The Rudd government's bid to boost the income levels at which the Medicare levy kicks in is in tatters after a key independent senator indicated he would not support the new thresholds as they stand.
The government wants to increase the income thresholds - from $50,000 to $100,000 for single income earners and to $150,000 for couples - before the one per cent levy is applied to taxpayers who don't have private health insurance.
Senator Nick Xenophon is one of seven senators the government needs to get the change through the upper house.
After prolonged negotiations with the government, he revealed he would kill the bill if the proposed new thresholds remained unchanged.
He wants the thresholds indexed to inflation.
"If the threshold had been indexed with the inflation rate since its introduction in 1997, it would have risen to around $67,000 for singles and $134,000 for couples," he said.
"I believe that is a more reasonable place to set the threshold."
Senator Xenophon also wants the matter referred to the Productivity Commission.
"I cannot support putting the threshold up double the rate of inflation," he said.
The government expected 600,000 people to drop out of private health insurance if the bill went through, he said.
"What will that do to the cost of health insurance for the people who stay in the funds?" he asked.
Senator Xenophon said he was also concerned the bill would drive more people into the public health system.
Opposition health spokesman Joe Hockey said he was pleased Senator Xenophon supported the coalition's view that the proposed changes could lead to an exodus from private health insurance and an increase in premiums.
A spokesman for Health Minister Nicola Roxon said the government still planned on keeping the bill in its original form but would continue talking with all senators.