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The third-best reform
How Congress ducks the problem of tax-free health insurance

Sunday, October 25, 2009

ECONOMIST ALAN Blinder once proposed Murphy's Law of Economic Policy, which goes in part: "Economists have the least influence on policy where they know the most and are most agreed." The health-care debate is threatening to show Blinder's law in action.

If there is one thing on which economists across the political spectrum agree when it comes to health-care reform, it is the unfair and counterproductive effect of the special tax treatment given to employer-sponsored health insurance. And if there is one issue that could end up bringing down the current health-reform effort, it is -- even more than the distracting debate over the public option -- the baby steps that the Senate Finance Committee version takes toward addressing the problem.

Even as the finance panel was finishing its work, signs of trouble were emerging in the House of Representatives: One hundred fifty-four Democrats, more than half the Democrats in the House, signed a letter to Speaker Nancy Pelosi (D-Calif.) urging her "to reject proposals to enact an excise tax on high-cost insurance plans that could be potentially passed on to middle-class families."

Employer-provided health insurance is tax free, no matter how generous. This is an artifact of World War II-era wage controls; employers attracted workers by offering insurance in lieu of pay increases. It has grown into the largest single preference in the tax code and the second largest -- after Medicare -- federal cost for health care: some $250 billion annually.

The impact of treating these forms of compensation differently is to shift money that would have gone to workers in the form of wages into health coverage. This in turn encourages people to consume more health care than they would have without the tax preference, driving up health costs. It is regressive because it represents a bigger benefit to earners in higher-income tax brackets. It is unfair because it gives those with employer-sponsored insurance a tax break not enjoyed by those who purchase coverage on their own with after-tax dollars. In short, it is the single most sensible source of financing for health reform.

The best approach would be to eliminate the tax-free treatment and use the money to provide tax credits. The second-best approach would be to cap the tax-free treatment at a set amount so that employees would have to pay tax on plans that cost significantly more than the average. The Senate Finance Committee had to settle for the third-best approach, which is to slap an excise tax on insurers for the high-cost plans they offer -- as if the costs won't be passed on to workers. The finance committee bill would impose a 40 percent excise tax on plans in excess of $21,000 for a family of four; the current average is $13,375. The tax would bring in an estimated $201 billion between 2013, when the tax would begin, and 2019; even more would come in down the road because the cap would be indexed to the overall inflation rate plus 1 percent, not health-care costs, which are growing much more rapidly.

This is anathema to labor, which explains the House Democrats' revolt. One argument is that it is unfair, as the House Democrats' letter put it, "to middle-income Americans that have forgone wage and salary increases for strong insurance benefits." But most existing collective bargaining agreements will have expired by the time the provision takes effect, so that mix can be renegotiated; if that is not enough, why not simply exempt existing union contracts? Another argument is that this approach penalizes workers in high-cost states and high-risk industries, along with older workers. However, the finance committee bill sets thresholds 20 percent higher in the 17 most expensive states for the first few years. Similarly, it sets a higher cap for retired workers 55 and older and for those in high-risk jobs.

Labor's answer is that these exemptions are not generous enough. But its basic position seems to be that its members should continue to forgo wage increases to obtain increasingly costly insurance -- and, more fundamentally, that union members should not have to ante up a dime from their generous benefits to ensure that others get basic coverage.

President Obama helped propagate the myth that health insurance -- and pretty much any other social good -- can be financed simply by slapping a tax on the wealthiest Americans. That's not sustainable -- and the sooner the president weighs in on the side of rationality, the better.

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