Skip to content

Obamacare’s Contradictory Tax Incentives

3 min readBy: Alan Cole

MIT Economist Jonathan Gruber, an architect of the Affordable Care Act, has been in the news lately for several comments on the design of the health care bill. One such story includes some remarks on 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 It was repealed in late 2019 before taking effect. , a 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. levied on employer-provided health plans. Gruber believes it was an important step towards eliminating the tax exclusion for these plans.

“Economists have called for 40 years to get rid of the regressive, inefficient and expensive tax subsidy provided for employer provider health insurance,” Gruber said at the Pioneer Institute for public policy research in Boston. The subsidy is “terrible policy,” Gruber said.

“It turns out politically it’s really hard to get rid of,” Gruber said. “And the only way we could get rid of it was first by mislabeling it, calling it a tax on insurance plans rather than a tax on people when we all know it’s a tax on people who hold those insurance plans.”

Dr. Gruber’s economic analysis is entirely on point. The tax exclusion for employer-provided health insurance payments is regressive in that it only benefits people with good full-time jobs. It is inefficient in that it distorts the incentive for employer-provided insurance as opposed to individually-purchased insurance. And it is expensive, too: it is the largest tax expenditure.

Lastly, he is right that insurance plans don’t pay taxes. Only people can bear the burden of taxes, and it is right to say that the people who get the taxed insurance plans are the ones who bear the burden. As we have acknowledged, the Cadillac Tax is a sort of patch for a hole in the income tax – even if it’s not a particularly good one.

Gruber’s political analysis, of course, are worthy of criticism. He takes pride in making the tax less transparent. One of our principles of sound tax policy is that taxes should be transparent, so that voters fully understand their costs.

But there is also some criticism to be made of his public policy argument. His remarks also imply that the Cadillac Tax is part of a coordinated effort to roll back the poor policy mentioned above:

“What that means is the tax that starts out hitting only 8% of the insurance plans essentially amounts over the next 20 years essentially getting rid of the exclusion for employer sponsored plans,” Gruber said. “This was the only political way we were ever going to take on one of the worst public policies in America.”

Unfortunately, the distortion from “one of the worst public policies in America” was actually reinforced by the rest of Obamacare. The Employer Mandate, which will go on employers’ tax forms as the “Employer Shared Responsibility Payment,” levies a new tax on businesses that fail to provide employer-provided health insurance.

All too often, the motives behind Obamacare’s taxes are incoherent. We don’t like the distortion towards employer-provided health insurance, so we levy taxes on it. But we also do like the distortion towards employer-provided health insurance, so much so that we will actually mandate it!

The tax code’s treatment of employer-provided health insurance is now incredibly muddled and conflicted. This is not just a problem in its own right. A lack of clarity in the tax code reveals a lack of clarity in the thinking behind it. Jonathan Gruber rightly disliked this economic distortion so much that he called it “one of the worst public policies in America.” Other architects of Obamacare, apparently, strongly disagreed, and further ingrained the economic distortion into law.

Critics of Obamacare – especially since Dr. Gruber’s comments came to light – have characterized the bill as opaquely imposing on the public a new vision for the health care sector. That description may be too kind. On critical issues, the bill’s architects appear to have no coherent vision at all.