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USC-Brookings Schaeffer on Health Policy

Wall Street Journal: What the ‘Cadillac Tax’ accomplishes–and what could be lost in repeal


Editor’s Note: This blog post originally appeared in the Wall Street Journal.


When an employer pays a worker in cash, the worker has to pay income and payroll taxes on the money. When an employer provides or subsidizes health insurance, the worker doesn’t pay taxes on the benefit. This practice, which dates to World War II-era wage-and-price controls, encourages employers to offer more generous health insurance plans as opposed to paying higher wages. It’s one of several reasons the U.S. spends so much more on health care than other rich countries.

To limit the growth of health-care spending, and to help subsidize insurance for low-income Americans, the Affordable Care Act took a step toward limiting this tax break. Beginning Jan. 1, 2018, the law levies a hefty excise tax on health insurance plans worth more than $27,500 per family or $10,200 per individual (with some adjustments to thresholds to be made for hazardous jobs such as those in law enforcement or construction and other factors). This has been dubbed the “Cadillac tax.” (For details, see this Cigna summary or this Health Affairs policy brief.)

Most people won’t be affected initially; the average employer-sponsored family plan cost $16,834 last year. But the tax was designed to hit a rising fraction of health plans over time. Perhaps 5% of families will be affected in 2018 and 15% in 2025. Many employers already are adjusting health plans in anticipation. The slower-than-projected pace of premium increases led the Congressional Budget Office and the Joint Committee on Taxation to conclude in March that fewer health plans would be hit by the excise tax than had been projected.

The provision remains controversial. Unions that have negotiated for generous benefit plans oppose it; so do some employers. There is a campaign to repeal the provision before it takes effectHillary Clinton has said she is “examining” it. “I worry that it may create an incentive to substantially lower the value of the benefits package and shift more and more costs to consumers.”

So it’s worth looking at why the Cadillac tax was included in the first place and what repealing it would mean.

*Tax incentives that favor health insurance over wages provide an incentive for Americans to spend more on health care than they otherwise would, perhaps more than they need to. Insurance policies that encourage people to use more health care because it’s “free” (with, say, very low co-pays and deductibles) don’t make sense.

*The Cadillac tax is a step toward curbing generous policies while leaving room for tax breaks for policies that provide ample coverage for people when they are really sick. It is meant to encourage employers to increase deductibles and co-pays so people will be better consumers of health care (so Mrs. Clinton has a point). It’s also meant to encourage insurers to scrutinize utilization and to lean on providers. It is imperfect: The threshold, for instance, is national, while health costs vary a lot by region. But that’s true of nearly all thresholds in the tax code. Mortgage interest is deductible on home loans of less than $1 million; that ceiling isn’t adjusted for the variation in housing prices across the country.

*Repealing the Cadillac tax would be a significant setback to efforts to curtail tax breaks and other policies that, while popular, encourage overuse of the health-care system or favor inefficient health-care providers. Tweaking or replacing the tax with an alternative that accomplishes the same goals is a possibility, though finding one that would raise as much money will be hard. Abandoning it would be a worrisome sign that political timidity dooms almost any policy to slow the growth of health-care spending.

*Although politicians and workers are skeptical, economists say that the more employers pay in health insurance benefits, the less they’ll pay in cash wages. When employers look at the cost of labor, they see both wages and benefits. Curbing benefits will tend to increase cash wages, which are taxable. Indeed, a big reason CBO and the Joint Committee on Taxation estimate that the Cadillac tax would yield $87 billion over the next 10 years is that they expect employers to cut back on benefits to avoid the  tax and put that money into (taxable) cash wages.

*Politicians worried about stagnant wages should remember that rising health costs are a reason wages haven’t risen faster. Workers represented by unions would seem to have the best shot at pushing employers to shift money from benefits to wages.

There’s a lot of talk about wringing inefficiency and unnecessary treatment out of the health system as well as shrinking tax loopholes, credits, exclusions, and deductions. The Cadillac tax as written into law won’t accomplish either goal completely. But if it succumbs to the latest round of assaults, the prospects for major legislation on health-care costs or tax reform would be substantially diminished.

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