The Obamacare Cadillac Tax and its Mixed Bag of Consequences

June 12, 2014

Both employers and unions across the nation have continued to realize the burdens of Obamacare. A recent survey of 360 large employers has shown business leaders’ discomfort with many provisions of the Affordable Care Act as well as their uncertainty about the future of the employer-driven health insurance system.

One out of three employers surveyed are considering moving to a defined contributions strategy, signaling discontent with ACA provisions that expand access to the health care system while bringing little benefit and limiting employer flexibility.

Among the top five provisions that make employers squeamish is the “Cadillac tax” on high cost health insurance plans. Beginning in 2018, an excise tax of 40 cents of every dollar above a certain threshold of employer-provided health insurance will be imposed. Individual plans and family plans will face thresholds of $10,200 and $27,500, respectively. For example, a tax of $320 would be levied on an individual’s plan worth $11,000.

Beyond raising $80 billion in revenue to offset a fraction of the cost of Obamacare, the tax seeks to contain health costs and reduce health spending. And it may indeed do so, but in an unnecessarily convoluted manner. The tax will actually be inequitable due to certain factors that influence the price of insurance.

Since 1918, employer-provided health insurance has been allowed to be deducted from taxable personal income. In turn, employers have been incentivized to compensate workers with smaller salaries and larger health insurance benefits. Besides decreasing income tax collections, the generous plans encourage policyholders to spend more than they need to on health care, thereby driving up its price.

This outcome is undesirable and could be remedied by simply eliminating the tax expenditure on health insurance and lowering the tax rate. The excise tax instead arbitrarily targets expensive premiums, achieving a similar result but with collateral damage to high-risk individuals and individuals in certain regions of the country. Simply put, the cost to insure an individual’s health is largely determined by his or her risk profile. Therefore, some individuals face higher premiums just because of age or health status, and imposing a tax on expensive plans will inequitably affect some of these individuals and families. Secondly, the price of health insurance can differ between regions because of cost of living factors, potentially to the extent that only one out of two identical plans (with different prices) will be taxed.

Although the excise tax may have a theoretical net benefit, scaling back the current tax expenditure on employer-provided health insurance and lowering the tax rate would end up being the fairest, least distortionary way to raise revenue and contain health care costs.

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