Important Considerations Before Ending the Health Care Tax Exclusion

With the recent shakeup in House GOP ranks, Representative Steve Scalise of Louisiana–who has headed up the conservative Republican Study Committee–was elected House Majority Whip, the third highest ranking leadership position. Scalise has been a principal proponent of the so-called American Health Care Reform Act which would repeal the Affordable Care Act (ACA). It also would replace the current tax exclusion for employer-paid health care with a standard deduction for Americans to opt either for employer coverage or the purchase of insurance on the individual or small group market. The measure has 130 cosponsors, and Scalise’s elevation into leadership ranks may very well breathe new life into efforts to craft a conservative alternative to the ACA.

Modifying the tax treatment of employment-based health coverage has long been a favored policy goal for a number of prominent Republican and Democratic office holders albeit often for different reasons. Ronald Reagan proposed capping the exclusion, and President Bush’s Advisory Panel on Federal Tax Reform also called for imposing a limit on the premium amount that could be excluded from a worker’s taxable income. In 2008, GOP presidential candidate John McCain called for replacing the tax exclusion with a tax credit, and Senators Burr, Hatch and Coburn’s 2014 health care reform “legislative proposal” would limit the tax exclusion to 65 percent of an average plan’s cost with the remainder presumably being changed to taxable.

On the Democratic side, the reform plan that was championed by Senator Ron Wyden, now chairman of the powerful Senate Finance Committee, when health care reform was being debated in that panel would have jettisoned the tax exclusion altogether. Moreover, there are a number of Democratic lawmakers, particularly in the Senate, who are sympathetic to the idea of capping it. Additionally, Jason Furman, currently Chairman of President Obama’s Council of Economic Advisors, has signaled his openness to shifting to an income-related, refundable tax credit.

The arguments advanced for eliminating or capping the tax exclusion for employment-based health coverage follow these general lines. Conservative economists, like Martin Feldstein, and many liberals as well maintain that the tax exclusion has distorted the market for both health insurance and health care leading to over-insurance and excessive consumer demand for medical services. They argue that there are too many “Cadillac” plans providing overly generous benefits subsidized by the taxpayer. If the subsidy was curbed or eliminated health care consumers would be more discerning, and health care would be reduced without adversely affecting health outcomes.

Some economists also raise various equity issues. Many liberals point out that higher income workers have considerably greater access to employer-provided coverage than their lower income counterparts, and for those who do have such coverage the income tax savings from the exclusion are considerably greater for higher income individuals than for middle or lower income workers. And both sides of the liberal-conservative divide note that the tax exclusion is very expensive and that there may be more efficient and effective ways to provide coverage. According to the Congressional Budget Office, excluding employment-based health insurance from both income and payroll taxes cost the federal government a staggering $248 billion in 2013.

Let me give add my two cents to this debate. Yes, the tax exclusion is very expensive, the largest single federal tax expenditure, and yes, there may be more efficient ways to provide health insurance coverage. But in our current political climate the chances of Democrats and Republicans reaching a consensus on a new system are less likely than a snowstorm in Washington in July.

Today employers are the principal source of health insurance coverage for the overwhelming majority of non-elderly Americans, and the tax exclusion for employer-provided health benefits was a critical factor leading to the creation of the current system of employment-based coverage. The ACA itself is structured on the notion that most workers will continue to receive coverage from their employers.

Limiting the health care tax exclusion inevitably would lead some employers to drop coverage. One analysis of Senator McCain’s 2008 campaign proposal to substitute a tax credit for the tax exclusion offered a mid-range estimate of the number of people who would lose their workplace coverage at 20 million. And reducing or ending the tax exclusion would translate into higher cost sharing by workers through increased deductibles, copays and coinsurance. Health care is not like markets for other types of personal consumption. Health care consumers rely on providers to advise them on what medical services they need. Compelling consumers to absorb more out of pocket costs is not in itself the answer to reining in health care costs. Instead, it is simply shifting costs rather than reducing them. Finally, the tax hit on middle income families would be considerably more than on their higher income counterparts simply because they have less disposable income.

One final point to be made is that the ACA already includes a 40 percent excise tax on higher cost health care plans effective in 2018 which many of us very much opposed and hope to revisit. According to various government projections, employers most likely will respond to this new tax by reducing covered services and increasing cost sharing requirements. At the very least, policy-makers should adopt a wait and see approach to evaluate the tax’s impact before making other major changes affecting employment-based coverage. Let’s not throw the baby out with the bath water.

Morning Consult