• Reforming the Tax Treatment of Health Insurance

    In Decmember, 2010 I wrote a post identifying what I thought a health reform compromise between Progressives and Conservatives might look like. One of the suggestions was reforming the tax preference now given to employer provided health insurance (Aaron and Austin on the mechanics). Here is what I wrote in December:

    End the tax exclusion of employer paid insurance. This is easily the most consequential policy that we could undertake to slow cost inflation in the private market. The Deficit Commission suggested this. It has long been a mainstay of Republican health care plans, like Sen. McCain’s, and the Patients’ Choice Act, the most comprehensive Republican bill submitted in the last Congress (but never scored by CBO). The tax on high cost insurance that is in the ACA (delayed by the reconciliation bill until 2018) is a back door way of achieving the same policy goal of slowing cost inflation. It would be better to cap this tax subsidy in a more straightforward manner and to do so sooner rather than later. It will take both sides to take this politically difficult step.

    There is word that reforming the tax preference of employer paid insurance is being discussed in the debt ceiling debate. I think the current debate about raising of the debt ceiling is one of the dumbest debates ever; Congress already voted for the spending, they are now voting to tell the executive branch to carry out the spending they already approved!

    However, if there is a reform of the tax treatment of employer paid health insurance that would be good news, no matter how it comes about. For wonks, it is the most obvious next step for anyone who thinks we need to address health care costs. Avik Roy for example is for it and we often disagree on many things, but not on this. Further, the debt ceiling debate is the type of negotiation that might be the only way to take the most obvious next step to address health care costs, because it is removing a powerful subsidy that benefits upper middle class persons with good employer-provided health insurance (like me).

    Democrats have already voted for it in the ACA (the tax on high cost insurance is a de facto capping of this subsidy), and Republicans almost always have a reform like this as the center of their health reform plans. Taking this step will expand the ability to the ACA to address health care costs, but it is also a flexible policy that will work as intended alongside of any reform approach I can imagine.

    Update: since the demise of the Clinton Plan, just about every Conservative reform plan has had changing the tax treatment of employer paid insurance as key. Pauly and Goodman in 1995, etc. Interestingly, it was the Dems that first passed a capping of the unlimited preference in the form of the high cost insurance tax. If both sides limit it in a more straightforward manner and do it sooner than 2018 it will be a big step, and dare I say, a bipartisan move ahead on health reform (that probably dooms it).

    • I’d really like to see an analysis of the distributional impact of this. How heavily would it hit those at various income levels?

      It appears that employer insurance is cheaper than individual insurance, in part because individual employees can’t opt out (individual mandate) and in part because of the power of group buying. To the extent ending the tax deduction ends these benefits, they should be replaced with something, such as the ACA’s exchanges.

    • Don, are you aware of this Health Affairs piece I wrote with Mark Pauly. Most people regard it as the classic statement of how government should subsidize health insurance through the tax system:


      It combines a lump sum refundable tax credit with a Roth Health Savings Account. That gets the incentives right in all directions. It puts current health and current consumption of other goods on a level playing field under the tax law. It puts current consumption (health and nonhealth ) on a level playing field with future consumption (again, both health and nonhealth). And it levels the playing field between third-party insurance and individual self-insurance.

      • @John Goodman
        I use your paper and others from that issue in my class…along with other stuff that has come out later on tax treatment of insurance. You think they include some change in the tax treatment in a debt limit deal?

    • Excellent. Let us hope this gets through.


    • The ACA brings us closer to being able to push people into the individual market in an ethical way. It provides some protection for people with pre-existing conditions and people who are older but not old enough for Medicare. These protections may need to be strengthened if millions are pushed into the individual market, but they make weakening the employer-based health insurance more defensible. So would, as Foosion suggested, using the ACA exchange to give individuals the power of group buying.

    • The truly novel thing about that article was the Roth Health Savings Account. To get all the incentives right, it’s very important that it be a Roth: after-tax depostis and tax free withdrawals. John McCain’s folks never understood that concept. Neither did Coburn/Burr/Ryan/Munes etc., in an otherwise very good bill. The Heritage Foundation has finlly endorsed the full idea — 15 years after the fact!

      Since that time we have added another component to the proposal at the NCPA that we think is very important: Unclaimed tax credits need to be directed to safety net institutions in the localilty where the unisured individuals reside. The full explanation in Ten Characteristics of an Ideal Health Care System: http://www.ncpa.org/pdfs/st242.pdf
      which you may also want to add to your reading list.