Len Burman, Jason Furman, Greg Leiserson, and Bob Williams of the Urban-Brookings Tax Policy Center contribute the following post to the Health Affairs Blog.

In his State of the Union Address, President Bush proposed a radical restructuring of tax incentives for health insurance. Instead of the current unlimited tax exclusion for employer contributions to workers’ health insurance, there would be a new standard deduction for health insurance (SDHI)–a flat exemption from income and payroll taxes for anyone who has qualifying health insurance. The SDHI would apply to both employer-sponsored insurance (ESI) and individual nongroup insurance. The exemption amounts–set at $7,500 for single coverage and $15,000 for family coverage in 2009–would be indexed to the CPI, which grows much more slowly than health care costs and premiums. As a result, even though the deduction will start off bigger than premiums for most people, it won’t be by the end of the budget period in 2017.

The Urban-Brookings Tax Policy Center has analyzed the pros and cons of this proposal in a new report, “The President’s Proposed Standard Deduction for Health Insurance: An Evaluation.” Like many health analysts, we worry that the proposal would undermine our current employment-based system that covers 60 percent of Americans without solving the problems in the nongroup market that can leave millions of sick and/or low-income people uninsured. But we think the proposal could be improved to ensure increased coverage and provide real help for many vulnerable families who lack insurance today or are at risk of losing insurance under the current system.

In a nutshell, here are our recommendations (see the full report for detailed discussion):

1. Replace the deduction with a refundable tax credit or a voucher. Either would give low-income families the same assistance as richer families would get and make it more likely that they would obtain coverage. And there would be less threat to current employment-based coverage.

2. Make eligibility for the credit or voucher contingent on states’ setting up effective mechanisms to guarantee availability of affordable health insurance in the nongroup market. That would reduce the uncertainty of coverage if traditional sources of health insurance weaken.

3. Dedicate additional funds to expand public programs like Medicaid and SCHIP, increase subsidies for small business ESI, and support pooling arrangements for nongroup coverage. Those steps would help those most vulnerable to losing insurance.

4. Eliminate tax subsidies for health savings accounts to equalize the treatment of different forms of health insurance. Without this change, high-deductible health insurance plans would have a huge tax advantage over other health insurance options, including aggressively managed care, even if the other options were more efficient and attractive to consumers.

5. Index the credit or voucher to the health CPI or even the rate of growth of all health spending rather than the slower-growing overall CPI. That change would protect against the erosion over time of incentives to obtain coverage.

The basic thrust of the President’s proposal–leveling the playing field for health insurance–is laudable. But the plan fails to address some of the most significant problems in today’s market for health insurance and actually threatens many of the most vulnerable families. Specific changes would make the proposal fairer and improve its chances of meeting its goals. Without those changes, it could worsen an already precarious situation.