Ask the Scholar
Document scope · 1 page
Scholar
Ask about this object, its catalog metadata, its source description, or the page inventory.
For page-specific OCR and visual context, open one of the page chats.
Scholar Source Context
Document identity
localId
55032220
label
Medicare Savings Accounts
core
doc
dtoType
document
citationUrl
pageCount
1
Source metadata
id
55032220
sourceUrl
contentType
document
title
Medicare Savings Accounts
citationUrl
collections
Records of the First Lady's Office (Clinton Administration)
Melanne Verveer's Subject Files
imageCount
1
hasImages
yes
source
import
hasTranscription
no
Source extras
naId
55032220
levelOfDescription
fileUnit
otherTitles
2068127-20130534S-126-003-2022
recordType
description
ocrSource
nara-archive
Single page context
seq
1
pageIndex
0
type
document
mediaId
3a9f6a4e47d8a389
ocrText
PHOTOCOPY
PRESERVATION
Medical Savings Accounts
CENTER ON BUDGET
AND POLICY PRIORITIES
August 18, 1994
TO: Members of Congress and health care L.A.s
FR: Ellen Nissenbaum
RE: Medical Savings Accounts and Health Care Reform
Most of the major health care proposals under consideration include provisions
allowing individuals to establish special Medical Savings Accounts (MSAs), yet these
provisions have received little careful analysis or attention. This important issue is
likely to be debated on the Senate floor and eventually in conference. I have
enclosed the Center's new report on the issues involved in MSAs.
The paper discusses some of the hidden dangers of including MSAs in health
care reform legislation. It addresses both MSAs to which individuals would
contribute and those designed to accept contributions from employers. Although
these two models of MSAs present somewhat different problems, both could result in
increased health care costs (regardless of the presence of an employer mandate) and
could jeopardize efforts to achieve universal health care coverage.
The analysis examines how benefits of individual contribution MSAs would
flow overwhelmingly to upper-income taxpayers much like individual retirement
accounts did before their use was limited to moderate-income taxpayers in 1986. In
addition, MSAs are likely to produce large revenue losses over time.
Various health care proposals include some form of an MSA. The Gephardt
and Rowland-Bilirakis bills would establish MSAs that would only accept
contributions from employers. The Michel and Dole-Packwood bills would establish
MSAs to which either individuals or employers could contribute. The Mitchell bill
does not create MSAs.
Support for this analysis was provided by the Henry J. Kaiser Family
Foundation, which is not affiliated with Kaiser Permanente or Kaiser Industries.
We hope you find this information useful. Please contact Iris Lav or David
Super for further information.
777 North Capitol Street, NE, Suite 705, Washington, DC 20002 Tel: 202-408-1080 Fax: 202-408-1056
Robert Greenstein, Executive Director
The New York Times
New York, New York
August 16, 1994
Don't Be Seduced by Medisave
Medisave, the proposal for medical savings
vary with their medical condition. The combination
accounts, is a bad idea that has crept into the health-
of Medisave and reform invites a scheme: healthy
care bills proposed by the Democratic leadership in
people buy catastrophic policies until they become
the House and by Bob Dole, the minority leader, in
sick or pregnant; then they switch to ordinary
the Senate. Medisave would allow people to save
coverage. The scheme would destroy the elemen-
money by purchasing health insurance policies with
tary need of insurers to charge healthy customers
very high deductibles and then invest the savings in
premiums when they are well to cover their costs
tax-free accounts.
when they get sick.
Advocates say Medisave can help control
Medisave will not work for another reason.
health-care costs through consumer choice rather
Most health-care costs are accounted for by pa-
than heavy-handed government regulation. Cata-
tients who exceed the $3,000 annual threshold. If
strophic coverage requires consumers to pay ordi-
these high-cost patients own fee-for-service policies,
nary medical bills out of pocket, leaving insurance
to pick up only large bills that exceed an annual
they lose any reason to search for low-cost provid-
threshold of, say, $3,000. That, according to advo-
ers. Studies show that surgical costs among compa-
cates, will compel consumers to monitor physician
rable hospitals can vary by tens of thousands of
and hospital fees carefully. But what advocates do
dollars; under catastrophic coverage, patients will
not say is that Medisave would hurt the poor and the
lose incentive to reward hospitals that charge low
chronically ill and inadvertently disrupt private
fees. Catastrophic coverage can also drive consum-
insurance markets.
ers away from low-cost primary care, which would
Medical savings accounts would attract the
come out of their pockets, toward high-tech, costly
rich, because they get the biggest benefit from tax-
fixes when they let a preventable problem fester.
free investments. And the accounts would attract
Medisave advocates are correct when they say
healthy people because they would not expect to
consumer choice can help control costs. But the
spend much money out of pocket for health care.
choice that consumers rich and poor, healthy and
But as healthy people gravitate toward cata-
sick - should have to make is between standard
strophic coverage, the pool of applicants for regular
packages of benefits. That way health plans would
coverage would consist increasingly of people who
be forced to attract applicants by offering high-
are more chronically ill and more costly to insure;
quality care and attractive prices - rather than
that would drive premiums higher.
picking off low-risk applicants with catastrophic
The problem grows worse under health-care
policies and leaving the high-cost patients for some
reform. Every bill would require health plans to
other plan to cover. Medisave is a needless payoff to
cover nearly any applicant at rates that would not
rich families and a body blow to market reform.
© 1994 by The New York Times Company, reprinted by permission.
CENTER ON BUDGET
AND POLICY PRIORITIES
FOR IMMEDIATE RELEASE:
CONTACTS: Iris Lav
Thursday, August 11, 1994
Art Jaeger
(Revised August 18, 1994)
(202) 408-1080
SPECIAL MEDICAL SAVINGS ACCOUNTS COULD JEOPARDIZE
UNIVERSAL COVERAGE AND PUSH UP HEALTH COSTS, ANALYSIS SAYS
Little-noticed provisions allowing individuals to set up special Medical Savings Accounts -
included in several of the health reform bills now before Congress - could jeopardize the
goal of universal or near-universal coverage and push up health costs for families, employers,
and government, according to an analysis issued today by the Center on Budget and Policy
Priorities.
The proposals for tax-advantaged Medical Savings Accounts are found in different forms in
several Senate bills and, in yet another form, in the House leadership bill. Although the
leadership bill now on the Senate floor does not include an MSA provision, an amendment
providing one may be offered during the debate.
According to the analysis by the nonprofit research organization, MSAs in plans without
employer mandates are likely to benefit high-income taxpayers disproportionately. In this
way, these MSAs are similar to individual retirement accounts before their use was limited to
moderate-income taxpayers in 1986. But with or without mandates, the analysis found, MSAs
threaten to push up health care costs.
Under all the MSA plans, individuals with catastrophic health insurance could deposit part of
their income in special accounts without paying tax and use the money to help meet their
deductible or other health care costs. Many proposals also would allow withdrawal of funds
for non-health care purposes, subject in some cases to a modest tax penalty.
While on the surface these proposals have some appeal, the analysis said they pose serious
problems. If younger, healthier people elect a combination of catastrophic coverage and an
MSA - in the hopes of keeping their unspent deposits as tax-advantaged investments - the
pool of those covered by comprehensive health plans will become older and sicker, pushing
up the cost of these plans, the analysis found.
'Gaming' the System Could Increase Costs
According to the analysis, people also are likely to "game" the system by using MSAs to
accumulate tax-advantaged savings when they expect low health costs and shifting to
comprehensive coverage when they anticipate higher costs.
"Gaming" could result, the analysis said, because most pending health care reform plans do
not include "pre-existing condition" provisions that prevent switching from minimal to higher
- more -
777 North Capitol Street, NE, Suite 705, Washington, DC 20002 Tel: 202-408-1080 Fax: 202-408-1056
Robert Greenstein, Executive Director
Medical Savings Accounts
Page 2
coverage. Without such barriers, individuals would be free to choose catastrophic coverage
when they are healthy and switch to comprehensive coverage when they begin a family or
face surgery.
The result would be upward pressure on the price of comprehensive insurance plans, which
would increase the cost to employers and families for premiums and to the federal
government for health care subsidies for low-income families, the analysis said.
'Individual-Deposit' MSAs Create High-Income Tax Breaks
MSA proposals fall into two general categories, but both are tied to use of catastrophic health
care plans, or insurance coverage that carries a high yearly deductible.
The proposals found in most health reform bills that do not include mandates requiring
employers to contribute to health insurance for their employees allow taxpayers to make MSA
contributions up to an annual ceiling and to deduct those amounts from their income for tax
purposes. Several Senate bills fall into this category.
Most of these proposals require MSA funds to be used for expenses that count toward a
deductible under catastrophic insurance plans. Some also permit use of the money for other
medical expenses that might not be covered under the plans, such as eye and dental care.
Some proposals also allow deposited funds to be used for any purpose after the employee
reaches a specified age.
MSA funds used to pay permitted types of medical bills are never taxed. A taxpayer in the
highest income tax bracket would save nearly $700 in federal taxes for every $1,000 spent on
medical care under an "individual-deposit" Medical Savings Account. Funds withdrawn for
non-permissible purposes are taxed as income when withdrawn and also are generally subject
to penalties. According to the analysis, however, taxpayers who withdraw funds for non-
permissible purposes can still come out ahead, even after paying the taxes and penalties. As
a result, high-income taxpayers who expect to remain healthy can use this form of MSA to
accumulate savings at reduced tax rates.
Under an "individual-deposit" plan offered by Senator Phil Gramm (R.-Tex.), the analysis
added, the net value of $3,000 of gross income after five years in the MSA would be nine
percent more than $3,000 of gross income saved in the traditional way. This assumes the
taxpayer is in the 36 percent federal income tax bracket and a seven percent state income tax
bracket and that the account earns only a minimal three percent rate of interest. The Gramm
plan allows taxpayers to use MSA deposits for any purpose without penalties, so long as the
there is enough left in the account to cover the yearly insurance deductible.
If held for 20 years, the $3,000 MSA deposit under the Gramm plan would have a net value
nearly a third greater than a deposit that did not enjoy such tax advantages, the analysis
added. And if the interest rate were five percent rather than three percent, the MSA deposit
- more -
Medical Savings Accounts
Page 3
made under the Gramm plan after 20 years would be worth 50 percent more than the deposit
lacking such tax advantages.
Other "individual-deposit" MSA proposals have more restrictive provisions that would lessen
the value of MSAs for investment purposes, but they would not eliminate the tax advantages
altogether, the analysis said. As a result, high-income taxpayers could still use the accounts
as a tax-advantaged way to accumulate savings.
"Individual-deposit MSAs generally would afford a substantial new tax break to healthy, high-
income people that would be unavailable to the vast majority of moderate-income families
that fall in the 15 percent tax bracket," the analysis concluded, adding that the tax break
would have no value at all for poor families that do not pay taxes.
"In this respect, MSA usage is likely to be similar to usage of Individual Retirement
Accounts before IRA use was limited to low- and moderate-income taxpayers in the Tax
Reform Act of 1986," the analysis said. Before 1986, it noted, 82 percent of IRA deductions
were taken by the one-third of individuals with the highest incomes.
Also, the analysis said, since virtually all those who would benefit can afford excellent health
insurance under the current system, "individual-deposit" MSAs are not likely to contribute to
the goal of making affordable health care coverage available to every American. Rather, it
said, they are likely to make the goal harder to reach by driving up the cost of comprehensive
health insurance.
'Employer-Deposit' MSA Provide Tax-Advantaged Savings
Bills proposed by Representative Gephardt and by Representatives Rowland and Bilirakis
would create MSAs that would only accept contributions from employers. Under these
proposals, employers could offer a combination of an MSA and a high-deductible insurance
plan as an alternative to comprehensive insurance coverage. Employers are required to spend
the same amount per employee regardless of which option is chosen.
Under the "employer-deposit" MSA in the House leadership's health reform plan, deposited
funds must be used for health care costs or remain in the account until the employee reaches
age 591/2. Under the Rowland-Bilirakis bill, unspent funds would be retained until the
employee reached age 65. At that point, they become available for any purpose without
penalties. For employees who are relatively healthy and accumulate balances in their
accounts, the "employer-deposit" MSA provides tax-advantaged retirement savings. Less
healthy employees, however, are likely to find the combination of catastrophic insurance and
an MSA inadequate to meet their health care needs, the analysis found.
Because the employer rather than the employee makes the deposits, "employer-deposit" MSAs
would avoid the potential for large federal and state revenue losses. Like "individual-deposit"
MSAs, however, they would create incentives for gaming the system that ultimately would
- more -
Medical Savings Accounts
Page 4
lead to increased costs for health insurance. For example, the analysis found, a young, single
person whose employer deposits $2,500 annually in an "individual-deposit" MSA and who
withdraws no funds for medical expenses would accumulate $28,000 over 10 years. If the
same person took $2,500 of earnings, paid taxes on it, and saved the after-tax earnings each
year for 10 years, the accumulation would be only $16,600.
"There would be strong incentives to accumulate tax-advantaged savings at times when few
health care expenses are anticipated," the analysis said. When high medical expenses became
more probable, the individual could simply switch to comprehensive coverage and keep the
MSA accumulation as savings.
If the concentration of less-healthy workers in comprehensive plans drove up premiums for
that type of coverage, the analysis said, employers would face increased costs for all types of
health coverage. Under the Democratic leadership bill, for example, employers would pay 80
percent of the increased cost of comprehensive plans for their employees. Even if the cost of
covering employees under catastrophic plans did not increase, employers would still have to
make larger payments into MSAs for their employees with catastrophic/MSA plans in order to
comply with the requirement that the same amount per employee is spent regardless of which
option is chosen. Under the Rowland-Bilirakis bill, either employers or workers would have
to absorb the additional costs.
In addition, the analysis said, families would face increased costs for their share of
comprehensive insurance premiums, and the federal government would pay more for
subsidizing low-income households that buy insurance and small businesses that must provide
insurance for employees. These added costs would require implementing other measures to
hold down costs to avoid swelling the deficit. For example, under the Rowland-Bilirakis bill,
these added costs could trigger reductions in eligibility for premium subsidies, leaving more
people uninsured. Under the Democratic leadership bill, payments to providers could be cut.
No Good Way to Design MSAs
"There does not appear to be a way to design an MSA that is not detrimental to the goal of
achieving universal or near-universal health care coverage at a reasonable cost," the analysis
concluded. "The ultimate cost of allowing Medical Savings Accounts, with or without
employer mandates, is likely to be fewer benefits with higher co-payments in comprehensive
insurance plans used by middle- and lower-income families. In addition, in the absence of an
employer mandate, a lower proportion of the population is likely to be covered by adequate
health insurance - since increased cost of comprehensive insurance would lead some
employers to drop insurance coverage, and a scale-back of subsidies would cause some low-
income families to fail to purchase health insurance."
The Center on Budget and Policy Priorities conducts research and analysis on a range of
government policies and programs, with an emphasis on those affecting low-income
Americans. Support for this analysis was provided by the Henry J. Kaiser Family
Foundation. The foundation is not affiliated with Kaiser Permanente or Kaiser Industries.
CENTER ON BUDGET
AND POLICY PRIORITIES
MEDICAL SAVINGS ACCOUNTS IMPEDE UNIVERSAL COVERAGE
by Iris J. Lav
Overview
A number of health care reform bills include provisions for tax-advantaged
Medical Savings Accounts. All of these bills tie use of such accounts to catastrophic
health care coverage - that is, a health insurance plan that carries a high yearly
deductible amount. Funds placed in a medical savings account may be used to pay
health care costs that count toward the insurance deductible. Under some bills, funds
placed in an MSA also may be used to pay other health care costs.
On the surface, MSAs have appeal. An MSA can enable people who are young
and healthy, along with people who have enough discretionary income to set aside for
contingencies, to feel they are keeping their own money rather than contributing it to
insurance company profits. In addition, proponents of injecting more free-market
discipline into health care believe that consumers can be made more price-sensitive -
and will consume fewer health care services - if they pay medical bills out of their
own accounts.
Nevertheless, there are serious problems with MSAs. These problems greatly
overshadow their surface appeal. Whether used with or without an employer mandate,
MSAs are likely to jeopardize the national goal of achieving universal health care
coverage at a reasonable cost.
If younger, healthier people choose catastrophic insurance with MSAs in the
hope of keeping their unspent deposits, the pool of people covered by comprehensive
health insurance will tend to be older and sicker. Since most of the health care reform
proposals allow free movement among health insurance plans, without regard to pre-
existing conditions, people are likely to "game" the system. People would be able to
use MSAs to accumulate tax-advantaged savings at times when they expect low health
care costs and then shift into comprehensive health care plans at times when they
anticipate high health care costs, such as
when beginning a family or needing
Financial support for the work of the Center
surgery. As a result, the price of a basic
on Budget and Policy Priorities in preparing
comprehensive health insurance plan
this report was provided by a grant from the
will be higher than it would be if all
Henry J. Kaiser Family Foundation. We are
people participated in a comprehensive
grateful for their support.
plan.
777 North Capitol Street, NE, Suite 705, Washington, DC 20002 Tel: 202-408-1080 Fax: 202-408-1056
Robert Greenstein, Executive Director
The upward pressure on the price of a comprehensive insurance plan would
increase the cost to employers and families for premiums and to the federal
government for subsidies. In addition, if individuals are permitted to deposit funds
into the MSA in addition to, or instead of, employers, MSAs can be used in part as a
new, non-productive tax break; this could increase the federal deficit and cause
revenue losses for many states. Several pending health care reform proposals would
create MSAs of this type. Like Individual Retirement Accounts before their use was
limited by the Tax Reform Act of 1986, MSAs are likely to yield large revenue losses
that disproportionately benefit high-income taxpayers.
'Individual-Deposit' and 'Employer Deposit' MSAs
It is useful to distinguish two broad types of proposals, both of which are called
Medical Savings Accounts. The two types of proposals have somewhat different policy
implications. One type may be called "individual-deposit" MSAs, while the other may
be called "employer-deposit" MSAs.
'Individual-Deposit' MSAs
"Individual-deposit" MSAs - such as those proposed by Senators Phil Gramm,
Bob Dole, and John Chafee and also in two separate proposals by Representative Bob
Michel - are included in bills that do not require employers to contribute to health
insurance for their employees. Under these proposals, qualified taxpayers (either
directly or through their employers) are allowed to contribute yearly amounts to an
MSA, up to a specified ceiling. To be qualified, taxpayers must have insurance
coverage through a catastrophic plan.
Contributions to "individual-deposit" MSAs may be deducted on an
individual's income tax when determining adjusted gross income, which means they
may be deducted whether or not the individual itemizes other deductions. If MSA
contributions are withheld from income by an employer, the withheld amount also is
not counted as wages or salary for purposes of computing income or FICA (Social
Security and Medicare) taxes. In some proposals, contributions made by a
self-employed individual or person whose employer does not provide insurance are
similarly exempt from income and FICA taxes.¹
1 The Dole bill allows individuals to make deposits in MSAs if they are not eligible to participate in
an employer-subsidized health plan or do not receive employer contributions to a medical savings account.
If an employer does make contributions for an employee to an MSA, the MSA deposits are tax-free to the
extent they do not exceed the difference between the premium cost of the catastrophic plan the employer
(continued...)
2
Most of the proposals require persons holding MSAs to use funds in an MSA
account to pay medical expenses that count toward the deductible amount of their
catastrophic insurance. Individuals who incur such expenses but do not reimburse
themselves from their MSAs are subject to a tax penalty. Some proposals, however -
such as Senator Gramm's - simply permit such reimbursements from MSAs to be
made.
Some of the proposals also permit payments from MSAs to be used for other
medical expenses that are not covered by catastrophic insurance and that therefore
would not count toward the deductible. Depending on the plan, expenses that do not
count toward the deductible might include costs for eye care, dental care, or mental
health services. Funds withdrawn from MSAs that are used to pay permitted types of
medical bills are never taxed.
If funds are withdrawn from MSAs for non-permissible purposes, they are
subject to income taxes as ordinary income in the year they are withdrawn. The
various proposals generally also apply penalties to such withdrawals, but differ in the
circumstances to which the penalties apply. Some bills also allow penalty-free
withdrawal of funds after the holder reaches a specified age.
'Employer-Deposit' MSAs
"Employer-deposit" MSAs have been proposed in both houses of Congress. are
Representative Andrew Jacob's amendment to the Ways and Means Committee bill
(which is included in the House Democratic leadership bill), the substitute amendment
proposed by Representatives Roy Rowland and Michael Bilirakis, and a sense-of-the-
Senate amendment offered by Senator Harris Wofford in the Senate Labor and Human
Resources Committee all include "employer deposit" MSAs. The bill recently advanced
by Senator George Mitchell does not include an MSA provision.
"Employer-deposit" MSA proposals allow employers to offer their employees an
option of a combination MSA and high-deductible insurance plan as an alternative to
comprehensive insurance coverage. They contain some mechanism for requiring
employers to spend the same amount per employee regardless of which option the
employee chooses; the mechanism may either be a component of an employer mandate,
as in the Jacobs amendment, or a non-discrimination requirement, as in the Rowland-
Bilirakis proposal. In either case, parity is accomplished by requiring the employer to
deposit into the MSA the difference between the employer's share of the premium cost
for the high-deductible coverage and the employer's cost for comprehensive coverage.
¹(...continued)
offers and the premium cost of a comprehensive plan for the individual.
3
For example, under the Ways and Means bill, an employer would be required to
contribute an amount equal to 80 percent of the cost of a comprehensive family plan for
each worker. If a comprehensive plan cost $5,500, the employer's required contribution
would be $4,400. If an employee chose the catastrophic/MSA option instead and the
catastrophic plan cost $2,000, the employer would contribute 80 percent - or $1,600 -
toward that plan and deposit the difference of $2,800 ($4,400 minus $1,600) in the
employee's Medical Savings Account. Once an employer elected to make a contribution
towards its workers' health insurance costs under the Rowland-Bilirakis proposal, the
process would be similar.² Under this approach, employees may not make additional
contributions to the MSA.
Under the Jacobs amendment, funds from the MSA must be used for health care
costs; there are no provisions for withdrawal with penalty for other purposes. Unused
funds must remain in the account. The only exception occurs after the employee
reaches age 59½. After age 59½, the funds in the MSA become available for any
purpose, without a penalty being imposed. The Wofford amendment was not
accompanied by detailed provisions, but it was understood that provisions similar to
those in the Jacobs amendment were intended. The Rowland-Bilirakis proposal would
allow penalty-free withdrawals after the employee reaches age 65.
'Individual-deposit' MSAs: Healthy, Higher-Income Taxpayers have Incentives to
Maximize Use
Many high-income taxpayers will garner substantial tax benefits from using an
"individual-deposit" MSA and would be likely to view these MSAs as an advantageous
way to pay medical expenses. For higher-income taxpayers who expect to remain
healthy, individual-deposit MSAs would be particularly advantageous because the
accumulated deposits would represent a new, tax-advantaged way to accumulate
savings. As a result, higher-income taxpayers who anticipate remaining healthy would
be likely to use MSAs and to contribute the maximum permissible amount to their
MSAs.
Consider a taxpayer in the highest federal income tax bracket. Either to pay
$1,000 in out-of-pocket medical expenses or to deposit $1,000 in a savings account
under current law, a taxpayer in the 39.6 percent federal income tax bracket would
2 Under the Rowland-Bilirakis proposal, deductibles for catastrophic plans would set so that these
plans would have actuarial values equal to eighty percent of the actuarial value of comprehensive plans.
Hence if comprehensive coverage cost $5,500 as in this example, a catastrophic plan would be expected to
cost about $4,400. If an employer had chosen to make $4,400 contributions towards its workers' health care
costs, a worker choosing the catastrophic/MSA option would receive a $1,100 contribution to his or her
MSA and have $3,300 of the catastrophic plan's premium paid by the employer.
4
MSAs Do Not Help, But May Adversely Affect, Low-Income Families
Medical Savings Accounts offer no advantage for low-income families. In fact, inclusion of MSAs in a
health care reform bill would likely disadvantage such families, because MSA usage is likely to
increase the cost of comprehensive insurance. The increased costs could make insurance unaffordable
for some low-income families that do not qualify for full subsidies. In addition, the cost to the federal
government of providing subsidies would be higher, increasing the likelihood that subsidies would be
scaled back for budgetary reasons and thereby further reduce the affordability of insurance for low-
income families.
Deductions No Value to Poor Households
MSAs subsidize the purchase of health care services through providing tax deductions for deposits into
the accounts. This can be of considerable benefit to high-income taxpayers (as is explained starting on
page 9). But such tax deductions are of no value to poor families that do not owe income tax, and thus
MSAs cannot be used to subsidize the purchase of medical services by such families. Moderate-income
families in the 15 percent federal income tax bracket would receive some subsidy from using an MSA,
but are likely to have insufficient resources or discretionary income to take advantage of these benefits.
MSAs Will Increase the Cost of Insurance
for Low-Income Families
All proposals for MSAs include some circumstances under which funds in the accounts may be used
for non-medical purposes. In some cases, funds may be withdrawn without penalty if the balances
remaining in the account meet a specified threshold; in other cases, a modest penalty is applied to
funds withdrawn for non-medical purposes. In some bills, funds may be withdrawn without penalty
when the holder reaches a specified age. These provisions invite younger, healthier people to choose
catastrophic insurance with MSAs in the hope of keeping their unspent deposits as tax-advantaged
investments, leaving an older and sicker pool of people to be covered by comprehensive health
insurance. As a result, the price of a comprehensive health insurance plan will be higher than it would
be if all people participated in a comprehensive plan.
For persons with incomes modestly above the poverty line, the increased cost of comprehensive
insurance - resulting from the concentration of healthier people in catastrophic insurance - could
represent a substantial burden. Since the various health care reform proposals begin to phase out
subsidies for purchase of health insurance at or just above the poverty line, many low-income families
are likely to bear directly a share of these higher premium costs. Some low-income families could find
insurance unaffordable and, in the absence of a requirement to purchase insurance, fail to purchase it.
MSAs will Increase the Government Cost of Subsidies
and Squeeze Funding Available for Subsidies
If the cost of comprehensive insurance rises, the cost to the federal government of providing subsidies
to low-income households will increase along with it. As a result, over the long run, inclusion of
Medical Savings Accounts in a health care reform bill could result in the scaling back of low-income
subsidies for budgetary reasons. This, too, would cause insurance to be less affordable for low-income
families and could lead some to fail to purchase insurance. In addition, the cost from MSAs in foregone
tax revenues, much of which is likely to subsidize high-income taxpayer' tax-advantaged investments
not related to medical care, may be substantial. A large revenue loss from MSAs would make a scale-
back of subsidies particularly likely.
5
have to earn $1,696 before federal income tax and payroll taxes are subtracted. (The
39.6 percent income tax plus the 1.45 percent Medicare tax equals 41.05 percent. Taxing
away 41.05 percent of $1,696 leaves $1,000.³) Using an MSA, however, would allow
such a taxpayer to deposit $1,696 rather than $1,000. If the funds are used for medical
payments, the taxpayer saves nearly $700 for every $1,000 he or she spends on medical
care. If the funds are not needed for medical care but instead are viewed as an
investment, the taxpayer will earn interest on a deposit of $1,700 rather than on $1,000.
The benefit of saving the maximum permissible amount through an "individual-
deposit" MSA would increase with the length of time the funds remained on deposit.
This may be illustrated by considering a deposit of $3,000 to an MSA in a single year
that remains in the account in subsequent years. For purposes of illustration, the
taxpayer is assumed to be in the 36 percent federal income tax bracket and in a seven
percent state income tax bracket.⁴ A three percent rate of interest is assumed to be
earned on the deposits.
If the MSA deposit were made under the provisions of the Gramm proposal,
interest on the $3,000 deposit would accumulate without being taxed on a yearly basis.
After five years, the first year's deposit of $3,000 would have grown to $3,480. The
Gramm proposal does not impose a penalty for withdrawals for non-medical purposes
so long as the amount remaining in the account is equal to the yearly deductible
amount of the catastrophic insurance plan. So assuming that the taxpayer made
deposits in subsequent years and a sufficient balance remained, the individual could
withdraw the entire $3,480 as ordinary income. Federal and state income taxes would
reduce the proceeds to approximately $2,070. This can be compared to an investment
the taxpayer could have made from ordinary after-tax earnings. The initial investment
made from $3,000 in gross income on which income taxes and payroll taxes first had to
be paid would have been much less - $1,742. In addition, the interest on the savings
in the non-MSA investment would have been taxed on a yearly basis. So after five
3 A taxpayer in this income tax bracket has income that far exceeds the maximum earnings on
which Social Security payroll taxes must be paid and so would receive an exemption - through using an
MSA - only from the Medicare tax, which is paid on all earnings. This simplified example does not
include the impact of state income tax. As discussed below, this taxpayer is likely also to owe state income
tax, and thus to have to earn more than $1,696 to retain $1,000 under current law.
4 The 36 percent bracket applies to individuals with taxable incomes over $115,000 and married
filers with taxable incomes over $140,000. Taxable income is gross income less all permissible exclusions
and deductions from income. Thus, a taxable income of $140,000 generally would correspond to a much
higher gross income - perhaps in the $170,000 to $200,000 range. In this and the following comparison,
the taxpayer is assumed to live in a state with an income tax that conforms to federal treatment of MSAs.
Thirty-seven of the 42 states that levy a personal income tax generally define adjusted gross income in the
same way as it is defined for federal tax purposes. These states would be highly likely to conform to a
change in federal tax laws relating to MSAs. The assumed marginal state tax rate is seven percent, which is
the rate at this income level in the median state.
6
Figure 1
Value of $3,000 of Gross Income Saved Under Gramm and Dole MSAs
Compared with Current-Law Savings
$3,500
$3,000
$2,500
Value for non-medical purposes
$2,000
$1,500
$1,000
$500
$0
After 5 Years
After 10 Years
After 15 Years
After 20 Years
Current Law
Dole
Gramm
Taxpayer is in the 36 percent federal income tax bracket and a 7 percent state income tax bracket.
The state conforms to federal treatment of MSAs. Interest rate is three percent.
Center on Budget and Policy Priorities
years, the initial investment outside of the MSA would have grown to approximately
$1,903. Consequently, the $3,000 of gross income put into the MSA would be worth 9
percent more than $3,000 of gross income saved in the normal way. If those initial
deposits were held for 20 years, the MSA deposit under the Gramm proposal would be
worth 30 percent more than a normal deposit that did not enjoy such tax advantages.
(See Figure 1).
Other "individual-deposit" MSA proposals have more restrictive provisions.
But where these restrictions lessen the value of MSAs for ordinary investment
purposes, they would not completely eliminate this tax advantage. For example,
Senator Dole's proposal taxes the interest earned on MSA deposits on a yearly basis.
The Dole proposal also applies a 10 percent penalty to a withdrawal for non-
permitted purposes, no matter what balance remains in the account. Under the Dole
proposal, the after-tax-and-penalty value of an MSA withdrawal made by a taxpayer in
the 36 percent federal income tax bracket would be slightly greater than the value of a
comparable investment made with after-tax dollars if the investments were held at least
14 years.
7
These examples, however, assume a modest three percent rate of interest earned on
the savings. If interest rates rise in the future, the value of retaining tax-advantaged
savings in an MSA would increase substantially. If a five percent rate of interest were
earned on the savings, for example, after 20 years the $3,000 of gross income deposited
and held in an MSA would be worth 51 percent more under the Gramm proposal -
and 16 percent more under the Dole proposal - than a deposit made from after-tax
income.
If the taxpayer in the example used above were in the 28 percent federal tax
bracket rather than the 36 percent bracket, saving through a Gramm-style MSA would
still confer substantial advantage - albeit somewhat less advantage than that secured
by the higher-income taxpayer.⁵ Under the Gramm proposal, an MSA deposit
withdrawn after five years for non-medical uses would be worth 7 percent more to a
taxpayer in the 28 percent federal tax bracket than a deposit based on the same amount
of gross income made into a normal account, based on a three percent rate of interest in
each case. After the 20th year, the MSA deposit would be worth 24 percent more.
In sum, the value of the tax break that MSAs confer increases with the income -
and the income tax bracket - of the user and is greatest for the healthiest, highest
income taxpayers. "Individual-deposit" MSAs would afford a substantial new tax
break to healthy, high-income people that would be unavailable to the vast majority of
moderate-income families that fall in the 15 percent tax bracket. In this respect, MSA
usage is likely to be similar to usage of Individual Retirement Accounts before IRA use
was limited to low- and moderate-income taxpayers in the Tax Reform Act of 1986.
Prior to the 1986 Tax Act, 82 percent of IRA deductions were taken by the one-third of
individuals with the highest incomes. (See box on next page.)
In addition, since virtually all of the taxpayers who would benefit from MSAs
can afford excellent health care insurance under the current system, the establishment
of MSAs would not contribute to the goal of making affordable health care coverage
available to every American. As discussed below, MSAs are likely to detract from the
ability to reach that goal by driving up the cost of comprehensive health insurance.
5 The 28 percent federal income tax bracket applies to single individuals with taxable income
between approximately $23,000 and $55,000 and married couples with taxable income between
approximately $38,000 and $92,000. Taxable income is gross income less all permissible exclusions and
deductions from income. Thus, a taxable income of $60,000, for example, would correspond to a much
higher adjusted gross income - on average, between $75,000 and $100,000 in adjusted gross income.
8
'Individual-Deposit' MSAs Similar to Pre-1986 IRA
The pattern of usage of Individual Retirement Accounts before 1986 gives an indication of what might
be expected under the MSA proposals. Prior to the Tax Reform Act of 1986, taxpayers at all income
levels could deposit up to $2,000 per year in Individual Retirement Accounts and deduct the
contribution from their taxable income. Interest on funds deposited in IRAs accumulated free from
taxation. Funds could be withdrawn after age 591/2 and were subject to taxation as ordinary income at
that time. As a result, the benefits from IRAs came from the deferral of taxation on the annual deposits
and the interest build-up and from the expectation that taxpayers would be in a lower tax bracket after
retirement than during their working years. IRAs were advantageous savings vehicles for some
higher-income taxpayers, however, even if they intended to pay the penalty for early withdrawal.
Even though taxpayers at any income level could use IRAs, actual usage was concentrated among
upper-income taxpayers. IRS tax return data show that in 1986, the last year in which IRA tax
deductions were available to all taxpayers, 66 percent of the tax units in the top four percent of the
income scale made IRA contributions. By contrast, only 13 percent of taxpayers in the middle third of
the income scale made such contribution. And only four percent of those with adjusted gross incomes
below $15,000 participated.
Furthermore, upper-income taxpayers tended to have the funds to make the maximum-permitted
contribution, while other taxpayers made more modest contributions. As a result, the distribution of
the amount of IRA deductions was even more tilted to the upper end of the income scale. According to
Congressional Research Service expert Jane Gravelle, ...IRAs cannot be characterized as a subsidy to
the middle class. In 1986, 82 percent of IRA deductions were taken by the upper third of individuals
filing tax returns (based on adjusted gross income). Since these higher-income individuals had higher
marginal tax rates, their share of the tax benefits was even larger."¹
MSAs may have distributional effects that are similarly skewed in favor of upper-income taxpayers as
those of pre-1986 IRAs. As discussed in the text, few low- or middle-income taxpayers are likely to
have sufficient savings to bear the risk of high uninsured health care costs. And the benefits to savings
through an MSA increase with increases in income and marginal tax rates.
1 Statement of Jane G. Gravelle, Congressional Research Service, Senate Committee on Finance, May
16, 1991.
'Individual-Deposit' MSAs May Leave Moderate-Income Taxpayers
Exposed to Unaffordable Medical Bills
In addition to being unable to take advantage of the lucrative tax breaks MSAs
can offer, there is another reason that MSAs are not a benefit for ordinary, moderate-
income taxpayers. For moderate-income taxpayers who have families and for those
who anticipate normal-to-high medical expenses, using an MSA with a catastrophic
insurance plan may pose a significant financial risk.
Persons covered by catastrophic health insurance must have the yearly
deductible amount - which may be several thousand dollars - available at the
9
beginning of each new year to which the deductible applies in case large expenses are
incurred early in the year. In addition, catastrophic insurance plans may cover fewer
types of medical services than comprehensive plans, and only payments for covered
services would count toward fulfilling the yearly deductible. As a result, a person with
limited financial resources who chooses catastrophic rather than comprehensive
coverage might risk incurring large medical bills that are not covered by insurance and
that the individual cannot afford. (See box on next page.)
'Individual-Deposit' MSAs Increase Cost of Comprehensive
Insurance and May Result in Fewer Insured
As noted, maximizing MSA deposits would be particularly advantageous to
high-income taxpayers, and to some moderate-income taxpayers, at times in their lives
when they anticipated relatively low medical expenses. At times when high medical
expenses might be anticipated, however, persons with modest financial reserves would
be better off using comprehensive insurance.
Under the current health insurance system, a significant bar to keeping minimal
coverage until substantial costs are anticipated is a worry that a "preexisting condition"
will develop and forever preclude the ability to obtain insurance. Such barriers would
be eliminated by many of the reform plans, so people would be allowed to choose to be
covered by catastrophic insurance when they are healthy, and then opt to buy
comprehensive insurance when they know, for example, that they will be starting a
family or requiring surgery.⁶ If this occurs, the pool of people using comprehensive
insurance will tend to have higher health care utilization and a higher per-person cost
of health care than would be the case if everyone working for a company or living in an
area were covered by comprehensive insurance.
To the extent that the cost of basic, comprehensive insurance plans increase
because they are covering less healthy people, the costs to employers and individuals
for premiums and the costs to the government for low-income subsidies also will
increase. In the absence of an employer mandate, this cost pressure could cause some
employers to drop insurance coverage. It also could result in the scaling back of
subsidies for budgetary reasons, causing some low-income families to fail to purchase
6 If a reformed system uses a similar preexisting condition barrier to shifting from catastrophic to
comprehensive coverage, many people would be stuck forever with deductible amounts that are
unaffordable in their changed circumstances. Some of the bills that include "individual-deposit" MSAs
continue to allow insurance companies to deny insurance coverage based on pre-existing conditions under
some circumstances.
10
Moderate-Income Families Choosing MSAs Risk
Unaffordable Medical Expenses
Some moderate-income families who use a combination "individual-deposit" MSA with a catastrophic
insurance plan may not have sufficient resources to cover their exposure to health care costs. Consider,
for example, the Jones family, which carries a catastrophic insurance plan with a $3,000 deductible
through the husband's employer. Like many moderate-income families, mortgage and living expenses
consume all of the Jones' income and they are mildly over-extended on credit-card consumer debt. The
Jones' keep $5,000 for emergencies in a money-market fund, but have no other liquid assets.
Assume the Jones' had $1,000 in MSA savings going into the year and made additional deposits
through the employer of $250 a month during the year. By early November, the family had paid
$2,500 into the account from the monthly deposits, and had paid $2,000 from the account for various
medical bills that counted toward the deductible, leaving $1,500 in the account. In mid-November, the
Jones' teen-age son broke two teeth in a sports game. The $1,000 cost of necessary dental work did not
count toward the deductible amount of their catastrophic insurance, but it was a permitted use of MSA
funds. The Jones' decided to pay the bill through their MSA, bringing the balance down to $500. Then
in late-November, Mr. Jones became ill and required emergency surgery. The family added $500 from
their money-market fund to their MSA balance to cover their remaining $1,000 deductible for that year.
In early January, as Mr. Jones prepared to resume work, complications developed and further surgery
was required. No funds were available in the MSA to pay the $3,000 deductible for the new calendar
year. In addition, Mr. Jones faced several additional weeks before he could return to work and did not
have sufficient sick leave to receive his salary for the period of anticipated absence. Paying the $3,000
deductible would reduce the family's money-market savings to $1,500, causing the family serious
concern about meeting living expenses during the unpaid leave.
health insurance. A scale-back of subsidies would be particularly likely if the cost in
foregone tax revenue of MSAs turns out to be high.⁷ Such pressures are likely to
increase the proportion of the population that is uninsured.
7
In addition to increasing the cost of comprehensive insurance and federal subsidies, "individual-
deposit" MSAs could result in substantial federal and state revenue losses. If MSA-users with high
incomes deposit the maximum-permitted amounts in order to secure tax-advantaged savings (above and
beyond amounts in MSA accounts that are used for medical costs), it is possible that greater tax deductions
would be taken for MSA/catastrophic insurance combinations than for comprehensive insurance.
Assume, for example, that a comprehensive family plan has a premium of $5,500 which can be
paid with pre-tax income either by an employer or an individual. For comparison, assume that a
catastrophic family plan has a premium of $2,500 and that the maximum permitted contribution to the
MSA is $4,000, bringing the total that can be paid or deposited with pre-tax income to $6,500. In this
scenario, the Treasury and state governments could lose tax revenue from an additional $1,000 of
potentially taxable income if a taxpayer chose the MSA/catastrophic combination and maximized MSA
contributions. A substantial revenue loss would be particularly likely if the enacted MSA deposit limits
were high- - they are $5,000 in Rep. Michel's original health care reform bill, for example - and some
catastrophic insurance plans had high premiums (which could occur if a plan offered full coverage for
medical expenses exceeding the deductible amount).
The additional revenue loss could be avoided by limiting the MSA deposit to the difference
between an individual's catastrophic insurance premium and a comprehensive insurance premium, as the
"employer deposit" MSAs do. The Dole bill attempts to address this issue by requiring that any individual
whose employer subsidizes insurance costs may deposit funds into an MSA only through the employer,
and by limiting the amount of tax-free MSA deposits in such cases to the difference between the cost of a
comprehensive plan for that individual and the cost of his or her catastrophic plan.
11
'Employer-Deposit' MSAs Also Increase Costs for Employers and Government
"Employer-deposit" MSAs do not allow individuals to make deposits to their
accounts.⁸ Instead, the employer would deposit into the MSA the difference between
what the employer would otherwise contribute towards the premium for a comprehen-
sive plan and the employer's share of the premium for a catastrophic plan. By
equalizing the employer payment and tax deduction for each option, the potential for
large federal and state revenue losses is avoided. But "employer-deposit" MSAs create
incentives for gaming the system similar to those induced by "individual-deposit"
MSAs. These incentives ultimately would lead to increased costs for health insurance.
Consider, for example, a young, single person earning $35,000 a year whose
employer deposits $2,500 each year for 10 years into the employee's MSA. If the person
withdraws no funds for medical expenses, the account would total just under $28,000 at
the end of the 10-year period. By contrast, if the same person took $2,500 of earnings,
paid federal and state income taxes and payroll taxes and then saved the after-tax
earnings each year for 10 years, he or she would have just under $16,600 saved at the
end of the period.⁹ (See Figure 2.)
There would be strong incentives to accumulate tax-advantaged savings at times
when few health care expenses are anticipated. When the individual came to a point in
life when high medical expenses became more probable, such as when he or she
married and started a family, he or she would presumably change to comprehensive
coverage and simply retain the MSA accumulation as "retirement savings." In this
example, the taxpayer withdrawing the accumulated funds after age 591/2 (under the
Jacobs amendment) or age 65 (under the Rowland-Bilirakis proposal) would receive an
advantage over having saved the funds in the normal way if his or her combined
federal and state marginal income tax rate at the time of withdrawal was less than 41
percent, a very likely scenario for all but the highest-income taxpayers.
As is the case with "individual-deposit" MSAs, younger, healthier employees
would be likely to choose the catastrophic/MSA combination, while employees at
greater risk of high health care costs would choose comprehensive coverage. As a
result, the cost of health insurance to employers, individuals, and the federal
government would go up. Premiums for comprehensive coverage would have to
8
If "employer-deposit" MSAs did allow individuals to make deposits to their accounts, they
would be similar to "individual-deposit" MSAs in their effects.
9
This calculation assumes a three percent rate of interest on the deposits and current taxation of
yearly interest earnings in both cases. The individual is assumed to be in the 28 percent federal income tax
bracket and a seven percent state income tax bracket.
12
Figure 2
Cumulative Value of $2,500 Gross Income Saved Each Year for 10 Years
Jacobs Amendment Compared with Current Law Savings
30,000
$
25,000
20,000
Cumulative Savings
15,000
10,000
5,000
0
1
2
3
4
5
6
7
8
9
10
Year
After-tax Savings
/
MSA
Calculation applies to an individual or family in the 28 percent federal income tax bracket and
7 percent state income tax bracket. Interest rate is three percent.
Center on Budget and Policy Priorities
increase to compensate for the higher average health care expenditures of the older, less
healthy pool of employees covered under the comprehensive plan.
In bills with employer mandates, employers would have to pay their 80
percent share of the increased cost of the premiums for comprehensive
plans. And since the cost to the employer for covering employees under a
catastrophic plan is tied to the cost of a comprehensive plan, the employer
also would have to make larger payments into the MSA to comply with
the requirement that the same amount be spent on each option. In bills
with no mandates, the employer would either have to increase its
contribution- possibly reducing wages to recover its costs — or leave its
workers to pay an increased share of premium costs.
Individuals who want or need comprehensive coverage also would face
increased costs for their share of the premium. If the absence of healthier
subscribers in the comprehensive insurance pool increased the premium
costs beyond a level that employers would tolerate, benefits under the
comprehensive option eventually might be cut back or higher co-
13
payments imposed - either of which could increase burdens on some
middle-income families needing care.
The cost to the federal government of subsidizing low-income households
that buy insurance and small businesses that must provide insurance for
their employees would rise in tandem with the increase in the cost of a
comprehensive benefit plan. These added costs would swell the deficit
unless offsetting cost containment measures were implemented. If
measures used to offset the increase in cost included reductions in
subsidies, insurance could become unaffordable for some low-income
households and small businesses. Mandates to purchase insurance could
be difficult to maintain in the face of such pressures.
Conclusion
There does not appear to be a way to design an MSA that is not detrimental to
the goal of achieving universal or near-universal health care coverage at a reasonable
cost. To the extent that individuals who can benefit from choosing a catastrophic/MSA
combination rather than comprehensive insurance do so - because they judge they are
less likely to become sick and hope to use the tax-advantaged savings for other
purposes - the cost of the comprehensive insurance needed by the majority of
Americans will increase. Comprehensive insurance will become less affordable for
both employers and individuals, and the cost to the government for subsidies for low-
income households will rise.
Thus, the ultimate cost of allowing Medical Savings Accounts, with or without
employer mandates, is likely to be fewer benefits with higher co-payments in
comprehensive insurance plans used by middle- and lower-income families. In
addition, in the absence of an employer mandate, a lower proportion of the population
is likely to be covered by adequate health insurance - since the increased cost of
comprehensive insurance would likely lead some employers to drop insurance
coverage, and a scale-back of subsidies would probably cause some low-income
families to fail to purchase health insurance.
August 17, 1994
14
Order Form
(Please print)
Name
Organization
Address
City
State
Zip Code
Phone Number
(
)
Qty
Title
Price Each
Total
Warning: Inadequate Low-Income Subsidy Design Can
$12.00
Cause Problems for Health Care Reform
Warning: Inadequate Low-Income Subsidy Design Can
$3.00
Cause Problems for Health Care Reform --- Summary
Comprehensive Subscription (see below)
$40
Basic Subscription (see below)
$25
In the District of Columbia, add 6% for sales tax (If tax
exempt, include copy of certificate)
TOTAL
ALL ORDERS MUST BE PREPAID
SUBSCRIPTIONS:
Comprehensive Package- $40 for a one-year subscription. Includes all poverty and income reports,
all budget analysis, and all reports and analyses on all three additional topics listed below.
Basic Package - $25 for a one-year subscription. Includes all poverty and income reports and
analyses and all budget analyses. Plus all reports and analyses on one of the following:
(check one)
labor issues, including employment, unemployment insurance, minimum wage
hunger and welfare issues, including food, nutrition, and health programs
state fiscal policy issues, including state budget and tax issues
Send this form and payment to:
Publications Service
Center on Budget and Policy Priorities
777 North Capitol Street, NE, Suite 705
Washington, DC 20002
Tele: (202) 408-1080 Fax: (202) 408-1056
HandsNet #HN0026