Feb. 22, 2016
Discussion Draft
Replacing the Evil “Cadillac” Health Plan Tax – A Dance with the
Devil!
Karl Polzer, Center on Capital & Social Equity
Battle lines are forming around the Affordable Care Act’s (ACA’s) tax on highcost health plans, scheduled to start in 2018. Defenders say it’s an important
feature of the law, in place to keep the costs of health plans and coverage
expansion under control. Opponents counter that it’s a blunt instrument that
unfairly targets plans whose costs are high for reasons beyond the control of those
running them. Health plans can be expensive for many reasons including covering
a disproportionate percentage of sicker, older people and paying for services in
places with high medical costs. Unions that have bargained for generous benefit
packages also object to the new tax.
The “High Cost Plan Excise Tax” (or Cadillac plan tax) serves intertwined
purposes in the ACA’s drive to increase health coverage. By penalizing high-cost
benefits, it raises revenues that can be used to cover more people. More important,
it is designed to counter an imbalance embedded in the U.S. tax code that provides
an incentive for employers to offer health benefits instead of higher wages. Since
the 1950s, employer contributions for health benefits have been tax-exempt for
employees, while wages are taxed. Most policy analysts and economists think that
promoting health benefits over wages is a bad idea; commonly shared resources,
like health benefits, are prone to inflate in cost at a greater rate than wages or
goods and services in general.i Today’s tax breaks for job-based health benefits, in
effect, create incentives that tend to accelerate health care costs. The Cadillac
health plan tax is way to try to apply the brakes.ii
Exempting employer contributions for health benefits from income tax also has
been criticized as unfairly favoring higher-paid employees, because the higher a
person’s tax bracket, the greater the monetary value of a tax break. Because of the
1
tax exclusion, company executives, in effect, pay about 60 cents for every dollar of
health benefits they receive, while minimum-wage workers pay roughly 90 cents
on each health benefit dollar.
The Cadillac plan tax, which soon will impose a 40-percent surcharge on the value
of health benefits exceeding a threshold of $10,200 for self-only coverage and
$27,500 for family coverage, may already be affecting marketplace behavior.
According to a recent analysis, 19 percent of employers in 2015 already had a plan
whose value exceeded the new tax’s benefit thresholds. By 2028, 42 percent of
employers would have at least one such plan.iii
Below, this paper explores approaches to replacing the Cadillac Plan Tax that
would be: 1) more effective, because they would send price signals to decision
makers in all health plans, not just those in the most expensive plans, and 2) fairer
for lower-paid employees. One problem with the current Cadillac tax scheme is
that the incentive to restrain the growth of benefits directly impacts only plans at
the upper extreme. Another problem is that, by taxing the plan or employer, the
burden of paying the tax will likely be passed on to low-paid as well as high-paid
employees.
Option 1
One way to create a stronger incentive to restrain the growth of health benefits that
is possibly more visible to individuals, while protecting lower-paid employees’
ability to afford coverage, could be to replace the Cadillac tax with the following:
1) Start including employer-financed health benefits in employees taxable income,
and, instead, 2) Provide a tax credit of a fixed amount for ALL covered employees
that is equal to the value of the current tax exclusion for middle-income
employees. This could be done in a budget-neutral way (or not), depending how
large the tax credits are. To see percentages of taxpayers in each bracket, see the
Appendix below.
With some tweaking, under such a change, lower-wage employees could be held
harmless from ending the tax exclusion, and those with higher wages would have
an incentive to keep health costs under control since their tax benefit no longer
would increase in tandem with the cost of the health package. The new fixedamount tax credit could be indexed to health care inflation or general inflation, or a
2
combination. It could also be adjusted for regional medical cost differences,
though the simpler the design the better.
Exposing higher-paid employees to the risk of health care cost inflation makes
sense as a way to incentivize cost savings. It’s likely that higher-wage employees
are better situated to influence management in designing health benefits. Most
important, such a system would imbed an incentive to examine health care costs
among a large number of employees in all health plans, not just in plans that
happen to approach a relatively high threshold.
While this proposal is probably superior to the Cadillac plan tax in many ways, it
would face political opposition. In fact, many would say: “Dead on arrival.” Just
as a tax credit of a fixed amount would make higher-paid employees more price
sensitive, such a change would also be seen as a tax increase, even though it might
help increase their wages in the long run by dampening health cost inflation.
Option 2
To address this political concern, the proposal could adjusted so that workers with
health benefits received a tax credit that rose along with their effective tax rate in a
way that held the bottom half of taxpayers harmless, but that provided a small, but
growing, monetary incentive for the those with higher income to support cost
savings in health benefits. For example, people below the median tax rate could
receive tax credits roughly providing full replacement of what they lost in tax
exclusion and also be held harmless from the impact of excess medical inflation,
while those with higher incomes could get tax credits initially roughly equal to or
slightly less than what they would have gotten under the current tax exclusion and
indexed to inflation less favorably. Over time, price signals facing the better-off
would slowly amplify unless the health plan costs were kept in line with overall
inflation.
But these policy tweaks to Option 1 would probably create another political
problem. The new tax credits would be more transparent than the current tax
exclusion. Critics now could easily compare a $2,000 tax credit that a company
executive would be getting toward the cost of a $5,000 health benefit package with
a $750 credit that the low-paid employee was receiving. And many might cry:
"That's unfair!" or “That’s wasteful – bad targeting of taxpayers’ money.” It is
3
ironic that the overt disparities in tax credits would simply reflect the hidden
unfairness of today’s tax exclusion.
Option 3
A simpler way to impart price sensitivity to higher-paid employees while
protecting those with lower incomes could be to cap the tax exclusion and provide
a limited deduction or tax credit for health benefit amounts that exceeded that
threshold. This could be fairly simple to administer now that employers are
required to estimate and report the value of health plans. For example, if the
threshold were set at the top of the 25 percent tax bracket, to the extent the health
benefits increased income beyond that amount, taxpayers could receive a credit of
25 percent of the portion exceeding the limit. In this way, the relative magnitude of
the tax break would not increase with the tax rate. The total allowable tax credit (or
deduction if structured that way) could also be capped at some amount.
How would this work? If the threshold for the tax exclusion were set at the top of
the 25 percent tax bracket, which is estimated at $91,150 in 2016 for a single filer
(see table below), then any amount of employer provided health benefits still
below the threshold after being added to income, would be excluded from taxation.
To the extent that employer-provided benefits caused total income (health benefits
plus wages) to exceed the threshold, the tax credit or deduction would reduce the
cost of health benefits falling above the exclusion threshold by no more than 25
percent (or whatever percent deemed appropriate). This policy could be
implemented gradually by initially setting the tax exclusion threshold a bit high,
then gradually lowering it each year to a desired point.
Such a tax scheme is not revolutionary. Taxation of employer-provided life
insurance is already is handled in similar fashion.iv A fixed amount of employerprovided life insurance is excluded from taxation. Amounts above that are taxed.
4
2016 Taxable Income Brackets and Rates
Rate
Single Filers
Married Joint Filers
10%
15%
25%
28%
33%
35%
39.6%
$0 - $9,275
$9,275 - $37,650
$37,650 - $91,150
$91,150 - $190,150
$190,150 - $413,350
$413,350 - $415,050
$415,050+
$0 - $18,550
$18,550 - $75,300
$75,300 - $151,900
$151,900 - $231,450
$231,450 - $413,350
$413,350 - $466,950
$466,950+
Source: Tax Foundation
As stated above, existing tax breaks for health benefits create incentives that tend
to accelerate health care costs. The Cadillac health plan tax is way to try to apply
the brakes. The political smoke now coming from health plan lobbyists should not
be a surprise. When brakes are applied to any system while the accelerator is still
being pushed, it’s no wonder that it would begin experiencing some friction and
instability. Also, no one likes to pay more for something.
But people needn’t worry too much about dramatic change. The American health
financing system is replete with complex and often conflicting incentives. Because
of the politics in play, it’s possible that the Cadillac plan tax may eventually be
repealed with no replacement. Another possibility is that regulators may end up
kicking its implementation down the road, much they have with the ACA’s
employer penalties for not offering coverage or for offering plans that don’t meet
federal standards.
___________
Appendix:
5
The chart below shows the distribution of taxpayers by tax bracket.
Endnotes:
i
For background, see “Retooling Tax Subsidies for Health Coverage: Old ideas, New Politics,” Karl Polzer, National
Health Policy Forum, Nov. 21, 1998. http://www.nhpf.org/library/issue-briefs/IB728_TaxSubsidies_11-12-98.pdf.
ii
In “Kill the tax exclusion for health insurance,” National Review, Aug. 19, 2014, Thomas Miller suggests “moving
toward a fixed-percentage tax credit, which would eventually provide the same level of tax code “discount” for
health-insurance-premium costs for anyone purchasing coverage — whether as individuals or through grouppurchasing arrangements. That would effectively subsidize low-income Americans more, and high-income ones
less, compared with the current tax exclusion for workers who receive job-based coverage.”
iii
“How Many Employers Could Be Affected by the Cadillac Plan Tax?,” Gary Claxton and Larry Levitt, Kaiser Family
Foundation, 2015.
The Internal Revenue Code’s section 79 provides an exclusion for the first $50,000 of group-term life
insurance coverage provided under a policy carried directly or indirectly by an employer. There are no tax
consequences if the total amount of such policies does not exceed $50,000. The imputed cost of
coverage in excess of $50,000 must be included in income, using the IRS Premium Table, and are
subject to social security and Medicare taxes.
iv
6