Saturday, October 3, 2015

One "tax" that makes economic sense

I ran across two pieces this week about the "Cadillac tax" on high-cost health insurance plans.  This tax, part of the Affordable Care Act, goes into effect in three years.  It will tax as ordinary income employer-provided health insurance premiums in excess of $10,200 for individuals and $27,500 for families.  It has been in the news because a number of politicians (including Hillary Clinton) have endorsed its repeal.

Ritu Agarwal, a b-school prof at the University of Maryland, argues the tax is an essential element of any policy that can successfully reform our health-care system.  The revenue from the tax finances ACA subsidies for health insurance purchases.  Also, the tax will force employers to shift more health care spending to individuals, who will be more careful with their own money than with someone else's when making decisions about their own care.  This will help bring down costs.

WP columnist Catherine Rampell points out another benefit from this tax: it will increase take-home pay.  One reason employee benefits represent at least 25% of the cost of labor is that many of these benefits are tax-deferred or are not taxed at all.  If the employer spends $1000 on wages, the employee takes home less than that after taxes.  If the employer spends $1000 on health insurance, the employee gets full value.  But total spending on compensation must equal the value created by the employee for the company, so an extra dollar spent on health insurance means one less dollar in wages.  And as premiums rise over time, wage growth slows.  So the Cadillac tax, which will lead employers to cut back on premium expenditures, will mean a raise for many employees!

Most economists would go one step further and tax all employer-provided health insurance premiums.  Why should individuals buying insurance on their own get no tax benefits, whereas those with employer-provided insurance get a big break?  Rampell points out that employer-provided health insurance was quite rare until wage controls were imposed during World War II.  Employers then used health insurance as a way to get around the controls and raise pay as labor became more scarce.

We are already in the 2016 election cycle and whoever is elected to national office will have to make a decision on what to do with the Cadillac tax.  Will they let it go into effect in 2018?

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