A major discussion point during the multiple attempts to repeal and replace the Affordable Care Act (ACA) was that health insurance premiums are rising too quickly, jeopardizing their affordability by many Americans. However, premiums are only one component of health care costs and a singular focus on them can be misleading in the overall health care discussion. The costs of medical expenses not covered by insurance (e.g., deductibles) and the costs of prescription medication are also important cost components of health care. But all of these items have one common thread: they represent indirect measures of the increasing cost of medical care. Once the focus is turned directly to the cost of medical services, two questions arise for those interested in tax policy. Does tax policy affect the cost of care, and can tax policy be used to decrease that cost?
How Do Tax Subsidies Affect Health Care?
Many economists argue that tax policy has a measureable effect on the cost of medical coverage. The employer-sponsored health insurance deduction and the exclusion for employer provided coverage are referenced in such assertions. The deduction allows employers to deduct health insurance expenditures without limit. The exclusion allows employees to exclude the employer-provided insurance benefit from their personal income. This combination of tax incentives represents an expensive government subsidy, with the Joint Committee on Taxation estimating that in 2017, it will be the single largest tax expenditure at $260 billion. Albeit costly, the financial impact of these subsidies does not necessarily correlate with the role that these measures play in increasing the cost of medical care.
Instead, economists point to our society’s behavioral tendencies that arise from this framework. They assert that a tax subsidy on the cost of insurance leaves employers, and by extension employees, less conscientious of those costs when purchasing health insurance. They also note that the exclusion encourages employers to rationalize more expensive coverage in lieu of higher wages. By desensitizing the need for cost comparisons among medical plans with over-inclusive coverage, economists argue that the system leads to medical cost inflation at a rate higher than inflation in other areas of the economy.
If the cost of insurance is susceptible to this type of manipulation, these economists further argue that the incentive is diminished for insurers to compete on price for covered medical services. This lack of competition then extends to medical service providers, whose business model is based on the ability to charge on a per-service basis. With less concern about claims payment from insurers, the number and types of treatments attempted is distorted.
There are many who will dispute these arguments and who will assert that the deduction and the exclusion are essential elements of affordable health coverage for millions of Americans. There are other factors that affect the cost of insurance and medical care outside of these elements, but understanding the basic position of these economists is essential to understanding one of the goals of the ACA’s “Cadillac” tax.
Health Care Plans & the Cadillac Tax
The (now-delayed) Cadillac tax is a non-deductible 40 percent excise tax to be paid by employers on health insurance whose cost is in excess of certain thresholds. It was to be first effective in 2018 after all of the other ACA provisions had taken effect. However, in 2015 Congress acted to delay the effective date of the tax to 2020, and at the same time made the tax deductible for employers subject to it.
Among the goals lawmakers had in mind, three were relevant to the topic at hand. Those goals included financial backing for the ACA’s other coverage expansion objectives, a reduction of the tax preference for employer-sponsored health care, and an attempt to curtail excess health care spending by employers and employees. The high rate of the tax was also designed to limit the subsidy that the deduction and exclusion provided. This was meant to remove or reduce the incentive for employers to use generous insurance benefits in lieu of higher wages, a goal that is also related to the goal of reducing excess health spending.
When it was passed, the Cadillac tax was set to generate $87 billion dollars in revenue over a decade., Later estimates reduced that number to $69 billion before the delayed implementation measures were enacted. The original estimate of $87 billion was about 8 percent of the cost of Medicaid expansion. The tax was preserved in draft versions of ACA replacement legislation, such as the American Health Care Act (AHCA) and the Better Care Reconciliation Act (BCRA). Although further delayed under each proposal, its survival was necessary to offset the cost of a proposed repeal of other ACA taxes.
As designed, Congress and the Obama Administration anticipated that the potential tax would dissuade employers from purchasing generous policies. The high rate was thought to reflect the actual cost of providing expensive insurance options. A resulting change in behavior was then to trickle down to insurers, who would have to more carefully craft policies to meet the needs of insured employees. Medical care providers were then expected to follow suit by developing more cost-effective treatment plans, as their capacity to bill insurers for multiple treatments or for certain non-covered options would be diminished. This was intended to encourage a system under which effective treatment options would be covered, and other less proven options would be discarded, creating a more efficient system of care.
Opposition to the Cadillac Tax
As mentioned previously, the Cadillac tax was delayed in 2015 to 2020 and was set to be delayed further under the AHCA or the BCRA. These delay measures respond to the reality that the tax is politically unpopular with both parties. It is also unpopular with employers.
One reason for this resistance is that the tax, while designed to only affect the most expensive policies, would begin to reach a broader range of policies over time. This is because the rate of inflation used to set the tax threshold is projected to be inadequate to keep pace with the actual rate of inflation for health insurance policy costs. The result is that over time more and more policies will be subject to the tax, with over 50 percent of policies in many states being expected to be subject to the tax by 2032.
The tax also does not address regional variations in health care costs, wages, and other factors, resulting in some geographical areas being more heavily affected by the tax than others. Furthermore, if the inflation index for the tax were adjusted so that it would only impact the top tier of the most generous policies, it would not be responsive to a different policy objective: that health care costs should be equalized among the employer-covered population and the population without employer options. Thus, it is possible to look at the employer-provided health care deduction, exclusion, and Cadillac tax as evidence that tax policy can (and perhaps does) affect health insurance costs, while acknowledging that tax policy may not hold all of the answers in the complicated world of health care.
For more information on the Cadillac tax and the employer sponsored health care provisions please contact your local CBIZ tax professional.
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