Now that the House has passed its version of tax reform, the Senate is eyeing a vote on its own tax bill the week after Thanksgiving. It’s about time for health-care stakeholders to take the implications of this effort seriously.
Of particular note in this context is the repeal of the Affordable Care Act’s individual mandate, which the Senate has proposed as an offset, providing over $300 billion in savings due to millions fewer individuals receiving subsidized health insurance. Additionally, a rarely discussed provision in congressional PAYGO rules could require over $135 billion in annual cuts to mandatory spending, targeting health-care programs including Medicare and ACA funding. Furthermore, changes to the medical expense deduction and orphan drug tax credit are both on the table, each of which would have notable consequences across health-care industries.
This article provides an overview of the implications of the various tax reform bills for a variety of health-care stakeholders, describing where each policy stands in the bicameral legislative process. Of course, the process remains extremely fluid, so additional developments are sure to arise over the next two weeks.
Sequestration: Medicare and ACA Cuts
The tax bill could trigger $136 billion in automatic sequester cuts from mandatory spending in 2018 — including $25 billion in Medicare cuts — if Congress doesn’t find another way to offset its deficit increases, according a letter from the Congressional Budget Office (CBO). The tax bill would add an estimated $1.5 trillion to the deficit over a decade. Congressional “pay-as-you-go” rules, called PAYGO, require that the Office of Management and Budget (OMB) to cut mandatory spending automatically if legislation increases the deficit beyond a certain point. Medicare can only be cut by a maximum of 4 percent under sequestration rules, which amounts to $25 billion in cuts. These cuts would gradually increase over time.
According to a report from the Committee for a Responsible Budget, the sequester would also zero out mandatory spending in the ACA except for Exchange subsidies and Medicaid expansion. Other mandatory programs subject to a full sequester or 100 percent cut include agriculture subsidies, student loans, and the Social Services Block Grant. Medicaid, Social Security, and other means-tested entitlements are exempt from the statutory PAYGO sequester.
If tax reform passes, Congress will be compelled to act before the end of the year to waive the PAYGO rules and stop the sequester. This legislation would ‘wipe the PAYGO scorecard clean’ to remove the deficit increase so that no sequester is triggered. Doing so would require 60 votes in the Senate. It is possible the bill would clear that hurdle if Democrats supported it to prevent potentially draconian sequester cuts or if it were attached to must-pass legislation. That’s what Congress did in the late 1990s and early 2000s when it passed legislation increasing the deficit, most notably the Bush tax cuts in 2001. “Senate Republicans will seek to waive application of those cuts, which has been done in the past for major legislation like this,” a Senate GOP aide recently said. “It will then be up to the Democrats to join us in preventing those cuts.”
Providers, insurers, industry stakeholders, and Medicare beneficiaries should all be aware of the potential impact of a 4 percent across-the-board cut to the Medicare program. If implemented, the sequester would apply directly to fee for service (FFS) claims, durable medical equipment (DME), prosthetics, orthotics, and supplies. For Medicare Advantage (MA) and Part D payments, CMS would be forced to cut each of its monthly contractual payments to plans. Low-income subsidies and additional subsidies for beneficiaries whose spending exceeds catastrophic levels in Part D are exempt from sequestration. Additionally, zeroing out the ACA’s risk adjustment program would cripple insurers. Concerns about patient access would be inevitable.
The Individual Mandate
The individual mandate requires all individuals who can afford health insurance to purchase some minimally comprehensive policy. Those who don’t carry insurance are assessed a $695 fine per year or 2.5 percent of their income, whichever is higher. The policy is designed to encourage a broader risk pool for health insurance markets — encouraging healthy individuals to purchase coverage before they become sick and reducing the amount of charity care provided to individuals who are not otherwise able to pay.
Senate GOP leaders announced last week that they plan to include a repeal of the individual mandate in their version of the tax reform bill to go into effect in 2019. That would save about $338 billion to help pay for other changes in the tax plan, according to the Congressional Budget Office (CBO), but it also intertwines the GOP tax bill with the complicated politics of health care. That trial balloon has survived so far, with none of the most likely defectors — Sens. Susan Collins (R-ME), Lisa Murkowski (R-AK), or John McCain (R-AZ) — calling the policy a deal breaker (although Sen. Collins has voiced some concerns). The plan has the support of House Speaker Paul Ryan (R-WI), and appears to have enough votes among House Republicans. So the individual mandate will likely live or die in the Senate.
Consumers in the individual insurance market would be impacted most directly, as the Congressional Budget Office (CBO) estimates that average premiums would increase by about 10 percent without the policy in place. CBO concludes that some individuals would no longer choose to purchase insurance because they are no longer required or because of the resulting increases in premiums. An estimated 13 million fewer individuals would have insurance over 10 years, causing significant downstream impacts for providers, insurers, life sciences companies, and other stakeholders. AHIP and a host of other health-care stakeholders oppose repeal of the individual mandate.
Sidecar: The Alexander-Murray Agreement
As part of the Senate deal to repeal the individual mandate in tax reform, there is a tentative agreement to hold a separate vote on the health-care deal negotiated by Sens. Lamar Alexander (R-TN) and Patty Murray (R-WA). The bipartisan package, announced last month, would: (1) fund the ACA’s cost sharing reduction (CSR) subsidy payments to insurers for two years; (2) streamline approval and relax affordability guidelines for 1332 Waivers; (3) add catastrophic “copper plans;” (4) compel HHS to issue regulations on selling insurance across state lines; and (5) fund consumer outreach initiatives and state reinsurance programs.
Significant challenges remain before the Alexander-Murray deal comes to a vote. Its fate is largely tied to that of the individual mandate, which is still in question in its own right. Moreover, Minority Leader Chuck Schumer (D-NY) has warned that Democrats won’t back the Alexander-Murray bill under these circumstances — despite the fact previous indications that the entire Democratic caucus supports it. Also in question is whether House Republicans would bring Alexander-Murray up for a vote, even if it were to pass the Senate. Ultimately, the bill’s prospects would be stronger as part of a larger must-pass bill than as a sidecar to the GOP’s tax overhaul, e.g., as part of an end-of-year funding deal.
The bill is intended to help stabilize the individual insurance markets and would likely allow insurers to lower premiums given the guarantee of receiving CSR subsidy payments. However, any initial benefit to consumers could be negated by repeal of the individual mandate, which likely will lead to increased insurance premiums in 2019. Insurers will be watching both provisions closely, and premiums for consumers will hang in the balance.
Medical Expense Deduction
Under current law, the IRS allows individuals to deduct qualified medical expenses that exceed 10 percent of a person’s adjusted gross income for the year. This includes preventative care, treatment, surgeries and dental and vision care as qualifying medical expenses. The medical expense deduction can also be used for long-term care expenses for chronically ill patients.
The House bill would repeal the medical expense deduction, effective in 2018, which the Joint Committee on Taxation (JCT) estimates would save about $10 billion per year. The Senate bill, on the other hand, maintains the deduction. Additionally, Sen. Rob Portman (R-OH) has filed an amendment in the Finance Committee to reduce the threshold to 7.5 percent — the pre-ACA level. While some expect the House will eventually adopt the Senate’s original version of the bill, the possibility remains that further negotiations over the policy could materialize in a House-Senate conference committee.
Individuals who experience high medical bills are direct benefactors of the medical expense deduction. Seniors’ advocates, spearheaded by AARP, have been among the staunchest supporters of the medical expense deduction throughout the tax reform debate.
Orphan Drug Tax Credit
The tax credit is part of the 1983 Orphan Drug Act, and is one of a host of incentives that supporters say have led to the approval of more than 500 new drugs for rare diseases affecting fewer than 200,000 people. Under current law, companies that develop drugs for rare diseases can receive a tax credit for half of the cost of their clinical trials. Notably, the program has come under scrutiny because critics say that some major drug makers have exploited it by obtaining the orphan designation for blockbuster drugs.
While the House bill takes a hatchet to the orphan drug tax credit — eliminating the program entirely — the upper chamber approaches the program with a scalpel. The version of the bill approved by the Senate Finance Committee would limit the orphan drug credit to 27.5 percent (instead of the current 50 percent rate) and introduce new reporting requirements.
Pharmaceutical companies and patients with rare diseases have championed the tax credit as necessary to provide incentives to explore cures for otherwise-neglected diseases. Over the last decade, the number of new drugs to treat rare diseases has proliferated. In 2016, nine of the 22 new drugs approved by the Food and Drug Administration were for rare diseases; in 2015, 21 of the 45 drugs approved fell into that category. The Biotechnology Innovation Organization (BIO) and the National Organization for Rare Disorders (NORD) have been among the most vocal advocates for maintaining the orphan drug tax credit.
Research and Development Tax Credit
Enacted in 1981, the Research and Development (R&D) Tax Credit provides a tax credit based on spending for new-and-improved products and processes. Eligible costs include employee wages, cost of supplies, cost of testing, contract research expenses, and costs associated with developing a patent. Startup companies can even use R&D tax credits to offset the employer portion of their payroll tax.
The respective tax reform packages in Congress maintain the R&D tax credit. However, the Senate plan includes policy changes designed to prevent companies from claiming both the orphan drug and R&D tax credit for the same expenditure. As with the other deductions, it’s somewhat more likely that the Senate policy ultimately becomes law. But the outcome of a potential House-Senate conference remains unpredictable.
Pharmaceutical companies researching treatments for rare diseases stand to lose a portion of their tax incentives under the respective tax reform proposals. However, orphan drug developers should be aware that qualifying clinical testing expenses that would have otherwise qualified for the orphan drug tax credit may be qualified for purposes of the R&D tax credit. Although the orphan drug tax credit is generally a more lucrative incentive, the availability of the R&D tax credit could help mitigate the impact of any changes.
Shea McCarthy is a Vice President at Thorn Run Partners where he and his team deliver sophisticated policy analysis, strategic counsel, advocacy services to leading health care stakeholders — from Fortune 500 companies to non-profit organizations. He has a B.A. in Economics and Computer Applications from the University of Notre Dame.