Taxing Employer-Sponsored Insurance Would Hike Social Security Benefits But Boost Federal Coffers

By :: May 8th, 2014

The tax subsidy for employer-sponsored health insurance is huge. Not only are the premiums exempt from income tax, they are also immune from Social Security payroll tax. The two subsidies combined will add more than $1.6 trillion to the deficit over the next five years alone.

But because that income is not included in the Social Security wage base, some workers also lose out on future retirement benefits. So what would happen if Congress repealed the exclusion for employer-sponsored insurance?

That question has a very complicated answer. The reason has a lot to do with those Social Security benefits, according to a new paper by the Urban Institute’s Karen Smith and my Tax Policy Center colleague Eric Toder.

Overall, the present value of those more generous Social Security benefits offsets some, but not all, of the higher taxes. But for some workers—especially those at lower incomes—those greater retirement benefits would more than compensate for their higher taxes.

Here’s why:

Taxing ESI moves three financial levers.  Since employer-paid premiums would be treated like wages, most workers getting ESI would pay more in income, Medicare, and Social Security taxes. Those higher income and Medicare taxes would have no effect on their future Social Security benefits. But raising the wage subject to Social Security taxes would boost benefits for some retirees.

The story gets complicated because each of those taxes affects households in different ways. For example, very low income households who fall below the income tax threshold (about $19,000 for a childless couple) would not face higher income taxes but would pay more Social Security and Medicare taxes. At the other end of the income scale, workers earning more than about $117,000 in 2014 will have already maxed out on their Social Security tax so even if their ESI is included in income, they won’t pay any more of that levy. And since there is no wage cap and no floor on the Medicare tax, everyone would pay more of that levy.

All these crosscurrents would have important consequences, not just for family incomes, but also for federal deficits and the health of the Social Security trust fund.

Because most people paying higher taxes are not yet collecting Social Security, the federal budget deficit would decline by about 1.6 percent of Gross Domestic Product to start—roughly equal to the increase in federal receipts.  But as those workers begin to retire and start collecting bigger benefits generated by their higher lifetime earnings, the net decline in the deficit would moderate and average 1.1 percent of GDP over the next half century.

Because higher payroll taxes would exceed benefit increases, taxing ESI also would improve the long-term health of the Social Security trust fund. However, it would not completely eliminate the account’s projected long-term deficit.

The effects of this trade-off between taxes and benefits would vary across and even within income groups. Overall, the present value of those higher Social Security benefits from including ESI in 2014 wages would offset only about 22 percent of the combined increase in payroll and income taxes. But it would compensate for about 72 percent of those higher Social Security taxes.

Since Social Security is progressive, workers in the lowest 20 percent of income would get a bit more in benefits then they’d lose in higher taxes. By contrast, households in the top five percent of income would recover only about one-third of their higher taxes in the form of bigger future Social Security benefits.

Over their lifetimes, all earnings groups would receive less in benefits than they pay in taxes. However, middle-income workers would face the largest tax increase as a share of their lifetime earnings. By contrast, low- and high-income workers would be hit by much smaller net tax rate hikes.

The bottom line: Eliminating the tax preference for employer-sponsored insurance would improve the government’s overall financial condition as well as the health of the Social Security trust fund. But the increase in Social Security benefits would affect different earnings groups in very complicated ways. And while the Social Security Trust Fund would be strengthened by higher payroll taxes, that improvement would be mitigated by an increase in benefits.






  1. Ralph H  ::  8:04 am on May 9th, 2014:

    So its a way to raise taxes without raising rates. You would see a big scream from what’s left of the middle class; particularly those unionized and corporate workers with decent plans.

  2. Ralph H  ::  8:27 am on May 9th, 2014:

    Oh yes if this passes we should include Obamacare subsidies and Medicaid as taxable income. Taxing ESI will be yet another disincentive to work and supporting your own family.

  3. Michael Bindner  ::  4:25 am on May 10th, 2014:

    First, if you tax employer sponsored health insurance as ordinary income, you put a stake in the heart of Obamacare. Also, if we move to single-payer or even a public option (which presumably would not be taxed) any gains go out the window.

    Second, the reason we have a large trust fund at all was a compromise Reagan made with Claude Pepper to raise payroll taxes and leave the Reagan income tax cuts alone. The understanding was that when we started to buy down the surplus, we would do it with either deficit financing or, more likely, even higher income taxes. If we have a problem meeting those obliagation, this is where we must turn. Indeed, this should be made a campaign issue to get the kind of Congress that will do what is needed.

    Finally, if we wish to improve Social Security for most beneficiaries, the answer is to equalize the employer contribution, put a lower cap and a higher floor on the employee contribution (and repeal the EITC) and fund the employer contribution with employer paid consumption taxes rather than payroll taxes – at least if we want personal accounts. If we don’t want personal accounts, a straight up VAT is best – which will also tax the income of foreign labor which produces products for American consumption (and lowers the pool of workers paying Social Secruity taxes now).

  4. externsteine  ::  7:42 am on May 10th, 2014:

    Thank you for almost every other educational web site. Where in addition could I am that sort of information printed in such an excellent tactic? I own a endeavor that I am purely at this moment running with, we have been on the glimpse outside intended for these kinds of facts.

  5. PAYROLL TAX RATES CALIFORNIA 2014  ::  6:00 pm on May 10th, 2014:

    […] TaxVox » blog Archive » Taxing enterprise-sponsored insurance coverage … […]

  6. Designer Handbags Wholesale  ::  5:55 am on May 11th, 2014:


  7. Switching From Group Health Insurance To An Individual And Family Plan | Insurance Advisor  ::  9:31 am on May 26th, 2014:

    […] costs onto their workers, individual coverage begans to look like a very viable alternative to employer sponsored group […]