This May Hurt a Bit

By DAN GOODGAME

Back in the early, innocent days of Hillary Rodham Clinton's health-care task force, several members urged that the group look not only at what the Federal Government should do to control costs and extend health coverage to the uninsured but also at what it should stop doing. Their most notable suggestion: Washington might limit the tax exemption for employer-purchased health insurance, which costs the Treasury $74 billion a year and mainly works to subsidize generous health plans for the best-paid Americans. The exemption, they argued, fuels overspending on health care and helps drive the cost of insurance beyond the reach of many low-income workers and small businesses. "Almost everyone agreed," says a senior White House official, "that it would be good policy to reform the tax subsidy."

Good policy, but not good politics -- especially not by the lights of labor- union members, who have used the tax subsidy to negotiate some of the most expensive health benefits in America. When union bosses, led by AFL-CIO president Lane Kirkland, got wind that the White House was even discussing limits on the tax subsidy for health insurance, they met privately with Mrs. Clinton and warned her that labor's support for health reform -- deemed essential by the Democrats -- was at risk. The First Lady then sent word to her erstwhile reformers: There's no sense even talking about the tax subsidy. The issue has thus become known as the "third rail" of health-care politics -- as deadly as a high-voltage train track.

Now, however, as Congress seeks new ways to finance health coverage for the uninsured, the tax subsidy is losing its untouchable status, especially among members of the powerful Senate Finance Committee, who are working to draft a bipartisan alternative to the Clinton health plan. Two key Democrats, David Boren of Oklahoma and Bob Kerrey of Nebraska, last week endorsed a health- reform bill sponsored by Republican Senator John Chafee of Rhode Island that would limit the tax subsidy and use the saving to help the working poor buy health insurance.

Senator Bob Packwood, the Oregon Republican, has long opposed limits on the tax subsidy but now says, "My mind is open." The rising cost of health care, he says, makes him wonder "whether we have encouraged, because of the tax code, too much health coverage . . . Cadillac coverage when we ought to be aiming for Chevrolet coverage." Senator Tom Daschle, the South Dakota Democrat, acknowledged that "it's safe to say that we won't allow a sky's-the-limit tax exclusion." And a top adviser to President Clinton predicted "a cap on the tax subsidy for upper-income people." Union leaders are on the alert. "We thought we had beaten this idea of taxing benefits, but now it's back again," said Gerald McEntee, president of the American Federation of State, County and Municipal Employees.

Union members defend the tax subsidy on the ground that in many cases they made wage concessions in return for better health benefits. However, their coverage often allows them to pay little toward their health-care bills and insulates them from the cost of their treatment choices. The Clinton plan provides incentives to most Americans to reduce health spending but not to those covered under union contracts, who are exempted for 10 years.

The tax subsidy is a product of a different era. America's health-care system, in which workers get health insurance mainly through employers, began to evolve during World War II, when labor was scarce and wages were controlled. Employers started to compete for workers by offering health insurance, which Washington deemed exempt from taxes. That didn't matter much when the average family paid about $60 a year in federal taxes, but as taxes rose during the 1970s and '80s, workers and employers faced a strong incentive to substitute tax-free health benefits for taxable wages. This pushed up the price of health care and of the tax subsidy.

Like most tax breaks, the one for health insurance is highly regressive: 60% of the $74 billion subsidy flows to the highest-paid 20% of Americans. Whereas the average family saves about $800 a year in taxes, those earning between $100,000 and $200,000 save $1,710 -- and the 35 million Americans with no insurance get no subsidy at all.

To address this inequity, the Chafee plan would limit the tax subsidy to the value of the "average" health policy in a region and would use the saving to subsidize insurance for those who now can't afford it. Clinton adviser George Stephanopoulos warns, however, that "taxing health benefits goes to the heart of people's fears that health-care reform might take away what they already have." Many lawmakers therefore favor a tax subsidy whose impact is limited to those at the highest incomes: say, $80,000 and above.

Even at that level, however, some high-paid union members with working spouses would be hit. It is perhaps a measure of organized labor's success -- at least for the shrunken ranks of its members -- that David Saltz, an AFL- CIO spokesman, protests that "just because something hurts upper-income people, that doesn't make it progressive."

With reporting by Laurence I. Barrett and Dick Thompson/Washington