Capping the Health Exclusion: May a Thousand Flowers Bloom

By :: June 10th, 2009

Until now, unions have been among the strongest critics of paying for health reform by limiting the tax exclusion for employer sponsored insurance. But on Monday, a well-connected labor lobbyist told me a deal could be done. “It all depends,” he said, “on what the cap looks like.”

Remarkably, in just a few weeks, lawmakers seem to have moved beyond the argument over whether the exclusion should be capped. Now, they are debating how. It is not easy. There are caps based on employee income, the value of the insurance, or both. There are caps tied to the actuarial value of coverage, or linked to geography. Then, there is the issue about how to index a cap.

First, a bit of boilerplate: Today, workers can get tax-free health coverage from their employer. Because this subsidy is excluded from taxable income, it is worth more to high-bracket workers than to those earning less. And the exclusion is very costly. In 2007, it reduced federal revenues by nearly $250 billion—about $145 billion in income taxes and $101 billion in payroll taxes.

With that kind of dough on the table, even a cap on the exclusion is a tempting way to help pay for a health reform. But what should it look like? 

If the goal is to raise cash, the simplest option may be to put a ceiling on the value of tax-free insurance. President Bush’s Tax Reform panel, for instance, would have limited the exclusion to $5,000 for single coverage and $11,500 for families, and indexed the cap to the Consumer Price Index. Because health premiums rise so much faster than the CPI, this design rapidly erodes the value of the tax break and raises lots for the Treasury.

But the commission's job was to reform taxes, not health policy. The Urban Institute’s Stan Dorn, seeking a more equitable exclusion, would tie the cap to the actuarial value of policies, not their price. In other words, benefits more generous than average would be taxed. Paul Van de Water, however, argues that such a structure would be too complicated to administer and might discourage employers from offering higher-quality plans.

While Stan would look to the value of benefits to measure “fairness,” others have different benchmarks. For instance, lawmakers from states where health costs (and, thus insurance premiums) are higher than average favor some geographic adjustment to the cap. Paul Fronstin found typical premiums for the same type of policy can vary by nearly 60 percent among states. Small business premiums can vary by more than 100 percent from state to state.

A regional adjustment may be politically attractive in the Senate, but it will also soak up a lot of potential revenue. Rather than scaling back the subsidy from a national average in lower-cost states, Congress is instead likely to just sweeten it for high-cost jurisdictions.     

Finally, some unions to prefer to base a subsidy cap on worker income rather than the value (however measured) of the insurance. Labor’s interest in this matter is no surprise since unionized workers are far more likely to have coverage that exceeds the Tax Panel’s limit than employees of non-union shops, according to a Tax Notes article by Eliza Gould and Alexandra Minicozzi. At the same time, union wages may well fall below an income cap.

Lots of really interesting policy questions to chew over, and no obvious answers. TaxVox will look more closely at each of these ideas over the next few weeks.           
 
         

6Comments

  1. Anonymous  ::  1:55 pm on June 10th, 2009:

    This is an interesting and potentially important development!

  2. Anonymous  ::  2:25 pm on June 10th, 2009:

    Howard,
    I'm a bit confused, maybe you can help clear something up. Here and in your post from Thursday you say the exclusion is worth about $246 billion in 2007. But here
    http://www.taxpolicycenter.org/briefing-book/key-elements/health-insurance/spending.cfm
    it says the exclusion was worth about $175 billion in 2008. Is that just the income tax portion? Or did the value really decline that much in one year?
    Thanks!

  3. Anonymous  ::  2:29 pm on June 10th, 2009:

    The complications are why this issue needs to be tied to comprehensive tax reform, although that would foil Rahm Emmanuel's goal of getting reform done by Labor Day.
    Under a VAT or Buinses Income Tax Model, external payments for health insurance would not be taxed as income, but would be VAT taxable, with the tax paid credited to the firm's VAT payment.
    There should be a ceiling for payments tied to any residual high-income tax, so that payments on behalf of an individual over the cap would be reported as income to be taxed, if applicable. For most folks, they would not be paid, but would for individuals earning over $50K/families over $100K under Graetz proposal and individuals over $75K and families over $150K in mine.
    This could still bring in some serious cash if the caps and income floors are set low. Under the Graetz proposal, the rate would be between 20% and 25%, while under mine it would be between 6% and 15% (the difference being that I have a huge business income tax – which oddly makes mine more regressive – except for the fact that my prebate for families is $500 per child per month and the fact that I do away with the home mortgage deduction).

  4. Anonymous  ::  2:40 pm on June 10th, 2009:

    Kevin,
    The Briefing Book table only includes the income tax expenditure. The payroll tax revenue loss is another $90 billion or so. (See http://www.taxpolicycenter.org/t09-0228 for projections of the income and payroll tax revenue gain from repealing the exclusion, as some cap options.)

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