UNDERSTANDING THE POLICY IMPACT OF SECTION 125 PLANS Lynn Quincy Mathematica Policy Research, Inc. (MPR) July 18, 2008 Lynn Quincy Mathematica Policy Research, Inc. (MPR) July 18, 2008

Key Questions Regarding Policy Impact Prevalence of workers “touched” by policy Potential savings by type of worker/family Responsiveness of workers to price reduction (in a voluntary system) Prevalence of workers “touched” by policy Potential savings by type of worker/family Responsiveness of workers to price reduction (in a voluntary system)

Potential Beneficiaries from a Section 125 Policy Zero Tax Liability/ Trivial Savings Employee Benefits from New Tax Savings for Coverage No Workforce Connection/ Self- Employed All Residents Employee (or connection to an employee) Employer Doesn’t Offer Coverage Employee Eligible for Employer’s Coverage Not Eligible for Employer’s Coverage Zero Employee Premium Contribution Employee Premium Contribution Not Sheltered by Section 125 Has a Section 125 plan

Among the Uninsured, 76 Percent Have a Wage Earner in the Family Work Status Percent of All Uninsured (National, 2006) No workforce connection in the family 17% Self-employed 8% Wage earner in the family 76% Source: Employee Benefit Research Institute Brief No. 310.

Only 22 Percent of Uninsured Employees Are Eligible for Their Employer’s Offer of Coverage Percent of All Uninsured Employees (National, 2005) Employer sponsors; employee is eligible 22% Employer sponsors; employee is not eligible 16% Employer does not sponsor 63% Source: Clemans-Cope, L., and B. Garrett. Unpublished estimates based on the February 2005 Contingent Work Supplement of the Current Population Survey (CPS) and the March 2005 Annual Social and Economic Supplement of the CPS. Washington, DC: Urban Institute, 2006.

Some Employees in Small Firms Do Not Have a Premium Contribution for Single Coverage Source: Agency for Healthcare Research and Quality. National Medical Expenditure Panel Survey-Insurance Component (MEPS-IC) Data for 2005 (Private-Sector Employees). Percent of Enrolled Employees with Zero Health Insurance Contribution Firm SizeSingle CoverageFamily Coverage 2–9 workers67%59% 10–24 workers49%33% 25–99 workers37%16%

Section 125 Plans Are Less Prevalent in Smaller Firms Source: Agency for Healthcare Research and Quality. Unpublished National MEPS-IC Data for 2004 (Private-Sector Employees). Firm Size Percent of Employees in Offering Firms Without a Section 125 Plan (National) 2–9 workers65% 10–24 workers50% 25–99 workers30%

The Potential Savings Depends on One’s Implicit Marginal Income Tax Rate The relevant marginal tax rate is the rate of tax paid on the last $X of income where $X is the annual premium amount This tax includes: –Federal income tax –Federal Insurance Contributions Act (FICA) tax –State income tax –Other, state-specific payroll taxes The relevant marginal tax rate is the rate of tax paid on the last $X of income where $X is the annual premium amount This tax includes: –Federal income tax –Federal Insurance Contributions Act (FICA) tax –State income tax –Other, state-specific payroll taxes

Federal Tax Bracket Rates Illustration for a single parent with one child:

Federal Tax Bracket Rates vs. Implicit Marginal Income Tax Rates Illustration for a single parent with one child:

Tax Code Features Designed to Assist Lower-Income Taxpayers Earned Income Tax Credit (EITC)—slides with income and is fully refundable Child Tax Credit—partially refundable Dependent Care Tax Credit—not refundable but credit percentage is higher for lower incomes Earned Income Tax Credit (EITC)—slides with income and is fully refundable Child Tax Credit—partially refundable Dependent Care Tax Credit—not refundable but credit percentage is higher for lower incomes These tax code features cause implicit marginal income tax rates to diverge from federal income tax bracket rates.

The Value of the EITC by Family Type (2008) Note: Married filers are allowed higher maximum earnings than unmarried filers.

Potential Marginal Tax Rates Facing a Single Parent with Two Children* (Negative rates not displayed) * Assumes that the state levies an income tax and has a state EITC (most advantageous scenario).

Overall Marginal Income Tax Rates Vary by Family Composition* Shaded areas indicate overall marginal tax rates in excess of 40 percent. Shaded areas indicate overall marginal tax rates in excess of 40 percent. * Includes FICA and federal and state income tax rates. This state levies an income tax and has a state EITC (most advantageous scenario).

Lower-Income Families Can Face Surprisingly High Marginal Income Tax Rates But… Marginal tax rates vary tremendously by income and family type. Marginal tax rates can be negative for families with children at incomes below 125 percent of the federal poverty level (FPL). (Participation in a Section 125 plan is always voluntary.) But… Marginal tax rates vary tremendously by income and family type. Marginal tax rates can be negative for families with children at incomes below 125 percent of the federal poverty level (FPL). (Participation in a Section 125 plan is always voluntary.)

State Tax Expenditure Leverages Substantial Federal Funds

Employers Also Benefit from Section 125 Plans When payroll is lower by the amount of the employee share of health premiums, the employer pays less in FICA taxes Some states assess other payroll taxes which may be lower When payroll is lower by the amount of the employee share of health premiums, the employer pays less in FICA taxes Some states assess other payroll taxes which may be lower

Section 125 Policy Impact: MPR Estimates for Minnesota For Minnesota, MPR estimated the impact of a “stand-alone” mandatory Section 125 policy for employers with 10 or more employees. We found: Policy reduced the number of uninsured by 12 percent Adults comprise the majority of those newly covered The newly covered are split somewhat evenly by under/over 275 percent of FPL Three-fourths of the newly covered enrolled in group coverage (the remainder enrolled in nongroup coverage) Policy reduced the number of uninsured by 12 percent Adults comprise the majority of those newly covered The newly covered are split somewhat evenly by under/over 275 percent of FPL Three-fourths of the newly covered enrolled in group coverage (the remainder enrolled in nongroup coverage)

Conditions Necessary to Benefit from a Newly Available Section 125 There is a wage earner in the family Wage earner has access to coverage and a nonzero premium contribution but is currently unable to purchase on a pretax basis Family faces a federal or state tax liability that could be decreased (or a refund that could be increased) Tax savings are nontrivial Special case: those eligible for an EITC refund must be able to “front” the premium amounts until taxes are filed There is a wage earner in the family Wage earner has access to coverage and a nonzero premium contribution but is currently unable to purchase on a pretax basis Family faces a federal or state tax liability that could be decreased (or a refund that could be increased) Tax savings are nontrivial Special case: those eligible for an EITC refund must be able to “front” the premium amounts until taxes are filed

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