The so-called Cadillac tax on high-cost health benefits is only slightly less progressive than capping the tax exclusion on the $250-billion annual tax break for employer health coverage because employers are likely to try and avoid paying either tax by restructuring health benefits, especially under the Cadillac tax, according to a new study from the nonpartisan, nonprofit National Institute for Health Care Reform (NIHCR).
But to the extent that taxes are paid—rather than premiums reduced to the threshold for taxation—the distributional implications of the Cadillac-tax approach—a 40-percent excise tax on high-cost benefits—could be important, according to the study by NIHCR Research Director Paul B. Ginsburg, Ph.D., also Norman Topping Chair in Medicine and Policy at the University of Southern California, and coauthors Chapin White, Ph.D, a RAND Corporation senior policy researcher; Christine Eibner, Ph.D., a RAND senior economist; and Sarah Nowak, Ph.D., a RAND physical scientist.
During debate of the 2010 Affordable Care Act (ACA), efforts to raise revenue and contain costs ultimately resulted in a 40-percent excise, or Cadillac, tax on premiums of health benefit plans that exceed $10,200 for individuals and $27,500 for families starting in 2018. The ACA also prohibits insurers and self-insured employers paying the Cadillac tax from deducting the payments as a business expense for federal tax purposes.
Under the tax-cap approach, higher-income people bear a higher tax burden because lower-income workers have lower marginal federal income tax rates. So if a premium exceeds the cap, lower-income employees will pay less in additional tax than higher-income employees. But to the degree that an insurer or employer is paying a 40-percent excise tax and decides to shift that cost to employees through lower wages, this could impact lower-wage employees disproportionately, according to the study. Within any company, the costs of health insurance provided to lower-wage employees—and thus the amount of excise tax due—would be larger in relation to their wages.
“While the tax-cap approach would be slightly more progressive than the Cadillac tax, the likely employer responses substantially reduce the differences,” Ginsburg said. “But, because, the Cadillac tax isn’t a deductible business expense, employers are likely to be much more aggressive in restructuring health benefits to avoid paying the excise tax, potentially increasing the impact on health care costs but also leading to larger changes for employees.”
The $250-billion annual tax break for employer-sponsored health insurance is among the most expensive—but nearly invisible—federal expenditures. Under current law, the value of both employer and most employee contributions for health insurance are excluded from employee federal income tax and employer and employee payroll taxes.
The study’s findings are detailed in a new NIHCR Research Brief—Limiting Tax Breaks for Employer-Sponsored Health Insurance: Cadillac Tax vs. Capping the Tax Exclusion—available here.
Focusing on 2020 and using the RAND Compare model to simulate health insurance offering behavior by firms, researchers calculated thresholds for a tax-exclusion cap that would raise the same revenue as the ACA Cadillac tax provision. The tax cap would have a threshold—or attachment point—in 2020 of $28,178 for family coverage compared to $29,118 for the Cadillac tax. So more families would be impacted by the tax cap—21.4 percent vs. 17.3 percent—but with smaller impacts per family. Under both approaches, higher-income families are more likely to be affected than lower-income families.
Revenue gains come from both payment of excise taxes and income taxes for premiums in excess of the attachment points and income taxes generated from wage increases to compensate employees for health benefit reductions when employers restructure benefits to reduce premiums to avoid paying taxes. More than half of the federal revenue increase comes from taxes on wage increases, diminishing differences in progressivity between the two approaches. Only about a third of Cadillac tax revenues is from the excise tax; the rest comes from taxes on higher wages to offset reductions in employer spending for health benefits, according to the study.
Impacted families below 200 percent of poverty lose $105 less per year under the tax cap than under the Cadillac tax. Impacted families with incomes between 200 percent and 500 percent of poverty lose $72 less under the tax cap, while those with incomes in excess of 500 percent of poverty lose $57 more under the tax cap. While differences in progressivity are in the expected direction, they are quite small.
“The strong incentive for insurers and employers to significantly restructure benefits to avoid paying the Cadillac tax is less than ideal,” Ginsburg said. “In contrast, the tax cap likely would yield a mix of tax payments and benefit restructuring. Congress also could diminish the strong incentive to restructure benefits under the Cadillac tax by making the excise tax payments deductible.”