How will the Cadillac tax shift low-income workers to Medicaid?

In his first post here at the Incidental Economist, Don Taylor (welcome Don!) suggests that capping the tax exclusion for health insurance premiums would be better policy than the Cadillac tax that is part of the Affordable Care Act.  He gives two reasons.  One is that a cap would be more progressive tax policy—it would tax low-income workers at a lower rate than high-income workers.  I agree that this is correct and would be desirable.  Don’s second reason is that he thinks a cap would shift fewer low-income workers to Medicaid than the excise tax.  This shift is a potential problem that I’ve discussed in recent posts here and here.  Unfortunately, I don’t think Don is right that a cap would be better.

As we review in our recent working paper, the standard economic theory of employer-sponsored health insurance says that employers choose to divide total compensation between wages and insurance benefits based on the average marginal tax rate of their workforce, weighted by the relative marginal utilities of wages and health insurance for each worker.  If firms choose generosity of coverage and premium levels based on tax rates averaged across workers, then even a tax increase targeted exclusively at high-income workers will result in less generous coverage and higher employee contributions to the firm’s health plan required from all workers.  The incentive for low-income workers to shift to Medicaid lies in these changes to the firm’s plan; it doesn’t arise directly from the tax.

As I said in my original post on this subject, we don’t have a philosophical objection to having more people covered by Medicaid, but we think this shift should be accounted for in the official budget scoring and as far as we can tell it hasn’t been.

 

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