Don't Scrap the Cadillac Tax

Not that kind of Cadillac.

Photographer: Pierre Verdy/Getty Images

Everyone likes having health insurance. Nobody likes paying new taxes. So the growing campaign against Obamacare's tax on expensive health plans was to be expected. But this tax deals with a root problem in the U.S. health-care system, and it would be better to fix its eminently fixable flaws than to kill it outright.

The tax is meant to address a critical weakness in the way Americans pay for their health insurance: The coverage they get from their employers -- unlike salaries and other forms of compensation -- is not subject to income or payroll taxes. This exemption is wildly expensive, costing the federal government $151 billion this year, more than any other tax expenditure. It's also regressive: The top 10 percent of earners get 30 times the financial benefits as the bottom 10 percent, because they're in higher tax brackets and they tend to have costlier health plans. 

QuickTake Obamacare, Assessed

Worst of all, leaving employer-provided insurance untaxed distorts the market, leading companies to provide more of their compensation in the form of health coverage and less as wages. That helps explain why 18 percent of U.S. economic output goes toward health care -- almost twice the average for industrialized countries. (That extra spending, as we're frequently reminded, hasn't led to better health outcomes.)

The Affordable Care Act is meant to change things, starting in 2018, by levying a tax on so-called Cadillac employer-sponsored insurance plans -- the slim minority that cost more than $10,200 in premiums for an individual or $27,500 for a family. The tax amounts to 40 percent of the cost above that threshold. The goal is to get companies to keep their spending below the threshold and direct the savings toward higher wages. Taxes on those new wages are meant to generate $87 billion over a decade toward the cost of Obamacare.

The tax's many critics -- employers, unions and health-care providers -- complain that it will encourage employers to shift more health-care costs to employees by pushing up co-pays and deductibles (not counted toward the threshold). And these are costs that fall harder on low earners. They also argue that if health-care cost growth returns to its pre-recession speed, the tax will soon enough apply to most people's insurance plans.

Those are fair criticisms, but they can be addressed without scrapping the tax. A better solution is the one proposed last February by a group of Republicans, including Senate Finance Committee Chairman Orrin Hatch and House Energy and Commerce Committee Chairman Fred Upton: Simply tax as regular income the value of health insurance above a certain amount.

Because the income tax is progressive, applying it to health insurance would spread the burden more fairly than the Cadillac tax and the existing exemption for health insurance do. And unlike the Cadillac tax, this approach would not give companies nearing the threshold the same incentive to drastically cut benefits.

It's true that to raise the same amount of revenue, the cap on tax exclusion would have to affect a greater share of health-insurance plans than the Cadillac tax would. But that wouldn't necessarily be a bad thing: The more that employers put health insurance on an equal tax footing with wages, the more likely they will be to raise wages as readily as health coverage.

The tax exemption for health insurance has persisted not because it's good policy, but because it's always hard to take back tax giveaways. Obamacare's attempt to bite the bullet can be improved on, but it shouldn't be abandoned altogether.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.