Lily Batchelder, Fred Goldberg, and Peter Orszag wrote,
Currently the vast majority of tax incentives operate through deductions or exclusions, which link the size of the tax preference to a household’s marginal tax bracket. Higher-income taxpayers, who are in higher marginal tax brackets, thus receive larger incentives than lower-income taxpayers. This Article argues that providing a larger incentive to higher-income households is economically inefficient unless policymakers have specific knowledge that such households are more responsive to the incentive or that their engaging in the behavior generates larger social benefits. Absent such empirical evidence, all households should face the same set of incentives.
Discussing our Hamilton Project paper, Orszag brought this point up with respect to the employer-sponsored health insurance tax exclusion. It’s hard to make an efficiency argument for the regressivity of that exclusion, and it’s tempting to raise its inefficiency as justification for the Cadillac tax …
I’ve enjoyed (more than I should) the excitement around Austin’s posts on Senator Cruz’s health care subsidies. This is partly because we originally made this point more than two years ago. But since you’re all paying attention now, I think it’s worth a brief explanation on why the Cadillac tax matters.
The first thing the Cadillac tax does is apply downward pressure on the cost of health insurance. In other words, it tries to get companies to avoid plans that cost more than $40,000 a year (what do you get with that?) and instead shunt more money into wages instead of benefits. But the second thing it does is limit the “subsidy” that goes to the well-off.
In other words, think of that 40% tax on amounts above the Cadillac tax limits as a means of recouping the ~40% subsidy that people are getting for their insurance. In other words, the Cruz family would get a subsidy only on the first $27,500 of their insurance. The subsidy they would then get is still a LOT ($9900 by my calculation), and would cover a number of people on Medicaid, but at least there would be a limit. Unless you think people who do get $40,000 a year just in health insurance deserve more than $10,000 from the government in subsidies to help pay it.
Sarah Kliff helpfully interprets Mitt Romney’s Meet the Press statements about health reform as meaning he is in favor of preventing individuals with pre-existing conditions from being turned down from a plan if they have continuous coverage. That is, if you remain enrolled in some insurance plan, you can switch from plan-to-plan without any barriers due to pre-existing conditions.
Of course neither HIPPA nor Romney’s portability concept(s) address circumstances in which individuals do not have continuous coverage. That is, they don’t by themselves help the uninsured. Additionally, just because one has access to a plan, doesn’t mean one can find one that is affordable. I know Romney has some ideas that he believes will reduce the cost of insurance (see his vision here). It’s not clear to me that they are intended to match the level of subsidization to low-income families that the Affordable Care Act (ACA) offers. In fact, I think that’s probably the point. That’s one reason why the proposal is likely less costly for the federal government.
Now, neither the Cadillac tax nor HIPAA is ideal. And my point is not that they are necessarily preferable to whatever Romney is offering (though details on his vision are insufficient for a full comparison). My point is only that there are elements of his vision that are already in some way addressed in current law. To some extent, they deviate from better ideas due to political forces that would also buffet Romney’s proposals. That’s political reality.
Finally, striving for universal coverage does not appear to be a priority of the Romney plan. If it is, I haven’t seen how it will work. Of course, Romney once had a pretty good idea in this regard. Once again, it seems like a lot of his vision(s) has (have) already made it into law (portability, tax equivalence, insuring the uninsured). He’s actually fairly good at health policy. He really ought to take more credit for that. I, for one, applaud him. Now, I’d like to see him put his effort into fleshing out some of his more novel ideas.
Don wisely wrote, “There could be some concerns about altering this subsidy before insurance is available in exchanges in 2014 which is something to keep in mind.”
He’s referring to the employer-sponsored health insurance tax subsidy, or the fact that at least the employer paid portion of health insurance is not subject to income and payroll taxation. For those with a Section 125 plan, the entire premium, whether paid by employer or employee, is not subject to those taxes. Most with employer-based coverage have such a plan, though this is frustratingly hard to quantify in detail (best I’ve found is noted here and here).
Now, do we need exchanges before altering the tax subsidy, as the Cadillac tax will do in 2018 and as some suggest we should do ASAP? The answer depends on what employers will do. If they continue to offer coverage, then, no, we don’t need exchanges. If they drop coverage in response to the change in the tax treatment of their plans then, yes, we ought to have exchanges in place to catch those who lose access to insurance.
We actually have some evidence about how employer offers change in response to variations in levels of tax subsidy. Those levels have changed over time, differ by state, and vary by individuals and employers according to differing marginal tax rates. Steve Pizer, Lisa Iezzoni and I exploited those variations in our recent working paper, which includes the following summary.
We estimate the elasticity of offer with respect to tax price at -0.56, which is larger in magnitude than Gruber and Lettau (2004) who found -0.25, and closer to Bernard and Selden (2002) who found -0.52 and Gruber (2001) who found -0.77. Gruber and Lettau use data from an employer survey (the Employee Compensation Survey) and employer surveys typically find higher offer rates than individual surveys (discussed in more detail by Bernard and Selden). Higher offer rates imply lower elasticities, holding effect sizes constant. The employer offer rate in our data (66%) was lower than Gruber and Lettau (91%) and lower than Bernard and Selden (83%) who restricted their sample to full-time workers and their families. [See working paper for full references.]
Translation: Tax price is the cost of employer-sponsored insurance in terms of foregone wage. The higher the marginal tax rate, the less in wages one has to give up to get a dollar of employer-sponsored insurance, the lower the tax price. The intuitive way to think about this is that the government is kicking in a larger subsidy, the amount in taxes it does not collect. Offer elasticity is the percent change in the probability of offer divided by the percent change in tax price. All elasticity estimates reported above are negative. As tax price goes up (as health insurance costs more in terms of foregone wage), employers are less likely to offer insurance. The estimates differ in degree of sensitivity, reflecting differences in data and methods.
But, even with those differences, qualitatively we know what to expect from increasing taxation of employer-sponsored plans. It can only encourage employers to drop coverage. Maybe not a lot, but it will have some effect. The effect may be swamped by the countervailing effect of a mandate, say, but there will be some effect. For this reason, it is probably a good idea to have exchanges in place.
I should say a few words about how the foregoing meshes with my post earlier today about employer offers in Massachusetts. As the data show, they have gone up. However, this is not a test of the Cadillac tax or any other substantial change in taxation of employer-sponsored health insurance. I’m not aware of any big changes to how those plans are taxed in Massachusetts (readers, correct me if I’m wrong on this). I think Massachusetts has been a test of the mandates (individual and employer) and subsidies. Changing the tax treatment of employer plans is a different experiment.
This is by far the clearest and most comprehensive explanation of the various tax subsidies provided for health care in our tax code that I have seen, from www.kaiseredu.org (around a 15 minute video with great slides by Larry Leavitt). If the super committee begins discussing tax reform, altering the tax preference provided to employer provided health insurance is a straightforward way to have a consequential impact on health care costs, as well as to reduce the deficit.
The Affordable Care Act has a de facto capping of this subsidy in the form of the tax on high cost insurance that was delayed until 2018 in the law, so Democrats have already voted for this. Altering the tax treatment of employer provided insurance is a hallmark of just about all Republican health reform plans, so this could be a place for an agreement. There could be some concerns about altering this subsidy before insurance is available in exchanges in 2014 which is something to keep in mind. It would be great if everyone watched this presentation before the fur starts flying.
Steve writes in politico his health policy grand bargain that he says would reduce spending by around $4 Trillion over 10 years and let both sides declare victory.
End the tax preference of employer paid insurance
Transition Medicare to defined contribution program for those under age 54
Block grant Medicaid
Adjust several aspects of the ACA (lessen subsidy triggers, end taxes imposed on device makers, etc.)
I wholeheartedly endorse his first suggestion. He correctly notes that while Republicans have long talked about reforming the tax treatment of employer paid insurance, the Democrats actually did it via the tax on high cost plans that is delayed until 2018 in the ACA. Ending or even capping the tax preference afforded to employer provided insurance and doing so earlier is easily the most consequential thing we could do to address health care costs in the private portion of the system. And it is a flexible policy that will improve the ability of the ACA framework to address costs that would also work as intended regardless of the direction that health reform takes. I wrote about doing so here and here and have done so bazillion times on the blog.
And my version of what the grand bargain would look like is here. Stepehen and I would likely quibble forever about many parts of what we have suggested as the middle ground ‘way forward’. But not about changing the tax treatment of employer paid health insurance. Here is what I wrote in March, 2010 just after the passage of the ACA:
The most bipartisan cost-control approach among health policy experts is ending, or limiting this subsidy. Democratic politicians are slower to convert, but I suspect some of the Republican support is strong because it is easy to be for something that seems impossible. The commission could help change that sense. [I was talking about the Fiscal Commission]
Capping or ending the tax exclusion would greatly improve the cost-saving potential of the newly passed reform. And such a policy is flexible, and would work well alongside any imaginable change (either to the right or left) to the framework enacted by the Senate bill.
update: Igor Volsky writes with a good point that it would probably be better to wait until 2014 to cap/end the tax preference for employer paid insurance when exchanges will exist to provide more insurance options.
On the heels of the Ryan budget comes word that the President will release a long term deficit reduction plan Wednesday, the details of which are unknown. This week, I am going to look back at several aspects of the Fiscal Commission final report that was released in December, 2010 to provide some context for the coming debate.
It is worth recalling that the report was approved 11 to 7, but that it needed 14 (of 18) yes votes to guarantee an up or down vote on the Report in Congress.* 12 of the 18 members of the commission were members of Congress at the time, and it is interesting that 5 of the 6 U.S. Senators on the Commission voted for the report, while 5 of the 6 members of the U.S. House voted against it. If there is momentum towards any sort of bipartisan health reform deal or long range deficit reduction approach that includes tax reform, Medicare, Medicaid or Social Security, it could be expected to bubble up first in the Senate, where a bipartisan gang of six has been discussing deficit reduction along the lines of the Commission report.
Tax reform is the general term for alterations of the income tax code, and includes changes in marginal tax rates as well as deductions and tax credits. The last major tax overhaul came in 1986. Over time, Congress has enacted many deductions and credits which are together called tax expenditures, and which either reduce a persons taxable income or directly reduce their income tax owed. Tax expenditures serve to advantage some tax payers over others, based on their circumstances (such as having children). Each of these changes were no doubt well intentioned policy changes, but they serve to reduce the amount of tax revenue received by the Treasury just as increases in explicit spending does (Military, Medicare, Agricultural subsidies, etc) and are viewed by some as unfair since many benefit relatively high wage earners. Further, they are not as widely understood as is direct spending to increase the budget deficit. To achieve a balanced budget, the ins (taxes) must match the outs (explicit spending and tax expenditures). There is a trade-off between marginal rates and tax expenditures and different combinations could raise the same amount of revenue, holding all else equal. These seemingly esoteric tweaks of the tax code are very important policy choices.
One of the key tables in the Fiscal Commission Final Report, is Table 6 on p. 29:
This table demonstrates the relationship between the marginal tax rates of the 2010 (and current) tax code** and what a revised tax code with fewer and lower marginal tax rates could be IF different combinations of tax expenditures are removed. If all expenditures are removed (like the home mortgage deduction, preferential tax treatment of employer paid insurance, child tax credit, deduct money given to your church, etc.) then the lowest rate would be 8% and the highest 26%. Note, that in each of the 3 scenarios shown, $80 Billion is dedicated to deficit reduction in 2015; the point being that if the increased revenue is spent on new programs, or to finance further tax cuts, there will be no deficit reduction effect. Fewer and/or smaller tax expenditures mean lower marginal rates, and vice versa, all else equal.
The Fiscal Commission identified an illustrative tax reform plan that ended many tax expenditures and capped others. Table 7 on p. 31 of the Fiscal Commission report details the mix of tax expenditures that would remain, and which would result in a lowest marginal rate of 12% and a top one of 28%. I want to highlight what this illustrative plan did to the tax exclusion of employer paid health insurance. From Table 7 (this is only part of the original table, the full table is at the end of the post):
The Fiscal Commission illustrative proposal would cap the tax exclusion of employer provided health insurance at the 75th percentile of premiums in 2014, and slowly move to end this tax expenditure totally by 2038. If the 75th percentile of premiums was $23,000 in 2014, then if your employer paid $23,000 or less for your health insurance in that year you would incur no tax liability on those premiums. If your employer paid $25,000 in premiums, for example, then $2,000 of this (amount above the cap) would be taxable as income in your marginal tax bracket. In 2038, the full amount paid by an employer on behalf of an employee for health insurance would be taxable income. The excise tax on high cost health insurance that is set to come into force in 2018 via the Affordable Care Act would be reduced to 12% under this proposal. Overall, this proposal would do two things as compared to ACA.
Address the tax treatment of employer paid insurance in 2014 instead of waiting until 2018 to do so via the excise tax on high cost insurance; this would increase the cost saving potential of the ACA.
Help focus attention on the fact that it is people like me who get employer based insurance who benefit from this tax expenditure.
The tax on high cost health insurance could work to slow health care costs by putting downward pressure on premiums in the same way that capping the tax exclusion could; indeed, there should be some tax on high cost insurance that would have the same impact as capping the tax exclusion at a certain level. However, I believe that it would be preferable to achieve most or all of this effect via capping the tax exclusion instead of imposing the tax on high cost insurance because it would help to highlight that the subsidy flows to employees receiving the health insurance. The high cost excise tax was sold rhetorically as a tax on insurance companies, while it is actually just a capping of a now unlimited tax benefit that flows to persons obtaining insurance from their employer. This subsidy is not understood by most employees. During the health reform debate I became obsessed with asking coworkers about the amount of tax free income they received via Duke’s employer paid health insurance premiums. Most said none. They were of course wrong, and I work at a school of public policy! Further, I believe that it would be simpler administratively than imposing an excise tax on high cost health insurance. The exact mechanism through which the tax on high cost insurance will be levied and passed onto employers and employees is unclear to me, but the tax would have to be passed on to have the intended effect, which is to incentivize less generous insurance as relatively expensive policies are taxed. Capping the tax exclusion has the same health policy goal.
Reforming the tax treatment of employer paid health insurance is a simple way (that is politically hard) to slow the rate of health care cost inflation. If the country turns to tax reform in the next weeks and months, health policy types shouldn’t tune out, because changing the tax preference of employer provided insurance is likely the most consequential way of improving the cost saving potential of the ACA, or any health reform alternative that I can imagine.
*I am unsure of what ‘an up or down vote in Congress’ would have really meant since the entire plan is not in legislative language.
**note the scheduled rates for 2011 in table 6 did not come to pass as the 2010 rates were extended in Dec. 2010.
In some recent posts (one, two, three) I’ve been discussing how the Cadillac tax provision of PPACA can be expected to shift some workers from private insurance to public insurance. This is the topic of my recent working paper with Austin and Lisa Iezzoni. One question raised by our results is: how can the Cadillac tax, which is aimed at high-premium health plans, affect public insurance enrollment, which is limited to low-income individuals? Isn’t it true that those covered by high-premium health insurance are high-income workers?
This turns out to be a difficult question to answer empirically because most surveys collect data either from households or from firms, not from both. The few that we know of that link workers to firms are not available to researchers outside of the Census Bureau.
We used the Medical Expenditure Panel Survey, which is a household survey that doesn’t have premium information but collects data on health care spending and insurance coverage. We tabulated privately covered spending on physician services by firm size-state-family income quintile cells to approximate the distribution of premiums. We assumed that physician spending is proportional to total health care costs and that total costs are proportional to insurance premiums (spending on hospital services is very noisy, reflecting variation in health more than variation in coverage). The results for the top 20% of the spending distribution (those expected to be affected by the tax in 2018) are illustrated below.
These results suggest that firms paying high health insurance premiums may be as much as four times more likely to employ high-wage workers than low-wage workers. Nevertheless, substantial numbers of low-wage workers are employed by these firms and it is these low-wage workers who are most likely to shift from private to public insurance in response to the Cadillac tax.
Our recent working paper raises questions about how much the Cadillac tax provision of PPACA will induce workers to shift from private insurance to public insurance. The idea is that the Cadillac tax will affect an increasing share of workers with private insurance, making compensation in wages more attractive over time (relative to compensation in health benefits). The likely result is that employer-sponsored health insurance will become less generous and some of the workers who qualify for public insurance will chose it instead. We used historical variations in tax rates to estimate how the likelihood of public and private coverage were affected by changes in tax laws. The results are shown in the chart below.
These results indicate that workers in the lowest four deciles (labeled D1-D4) are less likely to obtain private coverage when tax subsidies decline while the likelihood that they will obtain coverage from public insurance increases in response to the same tax change (although not as much). We also see an increase in the probability of public coverage among high-wage workers (especially in the top two deciles, labeled D9 and D10) that reflects improved relative attractiveness of TRICARE, the public insurance program for retired career military personnel. As discussed in a prior post, we predict that these effects will combine to shift about 3% of workers and their families from private insurance to public insurance as the impact of the Cadillac tax grows from 2018 to 2030.
The Patient Protection and Affordable Care Act (PPACA) imposes a 40% excise tax on insurance premiums above a threshold. This tax, intended to help limit the growth of health care costs, was referred to as the Cadillac tax during debate on the legislation because the threshold was set high enough to exempt all but the most expensive insurance policies when it goes into effect in 2018. The tax thresholds are indexed to inflation, but health insurance premiums have historically grown faster than general inflation, as shown by the chart below from the Kaiser Family Foundation.
If these trends continue, the thresholds for the excise tax will affect a larger and larger share of the distribution of premiums every year. In our recent working paper (also available here) we calculated the expected value of these thresholds in 2018 and 2030 and (using 2009 dollars) compared them to the distribution of premiums in 2009.
The threshold for family coverage will be $27,500 in 2018. Assuming health care costs grow at 6% per year (which is low by historical standards), the 2009 value of the threshold is $27,500 x 0.949 = $15,757. This was roughly the 80th percentile of the family premium distribution in 2009 according to the figure below, which has a vertical line marking this point (graphs reproduced from Kaiser Family Foundation). The calculations for the individual premium distribution are $10,200 x 0.949 = $5,845.
So the thresholds will fall at about the 80th percentile of the family and individual premium distributions in 2018. Starting in 2020 these thresholds are indexed to the CPI, but medical inflation has averaged about 2.5 percentage points above GDP growth since 1970. If we assume that health care costs will grow 2.5 points faster than inflation (CPI + 2.5 is more conservative than GDP + 2.5), then these tax thresholds will fall at about the 50th percentile of the premium distribution in 2030.
As we discuss in our working paper, these calculations suggest that the excise tax will affect a lot of workers and firms pretty quickly. The expected effects of the tax include making private insurance coverage less generous, causing employee contributions to increase, shifting total employee compensation from health benefits to wages, and encouraging more workers to take up public insurance if they qualify instead of private insurance. It may also raise a great deal of revenue.
In our opinion, reducing the generosity of some employer-sponsored insurance is desirable because it helps reduce health care cost growth and bring down the federal deficit. The shift in compensation from health benefits to wages is also probably a good thing for the same reason. The tax-induced shift from private to public insurance is a more ambiguous outcome. If public insurance is adequately funded we have nothing against it, but we are concerned that this shift may not have been accounted for in the official scoring of the law.
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