With tax reform, Congress missed an opportunity to fix original sin of US health care

With the passage of the Tax Cut and Jobs Act in late 2017, Republicans implemented far-reaching tax cuts that will allow tens of millions of families to keep more of their own money and made a number of long overdue changes to the nation’s tax code.

For instance, they scaled back deductions for state and local taxes, mortgage interest, and a slew of other special interests. However, Republicans missed a major opportunity to roll back America’s largest and arguably most harmful tax deduction: the tax exclusion for employer-sponsored insurance.

{mosads}The tax exclusion allows companies and workers to exempt employer-provided health insurance benefits from personal and payroll taxes. Starting in 1943, employers began offering health insurance to attract job applicants after the Franklin Roosevelt administration imposed a wage freeze. These benefits became so popular that large employers successfully lobbied Congress to exempt employer-based insurance from taxation in 1954.

During the past 60 years, tax exclusion has encouraged companies to compensate 155 million U.S. households through health insurance, instead of higher salaries. This has helped to stagnate wage growth, especially among lower- and middle-income Americans, as the rising cost of health insurance has eaten away at earnings.  

After observing five years of national wage and insurance data, a 2005 report issued by Harvard University revealed every 10 percent increase in health premiums generates a 2.3 percent decline in wages because “[workers] bear the full cost of the premium increase.”

Similarly, a recent analysis of Illinois school districts found teachers lose 17 cents in salary for every dollar increase in health care premiums.

The tax exclusion also harms workers by driving up the cost of health care. Because employers typically cover 82 percent of the cost their employees’ premiums, workers have an enormous incentive to pick plans with low out-of-pocket expenses, driving them to overspend on unnecessary tests and excessive procedures.  

According to the Congressional Budget Office, the employer exclusion increases health insurance premiums by 15 percent because “the open-ended nature of the subsidy gives employers and employees an incentive to select more extensive coverage than they otherwise would.”

Although Congress missed an opportunity to fix the employer exclusion when it passed the Tax Cuts and Jobs Act, it can still repeal or roll back this deduction in the near future, thereby achieving aims Democrats and Republicans agree on.

The employer health insurance exclusion costs the federal government roughly $260 billion in lost tax revenue every year. According to the nonpartisan Tax Foundation, the federal government could eliminate the exclusion and slash tax rates across the board for everyone by 14.6 percent without adding a penny to the national debt. This would increase economic annual activity by $125 billion and create 826,000 new full-time jobs.

Another promising reform would replace the employer exclusion with a personal tax credit that goes directly to individuals. This would allow employees who are unsatisfied with their options to shop on the individual market for a plan that fits their unique medical needs, rather than be subject to the financial goals of their employer.

Critics warn ending the exclusion would cause companies to toss millions of workers into the ranks of the uninsured. The American Benefits Council, which lobbies on behalf of the nation’s largest health plans, claims rolling back the exclusion “directly threatens [employer-sponsored] coverage.”

Despite these dire warnings, it’s far more likely companies will continue to offer quality health insurance plans, but those plans will be leaner and more cost-effective. Without the tax exclusion artificially distorting benefit designs, companies would introduce incentives for workers to visit less expensive providers, practice healthy lifestyles, and control costs. Stanford and Columbia University economists estimate repealing the deduction would reduce wasteful health spending by as much as 33 percent.

In the past, powerful interest groups have defeated every attempt to squash the employer exclusion. Presidents Ronald Reagan, George H.W. Bush, and George W. Bush supported reforming or repealing the deduction in some form, but large insurers, unions, and corporations ensured these vital proposals went nowhere in Congress.

It’s up to our elected representatives, especially those congressional leaders who have said repeatedly they are serious about making health care more affordable and patient-centered, to end the tax code’s preference for employer-based insurance — a move that would boost the economy, create a fairer tax code, and provide better options for millions of consumers.

Charlie Katebi is a state government relations manager at The Heartland Institute.