The Time Has Come To End The Health Care Tax Exclusion

Posted by

Merrill Goozner

First published 4/11/11 on Gooz News

President Obama on Wednesday will unveil his counteroffer for bringing the nation’s budget deficit under control. Last week, the Republican plan authored by Rep. Paul Ryan, R-Wisc., chairman of the House Budget Committee, focused public attention on cutting health care subsidies for seniors and low-income people. Will the president go after the bloated health care sector, too?

Here’s one way he could raise a half trillion dollars in the next four years from health without touching seniors or the poor. The plan would win plaudits from tax purists and deficit hawks. And it would make a major contribution to holding down the growth in health care costs, while testing Ryan’s claim to back putting tax expenditures on the table.

The president should propose eliminating the income tax exclusion for health care benefits.

About three-quarters of Americans receive their health insurance through employer-sponsored plans. Those employer payments, about $800 billion a year, are entirely exempt from income tax. It is the largest single exemption in the tax code, surpassing the home mortgage interest deduction, charity deductions and every corporate income tax break.

A portion of this exclusion will be eliminated after 2018 under health care reform. If all employers’ health insurance payments were considered part of workers’ wages and taxed at prevailing rates now, it would raise $117.3 billion this year and $553.7 over the next four years, according to the Joint Committee on Taxation. Longer term, it would raise trillions.

Removing this tax break wouldn’t be very popular with the average American. They would, no doubt, see it as a tax increase, which it is. But who ever thought that the Republicans, just a few months after winning control of the House by scaring the bejeezus out of seniors with ads saying the Democrats’ health care reform law was a half trillion dollar cut in Medicare (which it is), would turn around and endorse a Medicare premium support scheme that the Congressional Budget Office says will make future seniors (anyone who today is under 55) pay 68 percent of their Medicare bills out of pocket after 2033?

If that’s the opening bid, taxing the health care benefits of the working population seems downright equitable and fair.

Let’s start with fair. Why should seniors and poor people bear the brunt of health care budget cuts? Medicaid budgets are already being whacked across the country as states move to bring their budget deficits under control. Seniors under reform bill are already having their Medicare Advantage payments cut. Tighter budgets under reform are inevitable – unless, of course, Republicans repeal the bill’s cost-cutting provisions.

So in the name of shared sacrifice, the 170 million Americans who get health care through private plans should also contribute to balancing the books. Removing the tax exclusion is the fairest way to do that.

Many health care experts worry about eliminating this tax break. They say it would put the greatest burden on plans that cover older and sicker workers since they pay the highest premiums. It could force many employers to drop coverage, since they would have to pay their share of payroll taxes on this newly declared income.

But both problems are partially offset by provision of the health care reform bill. The bill capped the differential that health insurance companies could charge employers for plans that cover mostly older and sicker workers (although some say that at three times a low-cost plan, it’s still too high).

And if employers drop coverage while delivering higher wages to workers (less the amount that employers will have to pay in payroll taxes), at least those workers will soon have exchanges where they can shop for affordable plans. And they will receive subsidies (paid for in part by those reduced Medicare and Medicaid payments) if their income is too low.

As for equity, taxing health benefits is progressive from a tax incidence point of view. Here’s why. The cost for any individual family in a group plan is usually the same. At most firms, a family with a combined income of $65,000 a year gets the same $10,000-per-year family coverage as a family earning $165,000 a year. But when it comes to paying taxes, the former pays at a 15 percent marginal tax rate compared to 28 percent for the latter.

If the firm employs mostly lower-wage workers and their rates are compared to top executives, the progressivity of taxing health benefits is even greater. Bottom line is that most of the new taxes raised by taxing health benefits would fall on higher-wage workers.

Will the president go that route? President Obama wants to tax the rich, a politically safe bet with the Democratic Party base. But the truth is that there is far more money in taxing health benefits. If he’s going to pay the political price for throwing higher taxes on the table, you might as well go where the money is.

Merrill Goozner is an independent health care journalist. He also maintains a blog at Gooz News.

2 comments

  1. I wouldn’t put it past Obama to scheme another way to raise taxes, especially if it further cements in Obamacare. But it will never get thru the house. He would be better allowing individuals to deduct their insurance premiums, instantly making insurance cheaper for that population. He could also flip the tax deduction rates, giving the lower income a higher deduction, and higher income a lower deduction.

  2. Why not expand the deduction to any individual who purchases health insurance? Further, let’s expand HSAs, and allow an individual or family deduct from their gross income any and all health care expenses. Wouldn’t that subsidize health insurance and give incentive to purchase health insurance, and see a doctor?

    Frankly, taxing doesn’t work. Hauser’s law.

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