Indexing the Health Exclusion: Pay Me Now or Pay Me Later

Senate Finance Committee Chairman Max Baucus (D-MT) is floating the following trial balloon: Congress would fund part of health reform with a cap on the tax exclusion of employer-sponsored health insurance but only at a level “significantly above” the cost of the standard plan offered to federal employees. The measure would also exclude policies bargained under current union contracts. In a bit of unsenatorial understatement, Baucus told reporters on Tuesday that this version of the cap “wouldn’t affect very many people.” Or, he might have added, raise very much money.

So why would Baucus push so hard for a cap that doesn’t tax many policies? My best guess: He’s playing the old camel’s nose under the tent game—getting the tax hike on the books even though it won’t raise much revenue for years.

It is simple to design such a plan. Just allow generous tax-free policies today, but freeze tax-exempt premiums at current levels. Over time, medical inflation will do the rest. As the costs of health care (and premiums) rise, that fixed cap will hit more policies.

Remember the rules of the game. President Obama says health reform must pay for itself, but over 10 years. That opens the door to a back-loaded tax system that generates relatively little today, but big bucks by the end of the decade. 

It is all about how you index the cap. And I suspect that’s where Baucus is headed. Various forms of inflation adjustments may seem like mere technicalities to voters—a definite plus for politicians—but the way you index a cap turns out to be a very big deal.

To see why, TPC took a preliminary look at three options—indexing the tax-free premium level to medical cost inflation (the most generous design), tying it to growth in the Consumer Price Index, or not adjusting at all for inflation, effectively freezing the cap indefinitely. In one model, indexing to medical costs would generate just $62 billion in income taxes over 10 years, while not indexing it all would raise 10 times as much, or more than $600 billion. Indexing to CPI would generate about $450 billion.

For an idea of how fast revenues build if the tax-free premium is not adjusted at all for inflation, the design TPC modeled would raise just $7 billion in 2010, but $136 billion in 2019. Keep in mind that the plan we used (about $5,600 for singles and $13,800 for family coverage) was probably less generous than what Baucus has in mind, but you get the drift.

Now, a cynic may say an unindexed cap is unsustainable–pressure would build to raise it as inflation eats away at the value of a tax-free policy. That may be true, but it isn’t Baucus’ problem. He’ll get credit from the Joint Tax Committee based on the assumption that his plan will remain in place.      

In a sense, Baucus may be trying to avoid a replay of catastrophic health reform back in the late 1980s. Old Washington hands remember that Congress passed a law to cover high-cost medical expenses, but had to repeal it even before it took effect. Why? Because it was easy for critics to gin up opposition to a measure that raised taxes right away but didn’t boost benefits for years. That may have been fiscally prudent, but it was a political disaster. Baucus, it seems, isn’t going to that mistake again.