Pros and Cons of Ending the Healthcare Tax Break

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The general consensus is that phasing out the tax exemption for employer-sponsored health insurance makes sense, and it’s one move that politicians on both sides of the aisle have endorsed, albeit sometimes in different ways.

Excluding employer-provided healthcare from taxable income is the largest single tax expenditure, accounting for somewhere between $109 and $163 billion in 2011, according to research from Pew’s Tax Expenditures Database.

A new study from the Tax Foundation looks at the impact of ending the exclusion, calculating the effects both with no other changes, as well as with a concurrent cut in individual rates. If the exclusion was eliminated but no other changes made, tax revenues would jump – not surprisingly, as individual incomes would be higher – by about $160 billion.

However, if you account for the fact that more individuals would move into a higher tax bracket (again, due to the bump up in their incomes), providing less incentive to work and invest, overall tax revenue still climbs, but by a smaller amount – about $133 billion.

What if the change were paired with cuts to income tax rates? If each rate was lowered by about 15 percent (so, the 15 percent bracket now is 12.8 percent), overall tax revenues jump by $29 billion, as taxpayers have greater incentive to work. Employment would benefit as well, to the tune of about 826,00 jobs, the Tax Foundation reports.

Clearly, the current treatment of employer-funded healthcare impacts tax revenue and employment levels. It also can encourage excessive use of healthcare services, as workers are somewhat insulated from their true cost. And, employers are forced to become experts in health insurance, or pay somebody else for their expertise in the subject.

However, while ending the exclusion might boost tax revenue, there’s no guarantee that it would significantly bring down healthcare costs. A 2011 study by the Health Policy Center estimates the reduction at about 1.5 percent. The reason? About 50 percent of the population spends very little on healthcare. That means, of course, not much can be cut there.

The same goes for the 10 percent of the population that accounts for about 65 percent of total spending. Their healthcare needs are simply too severe. This leaves just the folks in the middle – the ones who are relatively healthy, but do access medical services. If their costs declined 5 percent, the overall impact would be a 1.5 percent decline in healthcare costs.

While the exclusion generally is considered regressive, benefiting execs and other higher-income earners (who are in higher tax brackets) more than the guys and gals in the plant or manning the store, who likely are in a lower bracket, not everyone agrees with this assessment. “For whom would it be more difficult to obtain coverage if not from their employer — Warren Buffett or his secretary?” asks Jim Klein, president of the American Benefits Council, speaking on NPR. “The benefit is very progressive. It means much more to a lower-paid person than a higher-wage individual.”

Even so, the general consensus is that phasing out the tax exemption for employer-sponsored health insurance makes sense, and it’s one move that politicians on both sides of the aisle have endorsed, albeit sometimes in different ways. The Affordable Care Act takes a small step in that direction by imposing a tax on more expensive plans. This starts in 2018 and applies to most plans whose costs top $10,200 for individuals or $27,500 for families. These plans will be subject to a 40 percent excise tax on costs above these levels.

Discuss this Blog Entry 3

Harry Moser (not verified)
on Aug 14, 2013

I suspect the tax savings would be even higher if the value of retiree health benefits were taxed in the higher income years when they were earned.

Edward (not verified)
on Aug 14, 2013

Anotther tax increase! No working person can bear any more taxes! Only a jackass or someone totally disconnected with working people would favor another tax increase. Here is an idea - spend within your means - no new taxes - ever!

Richard T. Ramsey (not verified)
on Aug 14, 2013

So you just made a great case for repealing the "Affordable" Care Act for now and replacing it with something truly affordable by the minority of American citizens who are working and paying all the taxes. How about a plan (bill) that Congress and the Public can read and understand before it is pased into law.

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Karen Kroll supplies the Business Finance community with reporting and commentary examining cash management and treasury-related topics.

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