While Likely to be Repealed, the “Cadillac Tax” Would Control Health Care Costs

July 16, 2019

Tomorrow, the House of Representatives will vote on H.R. 748, sponsored by Representative Joe Courtney (D-CT). This bill would repeal the excise tax on high-cost employer-sponsored health coverage, otherwise known as the “Cadillac tax,” for taxable years starting after 2019. While repealing is likely to pass the House, ideally, the tax should be implemented. It isn’t perfect, but it would limit our tax code’s subsidization of employer-sponsored insurance and likely reduce health-care costs.

The Cadillac tax, which was established by the Patient Protection and Affordable Care Act (known generally as “Obamacare”), levied a 40 percent excise tax on health insurance benefits surpassing certain dollar thresholds for both individuals and families. In 2022, when the tax is scheduled to be implemented for the first time, it would tax $0.40 of every dollar of health insurance benefits over $11,200 for individuals and $30,150 for families. According to Kaiser Family Foundation, in 2018, average annual premiums for individuals were about $7,000, and about $20,000 for families.

Though the Cadillac Tax was established about a decade ago, it has never gone into effect, largely due to its unpopularity. One reason for that is because it would apply to more health insurance plans over time. While the tax’s parameters are adjusted for inflation, the cost of health insurance plans rises faster than inflation, resulting in bracket creep that would push more insurance plans into the Cadillac tax’s territory over time.

Another reason is that it would impact certain industries more than others. Because it is an excise tax on high-cost health insurance plans, employers who provide more compensation in the form of health insurance benefits relative to wages would be particularly hurt by the tax.

Despite its unpopularity, the Cadillac tax would be beneficial because it would functionally cap our tax code’s income tax exclusion for employer-provided insurance. This exclusion is our tax code’s largest tax expenditure, reducing federal revenues by about $2.8 trillion from 2019 to 2028, and many economists believe it has contributed to increasing health-care costs. While an employee’s wages are taxable, health insurance benefits can be excluded from an employee’s taxable income. Since health insurance benefits are also deductible for employers, this health-care spending goes untaxed. This hole in the tax code encourages employers to provide more compensation in the form of health insurance, rather than wages.

The Cadillac tax would likely curb the growing cost of health care by increasing the cost of high-cost health insurance plans. All else equal, consumers demand less of a product when its price increases. In the case of the Cadillac tax, it would reduce the amount of health insurance provided by employers, and as a result, fewer health-care services would be consumed. This would work to reduce the cost of health care.

It should be acknowledged, however, that this could be difficult for some employers, particularly those whose employee benefits are covered by union contracts. It could be difficult for them to renegotiate provided benefits.

While the Cadillac tax stands little chance of being implemented, it would make our tax code better by limiting a tax expenditure that subsidizes the provision of health insurance. It’s not a perfect solution, but it is a reasonable attempt to help limit the impact of the employer-sponsored insurance exclusion and help control health-care costs.

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