Tax Reform’s Unhealthy Omission

Tax Reform’s Unhealthy Omission
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The House and Senate recently passed tax reform bills because they successfully made the case that reform is a “once-in-a-generation” opportunity that is long overdue. It’s a compelling argument. When the last tax reform bill passed in 1986 the Internet was in its infancy and cell phones were the size of a briefcase. The world has changed, the argument goes, but our tax code has not.

What’s curious, however, is that the largest deduction in the tax code – the exclusion from income tax of employer-sponsored insurance, which dates back to the 1940s – is untouched by the reform bills. This omission is an enormous missed opportunity for American consumers and both political parties.

The tax treatment of health care may be the most important and least understood aspect of our tax code. In fact, it may be the golden thread that could unravel a system that creates ever-increasing costs and confusion.

Congress should keep the employee exclusion on the table for three reasons:

First, in terms of its scope, this deduction is massive. At $236 billion annually it’s larger than the GDPs of countries like Finland, Greece and Portugal. If it were a spending program it would be our nation’s third largest health care program behind Medicare and Medicaid. Compared to other deductions, it’s more than the cost of the mortgage interest and charitable deductions combined.

Second, the deduction essentially created today’s third-party payment model that has led to runaway health inflation. People pay too much for health care because it feels like someone else is picking up the tab. For 70 years, the code has incentivized a third party – insurance companies – to handle the transaction between patients and providers. This dynamic is so ingrained in our national psyche that most people have no reason to consider it until they’re self-employed. Our third-party system insulates patients from cost and does not force the kind of price transparency and competition consumers generate and expect in every other area of the economy.

Some argue that fee-for-service transactions, or the market generally, is the problem, but that’s not the case. The problem is not that the market has failed but that it has never been tried. As Greg Scandlen, founder of Consumers for Health Care Choices, argues, “[A]lmost everything we do in the course of our economic lives, we do on a fee-for-service basis. When we go to the movies, get our oil changed, have our roof replaced, buy a computer, get a haircut, hire a babysitter, buy a steak dinner, get someone to do our taxes or defend us in a suit, we do it on a fee-for-service basis. None of it is particularly inflationary.”

The exception, of course, is health care. It’s no wonder costs continue to escalate.

Third, the exclusion is unfair. It is regressive (wealthy people receive a greater benefit) and it discriminates against the self-employed and people who don’t get health insurance through their employer. Some experts, including Jonathan Gruber, a key architect of the Affordable Care Act ( ACA), argue the employee exclusion was an accident of history that never should have been created.

“It was just a way to allow employers to evade the wage and price controls of World War II,” Gruber told NPR’s Julie Rover in 2012. “And it's sort of grown exponentially since, and there really isn't a single health care expert who would design a system from scratch which would include this feature.”

In the near future, the exclusion will make less sense than it does today. By 2020, 40 percent of all workers may be “contingent” employees (i.e. independent contractor or “gig” employees) according to a study by Intuit. None of those workers would benefit from today’s code.

The conventional wisdom says Congress doesn’t want to deal with health care in the context of tax reform following the failure of efforts to repeal and replace the ACA. This is shortsighted. The tax treatment of health care is a problem that preceded the ACA and in many ways led to the ACA. While the repeal of the individual mandate might be popular with conservatives, it is not fundamental health reform.

Final passage of tax reform is likely but hardly guaranteed. Why not look for areas of common ground that could be useful at the 11th hour? In the past decade, leaders in both parties have offered serious proposals to reform the tax treatment of health care. In 2007 and 2009, U.S. Sen. Ron Wyden, D-Ore., offered the bipartisan “Healthy Americans Act” that turned the employee exclusion into a portable tax credit for individuals. Joining Wyden were 14 Senators across the political spectrum including Lindsey Graham, R-S.C., and Maria Cantwell, D-Wash. Other Republicans who have supported equalizing the tax treatment of individually purchased and employer-sponsored health coverage include U.S. Sen. John McCain, R-Ariz., and House Speaker Paul Ryan, R-Wis.

To be clear, none of these policymakers are calling for ending employer-sponsored insurance. Even if the exclusion were transferred entirely into a portable credit or deduction, employers would still have a strong incentive to provide health insurance in order to recruit and retain talent and promote the health and well-being of their workforce. A gradual move away from the status quo is more likely, as James Capretta at the American Enterprise Institute has advocated.

If tax reform is a “once-in-a-generation” opportunity, it’s hard to justify ignoring the largest deduction in the code, particularly when Congress has shown a willingness to modify the mortgage interest deduction.

At eHealth, the company I lead, consumers consistently tell us they value choice as much as cost. Moving away from a third-party payer model toward one that puts patients at the center would revolutionize and reboot our health care system for the 21st century. It’s a policy leaders in both parties have embraced. It’s not 1986, or 1946, anymore. It’s long past time to give consumers the power to make real decisions and choices about their health care.

Scott Flanders is the CEO of eHealth, Inc.

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