Minor Thoughts from me to you

I've said before that McCain's healthcare plan is one of the few proposals he's made that I actually like. Robert Carroll explained some of the benefits in the Wall Street Journal.

The McCain health-care insurance tax credit may well be one of the most misunderstood proposals of this presidential election. Barack Obama has been ruthless in his attacks. But the tax credit is highly progressive and will provide a powerful incentive for people to purchase health insurance. These features under normal circumstances should endear Democrats to the proposal.

There has been a lot of rhetoric and misstatements, but what exactly does Sen. McCain have in mind? He would replace the current income tax exclusion for employer-sponsored health insurance with a refundable tax credit -- $5,000 for those who purchase family coverage and $2,500 for individual coverage. Mr. McCain would also reform insurance markets to stem the growth in health insurance premiums.

What many may not realize is that the federal government already "spends" roughly $300 billion to $400 billion through the tax code to encourage people to pay for their health care through employer-sponsored health insurance. This subsidy takes the form of the exclusion for employer-sponsored health insurance from both income and payroll taxes.

Consider the current exclusion. Its value rises with how much someone spends on health care, and how much of this spending is funneled through employer-sponsored health-care coverage. This creates an incentive for people to purchase policies with low deductibles, or which cover routine spending. These policies look a lot less like insurance and more like prefunded spending accounts purchased through employers and managed by insurance companies. Consider homeowners and auto insurance policies. Do these cover routine spending on cleaning the gutters or tuning up a car?

The subsidy encourages people to buy bigger policies that cover more, and leads to greater health-care spending. Moreover, lower deductibles and coverage of routine spending dulls consumers' sensitivity to price. Reducing the tax bias should result in insurance that is more focused on catastrophic coverage and less on routine spending.

By replacing the income tax exclusion with a fixed, refundable credit, the McCain proposal reduces the tax bias for large insurance policies. Because the credit is for a fixed amount, regardless of how much you spend on health care, it helps break the link between the existing tax subsidy and how much is spent on health care. This improves incentives in the health-care market by reducing the bias that has contributed to such a high level of health-care spending.

Moreover, the credit provides a powerful incentive for people to purchase insurance. The two tax provisions -- the new credit and the repeal of the income tax exclusion -- on net provide a substantial tax cut of $1.4 trillion over 10 years. Not only do most Americans receive a tax cut under the McCain proposal, but the tax cut is directed toward low and moderate income taxpayers.

What is striking about this picture -- and contradicts Mr. Obama's public comments -- is that the McCain tax credit for the purchase of health insurance exceeds the value of the current exclusion for all income levels shown. Indeed, it generally provides more resources to purchase health insurance than the existing exclusion. The total subsidy for health care would rise from about $3.6 trillion over 10 years today to roughly $5 trillion under his proposal.

Will the insurance that is purchased be a generous plan with first dollar coverage or low deductibles? It is much more likely to be a plan with higher deductibles that is more focused on providing true insurance against catastrophic losses rather than a more generous plan that includes a lot of prepayment for routine and predictable medical expenses. But this is precisely one of the objectives of the policy: to reduce the current tax bias that encourages people to funnel routine health expenses through insurance policies.

The elimination of the income-tax exclusion should reduce private health-care spending; to the extent this reduces the cost of health care, it should also put downward pressure on the growth of Medicare and Medicaid costs. Thus, by removing the tax bias for more generous health coverage, the McCain health credit also has the potential to provide important dividends to the entitlement problem down the road.

To be clear, I'm not wild about the subsidy that McCain's plan excludes. But I love the way it changes the current health insurance incentives. It not only gives people the motiviation to spend less on healthcare -- it also gives them the means to do so.

Too bad it has no chance of being passed into law. Even if McCain wins the presidency, the Democrat House and Senate would never pass this plan.