"'Cadillac' tax isn't a tax -- it's a plan to finance real health reform"

[Clio the Leo]

'Cadillac' tax isn't a tax -- it's a plan to finance real health reform
By Jonathan Gruber
Monday, December 28, 2009

As we prepare for the final round of debate over health reform, perhaps the most contentious issue will be financing. Both the Senate and House agree that most of the financing for reform should come from scaling back overpayments to Medicare insurers and providers, as well as excise taxes on some of the sectors that will most benefit from 30 million newly insured consumers. But the two houses remain apart on where to find the remaining dollars. In the Senate, the gap is closed by relying on the "Cadillac tax," a 40 percent assessment on insurance plans with premiums of more than $8,500 for singles and $23,000 for families. In the House, the gap is closed with a surtax on those earning more than $500,000.

The Senate assessment on high-cost insurance plans has much to recommend it, which is why it is almost universally favored by health policy experts. It would reduce the incentives for employers to provide excessively generous insurance, leading to more cost-conscious use of health care and, ultimately, lower spending. In other words, it "bends the curve." It would also be progressive, in that it would take from those with the most generous insurance to finance the expansion of coverage to those without insurance.

But there have been numerous criticisms of the Senate financing. Perhaps the strongest is that some insurance plans will be "unfairly" burdened. For example, firms with older employees may have higher insurance costs not because their plans are more generous but because the employees themselves are more expensive to insure. Thus, many claim that this is a tax not on excessively generous insurance plans but on those who happen to have high insurance costs.

But this argument misses an important point: The assessment proposed in the Senate is not a new tax; it is the elimination of an existing tax break that is provided to exactly these firms. Under current law, if workers are paid in wages, they are taxed on those wages. But if they receive the same amount of compensation in the form of health insurance, they are not taxed. As a result, the tax code has for years provided a large subsidy to the most expensive health plans -- at a cost to the U.S. taxpayer of more than $250 billion a year. To put this in proportion, the cost of this tax subsidy to employer-sponsored insurance is more than twice what it will cost to provide universal health coverage to our citizens.

The excise tax on generous insurance plans would simply offset this bias for the most expensive health insurance plans -- and only on a partial basis. To understand how, consider two firms. One has an average insurance cost per family of $13,000, the national average. The other spends twice that much, $26,000 -- perhaps because its workers are older or perhaps because it provides much more generous coverage. Under today's system, a typical middle-income worker at the first firm gets a tax break of $4,550 while a worker at the second gets a $9,100 break. Taxpayers are literally sending twice as much money to the second firm simply because its insurance is more expensive -- regardless of the reason.

All that the excise tax would do is mitigate this tax preference. The second firm in this example would pay a 40 percent tax on its health spending above $23,000, for a total tax of $1,200. Even after this tax, the second firm would get a net tax break of $7,900 -- almost three-quarters larger than the break for the first employer. So we have not taxed that second firm. We have simply (partially) offset the enormous tax break it was already getting from the government.

Moreover, most experts and Congress's Joint Committee on Taxation assume that most companies would not end up paying this tax but would instead reduce their insurance spending to below the threshold for the tax. And when firms reduce their insurance generosity, they make it up in higher pay for their workers. We saw this in the late 1990s, when the rise of managed care temporarily lowered insurance costs, and wages rose in real terms for the first time in many years. But as soon as managed care was weakened and health costs rose again, we once again saw flat or declining real wages in the United States.

By my calculations the excise tax in the Senate legislation will raise U.S. worker wages by a total of $223 billion over the next decade, which would mean about $660 in extra annual earnings per employer-insured household by 2019. Moreover, the vast majority of those wage increases accrue to middle- and lower-income households; 90 percent would go to families with incomes below $200,000.

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The writer is a professor of economics at the Massachusetts Institute of Technology.
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