A little-known way the tax code subsidizes spending on health care

https://www.brookings.edu/articles/a-little-known-way-the-tax-code-subsid
izes-spending-on-health-care/ 

Well before the first Medicare cards were printed, the government began
subsidizing health care spending through a provision that continues to
this day: the itemized medical deduction (IMD), which allows taxpayers
to deduct certain out-of-pocket medical spending from their income in
the calculation of their taxes. While the IMD was originally intended to
provide tax relief to those incurring high medical costs, it currently
serves only a small fraction of that population due to the way its
design interacts with other features of the tax code and large barriers
to claiming the IMD that result in unclaimed tax savings. The
combination of these attributes means that those most in need of relief
from high medical spending tend to not benefit from the IMD. 

Reforming the structure of the IMD could expand its reach to more people
with a high medical cost burden, and streamlining and simplifying the
claiming process could increase the share of tax savings that are
claimed. However, policymakers should revisit the IMD as a way to
address the financial risks of deterioration in health relative to
alternatives, such as expanding public health insurance programs or
subsidizing private health insurance coverage. 

Background and significance  
The IMD was created by the Revenue Act of 1942. This landmark
legislation expanded the federal income tax from a system that applied
only to a thin slice of high-income households to a large-scale levy to
finance the ongoing war effort. The rationale behind the IMD was to
cushion lower-income families from “undue hardship” created by the tax
system on taxpayers with “extraordinary” medical expenses (Sierk 1966).
Since only 14% of the U.S. population had health insurance coverage at
the time the act was passed, it is likely that many taxpayers qualified
for relief from this provision.1 

Some policy changes since the Revenue Act of 1942 have led to
modifications of the income threshold and changes in the items that can
be included as qualifying medical expenses. However, the IMD has largely
remained intact through eight decades of significant changes in the role
the government plays in subsidizing health care, including IRS rulings
that allowed for the tax-exempt status of employer-sponsored health
insurance, the introduction of Medicare and Medicaid in 1965, and the
implementation of the Affordable Care Act (ACA) in 2014.  

Today, the IMD represents a notable share of out-of-pocket medical
spending and forgone tax revenue. In 2022, taxpayers deducted $92.9
billion in IMDs, almost one fifth of total out-of-pocket medical
spending that year.2 These deductions equated to an estimated $9.5-12.3
billion in forgone federal tax revenue.3 Measured against other ways the
tax code subsidizes health care spending—such as premium tax credits to
purchase health insurance through exchanges or the exclusion of
employer-sponsored health insurance from income taxes—the forgone
revenue from the IMD is more modest. However, the IMD is still
consequential, especially for those 65 and older: In 2022, approximately
$62 billion—or 2/3 of total IMDs—were claimed by taxpayers over 65 (see
Figure 1).  

Figure 1
Share of itemized medical deductions claimed by age
Under 26 (1.1%)
26–35 (4.6%)
35–45 (7.1%)
45–55 (9.1%)
55–65 (11.4%)
65+ (66.7%)
Source: 2022 SOI Tax Stats – Publication 1304, Table 2.6.
The Brookings Institution

How does the IMD work, and who receives the tax savings?
The itemized medical deduction allows taxpayers to deduct certain
out-of-pocket health care costs from their taxable income. Deductible
medical expenses include amounts spent out-of-pocket for the diagnosis,
treatment, or prevention of disease, including payments to doctors,
dentists, and other licensed practitioners; hospital and nursing home
care; prescription drugs; and medical equipment like wheelchairs and
hearing aids.4 Deductible expenses also include insurance premiums for
medical care that are not paid by an employer, transportation costs to
receive medical care, improvements made to a home to accommodate a
disabling condition like ramps or bathroom modifications, or long-term
care services for a chronically ill individual.5 It is worth noting that
some of the allowable expenses—for instance, capital-intensive expenses
to modify a home—can only be claimed as deductions by those who have the
resources to pay for these expenses in the first place. Only medical
expenses paid out-of-pocket that exceed a particular threshold—7.5% of
the taxpayer’s Adjusted Gross Income (AGI) in 2025—can be included on
one’s tax return. 

To benefit from the itemized medical deduction, a taxpayer must first
choose to itemize his or her deductions. Taxpayers have the choice of
claiming the standard deduction or itemizing their deductions and
generally choose the option that minimizes their tax liability. In
addition to medical expenses above 7.5% of AGI, itemized deductions
include other provisions, such as interest paid on a home mortgage,
state and local taxes, and charitable donations; thus, the decision to
itemize depends on how the total of these items compares to the standard
deduction. In 2024, the standard deduction was $14,600 for a single
taxpayer and $29,200 for taxpayers married filing jointly. 

Table 1 shows how the IMD affects the taxable income of a household with
$40,000 in medical spending for different values of adjusted gross
income (AGI) and other itemized deductions. All else equal, someone with
the same medical spending but higher AGI can include less of their
medical spending on their tax return than someone with lower AGI because
only the amount that exceeds 7.5% of AGI is deductible. This can be seen
by moving across columns to the right: Holding their other itemized
deductions fixed, households with higher incomes see a smaller reduction
in their taxable income. 

However, the deduction becomes more valuable for taxpayers with more
itemized deductions aside from medical spending, such as mortgage
interest or property taxes. This can be seen by moving down each row: As
other itemized deductions increase, the reduction in taxable income from
the IMD is larger. Since households with more resources tend to have
both higher incomes and higher itemized deductions besides medical
spending, the IMD tends to result in greater reductions in taxable
income among these higher-resourced taxpayers. 

Table 1
Change in taxable income due to IMD for household with $40,000 in
medical spending By AGI and other itemized deductions

Table with 4 columns and 4 rows. (column headers with buttons are
sortable) Adjusted Gross Income (AGI)
Other Itemized Deductions	$50,000	$100,000	$250,000
$0	-$4,750	-$1,000	$0
$15,000	-$18,500	-$16,000	-$4,750
$30,000	-$18,500	-$31,000	-$19,750
Note: For each scenario, we assume a filing status of married filing
jointly (with a standard deduction of $31,500) and that medical expenses
exceeding 7.5% of adjusted gross income (AGI) are deductible. Taxable
income equals AGI less the higher of the standard deduction or total
itemized deductions. The change in taxable income due to the IMD
represents the taxable income when itemized deductions include eligible
medical spending less taxable income when itemized deductions do not
include eligible medical spending. The Brookings Institution
Get the data

The tax savings from the IMD can be determined by calculating the tax
liability with and without deductible medical expenses included and
finding the difference. For a given reduction in taxable income, the tax
savings is typically larger for higher-income taxpayers who are in
higher tax brackets, reinforcing the relationship described above.6  

How the tax savings are distributed across the population depends on the
relationship between income, out-of-pocket medical spending, and the
value of other itemized deductions. Prior work examined the distribution
of IMD tax savings and found that they are heavily skewed towards
higher-income and older taxpayers (Goda et al. 2025). Approximately 94%
of the tax savings accrue to the top half of the income distribution and
41% accrue to the top 10%. This is because both itemization rates and
marginal tax rates increase with income, and these factors are stronger
than the effect of the lower threshold. Figure 2 shows the share
claiming IMDs generally increases by income and by age. Despite the fact
that higher income taxpayers face a higher income threshold, claiming
rates go up with income for all but the highest decile of the income
distributions. Claiming rates increase from only 1% of taxpayers under
age 50 to more than one in six taxpayers – 17.5% – age 85 and over.
These data underscore the IMD’s importance as a mechanism for financing
health care costs at older ages. 

Figure 2: Share claiming Itemized Medical Deduction, 2018-2019

Figure 2, Panel A
By income decile
1
2
3
4
5%
0.8%
1.1%
1.5%
1.8%
2.5%
3.5%
4.4%
4.8%
5.1%
3.7%
1
2
3
4
5
6
7
8
9
10
Source: Goda et al. 2025, Table 1 (Panel B) and Table 2 (Panel B).
The Brookings Institution
Get the data

Figure 2, Panel B
By age
5
10
15%
1.0%
2.4%
3.0%
4.3%
5.0%
6.7%
8.6%
10.6%
17.5%
0–49
50–54
55–59
60–64
65–69
70–74
75–79
80–84
85+
Source: Goda et al. 2025, Table 1 (Panel B) and Table 2 (Panel B).
The Brookings Institution
Get the data

How well does the IMD deliver benefits to those with high medical costs?
The notional goal of the IMD is to provide relief to people with high
out-of-pocket medical spending. However, the IMD falls short of this
objective in three key ways. 

Most people with high medical costs are not eligible for tax relief from
the IMD. The first way the IMD deviates from the broader objective is
that not everyone with medical costs above 7.5% of their AGI is even
eligible for tax relief from the IMD. This results from the requirement
that taxpayers itemize their deductions and have positive taxable income
to deduct. According to data from the nationally representative Health
and Retirement Study (HRS) in 2018, while approximately 47.1% of
households age 50 and over have medical spending above 7.5% of their
AGI, only 6.0% are eligible to receive additional federal tax savings
due to their high medical spending. In combination with the fact that
marginal tax rates rise with income, the requirements above result in
tax savings that are concentrated among high-income households—who are
also likely to have other means to cushion losses from high medical
expenses. 

A substantial share of tax savings from the IMD are left unclaimed.
Taking advantage of the IMD requires knowing that it exists, keeping
records of out-of-pocket expenses, determining eligibility, and filing
the appropriate tax forms. In previous work analyzing the HRS, I found
that among older households, approximately 62% of potential tax savings
were claimed over the 1996-2012 period (Goda 2025). The ratio of
claimed-to-potential tax savings was even lower among those with lower
levels of income and wealth and those in poorer health (see Figure 3).
Thus, the fact that not all available benefits are claimed counteracts
some of the IMD’s effectiveness in redistributing to those who incur
high health care costs. 

Figure 3: Share of potential tax savings from Itemized Medical Deduction
that are claimed 

Figure 3, Panel A
By AGI quintile
Bottom
Second
Middle
Fourth
Top
10
20
30
40
50
60
70
80%
Source: Goda 2025, Figure A.8 (Panel B), Figure A.9 (Panel B), and
Figure A.11 (Panel B). Note: Shaded area shows the 95% confidence
interval. The Brookings Institution
Get the data

Figure 3, Panel B
By wealth quintile
Bottom
Second
Middle
Fourth
Top
45
50
55
60
65
70%
Second53.0%
Second53.0%
Source: Goda 2025, Figure A.8 (Panel B), Figure A.9 (Panel B), and
Figure A.11 (Panel B). Note: Shaded area shows the 95% confidence
interval. The Brookings Institution
Get the data
Figure 3, Panel C
By health status
Excellent
Very Good
Good
Fair / Poor
55
60
65
70
75%
Very Good64.8%
Very Good64.8%
Source: Goda 2025, Figure A.8 (Panel B), Figure A.9 (Panel B), and
Figure A.11 (Panel B). Note: Shaded area shows the 95% confidence
interval. The Brookings Institution
Get the data
Compliance costs eliminate most of the benefits that claimants receive.
The fact that many of those eligible for the IMD fail to claim it
reveals that there are meaningful barriers to claiming. One can quantify
the economic burden of a tax deduction by assuming that those who are
not claiming are rationally weighing the costs of claiming—in terms of
time and hassle—against the benefits—in terms of tax savings—and taking
the action associated with greater economic benefits.7 Data from the HRS
suggest that the implied time and hassle costs of claiming the IMD are
large relative to the expected tax savings: On average, the implied
costs are around $1,000, while the tax savings are approximately $1,300.
In other words, the hassle and complexity of claiming the IMD is both
keeping people from utilizing it and reducing the net economic benefit
to those who do claim it. 

How have recent policy changes affected the IMD?
The Affordable Care Act (ACA) raised the AGI threshold for claiming the
itemized medical expense deduction from 7.5% to 10% for most taxpayers
beginning in 2013, though taxpayers aged 65 and older were temporarily
exempted from the increase until 2017. The Tax Cuts and Jobs Act (TCJA),
signed into law in December 2017, temporarily reversed this change,
restoring the 7.5% threshold for all taxpayers for tax years 2017 and
2018. Subsequent legislation extended the lower threshold and made it
permanent in 2020. 

The TCJA also included a large increase in the standard deduction. A
higher standard deduction results in fewer taxpayers benefitting from
itemizing their deductions and thus fewer tax returns itemizing.
However, the taxpayers who still choose to itemize when the standard
deduction is higher have higher average deductions. In 2017, when the
standard deduction was much lower, 30.6% of tax returns claimed the
itemized deduction and 6.7% claimed the IMD, while in 2018, 11.4% of tax
returns itemized and 3.0% claimed the IMD. However, among those who
claimed the itemized medical deduction, the average amount claimed
increased from $10,081 to $17,069. On net, the changes in the TCJA
reduced the forgone tax revenues from the IMD and also concentrated the
tax savings among an even smaller subset of the population who tended to
be older and have higher income (Goda et al. 2025).8 

In July 2025, the One Big Beautiful Bill Act (OBBBA) was passed by
Congress and signed into law by President Donald Trump. Among the
hundreds of provisions in its approximately 1,000 pages, OBBBA contains
several changes to federal health care programs, such as imposing work
requirements on Medicaid enrollees starting in 2027. In addition, the
enhanced Premium Tax Credits in the American Rescue Plan are scheduled
to expire at the end of 2025. Combined, the Congressional Budget Office
predicts that these changes will reduce health insurance coverage for an
estimated 16 million people by 2034, which could impact the amount of
unreimbursed medical spending subject to the IMD. 

The bill made also several changes to itemized deductions that more
directly impact the IMD. These changes include: 

Higher standard deduction. The TCJA nearly doubled the standard
deduction starting in 2018, increasing it from $6,500 to $12,000 for
single filers and $13,000 to $24,000 for married couples filing jointly.
This increase was set to expire at the end of 2025, but the OBBBA made
higher levels permanent and set them to $15,750 for single filers and
$31,500 for married couples filing jointly. Increase in State and Local
Tax (SALT) deduction. The OBBBA temporarily increased the cap on the
itemized deduction for state and local taxes from $10,000 to $40,000 for
2025, increasing by 1% each year until 2029. This cap phases out for
high earners and is scheduled to revert back to $10,000 after 2029. Tax
treatment of charitable contributions. A tax deduction for charitable
contributions made by an individual taking the standard deduction is now
allowed for cash donations up to $1,000 (or $2,000 for married couples
filing jointly). Those who itemize their deductions are now subject to
an income floor, where contributions that exceed 0.5% of AGI are
allowed. The higher standard deduction was carried forward from the 2017
TCJA, but the others are new to the 2025 bill. A higher cap on the SALT
deduction increases the likelihood that someone will benefit from
itemizing their deductions, so all else equal, this change will result
in more tax returns claiming the IMD. Conversely, allowing some
charitable donations to be deducted without itemizing and reducing the
amount that can be included in itemized deductions might push slightly
in the other direction. 

On net, it is likely that these changes will result in some increases in
the share of taxpayers claiming the IMD and a slightly lower average
amount claimed over the next few years relative to recent history.
However, these changes will likely be small relative to the changes from
2017 to 2018 stemming from the TCJA. 

How should policymakers think about the IMD going forward?
The IMD operates as a form of insurance: If someone experiences a health
shock that results in higher medical spending, lower income, or both,
the IMD may reduce the tax liability they owe with a subsidy rate
related to one’s marginal tax rate. However, unlike health insurance
payments that are often made directly from insurers to providers at or
around the time of service, the tax relief from the IMD is generally
delivered many months later. Moreover, taking advantage of it requires
knowing that it exists, keeping records of out-of-pocket expenses,
determining eligibility, and filing the appropriate tax forms. 

Taking a step back, it is important to evaluate the IMD as a policy
lever relative to other potential policies, such as expanding public
insurance programs like Medicaid or Medicare or encouraging private
insurance coverage through subsidies, tax exclusions, or more generous
government payments to providers. A complete comparison requires not
only understanding the degree to which benefits are targeted to high
medical spenders but also incorporating potential positive impacts on
risk protection and/or health and any distortionary impacts on other
economic decisions. However, the high implied economic burden of
claiming a medical subsidy through the tax code combined with its
redistributive features suggests that replacing the IMD with, for
example, more generous coverage for long-term services and supports
would likely improve risk protection more efficiently. 

Within the existing framework, the IMD would be more likely to insure
health risks by increasing claiming among those eligible and/or
expanding eligibility among those with high medical spending. 

What interventions could increase IMD claiming among those eligible?
Many forms of government benefits are not fully claimed by those who are
eligible, and understanding why can help inform appropriate policy
actions. In the case of the IMD, the data show that households in the
Health and Retirement Study are more likely to claim the IMD when they
have been eligible for the IMD multiple times, suggesting that
households might learn about the IMD over time or are able to streamline
the tracking of their medical spending. It is worth noting that
interventions that increase claiming among those eligible are likely to
make the IMD more progressive, since a smaller share of eligible
low-income households claim the IMD. 

Reduce the administrative burdens associated with claiming the IMD. The
most ambitious intervention would be to require health care providers
and insurers to track and report eligible amounts that an individual
paid in a new Form 1098-M, similar to Form 1098 that requires financial
institutions to report mortgage interest paid or Form 1098-E that does
the same for student loan interest. The requirements would apply to
amounts above a dollar threshold.9 These amounts would have to be
adjusted by the taxpayer up or down depending on whether they were paid
through a tax-favored health savings account or the individual paid for
other expenses eligible for deduction that are not within scope of Form
1098-M. While likely to reduce the frictions in claiming the IMD, this
reform would likely be costly for providers to comply with. Increase
awareness of the IMD through educational campaigns. While unlikely to
have the same impact as third-party reporting, efforts by tax preparers,
health care providers, and the IRS to increase awareness of the IMD
could be meaningful given the complexity involved in understanding what
expenses are deductible and how the IMD works.10 What policy changes
would expand eligibility among high medical spenders without
dramatically increasing the cost to the government? The changes
described below modify the structure of the IMD and serve to either
increase the tax savings available to lower-income households or enhance
the progressivity of the IMD by reducing the tax savings available to
higher-income households. Each can be calibrated to “right-size” the
subsidy as the structure of the tax subsidy is largely independent of
the optimal level of the subsidy. 

Increase the IMD income floor. The most straightforward way to reduce
the concentration of tax savings among higher-income households is to
increase the AGI threshold that medical spending must exceed in order to
be eligible. Increasing the income floor from 7.5% of AGI to 30% of AGI
results in the bottom half of the income distribution incurring 76.5% of
eligible medical spending. Prior work suggests that this change in
isolation would reduce forgone tax revenues to approximately 26% of its
current level. Remove the requirement to itemize. Higher-income
households are more likely to itemize their deductions due to factors
like higher homeownership rates that result in itemized deductions
larger than the standard deduction. Thus, removing the requirement to
itemize would increase the share of eligible households at lower points
of the income distribution. While lifting this requirement alone would
be costly—resulting in approximately 382% higher forgone revenues—prior
research suggests that combining it with an income floor of 30% of AGI
could change the distribution of tax savings across income in a roughly
budget-neutral way (Goda et al. 2025). Convert the subsidy from a
deduction to a refundable credit. As in many areas of tax policy,
deductions are more valuable to high-income taxpayers due to the
progressive income tax schedule. In contrast, the value of a refundable
tax credit is independent of income and reduces someone’s taxes
dollar-for-dollar. Expanding access by converting the IMD to a
refundable credit worth 2% of out-of-pocket spending that exceeds 7.5%
of AGI would be approximately budget-neutral and would lead to tax
savings that are progressive, on net (Goda et al. 2025). Reduce the
scope of allowable medical spending. The types of services that can be
included as an itemized medical deduction have expanded over time
through court rulings and evolving medical standards. Some of the
allowable expenses—for instance, capital expenses to accommodate a
disability—are likely to accrue to taxpayers with more resources.
Refocusing the list of allowable expenses would reduce costs and could
make the subsidy more equitable. The IMD was originated in 1942 with a
worthy goal—to mitigate the tax burden on those facing hardship from
high health care costs at a time when the tax code was expanding
significantly and there was little formal protection against those
risks. However, today the IMD is costly to claim, and its benefits are
concentrated among a small share of the households with high medical
costs—disproportionately those who tend to have more resources. Given
the dramatic changes in both the health insurance landscape and the
government’s role in the provision of health care services over the
ensuing 80 years, this policy should be revisited by policymakers. 


-- 
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