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Obamacare’s “Cadillac Tax” – A Poor Patch for a Hole in the Income Tax

1 min readBy: Alan Cole

The “Cadillac TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. ” provision of the Affordable Care Act, which levies a 40 percent marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. on expensive employer-provided insurance, is unpopular in some circles. The Cadillac TaxThe Cadillac Tax is a 40 percent tax on employer-sponsored health care coverage that exceeds a certain value. The aim: to curb health-care cost growth, reduce favorable tax treatment of employer-provided insurance, and help fund the Affordable Care Act (ACA). It was repealed in late 2019 before taking effect. is not ideal, but Cadillac plans – and other health care plans, too, for that matter – should be part of the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. .

Health benefits are known as “in-kind” compensation. Firms give health benefits to workers in exchange for labor, just like a salary. In-kind compensation should, in general, be taxed at the same marginal rate as salary. Otherwise, firms can change your tax liability by shuffling your compensation between salary and benefits, which is silly and wasteful. The tax code’s purpose is to raise revenue, not to direct the means by which people are paid for their work.

Employer-provided health insurance has historically been untaxed – a poor policy likely to encourage overspending on health insurance. While the effects of tax policy are often hard to measure empirically, there is certainly a broad consensus that Americans pay too much for their health care.

The Cadillac Tax helps equalize the treatment of health benefits and other sorts of compensation, but it is still a poor substitute for simply including health insurance in the tax base and lowering rates. As it is designed now, there is a massive spike from a zero marginal tax rate on family plans below $27,500 to 40 percent for plans above that amount.

It’s as if the Obama administration is absolutely certain that the optimal amount of employer-provided health insurance for everyone – no matter what the rest of their budget looks like – is exactly $27,499. I, personally, am not so sure; some epistemological modesty from the architects of the ACA would have been welcome.