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October 14, 2021
Health insurance Health care costs
Mark V. Pauly
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The combination of tax reform that collects more revenue from higher income people with spending on a wide variety of public programs to help working families is a ubiquitous topic of current discussion. Objections to higher taxes (on anyone) usually are based on concerns that those more heavily taxed (whether profitable corporations or higher income earners) may change their behavior in ways that harm efficiency in the economy. However, I propose a potential change that would combine higher taxes on high-income people (by selectively closing a loophole from which they obtain much of the fiscal benefit) with a change in incentives to spur choice of employment-based health insurance plans that are more effective in containing the cost of medical goods and services.1 If past history is any guide, this change could spill over into reduced volumes of low-value care and lower prices for public and exchange health insurances as well.2
The tax break that should be targeted is the exclusion from federal income and payroll taxes (state and local taxes too) of payments that employers and workers make to obtain health insurance in connection with workers’ jobs. This exclusion has a 10-year cost in terms of lost federal revenues of close to $3 trillion (almost enough to finance Build Back Better on its own). More importantly for current policy, the tax reductions are larger for higher income people than for lower income working families. Both the higher marginal tax rates on higher incomes and the more generous plans such workers choose combine to reduce their taxes much more than those of their lower income counterparts.
These observations suggest a more targeted strategy to deal with this loophole than was present in the Obamacare Cadillac tax or other proposals to cap or recycle tax breaks for all workers. Instead, we need to concentrate taxation only on higher income workers (either higher income from higher wages or from investments and other sources) but leave the full tax exclusion in place to encourage continuation of coverage for those with average or below-average incomes. The precise numerical cutoff would be a political decision (e.g., above 400% of the poverty line), though I offer some thoughts on how to choose that cutoff below. Gruber estimated that 83% of benefit from the exclusion goes to the upper half of the income distribution, so even tapping a fraction of this high end would raise serious amounts of taxes.3
The main benefit from this change would not only be higher taxes on upper-income people (the near rich and the merely rich) but also stronger incentives for them to choose lower cost plans. This incentive would be strongest for people who work for employers offering a variety of (presumably) decent health plans at different price points. If I had been forced to pay taxes on the extra $3,600 a year I spent for the most generous health plan at my job, compared to a good quality but limited-network, aggressively managed HMO, I might have chosen the latter. The lower cost would be 100% real health care cost savings. For employers (mostly smaller ones) that offer only one health plan, higher taxes on better paid (and probably more influential) workers might cause those workers or their union to ask the employer to put greater effort into searching for ways to boost their take-home pay by economizing on health benefits. They might even agree to tolerate the new plan’s limits.
There is always the possibility that some higher income workers faced with taxes on health insurance premiums might decide to go entirely without health insurance. Social concern for rich, voluntarily uninsured people (think of an uninsured Elon Musk) might not be so great—but, more generally, it seems likely that people at this income level would at least choose catastrophic health insurance coverage in the individual market, if not through their employer.
Of course, limiting taxation of benefits to a subset of workers would not yield the full $3 trillion, but it would ensure that high-income workers pay their fair share of taxes. It also probably would collect as much tax revenue as various proposals to increase the federal estate tax and other wealth taxes after exclusions and legal readjustments in wealth are taken into account.4 And, since rising health care costs are not primarily driven by low-income workers, but rather by those more economically fortunate, it might well have a disproportionate effect on lowering spending growth once the health care economy returns to normal.
There is one other consideration about the income level at which taxation (probably phased in) might start—one might also propose a step toward harmonization of the tax subsidies offered to self-employed or other people who buy individual coverage on ACA marketplaces. Current policy does not offer tax credits to people whose income is large enough that the standard for affordable coverage (a premium greater than 8.5% of “income” for a benchmark silver plan) would apply to them. At higher income levels, this rule leaves out most individuals who are not over 60 and/or do not live in much-above-average medical cost areas. Those persons should be expected to pay taxes on all or part of their compensation that comes in the form of employment-based insurance premiums—both the employer share and any individual payments under a cafeteria plan. It will be more difficult to match the generous tax credits for low-income buyers of marketplace insurance with the few hundred dollars’ worth of payroll tax exclusion—but perhaps the time is ripe to correct things at the upper end of the income distribution.
At present, each wage-earner’s W-2 form lists (in box “GG”) the total cost for that year of employment-based health insurance premiums (“for information only”). It would not be administratively complex to require some or all of that payment to be included in a person’s taxable income if the person was ineligible for tax credits for individual insurance. Of course, people subject to higher taxes would likely object (depending on how the extra taxes they would pay were used). Limiting tax deductions and exclusions is always hard; the Obamacare cap on health insurance was repealed, and the Democrats are planning to do the same thing to Trump’s lid on state and local tax (SALT) exclusion. However, in the latter case, it is arguable that reducing local government spending harms lower income workers, whereas higher worker health insurance premiums taking a bigger bite out of low-wage workers’ pay seem less deserving of protection. There might be an opportunity—as part of a politically attractive overall package to improve tax justice— to limit eligibility for some income tax deductions and exclusions for higher income people. And doing so could produce more thoughtful comparisons of the costs versus the benefits of generous insurance by people who are fortunate enough to be in a position to make such comparisons.
1 Pauly MV. Limiting the tax exclusion for employment-based health insurance: are improved equity and efficiency enough? Natl Tax J. 2009; 62(3)(September): 555-562. 2Baker, LC, Shankarkumar, S. Managed care and health care expenditures: evidence from Medicare, 1990 to 1994. In: Garber, AM, ed. Frontiers in Health Policy Research, Volume 1. Cambridge, MA: NBER; 1998: 117-152. 3Gruber, J. The tax exclusion for employer-sponsored health insurance. Natl Tax J. 2011;64(2): 511 – 530. 4Li, H, Smith, K. Analysis of Senator. Warren’s and Senator Sanders’ Wealth Tax Plans. Tax Foundation website, https://taxfoundation.org/wealth-tax/. Published January 28, 2020. Accessed October 7, 2021.
Mark V. Pauly, PhD, is Bendheim Professor in the Department of Health Care Management, professor of health care management, and business and public policy at The Wharton School and professor of economics in the School of Arts and Sciences at the University of Pennsylvania. A former commissioner on the Physician Payment Review Commission, Pauly has been a consultant to the Congressional Budget Office, the Office of the Secretary of the US Department of Health and Human Services, and served on the Medicare Technical Advisory Panel. He is coeditor-in-chief of the International Journal of Health Care Finance and Economics and coeditor of the recently published Handbook of Health Economics, Volume 2. Pauly has been elected president of the American Society of Health Economists this year. He is the 2012 winner of the William B. Graham Prize for Health Services Research and the 2012 recipient of the University of Pennsylvania Provost’s Award for Distinguished PhD Teaching and Mentoring.
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