Insurance premium taxes: A lump-sum proposal

Abstract

All insurance companies in the United States are assessed state premium taxes based on percentages of written premiums. In this article, the authors argue that the proportional premium tax system is unfair to higher risk insureds because they must pay greater state premium taxes, even though they do not cause the state greater expenses. As an alternative, the authors propose a lump-sum premium tax system in which all insureds pay a fixed dollar tax that may or may not differ by risk classification. Although lump-sum taxes are widely recognized as Pareto dominant with respect to proportional taxes, the potential advantages of lump-sum taxes have not been explored in the premium tax context, in which random outcomes and the heterogeneity of risks play important roles. The authors compare the potential advantages of lump-sum premium taxes with their potential disadvantages in terms of administrative expenses, moral hazard, and adverse selection.