Public Policy Analysis & Opinion

A market-driven approach with "a measure of compassion"

The Supreme Court ruling moves national health care one step closer

By Kevin P. Hennosy

We now have a market-based national insurance system for health care financing. As Alexander Hamilton described his financial plan that created a nation out of competing debt-ridden states through federal assumption of state debt: "It will be far more difficult to undo than to do."

It is time to get to work, provide health insurance benefits and, yes, make some money.

On June 27, 2012, the United States Supreme Court ruled that the overwhelming majority of the Patient Protection and Affordable Care Act (PPACA) of 2010 was constitutional. The Court majority relied on the broad authority of Congress to tax as the constitutional foundation of the law's requirement that individuals who can afford health insurance secure coverage through group or individual policies.

Rough Notes first called attention to the central importance of Chief Justice John Roberts' interpretation of the individual mandate in terms of a tax in the November 2011 edition of the magazine. (See "Is it a tax?" on page 68.)

While the "individual mandate" is more complex and less universal than "single-payer systems" that provide health-care financing in most industrialized countries, the provision is not as draconian as many opponents describe it. The statute provides multiple layers of expanded public health care coverage and subsidies to ease the cost of securing private coverage.

One such subsidy is directed at the small businesses and nonprofit entities that employ low-income workers. The subsidy takes the form of a tax credit. Implementation of the tax subsidy provision has drawn the attention of Senator Olympia Snow (R-Maine), ranking member on the Senate Small Business and Entrepreneurship Committee, and Representative Sam Graves (R-Mo.), chair of the House Small Business Committee.

In response to inquiries from Senator Snow and Representative Graves, the Government Accountability Office (GAO) conducted a study of the use of federal tax credits for small businesses that subsidize the purchase of health insurance benefits. The PPACA provides tax credits for businesses, credits that began for tax years beginning January 1, 2010.

According to the GAO report, the credits apply to "certain employers with employees earning low wages—small business and tax-exempt entities—that pay at least half of their employees' health insurance premiums." These businesses must:

• Be a small business or tax-exempt employer located in or having trade or business income in the United States and paying premiums for employee health insurance coverage issued in the United States.

• Employ fewer than 25 full-time-equivalent (FTE) employees in the tax year (excluding certain employees, such as business owners and their family members).

• Pay average annual wages of less than $50,000 per FTE in the tax year.

• Offer health insurance and pay at least 50% of the health insurance premium under a "qualifying arrangement." This means that the employer uniformly pays at least 50% of the cost of premiums for enrolled employees, although the IRS did develop relaxed criteria for meeting this requirement for tax year 2010.

The tax credit provides a material subsidy to the purchase of private health insurance policies. "Through 2013, small businesses can receive up to 35%, and tax-exempt entities can receive up to 25% of their base payments for employee health insurance premiums; these portions rise to 50% and 35%, respectively, starting in 2014." (In the tax years 2014 to 2016, the small businesses must purchase coverage though the PPACA health insurance exchanges in order to qualify for the credit.)

In response to the requests from Senator Snow and Representative Graves the GAO examined the implementation of the tax credit provisions in the following three areas:

• To what extent the credit is being claimed and what factors, if any, limit employer claims, and how these factors can be addressed

• How fully the Internal Revenue Service (IRS) is ensuring that the credit is correctly claimed by eligible employers

• What data are needed to evaluate the effects of the credit

Tax return data from 2010 returns (filed in April of 2011) provided the basis of the GAO's analysis of the use of the credits. The GAO interviewed "IRS officials as well as groups representing employers, tax preparers, and insurance brokers" and organized discussion groups. The GAO also consulted with stakeholders and the IRS to develop the proper data set to conduct a performance audit of the tax credit provision.

The GAO found that small employers are not making full use of the program. The GAO examiners believe this is the result of a combination of the complex eligibility requirement, coupled with the facts that the prevailing cost of health insurance is still relatively high and the tradition of providing health insurance by small employers is relatively rare. According to the report, 83% of employers that are projected as eligible for the tax credit do not currently offer health insurance coverage to their employees or principals.

The availability of the new tax credit subsidies does not as yet counter these traditional trends. The GAO investigators reported that the tax credit program proved to be underused. "Fewer small employers claimed the credit for tax year 2010 than were thought to be eligible based on rough estimates of eligible employers made by government agencies and small business groups.

"IRS data on total claimants, adjusted to account for claims by partners and shareholders, show that about 170,300 small employers made claims for the credit in 2010." In addition to the employer claims, another 165,000 claims for the tax credit came to the IRS from principals and shareholders of eligible entities.

"The average credit amount claimed was about $2,700. Limited information is available on the distribution of claim amounts for business entities because IRS focuses its data collection on the taxpayers filing credit claims, who may be partners or shareholders claiming their portions of a business entity's credit."

However, the GAO report documents that it is difficult to conduct research into this market sector because there is not a single database of information available for analysis. In order to write its report, the GAO reviewed information drawn from multiple databases and conducted discussion groups populated by representatives of related business and government sectors. Nevertheless, the report notes that even basic benchmarks of information, such as the projected number of businesses and individuals eligible to receive the tax credit varied greatly.

"Though statistical modeling corrects for imperfect data to match these rules, models are not precise. While acknowledging the data limitations, several entities produced estimates of the number of employers potentially eligible for the credit. The Council of Economic Advisors estimated 4 million and SBA estimated 2.6 million. Other groups making estimates included small business groups such as the Small Business Majority (SBM) and the National Federation of Independent Businesses (NFIB). Their estimates were 4 million and 1.4 million, respectively."

In order to claim the tax credit, nonprofit institutions may claim the credit, even if the organization has no taxable income, by filing IRS Form 990T. In cases when the organization's revenue is not subject to tax, the organization will receive the credit amount in the form of a refund.

Small business owners must file IRS Form 8941, "Credit for Small Employer Health Insurance Premiums." If the enterprise's tax liability does not exceed the credit amount available, the balance in excess is not receivable as a refund by the business.

The amount of the credit available to an employer is capped by a figure calculated by the Department of Health and Human Services (HHS), which purports to establish the average premium paid in small group markets per state.

Critics of the PPACA implementation already charge that HHS is arriving at average premium figures that are inaccurately low. The GAO investigation echoes this concern over the average state premium data. The investigators reported the following:

"State average premiums also reduced some credit amounts by reducing the amount of the premium base against which the credit percentage is applied. This premium base may be reduced when it exceeds the state average premiums for small group plans, as determined by HHS. If so, small employers are to use the state average amount, which in essence caps the premium amount used to calculate their credit. According to IRS data, this cap reduced the credit for around 30% of employer claims. For example, a nonprofit representative told us that her credit dropped from $7,900 to $3,070 because of the cap in her state."

Businesses and organizations that qualify for this tax credit still qualify for a tax deduction for health insurance premiums. That deduction applies to premiums paid in excess of the amount eligible for the credit.

The GAO report acknowledges that this tax credit program is targeted at a market that is historically resistant to the purchase of health insurance. The investigators note that "the small employers do not likely view the credit as a big enough incentive to begin offering health insurance and to make a credit claim, according to employer representatives, tax preparers, and insurance brokers we met with."

The report ignores two intuitive elements of this small group market that could work against expanding coverage.

First, in order to qualify for the tax credit, small businesses must report a greater level of detail about the enterprises' employment practices than is currently required. While the GAO report focuses on the time and effort it takes to complete these reporting requirements, the report does not mention the possibility that such small employers might be hiding just how many people work for them on a full- or part-time basis in order to avoid tax and working condition rules; therefore, the principals may not be willing to report accurate data for the purpose of obtaining the tax credit subsidy.

Second, while the investigators did interview insurance carriers and producers, the report makes no mention of sales compensation relative to the amount of work that goes into selling a small group policy. The commission structure provides incentive for producers to focus on larger groups rather series of smaller groups—favoring wholesale over retail. In addition, critics of the Medical Loss Ratio provision of the act point to pressures on carriers to reduce sales commission compensation, which places greater emphasis on securing large blocks of business over sales to small businesses. The Administration has offered a bounty program to producers who sell certain types of coverage.

The GAO report leaves the distinct impression that Congress did not create an attractive enough incentive to interest small employers with low-compensation employees to initiate purchasing health insurance coverage. The report strongly implies that the subsidy should be increased, but the GAO stopped short of formally recommending the change.

The GAO recommended amending the tax credit program in two ways:

• Increasing the amount of the credit for some by eliminating state premium averages.

• Expanding eligibility requirements by increasing the number of FTEs and the wage limit allowable for employers to claim the partial credit, the full credit, or both. This expansion would not, however, likely affect the smallest employers, which do not offer health insurance.

The Obama Administration's proposed 2013 budget contains a provision to expand the program to businesses with at least 50 employees and would eliminate the minimum employer contribution requirement entirely.

In addition, the GAO recommended simplifying the calculation methods to determine eligibility:

"The investigators recommended using the number of employees and wage information already reported on the employer's tax return, which could reduce the amount of data gathering as well as credit calculations, because eligibility would be based on the number of employees and not FTEs. The GAO acknowledged that this option came with a trade-off: less precision in targeting the full and partial credit amount to specific small employer subgroups."

In addition, the GAO suggested that the tax credit should be amended to offer a flat credit amount per FTE (or number of employees) rather than a percentage, which would reduce the precision in targeting the credit.

As partisan and ideological dynamics fade into history, the implementation of a national health insurance financing system will require energy and creativity.

As Kansas Insurance Commissioner Sandy Praeger (R) observed: "This is a first step in creating a health care system that works for all of our citizens. The law will be refined as we go forward just as many laws are, but it establishes as public policy the importance of everyone in this country having access to affordable health care. In addition, we need to take the next step. This addresses the problem of access to health care, and now we have to find ways to bring costs under control.

"The law uses a market-driven approach with a measure of compassion to let people buy their own health insurance at the cost and coverage they can afford.

"We are going to have to wait, however, to see what the November election holds regarding the law's long-term future."

The author

Kevin P. Hennosy is an insurance writer who specializes in the history and politics of insurance regulation. He began his insurance career in the regulatory compliance office of Nationwide Insurance Cos. and then served as public affairs manager for the National Association of Insurance Commissioners (NAIC). Since leaving the NAIC staff, he has written extensively on insurance regulation and testified before the NAIC as a consumer advocate.