UNDERSTANDING THE POLICY IMPACT OF SECTION 125 PLANSUNDERSTANDING THE POLICY

IMPACT OF SECTION 125 PLANS

Lynn QuincyMathematica Policy Research, Inc. (MPR)

July 18, 2008

Lynn QuincyMathematica Policy Research, Inc. (MPR)

July 18, 2008

Key Questions Regarding Policy ImpactKey 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

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

Among the Uninsured, 76 Percent Have a Wage Earner in the Family

Work StatusPercent 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 CoverageOnly 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 Unpublished estimates based on the February 2005 Contingent Work Supplement of the Current Population Survey (CPS) and the March 2005 Annual Social and Economic Supplement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

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 Size Single Coverage Family Coverage

2–9 workers 67% 59%

10–24 workers 49% 33%

25–99 workers 37% 16%

Section 125 Plans Are Less Prevalent in Smaller Firms

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 workers 65%

10–24 workers 50%

25–99 workers 30%

The Potential Savings Depends on One’s Implicit Marginal Income Tax Rate

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 RatesFederal Tax Bracket Rates

Illustration for a single parent with one child:

-20%

-10%

0%

10%

20%

30%

$9,000 $14,000 $19,000 $24,000 $29,000 $34,000 $39,000

Family Income

Federal Income Tax Bracket Rates

Federal Tax Bracket Rates vs. Implicit Marginal Income Tax Rates

Federal Tax Bracket Rates vs. Implicit Marginal Income Tax Rates

Illustration for a single parent with one child:

-20%

-10%

0%

10%

20%

30%

$9,000 $14,000 $19,000 $24,000 $29,000 $34,000 $39,000

Family Income

Federal Income Tax Bracket Rates

Implicit Federal Marginal Income Tax Rates

Tax Code Features Designed to Assist Lower-Income Taxpayers

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.

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)The Value of the EITC by Family Type (2008)

Note: Married filers are allowed higher maximum earnings than unmarried filers.

$0

$1,000

$2,000

$3,000

$4,000

$5,000

$6,000

$0 $10,000 $20,000 $30,000 $40,000

Family Earnings

EIT

C A

mo

un

t Two or more Children

One Child

Childless

Potential Marginal Tax Rates Facing a Single Parent with Two Children*

(Negative rates not displayed)

Potential Marginal Tax Rates Facing a Single Parent with Two Children*

(Negative rates not displayed)

0%

10%

20%

30%

40%

50%

60%

$9,398 $11,862 $13,687 $17,337 $20,986 $24,636 $29,198 $34,673 $40,148 $45,623 $51,097

Family Income

Ta

x S

ub

sid

y P

erc

en

tag

e

State

FICA

Federal

* 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*

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).

Family Composition Income as a Percent of FPLAdults Kids 75% 100% 125% 150% 175% 200% 225% 250% 275% 300%

1 0 11% 28% 32% 23% 26% 28% 28% 28% 28% 28%2 0 9% 15% 13% 17% 23% 23% 23% 24% 28% 28%

1 1 -18% 2% -1% 35% 45% 47% 50% 44% 30% 28%1 2 -34% 0% 9% 48% 56% 59% 51% 28% 29% 30%1 3 -14% 4% 28% 48% 59% 34% 28% 29% 30% 31%

2 1 1% -10% 19% 45% 45% 42% 33% 28% 28% 28%2 2 -34% -7% -2% 31% 54% 54% 51% 37% 28% 28%2 3 -34% -7% -2% 23% 28% 52% 51% 34% 27% 28%

Family Composition Income as a Percent of FPLAdults Kids 75% 100% 125% 150% 175% 200% 225% 250% 275% 300%

1 0 11% 28% 32% 23% 26% 28% 28% 28% 28% 28%2 0 9% 15% 13% 17% 23% 23% 23% 24% 28% 28%

1 1 -18% 2% -1% 35% 45% 47% 50% 44% 30% 28%1 2 -34% 0% 9% 48% 56% 59% 51% 28% 29% 30%1 3 -14% 4% 28% 48% 59% 34% 28% 29% 30% 31%

2 1 1% -10% 19% 45% 45% 42% 33% 28% 28% 28%2 2 -34% -7% -2% 31% 54% 54% 51% 37% 28% 28%2 3 -34% -7% -2% 23% 28% 52% 51% 34% 27% 28%

Lower-Income Families Can Face Surprisingly High Marginal Income Tax Rates

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

State Tax Expenditure Leverages Substantial Federal Funds

Single Parent, 2 ChildrenPurchasing a Family Policy

Employee Premium Share for a Single Policy:

$ 248

Federal Income Tax Savings

@ 32% $ 79

FICA or Payroll Tax Savings

@ 7.7% $ 19

State Income Tax Savings

@ 11% $ 26

Net Cost of Coverage After Tax Savings:

$ 124

Percentage Savings 50%

Percent of Savings From Federal Sources

79%

Employers Also Benefit from Section 125 Plans

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 MinnesotaSection 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:

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

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

Contact InformationContact Information

Lynn QuincyMPR

lquincy@mathematica-mpr.com202-264-3449

Lynn QuincyMPR

lquincy@mathematica-mpr.com202-264-3449