Will President Obama defend the 'Cadillac tax' to cut health-care costs?

Tuesday, January 12, 2010

MONDAY'S White House meeting between President Obama and labor leaders focused on one of the most contentious -- and most sensible -- aspects of health reform: the proposed tax on employer-provided, high-value health insurance plans. The Senate version of the health-care bill would impose a 40 percent excise tax on insurance at or above $23,000 annually in 2013; the House contains no comparable measure. This so-called Cadillac tax would be paid by insurers but presumably its costs would be passed on to those who purchase such policies, both corporations and workers.

For no particularly good reason, the U.S. tax code asks workers to pay taxes on any wages they receive -- but when they receive benefits in the form of health insurance, they do not have to pay any taxes on them. This forces people who don't get health insurance at work to subsidize those who do. People in the higher tax brackets benefit the most. The system is regressive, in other words -- and it encourages excess spending on health care.

Congress couldn't bring itself to correct this situation entirely, in large part because of opposition from union leaders. But the Senate, in its version of health-care reform, took a step in the right direction with its Cadillac tax. The attraction of the tax is that it raises money to pay for health reform -- about $150 billion from 2013 to 2019 -- while simultaneously making health reform less costly, by reducing the over-consumption of health care. Union leaders strenuously oppose even this change.

One of their arguments is that what is presented as a tax on Cadillac health plans will quickly end up covering Chevys as well. The $23,000 annual limit for a family policy ($8,500 for individuals) would increase annually, growing by the consumer price index plus one percent. The Congressional Joint Committee on Taxation estimates that fewer than 8 percent of taxpayers would be affected in 2013. But if health-care costs continued to rise far faster than inflation, as they have for years, over time the tax would apply to more workers. Whether this is good or bad depends on whether you believe in the basic laws of economics: Employers are willing to pay a certain total compensation, whether as wages or benefits; if benefits become less attractive they will substitute an equivalent amount of cash. As the congressional Joint Committee on Taxation explained, "as consumers spend less on tax-excluded health benefits, their taxable cash wages will rise." Unions contend that their workers will simply lose out, not get higher pay. That contradicts not only economic history and theory but also labor's argument that workers' tax-free benefits must be maintained because they were bargained for in lieu of wages.

Another argument against the Cadillac tax is that it would unfairly apply to policies held by workers who are older, sicker or in higher-cost areas -- not just investment bankers whose plans include free gym memberships. But the Senate plan deals with this objection by pushing up the level at which the tax kicks in ($26,000 for a family plan) for workers in certain industries, including law enforcement officers, construction workers and miners. If anything, the risk is that too many occupations are being carved out. In addition, the thresholds are increased in the 17 highest-cost states by 20 percent in 2013, 10 percent in 2014 and 5 percent in 2015.

The most likely compromise on the tax would raise the threshold even higher, for everyone. That would be a mistake. It would reduce the impact on controlling costs and drain badly needed revenue; a $26,000 threshold would bring in about $100 billion less through 2019 than the existing $23,000 level. Also counterproductive would be any move to further loosen the indexing and let the threshold grow more quickly. The point, after all, is to try to keep the growth of health costs as close as possible to the overall rate of inflation.

The health-care reform bill already does a great deal to increase costs to the government and too little to control health costs over time. Yet President Obama has cited as a chief goal of this reform getting a handle on those costs, which otherwise threaten to bankrupt the government. The administration should use the conference to strengthen, not weaken, the cost-control mechanisms that have survived the legislative process.

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