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‘Cadillac’ health care benefits aren’t always what they seem

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The following is a preview of an article to appear in Tax Notes, “Who Loses if We Limit the Tax Exclusion for Health Insurance?”, by Elise Gould, Economic Policy Institute, and Alexandra Minicozzi, the Congressional Budget Office.

Authors’ Note:
In making health care reform a budget priority and convening this week’s summit on the subject, the President is jump-starting a much-needed change in our nation’s health care policy. Health care reform is a moral imperative for the tens of millions of Americans without coverage, for the millions more who are joining them as their jobs disappear in this recession, and even for those with insurance who are forced into bankruptcy by medical costs — about half of all personal bankruptcies nationwide.

Health care reform is also imperative for the nation’s economic health. The chief U.S. budget-watcher, Peter Orszag, who directs the Office of Management and Budget, is clear on this point, saying: “The path of fiscal responsibility must run directly through health care.” There is solid, well-documented research that shows that the right kind of health care reform (such as, for example, the Health Care for America plan developed with support from the Economic Policy Institute) can pay for itself over time.

But there are legitimate questions about how to pay for the costs of reform. One idea, taxing so-called “Cadillac” health care coverage provided by employers, has been gaining some congressional support. This idea, of limiting the tax exclusion that now exists for participants in the most expensive employer-sponsored coverage, is the subject of our new research. The findings of this study, conducted by EPI Health Policy Research Director Elise Gould and CBO Analyst Alexandra Minicozzi, will be published in a forthcoming edition of Tax Notes. A more in-depth analysis is available in this EPI Working Paper.

As outlined below, the research shows that the burden of the proposal to tax high-priced health coverage will fall heavily on two groups who are least able to bear it: workers in small firms and workers in employer pools with higher risks, such as those with a high percentage of older workers.

First, small businesses are paying high premiums for the insurance they provide to their employees — not because the plans are especially lavish, but because they include too few employees to constitute the broader risk pool that would qualify them for lower costs for the same coverage.

Second, employees whose characteristics cause them to be classified as higher risks make them more expensive to insure. Adding a tax on top of the cost of premiums they and their employers pay will likely drive more of them into the ranks of the uninsured.

Many call these high-priced insurance plans “Cadillac” coverage, but that is a misnomer. The high price may stem not from any bells and whistles in their coverage but from a fundamental inequity in the way that insurance for these groups is currently priced. This policy idea is a blunt instrument that may do harm to the very people we should be striving to help.

This, by no means, should delay action on ambitious health reform because the long run budget and deepening recession demand it. President Obama’s budget makes a realistic and substantial down-payment, and health policymakers know that there’s more money out there to be saved through intelligent reform, which improves quality and efficiencies in the entire system. Taxing health benefits is one way to bridge the funding gap, however, it shouldn’t be taken on without serious consideration of the losers and without a viable system in place for everyone.

Research Summary:

The president’s budget sets aside over $600 billion as a down payment for health reform, primarily by limiting income tax deductions for wealthy Americans and removing Medicare Advantage, but it acknowledges that this will not be enough. Limiting the tax exclusion for employment-based health insurance premiums is the next obvious source of revenue, as Senators Wyden and Baucus, independently of each other, have suggested.

Current law allows employer contributions to health insurance premiums to be excluded (without limit) from workers’ taxable income; employee contributions are also excluded from taxable income at qualifying firms. Eliminating or capping the exclusion would amount to a new tax on health insurance benefits for workers.

Our paper examines one well-known proposal to cap the tax exclusion (2005 Tax Reform Panel), but our results could be extrapolated to a variety of other proposals which set a fixed value limit on the tax preference, such as a flat tax deduction or credit.

Our findings contradict the unsubstantiated, often repeated claim that those with exceptionally generous “Cadillac” plans are the biggest winners under the current tax treatment. For plans with the same generosity, we find that key factors in determining who would be affected by making these benefits taxable are age of workers and size of firm. Individuals with mostly older co-workers or those who work at small firms are substantially more likely to pay a lot for health insurance.

Workers’ health risks and small firms’ higher administrative costs and inability to effectively pool risks play an important role in determining who has high health insurance premiums. Therefore, in contrast to what is suggested in the public discourse, enrollees in firms with these characteristics stand to lose the most from a change in the tax treatment of premiums. In addition, if the value at which the cap is set is indexed to overall inflation and not to the faster inflation rate of health care premiums, the number of people affected can easily double over the next 10 years.

Our paper offers an important contribution to the debate that is developing over this approach because it highlights, for the first time, the distributional impact of limiting the tax preference. To date, no one has characterized the population which actually enrolls in relatively costly employer plans even though the vast majority of premiums paid for employment-based health insurance are untaxed. That said, our research is only one piece of the puzzle. Reducing the tax exclusion would likely accelerate the erosion in employer-sponsored insurance that has occurred since 2000, particularly for small firms who are most sensitive to price changes. There would be hurdles to overcome in administering such a policy as well.


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