Cadillac Tax Working as Planned on Auto Workers

The Detroit Free Press yesterday reported that veterans in the United Automobile Workers Union (UAW) may need to pay deductibles on their health plans for the first time. The generous plan for senior workers is expensive, and therefore a near-certainty to trigger the Affordable Care Act’s “Cadillac Tax,” a 40 percent levy on employer health premiums above a certain threshold. The UAW is currently looking at options to deal with this eventuality. The situation above is not a mistake in the Affordable Care Act; rather, it is the Cadillac tax fulfilling both of its intended goals.

The first goal is to encourage substitution from employer health benefits back towards ordinary compensation, like wages and salaries. Under the current U.S. tax system, employer health benefits are not counted as taxable income. As a result, employers often offer health plans in lieu of cash, in order to save their employees on taxes. This is an artificial change in behavior provoked by the hole in the tax code; it’s not necessarily efficient in itself. As such, the Cadillac Tax can be seen as an effort to patch up this hole in the income tax (the single largest tax expenditure by Congress’s estimate) and return behavior to normal.

The second goal of the Cadillac Tax is to raise revenue. It’s important to note here that even if the UAW manages to avoid the Cadillac Tax, higher revenues will result. If the UAW and employers reduce spending on member health plans in the next collective bargaining agreement, the unspent money will show up on someone’s tax return as taxable income.

This particular feature of the Affordable Care Act continues to have the exact effects that its designers intended, and the exact effects that economists would expect.