closely with state welfare and regulatory agencies, institutions that have not traditionally worked closely with either federal or state taxing authorities.

The second administrative problem involves using the tax system to target children, who are not typically taxpayers. The IRS deals with taxable units that are usually families. Because children are almost always the dependents of adult taxpayers, it adds a layer of complexity to target any tax incentive only to children. In addition, on the insurance side, most children receive coverage through a family policy that is purchased by at least one of the parents, either through that parent's employer or directly from an insurance company. The practical solution to this problem is to realize that most uninsured children are dependents of parents who are also uninsured, so that any tax policy to subsidize the purchase of family policies will increase the level of coverage of children and adults alike. Because children on average use less health services than adults, a less targeted subsidy that includes more adults will cost more than a subsidy targeted only to children.

There are several options for the design of a tax subsidy for children's health insurance, but they vary in terms of their ease of administration and their ability to actually increase the level of coverage. For simplicity, the following section considers two methods of providing tax subsidies—tax credits and tax deductions—and two targets for these subsidies—employers and taxpayers.

Tax Deductions

In its simplest form, our income tax system works on the principle of imposing a tax that is a percentage of a taxpayer's or business firm's taxable income. Taxable income may be less than gross income to the extent that the taxpaying unit is able to subtract actual expenditures that are allowable as tax deductions or a fixed amount for each member of the taxpaying unit (called exemptions). Examples for families include standard exemptions based on the number of children in a family, mortgage interest payments, and medical expenditures above 7.5 percent of adjusted gross income. Each of these deductions from income is designed to lower the taxes of families that have children, own their own homes, or experience unusually high medical expenses. Business firms are allowed to deduct from gross income almost all costs of conducting their business including the cost of raw materials, labor costs, and the costs of fringe benefits, including what the firm pays for a group health insurance plan for its employees.

Because the cost to the employer of providing dependent coverage through a family policy is already fully deductible as a business expense, there is no opportunity for using tax deductions as an additional inducement for employers to expand coverage. The use of the deduction for health insurance expenses could be made contingent on providing all employees and their dependents a specified level of benefits, but this becomes equivalent to a mandate and has all the disadvantages discussed above. In addition, if the employer retains the freedom not to provide health insurance at all, any requirement that the tax deduction could only be used when all dependents were covered would create strong incentives for many firms to drop the provision of health insurance. The result would likely be an increase in the number of uninsured children, not the desired decrease.

Using a tax deduction for individual taxpayers is a different story, because the current use of the deduction is so limited that it has very little effect on the purchase of private health insurance. There are two very limited ways that the purchase of health insurance can be deducted from gross income. Self-employed individuals can currently (1998 through 1999) deduct as a business expense 45 percent of the cost of health insurance for themselves and their family. To make this more compatible with the full deductibility of the cost of health insurance for working people who are not self-employed, Congress recently passed provisions to increase the self-employed deduction gradually to 100 percent by the year 2007.29 The coverage of dependents is allowed but is not required by the tax law. A positive incentive for


Taxpayer Relief Act of 1997, Public Law 105-34, August 5, 1997, Sec. 934.

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