Are tax credits or tax deductions for the individual purchase of health insurance better?

A recent editorial in The Wall Street Journal (link for subscribers) on weighs in on moving toward a system in which individuals would have more control over their health care and health spending. The editors endorse a tax deduction over a refundable tax credit to facilitate individual ownership of health insurance.

They argue that a refundable credit that would "go to individuals who pay no taxes at all -- essentially in the form of a government handout to buy individual insurance."

The Journal explains how the Republicans are divided on this crucial financing issue:

"One camp, led by President Bush and Arizona's Jon Kyl in the Senate, supports a 'standard deduction' along the lines unveiled by the White House earlier this year. Mr. Bush's proposal would replace the unlimited health-care tax deduction for employers with a $15,000 deduction for a family, or $7,500 for an individual. The deduction would apply both against the income and payroll tax, and would go a long way toward creating a more affordable private insurance market. Presidential candidates Rudy Giuliani and Mitt Romney also now favor a version of the tax deduction policy.

"On the other side are several Senators, led by South Carolina's Jim DeMint and Oklahoma's Tom Coburn, who agree on ending employer subsidies but want to give individuals a 'refundable' tax credit. North Carolina Senator Richard Burr has proposed a tax credit of $5,400 per family, and $2,160 per individual."

While the Journal says that either alternative would be preferable to "the current slow march to government-run health care," the editors don't explain how the millions of uninsured people will be helped if they make too little for the deduction to have much value.

An individual tax deduction would be preferable to the current invisible exclusion of health insurance from the taxable income of workers, with all of its distorting consequences. But people at the lower end of the income scale need more help to buy insurance.

A new paper by Professor Bryan Dowd of the University of Minnesota, published by AEI, does an excellent job of explaining the policy and the price of the current system. He argues that a credit is preferable, and he explains several ways it could be structured.

He estimates that if the current $189 billion annual "tax expenditure" for job-based health insurance were divided among all of the 224 million Americans not eligible for Medicare and Medicaid, it would provide a refundable credit of $840 per person.

Not enough.

He makes the argument that we heavily subsidize health insurance for wealthier Americans but not for those who have fewer resources and options to buy health insurance. Dowd says that the subsidy could be adjusted by income and geography.

He praises the Bush administration for putting the issue front and center in the policy debate and for "encouraging both greater equity in the tax code and debate over our current system."

My take? It may be that we need to combine a tax credit and a deduction to make progress.

The refundable credit would be more valuable to those at the lower end of the economic scale by providing meaningful help to purchase health insurance. And a deduction would be more like the tax benefit that those with job-based insurance currently receive through the tax exclusion. The deduction should be capped to limit the open-ended tax benefit it provides to those with the most generous health benefits, as President Bush has proposed.

The specifics can flow from the budget numbers to determine the amount of the credit and deduction and what the cutoff and triggers points would be.

The good news: At least we are having this debate. The bad news: The encroachment of government programs continues in the meantime.