When it comes to health care, Republicans generally spend their time thinking about the best way to repeal and (maybe) replace Obamacare. And when Obamacare overlaps with their rigid stance on taxes – as it does with the so-called “Cadillac Tax” – Republicans are unified in their opposition. But here’s the kicker: so are most Democrats.
Last year, Hillary Clinton called on Congress to repeal the Cadillac tax. “Too many Americans are struggling to meet the cost of rising deductibles and drug prices,” Clinton said in a statement. “That’s why, among other steps, I encourage Congress to repeal the so-called Cadillac tax, which applies to some employer-based health plans, and to fully pay for the cost of repeal.” Clinton weighed in after saying she was worried the tax “may create an incentive to substantially lower the value of the benefits package” and shift costs to consumers.
Who says there’s no consensus in politics?
The tax’s main defenders are economists.
As with many issues, the people basing their opinions on the evidence (i.e., the economists) are right, and the people basing their opinions on ideology and group-think (i.e., the politicians) are wrong.
To understand why, you need to understand how our tax system subsidizes employer-sponsored health insurance – which is still the way most working age Americans and their families get health coverage. In the typical employer-employee relationship, the employee receives a salary from the employer for the work performed, and then has to pay taxes on that money. The employee can then use the remaining funds to cover the rest of their expenses. Your employer can’t get around this requirement by simply cutting your pay and then agreeing to make monthly mortgage payments on your behalf. The IRS thought of that. But there are a few loopholes.
One, for example, has to do with conferences. If you travel to a conference in New York “for work” but decide to spend a few days in the city for fun, you’re employers decision to cover your airfare and hotel room will count as a business expense rather than as your income. As a result, you receive a benefit from your employer, but don’t have to pay any taxes for that benefit. This is a key reason why there are so many conferences. And it’s also a key reason why we have so much employer-sponsored health insurance. Unlike your salary, the value of the health insurance premiums your employer makes on your behalf come tax-free. You don’t pay taxes on what would otherwise be treated as “income,” and your employer can claim that they are being beneficent by providing their employees with an essential benefit.
The upside to this system is huge as it creates a situation in which most Americans find themselves in a decently sized risk pool, thereby lowering premiums and making the plans more affordable. A 2009 study by the Tax Policy Center estimated that the federal subsidy rate ranged from 7 percent of premiums for low-income workers and up to 37 percent for those with higher incomes. If you include savings in state taxes, the subsidy rate can exceed 40 percent.
But it also has significant downsides. If you’re concerned about structural inequality in the tax code, you’ll notice that the health insurance subsidy is extraordinarily regressive – a fact that was reflected in the TPC study cited above. The biggest subsidies (which can be as high as 37 percent) go to those with high incomes who least need help affording insurance.
Perhaps more important, however, is that the subsidy is incredibly inefficient. The current health care market (even after Obamacare) is saturated with two types of health care plans. On one hand, there are high-cost, low-deductible health plans, which insulate consumers from the costs of health care and lead to greater use of services, thereby driving up costs. On the other hand, there are high-deductible health plans, which cost less up front to the purchaser, but incentivize more thoughtful spending and typically use financial incentives – such as co-pays – to drive patients to consume high value care and discourage them from consuming low or no-value care.
The current health care subsidy in the tax code encourages the purchase of expensive, low-deductible policies. This creates a bias toward people over consuming health care services and under consuming everything else that money might buy, meaning that there are fewer cost controls than would exist if consumers were paying the full freight. This, in turn, helps fuel America’s high health care spending, which at 17.5 percent of GDP is among the highest in the world, despite health outcomes no better than the norm.
This inefficiency in the health insurance market is a key issue that Obamacare attempts to address. But it does so in a clunky way. The small-C conservative thing to do would have been to cap the health insurance subsidy and then phase it out over time as the market adjusted to the new exchange model. Doing so, however, would have violated President Obama’s pledge to avoid any tax hikes on middle-class Americans. And so his team came up with the Cadillac Tax, a form of excise tax (like on tobacco or alcohol) to be levied on unusually expensive health insurance plans.
Specifically, the health law provision imposes a hefty 40 percent excise tax on premiums that would exceed about $10,200 for individuals and $27,500 for families. So, if a plan cost $11,200, it would face a $400 tax – 40 percent of the amount above the threshold.
Calling this provision a “tax,” though, is really a misnomer. While the Cadillac tax certainly would result in increased tax revenue, that is not the aim of the provision. Rather, the Cadillac tax meant to encourage encourage employers to offer plans that fall below the spending threshold. In other words, its a back-door tactic to scale back too-robust plans and change the current employer-sponsored health insurance market.
But there is a significant problem here. For one thing, there is a concern that the Cadillac tax would lead to more employers to raise deductibles and co-pays, which is especially hard on lower-income workers, rather than purchasing insurance with more aggressively managed care. Private firms have already spent the last several years gearing up for this change, but this trend appears to be already underway.
Another concern is that the Cadillac Tax is a blunt instrument that doesn’t take into account granularities in the health-care system. When Obama officials spoke about the Cadillac Tax, they often described it as “an excise tax on high-end health care policies like the ones that executives at Goldman Sachs have.” But that isn’t quite accurate.
Obamacare pegged the Cadillac Tax to grow at the same rate as inflation. It does not, however, adjust for people who live in places where health care is really expensive. So, for example, the threshold is the same for people in Illinois, where health insurance is relatively cheap, as it is for people in remote states like Alaska, where its vastly more expensive.
In addition, the problem with indexing the tax to inflation is that health care spending typically grows faster than the rest of the economy. So, if that trend holds true in the future, it means that more and more plans will end up subject to the threshold. In other words, at some point the Cadillac Tax will hit Fords too. In that world, the Cadillac Tax becomes a tax on most health insurance, even those that aren’t particularly robust.
How many plans could get hit with the tax? Over the past few years, there have been a slew of papers that estimate how many current health care plans could get hit by the Cadillac tax. The Kaiser Family Foundation, for example, estimates that the percentage of plans subject to the Cadillac Tax will rise from 28 percent in 2018 to 42 percent a decade later. Similarly, Towers Watson thinks health-care costs will grow even faster, with 82 percent of plans getting hit by 2023. These estimates were made before the tax was delayed to 2020, but the conclusions largely remain the same.
The solution here, though, is not to call for the repeal of the Cadillac Tax. Rather, the solution is probably a combination of consumer education and further insurance market reform. Both parties should be able to support reforming the Cadillac Tax on fundamental economic principles. Doing so would go a long way to assuage voters’ concern that the parties cannot agree on anything, and create the kind of incentives necessary to reign in distorted health care costs.
Featured Image Credit: Erik Forsberg on Flickr (via creative commons)