Premium tax in PPACA may substantially distort the health insurance market, undermine competition
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Douglas Holtz-Eakin, former director of the Congressional Budget Office and president of the American Action Forum, recently published an interesting report addressing the tax that the Patient Protection and Affordable Care Act (PPACA) imposes on health insurance providers. Holtz-Eakin compellingly argues that the structure of the tax will almost necessarily force some insurance providers to raise their premiums, leaving health insurance firms exempt from the premium tax with a competitive advantage that will distort price signals in the health care market.

Here's how the tax functions. PPACA establishes an annual "fee" that health insurance providers collectively will have to pay the federal government beginning in 2014. In its first year, the fee will amount to $8 billion, and it will rise to $14.3 billion by 2018, at which point the fee will be adjusted for inflation and modified accordingly in ensuing years. Insurance providers will have to calculate their share of the total premium dollars subject to the fee, and the fee will then be proportionately levied on each insurance provider according to the size of its share.

Non-profit insurers, which account for about half of the national insurance market, are (mostly) not subject to the fee. For-profit insurers will therefore bear the tax burden imposed by the fee, as would be normally expected. However, the fee deviates from standard tax policy in a very important respect: it is not tax deductible. Though the mandatory fee is unambiguously a cost of doing business for the health insurance providers subject to it, the tax code will not regard it as such, treating it instead as earned income. Thus, if a for-profit health insurance provider earns a dollar and puts that dollar towards paying the premium fee it owes the government, it will still owe 35 cents in corporate taxes on that dollar.

Holtz-Eakin points out that this unconventional tax structure will dramatically skew the health care market in favor of non-profit providers. Insurers subject to the free will have to make up for the expense it imposes on their business somehow, either by cutting their costs or by raising their premiums. Those not subject to the fee will obviously not face this dilemma, and hence they won't face any financial pressure to raise their premiums. However, the for-profit insurers subject to the fee will suffer the most, as their losses will be compounded by the fee's non-deductibility. Holtz-Eakin calculates that for-profit insurers subject to the tax will have to raise their premiums by $1.54 for every $1 imposed on them by the fee just to break even.

Consumers will naturally shift towards the firms charging lower premiums. The policy thus favors some providers over others according to how they structure their finances (for-profit vs. non-for-profit), rather than the quality of their services.

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