Don’t repeal the ‘Cadillac tax’ — modify it

Over the past year, I gave several public presentations on the economics of the Affordable Care Act (ACA). During each presentation, I saved a few minutes to explain the “Cadillac tax.” The tax is 40 percent of the cost of employer-provided health coverage that exceeds $10,200 for individual coverage and $27,500 for family coverage. The tax, which will be levied on employers, begins in 2018. I then asked for a show of hands to see who was in favor of the tax and who opposed it.

{mosads}Regardless of whether I was addressing clinicians or the general public, the overwhelming majority of listeners were opposed to the Cadillac tax. Recent data indicate that the sentiment I saw in Houston audiences is similar across the country. Yet most economists, regardless of their political persuasion, are strongly in favor of the Cadillac tax. Why the disconnect? I can understand the anxiety the public has about the Cadillac tax. Without many details, most people with employer-sponsored insurance (ESI) would be worried about facing higher taxes.

However, most people with ESI would not be subject to the tax. It’s been estimated that one in four plans will trigger the Cadillac tax in 2018. In addition, it is likely that the Cadillac tax will make all workers better off in the long run. Just as bailing a drug abuser out of jail enables continued drug addiction, Cadillac health plans often function as an enabler for excessive healthcare spending. When patients face low deductibles and copayments, with a wide provider network, the sky is the limit in terms of healthcare spending. There is no incentive to question the cost of a diagnostic test your doctor orders, or to consult your insurer’s website to find a lower-cost, high-quality specialist for a complicated procedure. Why bother? It’s all covered by insurance.

This price insensitivity raises costs for everyone covered by a firm’s insurance policy. Every excessively priced or unnecessary medical claim feeds into the calculations of the insurance premium for the next year. Encouraging employees to be more cost-conscious will lower demand for services in health care markets, reducing the equilibrium price of services for everyone. That is, healthcare providers will realize that they can’t always rely on high-dollar customers to boost their bottom line. Market discipline will force doctors and hospitals to charge more reasonable prices for services, and inefficient providers will be pushed out of the market.

Do we really need to worry about healthcare providers charging higher prices? Only recently has the public become concerned about escalating prescription drug prices, as a few flagrant examples have attracted media attention. But keep in mind that the inflation rate for prescription drugs between 2000 and 2012 was 54 percent, while the inflation rates for hospital care and physician services over this time period were 119 percent and 42 percent, respectively. That’s why health insurance premiums for employer-sponsored family coverage rose 69 percent between 2004 and 2014.

An added benefit of the Cadillac tax is that as the generosity of health insurance declines, workers will experience an increase in take-home pay. Labor markets reach an equilibrium based on the full compensation package for workers, including both wages and benefits. In competitive labor markets where labor supply is not infinitely elastic (for example, one can’t hire an unlimited number of workers at the current wage), employers who reduce the generosity of health insurance in response to the Cadillac tax will have to raise wages to maintain their current workforce.

The Cadillac tax could harm smaller employers whose workforce has a high share of older workers, or an unusually high share of workers with high-cost chronic diseases. Large employers don’t face this problem because their workforces are less likely to have high shares of high-health-cost workers. The challenge of finding coverage for subgroups of high-cost workers has been reduced by other provisions of the ACA, but that would take an additional Contributors piece to explain clearly. One can modify the Cadillac tax to address this problem. The tax could be limited to firms with more than 50, or 100 workers. The appropriate cutoff could be determined by comparing the variability in healthcare costs and worker health status by firm size. The law could also be modified so that the tax is applied only at higher dollar values for firms with an unusually high share of unhealthy workers. Medicare risk-adjusts payments to Medicare managed-care organizations according to the risk profile of their customers, and the same methodology could be applied for the Cadillac tax.

The Affordable Care Act is a complex piece of legislation, with several moving pieces working in tandem to increase access to healthcare in the U.S. while controlling cost growth. The Cadillac is just one piece of the puzzle, discouraging excessive spending by firms on health insurance benefits that ultimately raises costs for everyone. Let’s turn off the money spigot that allows health care providers to continually raise prices at rates faster than the general rate of inflation. In the long run, it may enable us all to receive Cadillac-level healthcare, without the brand-name price tag.

Ho holds the Baker Institute Chair in Health Economics at Rice University’s Baker Institute for Public Policy. She is also a professor of medicine at Baylor College of Medicine.