Regardless of the election outcome, tax policy will be at the forefront of the agenda next year, as key provisions of the 2017 Tax Cuts and Jobs Act expire in December 2025. Congress can consistently accomplish the task of keeping tax rates as low as possible. Reduce the deficit by cutting wasteful tax cuts, including today’s exorbitant and distorted subsidies for job-based health insurance.
It is illegal to completely exclude premiums paid for employer-sponsored insurance (ESI) from income and payroll taxation. Office of Management and Budget (OMB) estimate It will cost the Treasury $0.3 trillion in 2023 and drain an additional $5.6 trillion from government revenue over the next 10 years. This is by far the largest tax cut in federal law.
It is also regressive, distorting both labor and health markets by encouraging overly generous and poorly managed health insurance at the expense of taxable wages and salaries. annual survey of employers said the average premium for ESI family coverage went from $19,600 in 2018 to nearly $24,000 in 2023. Ministry of Finance estimated 88% of the tax benefits from the ESI exclusion go to households with incomes above the median. This tax benefit applies to everyone enrolled in an employer plan, including executives who can afford health insurance without government assistance.
Subsidizing health insurance through tax breaks was not a carefully considered policy. During World War II, employers attracted workers by offering health insurance to supplement regulated war wages. The IRS responded to this development by clarifying that these benefits do not count as taxable compensation for affected workers. This favorable ruling increased the value of ESI and facilitated its rapid adoption. Over time, employers began to believe that offering ESI was necessary to attract talented workers.
Because ESI is the gateway to private insurance for the American middle class, it is politically robust, which is a big advantage of ESI. Without ESI, the US could gravitate towards full public control of its insurance markets, which risks replicating the struggles of the UK National Health Service. New census data ESI enrollment in 2023 is expected to be 54% of the total population, or 178 million people.
The Affordable Care Act (ACA), passed by Congress in 2010, imposed new rules on ESI, but did not end it. The “Cadillac Tax,” a new tax on employers that offer ESI plans at a cost above the annual basis, was a somewhat clumsy effort to limit tax subsidies without acknowledging that’s the purpose. Still, it faced fierce resistance from companies and labor unions, and as a result, Congress repealed this in 2019.
There is no need to maintain the current tax cuts to prevent ESI erosion. Even if subsidies were limited, workers would still receive valuable tax-advantaged coverage that would be more valuable than other coverage in most cases.
A redesigned tax cut should follow a few simple principles.
- First, it must be limited in some way to encourage both employers and workers to purchase cost-effective plans.. Under current law, if the cost of an ESI plan increases, the federal government will cover about one-third of the additional cost. The subsidy redesign would require that government funding be withdrawn if premiums exceed an acceptable range.
- Second, the same level of subsidies should be provided regardless of the worker’s income. Today’s tax cuts favor higher-paid employees because their value increases in tandem with the income tax system’s progressive tax rate structure. For example, excluding the $25,000 ESI premium from taxable compensation would be worth $9,250 to a worker paying a 37 percent income tax rate and $2,500 to a worker paying a 10 percent tax rate. A fixed tax credit per worker would be fairer.
- Third, tax subsidies should be encouraged. Employers need to adopt best practices in insurance plans. In particular, these plans should encourage employees to use higher-cost health care providers by allowing them to share in the savings from more efficient use of services.
A common argument against this tax reform is that employers already have a strong incentive to save, but are blocked by forces beyond their control. Evidence suggests otherwise. Some known ways to reduce costs include: Reference priceemployers are reluctant to get ahead of competitors with controversial benefits changes, so they pass on it.
Congress needs to change the rules so that all employers work to reduce costs to avoid paying premiums with after-tax dollars. Sensible reform could significantly reduce spending in the federal budget and increase cost discipline in health care delivery, while preserving ESI as a valuable fringe benefit.
