Health insurance costs: Will new tax subsidies help?

Health insurance costs  for low and moderate-income earners will be lowered through tax credits when the 2010 health reform law takes effect. But will the plan actually lower health insurance costs?

Sarah Beth Glicksteen/The Christian Science Monitor/File
This file photo illustration shows the a nurse holding a stethoscope at Fenway Community Health in Boston. Under the health reform law, new tax credits are aimed at lowering health insurance costs for low- and moderate-income earners.

In just a few years, the 2010 health reform law will begin providing subsidies to help low- and moderate-income people buy health insurance. And that assistance is supposed to be delivered through tax credits—with payments going directly from the IRS to insurance companies.  But will those credits actually work? Maybe, but it won’t be easy.

As it happens, we’ve had plenty of experience with such credits, which in recent years have increasingly replaced direct spending programs.  For example, the Earned Income Tax Credit (EITC) subsidizes wages for low-income families, while the American Opportunity Tax Credit (AOTC) helps pay college costs. But critics complain these credits are poorly timed.

Unlike welfare, the EITC doesn’t kick in right away if someone loses a job—or gets one. As for AOTC, students may have to wait more than a year after they pay their tuition before being reimbursed up to $2,500 of their education costs. If your ability to borrow is limited and you can’t write that up-front check, relief may come too late to matter.

The Affordable Care Act addresses this timing problem by making advance credit payments. Starting in 2014, eligible people who buy insurance through the exchange  will have payments made on their behalf immediately. Nobody will  have to front money to purchase insurance and wait for reimbursement.

Problem solved, right? Maybe.

The advance payment will provide money when it is needed. But by solving one problem, the legislation created another one – advancing payments to some people who ultimately won’t be eligible.

Here’s where it gets really complicated. Because a person’s 2014 tax return won’t yet be processed when they purchase insurance, their 2012 return (filed in April, 2013) will be used. But during that lag time some people will see their income increase enough to make them ineligible for credit.

Not a problem, says the law, you’ll just pay the excess credit back on a future tax return.  And, if your income is four times the poverty level, you’ll have to pay back only some of it.  Still, some people with modest incomes may end up owing a large tax bill when they file their next tax returns.

Low-income households whose income falls will have the opposite problem. Their income will drop in that long period between the time they file that year-old return (showing income from 2 years ago) and the moment they actually buy insurance. That means they’ll appear ineligible and either need to further document their income to get their payments started or have to wait until they file their next return.  Clearly, the advance payment doesn’t solve their problem.

We know from the EITC research that these families’ incomes bounce around, sometimes due to a job change, marriage, divorce, and or other life-changing shift. Trouble is, nobody is very good at predicting these changes, making calculating advance payments correctly devilishly hard. New research from staff at the Congressional Budget Office and Treasury Department presented at the National Tax Association annual meetings corroborated difficulties with advanced payments.

The IRS is already stressed to its administrative limits, and the Affordable Care Act will only add more pressure. If Congress doesn’t fix  this complicated payment scheme, an already overburdened IRS will be under fire again in a few years – this time for over- and under-paying insurance companies.

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