US Elections and startup/small-business economics

I’m surprised that John McCain’s proposal to make health insurance benefits taxable has not received more notice. For a startup, cash is expensive and hard to find and it is a tremendous handicap for US startups that we have to  pay a huge amount for insurance for employees. But under current US tax law, the  benefit is not taxable – the company gets to deduct the costs as an expense and the employee just gets the benefit (such as it is). The McCain plan as described by its proponents works like this

Consider a married taxpayer whose employer now pays $10,000 for a health-insurance policy. Ending the exclusion will raise that individual’s taxable income by $10,000 — but the $5,000 tax credit will exceed the extra tax liability whether the marginal tax rate that individual pays is 10% or 35% or anywhere in between. Indeed, the lower the taxpayer’s income, the more of the credit that will be available to pay for health care that’s not reimbursed by insurance.[cite]

My first thought on reading this was “we’re overpaying for health insurance” since $10K/year is not anywhere near what insuring a family costs us. Some research on insurance costs, however, shows that the problem is that their numbers are false.   Studies generally say an average insurance policy costs $12K/year, but of course, at a technology company we are paying benefits in the top tier, not buying some Discount Bring Your Own Needle if You Need Stitches Insurance. The break even point for a family in a state like CA where there is going to be a state tax penalty as well is around $13K and prices are increasing at a very rapid pace while the credit is limited to increasing about 2%/year. For a single person, break even is around $7K.

Furthermore, the average is skewed by the advantage big companies have – one that gets much stronger under this bill. Suppose that you are trying to hire a brilliant engineer who also has an offer from IBM.  Your costs to insure her family will be $19K/year and theirs will be, perhaps, $14K year because they can negotiate discounts. That’s a problem we have now. But under the McCain plan she has to also factor in a $5K increase in tax liability from you for the same level of policy – reducing her net salary however the credit works.  If she’s at the 28% level, then that’s a $1400/year penalty for her on federal taxes not to mention an additional nearly $500 in state taxes in places like California.

I wonder about the reporting mechanics of this plan and how it interacts with other costs. Do we have to produce more paperwork for this non-wage benefit? Does it go onto W2 forms? How does it interact with state taxes or HRA accounts or … ?  The sense you get from reading McCain’s proposal is that he wants to get rid of employer paid health plans:

While still having the option of employer-based coverage, every family will receive a direct refundable tax credit – effectively cash – of $2,500 for individuals and $5,000 for families to offset the cost of insurance. Families will be able to choose the insurance provider that suits them best and the money would be sent directly to the insurance provider. Those obtaining innovative insurance that costs less than the credit can deposit the remainder in expanded Health Savings Accounts.[cite]

That “sent directly to the insurance provider” is not confidence inspiring. I’m imagining trying to hire someone under these conditions.

The Obama proposal is simpler.

The Obama Small Business Health Tax Credit will provide a refundable credit of up to 50 percent on premiums paid by small businesses on behalf of their employees.[cite]

Don’t know what the “up to” means in detail, but the idea is easy to understand.