Strengthen Employer Coverage to Tackle Major ACA Challenges
More than 177 million Americans receive health care benefits through employers and the favorable tax treatment of these benefits in the U.S. tax code helps protect employees and their dependents from the current uncertainties of the Affordable Care Act exchanges. Despite employer-sponsored care’s important role, modifying the tax treatment of employer-provided health benefits has long been a goal of some policymakers and health economists on both sides of the political aisle.
For more than 60 years, employer-provided health benefits have been excluded, without limit, from income and payroll taxes. And over time, this benefit has emerged as a basic building block of our health care system. Given the role of employer-sponsored health insurance in providing stability in coverage to so many Americans, making a substantial change to the tax treatment of employer-provided health care could cause a significant disruption.
The large dollar amount associated with the tax exclusion makes it a particularly rich revenue target for those seeking to expand coverage to the uninsured under the ACA and for those seeking to repeal and replace the law with something different. However, limiting the tax exclusion brings with it a number of disadvantages: It would serve as a middle-class tax hike; drive up health insurance costs for millions of American employees; and eliminate the strong incentives currently in place that constantly pressure large purchasers of health to demand more efficient, affordable, and effective care from the marketplace.
One of the principal arguments for limiting the tax exclusion is that it artificially depresses wages. The evidence, however, regarding whether the tax preferred treatments of health care holds down wages is, at best, inconclusive. Moreover, even though take-home pay may increase, some portion, and perhaps all, of a pay increase could be consumed by higher out-of-pocket health care costs, particularly among those with chronic health conditions.
For example, if an employer increases the deductible in its health plan by $1,000 and reduces an employee’s premium by $500 to avoid the tax cap, the employee’s pre-tax pay will increase by $500, but their take-home pay will only increase by $340 after taxes, while their out-of-pocket costs are now up to $1,000 higher for the same health care services. For those employees with chronic health conditions, their higher out-of-pocket medical costs could easily consume all of their higher take-home pay and more. Higher deductibles and co-payments may make consumers more cost-conscious, but such cost discipline is likely to only have a modest effect on reducing wasteful health care spending.
Proponents for limiting the tax exclusion also argue the exclusion is an unfair way to promote the purchase of health insurance because it is regressive as it disproportionately favors the wealthy. However, when testifying before Congress in 2009, economist Jonathan Gruber, one of the architects of the ACA, noted that capping or eliminating the tax exclusion on employer health care benefits would be a “middle-class tax increase.” Although such a proposal would apply across all incomes, “it would still be a sizeable increase in taxation for middle income families, with 10 percent of the revenues coming from families below $50,000 in income, and 28 percent from families with $50,000 to $100,000 of income.”
A number of studies estimating what impact capping the tax exclusion on employer-provided health benefits would have on employees show exactly what Gruber described it would be in 2009. For example, a 2015 Urban Institute study estimated that capping the tax-exclusion at $10,746 for single coverage and $28,930 for family coverage in 2020 would increase taxes on 16 percent of middle-class (middle-quintile) employees by an average $710.
Proponents for limiting the tax exclusion also claim only the most generous plans would be affected and that most Americans’ plans would not be taxed. However, depending on how a limit on the tax exclusion is indexed for inflation, more and more employees over time could be taxed on their health benefits because the cost of employer-sponsored health benefits typically increases much faster than other prices. For example, while medical care prices have increased 4.8 percent over the past 12 months, they are rising four times faster than all other prices (1.2 percent). If the threshold limit for the tax limitation increases over time by the Consumer Price Index and not medical inflation, the tax limitation threshold will increase more slowly than the cost of the average employer health care plan. Eventually, the cost of today’s “average plan” will be subject to the tax.
Policymakers from both political parties have long sought budgetary “savings” by reducing the value of the tax preference for employer-sponsored care. Too often, these efforts fail to take into account the entirety of the substantial benefits derived from encouraging employer-sponsored care. Getting rid of or reducing the tax preference would not only serve as a middle-class tax hike, it would also harm efforts to maintain strong risk pools and to cover the maximum number of people. As we have learned from experience with the ACA, encouraging people to get covered is a costly and challenging endeavor, and risk pools are difficult to maintain as well. Employers, however, are both good at getting people covered and maintaining manageable risk pools. Public policy should be aimed at encouraging these important goals.