Tax on expensive health insurance plans could cut care along with costs

This piece originally appeared in the Wall Street Journal’s Think Tank.

The Affordable Care Act took enormous strides toward providing access to health-care coverage to the tens of millions of uninsured Americans and reining in the skyrocketing costs of health care that heavily pressured households and public budgets, addressing what we consider the most glaring shortcomings of the U.S. health system. When it comes to cost control, however, the policy virtue of one provision of the ACA–the excise tax on high-cost employer-sponsored health insurance plans, frequently called the Cadillac tax–is often overstated.

This provision levies a 40% tax on the cost of insurance plans that exceed $10,200 for individuals in 2018 ($27,500 for non-single plans). The policy goal of this tax is to nudge workers into opting for plans that charge lower premiums. Lower premiums in turn imply higher co-pays, deductibles, and cost-sharing. To be clear, these higher out-of-pocket costs are the point of the tax, not a byproduct. The theory is that as each new episode of obtaining care becomes more expensive households will cut back on health spending and this will help contain costs.

We think this is roughly true. Evidence shows that making health care more expensive does induce people to consume less of it. But the same evidence shows that people do not cut back only on care that is ineffective or somehow luxurious; instead, they cut back across the board. Expecting sick Americans to decide on the fly in an opaque and uncompetitive marketplace what health care is cost-effective–and what is not–is an unrealistic and unfair approach to containing costs.

While overall costs may be pushed down by the excise tax, this is a good outcome only if one believes that the health care squeezed out is merely the ineffective kind. But a lot of welfare-improving care may also be a casualty, and for some patients, cutting back on medically indicated care because of the increased cost-sharing could increase their overall spending. For example: some patients who cut back on low-cost pills to contain cholesterol end up in emergency rooms.

Cutting utilization is also a limited cost-containment strategy. Americans’ extraordinarily high health spending compared with our international peers is not driven by profligate utilization of health care but, instead, by much higher prices per unit of care. Studies have not shown cost-shifting to do anything to the price side of the equation. The excise tax is not aimed at nor will it reduce health-care prices.

Defenders of the tax say that because firms will be induced to push down premium costs, this gives space for employers to increase cash wages. As economists, we think this is likely correct in the long run if the economy returns to full employment. But the U.S. economy has spent a lot of time away from full employment in recent decades, so for many workers the compensating wage increases might be a long time in coming. Further, much of these higher cash wages will, on average, be forked over to health-care providers to pay higher out-of-pocket costs. Some defenders of the tax call the outcome of higher wages a “pay increase” or say it will “boost incomes” for workers. This is absurd; the tax reduces total after-tax compensation for workers.

The “Cadillac tax” label grates because the tax is not aimed at “Cadillacs”–plans that shield workers even from discretionary health purchases such as, say, designer eyeglasses or hot-stone massages. Simply put, “expensive” does not equal “good” insurance. Health insurance plans can be expensive because they’re in high-cost states, or because firms are small and lack bargaining clout with insurers, or because the workforce of a given employer is older than average. Pre-ACA research indicated that as little as 4% of the variation in health insurance premiums was driven by generosity of coverage. Further, the tax is designed to, over time, scoop up more and more of the employer-sponsored plans in the U.S. economy.

There are other, less damaging ways to limit the tax preference for employer-sponsored premium payments. The president’s proposed budget recommends capping the income tax preference for all tax deductions (including employer-sponsored health insurance) at 28%. This would leave more than the bottom 95% of workers’ exclusion untouched but would still raise considerable revenue. Best, the targeting of those being nudged into higher out-of-pocket costs would be based on these households having high incomes–and not based on these workers having a high-cost health plan that they obtained through the roulette of the U.S. health insurance market.

It is understandable why, in 2009, architects of the ACA sought to insert all manner of cost-control devices into the legislation: Health-care costs had risen more rapidly than overall economic growth for decades and had climbed particularly swiftly in the early 2000s. Since 2006, however, the rate of growth of health costs has decelerated significantly. Research indicates this is not just an outcome of the Great Recession. This cost-growth deceleration is so rapid that between 2011 and 2014, the Congressional Budget Office estimate for federal spending on health care in 2021 declined by roughly $300 billion. This slowdown in cost growth gives time to ensure that policy strategies for cost containment focus on not just less spending but also better value for money. The excise tax is a shotgun blast. But what’s needed for cost containment is a scalpel.