If you want to understand why the Bush administration is pondering eliminating the tax deduction for employer-provided health insurance, consider this year's Economic Report of the President. There, White House economists assert that the deduction unfairly subsidizes employees of some companies while encouraging overly generous health policies that focus on routine medical care.
"If automobile insurance were structured like the typical health policy, it would cover annual maintenance, tire replacement, and possibly even car washes," said the report, concluding that "health insurance markets can be improved . . . [to] focus on large expenditures that are truly the result of unforeseen circumstance" and "to provide a more standardized tax treatment of all health care markets."
 
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The argument points to a certain truth about President Bush's free-market economic policies that Bush supporters say is unappreciated: In crafting a broad agenda for his second term, Bush is trying to adhere strictly to economic theory, perhaps even more so than during the Reagan administration's early battles over deregulation and taxes.
In a speech yesterday at the American Enterprise Institute, N. Gregory Mankiw, chairman of the White House Council of Economic Advisers, spoke repeatedly of "standard economic theory," "textbook economic theory" and "scholarly literature in economics" to bolster his arguments.
Indeed, theories on economic efficiency, savings incentives and government debt finance -- arcane in the nation's capital if not in the academy -- will likely dominate debate over the president's push to revamp Social Security and the tax code in the coming years. It will pit Bush's philosophy that taxation and government spending distort economic decision-making and impede growth against arguments that government should steer some decisions for the broader good.
"I can say without equivocation: This president has been pretty heavily influenced by economic theory," said R. Glenn Hubbard, who was Bush's first Council of Economic Advisers chairman.
Critics say the White House's theoretical arguments may fly in the face of empirical evidence. They argue that health care, for instance, is fundamentally different from auto care: If insurance does not motivate to get routine checkups, the ultimate cost to the health care system of treating late-stage cancer is far higher then replacing a transmission. And while the business deduction for health insurance costs may violate some standard textbook tenets, said Austan Goolsbee, an economist at the University of Chicago, consider the alternatives.
"In terms of economic reasoning, there is not a flaw in the argument," he said of the White House's position. "The flaws are about the politics. . . . Do they have some plan to cover the people who would lose their health insurance [if the deduction is repealed]? Probably not."
Martin Baily, a Council of Economic Advisers chairman in the Clinton White House, recalled a contentious debate over tax incentives to promote savings. Theoretically, offering to shelter savings from taxation should induce people to save more, but years of Individual Retirement Account and 401(k) plan studies did not support the theory, Baily said.
"Theory is ambiguous," he said. "That's why we tended to focus on empirical evidence."
Before the president's second term has even begun, controversial economic proposals have already surfaced, each with a strongly worded theoretical argument in its favor.
In its fledgling tax reform thinking, the administration would like to dramatically cut, if not eliminate, taxation on interest, dividends and capital gains, shifting taxation from savings and investment to income used to buy and consume.
Mankiw cited "a large scholarly literature" in arguing that a "way to strengthen the economy would be to reduce the tax bias against saving and investment inherent in the current system. The literature suggests that the optimal tax system would use consumption, rather than income, as the tax base."
But things may not be that simple, said Peter Diamond, an economist at the Massachusetts Institute of Technology. True, 30 years ago, prominent economists Joseph Stiglitz and Tony Atkinson postulated that the optimal tax rate on income from savings is zero. But three years ago, University of California at Berkeley economist Emmanuel Saez knocked the Stiglitz-Atkinson theory down a notch with research arguing that if savings aren't taxed, affluent savers and investors will end up paying proportionately less taxes than wage earners who might be struggling to make ends meet. On grounds of fairness alone, Saez concluded, wealth should be taxed to some degree.
