Building a Better "Cadillac"
Henry J. Aaron, Linda J. Blumberg, Paul Ginsburg, Stephen Zuckerman
The excise tax on high-cost health insurance plans, a provision of the Affordable Care Act (ACA), has the potential to achieve two important goals by curbing the open-ended exclusion of employer-financed health insurance from personal income and payroll taxes. It will reduce the incentive to offer health insurance with features that permit or encourage excessive health care spending. It will also generate revenues that offset the costs of health insurance expansion.
The objective of curbing the employer exclusion has enjoyed bipartisan support among health and public finance economists for decades.1 Many supporters reason that the unlimited exclusion from personal income and payroll taxes encourages companies to offer, and their employees to select, coverage so generous that people use more health care (in both quantity and price) than is optimal. Others oppose the exclusion because it is regressive, reducing taxes most for high-income households and least for low-income households. The Cadillac tax simultaneously raises revenue progressively and advances the broader objectives of curbing overly generous insurance coverage.
The Cadillac tax has drawn five main criticisms that we address in this paper:
- The tax does not sufficiently allow for variation in health insurance costs by location, business type, worker health status, and other idiosyncratic features of particular businesses or their labor forces. We outline ways to address this problem.
- The indexing rules used to update the threshold at which the tax begins to apply almost certainly will eventually extend the tax to plans that are not unduly generous. We suggest indexing the thresholds based on GDP or GDP plus 0.5 percent instead.
- To avoid the tax, employers may take actions that increase deductibles and other cost-sharing. These steps, in turn, may discourage use of effective health care and/or unduly burden low- and moderate-income households with high medical expenses. This serious problem can be addressed by providing direct financial aid to financially vulnerable people in the form of tax credits, direct assistance through the ACA Marketplaces, or other means.
- Some members of Congress have proposed a cap on the exclusion, instead of an excise tax.2 In practice, the two approaches are likely to produce similar effects. Either approach would be superior to simple repeal of the Cadillac tax, although we prefer the cap on the exclusion because it is more straightforward to address the problem of an unlimited exclusion by limiting it, and the cap is likely to be somewhat more progressive.
- The tax would discourage flexible spending accounts because such accounts alone may trigger the tax, regardless of total premiums. A simple solution to this problem is at hand with the Obama administration’s recommendation to permit employers to average such deposits over their workforce and add this amount to employer premium costs when computing Cadillac tax liability.
The Cadillac tax was originally scheduled to begin in 2018. On December 3, 2015, Congress voted to suspend implementation for two years. A majority of both houses of Congress seemed to support repeal. Delay won out because repeal would have boosted the deficit much more than postponement did under budget scoring rules. Now, with the election of a president who has pledged to repeal all or most elements of the ACA, even delayed implementation of the tax is in doubt. We believe that a modified version of the Cadillac tax can still play a valuable role both in fostering health care cost containment and in providing revenues to expand coverage, either under a modified version of the ACA or in an alternative that achieves a similar level of coverage.
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