A little-noticed part of President Bush's new health-insurance proposal could pose a sticky question: Is it worth getting a tax break for health coverage if it means you will end up with smaller Social Security checks when you retire?White House spokesman, Alex Conant, said workers could forgo the deduction if they choose, however, they would face much higher taxes than under current law if they get coverage from employers because they would owe taxes on the value of the coverage.
Bush's proposal to create a tax deduction for health insurance, if enacted into law, could reduce Social Security benefits for many Americans because the deduction would apply not only to income taxes, but also to payroll taxes that go to Social Security. While most workers might welcome a cut in payroll taxes, the flip side is the less they pay into Social Security, the less they can collect when they retire.
UPDATE: In comments, Kvatch asked "wouldn't the increase in taxable income be subject to payroll tax before the deduction is taken?" Good question, and I wondered the same thing. It's complicated, so here's the explanation from the Tax Policy Center [pdf file]:
Taxable payroll, both for the purposes of calculating Social Security and Medicare taxes and for the purpose of calculating Social Security benefits, would be redefined as earnings plus employer contributions to health insurance minus the new standard deduction of $7,500 for individuals or $15,000 for family coverage. Employers would adjust taxation and withholding according. [...]This stuff makes my eyes glaze over, but the Tax Policy Center hopes to release distributional tables to illustrate what they mean soon. As soon as they do, I'll post them online. In the meantime, click over and read their initial assessment of the health plan. They feel it's a good start, but needs some major tweaking.
The 35 percent of households under age 65 who do not owe any income tax would likely get no tax benefit for purchasing health insurance because their current reduction in payroll taxes would be largely offset by reduced Social Security benefits in retirement. For example, if a low-income worker purchased insurance in the individual market, his payroll taxes under the proposal would go down by $1,148 (or the 15.3 percent rate multiplied by the $7,500 exclusion). But, his future Social Security benefits would also go down by nearly as much in present-value terms as the current payroll tax savings. It is important to note that most of the people who save on payroll taxes would receive smaller Social Security benefits in retirement. For low- and middle-income families that gain health insurance (and a $15,000 reduction in Social Security earnings), this could translate into a very substantial drop in retirement living standards.