The Health Implications of Tax Reform
Federal tax legislation is in its final stages and is expected to reach President Donald Trump’s desk this week. The conferenced version of the Tax Cuts and Jobs Act (PDF) was released by Republican leaders on Friday, and the House is expected to vote on it tomorrow, with the Senate following shortly thereafter. Both sides of Congress are likely to hold a simple up-or-down vote without the opportunity for additional debate or amendments. Things in DC are moving fast, and the legislation has far-reaching implications for health and health care. A summary of the health-relevant components of the tax bill are included in the chart below.
The updated version of the tax bill repeals the individual mandate penalties of the Affordable Care Act (ACA) beginning in 2019. According to the Congressional Budget Office (PDF), this repeal provision would reduce the federal deficit by $318 billion over 10 years and would increase the number of uninsured by 4 million in 2019 and 13 million in 2027. An estimated 1.8 million Californians would be among them.
The Congressional Budget Office (CBO) projects that if this provision is enacted, premiums in the individual market will increase by an average of 10% in most years within the 10-year budget window because “healthier people would be less likely to obtain insurance and because, especially in the nongroup market, the resulting increases in premiums would cause more people to not purchase insurance.” CBO expects most states’ individual markets would remain stable. State officials, however, have expressed concerns that individual mandate repeal could lead insurers to exit markets.
In addition to disrupting marketplace stability, an additional 13 million uninsured people would increase the incidence of uncompensated care. The provision is also likely to reduce total reimbursement to safety-net providers, potentially handicapping their ability to invest in delivery-system improvements such as telehealth or team-based care, which have been shown to improve timely access to care.
Moreover, financial hardship due to medical debt is also likely to rise. The newly uninsured will likely be treated less effectively and will no longer have insurance to cover the costs.
As is widely known, the Senate version of the bill originally passed by a razor-thin margin of 51-49 with Sen. Susan Collins (R-ME) agreeing to vote in favor only after receiving concessions from GOP leadership that individual market stabilization measures would be enacted, including temporary funding for both the ACA’s cost-sharing subsidies and state reinsurance efforts to offset insurers’ most expensive claims. Although the intention of these measures is to increase marketplace stability and mitigate the negative impact of eliminating the individual mandate penalty, a November 29 CBO report and various think tank analyses suggest the additional bills would have a negligible impact on premiums and the uninsured. Whether leadership will indeed bring the measures up for a vote as promised, and whether they would pass, also remains to be seen. There is a chance we could see them as part of the upcoming December 22 continuing resolution, or they could be attached to funding votes in early 2018.
Medical Expense Deduction
Under current law, the Internal Revenue Service (IRS) allows individuals to deduct qualified medical expenses that exceed 10% of a person’s adjusted gross income for the year. This includes preventive care, treatment, surgeries, and dental and vision care. The medical expense deduction can also be used for long-term care expenses for chronically ill patients. It greatly affects individuals and families with high medical costs such as cancers, childhood disabilities, and chronic disease. Approximately nine million people claimed the medical expense deduction on their 2015 tax returns. In 2014, more than a million Californians used it.
Whereas the original House version of the tax bill eliminated the medical expense deduction, the pending version released on Friday adopts the Senate approach and temporarily makes the medical deductions available to more people. The Tax Cuts and Jobs Act (TCJA) would reduce the medical deduction threshold to 7.5% of gross income for the 2017 and 2018 tax years, then return it to the 10% threshold in effect today. Temporarily reducing the threshold and retaining it in the long term will ease the financial burden on qualified individuals and families.
Private Activity Bonds
Hospitals, universities, and other entities use tax-exempt bonds, known as private activity bonds, to finance large-scale projects such as hospital or clinic construction. Cities and counties also use these financing mechanisms to invest in public health programs, including affordable housing. In addition to providing tax credits to investors, such bonds can also be refunded in advance, which lowers overall borrowing costs. Pending tax legislation preserves the tax-exempt status (which would have been eliminated under the House bill) but repeals the advance refundability. This change will effectively increase hospital, education, and public health capital costs.
Orphan Drug and R&D Tax Credits
The bill affects two health care-related tax credits for industry, the Orphan Drug Tax Credit and the Research and Development Tax Credit. The Orphan Drug Tax Credit currently allows companies that develop drugs for rare diseases (affecting fewer than 200,000 people) to receive a tax credit for 50% of the cost of clinical trials. Pharmaceutical companies and patients have championed the tax credit as necessary to provide incentives to explore cures for otherwise-neglected diseases. Supporters say the tax credit helped facilitate approval of more than 500 new drugs. Critics assert that some major drug makers have exploited the tax credit by obtaining the orphan designation for blockbuster drugs. The pending tax bill would decrease the Orphan Drug Tax Credit from 50% to 25% of qualified clinical testing expenses. The TCJA would also alter how research and experimental expenses are handled within the tax code. In effect, the changes to both tax credits will increase the cost of drug development.
Large Cuts to Health Programs
The CBO projects (PDF) that tax reform would trigger $136 billion in automatic sequester cuts from mandatory spending in 2018 — including cuts to Medicare, risk-adjustment payments, and social services — unless Congress votes to waive the rule and avoid the cuts. This is because Congressional “pay-as-you-go” rules, called PAYGO, require that the Office of Management and Budget (OMB) automatically cut mandatory spending if legislation increases the deficit beyond a certain point, and the tax bill would add roughly $1.4 trillion to the deficit over a decade. CBO projects that the 2018 PAYGO cuts would include $25 billion from Medicare, $6 billion in ACA risk-adjustment payments, and $1.7 billion in social services block grants. Those cuts would increase on an annual basis without congressional intervention, and all directly affect health. Means-tested programs such as Medicaid are exempt from PAYGO rules.
While the pending tax bill would be the trigger for the PAYGO cuts, neither party would like to see these across-the-board cuts occur. As such, if tax reform is enacted, Congress would be compelled to act before the end of the year to waive the PAYGO rules and stop the sequester. Doing this requires 60 votes in the Senate, necessitating support from both sides of the aisle.
Apart from PAYGO maneuvers, the sheer size of the tax change will necessitate future budget decisions during which additional health programs or health funding could be cut. Given that the bill is projected to expand the deficit by $1.4 trillion and Speaker Ryan and others are calling for entitlement reform, the tax bill will create pressure regarding where to invest limited (and potentially declining) tax revenue. Additional health impacts will ensue if future cuts focus on programs such as CHIP, Medicaid, Medicare, and the Public Health and Prevention Fund.
Given that the proposed structure of tax reform includes higher cuts for upper-income taxpayers compared to lower-income people, the legislation stands to exacerbate income inequality, which in turn has been proven to negatively affect health for those at all income levels.
Graduate School Tuition Waivers and Student Loan Interest
It is also important to note what is not included in the bill — tuition offset taxes and student loan interest deductions. Under the House version of the bill, many health care trainees who are key to the success of the US health care system — including future doctors, physician assistants, nurses, pharmacists, and scientific researchers — faced increased costs. For those who pay tuition by serving as graduate student instructors and/or graduate student researchers, the tuition waivers they receive would have been taxed as income. Those carrying debt as they enter the workforce would have lost the ability to deduct their student loan interest under the House proposal. Such changes would have driven up the cost of graduate education, potentially weakening the future workforce by causing fewer students, including those from underserved communities, to pursue the advanced education needed to staff health care, envision innovation, and develop new cures. The Senate version did not include these elements, and the final version does not either. If the tax bill passes as currently written, tuition offsets will not be taxed and student loan interest will continue to be deductible.
Pending tax legislation could drastically increase the number of uninsured people, stoke the growth of uncompensated care costs, and destabilize the insurance markets by increasing premiums and causing healthy people to opt out of coverage. Proposed modifications could also slow drug development, particularly for rare diseases, and significantly limit the access of hospitals and public health agencies to necessary financial capital. On the positive side, temporary changes to medical deductions could help ease the burden on individuals and families with high medical expenses — for two years, anyway, until the terms return to precisely where they sit now. Last, the conference version of the bill helps preserve America’s prospect for developing a strong future health care workforce by avoiding additional taxations on graduate student education.