President Obama is under attack for breaking his campaign promise to leave the middle class unscathed by future tax increases. The complaint: The requirement to purchase insurance is tantamount to a tax, because failure to buy incurs a fine. Since many families with incomes below $250,000 would be affected by the penalty, this appears to violate his campaign promise.

Given our financial problems, his campaign promise to exempt 95 percent of Americans from responsibility for deficit reduction was reckless and ill-advised. But the pay-or-play penalty is really a user charge, not a tax.

Here’s why.  Under the proposals being considered by Congress, individuals will, for the first time, be guaranteed access to insurance. Everyone in a given age class will be able to buy insurance for the same price in their market, regardless of pre-existing conditions. This corrects a major flaw in the current market. But, for it to work, almost everyone needs to participate. And that is why a penalty is necessary.

But pay-or-play is more than a penalty for "free riders."  In the new market, individuals who opt to be uninsured will be getting something very valuable: access to insurance when they become ill. What is that worth? In 2004, the average healthy 35-44 year old spent about $2,300 on health care (including the part paid by insurance), based on data from Medical Expenditure Panel Survey (MEPS). An unhealthy person of the same age spent 6 times as much ($13,800) on average, and is often denied coverage entirely.
 
We don’t know what premiums would be in the new reformed health insurance marketplace, but the MEPS data allows for ballpark estimates (ignoring the overhead and marketing costs of insurance).  Suppose everyone in a given age class pays the same premium regardless of their health status—as would be true under all the major congressional reform proposals.  The average 35-44 year old spent about $2,800 (because most are very healthy) in 2004.  So, the difference between the community-rated premium and the risk-adjusted premium for comprehensive insurance would have been something like $500. .  The extra $500 is basically the cost of access to insurance when you get sick

Because health expenditures increase with age, older workers would see even bigger differences.  A healthy 55-64 year old spent about $4,500 on health care in 2004, compared with an average of $6,500.  Thus, her cost of access to insurance would be about $2,000.  In fact, since people can’t predict their future health status, the value of guaranteed insurability is even greater because having insurance eliminates a major source of risk. 

In that context, the $750 penalty on individuals who fail to buy insurance in the Senate Finance Committee bill looks like a reasonable premium to pay for guaranteed access to coverage.

Of course, pay-or-play is a little different from user fees for national parks because you can choose to skip the trip if you think the fee is too high, whereas the insurance penalty would be mandatory (except for those covered by a hardship exemption).  However, if you don’t go into Yellowstone, you miss Old Faithful, whereas everyone benefits from guaranteed insurability whether they pay for the option or not.  In that context, it seems reasonable to charge everyone for the benefit. 

There are some problems with the proposal. Penalties should compensate insurers for covering previously uninsured people with health problems. The insurance industry is correct when it says too many people are exempt from the Finance panel’s penalty. And the subsidies are too small to allow many middle-income people to be able to afford insurance.

But pay or play is not a violation of the campaign promise.

For more on the distinction between user fees and taxes, see Eric Toder’s excellent Talmudic discourses on TaxVox a few weeks ago, here and here.  Also, see the Urban Institute Health Policy Center's careful analysis of how premiums might vary by age in the reformed marketplace under different assumptions.