Why is company provided health insurance tax free, but individual health insurance is not?

Question

Why is company provided health insurance tax free, but individual health insurance is not?

I do not understand the rationale for making health care contributions by companies non-taxable, but if an individual buys health insurance, they cannot deduct that expense. Obviously this policy enormously rewards anyone who is an employee of a company that offers a health plan and penalizes people who are self-employed or unemployed.

Who is benefiting by this policy? Is there some special interest at work here?

For example, if a company provides HOUSING to an employee (or any other benefit) then it is taxable. It is only HEALTH benefits that are not taxable.

Answer 1

During World War II, the United States (US) instituted wage and price controls. To attract better employees, companies would offer benefits to get around salary limits. Health insurance was one of the more successful benefits.

At that time, income taxes were newer and there were many ways to evade them. Companies could generally deduct expenses. So at that time, health care was deductible because everything was. And at that time, only wages were taxable compensation from employer to employee.

Since that time, many other benefits have become non-deductible for employers, e.g. housing or the reduced deduction for meals and entertainment. But health care is generally regarded as different, as a necessity. While everyone needs to eat, not everyone needs to eat at a $100 a meal restaurant. People who need expensive health care really need it. People who eat expensive food just prefer it.

And of course, health care is more intermittent where food is relatively consistent. You don't need ten thousand calories one day and zero the next. But some families have no health care expenses in a year while another might have cancer or a pregnancy. Note that medical care expenses can be deducted for individuals if they are large enough in aggregate and you itemize.

And of course both businesses and workers have incentives to maintain the current system with deductibility. Health insurance is a common benefit. Housing is not (although it's worth noting that travel housing and meals are deductible). So there have been few people impacted by making housing taxable while many people would be impacted by taxable health insurance.

You can deduct health insurance costs if self-employed. It's also not true that health insurance is the only benefit with preferential tax treatment. Retirement and child care are also deductible. Even meals and housing can be deducted in certain circumstances. The complex rules about what and how much is deductible.

There have been rumbles about normalizing the tax treatment of health insurance and medical care, but there is a lot of opposition. Insurance companies oppose making all healthcare expenses deductible, as that reduces their effective benefit. They would prefer only insurance premiums be deductible. Traditionally employed individuals oppose making health insurance taxable, as that would increase their taxes. So the situation persists. There isn't quite enough support to move in either direction, although the current compromise is economically silly.

Answer 2

All questions regarding why is activity X taxed but activity Y taxed differently boils down to: The legislature wanted to promote or discourage the activity.

By making employer provided healthcare tax free to the employee, the average worker like the plan. Not only is a significant portion not coming out of my paycheck, I also don't have to pay taxes on the benefit. Some organization pushed for this and the legislature agreed.

Answer 3

This probably is a question that belongs on History but here's the basic reason: the or Employee Retirement Income Security Act (ERISA) of 1974 established that health benefits under approved plans were not taxable to the employee. If the employer were to pay for an employees non ERISA approved individual plan, it would be a taxable benefit.

The longer story is that many polticians (esp. President Richard Nixon) were concerned that public pressure was going to lead public sentiment toward nationalized health care. This made health insurance more affordable to employees and effectively made it a cheaper way to compensate employees similar to how 401K contributions are worth more (in nominal terms) to the employee than an equivalent amount of cash. While the law was not signed by Richard Nixon due to some other stuff that was going on, it was something proposed and pushed by his administration.

Answer 4

The idea is that the premiums (or costs) associated with the plan are a business expense, you know that already. The distinction here is that employees don't pay premiums, they elect to contribute. The company sponsors a plan, the employees then choose to accept less salary in order to participate in the employer's plan. The idea is that you're foregoing income.

Why is the employee not taxed on this cost? One major reason is that the employee has no say in, and often no idea, what the gross costs are (some find out if they ever receive COBRA election paperwork).

There are more benefits than strict healthcare that are Section 125 eligible. The government has a vested interest in keeping the population healthy, and when the ERISA laws and Section 125 were written it was (and still is) a pretty low friction way to get health insurance out to more people. At this point, taking away the tax break from the employees would be a huge government take away from most of the population. Try to get a politician to take something away from taxpayers.

Why doesn't the deduction exist in kind to people buying individual coverage? Ask your legislators. There are thousands of preferential tax treatment oddities, where some industry will get some sort of benefit or break. I'm not sure what leads you to think there needs to be some supremely logical reason for this oddity to exit.

Answer 5

Basically a company who provides health insurance for their employees provides it as part of the employee's salary package. This is an expense by the company in its pursuit of making income.

In general, tax deductions are available on any expense incurred in deriving income (the exception is when social policy allows deductions for other types of expenses).

If you pay for your own health insurance individually, then this expense is not an expense for you to derive your income, and as such is not tax deductible.