L ike the phoenix, a key piece of the Affordable Care Act has risen from the ashes, resurrected, believe it or not, by the Republican Study Committee — a caucus of conservative House Republicans. The RSC proposed capping the tax exclusion for health benefits that is currently available for employer-sponsored health insurance (ESI) and extending the same level of tax exclusion to all Americans regardless of where or how they obtain their coverage. The proposal echoes and improves upon the ACA “Cadillac tax” and deserves bipartisan consideration to combat inflation of health costs.
Current law excludes ESI premiums — both the employer and the worker shares — from an employee’s gross income that is normally subject to income and payroll taxation, even though employers can deduct these payments as business expenses. This is the tax code’s largest tax expenditure, reducing federal revenue by almost $3 trillion between 2019 and 2028. It encourages employers to substitute untaxed health-insurance expenditures for taxed wages and employees to obtain their health coverage at work. Economists have long regarded the exclusion as economically inefficient and regressive.
The ACA’s Cadillac Tax imposed a 40 percent tax on the amount of ESI spending that exceeded an upper limit — a $10,200 threshold for single coverage and a $27,500 threshold for family coverage, as of 2018 when the tax was originally slated to go into effect. Thresholds would increase annually with the Consumer Price Index. Since the CPI has increased more slowly than the growth in health-care spending, the impact of the tax was expected to grow over time, affecting about 16 percent of employment-based health plans in 2018, increasing to about half of such plans by 2025.
Economists across the political spectrum believed that the tax would curb health-care costs by discouraging the use of high-cost health insurance, encourage health-plan redesign to make it more cost-effective, and increase wages or other fringe benefits in place of health-insurance spending. A flat tax on premium coverage would generally be considered regressive, taking a larger percentage of income from low-income taxpayers than from high-income taxpayers. But the impact of the Cadillac tax was expected to be progressive since the tax would generate direct revenue from mostly higher-income taxpayers who were more likely to have higher-priced insurance plans and indirect revenues — health-insurance benefits shifted into taxable wages — at our tax system’s progressive rates. The Congressional Research Service predicted the tax would reduce national health expenditures by $40 billion in 2024.
The Cadillac tax, though, as with many ACA programs, was not to be. Congress delayed the implementation date to 2020, delayed it again to 2022, and then, in 2019 in a bipartisan vote, repealed the Cadillac tax altogether.
The RSC FY 2025 Budget Proposal notes that repealing the ESI exclusion, while desirable, is not feasible now. Instead, it suggests a capped exclusion for all spending on health insurance by and on behalf of the tax filer. This would substitute taxpayers’ progressive marginal rates for the 40 percent of the Cadillac Tax for spending above the limit. The cap would apply to spending by ESI plans, as the Cadillac tax did, and also allow individuals to exclude payments for health insurance, up to the capped amount, from taxation.
Expanding the exclusion to insurance that is not purchased directly by employers will equalize the tax treatment of all health-insurance products and encourage the development of new insurance products for individuals. Workers with ESI will have cheaper plans and higher wages. Workers without ESI will have increased insurance choices to purchase with their newly tax-advantaged dollars. Everyone will benefit from more competition in the insurance market.
The RSC says the plan will be budget-neutral. But the most important goal is to structure the plan so that it acts as a brake on premium and expenditure inflation. The more effective the proposal is at restraining wasteful health spending — either because of the caps or by eliciting more efficient insurance plans — the more money will be available for other important priorities. In today’s contentious Washington, this is a plan both parties can back.