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Taxing Health Benefits Could Cause Unintended Consequences

When President Barack Obama’s aides recently showed new openness toward taxing health care benefits to help cover the uninsured, they suggested an area of possible compromise on health reform. The President had opposed taxing the benefits as a candidate. More recently, the mantra of aides has been that although the tax isn’t Obama’s idea, all proposals on funding health reform are on the table. So far, at least two health reform proposals would tax health benefits — at least at some level — to fund reform, and a group of lawmakers is drafting a separate measure.

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The health care reform situation now
Currently, 46 million Americans — 17 percent of the population — have no health insurance. They generally don’t obtain preventive care, often end up in hospitals and emergency rooms for preventable conditions, and create crippling medical expenses for their families and the hospitals that serve them. The cost of treating uninsured patients drives up the cost of medical care for everyone.

President Obama has repeatedly advocated extending health coverage to the uninsured, both for reasons of compassion and as a way to encourage disease prevention and cut health costs as a result. His proposed 2010 budget would create reserves of more than $643 billion over 10 years to cover the uninsured. Both Democrats and Republicans, however, have balked at the administration’s plan to pay for coverage partly by raising taxes on those who earn more than $250,000 per year. And by some estimates, the $643 billion wouldn’t be enough anyway because the cost of health coverage for the uninsured could reach $1 trillion.

That has prompted a second look at the longtime policy not to tax employee health benefits, a decision that cost the federal government some $246 billion in forgone tax revenues in 2007. About 61 percent of Americans are covered through employer-provided group health insurance, according to an analysis of census data cited by the Kaiser Family Foundation. Employees pay no tax on the value of their health benefits, and employers get to deduct the value of the benefits from their income. Favorable tax treatment has encouraged employers to offer health coverage, but some argue it also has insulated employees from the true cost of health care and led them to obtain unneeded services.

Taxing proposals
As lawmakers try to put together a health care measure, interest in taxing health care benefits has risen, particularly on taxing higher-income workers or those with so-called “Cadillac plans,” or expensive coverage. Those with high-end coverage probably wouldn’t be taxed on the full cost, only for what exceeded a specific amount or cap.

Details are scarce on the work in progress, but two proposals already under discussion would tax at least some employer-paid health care premiums. One is the Healthy Americans Act, sponsored by Senator Ron Wyden (D-Oregon) and 13 others, evenly divided among Democrats and Republicans. Under the Healthy Americans Act, everyone would have to buy health insurance and pay for it through their federal income taxes. People could choose from private health plans, paying extra for coverage beyond the basics.

In November, Senator Max Baucus (D-Montana) aired his proposal, which would cap the tax exclusion for health premiums. He suggested taxing employee health benefits on a sliding scale based on income.

Senator Thomas Carper (D-Delaware) says he will work toward a compromise that blends features of both the Healthy Americans Act and the Baucus proposal. He has supported taxing health benefits costing over a given amount.

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What’s in the cards
The Obama administration clearly sees that a window of opportunity for health care reform exists right now, although it has yet to offer much beyond the proposals in its 2010 budget. Although the tough economic climate and Obama’s own campaign promises would argue against expanding taxable income and raising taxes, the President may succeed in arguing that the benefits of making sure everyone has health coverage outweigh the negatives of added taxes. It also remains to be seen what health reform does to the current employer income tax deduction for health benefits.

If the value of health benefits is taxed, employers obviously will need to change payroll programs that calculate federal tax deductions. How simple or difficult the change would be will depend on Congress. Paul Fronstin of the Employee Benefit Research Institute noted that self-insured employers may find it difficult to calculate the value of their health coverage. It’s also not clear how benefits options such as flexible spending accounts would affect the value calculation.

Elise Gould of the Economic Policy Institute questions whether a health coverage cap will accurately distinguish between a true “Cadillac plan” and insurance that’s costly because it covers a group of older employees, for example. She also questions whether forcing employees to shoulder more of the cost of health care through taxation will nudge them toward wiser health care choices. Cheaper choices may save money in the short run but may cost more in the long run if they result from delaying care or preventive measures.