Sen. Rand Paul’s Obamacare Replacement Proposal

This page outlines his proposal. I regard it as a great improvement over Obamacare. I like two significant changes he proposes for Health Savings Accounts – that HSA money can be used to pay health insurance premiums (not allowed now), and removing the current strict rules on having a high deductible health insurance policy. However, there are two things regarding HSAs that I find misguided.

First, he proposes a tax credit for contributions to an HSA rather than a tax deduction. Common usage of the terms in bold are (a) a credit reduces tax owed, and (b) a tax deduction reduces taxable income. Also, a credit would be incoherent with the Equalize the Tax Treatment section of the proposal.

To clarify this, assume the following. John Doe is single and paid wages of $50,000, and contributes $3,000 to his HSA. Assume no other complicating deductions or credits. For 2016 his Form 1040 numbers would be the first column of numbers following. The second column of numbers shows what they would be with a tax credit rather than a tax deduction.

Wages                                         $50,000                          $50,000                        $53,000

HSA deduction                              - 3,000                                    0                                  0

Standard deduction                        - 6,300                           - 6,300                          - 6,300

Personal exemption                       - 4,050                           - 4,050                          - 4,050

Taxable income                          = 36,650                         = 39,650                       = 42,650

Tax                                               $5,038                            $5,690                          $6,440

HSA credit                                            0                            -3,000                          - 3,000

Net tax                                         $5,038                            $2,690                          $3,440

Moreover, if John Doe’s employer provided and paid for insurance coverage for him, his tax would be the $5,690 shown in the second column (with no deduction or credit as is the case now). However, if an HSA contribution became a credit, it would be wise for the employer to stop paying for the coverage, increase John Doe's pay $3,000, and John Doe buy his own insurance. That would reduce his tax to $3,440 (from $5,690) as shown in the third column of numbers. Hordes of other employees would follow suit, and much larger federal deficits would follow. 

The second thing, which makes no sense to me, is to allow individuals to make unlimited contributions to an HSA. That would turn HSAs into a huge tax haven. One could put all of one’s investments into the HSA and shelter interest, dividends, and capital gains from income taxes (until withdrawn?).