Employer-sponsored health insurance coverage is a unique feature of the American health care system. About 158 million individuals in the country under age 65 get their insurance through an employer. Employer-sponsored insurance became very common during the World War II era. The federal government placed wage caps on employers to control rising wages and prices. However, as a concession, the federal government decided to exempt employer-provided health benefits from income and payroll taxes. Despite the wage caps, employers could now compete for labor by offering generous, tax-free health benefits. The natural result of this was that many employers started offering health insurance to employees.
The tax-exempt status of employer-sponsored health insurance has long been a point of debate in the broader health care conversation. The so-called Cadillac tax, a tax on employer-sponsored health benefits whose value is greater than a specified limit, was created to try to offset some of the effects that tax-exempt health benefits have on the market. In mid-July, the U.S. House of Representatives voted to repeal the tax by a vote of 419-6. It is unknown whether the Senate will take any action on the bill. In this research brief, I will put the Cadillac tax in the context of the health care debate and look at some possible outcomes if the tax were implemented or repealed.
History of the Cadillac Tax
The Cadillac tax was introduced as part of the Affordable Care Act when President Obama signed the law in 2010. Initially, the tax was to take effect in 2018. However, legislation was passed in 2015 that delayed the law until 2020, and another piece of legislation in 2018 delayed the implementation of the tax until 2022. Now the tax has been entirely repealed by the U.S. House.
ACA in Court
Of course, the current debate in Congress concerning the Cadillac tax would be a moot point if Republican-led states and the Trump Administration have their way and the ACA is thrown out. In 2018, District Court Judge Reed O’Connor heard Texas v. Azar which was brought by 18 state attorneys general. The plaintiffs argued that because Congress had zeroed out the tax penalty associated with the individual mandate, the law no longer has tax authority and therefore must be completely invalidated. The case is now being heard in the Fifth Circuit where a ruling to uphold Judge Reed’s decision will likely initiate a Supreme Court challenge. A ruling to strike down Judge Reed’s decision could cement the law into place once again.
What could happen if the tax is implemented? Repealed?
Health care scholars and industry insiders have differing views on whether the tax should be implemented. There are no clear-cut coalitions that fall along party lines. At the heart of the debate is the question of whether to require expensive health plans to pay a tax on the premium dollars they spend above a certain threshold.
Here is how the tax would work. Right now, every dollar spent by an employer on an employee health plan is tax-exempt. With the implementation of the Cadillac tax, dollars spent above a certain threshold would be taxed at a rate of 40 percent. In 2022, when the law is supposed to go into effect, the thresholds for the tax would be any amount above $11,200 for single coverage and $31,000 for family coverage. The threshold limits will rise each year based on the consumer price index. A report from the Kaiser Family Foundation found that if the tax is implemented, one in five employer plans could be affected. This could grow even higher as the threshold limits are tied to general inflation, instead of health care inflation, as the latter tends to rise faster.
Believe it or not, labor unions and large employers are generally on the same side on this issue. They want to see the tax repealed. It is cheaper for employers to provide tax-free health benefits than taxed income. Those who believe the tax should be repealed also believe that if the law were implemented, employers would find ways to shift the additional costs imposed through the tax to the employees through higher deductible plans.
It is hard to get a group of health care scholars to agree on something. However, a sizeable number of prominent scholars agree that the tax should go into effect. Over 100 health economists and policy analysts from the Right and Left sent a signed letter to Majority Leader Mitch McConnell and Minority Leader Chuck Schumer stating,
The Cadillac tax will help curtail the growth of private health insurance premiums by encouraging employers to limit the costs of plans to the tax-free amount. The excise tax will discourage the provision of insurance that covers such a large proportion of health care spending that consumers have little incentive to insist on cost-effective care and providers have little incentive to provide it.
Those who support the tax believe that it will incentivize employers to find creative ways to provide the same level of coverage and reduce costs to avoid the tax. Or, per the law’s intention, employers will reduce the generosity of their plans, incentivizing patients to cut costs and shop for cost-effective providers. More individuals could buy insurance in the individual market, as well, strengthening the risk pool and lowering premiums.
Another aspect of this debate is the impact on the federal deficit. A new Congressional Budget Office estimate says that the complete repeal of the tax would increase federal deficits by about $197 billion between 2020 and 2029.
Whether Congress repeals the law or not remains to be seen. But what we do know is that repealing, or further delaying the law, will likely exacerbate the negative impacts of completely tax-exempt employer insurance. People will continue to consume more health care than they would if the tax preference had not been in place. It will also increase the federal deficit, which currently sits at $22 trillion. Implementing the Cadillac tax may also help simplify the tax code and create a more level playing field among large employers and smaller employers who provide health insurance to their employees. Reducing health care costs, funding government commitments, and simplifying the tax code are all worthwhile goals. As the Tax Foundation points out, implementing the Cadillac tax may move us closer to those goals.