A heated debate has emerged over the so-called Cadillac plan tax on workplace health benefits that exceed certain levels. The tax, scheduled to go into effect in 2018, is the last remaining piece of the Affordable Care Act (ACA) to be implemented.
Bipartisan efforts are under way in Congress to repeal the tax, and Democratic presidential candidates Hillary Clinton and Bernie Sanders have said they favor scrapping the tax. (Republican candidates are all advocating repeal of the entire ACA, though some have also advocated a tax on employer-provided health benefits that would have effects similar to the Cadillac plan tax.)
Economists and deficit hawks like the Cadillac plan tax, which was included in the ACA to raise revenues (currently estimated at $91 billion over 10 years) to finance expanded coverage, as well as to constrain health care costs. But pretty much everyone else—including a wide range of interest groups, employers, workers, and the public—seems to detest it.
Terms of the Tax
The Cadillac plan tax would assess a 40% tax on the cost of any workplace health benefits that exceed certain thresholds—$10 200 for a single person and $27 500 for a family. It would apply to a broad spectrum of benefits, including employer and employee premiums for medical insurance, on-site medical clinics, and pre-tax contributions to health savings accounts and flexible spending accounts.
The thresholds for the tax would increase with general inflation over time, which is far less than the historical growth in health insurance premiums. As a result, at projected increases in premiums, the proportion of employers offering at least 1 health plan that would be affected by the tax would increase from 26% in 2018 to 42% in 2028. (Most small businesses offer only 1 plan, whereas larger firms typically offer 2 or more options.)
To understand the genesis of the Cadillac plan tax, you need to understand how the current tax system subsidizes employer-provided health benefits. That requires a trip to economics class.
When an employer gives you $10 000 in wages, you pay income, Social Security, and Medicare taxes on those wages. How much tax you pay depends on your income, which determines your marginal tax rate.
But if an employer gives you $10 000 in health benefits, that sum doesn’t count as income and you pay no taxes on it. The government is, in effect, subsidizing those benefits by allowing them to be provided exempt from taxation. The subsidy is the cost of the benefits times your marginal tax rate for income and payroll taxes. In total, the subsidy for employer health benefits will cost the federal government $334 billion this year.
Economists have long disliked this open-ended subsidy. Like any subsidy, it produces market distortions, leading employers to provide more generous health insurance than they would if benefits were instead taxed like wages. It’s also regressive—higher-income workers have higher tax rates, so they get a bigger subsidy than lower-income workers.
Directly taxing health benefits has long been a political nonstarter. The Cadillac plan tax is essentially a backdoor way of capping the current subsidy for employer-provided benefits. The tax would be paid by insurers and employers. However, the general assumption is that employers will seek to avoid the tax by making sure that health benefit expenses are below the thresholds that would trigger it.
But, if few companies pay the tax, how does it raise $91 billion in revenue? That requires another trip to economics class.
Economists—based on theory and the available evidence—believe that the total compensation provided to workers is largely driven by market forces. Some of that compensation is in the form of wages, and some is in the form of health and other benefits. If the Cadillac plan tax encourages some employers to reduce the amount of health benefits they provide, economic evidence suggests that they will raise wages by a comparable amount (though those wage increases may not come immediately or be equally distributed across workers). As wages increase, so do tax revenues.
Assuming employers respond to the Cadillac plan tax by reducing the cost of health benefits, the key question is “How?”
The tax would no doubt encourage insurers and employers to find efficiencies and negotiate more aggressively with hospitals and clinicians. But market incentives to do that already exist, even if they are somewhat muted by the tax subsidy for employer-provided insurance. It is fanciful to think that premiums can be reduced substantially, and that growth over time can be kept in line with general inflation, without reducing the amount of health benefits provided to workers. It is likely that employers will respond to the Cadillac plan tax by increasing patient cost-sharing, accelerating a trend towards higher deductibles that has been happening for years.
Raising deductibles and other patient out-of-pocket expenses would allow employers to avoid the Cadillac plan tax by shifting costs to workers, which would in turn constrain health spending as people respond by curtailing their use of health services and prescription drugs.
The Cadillac plan tax would, if implemented, be a powerful force for containing health care costs, but it would not be painless or without consequences. It would be nice to think that there is some magic pixie dust for controlling health costs. Sadly, that kind of thinking is rooted in fantasy, not reality.
Opposition to the Cadillac plan tax is building, on both political and substantive grounds. However, writing its epitaph is still somewhat premature, as there is no consensus on how to replace the revenues it raises or how to constrain health care spending in some alternative way. When a new president takes office in 2017, this may be one of the biggest health care issues awaiting him or her.
About the author: Larry Levitt, MPP, is Senior Vice President for Special Initiatives at the Kaiser Family Foundation and Senior Advisor to the President of the Foundation. Among other duties, he is Co-Executive Director of the Kaiser Initiative on Health Reform and Private Insurance.
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