JAMA Forum — The Tax Treatment of Health Insurance: Obama vs Romney

Austin Frakt, PhD

Austin Frakt, PhD

Outside of elite health policy circles, the tax treatment of health insurance receives less attention than it deserves. It is therefore worth considering how the 2 presidential candidates view this important issue.

First a few facts. Contributions toward health insurance premiums paid directly by employers are not subject to payroll, federal, or state income taxes. For most workers—close to 80% of those with employer-based coverage—the contributions they make toward their premiums (the amounts they see deducted from their paychecks) also avoid all taxation.

Economists agree on theoretical grounds and have shown empirically that all contributions toward premiums—those made by employers and workers alike—are forgone wages. In other words, wages are lower by exactly the amount of the premium, even when the employer seems to pay it. What’s going on here is that employers are shifting compensation from wages to premiums. The preferential tax treatment of the latter encourages this.

Because wages are taxed, compensation in the form of health insurance in lieu of wages reduces government revenue. In fact, it reduces it a lot: $250 billion per year. Just to put that figure in perspective, $250 billion is almost half the Medicare budget. It is more than 3½ times the average annual cost of the Affordable Care Act’s low-income health insurance subsidies. Employer-sponsored health insurance is among the most subsidized types of health insurance in America, almost as subsidized as Medicaid.

The preferential tax treatment of employer-sponsored health insurance also encourages more generous coverage and higher health care spending. By one estimate, health spending among insured workers is 26% higher than it otherwise would be if not for the tax break.

None of the above applies to health insurance purchased individually rather than through an employer. If you purchase health insurance outside of work, you pay taxes on the money you use to pay for it. If you buy it through work, it’s tax-free. I am aware of no justifying principle for that distinction.

Both President Obama and Mitt Romney seem to want to end that distinction, but possibly in different ways.

President Obama’s Approach

The President’s approach is clear. It’s codified in Title IX, section 9001, of the Affordable Care Act as an “excise tax on high cost employer-sponsored health insurance.” Beginning in 2018, it would impose a 40% tax on the amount of health insurance premiums above $10 200 for individual coverage and $27 500 for family coverage. Those thresholds are to be indexed to overall inflation—not medical or insurance premium inflation, which is typically much higher. Hence, over time, this so-called “Cadillac tax” will become a “Chevy tax,” as it applies to plans of lower and lower generosity.

Imposing a flat 40% tax above a threshold is not the same thing as subjecting employer-sponsored health insurance premiums to taxation. For one thing, the entire 40% tax would be general federal revenue, not split among Social Security, Medicare, and federal and state governments as would be the case if payroll and income taxation were applied to premiums. For another, it is not progressive, as income taxes are. The excise tax hits every dollar above the threshold equally, independent of income. In his book Inside National Health Reform, John McDonough notes that President Obama opposed the more progressive approach of reducing or eliminating the degree to which employer-sponsored health insurance was shielded from payroll and income taxes.

However, the effect of the excise tax is expected to be very similar to applying payroll and income taxes to health insurance. The expectation by experts is that it will encourage employers to avoid the tax by reducing the generosity, and therefore premiums, of the plans they offer. In turn, over time, the economics of the labor force dictate that dollars not spent on premiums would be spent on wages (as many economics studies have shown), which will be hit with the progressive mix of payroll and income taxes. Consequently, the excise tax is a cap on the tax excludability of employer-sponsored health insurance.

Mitt Romney’s Approach

Romney’s approach to addressing the favorable tax treatment of employer-sponsored health insurance and its effects is, to date, vague. Although he has recognized this as an important issue, to my knowledge, the candidate has expressed his intent in this realm only twice, once on his website and once in a speech. His website says he wants to “end tax discrimination against the individual purchase of insurance.” In a June speech in Florida, he said,

Well, right now, most people get their insurance through their employer, and the reason they do that is because their employer gets a tax deduction when they buy insurance for you. But if you’re a very small-business person—let’s say a one-person business—you don’t get a tax deduction for buying insurance. And if you’re an individual that’s not employed, you don’t get a tax deduction for buying your own insurance. What I would do is level the playing field and say individuals can buy insurance on the same tax advantage basis that businesses can buy insurance.

This sounds like Romney is predisposed to expand the favorable tax treatment of health insurance, not reduce it. Doing so would not help address the (too low) government revenue and (too high and growing) health care spending problems the nation faces. Let’s be clear: expanding the preferential tax treatment of insurance purchase would cost a fortune.

Now, it is possible that by acting to “end tax discrimination” and “level the playing field,” the candidate means to reduce the favorable treatment of employer-sponsored plans. Or perhaps he means something else entirely, such as offering tax credits for purchase of health insurance on the individual market. From his communications, we just can’t tell.

Grading the Work

For passing legislation to address the issue, I give President Obama a grade of A. For doing so in an indirect and very delayed way—although compelled by politics, to be sure—I give him a C. Likewise, I grant Romney an A for recognition of the issue but an incomplete for not yet providing enough detail for us to fully apprehend his intent. As an economist, I give the idea of excluding individually purchased products from taxation an F.


About the author: Austin B. Frakt, PhD, is a health economist and an assistant professor at Boston University’s School of Medicine and School of Public Health. He blogs about health economics and policy at The Incidental Economist and tweets at @afrakt. The views expressed in this post are that of the author and do not necessarily reflect the position of Boston University.

About The JAMA Forum: To provide ongoing coverage throughout this election year, JAMA has assembled a team of leading scholars, including health economists, health policy experts, and legal scholars, to provide insight about the political aspects of health care. Each JAMA Forum entry expresses the opinions of the author but does not necessarily reflect the views or opinions of JAMA, the editorial staff, or the American Medical Association. More information is available here and here.

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