The latest entry in the U.S. Senate's "Find the Health Care
Compromise" contest comes from Senator John Kerry (D-MA).
Kerry has suggested including in health legislation a new excise
tax on "gold-plated" or "Cadillac" health insurance policies. He
offered this idea as an alternativeto proposals that would cap the
longstanding tax exclusion for employer-provided health insurance.
But it is not the right way to go.
The Need for Tax Reform
Before considering Senator Kerry's proposed substitute, it is
important to note that capping the tax exclusion itself has merit
only if it is a revenue-neutral reform of health care tax
policy--not as a way of increasing taxes to pay for new or expanded
health spending programs.
That said, the basic idea of setting a limit on how much income
workers can get tax-free in the form of health insurance benefits
does have bipartisan support. But it has also drawn opposition from
unions who have negotiated generous tax-free health insurance
coverage for their members.
Proponents of setting a cap on the tax exclusion point out that
Congress has set limits on almost all other tax-free fringe
benefits. For example, under current tax law, only the premiums on
the first $50,000 of a worker's group term life insurance policy
are tax-free. Similarly, no more than $5,000 per year per
family can be set aside on a pre-tax basis to pay for daycare for a
worker's dependents. There are also limits on tax-free
contributions to 401(k) plans.
Of course, employers can always provide additional life
insurance coverage or dependent daycare for their workers. It is
just that tax law requires that the value of any such extra
employer spending be treated as taxable income to the workers
receiving those fringe benefits--the same as if it had been paid to
them as cash wages.
Setting a limit, or a cap, in the income tax code on tax-free
employer-provided health benefits would work the same way. An
employer could still provide its workers with a plan that costs
more than the cap, but the extra spending would be appear on the
employees' W-2 forms as taxable income.
Of course, once those employees realize that they are going to
be taxed on the money anyway, they might decide that they would
rather spend it on something other than extra health insurance.
That is why the idea of capping the tax exclusion has long appealed
to serious health care reformers across the political spectrum as a
way of boosting cash compensation as well as increasing consumer
cost consciousness when it comes to the value of health benefits
and the medical care that they buy.
The Kerry Proposal
Senator Kerry's proposal of an excise tax is not the same as
reforming the tax exclusion. Faced with union opposition to capping
the tax exclusion Senator Kerry suggests that Congress instead
impose a new excise tax on health insurance policies that exceed a
As with other "compromise" ideas now floating around Congress,
the specifics behind the sound bite have yet to be spelled out.
However, beyond setting the dollar amount for coverage above which
the excise tax would apply, another issue matters: Will the
tax be applied only to insurance policies sold by commercial
insurers, or will it also apply to self-insured plans?
This question matters because the more expensive health
insurance plans are not likely to be purchased from commercial
insurers either as individual policies or as group policies for
workers in small businesses. Rather, they are likely to be plans
covering executives in large companies or unionized workers in the
private and public (state and local government) sectors--the same
people who tend to also have the most generous pension plans, for
much the same reasons.
Currently, about 45 percent of workers with employer-sponsored
health insurance are in "fully insured" plans--that is, plans
purchased by employers from commercial health insurers. The other
55 percent get their coverage through self-insured plans designed
and managed by a single employer, a group of employers, or a union
where the plan is funded through contributions from employers whose
workers belong to the union.
However, the distribution of the two plan types is highly skewed
based on firm size. In 2008, 88 percent of workers in firms with
three to 199 employees were in fully insured plans, while 89
percent of workers employed in firms with 5,000 or more employees
were in self-insured plans.
Targeting Employer and Union Plans
Thus, the more expensive health plans are likely to be
self-insured plans. While it is true that self-insured plans often
contract with commercial health insurers for administrative tasks,
in most cases the insurer just gets paid an agreed-upon, per-unit
fee for the services it provides. Deciding the benefit package--and
thus what the plan will cost--is entirely up to the employer.
Consequently, an excise tax on "gold-plated" or "Cadillac"
health insurance plans that is imposed only on fully insured plans
would likely have very little effect. Commercial insurers probably
sell few policies today that would become subject to the tax, and
they would likely cease offering any such policies as soon as the
tax takes effect--on the reasonable presumption that what little
customer demand currently exists would disappear.
Furthermore, applying the excise tax to the "administrative
services only" (ASO) business of commercial insurers would also
have little effect. To avoid the tax, commercial insurers would
simply refuse to enter into ASO contracts with self-insured plans
whose benefit costs were above the tax threshold. At the same time,
the employer or union sponsors of those self-insured plans could
also avoid the tax--without changing the benefits or costs of their
plans--simply by moving the claims processing and other
administrative functions in-house.
Thus, in order for an excise tax on "gold-plated" or "Cadillac"
health insurance plans to have more than a negligible effect,
Congress would actually have to apply the tax directly to
the employers and unions that sponsor self-insured plans whose
benefit costs exceed the tax threshold.
The economic effects of doing so would largely be the same as
those from capping the tax exclusion for employer-sponsored health
insurance benefits. The political effects would largely be the same
as well, as those who object to capping the tax exclusion--unions
and large employers--would have the same beef with an excise
The Wrong Route
Senator Kerry's "compromise" proposal is a political device to
hide a tax on workers of all incomes rather than to reform the tax
treatment of health care. Applying an excise tax to all
"gold-plated" or "Cadillac" health insurance plans, both fully
insured and self-insured, would not have the same effects as
capping the tax exclusion and providing tax relief in a
revenue-neutral way to Americans who cannot afford coverage.
is Senior Research Fellow in the
Center for Health Policy Studies at The Heritage Foundation.
U.S. Code § 129(a)(2)A.