Congress must not delay the Cadillac tax for health care

Congress must not delay the Cadillac tax for health care
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The House of Representatives may enjoy a bipartisan moment this week. A significant number of Democrats may join most or all Republicans in voting to delay the effective date of the Cadillac tax on high cost employer provided health insurance mandated by the Affordable Care Act. It is often inspiring when lawmakers reach across the aisle to find common ground. In this case, though, the bipartisan consensus is wrong.

Congress should accelerate the Cadillac tax rather than delay it. The tax will help correct a major flaw of the tax system, which is the unlimited tax break for employer provided health insurance. Although workers pay both income and payroll taxes on their cash wages, they are not taxed on their health benefits. That disparity creates an incentive for more pay to be provided through health insurance rather than cash wages.

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The tax break for employer provided health insurance has played an important role in encouraging employers to give benefits, thereby reducing the number of uninsured Americans. The problem is that the tax break is unlimited. It applies even to high cost Cadillac health plans that cover routine care along with featuring low deductibles and copayments. Those extravagant plans encourage overuse of health care by those fortunate enough to have that coverage. This higher demand for medical services drives up costs for other patients.

The best solution would be to cap the tax break. Health benefits that cost less than the cap would remain tax free, but health benefits above the cap would be subject to income and payroll taxes. The Cadillac tax follows that general approach, taxing health plans whose annual costs exceed a cap. If the Cadillac tax was in effect this year, the cap would be $10,200 for individual plans and $27,500 for family plans. Only a few plans are above the cap now, but their numbers will grow in upcoming years because the cap is slated to rise more slowly than medical costs.

To be sure, the Cadillac tax design is imperfect. Rather than applying income and payroll taxes to benefits that exceed the cap, it subjects them to a flat 40 percent tax, collected from the insurers. Collecting the tax from insurers is a gimmick, as insurers will pass the tax on to employers, who will pass it on to workers. It would have been more honest to directly tax the workers who ultimately pick up the tab. It also would have been better to link each the tax of each worker to his or her tax bracket.

But the perfect should not be the enemy of the good. Despite its flaws, the Cadillac tax provides a powerful offset to the open ended health insurance tax break. Unfortunately, the tax has not yet taken effect, and it may never do so. When the tax was adopted as part of the Affordable Care Act in 2010, it was slated to take effect in 2018, four years later than many of its other provisions. In late 2015, Congress delayed the tax to 2020. Early this year, Congress delayed it again, this time to 2022. The House is now poised to vote on legislation delaying the tax to 2023.

The Cadillac tax is opposed by several different groups for various reasons. Labor unions oppose it because some member benefits would be subject to the tax. Their opposition has swayed many Democrats. Business owners oppose it because they want to be able to offer unlimited tax free fringe benefits. Many Republicans are happy to oppose any tax, particularly one that was added by the Affordable Care Act.

The Cadillac tax does have one constituency behind it. More than 100 economists signed a letter in 2015 arguing that the tax should not be delayed or reduced unless it is replaced by a better cost control measure. That position has drawn support from numerous tax and health policy experts across the ideological spectrum, including my colleagues at the American Enterprise Institute, scholars at the Center on Budget and Policy Priorities, and economists at the Urban Brookings Tax Policy Center.

Unfortunately, the voices of these policy experts have been drowned out by the interest groups lined up to lobby against the Cadillac tax. If lawmakers on both sides of the aisle are serious about controlling health care costs and curbing misdirected tax breaks, the Cadillac tax, or a better designed replacement, should take effect as soon as possible.

Alan D. Viard is a resident scholar at the American Enterprise Institute, where he studies federal tax and budget policy. He previously served as an economist at the Federal Reserve Bank of Dallas, the White House Council of Economic Advisers and the United States Joint Committee on Taxation.