Should Employee Health-Care Benefits Be Taxed?

January 12, 2006

Via TaxProf Blog, the Bush administration has officially rejected the recommendation of the Advisory Panel on Federal Tax Reform to limit the tax subsidy granted to employer-provided health-care benefits. From Bloomberg:

President George W. Bush has rejected a key proposal of his tax reform commission, which would impose a tax on some employer-provided health benefits, said Al Hubbard, the president’s top economic adviser.

The Advisory Panel on Federal Tax Reform, commissioned by Bush to suggest ways of reworking the tax code, recommended taxing workers on health insurance benefits valued at $11,500 or more for a family, arguing the current system encourages expensive and unnecessary “Cadillac” plans.

“I know the president’s not interested in pursuing that,” Hubbard, director of the president’s National Economic Council, said in an interview. Instead, Bush will promote expanding untaxed health savings accounts and increased deductibility of medical expenses, he said. (Full piece here.)

Is it good tax policy to remove employer-provided health-care benefits from the federal income tax base? Maybe not.

A vestige of World War II price controls, the exclusion for employer-provided health care is the largest preference in the tax code with an estimated 2006 value of roughly $126 billion. By substantially narrowing the federal tax base, it forces all taxpayers to pay higher tax rates, increasing the distortion caused by federal taxes in markets and ultimately reducing U.S. economic performance. If widening Americans’ access to health care is our policy goal, there may be much less costly ways to achieve that than through the federal tax system.

Here’s more from our analysis of the tax reform panel’s final report to the Treasury:

Recommendations in Need of Reevaluation:

Exclusion for employer-provided health insurance Both plans would cap the tax exclusion for employer-provided health insurance at $11,500 for families and $5,000 for individuals. A vestige of World War II price controls, the exclusion for employer-provided health care is the largest preference in the tax code with an estimated 2006 value of roughly $126 billion. This exclusion has greatly distorted the health care market by creating a third-party payer system that makes employers and insurance companies—not employees or patients—the true “customers” of health care. Patients do not act as true consumers because they pay only a fraction of the cost and actually have the incentive to over-consume health care. While most economists see the only solution to this government-created problem is to eliminate the exclusion, capping the exclusion may be a short-term step in the right direction. However, the Panel’s recommended cap levels are so high, and indexed to inflation, that most health plans are likely to be unaffected in either the near term or long term. Thus, the proposal may have little effect on controlling third-party health expenses.

Further reading: Three Decades of Government-Financed Health Care in the United States, by Patrick Fleenor


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