Will tax incentives work for LTC insurance?

In 1999, President Clinton proposed a tax credit for families who had a relative receiving long-term care. Under the proposal, families would not have to document how they spent the money. Virtually any costs--equipment, medical services, transportation, legal fees, and even respite care--could be paid for by the credit. The policy's purpose was to reduce the financial burden of long-term care on low-income households, just as the child-care tax credit is designed to reduce the burden of child care for families who need it. The Clinton administration hoped that the tax credit might at best produce a slight drop in Medicaid-financed nursing home care because it would make home care for the elderly slightly more affordable. The proposal was blocked by the Republican majority in Congress.

**********

Four years later, the Bush administration has offered a more targeted policy in which taxpayers would receive a tax deduction for their long term care insurance premiums. In contrast to the Clinton proposal, the Bush long-term care tax deduction is designed to affect behavior: specifically, to encourage families to purchase long-term care insurance.

In June, Senators Charles Grassley (R-Iowa), Bob Graham (D-Fla.), Barbara Mikulski (D-Md.), and John Breaux (D-La.) offered a third proposal for using tax laws to influence long-term care: S 1335, the Long-Term Care and Retirement Security Act of 2003. Their legislation includes both a tax deduction for long-term care insurance premiums and a tax credit of $1,000 in 2004 for people who require at least six months of long-term care during the year. The American Health Care Association endorsed S 1335 in July.

Nursing Homes/Long Term Care Management asked several nationally recognized experts on healthcare financing to comment on the differences between a long-term care policy based on tax deductions, such as the Bush administration proposal, and one based on tax credits. Despite differing perspectives, they were all skeptical about the usefulness of the current legislative proposals for encouraging enrollment in long-term care insurance.

Edward Neuschler, a senior analyst at the Institute for Health Policy Solutions, notes that tax deductions are intended to reduce a household's taxable income. This means that the value of the deduction depends on the taxpayer's income. The deduction has the greatest value when it reduces taxable income to a lower tax bracket. The deduction would therefore have relatively little value to a low-income taxpayer.

Neuschler notes that most home owners paying for a mortgage already itemize their deductions, but rarely find it worthwhile to take advantage of deductions for medical expenses. Neuschler points out, though, that even for the wealthy, "the value of deductions is declining" because recent tax cuts "flattened" tax rates. Put another way, tax cuts reduce the incentive for wealthier taxpayers to pursue deductions that lower their taxable in comes.

Professor Mark Pauly, PhD, chairman of the Department of Health Care Systems of the Wharton School of Business, suggests that use of a tax deduction to encourage people to buy long-term care insurance is illogical. "If your income after you retire is more than $50,000, there is less reason for having long-term care insurance," he explains, because assets will usually be sufficient to pay for a nursing home stay: "High-income people who get the biggest break out of a deduction have the least need for the insurance." In Dr. Pauly's view, the tax deduction will not provide a financial incentive for middle-income families who have the most practical need for long-term care insurance.

Tax credits, in contrast, act more as a direct incentive, especially to lower-income people. According to Neuschler, tax credits are worth more to lower income families than to wealthier families because they take the same amount of money out of every household's tax bill. A $100 savings is more important to a household with a tax bill of $1,000 than to a household with a tax bill of $50,000.

"Credits can be designed to benefit a large percentage of the taxpaying public," Neuschler explains. "You could make it worth 100% of the cost of the insurance premiums, up to maximum allowance, and you can even make it refundable"--i.e., the benefit can be structured so that a family claiming the credit could even receive a refund on the taxes that they've already paid through withholding.

Despite this advantage, Neuschler is not certain that tax credits would lead to increased purchases of long-term care insurance: "My sense is that we really haven't used tax credits to seriously encourage specific consumer behavior in any direction." Recent attempts by states like Minnesota to use tax credits for long-term care insurance and by the federal government to provide employer tax credits for a long-term care benefit have not been large enough to get much of a response as yet.

Dr. Pauly agrees that the size of a tax credit is an important factor. "Give me a large enough credit," he quips, "and I can rule the world!" Consumer perception of the level of risk is also important. Tax credits did not work effectively to encourage purchasing earthquake insurance, for example, because most consumers do not view earthquakes as a likely event. Although the need for nursing home care, in contrast, is a relatively high-probability event, it may not be perceived that way. Dr. Pauly suggests that a massive government campaign to inform consumers of the real likelihood of long-term care needs would be an important contribution to increasing enrollment in long-term care insurance plans. Such an information campaign also would cost the Treasury less than the proposed tax deduction.

Edwin Park, senior health analyst of the unashamedly liberal Center on Budget and Policy Priorities (www.cbpp.org), also favors tax credits as the method of choice for encouraging the purchase of long-term care insurance. A member of the policy staff of the late Sen. Daniel Patrick Moynihan (D-N.Y.), Park recently posted on the Web a critique of the administration's tax deduction proposal. From his perspective, however, a quid pro quo for any tax benefits for purchasing long term care insurance should include mandated changes in the behavior of the insurance industry.

Park believes that ineffective regulation of private long-term care coverage is a core problem--he says it affects access, affordability, and the type of benefits that enrollees receive. "Often the people who need it most--older workers and the disabled--can't get a policy," he contends. While a tax credit can make insurance policies more affordable, the real benefit, says Park, would lie in market reforms associated with the credit. These could include requiring policies to provide inflation protection--a somewhat costly option now--and other provisions to ensure value and access for policyholders.

The looming presence in all this, of course, is Medicaid. Dr. Pauly, like many long-term care leaders, believes that the role of Medicaid in paying for nursing home expenses distorts consumer decisions on long-term care insurance. "If you're rich, you don't need it," he says, "and if you're not, you know that Medicaid will be there for you."

Proponents of estate planning, using Medicaid to shield assets from long-term care expenses, may not agree with Dr. Pauly that the "real problem is Medicaid" which, in this context, is seen as a solution. Our interviews disclosed virtual unanimity, though, that tax deductions are not the way to go in incentivizing Americans to forego Medicaid assistance and purchase long-term care insurance.

To comment on this article, please send e-mail to [e-mail].