Around Christmas a few years ago, Princeton University economist Uwe Reinhardt was looking forward to a holiday dinner when his wife told him he shouldn’t bother setting a place for himself. She had scheduled a colonoscopy for him for the next day.
“I blew up and said, ‘Why do I need to do this now?’” Reinhardt recalled in an interview. His wife explained that any money left in their flexible spending account at the end of the year would be forfeited.
“To this day, I remember lying on the gurney thinking, ‘this has got to be the most insane thing,’” said Reinhardt.
FSAs, which allow consumers to put aside before-tax dollars to pay for medical expenses, are getting close scrutiny as Congress scours the health system for money to finance an ambitious expansion of insurance.
The Joint Committee on Taxation told Senate leaders recently they could collect $68.6 billion over 10 years by abolishing the accounts, along with separate ones in which employers contribute money for workers to use for health care expenses. Eliminating both types of accounts would pay for four percent or more of the estimated $1 trillion to $1.5 trillion cost of expanding coverage to the 46 million uninsured.
The search for revenue is renewing debate over FSAs, long controversial in some health policy circles. Critics say the accounts are a tax shelter for the affluent that encourages spending on unnecessary tests or frivolous items, such as an extra pair of glasses. Proponents say FSAs help people pay for high medical expenses that aren’t covered by insurance.
Complicating the debate: The government doesn’t track even basic details on how the accounts are used, how much money is involved and what happens to the unspent funds. The only data available come from the industry—the companies that administer the programs for employers. Even that information is incomplete. Industry executives visited Capitol Hill this week to argue on behalf of the plans.
“We’re very concerned there are misconceptions out there,” says Jody Dietel, an executive with WageWorks, a San Mateo, Calif., company that administers accounts for more than one million people. “There’s this wild notion that people are using it for really off-the-wall treatments and that’s not what we’re seeing.”
First authorized by Congress in 1978, FSAs allow workers to stow part of their paychecks in a special kitty to be used for health care expenses not covered by insurance. There is no maximum limit, although employers often set one. The money isn’t taxed, but employees can use it only for expenses incurred in a given calendar year or a two-and-a-half-month grace period in the following year. (The grace period was only added a few years ago.) After that, leftover cash is forfeited to the employer.
The Internal Revenue Service doesn’t know how many people have flexible spending accounts, but the industry estimates the number at about 30 million. Karen Frost, an executive with Hewitt Associates, which administers eight million of the accounts, says that, on average, employees using FSAs earn about $60,000 a year and put aside about $1,200.
Some economists and health policy analysts favor abolishing FSAs, which they say are bureaucratic and paperwork headaches that force people to cobble together dozens of small receipts to win reimbursement, and leave them scurrying around to buy extraneous items to use up the money. They also say accounts are of little use for people in lower tax brackets, and can end up costing them as much or more in lost Social Security benefits, which are based on payroll-tax contributions.
“They complicate people’s lives for minimal tax benefit,” says Chuck Marr, director of federal tax policy at the Center on Budget and Policy Priorities, a nonprofit research organization in Washington that has recommended that Congress abolish or scale back the accounts. “FSAs encourage people to buy things they don’t need. The leftover money goes to the employer. It’s just cash for them.”
It’s not clear how much FSA money is left on the table each year. Mercer, a consulting firm, says its survey of employers last year found that the average employee forfeited 4 percent of the money put aside in 2008, while Aetna Inc. says that workers in the plans it administers failed to spend 14 percent of their accounts in 2007.
Also unclear is what happens to the forfeited money. The IRS doesn’t tell employers what to do with it, aside from barring them from returning it to the workers who contributed it. Many companies use the leftover money to pay the fees charged by the corporations that administer the accounts, says John Hickman, who heads the health benefits practice at the law firm Alston & Bird. He says administrative fees usually range from $4 to $10 per month per participating employee.
Companies also are permitted to use the leftover money to cover losses incurred when workers spend all the money designated for their accounts early in a year but quit before they have fully paid into the accounts. (Under IRS rules, employers take the same amount of money out of each paycheck.)
In its lobbying campaign, the industry has been arguing that rather than abolish or limit the use of the accounts, Congress should change some of the rules that make them so complicated for consumers. Under one industry proposal, employers would have to refund to workers unspent money at the end of the year. The money would then be taxable.
To counter the argument that FSAs are a tax shelter for the affluent, the industry has been telling congressional staffers that lower-income people use the accounts, and that most of the money is spent on such things as prescription drugs and dental care. Hickman, who is also on the board of the Employers Council on Flexible Compensation, an industry trade group, says FSAs have helped make medical care more affordable--one of the goals cited by lawmakers seeking to overhaul the country’s health care system.
“It’s interesting to me that they feel they need to fund health care with health-care related priorities,” Hickman says. “If health care is a national priority, then maybe this is something that should be funded with other tax dollars.”
But some of the other changes Congress is considering may make it hard to keep flexible spending accounts as they are, according to the Center on Budget and Policy Priorities. If Congress decides to tax employer-provided health insurance, as the Senate Finance Committee is considering, employers and workers might shift more money into flexible spending accounts—thus depriving the Treasury of some of the money that lawmakers were hoping to raise.
Reinhardt, a health care expert who wrote about FSAs on his Economix blog on nytimes.com, says that curbing the accounts is only fair, considering that lower income people might have new financial responsibilities, such as carrying insurance, under a health care revamping.
“There are an awful lot of higher income people who are getting this higher subsidy when they demonstrably don’t need it,” Reinhardt said in an interview. “If you’re talking about asking people to be more responsible, why don’t you start with the upper income people first, instead of asking the gas station attendant to do all the rationing?”