Research Desk: Do changes to flexible spending accounts hurt middle-class families?
By Dylan Matthews
A discussion broke out at lunch today about flex-spending accounts. In the new healthcare bill is an item reducing FSA limits to $2500. Of course the right-wing side of the table (most of my colleagues) complained at how the government is taxing them even more to help pay for the un-insured. But isn't it true that most "middle-income" (< $250k) families use these and they'd technically be the ones paying more (if even a little) in taxes?
An FSA is a flexible spending account, in this context a medical flexible spending account, which allows employees to set aside a portion of their earnings to pay for medical expenses not covered by an insurer. The funds are exempt from income or payroll tax but must be used by March 15 or the balance of the FSA is forfeited. Currently, there is no maximum contribution to FSAs.
The Affordable Care Act introduces a cap on FSA contributions, allowing only $2,500 a year starting in 2013. It also prohibits FSA holders from using the funds to pay for over-the-counter medication not prescribed by a doctor, and doubles the penalty -- from 10 percent to 20 percent -- for using the funds for non-medical purposes.
An analysis from Hewitt Associates finds these new rules probably won't affect most FSA users. For one thing, the average yearly contribution is $1,441, well under the new limit, with only 18 percent of FSA users currently spending over $2,500. Those who do, Hewitt finds, tend to make over $150,000 a year. The over-the-counter rules will likely have a minimal impact as well. Just 7 percent of FSA claims are for over-the-counter drugs, most of which will still be available under the new rules. And with only 20 percent of employees using a FSA, the percentage of Americans affected by the new rules will be rather small indeed.
It's worth noting that FSAs have a number of downsides even in this revised form. By requiring the funds be spent on health care, and spent within a year, they encourage unnecessary procedures and drive up medical costs. And they tend to help high-income people much more than lower- or middle-class workers. By exempting contributions from payroll taxes, FSAs reduce workers' total contributions to Social Security, and thus their later benefits. Their income tax benefits affect only those paying personal income taxes, which is to say middle- and upper-class earners, with upper-class taxpayers benefiting the most. Some, such as the Center for Budget and Policy Priorities, have taken these as reasons to eliminate FSAs altogether, or limit them much more severely than the Affordable Care Act does.
Dylan Matthews is a student at Harvard and a researcher at The Washington Post.
August 23, 2010; 12:30 PM ET
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