A big Republican health care fix proposed in 2005 and 2016 missing from current bill - why?

The House Republican plan to repeal and replace the Affordable Care Act (aka Obamacare) that was released on March 6 omits something that the House Republican health reform blueprint of June 2016 said would be included. The missing item is a big one, that if modified, would make the tax law more equitable, reduce health care spending, raise revenue (that could be used to help those without insurance), and help a lot of people know what their health insurance costs.

The missing change is to reduce the largest (most costly) tax benefit in the law - the exclusion for employer-provided health insurance. The House Republican blueprint for health reform stated that the annual cost is $266 billion a year (income and payroll taxes not collected due to the tax break). In June, they proposed to limit this exclusion to replace the "Cadillac" tax.

Here are observations made in the June plan on this generous tax break enjoyed by about 60% of employees (see June 2016 plan at page 15). I encourage you to read the full-text (about a page) as the Republicans lay out strong arguments why this generous tax break should be pared back.

• The tax break has no cap (as do contributions to retirement plans). It is "unlimited and uncapped, so the federal subsidy is endless."
• The CBO says the annual cost of this subsidy (meaning tax revenue that doesn't get generated due to employees being able to exclude from income what their employers pay towards their health insurance) is $266 billion per year. (Note: This is the largest tax break in the tax system by far; other large ones, such as the mortgage interest deduction and lower rate for capital gains are less than half of the figure for the exclusion.)
• "CBO has estimated that the exclusion increases average premiums for employer-based coverage 10 to 15 percent above what it would have been without the benefit because" it incentivizes employers and employees to get more expensive plans.
• The tax benefit is regressive because it provides a greater savings to individuals in higher tax brackets.
• "Our plan proposes to cap the exclusion at a level that would ensure job-based coverage continues unchanged for the vast majority of health insurance plans. Only the most generous plans would see a difference."

My observations:

• The House Republican plan released in early March does not make the above change highlighted in their "A Better Way" plan and keeps the Cadillac tax, but postpones its effective date from 2020 to 2025.  [See these House Ways and Means links to the proposal - here and here.]
• While the March 2017 plan repeals the individual and large employer mandates and the ACA taxes (including a big tax break for the top 1% and even bigger for the to 0.1%), why did it keep the employer-provided exclusion as is despite saying last June that this provision was a problem and fixing it would be better than having the Cadillac tax? [For an overview of this tax, see IRC Section 4980I and the Tax Policy Center explanation.]
• I think there are two possible reasons why the House Republicans omitted any change to the health insurance subsidy employees get when their employer pays all or part of their health insurance costs: (1) They discovered that it has become an "entitlement" so is difficult to modify; or (2) They are waiting to cut it back later either in one of the three bills they say it will take to handle ACA repeal/replace or for tax reform to generate revenue for a rate cut.
• I have not yet seen a news reporter mention this exclusion.  In fact today on an MSNBC show, a reporter and commentator stated that a goal of the Republican plan and less funding for health care was to allow market forces to handle costs.  Well, the employer-provided health care exclusion is an intrusion on market forces.  Economists estimate that it drives up health care costs by encouraging employees to get more expensive plans and it removes the supply and demand effects that should exist. A quick example of that - if you have such coverage, you know the first question a doctor asks is if you have coverage and you never hear about prices. There is an excellent discussion of this in the 2005 final report of President Bush's Advisory Panel on Federal Tax Reform (pages 78-82). That's yet one more Republican plan that called for reducing this tax break to make the law more fair and to pay for lower tax rates! (The plan called for capping the exclusion amount and allowing those without employer-provided health coverage to get a deduction for a portion of their health insurance cost.)

What do you think?

Time to justify your favored tax breaks - if you can

On June 27, 2013, Senator Baucus, Chair of the Senate Finance Committee and Senator Hatch, Ranking Member of the committee issued a call to everyone asking them to submit justification for keeping any tax break they believe should be in the federal tax law. They refer to this as a "blank slate" approach. That is, assume that none of the 200+ special tax breaks ("tax expenditures") are in the tax law. If you believe any should be there, send them the reasons why. House Ways and Means Committee Chairman Camp called this idea "welcome news" (6/27/13 press release).

The senators refer to the Joint Committee on Taxation tax expenditure report to define what a tax expenditure is. The Joint Committee on Taxation does not count rules tied to the basic design of a type of tax as tax expenditures. For example, the JCT states in its February 2013 report:

"Under the Joint Committee staff methodology, the normal structure of the individual income tax includes the following major components: one personal exemption for each taxpayer and one for each dependent, the standard deduction, the existing tax rate schedule, and deductions for investment and employee business expenses." (page 3)

The JCT also notes that the carryover of net operating losses is a normal part of an income tax. (page 8)

I can't think of any deduction, exclusion, credit or special rate that is crucial to our tax system. The provision that likely saves me the most tax dollars is the exclusion for employer-provided health insurance.  But, I should be paying income and payroll taxes on that benefit - it is income and something that not all individual filers get benefit of.  This is also the largest tax expenditure - over $110 billion per year. Removal of this special tax rule ought to allow for a drop in the individual tax rates. Some will argue that people will drop their employer-provided health insurance if it becomes taxable. I doubt it because the tax you pay on it is likely to still be far less than if you get your own insurance and pay for 100% of its cost. And, this change might also lead to a drop in insurance costs when the policy holders actually know the cost of that coverage.

The research tax credit is an incentive to conduct research in the US which is a good idea. And it also helps cover some of the spillover benefit others get from a company's research. So there is some justification for this credit even in the blank slate approach to tax reform, but it needs to be weighed against a lower tax rate and a simpler system. A simpler credit is likely still a good idea, as is expensing R&D rather than capitalizing and amortizing it (and simpler, and it is just a timing difference).

Ok - I'd also argue for allowing small businesses, even those with inventory to use the cash method rather than accrual because it is easier for them. This is just a timing item, so really not a significant cost. Also, the term "tax expenditure" is not viewed by everyone the same way. The JCT treats use of the cash method of accounting by a business to be a tax expenditure, but the Treasury Department does not (see page 21 of the JCT February 2013 report).  For more on this topic, please see Rethinking the Income Tax Calculation - A Look At Tax Expenditures, AICPA Tax Insider, 2/10/11.

What special tax rules can you justify keeping - and what is the justification?

Senate Finance Health Reform Financing Options

On May 18, 2009, the Senate Finance Committee released Financing Comprehensive Health Care Reform: Proposed Health System Savings and Revenue Options. It offers a variety of approaches for finding money in the government's health care spending and for improving the system. It includes possible ways to cut back on the employer-provided health insurance exclusion. This is good to see because as I mentioned other times in this blog, there are too many dollars in this exclusion that need to be reworked so as to benefit more people and to get more people, particularly higher income individuals, to pay more of their health care expenditures. Even having them pay tax on a portion of the benefit leaves a generous subsidy from the employer and federal and state governments.

For example, if high income individual Sarah in a 35% bracket had to include 20% of her employer-provided benefit of $10,000 of health care insurance, she'd include $2,000 of that in her taxable income and pay $700 of tax. She gets $10,000 of health care coverage for a cost of $700. The government can use that $700 (or it likely would take more) to provide benefits not just to employees getting health care coverage at work but to others.

The SFC's finding options all tie to health care which is good to see.

An interesting addition to the list of options is to impose an excise tax on sugar-sweetened beverages. While a good idea as a user-pays type of tax for unhealthy behavior, it will raise a lot of issues including complexity and fairness. After all, there are a lot of foods that may be worse for people including fried foods. Perhaps incentives and education programs to get people to drink water out of the tap would be good.

Anyway, it is nice to see a range of funding options that include reducing overly generous tax breaks that do not benefit everyone, ways to reduce costs, and new ideas like "unhealthy eater" taxes. It is a better list than offered recently by the Administration because it finds health care reform dollars in the health care system where there are a lot of dollars available (although the Administration's approach might be easier to enact). Good for the Senate Finance Committee!

Additional information:

• Senator Baucus and Grassley press release on the options report
• 111th Congressional hearings on health care reform
• my 5/17/09 post on the Administration's tax changes to help fund health care reform

What do you think?

Easy Fix to Help Federal and State Budgets (and Health Care)

I have written about this topic before - policymakers lament trying to find dollars to help get more people health care, yet millions of workers reap overly generous tax benefits when their employer pays all or part of their health care coverage. These generous tax benefits represent dollars from the federal and state budgets that could be used for other purposes. And, the problem is even worse because having so many insured employees not directly involved in how much their health care coverage costs tends to make them get too much health care at times, which drives up costs for everyone.

Here are prior posts:

• Health Care Spending versus Extending 2001/2003 Tax Cuts - Tough Issues
• Tax Reform and Health Care Reform

On 7/31/08, the Senate Finance Committee held a hearing on Health Benefits in the Tax Code: The Right Incentives.

Each of the three witnesses commented on the exclusion for employer-provided health insurance. Joint Committee on Taxation Chief of Staff Edward Kleinbard noted:

"the current system of providing a generous tax subsidy for employer provided health care with no or little subsidy in the case of insurance purchased outside of the employer market distorts taxpayer and market behavior. The existence of the subsidy reduces the price of the consumption of health care, leading to overconsumption of health care relative to other goods and services for those taxpayers with qualifying plans, and very expensive health care for taxpayers in the individual market. Unlike most tax expenditures, the large subsidy associated with employer-provided health care is subject to few statutory limitations."

The exclusion, measured as a tax expenditure, is one of the largest in the income tax system. It is also an exclusion from Social Security and Medicare taxes. Kleinbard's testimony noted the cost of this tax break for 2007 as:

• Income taxes $145.3 billion
• FICA $100.1 billion

That's a lot of money!

Most, if not all states also follow the federal exclusion.

The exclusion is an even better deal than a tax deduction because the employee has not spent anything to get the break (ok - except for foregone wages). For example:

Jamie's employer pays $10,000 for Jamie's health insurance coverage. If the employer did not provide this benefit, the employer would liekly increase Jamie's salary by $10,000. Under our tax system, having the mployer pay for Jamie's insruance is a much better deal than getting $10K more of salaty. The $10K is not taxable to Jamie, although the employer deducts it on their tax return. Also, no FICA or Medicare tax is owed by either party on the $10K. If Jamie's marginal tax rate is 25%, Jamie save $2,500 of taxes. BUT, if Jamie had to include the $10K in income, Jamie would still have a good deal - getting $10K of insurance benefit for $2,500.

The federal government should cut back on this exclusion and better target it so more relief is given to low-income taxpayers. For example, depending on one's income level, an increasing percentage of the health insurance benefit would be included in income.

This would give the federal government funds to help move health care towards universal coverage. It would help states with their revenue problems.

AND - it would bring greater equity to the tax system. Today, it is more likely that higher income workers have health insurance from their employers. When individuals have to buy insurance on their own, there is not tax break.

Also, cutting back on this tax break would mean that employers would have to include the amount of the benefit on the employee's W-2. That would be good because today, most employees probably can't tell you how much the benefit is. This change would also be a good start in moving towards the bigger health care solutions that are needed.

What do you think?