larger benefit to those in higher tax brackets, the credit will be progressive, providing a larger benefit to poorer Americans. Ending the tax exclusion will remove the incentive for individuals to purchase more healthcare than necessary, and will find people looking more of their actual health insurance expenses straight in the eye. And ending the tax exclusion may induce more people to get health insurance outside of their job, which will allow them to change employers without worrying about a loss of health insurance—this could result in better matches between workers and firms and a more productive labor force.

In a nation that values self-reliance and personal responsibility, people should not foist the costs of treatment onto others by refusing to carry insurance.

This tax credit is very different from the subsidies that ObamaCare offers to low- and middle-income people in the state-based exchanges. Those subsidies—available only to workers whose employer does not offer a plan that the government feels is adequate—require the purchase of comprehensive coverage for even routine services rather than limiting the requirement to protection against extremely expensive catastrophic events.
The serious problem facing society is that the costs of treating the uninsured for catastrophic medical events often get passed on to the rest of us. Given that, it makes no sense to mandate that people insure against ear infections, strep throat, and canker sores. The solution should be limited to the problem. Offering a tax credit to people who purchase catastrophic coverage directly addresses the problem of people being unable to afford treatment for catastrophic events, and should help to make such coverage more affordable by increasing the balance of the risk pool.
Uninsured individuals being bankrupted after receiving treatment for catastrophic events is a serious problem, as is individuals who wish to purchase health insurance but can’t afford it because too few healthy people are in the risk pool. These problems allow for government action. ObamaCare, although constitutional, isn’t the answer. It is overly broad, too expensive, and builds on the current, structurally flawed system with its distortionary incentives to overconsume and overinvest in healthcare. A tax credit that empowers people to purchase catastrophic coverage offers a better solution.
The Court’s decision isn’t an endorsement of the status quo, and doesn’t imply that ObamaCare is good policy. Republicans and Democrats need to work together to achieve serious, comprehensive reform. Republicans want to repeal and replace? Great. They must convince the country that their replacement is better than ObamaCare. That hard work begins now.
Michael R. Strain is a research fellow at the American Enterprise Institute.